Money and Power

by William D. Cohan

  With Gorter’s retirement in 1988, Paulson became head of the Chicago office. At the end of 1990, Friedman asked Paulson to co-head investment banking with Hurst and Overlock. At first, the arrangement was a bit awkward, but the three men got along reasonably well and were able to divide up the managerial responsibilities. They also continued to work with clients, an arrangement that made Paulson comfortable. He also took on responsibility for Asia, which for Paulson was a revelation, since most of his international experience centered on canoeing trips in Canada. “I got Asia by default,” he said. “No one wanted to go to Asia. We had almost no business there. I remember Bob Hurst telling me, ‘You should go to Asia because Chicago’s closer.’ ”

  Paulson said he became “fascinated” by Asia and determined to build up the firm’s presence there. One way to do that—as he and Rubin had done in Mexico with Goldman’s assignment to privatize Telmex, the telephone company—was to work hard to win the assignment to privatize formerly state-owned enterprises. Paulson believed this represented a “branding opportunity” for Goldman in these foreign countries. He convinced Goldman’s partners to invest $1 million in Star TV, the largest satellite-TV provider in Asia, owned by Hong Kong billionaire Li Ka-shing. He convinced Tung Chee Hwa, a shipping executive who became the first chief executive of Hong Kong in 1997, to take him to China, in 1992, to meet Jiang Zemin, just before he became China’s president. “I was very impressed with President Jiang Zemin and what he knew about the U.S.,” Paulson said. “And what he knew about markets.” Paulson and J. Michael Evans worked together intently to win for Goldman the assignment to underwrite the IPO of China Mobile. “I still remember the legendary Chinese premier Zhu Rongji, whom I greatly admired, looking at Mike Evans and saying, ‘Mr. Evans, if I had ten people like you I’d restructure all of our state-owned enterprises. And if I had 100, I’d turn around this country,’ ” Paulson recalled.

  There was no question that by the fall of 1994—and his walk in Central Park with Corzine—Paulson was a premier investment banker. The question on the table, though, was could he figure out a way to work with Corzine in a subservient position to lead Goldman Sachs out of its funk?

  ——

  IMMEDIATELY AFTER FRIEDMAN’S announcement that he would resign came the stories that Goldman would experience an unprecedented “wave of retirements” of limited partners that could “suck about $400 million of partners’ capital out of Goldman” in the next five years, reducing the firm’s $5 billion capital account. Friedman then admitted the firm was in discussions with private investors to replace the capital that its limited partners—including Friedman, who reportedly had $100 million tied up in the firm—might take out after they left. But there was no pressure on Goldman to raise new money, Friedman insisted. “We have never been in a stronger capital position,” he said. “Each time we raised money we didn’t have a pressing need for it.” Two months later, on November 29, Goldman announced that it had raised another $250 million in equity capital from the Hawaiians, at the Bishop Estate, for between another 4 percent and 5 percent of the firm, which valued it at between $5 billion and $6.25 billion, a higher valuation than two years earlier. The new investment increased the total ownership by outsiders in Goldman to 20.5 percent, from 16.5 percent.

  With his decision to take the number-two job at Goldman made and announced, Paulson had some serious explaining to do to Wendy. He had left Chicago a few days earlier, telling her his view that he was unlikely to become a leader of the firm. Indeed, such was his mind-set going into the weekend that he did not bring enough clothes with him for an extended stay in New York. Someone went to Brooks Brothers and bought him a bunch of shirts and ties. Wendy sent him some suits. He moved into the Pierre for months. “I didn’t go home,” Paulson said. “I just stayed in New York.” He called her on Sunday night before the public announcement. She was in a state of shock. “Wendy, I have to do this,” he told her. He just needed to help the firm get “through the crisis and then I can reassess.” He told her he needed to help the firm in its time of acute need. With Corzine’s appointment as the firm’s new leader, he felt his presence was essential to make sure the firm’s strategic direction stayed on track and to make sure that any personnel cuts were not made irrationally. “The investment bankers were so disillusioned with what was going on,” he said. “We had a disproportionate number of investment banking partners relative to the profit, and they were very concerned about the trading losses.” He told his wife, “I’ll be able to play a key role in getting them to stay. I just have to stay and work here and get this done.” Wendy Paulson was not happy with the turn of events. “Wendy has always been very supportive of me,” Paulson said, “and she basically said, ‘This is terrible, but I’m going to come to New York and find an apartment for us.’ ” (In February, they moved into a modest apartment in a building above the movie theater at Sixty-seventh and Broadway, around the corner from the Second Church of Christ, Scientist, at 77 Central Park West, which the Paulsons attended regularly. Later, they bought two apartments in the building, for $2.88 million, and combined them; they sold the combined apartment in 2006 for just under $8 million.)

