Money and Power

by William D. Cohan

  The offer letter was technically and legally flawed—for inexplicable reasons—and with Buffett unavailable, Meriwether, who disliked the deal anyway, let the offer lapse. He decided to take his chances with McDonough, the Fed, and the bank consortium. The time had come to act. Based on a proposal made by Herbert Allison, then president of Merrill Lynch, the sixteen banks that were LTCM’s largest counterparties would contribute $250 million each—a total of $4 billion—to LTCM in exchange for the vast amount of the firm’s equity that had been owned by the original partners. LTCM’s investors would be wiped out, but Allison hoped his plan would allow for an orderly liquidation of the firm’s positions and prevent a systemic crash. By this time, Paulson was more than a little fed up with Corzine’s antics with LTCM—first wanting to buy the hedge fund outright and then making a bungled show of trying to make a last-minute investment in LTCM—and started to lash out. He insisted that Thain trail Corzine at every turn. “It was really a matter of trust and confidence and making sure someone understood the numbers,” Paulson said. “And that we were doing this in a disciplined way, where the firm’s reputation wasn’t going to get hurt. Because this was a mess. Goldman Sachs was trying to do several different things at once, and I didn’t even know about some of them.”

  On the evening of September 22, Fisher and McDonough asked the heads of the sixteen banks to come to the New York Fed building on Liberty Street to discuss a Fed-orchestrated bailout of LTCM. Fisher permitted each bank to bring two representatives. Corzine came with Thain. Throughout parts of that meeting and during meetings on subsequent days, Paulson was on the phone with Thain, and he was increasingly angry that Goldman would have to pony up, first $250 million, and then $300 million (chiefly because Bear Stearns had declined to participate at all). With the basic agreement finally in place, the lawyers drafted up the paperwork over the next five days, trying to herd the cats toward a final agreement.

  Many compromises were made along the way and much pain was taken by the consortium of banks. By agreeing to invest close to $4 billion in the LTCM carcass, they were saving themselves at the expense—of course—of the LTCM partners, who certainly deserved to take it on the chin. Early Sunday evening, September 27, while Corzine was returning to Manhattan from his 6,200-square-foot “majestic beachfront home” in Sagaponack (sold in 2010 for $43.5 million to hedge-fund manager and Goldman alum David Tepper), Bob Katz, Goldman’s general counsel, informed the assembled lawyers that Goldman would drop out of the deal if any of the nearly $4 billion being put into LTCM went out the door to Chase, which was planning to take back the $500 million that LTCM drew down from its revolving line of credit as disaster struck, per Jimmy Cayne’s suggestion. “The point was to rescue Long-Term, not to rescue Chase,” Lowenstein wrote, and the other bankers, who felt the way Goldman did, were only too “happy to let Goldman play the heavy.”

  Chase thought Goldman was bluffing. Thomas Russo, the Lehman general counsel, did, too, and told Katz so. Without the payment, Chase said it would walk. With the payment, Goldman said it would walk. “There was no deal,” Katz said later. When Corzine called in to the meeting while on the road back from beach, he reiterated Goldman’s position. “Jon,” exclaimed the Chase banker, “there is no polite way to say this: Goldman can go fuck themselves.” Corzine held firm. The deal was dead, at least for Sunday night. Herb Allison at Merrill was caught in the middle. He knew that if Goldman walked, the whole deal would fall apart. “One always has to indulge the bad boys at Goldman,” Lowenstein wrote. Later Sunday night, Chase caved in and allowed the newly recapitalized LTCM to keep the $500 million in the fund and to not pay the money out to the bank syndicate. Goldman was back on board. “None of us liked having to step up,” Paulson said. “But it was really the only thing to do. When John Thain recommended that we do it and that we put together a structure where we had a fighting chance of avoiding very big losses, I signed off on it.”

