For an M&A guy like Friedman to go from running investment banking to running fixed income could not have been an easy transition—to say nothing of being highly unusual—and he compensated for it by asking a blitzkrieg of questions until he got the information he felt he needed to make the right decisions. Fortunately, Friedman had Rubin as his partner running the group, and Rubin did understand trading and debt from a market perspective, as opposed to the more theoretical perspective that an M&A banker would have. They were an effective team.
Friedman was taken aback by the shape he found the fixed-income group when he and Rubin arrived. “It was a shock when you got there,” he said, “just how far behind the rest of the firm they were.” He was especially concerned that there was “no brainpan” to deal with what they both quickly discovered was a major problem right from the start. “The top of that division was an intellectual vacuum,” he said. The fixed-income division traded nearly every debt-related security available, including government bonds, high-grade corporate bonds, high-yield bonds, and mortgage-backed securities. “The business was big, with a lot of risk,” Rubin explained. Much to their surprise, Rubin and Friedman discovered that Goldman’s “traders had large, highly leveraged positions, many of them illiquid, meaning that they couldn’t be sold even at generous discounts to the price of the last trade,” he continued. “As losses mounted, Steve and I tried to figure out what to do.” Not only did Friedman and Rubin—understandably—not know what to do but neither apparently did Goldman’s fixed-income traders.
The traders had lost more than $100 million. “Today that wouldn’t mean much,” Rubin allowed, “but in that world at that time, it was very meaningful.” Worse, they couldn’t figure out a way to stop the bleeding. “Suddenly, our biggest trading operation had gone sour, and we didn’t understand why or what the future might bring,” he continued.
Question time. Friedman and Rubin headed to the trading room. “Let’s all sit down and try to understand what we’re holding,” they told the traders. “If we have positions we shouldn’t have, let’s get rid of them.” The problem was that the bonds Goldman was trading had embedded options that the Goldman traders hadn’t accounted for in a rapidly changing interest-rate environment. For instance, as interest rates fell during 1985 and 1986, home owners rushed to refinance their mortgages, as would be expected. This caused Goldman’s portfolio of mortgage-backed securities, which contained mortgages with higher interest rates, to be paid off early (through the refinancings) and to lose value rather than increase in value as would be expected when interest rates fell, since the value of a bond with a higher interest rate increases when relative interest rates fall. Goldman had a similar problem in its portfolio of corporate bonds. “What happened to us represents a seeming tendency in human nature not to give appropriate weight to what might occur under remote, but potentially very damaging, circumstances,” Rubin observed. This tendency was compounded by the fact that traders had an intuitive expectation that bonds could always be traded at or near the price of the last trade, a fine thought when markets are functioning relatively normally. “But when conditions deteriorate severely,” Rubin explained, “liquidity diminishes enormously. Traders often can’t sell bad positions except at enormous discounts, and sometimes not at all. Then they may be forced to sell good positions to raise money.… Unexpected losses can develop rapidly and be huge.”
Understandably, the losses in the fixed-income group led to some serious griping around the firm, especially when the firm lost another $200 million in fixed-income trading in February 1986. “They really got clobbered,” Friedman explained. “They didn’t have sufficient integration with research. And the internal morale was such that when you’d have monthly partners meetings, investment bankers would be saying to traders as they came off the elevator to go into the meeting, ‘Well how much money did you guys lose this month?’ That’s not a great morale thing.”
Friedman and Rubin set about changing the gestalt of the fixed-income group by taking a most un-Goldman-like step: they hired a group of senior traders from Salomon Brothers—the fixed-income leader—to perform an extreme makeover. First, Goldman hired Thomas Pura, thirty-two, who chose to go to Harvard instead of signing up with the Kansas City Royals after high school. He regularly participated in Ironman triathlons and brought to the department “a new intensity and a risky style of trading that was bolder and more aggressive than anything Goldman Sachs fixed-income had ever seen,” according to Lisa Endlich in Goldman Sachs: The Culture of Success. Then Goldman hired David DeLucia, thirty-three, to head up corporate bond trading, sales, and syndication in New York and transferred to London the previous head of the business, J. Nelson Abanto. Finally, Goldman hired Michael Mortara, thirty-eight, to lead Goldman’s mortgage-backed securities trading business soon after Salomon fired him and Lew Ranieri, the architect of the securitization business on Wall Street. “Hiring outsiders for senior positions was rare enough at Goldman,” Beth Selby wrote in Institutional Investor in December 1990. “[B]ut to bring each in as a partner was almost too much for the culture to bear, so the duo”—Friedman and Rubin—“pulled back. The new [Salomon] partners were told that although they were masters of their trading desks, they must staff those businesses from within the firm—no more new blood.”