  Even though Friedman wasn’t due to retire until the end of November, he quickly vacated 85 Broad Street and moved to Midtown, where he joined John Weinberg. He also had his health checked. “I frequently felt crummy,” Friedman said. “I couldn’t tell you how frequently I got these episodes”—the arrhythmia—“because I wasn’t smart enough to know I was having them. I just thought I was suffering from jet lag.” He visited with doctors at Mount Sinai Hospital, New York Hospital, and the Cleveland Clinic. His condition was not a rarity. “What they worry about is not how fast your heart is going,” he said. “When they diagnosed me, it was going 150 beats a minute. They worry about the irregularity. Can a clot form and, you know, get a stroke? It never occurred to me—and, hey, I’m a jock—it never occurred to me to take my pulse.” After receiving the diagnosis, the doctors gave him blood-thinning medication.

  Years later, at the end of 2002, Friedman would join the parade of Goldman partners working for the federal government. Joshua Bolten, a former Goldman partner who was then the White House chief of staff, wanted to recruit Friedman to replace Lawrence Lindsey as an assistant to President Bush for economic policy and the head of the National Economic Council, the same job that Clinton had created for Rubin a decade earlier. (Bush had fired Lindsey abruptly after he bucked the party line about the potential true cost of the Iraq War, suggesting it could be—correctly—as much as $200 billion or more.) One night, after dinner, Friedman was reading something and suddenly had another heart “incident.” Next thing he knew, he had spent nine hours on a gurney at New York Hospital “having stuff dripped into his veins.” When he got back home, he decided to call Bolten at the White House and tell him he could not take the job. He was too concerned about his heart and the stress that being at the White House would put on him. “My wife is standing there and she was doing high-fives,” Friedman recalled.

  About five minutes later, the phone rang. Barbara went looking for her husband. “It’s the White House calling,” she told him. “I think it’s the president.” Friedman got on the phone with Bush. His wife could only hear his side of the conversation—a lot of “Yes, sir” this and “Yes, sir” that. Recalled Friedman: “He said, ‘Look, you go talk to your doctors. We really want you here. You take your time. You talk to the doctors. And if they say you can do it, do it.’ His father, Bush 41, had this and has this. He said—and this is the clincher—he said, ‘You know, my old man fought a war with this. You can be an economic adviser.’ ” After agreeing to take the proper medication, the doctors cleared Friedman to take the job, and he did. “And by God, I went two years in Washington without an episode,” he said.

  CHAPTER 15

  $10 BILLION OR BUST

  From the outset, Corzine and Paulson had to figure out ways to apply tourniquets to the blood rushing out of the Goldman
Sachs corpus. The trading losses continued in September, October, and November. “Big losses, hundreds of millions [of dollars] in a big part of the firm,” one partner said. Some partners attributed the ongoing losses to Winkelman shutting down after he realized he was not going to be running Goldman Sachs. “Mark Winkelman was literally dysfunctional because he wasn’t running the firm,” explained another partner. “I don’t know if it was a nervous breakdown or whatever. You just have to talk to him and have him tell you what he went through.” (Winkelman declined repeated requests to be interviewed.) The problem with Winkelman was compounded by the fact that he was still head of fixed-income and Corzine, his former partner in running fixed-income, did not want to micromanage Winkelman after he became the head of the firm. “For a long time he just sort of sat in his office,” one partner said of Corzine. “He would sit in his office breaking out in tears at various times while the firm was losing all this money.”

