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WHATEVER SOCIAL AND behavioral problems the firm seemed to be having as the John Weinberg era faded away, there was no question Goldman Sachs—more than ever—still knew how to make money. Institutional Investor estimated the 1990 “honeypot” at “north of $600 million,” and Forbes wrote, without caveat, that the firm made $1 billion in net income in 1991. The Ad Hoc Profit Maximization Committee seemed to be working quite well. Goldman was not only the leader in the traditional investment banking businesses of underwriting debt and equity securities and in advising on M&A deals, but it had also started to become a leader in the business of investing its own capital, as a principal in trades and as a major investor in a variety of its own private-equity, bridge loan, and hedge funds. For years, there had been a reluctance under the traditional investment bankers Whitehead and Weinberg to take risks as principals, but there was no holding back now that the transaction-oriented Rubin and Friedman, arbitrageur and M&A banker respectively, were in charge. And besides, many of Goldman’s competitors were way ahead of it in taking these risks; Goldman, playing catch-up to some degree, was determined to show the rest of Wall Street how to take these risks, in a prudent fashion (or so it hoped). By the early 1990s, Mark Winkelman had resurrected J. Aron, in part by broadening the commodities it traded, including oil and grain, among others. Winkelman rode his masterful management and turn-around skills to a seat on the Management Committee and as co-head of fixed-income with a successful trader named Jon Corzine. J. Aron had become a big part of Goldman’s profit story. After years of acting only as an agent in the buying and selling of interest-rate swaps, Goldman had started acting as a principal in that business, too. “We were in the chicken camp on that,” Friedman said, before Goldman found courage. Goldman had also started a $783.5 million distressed investing fund, the Water Street Corporation Recovery Fund—named after a street that runs perpendicular to Broad Street in downtown Manhattan—with $100 million of its partners’ money to invest in the discounted debt securities of companies as a way to control them after a restructuring process.
Like other firms, Goldman had started a series of private-equity funds to invest its own capital, and that of third parties, in companies and in real estate that the funds—and Goldman—would control. The first Whitehall real-estate fund—named after another downtown street—was started in 1991 to buy skyscrapers, particularly in Manhattan, and other massive real-estate projects around the globe. Goldman’s first private-equity fund, with more than $1 billion in it, began in 1992. Like many of its competitors, Goldman even started to make “bridge loans”—secured and unsecured loans put on Goldman’s balance sheet—to companies in the process of buying other companies, enabling them to “bridge” their financing needs. The loans offered Goldman the potential for huge fees—after all, the financing made the deals possible—but also the huge risk that the loans might not be paid back or syndicated to other investors (oops!). By December 1990, a number of these loans that Goldman had made—for the leveraged buyouts of Southland Corp., the owner of 7-Eleven, of National Gypsum, and of R. H. Macy—had come a cropper. And one bridge loan in particular—made by First Boston in March 1989 for an acquisition of the Ohio Mattress Company, owner of the Sealy and Stearns & Foster mattress brands—became known as “the Burning Bed” deal and almost sank the venerable investment bank after the $457 million loan could not be repaid in the wake of the collapse of the junk-bond financing market. The loan represented 40 percent of First Boston’s capital and forced the bank into the arms of Credit Suisse.
Goldman’s growing fascination with its principal businesses—whether in trading or investing—was understandable, especially from a good, old-fashioned moneymaking perspective. After all, advising on an M&A deal could take a year, or longer, between germination of an idea and a successful closing. While the fee on a big merger assignment could easily be in the tens of millions of dollars and require little capital to accomplish (bridge loans aside, a product that quickly faded from the scene given the deadly risks), there was also the risk that a deal team could spend huge amounts of time working on a project that might not happen or another company might win the asset, leaving nothing to show for many hours of work. The same could be said, too, for the underwriting of debt or equity securities, which may or may not end up happening, and, worse, tie up the firm’s capital, as Goldman knew well from the 1987 BP underwriting. Even a successful underwriting—for instance, Goldman’s handling of the Ford IPO—could take years and yield relatively little in fees (but huge bragging rights for sure). A successful trade, though, while also requiring the firm’s capital, could be resolved far more quickly than an underwriting or an M&A assignment, usually in days or weeks. If the traders were clever and astute and (mostly) avoided reckless trades, the profit potential could be enormous, as Goldman was discovering.
