Too Big to Fail

by Andrew Ross Sorkin

  Every year the board of Goldman took a four-day working trip abroad, and since being handed the reins of the firm from Hank Paulson two years earlier, Blankfein had insisted that they meet in one of the new emerging economic giants, one of the BRIC nations: Brazil, Russia, India, or China. It seemed only appropriate: It had been one of Goldman’s economists who had coined the appellation for those four economies, to which the world’s wealth and power were now shifting. To Blankfein it was a matter of walking the talk.

  St. Petersburg was only the first part of the trip, where’d they’d be given an update on the firm’s finances and have a strategy-review session; it would be followed by two days in Moscow. Goldman’s chief of staff, John F. W. Rogers, had used his pull to set up the board meeting with Russia’s tough prime minister, Vladimir Putin, whose anticapitalist ideology made it clear that he would be no patsy to the United States.

  As Blankfein ambled back to the Hotel Astoria, past the massive equestrian monument to Nicholas I, he pondered his fears: What if oil prices were to slide, say, to $70 a barrel? What then? And what about Goldman itself? Despite his proven success, Blankfein admitted to being “paranoid,” as he often described himself.

  Being in Russia did bring back some anxious memories. It was here in 1998 that things went very wrong for Goldman when the Kremlin caught the world unawares by suddenly defaulting on the nation’s debt, sending markets around the world into a tailspin. They called it a contagion: Soon afterward, Long-Term Capital Management was struck.

  The chain of events caused Wall Street firms to rack up enormous trading losses, and the damage at Goldman was eventually so severe that it had to push back its plans to go public.

  As the current market troubles unfolded, Goldman was being mercifully spared the kinds of hits that Lehman, Merrill, Citi, and even Morgan Stanley were taking. His team was smart, but Blankfein knew that luck had played a big role in their accomplishments. “I really think we are a little better,” he had said, “but I think it’s only a little better.”

  Certainly, Goldman had its share of toxic assets, it was highly leveraged, and it faced the same funding shortfalls caused by the seized-up markets as did its rivals. To its credit, though, it had steered clear of the most noxious of those assets—the securities built entirely on the creaky foundation of subprime mortgages.

  Michael Swenson and Josh Birnbaum, two Goldman mortgage traders—along with the firm’s chief financial officer, David Viniar—had been instrumental in making the opposite wager: They had bet against something called the ABX Index, which was essentially a basket of derivatives tied to subprime securities. Had they not done so, things could have turned out differently for Goldman, and for Blankfein.

  Blankfein couldn’t help but notice all the Mercedes clogging the streets as he walked back to his hotel room. And that was only the most visible conspicuous consumption taking place. Flush from their profits not only from gas and oil but from iron, nickel, and a host of other increasingly valuable commodities, Russia’s so-called oligarchs were buying up supersized yachts, Picassos, and English soccer teams. Ten years ago, Russia could not pay its debts; today it was a fast-growing, $1.3 trillion economy.

  Goldman’s own complicated history with Russia dated back much earlier than its stunning default. Franklin Delano Roosevelt once offered to make Sidney Weinberg, Goldman’s legendary leader, ambassador to the Soviet Union. “I don’t speak Russian,” Weinberg replied in turning down the president down. “Who the hell could I talk to over there?”

  After the collapse of the Soviet Union, Goldman was among the first Western banks to try to crack its market, and three years after the fall of the Berlin Wall, Boris Yeltsin’s new government named the firm its banking adviser.

  Profits proved to be elusive, however, and Goldman pulled out of the country in 1994 but would eventually return. By 1998 it helped the Russian government sell $1.25 billion in bonds; when, two months later, after the default, the bonds proved to be virtually worthless, the firm again withdrew. Now it was back for a third try, and Blankfein was determined to get it right this time.

  The next morning, at 8:00, the Goldman board began its session in a conference room on the ground floor of the Hotel Astoria, which had been in operation since 1912 and was named after John Jacob Astor IV. Legend had it that Adolf Hitler had planned to hold his victory celebration there the moment he forced the city to surrender, and was so confident in his triumph that he had had invitations printed in advance.