  Goldman’s ongoing losses, of course, ate into the firm’s finite capital, and since the firm was highly leveraged—at that time nearly 50 to 1, meaning that roughly $100 billion of assets were being supported by roughly $2 billion in partners’ capital—the risk of financial disaster started looming larger and larger. “There’s two sets of issues,” Paulson said, speaking about the firm’s problems in 1994. “There’s leverage and the lack of permanent capital. Then there’s liquidity. Now when banks and investment banks die they die quickly because of liquidity problems.” In 1994, liquidity was not a problem for Goldman, but there were factors that could make it one in a hurry.

  One ongoing threat to the firm’s liquidity at that time was the partners themselves. If they decided to leave, they could take out their accumulated capital—albeit over time—and deplete the firm’s finite overall capital. As the losses in 1994 mounted, many partners became increasingly nervous that the firm was at risk. They personally might lose the wealth they had accumulated at the firm, wealth that remained out of their grasp while they remained general partners. The abrupt departure of a large group of partners—all demanding their capital at the same time—could have resulted in a run on Goldman Sachs. “Jon and I made a huge effort to persuade partners to sign up,” Paulson said. “To stay and not leave.… We had some people who got very scared and left.”

  A lot actually. Some forty partners left Goldman at the end of 1994, the first time anything like that many partners had voted with their feet. “People resigned out of fear,” one partner said. “That should tell you something.” A number of the departures were very upsetting and cut through the muscle of the firm into the bone. Howard Silverstein, the partner in charge of Goldman’s Financial Institutions Group, left. “He was perceived as being an expert,” one partner on the Management Committee said. “And all he did was just do a simple calculation if this continues. You know: wiped out.” The departure that really shocked people was that of Charles “Chuck” Davis, who was running Goldman’s banking coverage group. “I almost slugged him,” another member of the Management Committee said when he heard Davis was leaving. Frank Brosens also took this opportunity to leave Goldman. More than balancing out the departures, however, was the naming of fifty-eight new partners, the largest group of new partners in the firm’s history. (The class of 1994 included such future Goldman leaders as Gary Cohn, Michael Evans, Christopher Cole, Byron Trott, and Esta Stecher, as well as Eric Mindich, who at twenty-seven was the youngest Goldman partner ever.) Although Paulson was plenty worried by the financial losses and the unprecedented departures, he said he never believed Goldman was “going to fail” in 1994. “I always believed that we would get enough people to sign up” to stay as partners, he said.

  The key to getting enough partners to stay was Paulson’s tough decision to cut around 25 percent of the firm’s costs. “We just cut to the bone,” Paulson said. “If you have to do something like that it’s just brutal. We found fat that we took out. That’s what it took to get a lot of the partners to stay.” Paulson cut people, travel expenses, allowances for overseas living, and many of Goldman’s vaunted perks. He even cut back on the use of a corporate jet and recalled grueling overseas trips flying around Europe and Asia on commercial flights, waving the Goldman flag with clients and nearly falling asleep in the meetings. Something like one hundred bankers and traders were dismissed. “Due to the prolonged, industry-wide turndown, some belt-tightening has been necessary,” Goldman said in a November 14 statement. “Each business unit and office has been doing their own reassessment, and several have made small, selective staff reductions where appropriate; others are still in the midst of the review process.”

  Another way Corzine got people to stay who might otherwise have left was by promising them the firm would soon go public and they would be rich. “His idea being to have people think it was lucrative to stay,” according to one partner who stayed.

