Inevitably, though, since trading is a zero-sum game where for every winner there is a loser, at the same time that Goldman was raking in profits, some of its clients, or “counterparties” as they were known on the trading desks, were bound to be suffering. Worse, apparently, some of Goldman’s European salespeople, who had helped to sell the firm’s “axes” earlier in the year, did not feel they were getting the recognition they deserved for pushing the deals out the door. Yusuf Aliredha, Goldman’s London-based co-head of European fixed-income sales, wrote to Sparks on October 17: “Dan, Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant. Aggregate loss for our clients on just these 5 trades alone is 1bln+. In addition team feels that recognition (sales credits and otherwise) they received for getting this business done was not consistent at all with money it ended making/saving the firm.”
Aliredha then described five 2007 CDO deals that Goldman had created and then sold to investors that now had come back to haunt the firm, at least if unhappy clients were any gauge. One of the five was the ABACUS deal, completed just a few months earlier by Fabrice Tourre and Jonathan Egol. Aliredha seemed concerned that ABN Amro, the big Dutch bank that had shared with ACA around $1 billion of mortgage-related risk on the deal, was not happy. “At the time this was the biggest axe for Egol & Fabrice as the portfolio was predominantly subprime BBB names picked by ACA,” he wrote to Sparks. “ABN was the only intermediary who was willing to take ACA exposure.… Not sure what the total amount of collateral that’s been called so far, but it must be at least $200–300MM on this trade alone.” In other words, Goldman was cleaning up and its clients—sophisticated investors to be sure—got killed.
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IN AN OCTOBER 29 internal presentation to the Goldman tax department titled “Contagion and Crowded Trades,” Craig Broderick, the firm’s chief risk officer, explained how the firm had navigated the rough waters in the credit markets and had reached port safely. He started by commenting that the “overall market events since Jan[uary] of this year—but largely concentrated over the summer period—are as dramatic and interesting as any I’ve seen in 25+ years in the business. I use the word ‘interesting’ only because we’re past the worst of it at least as far as our own exposure goes[,] [but it was] pretty scary for a while.”
He acknowledged that the firm’s willingness to mark down its long positions “gave rise to all sorts of stories about how we are marking our books” and to questions about the “significant differences in marks vs. competitors” and that “there are a lot of disputes with clients,” but he viewed Goldman’s mark-to-market prowess as a singular accomplishment. “Best success here was on our marks and our collateral calls,” he continued. “First mover advantage, most realistic marks, competitors unwilling to mark fully given implications for their own trading positions.” The next day, Blankfein asked Viniar and Cohn how the “review of the mortgage and [CDO] books” went. Viniar responded, “Extremely well. You will be very pleased.”
It was increasingly easy to see why. According to an internal Goldman document about the quarterly performance of the mortgage group, Birnbaum was still printing money, although the pace at which he was doing it had—understandably—slowed in the fourth quarter. Nevertheless, the profit numbers were astounding, especially compared to the financial bloodbath occurring across the rest of Wall Street. Through October 26, Birnbaum’s group had made $3.7 billion in profit, more than offsetting losses of around $2.4 billion in the rest of the mortgage business.
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PICKING UP ON the idea Fortune had explored a few months earlier, the New York Times explored the idea of how Goldman had done it. “For more than three months, as turmoil in the credit market has swept wildly through Wall Street, one mighty investment bank after another has been brought to its knees, leveled by multibillion-dollar blows to their bottom lines,” observed reporters Jenny Anderson and Landon Thomas Jr. “And then there is Goldman Sachs. Rarely on Wall Street, where money travels in herds, has one firm gotten it so right when nearly everyone else was getting it so wrong. So far, three banking chief executives have been forced to resign after the debacle and the pay for nearly all the survivors is expected to be cut deeply.” Meanwhile, Blankfein—the Times predicted—would easily top the $54 million in compensation he had made in 2006 and likely would receive as much as $75 million. (In the event, it was closer to $70 million.)
