This was the profile of the man the Sachses invited to join Goldman Sachs on January 1, 1918. “Catchings was a brilliant person,” Walter Sachs wrote of him years later, “but I’ve always used this term in regard to him: ‘Most men can stand adversity and very few men can stand success.’ In my estimation, he was the second genius in the firm,” after Henry Goldman. The war had been tough on Goldman’s business. “Things came to a stop,” Sachs observed. “It was impossible to issue securities in the ordinary way. There was relatively little done. We carried on, but it was more or less just carrying on without moving forward.” Catchings’s arrival at the firm coincided with the end of the war and the resumption of the issuance of corporate securities. He “played an amazingly constructive part in that,” Walter Sachs said, but added that despite his brilliance “very often when men are your partners you don’t know everything about them. You only find out things after they cease to be your partners.”
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WITH A SENSE of renewed optimism in the possibilities that the banking business afforded in the postwar era, the Goldman Sachs partners decided to abandon their offices at 60 Wall Street in 1920 and purchased, for around $1.5 million, a twelve-story “fireproof” office building at 30–32 Pine Street, built on the site where Marcus Goldman had first started his firm.
Business boomed at Goldman Sachs in the postwar years. Sachs credited Catchings with creating “such great companies” as National Dairy Products Corporation—a combination of Hydrox in Chicago, Sheffield Farms in New York, and Rieck McJunkin Dairy Company in Pittsburgh—that later became Kraft Foods. He also helped to create what became the General Foods Corporation by combining the Postum Cereal Company, Maxwell House Coffee, Jell-O, and many others. These companies, and others that Catchings helped to create, remained clients of Goldman Sachs for generations, and Goldman partners took their turns, seriatim, on their boards of directors, further cementing the ongoing and close relationships.
With Catchings’s enormous commercial success at Goldman Sachs came a corresponding increase in his desire for more power and authority at the firm, in the enduring Wall Street fashion. Catchings’s friend and classmate Arthur Sachs was spending more and more time in Europe to tend to the firm’s business there, and the two men drifted apart. Arthur Sachs thought Catchings had become a bit of a rogue and a charlatan and should not have the greater partnership share he was demanding. But Arthur Sachs was away in Europe, in an era when communication was by cable and was slow at best. Walter Sachs was left to contend with Catchings and his power grab. “In those days,” Sachs said of Catchings, he was “a handsome, attractive, slim person of great charm of personality. But as he became successful, he became more and more difficult.”
Walter Sachs struggled with what to do about Waddill Catchings. “Our business had grown so, and the load was tremendous,” he observed. “The burden was just too much for me.” In the end, Walter Sachs acceded to Catchings’s demands for greater control of the firm. “I thought that was the wise decision, and I very soon found out that I was wrong,” Sachs said. “But I made that decision.” He observed that it was a “question of partnership relationships and percentages and so forth, and dominancy in the partnership. Arthur was very unhappy about that, but I thought at the time it was the wise thing to do.” By 1928, Catchings was the Goldman partner with the largest stake in the firm, and his power became increasingly absolute at the very moment when a degree of caution would have been a far more appropriate response to a time of rapidly increasing stock prices. Those prices were going up because, it was said, “there weren’t enough [stocks] to go around, and, accordingly, they had acquired a ‘scarcity value,’ ” according to John Kenneth Galbraith in his landmark history of the Depression, The Great Crash. This would be a time when the Goldman partnership would not display a high degree of competence regarding risk control.
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RANK SPECULATION BY greedy investors is nothing new, of course. It was not new in the first decade of the twenty-first century, nor was it new in the late 1920s. Human beings’ enduring infatuation with climbing aboard one freight train of get-rich-quick schemes after another has rarely ended well and always provides invaluable fodder for financial journalists and historians. Why we never seem to learn from the problems caused by our own ongoing reckless behavior is mysterious and unexplainable. According to Galbraith, “Historians have told with wonder of one of the promotions at the time of the South Seas Bubble,” which—you will no doubt recall—was what happened when the South Sea Company agreed to refinance the £10 million of British debt incurred during the course of the War of the Spanish Succession, which ended in 1713. The British government agreed to grant the South Sea Company exclusive trading rights to all South American countries in exchange for South Sea’s agreement to refinance the government war debt. Investors in South Sea would receive annual 6 percent interest payments—paid by the British government after taxing goods South Sea imported from South America—as well as stock in the company. The parties repeated this seemingly innocuous deal several times in the decade, with disastrous results. One such South Sea capital-raising exercise, according to Galbraith, was “for an undertaking which shall in due time be revealed.” The historian noted with some understatement, “The stock is said to have sold exceedingly well.”
