At the Management Committee meeting the next morning, Paulson asked Corzine to describe what had happened between him and Cahouet and the possibility of a merger between Goldman and Mellon. Corzine didn’t respond. “He gave a limp leg and basically said nothing,” one partner at the meeting recalled. Incredulous, Paulson then asked Flowers to come to the meeting and give the Management Committee a briefing. Flowers came in and gave all the details of the discussion, just as he had done the day before with Paulson. “Jon’s so mad and angry, he ran out of the management committee and into his office,” another participant in the meeting said. Corzine’s allies on the Management Committee then got angry with Paulson. “One person said, ‘You guys shouldn’t have done that. You’ve embarrassed him and now what if he quits or something?’ ” But the majority of the Management Committee was so irate at Corzine for discussing a merger with Mellon without its knowledge or consent—and then not coming clean about it—that they decided to prevent him from engaging in any future strategic discussions at all. The committee gave that responsibility to Paulson exclusively. Not a word of this decision leaked beyond the Management Committee itself. The discussions with Cahouet and Mellon were terminated immediately.
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PAULSON PUT TOGETHER a strategic-planning committee—including on it Lloyd Blankfein, the head of FICC, Goldman’s immensely profitable business focused on fixed-income, interest rates, and currencies; Steven Einhorn, the head of research; Christopher Cole, another prominent FIG banker; and Peter Weinberg, one of the three heads of investment banking—to begin to explore what the future of the banking industry would look like and whether (again) the firm should go public or should consider a merger. “We concluded we needed a lot of capital,” Paulson said. The committee was divided about whether an IPO was the right answer or whether a strategic merger would get the firm to the place it needed to be. For his part, Paulson was again becoming increasingly irritated. First, Flowers was going around and showing various senior partners how much his or her Goldman stock would be worth in an IPO, behavior Paulson thought especially uncouth. Flowers’s attempts to appeal to employees’ greed infuriated Paulson to the point where he resolved that Flowers’s days at the firm were numbered. Second, in the wake of the Mellon breach, Paulson was now openly feuding with Corzine. Their arrangement made him uncomfortable under any circumstance, but on the eve of what certainly was looking like a serious vote of the partnership in mid-June about the idea of an IPO, it was terribly unseemly for the two senior partners running the firm to be clashing.
Paulson made the decision to leave Goldman if Corzine remained the firm’s CEO. He told his allies on the Executive Committee what he had decided. There was little doubt that Paulson was willing to follow through on his threat, but he must have known that his preferred outcome would be the one the committee would insist upon instead: to wit, there was no way the firm could afford to lose Paulson on the eve of the firm’s long-awaited IPO. Not only could he not leave, the committee—or at least the three of the four members on it (Hurst, Thornton, and Thain) not abstaining (as Paulson and Corzine might be inclined to do)—demanded that Paulson take the reins of the firm with Corzine. Thain, a onetime close ally of Corzine’s and one of the executors of his estate, was asked to speak with Corzine about the committee’s decision.
Thain’s message was clear and delivered to Corzine as a fait accompli: he had to agree immediately to become co-chairman and co-chief executive with Paulson. The other members of the committee were so concerned about Corzine’s freelancing and that Paulson might follow through on his latest threat to leave that they gave Corzine little choice. They also knew that with the stock market booming, especially for financial stocks in the wake of the blockbuster merger between Travelers and Citibank to form Citigroup (the merger that effectively ended Glass-Steagall), the time was fast approaching when the Goldman partnership would have little choice but to vote to go public. They knew they would need a CEO to lead them and decided Paulson would be the man to do it, not Corzine.
Sometime around Memorial Day 1998, Paulson and Corzine met to discuss the Executive Committee’s decision. Corzine tried to talk Paulson out of it, or to at least convince him to wait until the full partnership had voted on the IPO at the upcoming mid-June retreat. But Paulson told him no, he would not wait. Corzine had to agree to the new arrangement immediately. The message delivered to Corzine was crystalline: “There’s a hard way and there’s an easier way.” Corzine took the news hard. Those walking by his office that day recalled hearing him get physically sick. But Corzine came around to the new reality. At a dinner with several other executives at the Park Avenue Café, at one point Corzine and Paulson stood up, and Corzine announced that he had decided to make Paulson his partner running the firm. The two men then hugged, sending the eyes rolling of the other men who witnessed the brief—and highly unlikely—bromance.