The market had started to take notice of the changes taking place at Goldman. Under the “reign” of Friedman and Rubin, Forbes reported in 1992, “Goldman seems to be putting less emphasis on serving clients and more on dealing for its own account.” The magazine noted that while other firms were ahead of Goldman in this activity, “for Goldman it is a landmark departure” and that while “[s]uch is the power of the firm that no one wants to criticize it in public,” one former partner said “flatly” that “[t]here has been an enormous change [at Goldman], from worrying about clients to worrying about revenues.” (Sensing that the Forbes article could be critical of the firm, Goldman executives declined the magazine’s requests for interviews.) For instance, for years under Whitehead and Weinberg, Goldman resisted entering the asset management business because those two senior partners did not want to compete with the money managers who bought the stock and bond offerings Goldman underwrote. But, under Friedman and Rubin, Goldman’s asset management business had grown considerably, to reach $30 billion in assets under management. “Goldman is only doing what the other firms do,” Forbes observed. “But that’s the point: In the past, Goldman set itself apart.” By 1991, Goldman found itself at loggerheads with investment banking clients. Some complained that Goldman’s Water Street Corporation Recovery Fund, set up to buy bonds of troubled companies, was working against them. They also accused the fund of basing investments on confidential information they had supplied to Goldman bankers.
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RUN BY PARTNERS Mikael Salovaara, Alfred “Fred” Eckert III, and to a lesser extent Kenneth Brody, from the outset the Water Street fund was known for Salovaara’s brilliant—but aggressive—tactics and its high returns. In the rough-and-tumble world of investing in the debt of distressed companies or those involved in a restructuring—where successful investors were known as “vultures”—there were many courageous and clever investors. Nevertheless, at thirty-seven years old, Salovaara stood out among them for both his investing savvy and his ability to turn arcane bankruptcy laws and practices to his advantage. But the very skills that made Salovaara an admired investor made him a lousy partner, and Goldman started very quickly to rue its decision to start the Water Street fund, which became an unwanted poster child for conflicts of interest—a supposed outlier for a firm that prided itself on being able to manage its conflicts.
Salovaara’s highly profitable investment in the bonds of Tonka Corporation, the toy-truck maker—where the fund made $71 million on an investment of $84 million—was a case in point. Water Street began buying the distressed bonds of Tonka during the summer of 1990, shortly after the fund started, when toy maker Mattel, Inc., made an amorphous public announcement about wanting to make an acquisition. Tonka, although struggling, was an obvious acquisition target for Mattel, so Salovaara made the decision to start loading up on its bonds, which were trading at a discount given the company’s financial difficulties. It was a risky bet, to be sure, because if no acquisition emerged, Tonka could be in serious financial trouble.
In late September, John Vogelstein, a principal at buyout firm Warburg Pincus—the largest shareholder in Ma
ttel—called Salovaara and told him Mattel was considering making an offer for Tonka. After the discussion, Water Street bought more Tonka bonds. In the end, Mattel did not make an offer for Tonka, since a third toy maker, Hasbro, made an offer for Tonka instead, and Mattel chose not to compete. Eventually, Hasbro acquired Tonka, but not until Hasbro increased its original offers for the Tonka bonds in order to win Salovaara’s support for the deal, leading to huge financial gains for Water Street—and speculation that Water Street had used inside information about a potential deal for Tonka to load up on its bonds. The Wall Street Journal reported that Vogelstein and Salovaara had spoken, and then Water Street bought more Tonka bonds. This “led to concerns among some Goldman clients, and was viewed as an embarrassment by some Goldman partners,” according to the New York Times. But this was a seriously gray area since insidertrading laws apply to trading in stocks, not bonds—although there remains to this day no good reason for a legal distinction to be made, especially since the bond market is exponentially larger than the stock market and inside information just as valuable. The SEC did investigate the matter, though, without making public its findings.
