Earlier this year, Greg
Smith, a young financial industry executive, announced his resignation from the
giant Wall Street firm Goldman Sachs, where he had worked for twelve years,
mostly in New York.
But he didn’t send his Goldman supervisors a standard resignation letter.
Instead, he worked
secretly for months on an essay “to distill into simple terms exactly what I
felt was wrong” (p. 236). After confirming Smith’s story, The New York Times published the essay just days after he cleaned
out his desk late on a Saturday night. (Readers of this blog might recall this posting about the op-ed on the same day it came out.)
Smith writes that “Goldman
would later tell me they had surveillance video of me walking out the front
lobby with my box and backpack. They thought I had larceny in my heart, when
all I had was freedom” (p. 243).
Smith’s ticket to
freedom--the op-ed piece explaining why he was leaving Goldman--attracted so
much attention that he was reportedly offered a $1.5 million advance to publish a book.
But reviews of his quickly
published memoir have been mixed. The New
York Times’ James Stewart complained that it “was curiously short on facts.”
Not surprisingly, The Wall Street Journal
sided with Goldman Sachs and said that Smith deluded himself into “taking his dissatisfaction [with his pay] as a betrayal by the firm he loved”—something
that Smith explicitly denies (p. 241). Forbes
said that his “story just doesn’t add up” or “make any sense.” These judgments,
as I’ll show, are unfair and miss the point.
Instead, I think this
book is an interesting glimpse inside a company that Rolling Stone magazine’s Matt Taibbi famously called “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
BusinessWeek’s reviewer, Bryant Urstadt, offers a more sympathetic reading,
comparing this Wall Street memoir to Michael Lewis’ Liar’s Poker, a tell-all story of Lewis’ time at the former Salomon
Brothers company that I described last year as “a hilarious send-up of
the big shots who ran Salomon by someone who saw their greed and recklessness
firsthand. Lewis was close enough to be on the inside, but critical enough
to keep his distance; his account turns out to be a readable introduction to
Wall Street, specifically the bond market, in the 1980s.”
Like Lewis, who was an
art history major at Princeton, Smith was
recruited out of an elite school (Stanford). But Smith was an economics major
who was passionate about comparative advantage and about making money. Lewis,
the liberal arts student, by contrast, seemed unimpressed with money and
bemused by investment bankers.
Lewis was also modest
about his own ambitions as a twenty-something young person. Greg Smith,
however, comes across as an earnest over-achiever who was proud of making it in
the competitive world of Goldman Sachs. To cite one example, he stresses how
rigorous the recruitment process was, pointing out that only 2.2 percent of
people who apply for internships or full-time positions get an offer (p. 9). He
was clearly pleased to be in the 2.2 percent. By contrast, Lewis “takes his own
advancement as a sign that something’s not right at Salomon Brothers” (to quote Urstadt's review). A little humility would have helped Smith’s case.
And he’s not nearly as
entertaining a writer as Lewis. Smith narrates at least two brief conversations
with Goldman big-shots happening at urinals, and it just sounds weird. Lewis, a
born storyteller, would have made more of this material.
Whereas Lewis quits after
seeing the absurdity of Wall Street’s bond market, Smith only gradually sees Goldman’s greed and ethical shortcomings. For years, he doesn’t ponder the
absurdity of profiting from complex financial instruments that few people
understood. Instead, he was so gung-ho about Goldman that he did corporate
recruiting for them.
Still, even if it lacks
drama, Smith’s story of growing disenchantment with an employer he loved does
tell us something about Wall Street's role in the global financial
crisis. We can profitably read Why I Left
Goldman Sachs as an accurate picture of a typical young person who entered
Wall Street in the early 2000s. And we should read the details, while
not bombshells, as significant indicators of the corrupted culture of Wall
Street, from a highly sympathetic source.
What follows are a few glimpses
inside the “great vampire squid’s” way of doing business, by one who was there
and saw how it contributed to the global financial crisis.
Goldman Sachs became a hedge fund rather than a trustworthy
adviser. A number of reviewers
have glossed over this important point, but it seems central to Smith’s
departure. As he puts it, “a fiduciary stood in a special position of trust and
obligation where the client was concerned. This role was applicable when the
firm was advising the client about how the client should best invest its money
versus pushing the client into investments that generated the largest fees. . .
