Goldman was headed for more trouble, and Corzine knew he had to get the Maxwell matter behind him. Goldman tried to get the judge in the pension suits to dismiss the cases but, instead, she ordered them to proceed and claimed that Goldman had “virtually ignored all the allegations at the heart of the plaintiffs’ case” when it filed its motion to dismiss. With the litigation hanging over the firm, Corzine decided to pay $254 million to settle the two pension cases plus the remaining potential claims against the firm. (He thought the actual cost to Goldman was closer to $400 million, once the cost of unrecovered loans, lost business, and fines was included.) According to the New York Times, the amount Goldman paid was more than twice what the market had expected. Worse, the paper reported, the cost of the settlement would be borne by those people who had been partners in 1989, 1990, and 1991—with 80 percent of the settlement cost paid by the 1991 partners. “Assigning the costs caused a rift at Goldman because 84 of the 164 partners who were asked to pay are limited partners and have no day-to-day responsibility for managing the firm,” the paper reported. “These partners wanted active colleagues, called general partners, to share the burden.” In a memo to the partners, the Management Committee wrote that the settlement “should meet the appropriate expectations that anyone who has been a general partner should have developed regarding how a matter such as this would be handled if it ever arose.”
Less well known was the fact that if Gene Fife, the partner negotiating on behalf of Goldman with Sir John Cuckney, the government-appointed arbitrator, had been unable to reach a settlement, Goldman would have been charged criminally. “Gene, I think you might be interested in this document,” Cuckney told Fife after they reached an agreement. “Had we been unable to agree to terms as we have just done, it had already been decided that our negotiations would have been terminated completely and Goldman Sachs would have been formally charged this day.” Corzine knew in his gut the time had come to get the matter behind the firm. “I have one of these theories, you turn up a rock at almost any place, any time, particularly where there’s trouble, there’s gonna be more trouble,” he said. “That’s how I felt about Maxwell.… I figured we were going to take a lot of flak for settling, but we were going to take a lot more flak every day and every month if we didn’t. For the life of me, I still don’t know for sure what happened. But it was one of these episodes that felt to me like it could go very negative for the firm.”
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IN ADDITION TO believing that he had to get the Maxwell lawsuits resolved, Corzine also wanted to expunge the fog of pessimism that seemed to have curled into every corner of the firm in 1994. “There was a psychology that needed to be broken about whether we could be successful at Goldman Sachs,” Corzine explained. “The ‘culture of excellence’ had come unwound and deeply bruised. And there were a bunch of pessimists who were willing to accept that, and I just wanted to challenge that psychology.”
At the annual partner offsite, at Arrowwood in January 1995, he put up a slide that caused audible gasps in the room. “I’m not really good at the vision thing,” Corzine told his partners, “but I’m gonna do the vision thing.” Coming off one of the worst years in the firm’s history, Corzine challenged the partners to generate $10 billion in pretax profits in the five years between 1995 and 1999, or $2 billion pretax per year. “There were a lot of people who were mumbling and grumbling; I could tell the minute the slide went up,” he said. “Some people thought it was ridiculous, some thought that I had undermined myself by doing that.”
Corzine said he didn’t mind the cynicism because he wanted to challenge the status quo at Goldman. He said that was “the art of leadership” and it was unacceptable to “sit around accepting that just because the immediate past was what it was, that’s what the future held.” He said it was “essential to change the attitude” at the firm “about whether we could be successful” again “and I absolutely believed that we could be successful again.”
The financial markets, though, were still concerned about Goldman’s financial health. As a follow-up to the $250 million in equity it had raised from the Bishop Estate in November 1994, in March 1995 Goldman “quietly raised” another $272 million in the private debt markets, according to the Wall Street Journal. “The latest capital drive is remarkable because it shows that while Goldman may be the top-rated brokerage firm by the credit agencies, institutional investors aren’t quite as sanguine about the firm’s credit prospects,” the Journal reported. The paper reported that Goldman had to pay an interest rate of close to 9.5 percent to attract investors for a ten-year security, significantly above the 8.846 percent rate that Lehman Brothers had to pay two weeks earlier to sell its own ten-year bonds.