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WHILE GOLDMAN’S TRADERS struggled with how to stanch the bleeding, Goldman’s M&A group was booming. Its prowess was so great that the firm took the rare step of participating in a long Sunday New York Times profile of Geoff Boisi, the thirty-eight-year-old partner who followed Friedman as head of the firm’s M&A group and had just been named co-head of investment banking. Such a massive helping of publicity for a young banker was most unusual at any Wall Street firm, virtually unheard of at Goldman Sachs—and usual fatal. Boisi explained that 1985 was his group’s “absolute best year ever”—the contrast with the bond traders could not be more stark—and that Goldman had worked with major companies on a string of high-profile deals, including General Foods in its merger with Philip Morris and Procter & Gamble in its purchase of Richardson-Vicks, and the deal by which Macy’s again became a private company (and would lead to its bankruptcy a few years later). Of Boisi’s additional role, Weinberg told the Times, “We are adding to his responsibilities. He is one of the substantial number of very bright individuals at Goldman Sachs. M&A is a very visible activity. He’s done an outstanding job. He certainly deserves everything he gets.”
Of course, there were the expected nods to teamwork and long hours. Boisi’s role in selling General Foods to Philip Morris captured well the life of an M&A banker at Goldman. For months prior to Philip Morris’s offer, Goldman had warned General Foods it might be vulnerable to a hostile takeover, given the popularity of its well-known consumer brands. General Foods’ management listened to Boisi and put in place a few defense strategies. Through the summer of 1985 rumors swirled that an offer might be made for the company. On September 24, Philip Morris launched a hostile offer of $111 a share in its stock for General Foods, valuing it at $5 billion. Boisi and his team plus another set of advisers at Morgan Stanley canvassed the market to see if a higher bidder could be found, one that would be friendly. By the end of the week, with Hurricane Gloria wracking the East Coast, Philip Morris raised its bid to $120 a share. General Foods capitulated, in part because Goldman’s analysis showed that few potential bidders could match Philip Morris’s offer. “We worked round the clock,” Boisi said. (And again one of its clients was sold.)
As the legal documents were being drafted deep into the night before they were to be signed, Boisi left around 3:00 a.m. to try to make it home to Long Island before the hurricane hit. When the deal was signed he was notified by a conference call, on which everyone cheered. “It’s a difficult life,” he said. “There have been more times than I care to remember when the phone rings, I just pick up my briefcase and go out to the airport. No clothes. No toothbrush. A couple of days later the clothes arrive. The de
al dictates your schedule.” All this success, of course, meant that Boisi was becoming increasingly wealthy, a subject he declined to discuss. Instead, he professed his loyalty to Goldman. “Right now, I can’t think of anything more exciting than being at Goldman Sachs.” Six years later, in 1991, after a power struggle with Rubin and Friedman, he left Goldman.
The Times featured Goldman again six months later, in April 1986, in another long Sunday piece that began by explaining the crucial role John Weinberg had played in the November 1985, $6.3 billion merger of General Electric and RCA, the largest non-oil merger ever. GE CEO Jack Welch called Weinberg personally to get him involved and the Goldman team—of course—“worked day and night over the Thanksgiving Day weekend” to get the deal done. Goldman’s fee for the deal was more than $7 million, a whopping amount at the time. Still, all those months later, the article revealed that Weinberg was still smarting a little from the fact that the media attention for the deal seemed to go to Felix Rohatyn, at Lazard, which represented RCA, a longtime client. Rohatyn had let the media know he had initiated the deal at a breakfast at his Fifth Avenue apartment with Welch. There was lavish front-page coverage of the deal in both the Times and the Wall Street Journal, highlighting Rohatyn’s role in bringing the two sides together. A week later, Time weighed in with a rare business cover story, “Merger Tango,” about this deal and others. Rohatyn “always says he does everything,” Weinberg said. “A lot of the things I do are unknown—they won’t be in my obituary but I won’t be here to read it anyway.” Indeed, a subsequent New York Times Magazine article about the deal—close to seven thousand words long—mentioned Goldman only once and Weinberg not at all. (Rohatyn had nineteen mentions in the article.)