The paper then explained how the “notoriously nervous” Viniar called for a “mortgage risk” meeting in his “meticulous” thirtieth-floor conference room in December 2006. “After reviewing the full portfolio with other executives, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses,” the Times continued. “With its mix of swagger and contrary thinking, it was just the kind of bet that has long defined Goldman’s hard-nosed, go-it-alone style.” When the mortgage market crashed in July, Goldman had already off-loaded much of its mortgage-related risks, the paper continued, quoting Guy Moszkowski, an analyst at Merrill Lynch who covered the investment banks. “If you look at their profitability through a period of intense credit and mortgage market turmoil,” Moszkowski said, “you’d have to give them an A-plus.” Anderson and Thomas then reported: “This contrast in performance has been hard for competitors to swallow. The bank that seems to have a hand in so many deals and products and regions made more money in the boom and, at least so far, has managed to keep making money through the bust.… Goldman’s secret sauce, say executives, analysts and historians, is high-octane business acumen, tempered with paranoia and institutionally encouraged—though not always observed—humility.”
The article also made the important points that Goldman’s “flat hierarchy” encouraged “executives to challenge one another” so that “good ideas can get to the top,” and that the firm’s risk department had as much status, authority—and compensation—at the firm as did the rainmakers, a claim no other Wall Street firm could make. “At Goldman, the controller’s office—the group responsible for valuing the firm’s huge positions—has 1,100 people, including 20 Ph.D.’s,” the Times continued. “If there is a dispute, the controller is always deemed right unless the trading desk can make a convincing case for an alternate valuation. ‘The risk controllers are taken very seriously,’ Mr. Moszkowski said. ‘They have a level of authority and power that is, on balance, equivalent to the people running the cash registers. It’s not as clear that that happens everywhere.’ ”
Anderson and Thomas went so far as to compare Goldman Sachs at the end of 2007 to the power and influence that J. P. Morgan & Co. had between 1895 and 1930. “But, like Morgan, they could be victimized by their own success,” Charles Geisst, a Wall Street historian at Manhattan College, told the paper. “Mr. Blankfein of Goldman seems aware of all this,” the article concluded. “When asked at a conference how he hoped to take advantage of his competitors’ weakened position, he said Goldman was focused on making fewer mistakes. But he wryly observed that the firm would surely take it on the chin at some point, too. ‘Everybody,’ he said, ‘gets their turn.’ ”
Not surprisingly, Lucas van Praag had spent a considerable amount of time “working with” the Times reporters to make sure Goldman’s perspectives were incorporated into their front-page article as much as possible. This was hardly surprising, of course, as nearly every piece of responsible journalism involves such give-and-take. The Sunday afternoon before the story was to run, van Praag briefed Blankfein, in writing, about what was coming, providing a rare glimpse into how Wall Street executives try to manage the journalists who cover them. For starters, van Praag explained that “we spent a lot of time on culture as a differentiator” with Anderson and that “she was receptive.” But, alas, he also reported, “Tomorrow’s story will, of course, have ‘balance’ ([i.e.,] stuff we don’t like). In this instance, we ha
ve spent much time discussing conflicts, and I think we’ve made some progress as she a[c]knowledges that most of her sources on the subject are financial sponsors which fact, unless edited out, is included and gives context.” (The story did mention that some private-equity firms worry that Goldman’s huge private-equity fund had become an unwelcome competitor.)
Van Praag also warned Blankfein of an emerging conspiracy theory about the firm, which the Times article might broach. “The article references the extraordinary influence GS alums have—the most topical being John Thain,” the former Goldman president and co–chief operating officer and former CEO of the New York Stock Exchange who had, the previous week, agreed to become CEO of Merrill Lynch in the wake of the firing of Stan O’Neal a few weeks earlier. “[B]ut [Bob] Rubin, Hank [Paulson], Duncan [Niederauer, who replaced Thain as CEO of the NYSE] et al[.] are all in the mix too. She hasn’t gone as far as suggesting that there is a credible conspiracy theory (unlike her former colleague at the NY Post). She does, however, make the point that it feels like GS is running everything.”