  Thain said the decision to put $300 million into the LTCM rescue was very controversial inside Goldman, and the controversy was exacerbated by the fact that Jimmy Cayne and Bear Stearns decided not to contribute. “I don’t think there was ever any real question of whether we were going to do it,” he said, “but it was controversial and people were very concerned but there’s a little bit of being a good citizen. When the head of the New York Fed says, ‘Look, we have this problem, and I need you guys to help,’ we were helping fix a problem that was going to be a problem for the system as a whole. Even though it was controversial, there was never really any doubt that we were going to do that. Bear Stearns and Jimmy Cayne, in particular, basically told the system ‘Screw off.’ That’s never a very good thing to do because sometime you may need help, and when you refuse to be a good citizen and help somebody else, then people remember that.” Of course, Goldman’s subsequent role in exacerbating Bear Stearns’s spectacular demise in March 2008 has been much debated, with some linking it to lingering anger over Cayne’s decision not to participate in the bailout of LTCM.

  The consortium of banks working together—albeit warily—had put their collective finger in the dike and prevented the collapse of the financial system. Alan Greenspan, the chairman of the Federal Reserve at the time, defended the Fed-orchestrated bailout. “Had the failure of LTCM triggered the seizing up of the markets,” he told the House Banking Committee on October 1, “substantial damage could have been inflicted on many market participants and could have potentially impaired the economies of many nations, including our own.” When Representative Barney Frank, of Massachusetts, criticized Greenspan for having the Fed organize the bailout that left “some of the richest people in the country better off than if you didn’t intervene,” Greenspan countered, “No Federal Reserve funds were put at risk, no promises were made by the Federal Reserve and no individual firms were pressured to participate,” a curious reinterpretation of the facts.

  There was no getting around the damage that the combination of the Russian and LTCM crises had inflicted on the markets, especially on the stocks of financial companies. The next afternoon, after the market closed on September 29, Goldman announced it was withdrawing its IPO and cited the “unsettled conditions” in the markets as the reason. Shares of many financial services companies had fallen as much as 50 percent since August. “You just have to look at how financial institutions are faring,” Corzine told the Times. “Those valuations are really dramatically lower.” Added Paulson about pulling the IPO, “This was not a close decision. This was a clear decision. I would conjecture that there would be very few people, if any, at Goldman Sachs who would question this decision.” Whereas during the summer, Goldman’s value was in the $30 billion range, the events of the previous weeks had reduced that to closer to $15 billion, and accordingly the amount of proceeds Goldman would get from the IPO would be reduced to $1.5 billion from $3 billion. In a “transatlantic rallying call” the next day, Corzine and Paulson told the firm not to fret about the withdrawn IPO. “Our watchword is steady as you go, full steam ahead,” Corzine said. “We have important work to do.” He added that “market dislocations have often provided opportunities for the firm in the past. Great institutions can distinguish themselves in difficult times.” Regarding the LTCM crisis, Paulson told the firm that it was an “earthquake without historical precedent” and the “subterranean shifts are still playing themselves out.” Corzine said of LTCM that Goldman was a “leader in seeking to dampen the systemic risk.” As phone handsets were “clumsily put down,” according to one account, Corzine left the firm with the exhortation: “Let us go forward!”

  Nineteen ninety-eight being an even-numbered year, Goldman would normally have been in the process of picking a new partner class to be announced at the end of its fiscal year, in November. But as part of the decision to pursue the IPO, the firm had decided not to make any new partners in 1998, in order not to change the pool of partners who would partake in the IPO bonanza, a honeypot worth between $50 million and $125 million (or more)
per partner, depending on their seniority and influence at the firm. Now, with the IPO withdrawn, Goldman announced on October 21 the names of fifty-seven new partners (among them Christian Siva-Jothy, the London trader who cost Goldman millions in losses in 1994)—putting them in line to become nearly instant multimillionaires the minute the decision was made to move forward again with the IPO. Goldman also announced the decision to force the retirement of between twenty and twenty-five existing partners—who would “become limited” in Goldman’s argot—a decision that would correspondingly cost those partners millions. “I am sure that with the prospect of an I.P.O. just around the corner, there are some in that batch of retired partners who are not happy about it,” one retired partner told the Times. “But I am sure there are others who just thought this was the time. You can’t wait forever, and being a Goldman partner is an extremely demanding job.”