  Blankfein, dressed in a blazer and khakis, gave the board an overview of the company’s performance. As board meetings go, it had been unexceptional.

  But it was the following session that was perhaps the critical one. The speaker was Tim O’Neill, a longtime Goldmanite, who was virtually unknown outside the firm. But as the firm’s senior strategy officer, he was a major player within the firm. His predecessors included Peter Kraus and Eric Mindich, both of whom were considered Goldman superstars, and O’Neill definitely had Blankfein’s ear.

  Board members had received a briefing book three weeks earlier and understood why this session was so vital: In it O’Neill would outline survival plans for the firm. He was effectively serving as the office’s fire marshal. Nothing was burning, but it was his responsibility to identify all the emergency exits.

  The issue facing them was this: Unlike a traditional commercial bank, Goldman didn’t have its own deposits, which by definition were more stable. Instead, like all broker-dealers, it relied at least in part on the short-term repo market—repurchase agreements that enabled firms to use financial securities as collateral to borrow funds. While Goldman tended to have longer term debt agreements—avoiding being reliant on overnight funding like that of Lehman, for example—it still was susceptible to the vagaries of the market.

  That arrangement was something of a double-edged sword. It could bet its own money utilizing enormous amounts of leverage—putting up $1, for example, and using $30 of debt, a practice common in the industry. Bank holding companies like JP Morgan Chase, which were regulated by the Federal Reserve, faced far more restrictions when it came to debt-fueled bets on the market. The downside was that if confidence in the firm waned, that money would quickly evaporate.

  Blankfein sat nodding in approval as O’Neill made his case. What had happened to Bear, he explained, was not just a one-off event. The independent broker-dealer was considered a dinosaur well before the current crisis had begun. Blankfein himself had watched Salomon Smith Barney be absorbed by Citigroup, and even Morgan Stanley merge with Dean Witter. Now, with Bear gone and Lehman seemingly headed in that direction, Blankfein had good reason to be worried.

  Blankfein’s own rise to the top at Goldman underscored for him just how fast things could change: A decade earlier he had been the short, fat, bearded guy who wore tube socks to the firm’s golf outings. Today he was the head of the smartest and most profitable firm on Wall Street.

  In one sense the arc of his career was classic Goldman Sachs. Like the firm’s founders and its longtime leader Sidney Weinberg, Blankfein was the son of working-class Jewish parents. Born in the Bronx, he grew up in Linden Houses, a project in East New York, one of the poorest neighborhoods in Brooklyn. In public housing you could hear neighbors’ conversations through the walls and smell what they were making for dinner. His father was a postal clerk, sorting mail; his mother was a receptionist.

  As a teenager Blankfein sold soda during New York Yankee games. He graduated as valedictorian of his class at Thomas Jefferson High School in 1971, and at the age of sixteen, with the help of scholarships and financial aid, he attended Harvard, the first member of his family to go to college. His perseverance revealed itself in other ways. Because he was then dating a Wellesley student from Kansas City, he took a summer job at Hallmark to be near her. The relationship, however, did not last.

  After college came Harvard Law School, and after graduating in 1978, he joined the law firm of Donovan, Leisure, Newton & Irvine. For severa
l years he practically lived on an airplane flying between New York and Los Angeles. On the rare weekends he found time to relax, he would drive out to Las Vegas with a colleague to play blackjack. They once left their boss a memo: “If we don’t show up Monday it’s because we’ve hit the jackpot.”

  By now Blankfein had started on the track toward becoming a partner at the firm, but in 1981 he had what he termed a “prelife crisis.” He decided that he wasn’t meant to be a corporate tax lawyer and applied for jobs at Goldman, Morgan Stanley, and Dean Witter. He was rejected by all three firms but a few months later got his foot in the door at Goldman.

  A headhunter sought him out for a job at J. Aron & Company, a little-known commodities trading firm that was looking for law school graduates who could solve complex problems and then explain to clients precisely what they had done. When he told his fiancée, Laura, who was also a corporate lawyer, with the New York firm of Phillips, Nizer, Benjamin, Krim & Ballon, that he was taking a job as a salesman of gold coins and bars, she cried.