On June 1—the Monday after the Memorial Day weekend—Goldman announced that Paulson had been promoted to run the firm with Corzine and that the two nineteen-member operating and partnership committees had recommended that the full partnership vote on the IPO proposal at the June 12 partners’ meeting. In the coverage of the two blockbuster announcements, the media understandably focused more intently on the news of the IPO. Paulson’s promotion was mentioned in passing, along the lines that it was in keeping with Goldman’s tradition of having two senior partners running the firm. No mention was made of the feud between Paulson and Corzine or the events that had precipitated the leadership change. “While Goldman has discussed proposals for its public sale seven times over the past 27 years, the recommendation by the two committees … is significant because it indicates there is broad support for a public sale,” Dow Jones reported.
The firm’s bankers working on the IPO—led by Flowers—had valued Goldman at $30 billion, according to the news service, at the high end of comparable estimates. Flowers based his valuation off the firm’s 1997 pretax profit of $3 billion and a first-quarter 1998 pretax profit of $1.02 billion. The media speculated that four members of the firm’s six-man Executive Committee—Corzine, Paulson, Hurst, and Zuckerberg—favored the IPO, while Thain and Thornton appeared less enthusiastic.
There was also plenty of speculation about whether the $30 billion was correct, what percentage of the firm would be sold—generally thought to be between 10 percent and 15 percent—and how the proceeds of the offering would be divided up. There was also speculation about whether Goldman would trade at a premium to Morgan Stanley, which traded at four times book value, and Merrill Lynch, which traded at 3.5 times book value. With Goldman’s equity at roughly $6.3 billion, these were not idle questions, especially since the firm had had an excellent second quarter and seemed to be on track for $4 billion of pretax profits, its best year ever. Regardless of what the multiple of book value would be—4 times, or even higher—the current general partners stood to make a killing, with estimates ranging from $100 million for junior partners to more than $200 million each for Corzine, Paulson, and Roy Zuckerberg, then the longest-serving partner. Also realizing massive windfalls would be both Sumitomo, which by then had $736 million of invested capital, and the Bishop Estate, which had $658 million of invested capital. An unanswered question in the early stages of the discussion was how to treat Goldman’s limited partners—those former partners who had helped create the firm’s success but who were no longer part of the day-to-day business. “At a multiple of two times book, I would think everyone would be very happy,” one limited partner told the Times. “At three times book, I think everyone would be positively delirious.” He had no comment, apparently, about how everyone would feel at a 4 times book valuation.
After a weekend meeting of the partners at Arrowwood—a far less contentious meeting than in years past—Goldman announced that a “majority of its partners” approved of pursuing an IPO and that the firm’s Executive Committee had “unanimously” agreed to recommend that course of action to the full partne
rship—implying that any opposition to the idea by Thain and Thornton had melted away. “The partnership is determined to match the firm’s capital structure to its mission of being the preeminent, independent investment bank in the world,” Corzine and Paulson said in a grandiose statement. “As a public company, Goldman Sachs will have the financial strength and strategic flexibility to continue to serve our clients effectively as well as respond thoughtfully to the business and competitive environment over the long term. This action will also meet a fundamental objective of the partners—to share ownership, benefits and responsibilities more broadly among all of the firm’s employees.”
Paulson and Corzine wrote that the decision to pursue an IPO came after “lengthy, open and intensive dialogue in the best tradition of Goldman Sachs. Our culture of collaboration and teamwork, which has been inextricably linked to the firm’s success, will continue to flourish in the new structure, reinforced by the manner in which we implement our plan.” They wrote that Goldman was “confident” and has never “been stronger in terms of the depth and breadth of our client relationships, the quality of our people and the market positions of our key businesses, many of which enjoy dominant leadership positions.” While immodest, it was difficult to argue with what Goldman was claiming: it was the predominant, preeminent, and most envied, feared, and revered investment bank in the world. But deciding to go public—while plenty momentous—was the not the same as pulling off a successful IPO, and the firm’s ability to do that in increasingly choppy markets remained to be seen.