Weinberg’s griping about lack of attention for Goldman’s role in the RCA deal was not only out of character but was also a bit odd since Forbes had, in February, just done a short profile of Goldman and Weinberg—including his photograph—and emphasized how obscenely profitable the firm had become. The magazine estimated Goldman had made $500 million in pretax profit in 1985, on revenue of $1.7 billion, a luxurious margin of 29 percent. Merrill Lynch made one-third as much money with four times more revenue. The Forbes piece wondered how many of the firm’s seventy-nine partners made more than $1 million a year. “We all do,” one partner told the magazine. When asked how Goldman had become so profitable, Weinberg replied that teamwork and the compensation system for the firm’s 4,600 nonpartners was the key. He said nonpartners in operations or risk management earned as much as did those professionals with glamour jobs in M&A. “That has left [Goldman] largely free of the infighting and backbiting that plague other firms,” Weinberg observed. Still, despite the teamwork, there were occasionally some gaffes that, Weinberg said, “irritated” the entire firm. In April, Jim Cramer told a newspaper that he earned enough money that “there isn’t anything I see in a store that I can’t buy.” Far preferable was Friedman’s habit of carrying around his paperwork in “a battered L. L. Bean bag” while also owning a large duplex apartment on the East River in Manhattan. There was a long tradition at some Wall Street firms—like Goldman and Lazard—of being scrupulous about keeping the offices modest, lest clients start thinking the fees they were paying were too high. Ostentatious displays of wealth were reserved for the home, or homes.
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BOTH ARTICLES, THOUGH, focused especially on the question of whether Goldman had sufficient capital to compete in the rapidly changing markets and to provide liquidity to the growing number of partners who were retiring. Would Goldman go public as many firms had, including Morgan Stanley in March 1986 and Bear Stearns in 1985? Unlikely, was Forbes’s verdict, pointing out that the firm had $1.2 billion in capital at the end of 1985. “With $1.2 billion and $750 million in excess, we have all we need to serve our clients,” Weinberg said. To the Times, he also minimized the possibility that the firm would go public anytime soon. He reiterated that Goldman had all the capital it needed and the partners could plot their “strategies without having to worry about quarterly earnings.”
There was a thread of concern—voiced by anonymous others—that Goldman might need additional capital to compete with Merrill Lynch, which had $2.6 billion of capital, and Salomon Brothers, which had $2.3 billion, as the business became more capital intensive. There was also a sense that a downturn in the business was inevitable and that Goldman would need capital to absorb future losses. “We’re going to have to manage the downside of the cycle,” Rubin told the Times. “The 30-year-olds were not on Wall Street during the last downside, even most of the partners weren’t partners then.”
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NOT SURPRISINGLY GIVEN Goldman’s ability to muddy the PR waters, Weinberg’s assurance about the firm’s comfortable capital position was an impressive head fake. It turned out that within weeks of the announcement of the GE deal, a partner at McKinsey & Co., the management consultants, had secretly approached Rohatyn and Lazard about the possibility of taking on a new client, Sumitomo Bank, Ltd., the giant Japanese financial institution. A few weeks later, on January 10, three executives from Sumitomo plus the McKinsey partners came to Rohatyn’s thirty-second-floor office at One Rockefeller Plaza. The Japanese banker explained their audacious idea of buying a chunk of Goldman Sachs so that Goldman could teach Sumitomo about the investment banking business. They wanted Rohatyn’s help to try to make a deal with Goldman. “Implicit was always the idea that they wanted a passive window into the investment banking business,” Rohatyn explained. “I told them we had the highest regard for Goldman, that they were one of the best-managed, if not the best-managed, firms in the business.” In February, Rohatyn flew to Tokyo to meet with the Sumitomo executives, where the seriousness of Sumitomo’s intent was conveyed to the Lazard investment banker.