A month later, two of the Journal’s investigative reporters, Alix Freedman and Laurie Cohen, wrote a 4,200-word front-page story about how the Bishop Estate was able to maintain its tax-exempt charitable status at the same time that it had an increasing array of profitable investments—for instance, its investment in Goldman Sachs—that it was permitted to shield from income taxes after winning one private favorable tax ruling after another from the IRS. Freedman and Cohen revealed that Bob Rubin, who had by then replaced Lloyd Bentsen as treasury secretary, had sought out the Bishop Estate with an unusual request in December 1992, when he was leaving Goldman—along with a reported $26 million pay package—to take the reins at the National Economic Council. Most of Rubin’s net worth was tied up in his partnership interest in Goldman, of course, and he was anxious to preserve the wealth he had meticulously built during his Goldman tenure. While it was not clear what the origin of the idea was, just after the Bishop Estate finished its first investment in Goldman and just as Rubin was leaving Goldman, the firm placed a call to the Bishop Estate, which agreed to guarantee—for a $1 million fee—the value of Rubin’s stake in Goldman, in the unlikely event that Goldman ever went bankrupt. “Bishop will get to pocket about $1 million in fees from Mr. Rubin and to enjoy the satisfactions, however intangible, of having a lasting relationship with the man who now, it turns out, oversees the IRS,” the Journal reported. Rubin also faced criticism for using the Treasury’s $20 billion discretionary fund to help bail out Mexico, which suffered a financial crisis shortly after devaluing the peso in December 1994. One of the main beneficiaries of the Mexican bailout was Goldman Sachs, which was one of the chief underwriters of Mexico’s sovereign debt and would surely have faced billions of dollars in lawsuits had the rescue financing not been put in place, which helped restore confidence in the Mexican economy and kept its bonds from defaulting.
Freedman and Cohen were granted a rare audience with two of the Bishop Estate trustees, Henry Peters and Richard “Dickie” Wong. During the interview, Peters and Wong “broke out of their reserve to lavish praise” on Goldman: the firm was an “astronomical opportunity” and a “long-term play” for the foundation because it was the “crème de la crème” of Wall Street. Soon enough, Freedman and Cohen elicited from Peters and Wong that what the Bishop Estate wanted from its $500 million investment in Goldman was a massive payday, the kind a Goldman IPO could provide. “Without being asked, Mr. Peters raises the topic of Goldman’s ‘IPO potential,’ ” the Journal reported, “then coyly says he won’t comment. But in the next breath, Mr. Peters blurts out: ‘Heck, I see an opportunity.’ ”
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A COMBINATION OF a general improvement in market conditions in the middle of the decade—coming out of the credit crunch of the late 1980s and early 1990s—plus the power of Corzine’s positive thinking began to have its intended effect on the type A personalities at Goldman Sachs. “He had enormous energy, unbounded energy,” one partner said, “and he was, in that sense, an energizing element in the firm. From where I sat in 1995, he looked like a good thing.” Corzine seemed to motivate people at Goldman. “Jon is inspirational,” David Schwartz said. “He would come to London three or four times a year. We’d all go into the conference room, and we would leave feeling so great about b
eing a part of Goldman Sachs.… Corzine was able to convey the culture in a really profound way.”
Another cultural change that Paulson and Corzine instituted after they took over and that seemed to ignite the troops was the new system of risk controls, accountability, internal police, and open lines of communication. Around that time, Goldman partner Robert Litterman, a former professor at MIT who had joined Goldman in 1985, created the “value-at-risk” model, which attempts to quantify how much Goldman could lose trading on any given day. (Many Wall Street firms still use a version of Litterman’s model, including Goldman, although the model’s ability to gauge genuine risk remains controversial.) Goldman created a risk committee that met regularly. The firm empowered internal accountants and risk assessors and gave them the authority to challenge traders on a regular basis about what they were doing. A chief risk officer position was created. Goldman completely transformed the way risk was assessed, calculated, and communicated on Wall Street—although no other firm on Wall Street took the matter nearly as seriously as did Goldman, in part because the firm had survived so many near-death experiences and in part because, unlike nearly every other large firm on Wall Street, the firm’s partners had their own money at risk on a daily basis. (In November 1996, the firm would become a limited liability partnership in order to further limit some of downside risks partners faced.)
