by Matt Taibbi
But any attempt to construct a narrative around all the former Goldmanites in influential positions quickly becomes an absurd and pointless exercise, like trying to make a list of everything. So what you need to know is the big picture: if America is circling the drain, Goldman Sachs found a way to be that drain—an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.
The bank’s unprecedented reach and power has enabled it to manipulate whole economic sectors for years at a time, moving the dice game as this or that market collapses, and all the time gorging itself on the unseen costs that are breaking families everywhere—high gas prices, rising consumer credit rates, half-eaten pension funds, mass layoffs, future taxes to pay off bailouts. All that money that you’re losing, it’s going somewhere, and in both a literal and a figurative sense Goldman Sachs is where it’s going: the bank is a huge, highly sophisticated engine for converting the useful, deployed wealth of society into the least useful, most wasteful and insoluble substance on earth, pure profit for rich individuals.
It achieves this using the same playbook over and over again. What it does is position itself in the middle of horrific bubble manias that function like giant lottery schemes, hoovering vast sums from the middle and lower floors of society with the aid of a government that lets it rewrite the rules, in exchange for the relative pennies the bank throws at political patronage. This dynamic allows the bank to suck wealth out of the economy and vitality out of the democracy at the same time, resulting in a snowballingly regressive phenomenon that pushes us closer to penury and oligarchy at the same time.
They have been pulling this same stunt for decades, and they’re preparing to do it again. If you want to understand how we got into this crisis, you first have to understand where all the money went—and in order to understand that, you first need to understand what Goldman has already gotten away with, a history exactly three bubbles long.
Goldman wasn’t always a too-big-to-fail Wall Street behemoth and the ruthless, bluntly unapologetic face of kill-or-be-killed capitalism on steroids—just almost always. The bank was actually founded in 1882 by a German Jewish immigrant named Marcus Goldman, who built it up with his son-in-law, Samuel Sachs. They were pioneers in the use of commercial paper, which is just a fancy way of saying they made money lending out short-term IOUs to small-time vendors in downtown Manhattan.
You can probably guess the basic plotline of Goldman’s first one hundred years in business: plucky immigrant-led investment bank beats the odds, pulls itself up by its bootstraps, makes shitloads of money. In that ancient history there’s only one episode that bears real scrutiny now, in light of more recent events: Goldman’s disastrous foray into the speculative mania of precrash Wall Street in the late 1920s and the launch of now-infamous “investment trusts” like the Goldman Sachs Trading Corporation, the Shenandoah Corporation, and the Blue Ridge Corporation.
It’s probably not worth getting into the arcane details of these great Hindenburgs of financial history too much, but they had some features that might sound familiar. Similar to modern mutual funds, investment trusts were companies that took the cash of investors large and small and (theoretically at least) invested it in a smorgasbord of Wall Street securities, though which securities and in which amounts were often kept hidden from the public. So a regular guy could invest ten bucks or a hundred bucks in a trust and pretend he was a big player. Much as in the 1990s, when new vehicles like day trading and e-trading attracted reams of new suckers from the sticks who wanted to be big shots, investment trusts roped in a generation of regular-guy investors to the speculation game.
Beginning a pattern that would repeat itself over and over again, Goldman got into the investment trust game slightly late, then jumped in with both feet and went absolutely hog wild. The first effort was the Goldman Sachs Trading Corporation; the bank issued a million shares at $100 apiece, bought all those shares with its own money, and then sold 90 percent of the fund to the hungry public at $104.
GSTC then relentlessly bought shares in itself, bidding the price up further and further. Eventually it dumped part of its holdings and sponsored a new trust, Shenandoah, and issued millions more in shares in that fund—which in turn later sponsored yet another trust called Blue Ridge. The last trust was really just another front for an endless investment pyramid, Goldman hiding behind Goldman hiding behind Goldman. Of the 7,250,000 initial shares of Blue Ridge, 6,250,000 were actually owned by Shenandoah, which of course was in large part owned by Goldman Trading.
The end result (ask yourself if this sounds familiar) was a daisy chain of borrowed money exquisitely vulnerable to any decline in performance anywhere along the line. It sounds complicated, but the basic idea isn’t hard to follow. You take a dollar and borrow nine against it; then you take that ten-dollar fund and borrow ninety; then you take your hundred-dollar fund and, so long as the public is still lending, borrow and invest nine hundred. If the last fund in the line starts to lose value, you no longer have the money to pay everyone back, and everyone gets massacred.
The famed economist John Kenneth Galbraith wrote up the Blue Ridge/Shenandoah incidents as a classic example of the insanity of leverage-based investment; in today’s dollars, the losses the bank suffered through trusts like Blue Ridge and Shenandoah totaled about $485 billion and were a major cause of the 1929 crash.
Fast-forward about sixty-five years. Goldman had survived the crash and, thanks largely to its legendary senior partner Sidney Weinberg (famous for having moved from being a janitor’s assistant to being the head of the company), gone on to prosper and become the underwriting king of Wall Street. Through the seventies and eighties Goldman was not quite the planet-eating Death Star of indomitable political influence it is today, but it was a top-drawer firm that had a reputation for attracting the very smartest talent on the Street.
