Confidence Men: Wall Street, Washington, and the Education of a President

by Ron Suskind

  BLANKFEIN: I know.

  LEVIN: . . . because they think you’re fiduciaries.

  BLANKFEIN: Not in the market making context.

  LEVIN: Yeah, but they are not told that not only are you not a fiduciary, you are betting against the same security that you are selling to them. You don’t disclose that. That’s worse than not being a fiduciary. That’s being in a conflict-of-interest position.

  In the 1970s the financial marketplace held many separate entities with distinct functions. Investment banks were partnerships, ever wary of the downside of investments because the partnership’s money, in the event of losses suffered by a client or the firm, was on the line. They advised clients, often being granted “privileged” information, and helped them decide what financial instruments to buy or how to manage their balance sheets or which were the good places to invest their capital. They could partner with a client in a deal, at which point the client’s interest and that of the investment bank were identical. Brokerage houses, meanwhile, represented clients, generally individuals, in managing their investments and executing trades. Market makers were involved in the issuance of stocks, standing, when needed, on the other side of trades to “make a market” for a buyer, or seller, in search of a trade. It was more of a technical function. And of course the cornerstone of the system was commercial banks, which took in deposits, paid interest, and, for the most part, made loans to businesses and individuals. When a bank wanted to get some extra yield on deposits that weren’t tied up in loans, it could do so only in the safest, sleepiest investments, mostly bonds, as designated by the rating agencies’ then-precious triple-A stamp.

  Now virtually all these functions are held, in sum or in large part, within a half dozen huge institutions that, together, hold assets that amount to nearly two-thirds of the U.S. GDP. They enjoy enormous leverage over the crafting of law, regulation, and wider acts of governance. They stand at the center of America’s vaunted professional class—a human yield, in many ways, of the enormous resources and effort the country commits to education—and have formative relationships with the large industrial and manufacturing corporations that are pistons and flywheels of America’s economic engine.

  What’s fascinating about the public exchange between Levin and Blankfein, among the most illuminating of this period, is how it so clearly elucidated the conflicts of self-dealing irreducibly knitted into the country’s largest institutions, and the very latest definition of “arbitrage.”

  The term had circled back, finally, to its etymological origins, to the French word, dating back to 1704, to denote a decision by an arbitrator or tribunal. An arbiter. A decider.

  The large firms are designed to gain “informational advantage” as a fiduciary and, day to day, simply to decide how to use it to crush competitors on the trading floor. After Levin grilled Blankfein about how Goldman traded for clients, against clients, and often for itself using the precious information gleaned from clients, computer models, or relationships with the government, Blankfein demurred that “we do other things in the firm . . . we are a fiduciary,” and then had to agree with Levin’s statement that “that is what confuses people.” Sitting behind Blankfein in the hearing room, Goldman’s battalion of lawyers gasped—this was the last place they wanted him to be.

  A fiduciary, by a variety of legal definitions dating back to Roman law, must not put his personal interests before that of the principal, the person to whom he owes a “duty of care,” which, in this case, would be the Goldman client. And “he must not profit from his position as a fiduciary,” say numerous court opinions, “unless the principal consents.”

  That last issue of consent, though, is ugly in its complications.

  What exists at this point, based on the stunning consolidations and concentrations of power among a few “too big to fail” institutions, is an unwritten code: clients are drawn to Goldman or JPMorgan or any number of large hedge funds not in spite of the threat that those firms will act beyond the edge of propriety, but because of it. They’re counting on it.

  Despite what Levin said, there was no confusion about it at all. Let them do whatever they want, just as long as I, as a valued customer, get a piece of it. And if I can help in any way, I will.

  This is, of course, the way criminal syndicates rise up. It’s an issue of might. If the government, with its power of law and prosecution, can’t challenge them, they spread, and their influence deepens. The large banks and their companions, unregulated hedge funds, had increasingly taken ownership of the trading enterprise, opened new casinos dealing with the more complex, often shadowy realm of debt, and figured out ways to rig it on their behalf. For the clients and smaller competitors, this hard reality first brought frustration, then, year by year, acquiescence, and finally a kind of furtive participation. If it’s not going to change, then why not be part of it? If they didn’t sign on, their competitor would. The aim for clients is to be large enough, or strategically important enough, that Goldman sees them as valued partners and protects them or, even better, gives them a cut.