The twin ideas that Goldman was “running everything” and that there was a “credible conspiracy theory” involving the firm would, soon enough, be major public-relations nightmares for the firm but, at that moment anyway, Blankfein was far more concerned about the promulgation of the idea that somehow the firm had avoided the mortgage meltdown and made a bunch of money. “Of course we didn’t dodge the mortgage mess,” Blankfein wrote to van Praag. “We lost money, then made more than we lost because of shorts”—so the firm did make money, and what he had previously called a “hedge” he was now referring to as a “short.” In any event, his next thought made the most sense. “Also, it’s not over, so who knows how it will turn out ultimately,” he concluded. Unable to resist adding his two cents, Gary Cohn, who had been copied on the correspondence, chimed into the discussion with the thought that Goldman was “just smaller in the toxic products.”
But, increasingly, investors and the media wanted to know how Goldman had bested the competition, succeeding wildly where others had failed. To try to answer this question, and in preparation for Goldman’s fourth-quarter earnings release—scheduled for December 18—Viniar prepared a one-page PowerPoint slide titled “How Did GS Avoid the Mortgage Crisis?” and subtitled “Our Response.” As had Broderick before him, Viniar touched on familiar themes, reinforcing a number of Goldman verities. “We were actively managing our mortgage exposure throughout 2006, and towards the end of the year we became increasingly concerned about the sub-prime market,” he wrote. “As a result we took a number of actions at that time and into early 2007 to reduce our risk. In the first quarter of 2007 we stopped our residential mortgage warehousing efforts, shut down our CDO warehouses, aggressively reduced our inventory positions, reduced counterparty exposure and increased our protection for disaster scenarios.”
He then launched into a particularly lucid analysis of how being honest with itself about the value of the mortgage securities on its books had made all the difference. No other Wall Street CFO could have made a similar claim. “Key to our ability to do this was our extremely robust mark to market philosophy,” he continued. “You simply cannot manage risk effectively if you don’t know what positions are worth. An accurate daily marking process makes difficult decisions considerably easier, as you tangibly feel the cost of inaction every day as the market declines. We have extensive price discovery and valuation resources and don’t subscribe to the notion that there are instruments that can’t be valued. So, we knew the value of what we had and managed our risk accordingly.… Given the complexity and diversity of risks in our business, we believe that it is critical to provide our teams with the confidence and support necessary to identify and escalate issues as soon as possible and to prioritize the interest of the entire firm over any individual objectives. In addition, we think it is important for senior leadership to be actively engaged in the business flows and decision-making process, in times of calm as well as crisis.”
CHAPTER 23
GOLDMAN GETS PAID
Not only Bear Stearns but also AIG, the international insurance behemoth, began to feel the effects of the aggressive way Goldman was marking its trading books. Which is not to say Goldman’s marks were wrong—quite the opposite actually—but only that they were not without serious financial and social consequences for others at ground zero of capitalism. In the aftermath of the global financial collapse, one of the reasons given for the historic decisions to rescue Bear Stearns and AIG was because of how “interconnected” these institutions were to one another, according to Robert Steel, the former Goldman partner who had joined Paulson at Treasury as undersecretary for domestic finance. Goldman’s marks were one of the ways firms became linked to one another. The consequences for the two Bear Stearns hedge funds—which likely would have collapsed anyway—were devastating and were exacerbated by Goldman’s marks; at AIG, the Goldman marks were equally momentous, especially since never before had the government saved an investment bank or an insurance company from bankruptcy.