  Several months later, Blankfein became a Goldman employee when the firm acquired J. Aron in late October 1981.

  After the oil shocks and inflation spikes of the 1970s, Goldman was determined to expand into commodities trading. J. Aron gave the firm a powerful gold and metals trading business and an international presence, with a significant London operation. But while Goldman was disciplined and subdued, J. Aron was wild and loud. When Goldman ultimately moved the trading operations of J. Aron into 85 Broad Street, its immaculately groomed executives were stunned to see traders with their ties wrenched loose and their sleeves rolled up, who shouted out prices and insults alike. When angered, they pounded their desks with their fists and threw their phones. This was not the Goldman way. And while Goldman prided itself on its culture and its calculated hierarchy, J. Aron had no use for formalities. After joining, when Blankfein asked what his own title was, he was told: “You can call yourself contessa, if you want.”

  Goldman’s Mark Winkelman was given the task of taming this unruly crowd. The Dutch Winkelman was one of Goldman’s first foreign partners, known for his analytical brilliance; he was one of the first executives on Wall Street to recognize the importance of technology for trading, as computers became smaller and more powerful. Winkelman first noticed Blankfein when he saw the short salesman wrestle the phone away from a trader who was trying to yell at a client who had cost him money.

  He shielded his protégé from a wave of job cuts at J. Aron that came the following year, the first widespread layoffs at Goldman. Blankfein was fortunate in other respects as well. Goldman had decided to make a major push into trading bonds, commodities, and currencies, and to take on larger risks. The firm had been a pioneer in commercial paper and a leader in municipal finance, but remained an also-ran in fixed income, compared with Salomon Brothers and others. Winkelman and Jon Corzine overhauled that part of the business and recruited talent from Salomon.

  Impressed by Blankfein’s well-honed diplomacy and his obvious intelligence, Winkelman placed him in charge of six salesmen in currency trading and, later, the entire unit.

  Robert Rubin, who then ran fixed income with Stephen Friedman, was opposed to the move.

  “We’ve never seen it work to put salespeople in charge of trading in other areas of the firm,” Rubin told Winkelman. “Are you pretty sure of your analysis?”

  “Really appreciate your experience, Bob, but I think he’ll do all right,” Winkelman responded. “Lloyd’s driven, and he is a very smart guy with a very inquiring mind, so I have some confidence.”

  The young lawyer soon demonstrated his trading prowess by structuring a trade that allowed a Muslim client to obey the Koran’s prescriptions against interest payments. At the time, the complex $100 million deal, which involved hedging Standard & Poor’s 500 contracts, was the biggest Goldman had ever done.

  Blankfein was also a serious reader, taking stacks of history books with him when he went on vacation. Never flashy or self-promoting, he was an almost ideal embodiment of the culture at Goldman, where no one ever said, “I did this trade,” but rather, “We did this trade.”

  Winkelman was crushed when he was passed over for Corzine and Hank Paulson in the top jobs at Goldman in 1994. Blankfein, who was made partner in 1988, was one of four executives named to take over Winkelman’s responsibilities. Winkelman left the firm.

  By 1998, as co-head of fixed income, currency, and commodities, Blankfein was running one of the most profitable businesses at the firm, but he was not seen as an obvious candidate for the top job.

  Eventually, Paulson was won over by Blankfein’s raw intellect and made him his co-president, prompting John Thain to leave the firm. For his part, Blankfein shaved his beard, lost fifty pounds, and quit smoking. When Paulson was nominated as Treasury secretary in May 2006, he announced that he had selected Blankfein as his replacement.

  For as long as Blankfein could remember, Goldman had been thinking that it might need a partner. In 1999, during Paulson’s stewardship, he had held secret merger talks with JP Morgan, soon after the firm had gone public. Those discussions ended abruptly when Paulson came home to his apartment one day and had an epiphany: “Legally, we would be buying Morgan, but JP Morgan was so much bigger than Goldman Sachs that in reality they would be taking us over, and they would bury us,” he later recalled. “I also knew that somehow we’d figure out how to do everything they could do.”

