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How Does Goldman Sachs Operate?
By Larry Doyle on July 7, 2009 | More Posts By Larry Doyle | Author's Website
Goldman Sachs (GS) is widely regarded as the top Wall Street bank. What makes Goldman so special? Is everything on the up and up? Is it one massive conspiracy? At the request of a number of readers, allow me to share my perspectives on Goldman Sachs, in general, and my thoughts on Matt Taibbi’s article in Rolling Stone magazine, “The Great American Bubble Machine.”
Goldman Sachs has always had a tremendous investment banking franchise along with outstanding risk management capabilities within its trading operation. That said, in the ’80s and ’90s Goldman was certainly one of the best shops on the street but it had plenty of company. In my opinion, Goldman separated itself from the Wall Street crowd after the repeal of Glass-Stegall which had previously separated commercial and investment banking operations.
With the repeal of Glass-Stegall, most investment banks looked to grow origination capabilities in order to compete with the large commercial banks. At the same time, most commercial banks looked to grow their investment banking and trading operations.
Goldman stood out by taking an entirely different tact. Goldman decided to utilize its capital and balance sheet less so for origination capabilities and much more for principal trading (that is, making bets and taking positions with its own capital). Effectively, Goldman decided to operate much more like a large multi-strategy hedge fund. Goldman took enormous risks both in their proprietary books but also in their trading activity with customers. Goldman made a concerted decision to dominate the markets in which they chose to play.
While Mr. Taibbi paints Goldman as one large conspiratorial machine, I beg to differ. In fact, the reason why I initially only skimmed the Rolling Stone article is because it oversimplifies the Goldman business model and paints the entire firm and all its employees with a broad brush.
In all of the examples Taibbi references, the indictment of Goldman’s actions could be effectively placed upon all of Wall Street. No surprise that Goldman was heavily involved in the meltdown of the Nasdaq at the turn of the century. As one of the largest equity underwriters in the business, it goes with the territory. That said, the two highest profile equity analysts implicated with pumping internet stocks were Henry Blodget of Merrill Lynch and Jack Grubman of Citigroup.
On the housing front, Goldman was hardly a major player on the origination side of the business. Lehman, Bear, Greenwich Capital, UBS, and Citigroup were larger players on the underwriting and distribution of mortgage-backed bonds. Goldman distributed bonds just like every other bank, but they were sharp enough to short the market near the top. Does that define a conspiracy? No way. That was a good trade.
Despite the fact that I am largely defending Goldman to this point, one needs to appreciate the fundamental nature of Goldman’s business model. If a firm is going to take large principal risk positions both within proprietary books and customer books (trading accounts used to trade with clients), two factors are of overwelming importance: information and relationships.
Goldman worked both of these angles very, very hard. Goldman developed extremely close relationships with the largest customers in the market and the largest power brokers in Washington and around the globe.
Given the quality and depth of their franchise, they became the envy of Wall Street. Did they abuse these relationships and information to the point where they were willing to break the law? I strongly doubt that. Were there instances when a senior Goldman executive shared information with a risk manager in confidence? Most likely. That would not be an uncommon occurrence on Wall Street.
Many of Goldman’s relationships are with very active trading hedge funds. These funds know one goal-making money. Are rules violated? I’m sure they have been. To that end, the hedge fund industry needs to be regulated aggressively. Is this a blanket indictment of Goldman Sachs? No.
On Wall Street, ‘Chinese walls’ are utilized to make sure that information is properly channeled. Has Goldman ever improperly ‘gone over the wall?’ I’m sure they have. As has every other Wall Street firm. Is it common practice? No way.
In regard to AIG (AIG) being a conduit for the funneling of funds to Goldman Sachs and every other bank. I believe Lloyd Blankfein when he says that Goldman held collateral from AIG and that if AIG did not make Goldman whole on its own that Goldman would have merely seized the collateral. That is standard practice.
Taibbi’s article, in my opinion, makes for good barroom banter on a long holiday weekend. While he marginally touches on the edge of Goldman’s business model, overall his writing is more sensationalism than credible business journalism.
I am not totally vindicating Goldman Sachs. Nor am I totally indicting them. I would make the same assessment of every shop on Wall Street. It just so happens that Goldman plays the game just a little bit better than most.
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In the spirit of good bar room jousting I offer the following comments.
You should read his article again.
If you know of better business reporting, tell us.
If you can write better business reporting do it.
The argument that all the biggies do what GS does but just not as well is not worth making, never mind repeating and signing your name to.
John,
I have over 500 posts at my site Sense on Cents. I encourage you to visit and critique liberally.
Rest assured, I’ll never have a problem signing my name to anything I write. Additionally, I competed against GS for over 23 years so I am speaking and writing from experience.
LD
Hi Larry,
You competed with them doing what? Were you competing for the massive transaction ‘clips’ (fees) or competing in the ‘trading game’ with someone else’s money?
What actual value do Goldman’s and others in ‘their game’ add to the economy?
They do not make anything. ‘Trading’, which seems to be a lot of what they do, is speculating on asset prices … isn’t that how we got here?
If that is ‘what they do’ then we are absolutely doomed would be my read.
Why the US government saved any of them remains a mystery to me.
Cheers.
Andrew
Andrew,
Trading can be speculating but not necessarily. I was a mortgage trader for 15 years and transacted business with mortgage originators, insurance companies, pension funds, money managers, investment advisers, bank portfolios, et al.
While many believe that ‘trading” does not make anything, they’d be wrong. The traders provide the capital and liquidity which allows individuals and companies to operate.
The markets I was involved in were highly competitive. The firms at which I traded in the 80s and 90s competed against Goldman (and every other shop) for business.
If these shops and markets do not operate, where do you think the companies and individuals will get the liquidity and capital to operate?
Hope this helps.
Why was there a bullish upgrade of Goldman Sachs Group Inc yesterday?
John,
With Merrill, Bear, Lehman all long gone, and Citi severely derailed, Goldman’s competition has largely been cut in half. There is still a lot of business getting done so as a result GS has the ability to mint money.
Additionally, GS is not burdened by a lot of the consumer assets that are defaulting at an ever increasing rate. Nor is GS weighed down by heavy exposure to a lot of the toxic assets that the commercial banks (Citi and BofA primarily) have.
While people may want to vilify GS, the fact is they are good risk managers.
I am not pretending that GS is a bunch of choir boys but they do know how to manage risk and make money.
To that end, their stock was upgraded by a high profile analyst, Meredith Whitney.