  Goldman and JPMorgan act as the arbiter, deciding, in ways both subtle and overt, which client prospers and which is crushed, with the goal being, ever and always, the bank’s profit. That’s called “protecting a balance sheet.” To be sure, the bank’s balance sheet.

  17

  Business as Usual

  Greg Fleming wasn’t planning to return to the Street. He had it all mapped out—the option he’d won, a precious gift: freedom. At only forty-seven, with enough money to do whatever he wanted, the options were all his.

  When classes commenced at Yale in the fall of 2009, he was already accustomed to not racing from his home in the New York suburbs to the city each morning and staying late most nights. He and his wife, Mellissa, went on a few vacations during the summer. He was spending time with his son and daughter; he was reconnecting with old friends from college. Up ahead was his ethics institute. He had another procession of Wall Streeters on their way to Yale for the fall semester as speakers.

  But someone, an old Merrill buddy, had said something that he couldn’t get out of his head: “Is this it, your last time out on the field?”

  He had been a member of a community, almost all men, who played, and played hard, in a storied game. It was social and professional. Their wives were friends. Finance was all any of the guys talked about. “I just couldn’t bear to think of the disaster at Merrill, even considering how proud I was to sell the firm—that that would be my last time at bat.”

  Which is why, come spring, he was far from Yale’s Elysian campus and back to a perch overlooking the skyline of New York. No spring semester in New Haven for Fleming. In February he took a top job at Morgan Stanley after an old buddy from Merrill, Morgan CEO James Gorman, pressed him to get back in the game. Almost immediately, Fleming was being seen as Gorman’s number two, there to whip various parts of the firm into shape.

  Now, looking out a wide window in Morgan’s executive suite, forty-one stories up, Fleming was considering whether he’d done the right thing. “There are moments when I wonder,” he said, waxing about his year thinking “beautifully disinterested thoughts” at Yale. “I’m entirely focused on substance these days, the gnashing of the business sector, and the banks, and it just keeps going on . . . in an environment that is very ugly.”

  But as reentry shock wore off, he’d begun to feel the native self-interest of New York and its needs. The banking industry’s recovery, now nine months along, now faced the threat of renewed ardor for financial reform.

  Fleming, like much of Wall Street, had recently become a fan of Tennessee’s former Democratic congressman Harold Ford, Jr., now at Bank of America/Merrill, who’d been taking on his former colleagues, especially the ones from New York who’d started attacking the Street. “In Texas, no one picks on the oil companies. No one in Michigan picks on the car companies,” Fleming said, paraphrasing a recent riff of Ford’s. “Why does everyone in the New York congress
ional delegation think Wall Street is now fair game? We’re the people paying taxes, providing the jobs. What industry is in New York—and I mean a real industry, that creates real employment—besides financial services?”

  But before a few minutes had passed, Fleming edged into a deeper conflict: a recognition that what was currently good for Wall Street, quarter to quarter, might not be good for the long-term interests of the wider country or its economy.

  He talked about the Street’s restored trading bonanza, namely in fixed-income debt and especially at firms such as JPMorgan and Goldman, now replenished with free Fed funds to trade enormous volume, and profit accordingly.

  Morgan, meanwhile, was trying to call for a “return to fundamentals” strategy, by focusing on traditional lines of business such as its brokerage operations and asset management, along with the mutual funds it pushed through a vast retail operation that included Smith Barney. Fleming was brought back to revamp and refresh those areas, “to create a solid, sustainable revenue stream that acts as a steady counterweight to fixed-income trading,” he said. Not that Morgan’s earnings were depressed, just less than the trading-fueled earnings of its two major competitors.

  “Morgan is now getting whacked for not being aggressive enough in certain areas of exotic trading,” he demurred. The firm’s stock price was sagging, in the high $20s, making it flat or down for the year, “and there’s pressure on James [Gorman] to change course.”

  Fleming said he was trying to be the voice of caution, of “stay on course.” The previous fall, up at Yale, he’d talked about being “like Colin Powell inside of Merrill, calling the alert on the fixed-income trading in mortgages” in the summer of 2006, when CEO Stanley O’Neal wanted to fire the firm’s head, an old-style risk manager and friend of Fleming’s named Jeff Kronthal. “I voiced my disapproval, but I didn’t resign. And I should have. If I had taken a stand, Merrill might have not loaded up on CDOs—more than $50 billion of them in the next year—and it might still be there today. But I didn’t.”

