Clients wary of Goldman Sachs as it applies its 15th principle?
In Goldman Sachs we trust? It's getting a bit harder perhaps. No matter how the SEC's (SEC news) civil complaint against Goldman Sachs (NYSE: GS) is resolved, it has certainly had an impact on the firm. Most importantly, it has pierced the patina of rectitude that the corporate world in general bought into. Some are now wondering if Goldman Sachs is beyond redemption and asking how vulnerable the firm is to more customer defections.
We are seeing the firm's underbelly exposed, and the results to many will be troubling. The New York Times offers a highly interesting piece that looks at how Goldman Sachs manages the conflicts it faces as it deals with customers. When times are good, and everyone is bullish on everything, the conflicts aren't a problem. But when markets sour, well, the conflicts become all but unmanageable in the eyes of many. The article offers specific examples when Goldman Sachs, by dint of its conflicts, angered several clients, who understandably felt the company was acting against them with its trading operations. The influence of the article cannot be denied; it certainly provoked a heated response.
Each example is telling. Goldman Sachs was selling bonds issued by Washington Mutual, even after the company was bearish on the bonds and initiated a large position on the WaMu stock. The same goes for the state of New Jersey, which was miffed that Goldman Sachs underwrote its bonds but then recommended that clients bet against the bonds in the CDS market. On behalf of the University of Pittsburgh Medical Center, Goldman Sachs arranged ARS deals, and continued to recommend that the hospital re-up, even as the market got dicey, and interest rates spiked. When the market blew up less than a month after Goldman recommended the hospital stay the course, the hospital wanted to redeem securities, as it did with other banks. But Goldman Sachs refused. The hospital understandably dropped Goldman Sachs as its investment banker. And then there's Bear Stearns, to whom Goldman Sachs sold the ill-fated Timberwolf CDOs, and the many other entities which bought CDOs just in time for the market to collapse.
The article even trots out the candid words--which we've noted several times--of then CEO of WaMu, Kerry Killinger, who didn't trust the firm one bit and put it in a confidential email. He likened working with Goldman Sachs to swimming with the sharks.
Part of the problem here is that Goldman Sachs has become so successful as a trading operation that everything it does is colored by that. If its economists issue a report bullish on gold or gas, people will assume Goldman Sachs is long the markets. If a county in Alabama hears that Goldman Sachs is telling people to short your bonds (after they've just underwritten them), they are going to get nervous, given Goldman Sachs' trading prowess and heft. All talk of firewalls and barriers will not be persuasive.
These conflicts are in a trading sense a good position to be in. You are in the middle of many information flows, and that's what can drive markets. At Goldman Sachs, this is known, according to the Times, as the 15th principle. While the company's 14 principles are drilled into new hires, the 15th principle is kept off the record. It's all about embracing conflicts and tension between clients and the firm.
That tension is getting hard to manage. The issue is what can be done about this. (Clearly, the company has to do something.) We may end up with some attempt to create firewalls between certain units. And that might do some good. Perhaps a firewall between bankers and traders would help. But most bankers often feel obligated to make markets in the issue they underwrite. They ought to be able to hedge to some extent. So it gets really tricky. Any ideas? - Jim