Galbraith likened the investment trust Catchings and Goldman Sachs—and many others—created in December 1928 to the opportunities the South Sea Company offered investors in the early 1700s. “As a promotion the investment trusts were, on the record, more wonderful,” he wrote. “They were undertakings the nature of which was never to be revealed, and their stock also sold exceedingly well.” Investment trusts were just another in a long line of clever Wall Street innovations designed to separate investors from their money. The idea was to create a shell company, or holding company, that would sell debt and equity securities to the public and then invest that money—less management fees, of course—into the shares of other publicly traded companies. The thinking was that professional managers had special insight into the vicissitudes of markets and could pick outperforming stocks. An investment trust was akin to what a publicly traded individual mutual fund might look like if it also piled on the leverage to maximize potential returns (and magnify potential losses). In short, these investment trusts looked a lot like the hedge funds of today with far fewer sophisticated investment strategies. The best modern analogy, although imperfect, might be the few publicly traded hedge funds—such as Fortress Investment Group and Och-Ziff Management Group (both run by ex–Goldman partners)—that seem to be offering investors the chance to invest with self-proclaimed financial geniuses who have figured out a way to make a silk purse from a sow’s ear.
Another analogy might be what has become known as a SPAC—special purpose acquisition corporations—which were all the rage a few years ago. Investors would give money to supposed experts in the art of acquiring companies using leveraged-buyout techniques—chiefly paying for the company with borrowed money—and then through the use of financial alchemy, spinning it all into gold. For whatever reason, people never seem to lose their infatuation with giving their hard-earned money away to other people who they are convinced will be better at investing it than they could themselves. In periods of market frenzy and irrational exuberance—the 1920s, the 1980s, the 1990s, the middle part of the first decade of the 2000s—these kinds of opportunities seem to make all the sense in the world to investors. This notion was reinforced by how these holding companies and empty shells trade in the market after their IPOs, increasing in value by leaps and bounds for no apparent reason—until the schemes fall apart, of course, which is an inevitable aspect of the narrative arc, all too easy to see in hindsight.
In fairness, Goldman was late to this particular party. Investment trusts had been floating around capitalist societies since the 1880s in England and Scotland, where small investors would invest their meager savings into these trusts that promised the opportuni
ty to invest in a diversified array of other companies. “And the management of the trusts could be expected to have a far better knowledge of companies and prospects in Singapore, Madras, Capetown and the Argentine, places to which British funds regularly found their way, than the widow in Bristol or the doctor in Glasgow,” Galbraith wrote. “The smaller risk and better information well justified the modest compensation of those who managed the enterprise.” Soon the idea was exported to the United States, primarily under the guise that this was a financial innovation worth imitating, lest Wall Street be seen as falling behind the City of London as a repository of brilliant new ideas.
At first, the trickle of such trusts to the New World was slow. In 1921, an SEC report of the phenomenon put the number at “about forty.” At the beginning of 1927, the same report noted there were 160 such trusts, and another 140 were established during the course of the year. During 1928, an estimated 186 investment trusts were established. By the first months of 1929, these trusts were being created at the rate of approximately one each business day, and a total of 265 made their appearance during the course of the year. As in any period of financial frenzy where salesmen are hawking the latest innovation—say, junk bonds, Internet IPOs, or mortgage-backed securities—some of the peddlers were honest and reputable—J. P. Morgan & Co. for example—and some were not. But when the market for innovation seems at its most indiscriminate and with prices investors are willing to pay only rising, it becomes increasingly difficult to tell the charlatans from the honest brokers. Worse, it may not even matter at such moments. Warren Buffett, the legendary investor with a knack for homespun observations about markets and human behavior, once observed, presciently, that it is “only when the tide goes out do you find out who is not wearing a bathing suit.”
In March 1929, Paul C. Cabot, one of the founders of State Street Investment Corporation, a treasurer of Harvard University, and a highly respected observer of the financial scene, wrote in The Atlantic Monthly what amounted to a clarion call to the investing public about the dangers lurking inside investment trusts. He recounted in some detail the troubles trusts experienced in England “because I strongly believe that unless we avoid these and other errors and false principles, we shall inevitably go through a similar period of disaster and disgrace.” He then explained that a few months prior to writing his article, he had testified before a New York Stock Exchange committee investigating the efficacy of the investment trusts. The committee wanted to know what Cabot thought of the phenomenon. “My reply was: 1) dishonesty. 2) inattention and inability. 3) greed.”
Indeed, Cabot’s chief criticism of the investment scheme—“All the profits go to the promoters and managers”—bears an eerie resemblance to the criticism of the 2008 financial crisis, right down to the leverage used to amplify supposed returns. Cabot explained that the managers of the trusts got paid only when they had paid off the senior-most securities in the structure. “[T]he compensation is dependent on the success of the enterprise,” he wrote. “But the difficulty is that the management or promoters have put up only a very small percentage of the total funds. If the enterprise is a complete failure, they have little or nothing to lose. It is natural, therefore, that they should take the attitude of ‘Let’s either win big or win nothing.’ This they accomplish by a very heavy pyramiding process. I do not believe there are many people who with only $100 equity would, as a general practice, proceed to borrow anywhere from $800 to $1000 worth of securities, and yet this exactly what many investment trusts are doing to-day.”