The Water Street fund was also the focus of other charges of conflicts of interest with other Goldman clients, such as the Journal Company, a bankrupt owner of newspapers that Goldman had previously worked with as an investment banker, and USG Corp., a gypsum-board manufacturer working hard to restructure out of bankruptcy, for which Goldman had underwritten securities. Despite Water Street’s success, the negative publicity around the appearance of conflicts of interest was more than Goldman bargained for. In early May 1991, the firm announced that Water Street would immediately stop making investments and wind down. “The intensity of the unforeseen reactions was out of the range we had anticipated,” a Goldman official told the Times, speaking on condition he not be named. “This is a client-driven firm. We are sensitive to the perceptions of people.” By July, the three Goldman partners—Salovaara, Eckert, and Brody—announced they were leaving the firm.
Other senior Goldman partners were leaving, too, including Geoff Boisi, the head of investment banking and subject of the slavish profile in the New York Times. Friedman had a bruising falling-out with Boisi, his onetime protégé in Goldman’s merger department. “No star shone brighter than Boisi’s,” Lisa Endlich wrote. “He was dyed-in-the-wool Goldman Sachs, a culture carrier of the first order and a formidable money generator. Like most of those who rose to the top of Goldman Sachs’ banking hierarchy, Boisi was intensely ambitious, with an understanding wife and family. The claims of the job seemed to have no limit.” After graduating from Wharton in 1971, he joined Goldman’s M&A department and became a partner in 1978. Two years later, he was head of the merger department. By 1988, he was named head of investment banking and went on the Management Committee. There was little question Boisi’s ambitions and talents made him a leading candidate to be part of the succession equation at Goldman Sachs whenever Friedman and Rubin decided to retire. But, in 1990, Boisi unexpectedly gave up his job running investment banking to take charge of strategic planning at the firm. He was forty-four years old. Neither Boisi nor Friedman will discuss what happened, but the scars in both men remain visible.
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THE WATER STREET debacle aside, being a principal required capital. Goldman had at its disposal its partners’ capital, the profits it retained annually, the $500 million Sumitomo had invested in 1987, and billions of dollars in borrowings. Nothing was more highly prized than equity capital, though, since that money could be leveraged—borrowed against—to create a bigger pile of cash that could be used to invest and to make bets. The downside of equity capital was that it could be expensive financing, in that it usually required parting with an ownership stake in the company. For instance, for its $500 million, Sumitomo owned a 12.5 percent nonvoting stake in Goldman, an investment Sumitomo assumed would increase in value over time as long as Goldman was prudent. Of course, from Goldman’s perspective, if the firm did well and its value increased, Sumitomo’s equity would likely be worth far more than the $500 million invested—which is exactly what happened—but if the firm did poorly, there was no obligation to pay the money back to the investor. By contrast, debt financing can often be far cheaper than equity financing, since a debt investor expects to receive for his borrowed money the return of the original principal plus a fixed rate of interest. Most companies have a mix of both debt and equity financings.