If nothing else, Hank Greenberg, the longtime chairman and CEO of AIG, was a smart and ruthless businessman. He diversified AIG beyond simply writing fire and casualty insurance to become the world’s largest underwriter of commercial and industrial insurance. He was also an innovator. He created insurance for directors and officers of corporations to try to protect them against their own blunders. He created environmental protection insurance and coverage for those threatened by kidnapping. AIG “built a team of skilled underwriters who were capable of assessing and pricing risk,” he often proclaimed. Greenberg also knew that AIG’s AAA credit rating gave the company a valuable and differentiated advantage in the marketplace by allowing it to borrow money cheaply and then to invest it at higher rates of return, and to make money on the spread. If this kind of thing could be done outside the ken of often onerous state regulations that blanket the insurance industry, even better.
To that end, in 1987, Greenberg created AIG Financial Products, known as AIGFP, by hiring a group of traders from the investment bank Drexel Burnham Lambert, led by Howard Sosin, who supposedly had a “better model” for trading and valuing interest-rate swaps and for generally taking and managing the risk that other financial firms wanted to sell. The market for derivatives was in its infancy, but growing, and Greenberg determined that AIG could be at its forefront. According to Greenberg, the overriding strategy at AIGFP was for the business to lay off most of the risks it was taking on behalf of its clients so that AIG was not exposed financially in the event of huge market-moving events that could not be modeled or anticipated. Under Greenberg’s watchful eye, he says, the formula worked famously: from 1987 to 2004, AIGFP contributed “over $5 billion to AIG’s pre-tax income” and helped the company’s market capitalization increase to $181 billion, from $11 billion.
The business Sosin and his team created was nothing more than a hedge fund inside an insurance behemoth with the added benefit that their access to capital was seemingly unlimited and costless and instead of getting the typical “two and twenty” hedge-fund deal, AIGFP’s traders got to keep between 30 percent and 35 percent of the profits they generated. This sweet arrangement allowed many of the four hundred or so people who worked at AIGFP to become very proficient about taking risks with other people’s money and to get rich.
Things at AIGFP were humming along so well that when Sosin and Greenberg had a falling-out, in 1993, and Sosin quit—taking a reported $182 million in severance with him—the business didn’t miss a beat under his successor, Thomas Savage, a mathematician who encouraged his traders to challenge him about the efficacy of the risks the group was taking. Savage retired in 2001 and was replaced by Joseph Cassano. Cassano had been the back-office operations guy at both Drexel and AIGFP before becoming the CFO and then getting the top job. By then, AIGFP had started insuring—innocently enough, it seemed—the risk that corporations might default on the debt they had issued. By
selling something that became known as “credit-default swaps” to nervous investors, AIG agreed to pay off the defaulted debt at 100 cents on the dollar. AIG got the premiums; investors got peace of mind. This was the kind of financial innovation Greenberg fancied, especially since AIG’s AAA credit rating made its cost of borrowing so low, a real competitive advantage. The biggest part—some $400 billion—of the AIGFP insurance book was written on behalf of European banks looking to take risk off their books as a way of avoiding the need to raise additional capital to appease the European regulators. “This is a great irony,” explained a former AIG executive. “The European banks went out and were able to buy credit-default insurance on their assets so that they didn’t have to keep as much capital on their balance sheet. So here was an insurance company in the United States with essentially no liquidity, no equity and no reserves providing equity relief for European insurance companies. Talk about the house of cards.”
As the writer Michael Lewis explored so elegantly in his August 2009 profile of AIGFP in Vanity Fair, Cassano was not a particularly benevolent leader. “AIGFP became a dictatorship,” one London trader told Lewis. “Joe would bully people around. He’d humiliate them and try to make it up to them by giving them huge amounts of money.” Needless to say, the camaraderie and openness of the Savage era was lost quickly in the savage Cassano regime. “Even by the standards of Wall Street villains, whose character flaws wind up being exaggerated to fit the crime, Cassano was a cartoon despot,” Lewis wrote. But none of that mattered particularly at AIG as long as Greenberg was running the show, since Greenberg was every bit Cassano’s match in ruthlessness, but a better and more astute businessman.
Money and Power Page 80