. This ideal of doing what is right for the client, and not just what is right
for the firm, was there, prescribed in the 1970s by former senior partner John
Whitehead in his set of 14 Principles” (p. 111).
So what had changed?
Goldman had been privately held until 1999, and its partners could maintain
control of the firm. Once Goldman went public, issuing stock in 1999, the
pressure to generate ever-higher profits increased, and the partners lost
control. Instead of investment banking, “proprietary trading” became the
profitable service to sell. And sometimes Goldman would become a co-investor in
such trades. “In the old days,” writes Smith, “the firm would advise a client
to invest its own money in something; in the new universe, the firm could now
invest its money in the same thing” (p. 113). The problem, however, was “when
the firm changed its mind (or masked its intentions) and made a bet in the
other direction from the client’s” (p. 113).
In other words, Goldman
might advise a client to buy into a complicated scheme and then turn around and
bet against that scheme. Such conflicts of interest became more common, but
Smith trusted his bosses “for a long time” (p. 114).
By the end of 2008, however,
Smith says that he was growing wary of a corporate culture that promoted a
trader to managing director who was gouging clients (pp. 154-55).
When Senator Carl Levin of Michigan held public hearings in 2010 on a famously “shitty deal” that
Goldman advised its clients to buy—the perfect example of a conflict of
interest and what Goldman called an “axe” (see below)—Smith watched them on TV
in Asia, where he met with a client the next day. When the client said that he
couldn’t trust Goldman, Smith’s instinct was to think of how to fix the problem
(p. 186). But the high-level Goldman partner working with him didn’t seem to
care and was only interested in making money in the short-run. “Maybe this was
an isolated example, but it was not what I expected from a partner” (p. 187).
However, other evidence from the
book suggests that this was not an isolated example.
PATC meetings or Bonus Day
Smith explains how a
ten-minute meeting each December would decide each employee’s Per Annum Total
Compensation (PATC). Informally, Goldman people called the ritual Bonus Day. As
he puts it, “there was an absurd amount of emphasis placed on these meetings.
For many people, the session determined a person’s entire self-worth” (p. 119).
On Bonus Day 2006, when
he was in his mid-20s, Smith was told that he would make “close to half a
million dollars” (p. 119). And, even though he had also been promoted to
becoming one of thousands of vice presidents, he was disappointed!
Later, he describes how
the compensation system became “largely mathematical: you were paid a
percentage of the amount of revenue next to your name” (p. 233). Naturally,
“the problem with the new system was that people would now do anything—anything—to pump up the number next to
their name,” which poisoned “young minds” (p. 233).
An excessive focus on
individual compensation, regardless of how well you served your clients, surely
helps to explain the problem, even at Goldman, which was widely considered to
be the best-run, most ethical Wall Street firm. No less than authority than Nouriel Roubini contends that compensation was a root problem in the crisis (Crisis Economics, pp. 68-69, 184-91).
Even if Smith is
motivated by sour grapes, which he denies, the problem of compensation,
attached to booking profits without regard to consequences, remains.
Elephant Trades and GCs
Amid growing uncertainty
in 2007, Smith also explains a growing emphasis on making huge “elephant
trades” that made Goldman a million dollars or more in profit. “When you
executed one of these trades, the revenue would go next to your name in the
form of a gross credit, or GC” (p. 126). Later in the book, he describes the
focus on GCs as corrupting Goldman’s culture (pp. 190, 229, 234). He tells how
his supervisor, Georgette, came to his desk and said, “The only time I want to
hear from you is in the form of a one-line email that states how the big trade
was and what the GCs were” (p. 225). This emphasis confirms the impression that
profit crowded out care for clients and corroded Goldman’s organizational
culture (Smith’s primary grievance).
While others think Smith
is naïve to complain about this—we are talking about Wall Street after all—he
is documenting an important shift in Goldman’s culture. And it’s a story
connected to larger cultural shifts (from Enron to professional sports and
beyond). As profit becomes everything—or the only thing—communal trust is
corroded.
“Structured derivatives” and selling tuna
Smith describes how the complex
financial products called derivatives could harm real people. For example, the
city of Oakland
bought a swap from Goldman that was designed to hedge against interest rate
increases. “The product ultimately backfired, and is now costing the city
millions of dollars” (p. 152). He likens Goldman’s sales of derivatives to a
company that sells tuna:
The
can clearly says, “Bumble Bee tuna,” and features a cute little logo. You go
home, and most of the time you enjoy some delicious tuna. But let’s say you get
home one day and find dog food inside the can. How can this be? you wonder. They
told me it was tuna. But then you look at the back of the can. There, in
print so tiny as to be almost unreadable, is printed something like “Contents
may not be tuna. May contain dog food.” (p. 153).
