On Sunday September 21, just before 3 pm, Lloyd Blankfein gathered the top executives of Goldman Sachs Group in his 30th-floor office and set off a chain of events that would forever change the company he leads.
It had been a week like never before on Wall Street. Lehman Brothers Holdings, the fourth-largest US securities firm, was bankrupt. The credit markets, which Goldman uses to fund its business, were frozen. And Treasury Secretary Henry Paulson, Blankfein’s predecessor as chief executive officer of Goldman, was begging the Congress for $700 billion to save the financial system. Goldman’s stock had plunged as much as 26 per cent in just one day.
In the brief meeting in lower Manhattan that warm Sunday, according to a person familiar with the events, Blankfein told his lieutenants the firm would become a bank holding company, ending its run as the jewel of global investment banks.
So began the next chapter in the history of Goldman Sachs, a company founded in 1869 by a former street peddler that had weathered many crises. It survived what may have been the most serious threat in September, only to be thrust into a new landscape where Goldman will have to prove that old virtues — a vast alumni network, a fierce partnership culture, high levels of compensation and trading acumen — are still of value.
It wasn’t until that weekend that Blankfein, 54, decided to break the glass and sound the alarm. Goldman was going to need the stability of a large deposit base, he concluded, to compete with the likes of JPMorgan Chase & Co and Bank of America, the nation’s two largest commercial banks.
Goldman executives, fortified with Chinese takeout, gourmet pizza and burgers from Harry’s at Hanover Square, had spent the weekend debating the firm’s options. Lawyers were preparing the paperwork to transform the bank into an institution supervised by the Fed. Some slept in the office. Blankfein was in close contact with Timothy Geithner, president of the Federal Reserve Bank of New York, and with John Mack, chief executive of rival Morgan Stanley, the person said.
After the meeting in his office, Blankfein secured the consent of his board of directors on a conference call. By 10 pm, as darkness engulfed Wall Street, Goldman and Morgan Stanley separately announced they would henceforth do business as deposit-taking institutions.
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That was only the first step in rescuing Goldman from what would have been an unthinkable fate last year, when the firm earned $11.6 billion and its three top executives — Blankfein and Co-presidents Gary Cohn and Jon Winkelried — earned a total of $203 million.
Over the next days, the trio, stewards of Goldman since 2006, would call Warren Buffett for a $5 billion investment to shore up their balance sheet. And they’d raise another $5 billion by selling public shares for $123 each. That price was 43 per cent higher than the $85.88 the shares touched in New York trading on September 18, their lowest level in four years.
Meanwhile, in Washington, Paulson, 62, was scrambling to sell his plan to relieve banks of toxic mortgage securities that had sucked more than $600 billion from their balance sheets and were now devouring investor confidence. He had already let Lehman go. The Fed had pledged $85 billion to keep American International Group, the world’s biggest insurer, from the same destiny.
On October 3, President George W Bush signed legislation establishing the Office of Financial Stability to oversee the US purchase of soured securities and loans from scores of companies, including Goldman. Edward Forst, 47, a former head of Goldman’s asset management unit who now helps manage Harvard University’s $35 billion endowment, helped set it up. On October 6, another Goldman alumnus, Neel Kashkari, a 35-year-old former technology banker who joined the Treasury in 2006, was named to lead it.
Then, a week later, Paulson reversed course and summoned Blankfein and eight other banking chiefs to Washington, where he told them the government would inject $250 billion into the banking system — including $10 billion for Goldman — and insure senior unsecured debt issued over the next three years. In exchange, the government would take stakes in their companies and control executive compensation.
At the pinnacle
Goldman has adapted before. It rose to the pinnacle of Wall Street profitability and power by creating a culture with a canny talent for reacting to what’s coming next.
“Change is a general operating principle,’’ says John Rogers, 52, Blankfein’s top counselor, who has managed the firm’s executive office under three CEOs. “We have people who live in the markets, and our culture is one of speed. It’s nimble.’’
The government plan is designed to make it easier and cheaper for banks to borrow money, alleviating the pressure on Goldman to gather deposits right away.
With that benefit will come restrictions.
Blankfein, Cohn, Winkelried and Chief Financial Officer David Viniar, 53, are among the executives whose compensation will be subject to new Treasury-imposed standards, although none of these rules is likely to make a material difference to pay practices at Goldman. While the company won’t be able to take tax deductions on salaries exceeding $500,000, bonuses that make up the majority of Goldman executives’ pay won’t be affected.
Less leverage
The Fed may impose stricter controls on the amounts and types of risks that Goldman and other banks can take in the future, although regulators haven’t said anything publicly.
Goldman’s record profits last year were fueled by trading and multibillion-dollar investments that leveraged the company’s total assets to shareholder equity more than 25 to 1.
Now the credit crisis of 2008 has shattered the business, and Goldman is switching gears. Blankfein plans to gather consumer and corporate deposits as a more-stable and lower-cost source of funding. He’ll dial back risk in trading and principal investing, which provided 68 per cent of revenue in 2007. And partners will have to learn to live with Fed inspectors in their midst.
The good news for Goldman is that the company’s expertise in making investments in distressed assets could pay off. The firm has already raised funds to buy assets ranging from mortgage securities to loans made to finance leveraged buyouts, and it sees opportunities to invest in the current environment, people familiar with the company say.
Goldman’s top executives declined to comment for this article. Blankfein scheduled an interview and then canceled on October 10, when the firm’s shares plunged 12 per cent and the Standard & Poor’s 500 Index finished its worst week since 1933.
The bad news is that the weak economy may depress business in other areas, including M&A and trading. Blankfein has described Goldman’s strategy as “chasing GDP around the world,’’ meaning the company makes money in economies that are growing fastest. “Our ultimate source of growth is the economy,’’ he has said.