Corzine had managed to get 74.7 percent of the partners to vote for the IPO. “I went from being the object of intense criticism at all times to having restored the belief that I knew what I was doing, that Corzine was not only going to survive but thrive,” he said. “I went from being a man who could not only make money to also someone who could get something done that nobody else could get done.”
Of course, the events of the weekend weren’t nearly as smooth as the public announcement would have people believe. For instance, like a congressman who knows that what he really wants to happen will happen no matter what he says in public, Paulson actually got up and spoke against the IPO. “I believed we were going to need to go public to get permanent capital,” Paulson said. “But when we all got together to vote I spoke against doing a public offering because I had a lot of experience—unlike some other people on the Management Committee—working with public companies, working to take companies public, understanding what an important change it is, how flawlessly you need to execute, and I felt with the management situation as unsettled as it was with Jon and me, with all the issues we had, and with all the issues that Goldman Sachs had had, and with Jon making this all about money and sending Chris Flowers around to meet with everyone and explain to them this is exactly what you’ll get if we go public, that it was the wrong time and the wrong way to get into this.” Others were offended by Flowers’s raw display of greed, even as they were seduced by the numbers. Many partners were “troubled by even secretly being greedy, culturally,” one of them said. Based on what other people said publicly, too, Paulson would have guessed Goldman would have remained private. “Some people were made to feel that if they voted for the IPO, they were voting against the history, the heritage, the culture,” Paulson said. “They were voting to take the dollars rather than looking at it strategically.” In the end, though, the vote was overwhelmingly in favor of the IPO.
What had bought Paulson’s support was Corzine’s agreement to make Paulson the co-chairman and co–chief executive officer. From that moment on, Corzine and Paulson’s mission was to sell, and that’s what they were busy doing. Goldman was nothing if not a massive selling machine. In an interview with the Times, on June 15, the two men made clear how little they expected Goldman would change in light of the decision to give up the firm’s privacy. They explained that Goldman would not become a “financial conglomerate,” it would not merge with a “Main Street” broker, and it would not entertain merger proposals from a commercial bank. Nor was the IPO about making Goldman’s partners even richer than they already were. “Contrary to what you might read, we are not doing this because of the money,” Corzine said. “This is not about money or cashing out.” Instead, Corzine emphasized that Goldman intended to use the IPO—and the capital generated from it—to become an even fiercer competitor. “We intend to be the pre-eminent, independent global investment bank,” he said. “We are going to be damn tough, and we will have the capital to compete.”
He also seemed to have found religion on the subject of mergers. That idea was off the table, he said, although Goldman might consider a few smaller acquisitions, especially among asset managers, where Goldman was still trying to grow the $160 billion it had under management. “We will have some new strategic opportunities, and we will go into acquisition mode,” he said. “I am not talking about mergers, but acquisitions.” As an example, Corzine could have mentioned Goldman’s May 1997, roughly $100 million acquisition of Commodities Corporation, a $2 billion managed futures, commodities, and currencies hedge fund based in Princeton, New Jersey, that counted among its founders Paul Samuelson, Larry Summers’s uncle.
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INTERNECINE WARFARE ASIDE, in the aftermath of the IPO announcement, Goldman Sachs seemed to be floating on a cloud: the partners were united behind a task (underwriting an IPO) for which they were the world’s experts and behind a cause (themselves) that provided them with all the incentive they could ever need to execute flawlessly. The valuation being bandied about for the firm seemed to grow daily—$30 billion, $35 billion, even $40 billion didn’t seem far-fetched. After all, if Morgan Stanley was worth 4 times book, then Goldman Sachs—universally acclaimed as the world’s best investment bank—should be worth even more. The Goldman IPO was very big news, and Wall Street seemed obsessed by it. True, the occasional analyst did wonder why the public should buy if Goldman Sachs was selling—“These guys are very smart, the best on Wall Street, and they are saying it is time to sell shares,” one analyst observed. “Is this the top? If anybody knows, they would”—but most people on Wall Street seemed to be caught up in the euphoria over the Goldman IPO.