Unfortunately, “most
clients pay as close attention” to “the fine print of the ten-page disclaimer
at the end of the contract” as “you do when you hit the Accept button before
downloading music from iTunes”(p. 153).
Clients beware?
A reasonable person might
therefore counter that buyers should be aware of what they are buying,
especially when they are investing millions of dollars in pension (or other) funds
for someone else. But Smith contends that Goldman preyed on the “Client Who
Doesn’t Know How to Ask Questions.” Such clients were “the perfect target to
sell a type of derivative known as an exotic—a very complex product that could
be made to look much simpler for the client when dressed up with enough bells
and whistles as a structured product” (p. 163). In other words, they were
buying tuna cans that might have dog food in them, but they had no idea.
Smith says that some of these clients
would end up on Goldman’s top 25 clients list, as ranked by the fees
they paid to Goldman. “There is something highly disconcerting,” he writes,
“about seeing a global charity or philanthropic organization or teacher’s
pension fund in the top twenty-five of a firm’s clients” (pp. 163-64). In other
words, Goldman profited from the naïveté of these non-profit clients.
Selling Axes
Smith says that he was
bothered by pressure to sell risky investments or positions that Goldman wanted
to axe from its books, even though it knew that these investments would harm
clients. Here’s how Smith nicely describes the problem:
The
firm believes, deep down, that one outcome is going to transpire, yet it
advises the client to do the opposite, so the firm can take the other side of
the trade and implement its own proprietary bet. One way to understand this is
to think of selling donuts. Say you own a Krispy Kreme doughnut store, and you
have too many doughnuts in stock and need to sell them before they go bad. In
order to drive up sales, you could say “Our doughnuts are fat-free!” That would
technically be a lie, but it wouldn’t get you sent to jail. It might open you
up to legal action, but who really wants to go to court? Suddenly people would
be rushing in to buy these delicious Krispy Kreme doughnuts, convincing
themselves that if a brand as reputable as Krispy Kreme is saying the doughnuts
are fat-free, then it must be true. Axes are something like surplus Krispy
Kreme doughnuts that Goldman wants to clear from its inventory, making a
compelling, but not always completely accurate, case for clients to buy them.
(pp. 230-31).
The most famous axe of
all was the notorious Abacus/Timberwolf deal made famous by Senator Carl Levin in
the following interchange with Goldman witnesses.
The problem with this deal
was that Goldman could “see what both buyers and sellers [were] doing” (p.
185). It knew that the Timberwolf investment was a bad one, and advised clients
to buy it, yet at the same time that it was also betting its own money that
Timberwolf would crash in value.
This problem of
“asymmetric information” means that Wall Street firms like Goldman are like
casinos that can “effectively see everyone’s cards” and even determine which
cards you get (in complex, unregulated derivatives. “Certainly not much scope
for the casino to lose in this scenario” (p. 248).
Working in London, Smith
was involved in selling dubious products akin to the “fat-free” Krispy Kreme
donuts to “the national banks of sovereign nations, countries with millions of
citizens who were depending on their governments to get their shit together”
(p. 232).
Goldman Sachs’ behavior
had terrible real-world consequences for governments in Europe
and around the world. Ripping off these central banks is hardly ethical
business, and Smith is right to be upset about this.
A whitewashing self-study
Smith describes how
Goldman went through a year-long Business Practices Study, ending in January
2011, which appeared to be more of an exercise in PR and spin than a genuine
attempt to learn lessons from the crisis, dashing his hopes (pp. 192, 218-19).
In a follow-up seminar to discuss the study a few months later, Smith says that
he suggested to a high-level partner that managing directors needed “to be held
accountable” and reforms be put into practice, but the partner “looked at me
with a blank stare and nodded wordlessly, almost robotically” (p. 230).
We shouldn’t be shocked
that Goldman failed to police itself as it ripped off its own clients. “This
was happening all over Wall Street,” writes Smith, “but Goldman Sachs was
supposed to be a leader” (p. 241).
Or maybe it really was
just a huge vampire squid.
Either way, Greg Smith is
free now.