  Unbeknownst to most people, the decision to “withdraw” the IPO, as opposed to “delaying” the IPO, was another clever piece of Goldman Sachs alchemy. This was the brainchild of Bob Hurst—“He emerged as the real hero,” Paulson said—who asked the lawyers if there would be any tax consequences of reconstituting the partnership by retiring a bunch of older partners and adding a new generation of younger partners. Being able to do this was very important to Paulson philosophically because he wanted to be “forward looking” by giving more of the IPO bonanza to the future generation of Goldman partners than to the past generation of Goldman partners. After examining the issue, the lawyers told Goldman that by “withdrawing” the IPO, the Goldman partnership could be “reconstituted” without tax consequences. Even though the process of pushing a bunch of partners into limited status with the IPO so close was exceedingly painful, Paulson said, it was the best thing for Goldman Sachs. “Politically, it was probably a mistake,” he said, “because I had to talk with some people who were some very good friends of mine—really good friends—and we treated them fair economically, but retired them before we went public. I thought that the more money the more senior people had, the worse it was going to be. I wanted to put shares in the hands of the future. The idea of making fifty-seven new partners that would have some stock and we would bind them to us seemed important.”

  Among those that Paulson shoved out the door in October 1998 was Executive Committee member Roy Zuckerberg—a Corzine ally—and, at sixty-two, then the longest-serving Goldman partner. He was also the firm’s largest individual shareholder, and becoming “limited” would cost him millions. No matter, he had to go. It was yet another fateful decision. Zuckerberg put the best face on it he could. “I decided the best thing for me in this case was to move on,” he told the Times. “I have been here 31 years. The business has become extraordinarily intense as it has become more globalized. I was faced with a decision whether to sign an agreement to stay on for another two years and decided not to.” He said he planned to serve one year as chairman of the Securities Industry and Financial Markets Association, a key Wall Street industry group, and spend time at his recently purchased $7.1 million house on eleven acres in East Hampton, with an eight-acre agricultural reserve suitable for farming and horses. “Now I have more time and can enjoy it more,” Zuckerberg said. Michael Corleone had nothing on Hank Paulson.

  The firm had also—relatively quietly, amid the IPO commotion—taken the unprecedented step of further bolstering its world’s-best M&A department by hoovering up the top M&A bankers at its major competitors. Turned out it wasn’t too difficult: Who could possibly resist the allure of being named a Goldman partner before its game-changing IPO? In short order, Goldman hired Ken Wilson, then a senior partner at Lazard, to work in FIG; Gordon Dyal, the head of M&A at Morgan Stanley; and Michael Carr, the head of M&A at Salomon Brothers. It was an M&A street sweep of unprecedented proportions and one only Goldman Sachs at the height of its powers could have had any hope of accomplishing. (To complete the sweep, in March 2000, Goldman also hired Jack Levy, the head of M&A at Merrill Lynch.) Not even when Goldman was desperately trying to build up its fixed-income business in the 1980s—and hired a group of traders from Salomon Brothers—had the firm done anything so audacious. Such was Goldman Sachs’s power at the end of the second millennium.

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  IN THE WAKE of the LTCM crisis and the $300 million contribution to solve it, the pulled IPO and the contentious decision to force the retirement of a group of older partners, the relationship between Corzine and Paulson had reached a breaking point. Adding to the growing rift, Goldman had nearly $1 billion in trading losses in the second half of 1998. (The firm’s pretax income for the year was $2.9 billion, some $100 million below 1997.) What would soon be known around 85 Broad Street as “the Glorious Revolution” was imminent. Unlike the civil war that broke out between the traders and bankers at Lehman Brothers that ended up tearing that firm apart in the 1980s, the war between the states at Goldman was less turf driven than personality driven. Paulson and Corzine simply did not get along, and the events of the second half of 1998 had merely shown others that the rift could no longer be covered up. Unfortunately for Corzine, he had shown himself to be the more strategically reckless of the two men and had lost his political support.