Not surprisingly, this was exactly the approach taken by Waddill Catchings, the senior partner of Goldman Sachs, in structuring and marketing the Goldman Sachs Trading Corporation. Goldman may have been late to the party—the trust began operation on December 4, 1928, less than a year before the stock market crash—but it joined in with great enthusiasm. “[R]arely, if ever, in history has an enterprise grown as the Goldman Sachs Trading Corporation and its offspring grew in the months ahead,” Galbraith wrote. The idea of the company was not to own the shares of companies for the longer term but rather to trade in and out of them to make money for shareholders.
At first, things started off modestly enough. In a typical underwriting, Goldman bought all 1 million shares of the Trading Corporation at $100 per share—raising $100 million—and then turned around and resold 90 percent of its stock to investors at $104 per share, generating proceeds of $93.6 million, making a cool $4 million profit—some on paper, some in cash—in the process. Two months later, the Trading Corporation sold another 125,000 shares publicly at around $126 each, raising another $15.75 million in the process. Of course, the value of Goldman’s remaining 100,000 shares kept trading higher as well. Goldman kept control of the management of the company—of which now it owned less than 10 percent of the shares—through management and investment contracts. Indeed, all of the partners of Goldman Sachs were the directors of the Goldman Sachs Trading Corporation, and the partners of Goldman had to approve any and all directors of the Trading Corporation.
By February 2, 1929, shares in the Trading Corporation had increased to $136.50 each, and by February 7, they were trading at $222.50, approximately double the value of the underlying securities the trust had bought with the original $100 million of investor proceeds. “This remarkable premium was not the undiluted result of public enthusiasm for the financial genius of Goldman, Sachs,” Galbraith deadpanned.
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IT TURNED OUT that Goldman had been buying the shares on the open market, driving the price farther upward in order to benefit Goldman Sachs, among other shareholders. And, if the subsequent voluminous 1932 congressional report on the factors that led to the 1929 Crash is to be believed, Goldman’s determined efforts to drive the price of Trading Corporation’s stock higher in anticipation of a merger between Trading Corporation and another trust, the Financial and Industrial Securities Corporation, can only be described as one of the first recorded instances of insider trading by Goldman’s partners. While trading on material nonpublic inside information in early 1929 might not then have been a criminal offense—it was not even banned in the United States until 1934 and not criminalized until decades later—the actions taken by both senior partner Waddill Catchings and his then colleague Sidney Weinberg to manipulate the stock of the Trading Corporation do not add up to the dictionary definition of moral rectitude either.
The day before Christmas 1925, Ralph Jonas and his partners organized the Financial and Industrial Securities Corporation to hold the stock they had amassed in several large banks and insurance companies, by far the largest holding of which was a 32 percent stake in Manufacturers Trust Company, a New York–based commercial bank. Jonas owned 45 percent of the outstanding shares of the Financial and Industrial Securities Corporation. In September 1928, Sidney Weinberg told Nathan Jonas, the president of Manufacturers Trust and the brother of Ralph Jonas, that Goldman would “like to take an interest” in the bank—this being in the years before Congress prevented the intermingling of commercial and investment banks through the Glass-Steagall Act. Nathan referred Weinberg to his brother Ralph, who in turn suggested that Goldman consider instead taking a stake in Financial and Industrial, which owned a 32 percent stake in the bank “sufficient to constitute working control” of it according to the report. But Weinberg decided not to pursue the Jonas brothers’ suggestion that Goldman take a stake in Financial and Industrial “on the ground that it preferred to form its own investment company.”
So on December 4, 1928—some two months later—Goldman created the Goldman Sachs Trading Corporation, including a ten-year exclusive right for Goldman and its partners to manage the business. According to the prospectus, the purpose of the trust was plenty amorphous: to “buy, sell, trade in or hold stocks and securities of any kind.” Subsequent communications between Goldman and the trust’s underwriters as well as with the New York Stock Exchange made clear that the purpose of the Trading Corporation was to “trade in securities.�
� In later testimony, Catchings said the purpose of the Trading Corporation was to “give the clients and customers of Goldman, Sachs & Co. the same kind of opportunity of making money which Goldman, Sachs & Co. as a firm had given to its clients and customers in previous years.” He added that “other banking houses had formed investment and trading companies and more were doing it, and we felt it was a wise thing for Goldman, Sachs & Company, as a firm, to afford to its clientele the same type of investment opportunities and service which every other house was affording to their clientele.” And Catchings was not shy about testifying about Goldman’s prowess, either. “Throughout the whole period of time of ins and outs and ups and downs of business, Goldman Sachs & Company had managed to select for issue to the public securities which on the whole had turned out to be very satisfactory investments, and it was the opinion of the firm that if an investment and trading company was formed which would engage in somewhat the same kind of investment policies as large individuals engaged in connection with securities issued by Goldman Sachs, it would be a beneficial thing to do.”
After the IPO of Trading Corporation, Goldman owned 100,000 shares for which it had paid $1 million, or $10 per share. Considering that the public bought the same shares in the IPO for $104 per share, Goldman’s profit was both immediate and immense. As part of the plan to offer shares in Trading Corporation at a discount to Wall Street dealers involved in the IPO syndicate, Financial and Industrial also bought 49,000 Trading Corporation shares at $102 per share, at a cost of nearly $5 million.
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