One of the people who became a partner during the 1994 turmoil was Armen Avanessians, a 1981 graduate of MIT with a master-of-science degree from Columbia University. Before joining Goldman in 1985 as a foreign exchange strategist, he was an engineer at Bell Laboratories, in New Jersey, where he worked in the common subsystems laboratories. Avenessians, more than perhaps anyone else at Goldman, was responsible for creating the internal, proprietary computer system that gave the firm an enormous competitive advantage in the assessment and monitoring of risk. Together with Mike Dunbo—who is now in charge of technology at Bank of America’s Global Markets Group—Avenessians created at Goldman what is called “SecDB,” short for “Securities Database,” an internal, homegrown computer system that tracks all the trades that Goldman makes and their prices, and closely monitors on a regular basis the risk that the firm faces as a result. “It meant that you didn’t have the corporate bond guys in New York doing something different than the corporate bond guys in London,” according to someone familiar with SecDB. As important, SecDB put sophisticated real-time securities pricing information in the hands of both the bankers and the traders, allowing bankers to have conversations with their clients about how a security might be priced in the market without having to consult with traders, which was often the path that bankers at other firms were required to follow. “You can have sophisticated bankers thinking about the same problems, but with exactly the same tools that the guys on the desk are using that were trading the billions of dollars,” this person continued. “You had a holistic view of how you looked at things. It’s been broadened out over fifteen or twenty years. It’s taken a long time, but it’s grown so that there’s a real uniformity to the way the risk is viewed.”
These changes began to pay off, and the firm became immensely profitable. By the second half of 1995, Goldman had turned its business around. In the last six months of the year, the firm earned $750 million, pretax, and its annual run rate for pretax profitability had improved to $1.5 billion. Corzine was becoming increasingly confident that his $10 billion pretax goal was within reach. The old culture had been a trading free-for-all, where, according to one partner, “if you were trading Treasuries and you liked oil, you just put a bet on for oil. And if you were trading equities and you wanted to buy corn, you just put on a corn bet. There weren’t a lot of limits. People were just doing things all over the place.” It now changed to a far more disciplined machine where risks were closely monitored. “What came out of the 1994 debacle was best practices in terms of risk management,” Paulson said. “The quality of the people, and the processes that were put in place—anything from the liquidity management to the way we evaluated risk and really the independence of that function—changed the direction of the firm.” When the firm “post-mortemed” 1994, Corzine said, the Goldman leaders had to parse between a “failure of strategy” and “a failure of execution.” They agreed that the strategy had been correct but the execution had been flawed, at least that year.
The top executives at Goldman Sachs became risk managers as much as anything else. “I didn’t say, ‘I’m a banker, I don’t understand this stuff,’ ” Paulson recalled. “I was at every risk committee meeting. I was doing everything I could to understand the firm’s risk. I did that right up until I left the firm.” In September 1995, Corzine explained to Institutional Investor that he had “rededicated the firm to client service” and the “days of Goldman being a hedge fund in disguise are over.” But he was careful to say that did not mean Goldman would simply return to being a low-margin broker between buyer and seller. “You can’t achieve the kinds of returns we want by just buying on the bid and selling on the offer,” he said. “Reading flows and taking positions is still a very attractive revenue producer for Goldman Sachs in the fixed-income and foreign exchange areas.” Corzine conceded that Goldman had been hurt by the departure of the forty or so partners who left at the end of 1994. To help compensate for the loss of talent, Corzine moved John Thain, the CFO, to London to co-head Europe with John Thornton, the M&A banker, to help “clean up the fixed-income mess.”
