Commentary: From white shoes to the 'Fabulous Fab' tap dance
NEW YORK (MarketWatch) -- More than anything else, the Securities and Exchange Commission's fraud case against Goldman Sachs Group Inc. has illustrated the fall of the firm from Wall Street's preeminent bank to riverboat casino.
The case is the final indictment in long decline for the brokerage. Some of the wounds have been self-inflicted, others by outside forces. The upshot is that during the last decade, Goldman /quotes/comstock/13*!gs/quotes/nls/gs (GS 153.04, +1.01, +0.66%) has transformed from a client-oriented firm to a bona fide hedge fund. For a while, it was one of the best. But now, as the SEC case shows, it's as sloppy and imperfect as any on Wall Street.
To understand how far the mighty have fallen, one needs to understand the awe and envy Goldman once elicited. Goldman wasn't just one of the most profitable firms, it was the No. 1 choice destination for graduates of Harvard Business School and Wharton. It was the first advisory choice for chief executives looking to do deals.
As Jonathan Knee, an investment banker now at Evercore Partners Inc. /quotes/comstock/13*!evr/quotes/nls/evr (EVR 36.36, -0.18, -0.49%) , put it in his book, "The Accidental Investment Banker," the admiration built into the Goldman brand helped him win the confidence of Fortune 500 CEOs despite his early inexperience.
Knee wrote that working for Goldman carried weight when he proposed sometimes unorthodox ideas that might have been dismissed had they come from other bankers. Instead, Knee wrote, CEOs would say, "'Well, he's from Goldman, so there must be something here.'"
He added "At least as important as the money, being at Goldman bestowed a kind of credibility that no other institution could match."
Knee said he left when he felt Goldman began moving away from its roots and other banks became more competitive by using their balance sheets to finance deals. But there was more to the change. Goldman's trading desk grew exponentially during the last decade and changed the culture of the bank.
Scale for risk, returns
More so than other investment banks, Goldman's financial reports are opaque black boxes. It's hard to determine just how much profit the trading desk was making, but you can get an idea of the scope. Between 1998 and 2008, Goldman more than doubled in size. Its roll of employees rose to 30,522, up from 15,361. Its principal investments grew to $13.96 billion, up from $1.4 billion and its leverage ratio rose to 26.2-to-1, up from 24.7-to-1. In other words, Goldman morphed into an uberbank, and its size and the risk the firm took on grew with it.
The problem with fast growth -- for any company not just Goldman -- is that it's hard to manage. Goldman was a staid partnership until it went public in 1999. After that, Goldman was in the wide open competition for investor dollars with Merrill Lynch & Co., Morgan Stanley /quotes/comstock/13*!ms/quotes/nls/ms (MS 29.93, -1.01, -3.26%) and J.P. Morgan Chase & Co. /quotes/comstock/13*!jpm/quotes/nls/jpm (JPM 42.41, -1.48, -3.37%) . It needed to drive earnings to match those banks. So when the lucrative initial public offering business and mergers and acquisitions dried up after the tech bust, Goldman turned to trading. It was the last place to make money in a stalled market.
The biggest example of this shift was the rise of Lloyd Blankfein to chief executive in 2006. Blankfein came up on the trading side of the firm. Trading has flourished under Blankfein and it was under his guidance that Goldman began to bet against the mortgage market in 2007 even as it was still churning out mortgage-backed securities.
It's no coincidence that Fabrice Tourre, the Goldman employee at the center of the SEC case, was hired in 2001 when Goldman was beefing up its trading arm. Like many hired during the era, Tourre's background differed from the traditional MBA-armed graduates hired by the firm. Tourre had a mathematics degree from Ecole Centrale, one of Paris' top universities.
Math whizzes such as Tourre were Wall Street's most sought-after people during the decade. Again, young employees good with numbers were placed on trading desks to help create or at least make sense of the increasingly complex derivatives dominating trading.
And what was the result? The "Fabulous Fab" crowing in an email about the derivatives "he created without necessarily understanding all of the implication of those monstuosities (sic)!!!"
'Monstrosities'
By now you get a sense of how the firm changed. Top bankers became disillusioned. Trading became the chief source of revenue. There were too many new faces. It was a new business even the smart guys didn't fully understand. For all of the firms chasing Goldman, it was Goldman that, in the end, had to chase, or at least stay a step ahead of other firms.
Goldman was successful, but that success came at a cost. The identity of the firm was lost. A bank that was once the gold standard of American finance succumbed to the temptations of quick, easy money.
The broker, in the end, became a bank with too many "Fabulous Fabs" and "monstrosities" when what it needed was to be Goldman Sachs.
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