  He didn’t want to make the same mistake again. “I mean, did we learn anything or not?” he said, and ran through a bearish analysis: at times like these, when the underlying economy is sluggish after a crash, and huge fixed-income players are looking for yield, that “we’ve always started to build the scaffolding for the next bubble, the next boom and inevitable bust.” He didn’t know where the bubble would begin to inflate—“we never do in the first year or two”—but he added that he was regularly checking for volatility in the fixed-income trading records of Morgan and other firms. “That’s where you see the first signs.”

  Just a short time into his job at Morgan, he was testing whether the marketplace—still structured, as it had long been, in terms of quarter-to-quarter yardsticks and short-term incentives—would respect a long-term, steady growth strategy.

  The answer: not at all. Unless Morgan quickly expanded and juiced up its fixed-income trading, with the now-familiar brew of complex credit hedges backed by a systemically risky web of credit swaps, he and Gorman might find their days numbered. “The question is will any of us be given enough time to show that we’re farsighted.”

  Thus, Fleming, sitting quietly atop the city, marked the distance between Yale ethics and prudence seminars and the compensation-assisted amnesia of Wall Street.

  He thought back over the past four years, over what he’d learned since what he calls his “Colin Powell moment” in 2006, and he came around to Obama, how he had his chance in early 2009, when Wall Street was scared and vulnerable. At that point, Fleming said, Obama “could have instituted compensation reforms because people thought their compensation would never be coming back. But that’s over now.”

  And that means New York, with its mighty industry largely restored by Washington, “will defy any change, even if it’s for their own long-term good.” Wall Street made its money furiously trading funds “it borrowed from the government at zero interest rates, and for them to take the level of compensation that they now are, and not see that people will say that the government did that for them, is unbelievably tone-deaf.”

  He recounted a recent conversation he had with an old friend from Goldman. “He said our compensation this year dropped to 42 percent” of earnings, down from the usual split of 50 percent. “I said, ‘Yeah, but on the elevated profits, that means 20 million bucks, and what value did you really create for that?’ ”

  As long as that compensation model exists, Fleming concluded, before returning to tend to Morgan’s traditional, old-line investment operations, “there will be no replacement businesses built” in America’s capital of money and risk.

  Fleming’s competitor now, as he revamped Morgan’s asset-management business, turned out to be one of his oldest friends, Larry Fink. It was a long way since, sixteen years back, Fleming, as a Merrill investment banker, helped Fink break his analytical operation away from Blackstone, the private equity firm, to form BlackRock. A few blocks east of Morgan Stanley, Fink’s firm, BlackRock, now stood like a behemoth. In December it closed its deal to purchase Barclays, making BlackRock the largest asset manager on the planet—larger than Fidelity or Pimco. By early 2010 it was managing $3.9 trillion in assets, including holdings, across its many funds, of a 5 percent or more share of 1,800 companies.

  But the ever-more-distinctive feature of BlackRock, and its claim to still being in the lineage of traditional investing, was that it was not a principal. It didn’t trade its own account, the way Goldman or JPMorgan or, for that matter, Morgan Stanley did. No proprietary trading desk, betting the firm’s money against its customers’ accounts, or deciding, if there was a choice between clients, who might end up on the losing end of an arbitrage. There’s no doubt that BlackRock leveraged all manner of “informational advantage,” but it did it strictly for clients. BlackRock invested other people’s money hoping to get a return.

  “I don’t have a balance sheet to protect,” said the loquacious Fink. “Jamie Dimon, everything he does is protecting his balance sheet.

  “I have $3 trillion in assets, and my job is to protect the capital markets . . . just do the right thing. I’m not here to suggest that I have all the right opinions, but my motives are pure. I have no personal conflict with the broader good.”

  That kept BlackRock clear of the conflict-of-interest problems that were currently the subject of congressional hearings for a Goldman or a JPMorgan. Fink had no “Chinese walls” to keep proprietary information straight in his head. He was still in the basic game: investing other people’s money in publicly traded securities to get a good return.