In 1990, in order to supplement the Sumitomo investment, Goldman obtained another $275 million from a consortium of seven large insurance companies in the United States, United Kingdom, and Japan. Two years later, in April 1992, Goldman turned to a new outside investor—a Hawaiian educational trust, Kamehameha Schools/Bishop Estate—for another $250 million in equity. The trust, known as the Bishop Estate, was established in 1884 after the death of Princess Bernice Pauahi Bishop, a great-granddaughter of King Kamehameha I, who unified the Hawaiian Islands in the early 1800s and kept them independent from European colonizers. At the time of her death, Princess Pauahi owned approximately five hundred thousand acres of prime Hawaiian real estate, among the most valuable oceanfront property anywhere, and this acreage became the chief asset of the Bishop Estate. The chief beneficiary of the trust is the Kamehameha Schools, a private institution for children of Hawaiian ancestry. Although Goldman would not say specifically what percent of the firm the Bishop Estate received for its $250 million, the New York Times reported that the money bought between 5 percent of the firm, valuing Goldman at $5 billion, and 6.25 percent, valuing Goldman at $4 billion. Given that the valuation of Goldman was $4 billion for Sumitomo’s investment five years earlier, the likelihood was that Goldman was worth $5 billion in 1992 and that the Bishop Estate’s investment was closer to a 5 percent stake.
Most Goldman partners credited Jon Corzine, the co-head of fixed-income and CFO, with arranging for this investment, but the lead was really brought in by an obscure fixed-income institutional salesman in the San Francisco office named Fred Steck.
Two years later, after another $250 million cash infusion into Goldman from the Bishop Estate, Steck was up for partner. A bunch of senior Goldman partners were discussing whether Steck had the right stuff. “Fred Steck, you know, I don’t really think Fred Steck should be a partner,” one of them said. “He doesn’t have the capability and he’s not broad-based. I’m not sure it’s the right thing.” But Corzine stood up for Steck. “Shut the fuck up,” Corzine said. “He just saved the firm.” Steck became a partner.
CHAPTER 13
POWER
One of the people Goldman hired as a consultant during its consultant-hiring spree was Lawrence Summers, a Philadelphia-born Harvard economist whose two uncles—Paul Samuelson and Kenneth Arrow—had both won Nobel Prizes in economics. Summers’s parents, Robert and Anita, were also economics professors.
During the summer of 1986, when Rubin and Friedman were still the co-heads of Goldman’s fixed-income group, Jacob Goldfield, a precocious and gifted young Goldman trader, suggested to Rubin that he and Summers should meet. Goldfield grew up in the Bronx, where his mother was a clerk in the New York City Health Department and his father had a small store, wholesaling women’s clothing. After graduating from high school in the Bronx, Goldfield studied physics at Harvard but also dabbled in graduate-level courses that interested him, including econometrics. At Harvard, Goldfield was famous for being really smart. One day, he and a friend, also a physics major, were studying for the exam in econometrics and decided to go see Summers the day before the exam, since Goldfield’s friend knew Summers and figured he could help them understand the difficult subject matter. Summers tried to help the two undergrads but finally gave up. Time was too short and the subject matter too complex. Even Summers hinted he would have trouble getting an A on the exam. In the end, Goldfield took the exam and got the highest grade the professor had ever given on a final. This was sometimes the way things went with Goldfield, whose in
tuition and different way of thinking generated occasional flashes of brilliance. Since Summers was in the economics department, he ended up hearing about Goldfield’s rather astounding achievement on the econometrics final. This led to their having regular discussions and the occasional meal together.
After graduating from Harvard, Goldfield bounced around Europe for a bit and then headed back home to the Bronx, where he lived with his parents. While at home, he took the LSAT and applied to Harvard and Yale law schools. He chose Harvard Law because he believed it to be less intellectual than Yale and therefore more practical and likely to lead to a better career (ironically, the opposite of Rubin’s reasoning). After his first year at Harvard Law, he managed to get an interview at Goldman for a summer job, which was not easy, since the firm did not recruit at Harvard Law, even though its two senior partners-to-be—Rubin and Friedman—were both lawyers. Through the Harvard Business School, Goldfield finagled an invite for lunch with a number of Goldman’s leaders. He got the summer job in the sales and trading group. Then, so he wouldn’t go to another firm, Goldman offered Goldfield a full-time job trading government bond options. He dropped out of Harvard Law School and joined Goldman Sachs.
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