By the annual partners’ meeting at Arrowwood in mid-January 1996, the firm was hitting on all cylinders. In the weeks leading up to the offsite, the papers were filled with speculation about whether this time—after five rejections in the previous twenty-five years—the Goldman partners would decide to go public. Corzine himself fueled the speculation by saying an IPO was being considered. “If you did not have this discussion there would be a big debate about why we aren’t talking about this,” he said. “In the long run, Goldman’s capital structure is expensive and vulnerable,” one rival Wall Street CEO said at the time. “It’s not as strong as a public company’s would be. It’s untenable.” He said, “If earnings are high, the capital structure is not a problem.… But if earnings are not great, they are vulnerable, and if they lose money there will be a crisis.”
The other looming question, though, about the potential Goldman IPO was a simple one of greed and mathematics. Since Goldman named new partners every two years, the fact was that 98 of the firm’s 174 partners, or 53 percent, had been partners only since the end of 1992. With 1994 being such a bad year, the majority of the firm’s partners had not had the chance to build up sufficiently large capital accounts to make it seem worthwhile to them to push for the IPO. They had not had “a shot at the golden carrot” yet, as one competitor put it. It seemed like déjà vu all over again. For Corzine, with a reported 1.5 percent stake in Goldman’s profits—the largest individual stake at the firm—the rewards were obvious, but he was just one vote. Corzine knew he had to tread carefully. “Now would be a good time to go public,” one newspaper observed on the eve of the meeting, “but it doesn’t need to.… Should the older partners risk alienating the younger ones by pushing for a flotation which would allow them to take their cash out?” Added another observer as the meeting opened, “If Goldman’s partners are salivating a little today, it will not be over the pheasant on the dinner menu. But not everyone will be so enthralled. Partners only recently instated will have accumulated much smaller stakes, perhaps of only $1 million, and will favour waiting for them to grow larger before the bank is sold. They want the jackpot, too.”
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WITH THIS BACKDROP, Corzine and Paulson assembled the Goldman partnership at the Arrowwood meeting. “A year and a couple of months does make a significant difference,” Corzine said in his remarks. “We—all of us—have turned the tide for this great organization.” Goldman had earned $1.4 billion pretax in 1995 (and its run rate during the last six months of the year was $1.75 billion) and therefore
to meet Corzine’s goal, the firm needed to earn an average of $2.2 billion during the next four years. Up went his $10 billion chart again. “A year ago,” he said, “the chart behind me was categorized as, at best, improbable and, at worst, simply Pollyannaish.” Not anymore. “It’s a big objective,” Corzine told his partners. “But it is clearly doable.”
Corzine articulated three goals and aspirations for the firm, the likes of which no other Wall Street firm had ever attempted, at least with anything resembling a straight face. First, Goldman needed to be “the world’s recognized best at providing a broad range of financial services” in the judgment of “our clients, outside regulators and creditors and, most importantly, in the eyes of our partners and people.” Second, Goldman needed to “constantly maintain and enhance our culture of excellence.” He noted, of course, the importance of “teamwork and mutual support.” The firm was committed to focusing on the long term and to a “merit-based reward system,” where “what you do” determined “your career path” not “who you know.”
Then, having fed the crowd boilerplate rhetoric, Corzine got to the heart of what Wall Street firms were really about: Goldman Sachs existed to “provide superior wealth creation for the owners and the best people” at the firm. The firm’s “financial objective,” he said, “was to achieve meaningful absolute profits” that would generate after-tax return on equity—net income divided by the firm’s capital—of “at least 20%.” Then Corzine mentioned in passing the subject that had been on his mind for years: whether Goldman would remain a private firm in the future or would go public. It was just a quick mention, but it offered a glimpse of what he planned to talk about the next morning and indicated that it was a matter of some ongoing importance to Corzine, especially since the whole idea had been dismissed summarily a year earlier. “We are going to move to a [return-on-equity] orientation regardless of our future capital structure,” he said. “In a private firm, ROE is a means for capital allocations, and in a public firm ROE is what drives multiples and therefore shareholder wealth.” He emphasized that focusing on ROE was a significant change for the firm and “will stimulate changes through time in how we run our business” and cautioned his partners that “we must get the benefits” of focusing on ROE “without its potential for seeding divisiveness” by favoring certain businesses over others, depending on their relative profitability.
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