Ironically, while Rohatyn was in Tokyo getting his marching orders, Goldman’s traders were busy losing another $200 million in trades they were having trouble understanding. That was the moment when Rubin and Friedman first broached the idea of an IPO of the firm with the Management Committee. Not only would having more capital help the firm absorb these outsize trading losses—until they could be stanched—but a group of older Goldman partners were looking to take as much as $150 million of their capital out of the firm and then retire. Then there was Goldman’s evolving business plan, which required more capital to increase Goldman’s principal investments in proprietary trading, private equity, and real estate. Upon hearing Rubin and Friedman’s pitch, the Management Committee—comprising partners nearing the end of their reigns—could see the wisdom of cashing out with an IPO. The consensus on the committee was that the firm should go public sooner rather than later. While Weinberg claimed to be largely indifferent to the idea, he endorsed the consensus view and agreed that Rubin and Friedman should present the idea to the annual partnership meeting later that year.
Then in March, Rohatyn called Weinberg out of the blue and broached the idea for the first time of Goldman taking an investment from Sumitomo. Unsure of what to think about such a far-fetched idea—this was well before foreign investment in the United States became commonplace—Weinberg agreed to have the meeting. In an effort to avoid being detected, Koh Komatsu, the president of Sumitomo, and a colleague took a page from a le Carré novel and flew from Osaka to Seattle and then from Seattle to Washington, and then flew up to New York on the shuttle. Wearing dark glasses to avoid being detected, they arrived at 85 Broad Street to see Weinberg. “I had to tell him,” Weinberg recalled, “that taking the shuttle from Washington National to LaGuardia was no way to hide. Those planes are full of guys from Wall Street—and reporters!” But what Komatsu proposed that day was as audacious as it was brilliant: for $500 million—not a penny less—Sumitomo would take a 12.5 percent stake in Goldman and agree to have no voting rights and no role in the firm’s governance. Sumitomo’s offer valued Goldman Sachs at $4 billion, a whopping 4.6 times Goldman’s $868 million in equity capital and an equally astronomic 3.3 times Goldm
an’s total capital of $1.2 billion, which included another $333 million of subordinated debt. Goldman’s rival, Morgan Stanley, had sold a portion of itself to the public at a valuation below three times book value. There was simply no ignoring an offer this sweet.
Weinberg could barely contain his excitement after Rohatyn and the Sumitomo executives had left his office. He called up his partner Donald Gant, a Harvard Business School graduate and investment banking coverage officer. “You won’t believe this, not in a million years,” he told Gant. “But I’ve just had the most amazing visit. Don, this may be nothing, but if it does work out, it could be very, very big. Come over to my office right away so I can fill you in. We’ve got work to do!” When Gant arrived, Weinberg told him about Rohatyn’s visit with the two Japanese bankers, wearing dark glasses. “Don, give Felix Rohatyn a call right away to see how serious this guy is about what he said to me,” Weinberg recalled, “that Sumitomo Bank wants to be a partner in Goldman Sachs. See if they’re really serious! Who knows? We may soon be Goldman Sake!”
Gant, who knew Rohatyn a little from the deal world, spoke with the Lazard banker and reported back to his boss that Rohatyn and Sumitomo were indeed serious. “We can’t just dismiss it,” Gant told Weinberg. “They have the money and want to be a silent partner. If we negotiate this the right way, Rohatyn says we can write our own ticket.” Weinberg deputized Gant to take the lead in the negotiations. “Knowing the Japanese, it could take a lot of time!” Weinberg said. He knew the Japanese well, having fought them as a marine during World War II and having been in Nagasaki after the bomb had been dropped to help open a prisoner-of-war camp.
Gant and Goldman’s chief financial officer, Robert A. Friedman, spent the next few months negotiating the deal with Rohatyn and three of his Lazard partners. “The negotiations were long and difficult,” the Times reported, as the two sides had to balance the rules about foreign ownership, what commercial banks were allowed to own of investment banks, and Goldman’s desire to have the Japanese money without giving up anything close to control or influence. Goldman also knew how powerful another $500 million in equity could be—it was close to 60 percent of Goldman’s equity capital, which had been built up over 117 years—especially when it could be leveraged thirty times over. That $500 million could be turned into $15 billion of trading power. In the end, the two sides agreed Sumitomo would pay $500 million to buy a form of debt convertible into 12.5 percent of Goldman’s equity over time. Also, either side could terminate the deal after ten years.
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