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WHAT A SHAME, then, that a little crisis—in the form of the blowup of the hedge fund Long-Term Capital Management, or LTCM as it was known—would come along at just this moment to spoil Goldman’s coming-out party. LTCM was the brainchild of John Meriwether, a famed Salomon Brothers bond trader and one of Corzine’s trading heroes. Meriwether started LTCM in 1994. Corzine had considered having Goldman make an investment in LTCM and even considered buying the firm itself. But, in the end, Goldman decided to be one of LTCM’s many trading partners on Wall Street.
As has been well documented in Roger Lowenstein’s best seller, When Genius Failed, LTCM combined all of Meriwether’s supposed trading expertise with the technical expertise of Nobel Prize–winning economists Robert Merton and Myron Scholes and with the regulatory expertise of David Mullins, the vice chairman of the Federal Reserve Board, who resigned his position to join LTCM. It was a partnership designed to maximize the seduction of potential investors.
Needless to say, LTCM was the envy of Wall Street—in the days before hedge funds were a dime a dozen—and firms rushed to do business with it, including Goldman. LTCM’s computer-driven investment strategy was to make so-called convergence trades, involving securities that were mispriced relative to each other, taking long positions on the inexpensive side of a trade and a short position on the expensive side of a trade. For the first two years, the strategy worked splendidly. Investor returns were around 40 percent during that period, and the assets under management swelled to $7 billion. The original partners and investors were getting richer and richer.
In September 1997, even though LTCM had earned $300 million in one of its best months ever, “the firm’s prospects were steadily dimming,” according to Lowenstein, because it was having trouble finding profitable trade
s in the shifting markets. On September 22, Meriwether wrote to investors that the fund “had excess capital” and intended to return to investors all the profits made on the money invested in 1994 and all the money invested in the fund after that date. This amounted to a return of about half the fund’s $7 billion in capital. The LTCM partners and employees kept all of their money in the fund. Investors saw this not as a lucky windfall—an idea hard to imagine today—but rather as if they were being deprived of water in Death Valley. They clamored to stay fully invested in LTCM, since the geniuses who had founded the firm were minting money. But the firm turned most of them down.
In 1997, LTCM earned a respectable 17 percent return for its investors, after fees. The performance was the worst of the firm’s short life but hardly fatal. As promised, LTCM returned to its investors $1.82 for every dollar they’d invested, although their original investment stayed in the fund. Meriwether’s concern about the markets and LTCM’s prospects proved prescient as 1998 unfolded. On August 17, Russia announced a devaluation of the ruble and a moratorium on the payment of $13.5 billion of its Treasury debt. The devaluation and the moratorium caught many investors off guard, not only at LTCM but at Goldman Sachs, too.
This opened up another fissure in the relationship between Paulson and Corzine, who had been on their best behavior in the weeks following the June IPO announcement. But the events in Russia were reminding Paulson an awful lot of 1994, and he was nervous. Not surprisingly, Corzine—the trader—wanted Goldman’s traders to ride out their positions. Paulson—the banker—was highly skeptical of that strategy. “Maybe if we hold on to some of these positions as you suggest, Jon, our losses will be less, but we’re not a hedge fund,” Paulson remembered telling Corzine. “We’re Goldman Sachs. And I want to get out of these positions and take our losses.” At this particular moment, Paulson had the upper hand at the firm, having just won the backing of the majority of the Executive Committee to promote him to co-CEO. He also figured that after taking the losses, the firm’s ROE for the year would still be in the very respectable range of 18 percent. Corzine told Paulson to his face that he agreed with the decision to cut and run but the message getting out around the firm was a different one. “Paulson and Corzine would communicate to the traders,” one partner recalled, “and Paulson would be communicating one thing and Corzine would be talking to them behind his back and maybe he was just fuzzy in what he said, but they sure weren’t hearing the same things from Corzine they were hearing from Paulson.” This made Paulson crazy.
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