  On November 8, seemingly out of nowhere, the Sunday Times, in London, ran a 375-word story under the headline “Goldman’s Corzine Urged to Resign.” (An earlier version of the story appeared on October 28 but then seemed to disappear.) According to the paper, “a leadership crisis is developing at Goldman Sachs in the wake of its aborted attempt at a stock-market flotation this autumn. The situation has become so extreme that Jon Corzine, chairman, is facing calls to resign.” Citing “senior figures within the firm,” the article said, “Goldman was badly in need of leadership and clarity on its future” and that since the IPO had been withdrawn, “the firm has seemed unable to recover its former confidence and recriminations have been rife.” The Sunday Times floated the notion that Thornton and Thain—both working in London (with one of them likely being the unnamed source for the story)—who were “the most public in opposing” the IPO, might be the next logical leaders of the firm. In any event, the story was an extremely rare breach of Goldman’s Victorian decorum. “For almost a year they ate, slept and drank the IPO,” explained one partner. “Suddenly they understood that it could not go ahead and were plunged into coping with issues like LTCM. It is not surprising that against that background you don’t have total clarity in the direction of the firm.” The paper even added the gratuitous thought that the firm’s preoccupation with the IPO had hurt the quality of its work—the “quality of Goldman’s work is not what it used to be.”

  According to Charles Ellis, Corzine was in London when the story first appeared on October 28. (Goldman naturally denied the accuracy of the paper’s report.) He had breakfast with a fellow partner and the story became the topic of conversation. When Corzine said he was not sure what he was going to do about it, his partner blew up. “You should be sure, Jon,” he reportedly said. “Since you’re wearing a business suit, I assume you have another meeting scheduled this morning, so here’s what you should do: Cancel any other meetings you’ve booked. Go directly to Heathrow and fly back to the States. Before you take off, call Roy Zuckerberg and Bob Hurst and tell them to meet you at your house in New Jersey today and make it absolutely clear to everyone that before the executive committee meets Monday morning, both Thain and Thornton are out—fired for playing politics and doing it in public so that it hurts the firm.… If you do this immediately, everyone will understand and will back you. And if you don’t, you’ll be in real trouble, because in six months they will force you out.” Corzine replied, according to Ellis, “I couldn’t do that. It would hurt the firm.” And he didn’t.

  There was no question Paulson had had it with Corzine. He could no longer envision the possibility of working with him as the co-CEO of a public Goldman Sachs. If the firm was to remain private, they could have divvied up responsibilities along business and strategic l
ines, but as a public company with public shareholders, that would simply not be possible. Even though the IPO had been withdrawn, there was no question that when markets improved—and when the firm’s leadership conundrum had been resolved—a new S-1 would be filed. Paulson simply could not wait any longer. While Corzine was skiing in Telluride, Colorado, he demanded clarity from his fellow senior partners.

  Before Christmas vacation, Paulson told them they had to choose between him and Corzine to lead the firm. But there was no real suspense. Once upon a time in the modern era of Goldman Sachs, the firm’s bylaws required a vote of 80 percent of the full partnership to remove any partner from the firm. But sometime in the 1990s (no one was precisely sure when), one partner who was fired refused to leave. In order get him out, the partners agreed to change the partnership agreement to make it possible for a vote of 80 percent of the Management Committee (or the Executive Committee, as Corzine had renamed it) to be what was needed to get rid of a partner, including the senior partner of the firm. With Zuckerberg gone from the Executive Committee and no one yet selected to replace him, the fait was accompli: Hurst, Thornton, and Thain (and Paulson, obviously) were resolved that the time had come for Corzine to go. The 80 percent was in hand. Had the vote been put to the full partnership, Corzine’s personal popularity would have likely carried the day—a point Paulson conceded. “He was more popular among the partners than I was,” Paulson said. “He was better known than I was.”