  During the Clinton administration’s first term, Congress was working on the legislation that would repeal the Glass-Steagall Act of 1933, tearing down the walls dividing banks, brokers, and other financial businesses. At the time, lobbyists for Goldman actually persuaded the committee writing the bill—which became the Gramm-Leach-Bliley Act of 1999—to include a minor amendment they had sought in the event that they ever wanted to become a bank holding company. That provision allowed any bank that owned a physical power plant to continue to own it as a bank holding company. Of course, Goldman was the only bank that owned a power business.

  Blankfein reflected on this history as O’Neill finished his presentation with a series of questions: Do we need to become a commercial bank? What does it mean if we become a commercial bank? How can we use deposits? How do we build a deposit base?

  Blankfein was quick to speak up afterward to encourage discussion. “Deposits provide funding only for certain activities,” he reminded the group.

  Gary Cohn tried to explain the situation in greater detail, saying that they wouldn’t be allowed to make bets with all of the deposits and advising them that they would “have to go out and buy some mortgages or go into the credit card business or originate mortgages.” These were businesses in which Goldman had no experience, and entering them would mean changing the company in a fundamental way.

  Sitting beneath twenty-foot-high chandeliers in the conference room, the directors and executives batted around a number of different ideas—developing an Internet bank, growing the firm’s private-wealth-management business. After an hour of debating alternatives, O’Neill shifted the discussion in another direction by proposing a different alternative: buy an insurance company.

  Insurance might have seemed, at first glance, an even more radical departure for Goldman than becoming a commercial bank. But Blankfein made the case that the two industries were more similar than dissimilar. Insurers use premiums from ordinary customers, just as bankers use deposits from customers, to make investments. It was no accident that Warren Buffett was a big player in the industry; he used the float of premiums from his insurance companies to finance his other businesses. Similarly, what was known in insurance parlance as “actuarial risk” was not unlike Goldman’s own risk-management principles.

  Goldman could not buy just any insurer, however; it would have to be a company large enough to put more than a dent in Goldman’s already hefty balance sheet. The top name on O’Neill’s list was AIG, American International Group, which by some measures was the biggest insurance
company in the world. The stock price of AIG had recently been decimated, so it might even be economical. Doing a deal with AIG had not, in fact, been a new idea; a possible merger had been talked about in hushed whispers at 85 Broad Street for years. Previous leaders of Goldman, John Whitehead and John Weinberg, both of whom were friends of Hank Greenberg, had suggested to him that the companies should perhaps do a deal some day.

  Everyone in the group had a view about AIG. Rajat K. Gupta, senior partner emeritus of McKinsey & Company, was intrigued, as was John H. Bryan, the former CEO of Sara Lee and one of Paulson’s closest friends.

  Bill George, the former head of Medtronic, the medical technology giant, appeared a bit more hesitant, and Gary Cohn said frankly that the idea made him nervous. They all looked to one particular board member for direction: Edward Liddy.

  As the chief executive of Allstate, the major auto and home insurer, Liddy was the one person in the room with actual experience in the insurance business. Some five years earlier Liddy had even tried to sell his firm to AIG, and Greenberg had dismissively rejected his pitch. “I think you ought to keep it,” Greenberg told him.

  Whenever the subject of insurance had come up at previous board meetings, Liddy had been unenthusiastic. “It’s a totally different game,” he had warned. His view on the matter hadn’t changed, no matter how much of a bargain AIG may have seemed. “It isn’t worth getting entangled with AIG,” he insisted.

  The morning session ended without any decisions being made about AIG, but the insurer came up again after lunch for an entirely different reason. AIG traded through Goldman as well as other Wall Street firms, and like many other companies would put up securities as collateral. There was just one problem: AIG was claiming that its securities were worth a good deal more than Goldman thought they were. Although Goldman’s auditor was looking into the matter, there was another snag: the auditor, PricewaterhouseCoopers, also worked for AIG.