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Goldman Sachs: a tale of two Smiths

Mon, 19th Mar 2012

The passage of Goldman Sachs from pillar of the Wall Street establishment to great vampire squid, symbol of excess, greed and everything that’s wrong with the financial sector, is a case history for our times. What happened?

Ownership, topically, is part of the story. Until the 1990s, Goldman Sachs, founded in 1869, was, if not liked, universally admired for its acumen, its connections and the intellect of its people. Like McKinsey in consultancy, it was the stamp on the CV that every budding investment bankers wanted to have.

Until 1999, when it went public, Goldman Sachs had been a partnership. Now, like any other ownership form, partnerships have advantages and disadvantages.  The ‘disadvantages’ are conservatism and limited access to capital (oh, wait...). The advantage, as Evening Standard city editor Tony Hilton told a Foundation forum recently, is that in a partnership, with unlimited liability, there is strong peer pressure to maintain ethical and other standards. As Adam Smith put it more than two centuries ago in a dig at joint-stock companies, ‘The directors of such companies..., being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own .... Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company.’ True to form, ‘anxious vigilance’, whether about money, clients or reputation, was conspicuously less after Goldman went public. The extent of the ‘negligence and profusion’, meanwhile, came into full view in another Smith’s celebrated retirement op-ed in The New York Times.

A similar erosion of standards can be seen in other professions that have travelled the same path. Contrast the law and accountancy. Legal firms, largely still partnerships, have mostly retained their professional ethos and reputation. The big accountants, on the other hand, abandoned the partnership form in the 1970s, since when, says Hilton bluntly, they ‘have become charlatans. It’s a classic story: ‘what's the profit and what would you like it to be’, and no one believes accountants are of any value at all any more. Those who do might ask why they all gave the banks a clean bill of health in 2007 and none of them spotted the crash – or they all did but looked the other way.’

The other thing that happened in 1999 was the repeal of the Glass-Steagall Act which had separated commercial from investment banking. In the giant new entities that were created, it was increasingly the securities and trading side that made the money and who naturally came to dominate a culture that instead of relationships and serving real-world customers with boring things like investment and raising capital was now all about transactions and deals. The extreme case was the sub-prime mortgage debacle (and its subsequent mirror image, the so-called robo-closures crisis), where there was no direct interaction with customers at all. That culture generated huge pecuniary interests for individuals to do whatever it took to make short-term returns for shareholders whose interests were served by volatility and above all towering leverage.

What’s more, and crucially, the banks’ dominant customers were now, just like them, part of the same superextractive culture. This explains two otherwise puzzling aspects of the story: why Goldman Sachs had so few qualms about the strategy of selling toxic assets to customers and then shorting them in the first place, and why those who bought them have been so muted in their criticism. Customers have conspicuously not deserted in droves, and in the fracas over Greg Smith’s New York Times article, executives of other banks have sympathised with rather than excoriated Goldman. This is not surprising, because none of them were surprised: as a wealth of material about Lehman and other failures makes clear, they were all at it, trying to milk customers and suppliers for everything they had. It wasn't that Goldman sold them dodgy products – they were doing that too – what riled them (and even caused some sneaking admiration) was that it was smarter at it than they were. Interestingly, this is already in the hands of some commentators becoming a defence of the status quo: as a colleague points out, Goldman Sachs’ PR advisers will be rubbing their hands at articles in the FT and elsewhere saying, in effect, wise up, that’s business, what’s the fuss? Anecdotes tell of applications for jobs at the bank going up rather than down in the wake of the article.

The fuss is of course, that what happened at Goldman Sachs also happened at Lehman Brothers and all the other investment banks; and the cumulative result was the catastrophe of 2008, with whose aftermath we are still struggling today. The process and its inevitable outcome are laid out in masterly fashion by Andrew Haldane, the Bank of England’s director for financial stability, in an important article in The London Review of Books. In the 19th century, he writes, ‘managers monitored shareholders who monitored managers; in the 21st, managers egged on shareholders who egged on managers’ – and, he might have added, accountants subject to exactly the same vicious incentives did nothing to raise the alarm or do anything else to prevent the disaster happening.

Four years on, the culture hasn’t changed. As Geraint Anderson, author of Square-Mile exposé 'Cityboy', put it bluntly on the Today programme recently, the City is still ‘a get-rich-quick scheme for clever, ruthless, greedy people’. The banks are still too big, and still in the de facto control of the unholy alliance of top managers and short-term shareholders who alone have benefited from bank developments of the last 15 years. It’s time to ask the obvious question. Are the explosive risks and incentives generated by today’s flawed PLC model compatible with society’s long-term requirements of its banking infrastructure? The answer, at least in the US and UK, is clearly no. Shareholders, and shareholder-managers, who have shown they are unwilling or unable to exercise the necessary ‘anxious vigilance’ over a sector that has the capacity to blow up the world, have exposed for that world to see the hollowness of their pretensions to 'ownership'. They no longer deserve the extraordinary and taken-for-granted
privilege of limited liability. Goldman Sachs, and other institutions like it, should return – or be returned – to the partnership form that places the risks and rewards back where they belong.


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User comments

Gordon Pearson :: 20th Mar 12
I agree wholeheartedly - limited liability partnership is a contradiction in terms. Its elimination would also limit the predatory activities of most fiancial intermediaries who hold shares and control them without real ownership. But will LLPs be banned? It's in the same category as limiting equity voting till shares have been owned for 6 months. Or excluding from voting those shares acquired by executives through a bonus scheme, such exclusion to apply while the executive is employed by the company (to av
:: 21st Mar 12
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