  ——

  BUT GOLDMAN’S PROBLEMS at that time weren’t only ones of cost and bad bets. A culture of undisciplined risk taking had built up over many years. “A lot of these practices were set up when [Rubin] was there,” one top partner said. “Okay? The lack of a risk committee, trusting individual partners, model-based analytics—that by God you can be smart and figure it all out—and letting traders become too important and being afraid to confront them if they’ve been big moneymakers. All that sort of stuff built up.” One change Paulson and Corzine made quickly was to take the dysfunctional Winkelman out of his seat and give the job of heading fixed-income to Michael Mortara, the Salomon Brothers recruit. “He stood up and said to all the partners, ‘There’s a new sheriff in town and the risk taking, particularly in our London office, was going to be curbed,’ ” Paulson recalled. “He spoke with great credibility.” They also quickly established a formal risk committee and made the auditing, risk, legal, and accounting functions at Goldman Sachs as important and respected a career path as being an M&A banker or a derivatives trader. “Out of that 1994 period came a lot of the processes and procedures we put in place, the infrastructure, the people to manage risk,” Paulson said. Added another partner: “Any great crisis can bring people together or push them apart.”

  One banker in the Financial Institutions Group who worked for Howie Silverstein was selected to be a Goldman partner in October 1994 and a month later signed the partnership papers. He was “excited over the moon,” he said. Friedman told him (before he abdicated) what his compensation would be, something like $750,000. “It wasn’t two hours later that my boss”—Silverstein—“came in and said. ‘It’s half of that.’ I then went in to see him about an hour later and said, ‘I’m leaving for the day. So if you want to cut my compensation again I’m not here.’ ” Next thing he knew, Silverstein had quit. “Obviously, the firm’s having a tough time,” he explained, “so you sort of say to yourself, ‘Well, what’s up with that? Aren’t these the guys that I’ve been slaving with—not for, with? I mean really working hard with for a long time, and they’re quitting? I don’t get that. How can you leave? I mean, just how does that square? When it gets tough, you’re supposed to get tougher.’ ” One day, in November, Winkelman left the firm. “Winkelman, who has been a key figure in recent years, was angered after losing out in the contest to succeed Mr. Friedman,” the Times reported.

  ——

  GOLDMAN SEEMED TO be coming unglued. Weinberg’s succession plan had come off the rails. Partners were leaving in bunches. Those who stayed had their compensation slashed. Ditto the new partners. The firm was losing lots of money each month; it was in danger of failing to meet its capital requirements with the SEC. Indeed, given how the year unfolded financially, some senior Goldman partners questioned why Friedman had not made his announcement to leave earlier in 1994—say in March—and then use the next six months to run an orderly succession process with less pressure, or put in place the next leaders under him and then leave after six months.

  Friedman has heard the criticism. “If I had known how the last quarter was going to be,” he
said, “I wouldn’t have retired. But by that time, it was done. I hadn’t known, and what could I do about it? I never thought the situation was remotely as troubling as people seemed to feel. I’d lived through these goddamn crises. I’d lived through the 1987 market break, the Freeman thing, and the Maxwell thing. And I’m not the world’s bravest person. I knew what really upset me. The Freeman thing did and the Maxwell thing; 1987 did. This didn’t. I thought, ‘My god, if you can’t stand the heat—I mean, you’re way ahead on profits if you aggregate the last few years.’ The positions were always liquid and … we always had the option of just taking the positions down to almost nothing. You then reduce overhead” and return to profitability. (The firm supposedly ended up making around $500 million pretax in 1994, well below the $2.7 billion it made the year before. Others dispute that the firm made money in 1994. They say the firm was able to make it look like it broke even in 1994 by reversing capital accruals that had been built up to cover calamities such as the losses in 1994. “It was a loss of hundreds of millions of dollars,” one person said.)

  What worried Friedman were not the monthly trading losses, which could be quantified and unwound. Rather, with the rise of derivatives and other asynchronous bets, he worried more about a catastrophic blowout, especially since the firm was private and had finite capital. “Part of what irritated me,” he said about the events of 1994, “was I was one of the people who came to feel in the 1980s that Goldman Sachs needed to go public, not because of any offensive reason—though an offensive reason was part of it—but I thought for defensive reasons. In a difficult world, where you’re competing with giants who might increasingly use risk as a competitive measure, I felt we needed permanent capital. Today from the vantage point of the Goldman Sachs board, it’s obvious that there would be no room for a global private partnership.”