It also, oddly enough, had a reputation for relatively solid ethics and long-term thinking, as its executives were trained to adopt the firm’s mantra, “Long-term greedy.” One former Goldman banker who left the firm in the early nineties recalls seeing his superiors give up a very profitable deal on the grounds that it was a long-term loser. “We gave back money to ‘grown-up’ corporate clients who had made [for them] bad deals with us,” he says. “Everything we did was legal and fair … but ‘long-term greedy’ said we didn’t want to make such a profit at the clients’ collective expense that we spoiled the marketplace.”
But then something happened. It’s hard to say what it was exactly; it might have been the fact that its CEO in the early nineties, Robert Rubin, followed Bill Clinton to the White House, where he was the director of Clinton’s new National Economic Council and eventually became Treasury secretary. While the American media fell in love with the storyline of a pair of baby-boomer, sixties-child, Fleetwood Mac–fan yuppies nesting in the White House, it also nursed an undisguised crush on the obnoxious Rubin, who was hyped as the smartest person ever to walk the face of the earth.
Rubin was the prototypical Goldman banker. He was probably born in a four-thousand-dollar suit, he had a face that seemed permanently frozen just short of an apology for being so much smarter than you, and he maintained a Spocklike, emotion-neutral exterior; the only human feeling you could imagine him experiencing was a nightmare about being forced to fly coach. The press went batshit over him and it became almost a national cliché that whatever Rubin thought was probably the correct economic policy, a phenomenon that reached its nadir in 1999, when Rubin appeared on that famous Time magazine cover with Alan Greenspan and then–Treasury chief Larry Summers under the headline “The Committee to Save the World.”
And “what Rubin thought,” mostly, was that the American economy, and in particular the financial markets, were overregulated and needed to be set free. During his tenure the Clinton White House made a series of move
s that would have drastic consequences. The specific changes Rubin made to the regulatory environment would have their most profound impact on the economy in the years after he left the Clinton White House, in particular during the housing, credit, and commodities bubbles. But another part of his legacy was his complete and total inattention to and failure to regulate Wall Street during Goldman’s first mad dash for obscene short-term profits, in the Internet years.
The basic scam in the Internet age is pretty easy even for the financially illiterate to grasp. It was as if banks like Goldman were wrapping ribbons around watermelons, tossing them out fiftieth-story windows, and opening the phones for bids. In this game you were a winner only if you took your money out before the melon hit the pavement.
It sounds obvious now, but what the average investor didn’t know at the time was that the banks had changed the rules of the game, making the deals look better than they were, setting up what was in reality a two-tiered investment system—one for bankers and insiders who knew the real numbers, and another for the lay investor, who was invited to chase soaring prices the banks themselves knew were irrational. While Goldman’s later pattern would be to capitalize on changes in the regulatory environment, its key innovation in the Internet years was its executives’ abandonment of their own industry’s quality control standards.
“What people don’t realize is that the banks had adopted strict underwriting standards after the Depression,” says one prominent hedge fund manager. “For decades, no bank would take a company public unless it met certain conditions. It had to have existed for at least five years. It had to have been profitable for at least three years in a row. It had to be making money at the time of the IPO.
“Goldman took these rules and just threw them out the window. They’d sign up Worthless.com and take it public five minutes into its existence. The public mostly had no idea. They assumed these companies met the banks’ standards.”
Jay Ritter, a professor at the University of Florida, says the decline in underwriting standards began in the eighties. “In the early eighties the major underwriters insisted on three years of profitability. Then it was one year, then it was a quarter. By the time of the Internet bubble things had declined to the point where not only was profitability not required next year, they were not requiring profitability in the foreseeable future.”
Goldman has repeatedly denied that it changed its underwriting standards during the Internet years, but the statistics belie the bank’s claims. Just like it did with the investment trust phenomenon, Goldman in the Internet years started slow and finished crazy.
After it took a little-known company with weak financials called Yahoo! public in 1996, it quickly became the IPO king of the Internet era. Of the twenty-four Internet companies it took public in 1997 for which data are available, a third were losing money at the time of the IPO. In the next year, 1998, the height of the Net boom, it took eighteen companies public in the first four months, and fourteen of them were money losers at the time of the IPO.
By the following April, the number of Internet IPOs on Wall Street had shot up ninefold compared to the first four months of 1998, and the overall amount of money raised by IPOs had jumped to more than $45 billion, topping the tally for the entire calendar year 1996. Goldman by then was underwriting a fifth of all Internet IPOs and went on to underwrite forty-seven new offerings in 1999.
Of those 1999 IPOs, a full four-fifths were Internet companies (including stillborns like Webvan and eToys), making Goldman the leading underwriter of Internet IPOs during the boom. The company’s IPOs were consistently more volatile than those of their competitors: the average Goldman IPO in 1999 leapt 281 percent above its offering price that year, compared to the Wall Street average of 183 percent.