  Not that booking strong performance had been, or would be, easy. With nearly $4 trillion to move, BlackRock—a bit like Fidelity’s giant Magellan Fund in the 1980s—had to beat the market, even as its size had grown to all but span the market. Fink and BlackRock had fought this “as the market goes, so goes BlackRock” problem with what they claimed, to general acknowledgment, was the best analytics in the investing world. BlackRock’s specialty, not surprisingly these days, was debt, especially mortgage debt; Fink had been working this terrain longer than almost anyone else. He had the distinction of having invented, along with Lew Ranieri, the basic concepts of securitization, and key early forms of mortgage-backed securities—specifically, collateralized mortgage obligations, a progenitor of CDOs. This meant that, in terms of interpreting mortgage data, with a special focus on repayment and default rates—all that affects those two key actions—BlackRock Solutions, the firm’s analytical arm, was an industry leader.

  Which was the prime reason Fink was so often on the phone to the Treasury Department from 2008 onward, and why, over the past few years, he had been handed nearly $9 trillion in troubled mortgage assets to manage on behalf of the U.S. government. More than half of those troubled assets were hauls from Fannie and Freddie—$5.5 trillion—along with a lion’s share of the government-assumed detritus of Lehman and AIG. Again, his was a fee-based business, and for this management ta
sk BlackRock received about $300 million in fees a year. The reward was also an unmatched, data-driven perspective into the abyss of “the country’s nationalized mortgage industry,” Fink said, “which, of course, is a fucking mess and needs to be turned back to the private sector.”

  He had expressed this and related points of view to Geithner and others at Treasury in phone calls every few months for several years. “Geithner just listens—doesn’t say much,” Fink reported, but what worried Fink more, with each passing month, was how “they’re just playing a game of Kick the Can.”

  All this means he knows too much—much too much—about how the fortunes of the government, and the wider economy, are tied to the still-unwinding mortgage debacle.

  So, while in one office tower Fleming was thinking about finding ways to challenge the dominance of fixed-income trading and “get the investment houses back in the business of investing in America,” Fink, across town, was singing a similar song, that “banks should be in the business of lending, and that will never happen unless the government stops coddling them.”

  That is more or less what Larry Fink was saying alongside the stage of an investment conference at a New York hotel in late May, as he waited for the crowd, about three hundred equity analysts, to get settled. The conference was sponsored by CLSA, a brokerage, investment, banking, and asset-management firm that is an emblem of how meaningless borders have become: it’s based in Hong Kong, specializes in how various investment sectors, such as transportation and clean energy, are expressed in the Asia-Pacific region, and is co-owner of Crédit Agricole, France’s largest retail banking group.

  CSLA is also known for its investors’ conferences: quiet, nonpublic affairs—no reporters allowed—where invited analysts pay dearly to get the insider views from star-studded guests, market makers, and movers in both government and business. Today’s rundown included David Rubenstein, the CEO of the Carlyle Group, the powerful Washington-based investment bank and home of former senior government officials; Jon Corzine, the former Goldman chief and New Jersey senator, just a few months past losing his New Jersey governor’s seat to a Republican, Chris Christie; Rodgin Cohen, of Sullivan & Cromwell; and Walt Lukken, Gensler’s predecessor as head of CFTC, who now ran a large clearinghouse for derivatives that would be extremely profitable if some reforms that Gensler was pushing—the kind of reforms that Lukken long opposed—became law. It’s no wonder the conference was oversubscribed: while investing in America is passé—returns are much better overseas—anticipating U.S. regulatory moves and trading accordingly is one of America’s signature growth industries. Goldman and JPMorgan made tens of billions buying up distressed mortgage securities by knowing, just a little ahead of everyone else, that the Fed’s policy of purchasing mortgage securities to keep asset values from tanking—a program started just after the September 2008 crash and now amounting to $1.2 trillion—would lift all boats marked “mortgage credit.” It’s not a complicated play: you need a lot of free capital and just a little advance warning. The latter is almost thoughtlessly granted to firms who help the government think through “market-oriented” solutions to this sort of problem. They’re arbiters—part of an unofficial tribunal of government and select businesses—who make consequential decisions . . . and get first position on an arbitrage as others hustle to fill the gap between what an insider knows and what the wider world is fast finding out.