How did they manage such extraordinary results? One answer was that they used a practice called laddering, which is just a fancy way of saying they manipulated the share price of new offerings. Here’s how it works: Say you’re Goldman Sachs and Worthless.com comes to you and asks you to take their company public. You agree on the usual terms: you’ll price the stock, determine how many shares should be released, and take the Worthless.com CEO on a “road tour” to meet and schmooze investors, in exchange for a substantial fee (typically 6–7 percent of the amount raised, which added up to enormous sums in the tens if not hundreds of millions).
You then promise your best clients the right to buy big chunks of the IPO at the low offering price—let’s say Worthless.com’s starting share price is 15—in exchange for a promise to reenter the bidding later, buying the shares on the open market. Now you’ve got inside knowledge of the IPO’s future, knowledge that wasn’t disclosed to the day-trader schmucks who only had the prospectus to go by: you know that certain of your clients who bought X amount of shares at 15 are also going to buy Y more shares at 20 or 25, virtually guaranteeing that the price is going to go past 25 and beyond. In this way the bank could artificially jack up the new company’s price, which of course was to the bank’s benefit—a 6 percent fee of a $500 million or $750 million IPO was serious money.
Goldman was repeatedly sued for engaging in these laddering practices by shareholders of a variety of Net IPOs, including Webvan and NetZero. Moreover, they were outed by one Nicholas Maier, the former syndicate manager of Cramer & Co., the hedge fund then run by the now-famous chattering television asshole Jim Cramer, himself a Goldman alum. While working for Cramer between 1996 and 1998, Maier contends that he was repeatedly forced to engage in the laddering practice in IPO deals with Goldman.
“Goldman, from what I witnessed, they were the worst perpetrator,” Maier said later. “They totally fueled the bubble. And it’s specifically that kind of behavior that has caused the market crash. They built these stocks upon an illegal foundation—manipulated up, and ultimately, it really was the small person who ended up buying in.”
In what would become a pattern of somehow managing to escape responsibility and legal problems by paying absurdly small fines, Goldman eventually agreed to pay a mere $40 million fine in 2005 to the SEC for its laddering violations, a fine that was obviously beyond puny relative to the sums involved. Also in line with the bank’s incredible pattern of general impunity, it managed to get off on its laddering offenses without a formal admission of wrongdoing.
Another practice Goldman engaged in during the Net boom and managed to escape serious punishment for was “spinning.” Here the investment bank would offer the executives of the newly public company shares at advantageous prices in exchange for promises of future underwriting business. Typically investment banks that engaged in spinning undervalued the initial offering price so that those “hot” opening-price shares would be more likely to rise quickly and therefore offer bigger first-day rewards.
In one example, Goldman allegedly gave multimillion-dollar special offerings to eBay CEO Meg Whitman (she was also a director at Goldman) and eBay founder Pierre Omidyar in exchange for a promise that eBay would use Goldman for future i-banking business.
And this wasn’t the only example: a 2002 House Financial Services Committee report showed that in twenty-one different instances, Goldman gave top executives in companies they took public special stock offerings that in most cases were quickly sold at a huge profit. According to the report, executives who received this preferential treatment from Goldman included Yahoo! founder Jerry Yang and two of the great Oil Can Harrys of the financial scandal age—Tyco’s Dennis Kozlowski and Enron’s Ken Lay.
Goldman was furious about the report and blasted back at then–committee chair Mike Oxley and the rest of Congress. “This is an egregious distortion of the facts,” said Lucas van Praag, a spokesman for Goldman Sachs. “The suggestion that Goldman Sachs was involved in spinning or other inappropriate practices around IPO allocations is simply wrong.”
And yet: at the end of that same year Goldman agreed to settle with not-yet-disgraced New York attorney general Eliot Spitzer, who accused Goldman, along with eleven other c
ompanies, of spinning and issuing bogus buy ratings of stocks. Here Goldman again got off easy, paying just $50 million. It also agreed, as part of the settlement, to no longer engage in spinning; in return, Goldman again got to avoid formally pleading guilty to any charges, and regulators agreed to forgo charges against its chief executives, who at the time included Hank Paulson.
Well, who cares about all this, right? Why begrudge a few rich guys a few advantageous stock offerings? There are actually many reasons. One, it’s bribery. Two, practices like spinning not only artificially lowered the initial offering price but deprived ordinary investors of critical information; they had no way of knowing that Goldman was playing around with the price of newly public companies in order to secure other business.
Beyond that, the House Committee concluded that Goldman’s analysts had kept on issuing “buy” recommendations long after the value of the stocks had fallen, in some cases doing so in exchange for promises of future business. Ritter, the Florida professor, concluded that companies whose IPOs were “spun” were deprived of about a fifth of what they could have made, on average. “We compute what the offer price would have been on each IPO to result in a first-day return that would have been 22.68 percent less,” he says. In other words, a company that took its company public in a “spun” IPO might lose $20 million on a $100 million offering.
Even worse was the practice of “soft dollar commissions.” Here Goldman would approach large institutional investment clients—insurance companies, pension funds, mutual funds, thrifts, and so on—and tell them that their access to hot Internet IPO shares would be contingent upon how much underwriting business they threw the bank’s way over time. Again, this artificially drove the initial offering price down, induced more investors to chase first-day gains, and generally fucked with the market by hiding pertinent information from investors on the outside.
