Money and Power (101 page)

Through all the turmoil, Goldman was minting money. In the third quarter of 2007, Goldman’s revenues were $12.3 billion—its second-highest quarter of revenue ever—and its net income was $2.9 billion. Goldman’s return on equity was 31.6 percent, nearly unheard of for a public company. On the earnings call, Viniar spoke specifically about the firm’s performance in mortgages. “The mortgage sector continues to be challenged and there was a broad decline in the value of mortgage inventory during the third quarter,” he said. “As a result, we took significant markdowns on our long inventory positions during the quarter, as we had in the previous two quarters. Although we took these marks, our risk bias in that market was to be short and that net short position was profitable. I would also note that you’ve heard me express our generally negative views on the outlook for mortgages since the beginning of the year, so you could correctly assume that we’ve been very aggressive in reducing our long mortgage exposure and conservatively marking down our long mortgage positions.”

Peter Eavis, a writer at
Fortune,
was the first to pick up on what he
called Goldman’s “
stunning strategy” of making a “huge, shrewd bet” while “the credit markets went sour” and “seems to have won big.” Eavis was not sure how Goldman pulled it off, but he observed cannily on September 20 that “[a]s the credit markets fell apart over the summer, causing the prices of hundreds of billions of mortgage-backed bonds to plunge, Goldman Sachs had already positioned itself so that it would profit massively from a decline in those securities.” He noted that Goldman’s third-quarter earnings “were far above expectations” with the “chief contributor to earnings blowout” being “trades that made money from price drops in mortgage-backed securities.” When he tried to figure out how much Goldman had made from the bearish bets—he did not know who at Goldman had been responsible for them—he observed that Viniar, on the third-quarter conference call, “declined to give a number for the amount of money Goldman made on its mortgage short.”

Not surprisingly, Eavis had not known—could not have known—that Birnbaum and company had been shorting the mortgage market for the previous nine or so months. What he did figure out, correctly, was that a decision would take time to make and to implement. “Amassing a large bearish position in mortgages would have required planning and direction from a senior level,” he wrote. “On the conference call, Viniar said the bet was executed across the whole mortgage business, implying that it wasn’t the work of one swashbuckling trader or trading desk. Of course, the prescience of the short sale would seem to confirm the view that Goldman is the nimblest, and perhaps smartest, brokerage on Wall Street.” He noted that Bear Stearns’s “mortgage business suffered considerably in the quarter” and Morgan Stanley “wasn’t as well hedged to bond losses” (in fact, according to
Michael Lewis’s
The Big Short,
Morgan Stanley would go on to lose $9 billion betting incorrectly on the outcome of the mortgage meltdown).

Lucas van Praag, Goldman’s longtime head of public relations, sent the
Fortune
article around to the firm’s top executives. Winkelried, for one, did not appreciate it. “Once again[,] they completely miss the franchise strength and attribute it all to positions and bets,” he wrote to the executive team. Blankfein elaborated on Winkelried’s observation. “Also, the short position wasn’t a bet,” he wrote. “It was a hedge. I.e., the avoidance of a bet. Which is why for a part it subtracted from VAR, not added to VAR.” (This was a very subtle argument, making a fine distinction—and Blankfein kept making it over and over again, even though few people could follow his logic. The fact of the matter was that Goldman had bet—correctly—that the mortgage market would collapse.) In an e-mail a few minutes later sent from his BlackBerry,
Peter Kraus, a longtime
Goldman partner and then the co-head of the firm’s investment management division, provided Blankfein a particularly unique—perhaps even myopic—insight. He explained that since the third-quarter earnings announcement he had met with more than ten prospective and current clients. “The institutions don’t and I wouldn’t expect them to, make any comments like [‘]ur good at making money for urself but not us,[’]” he wrote to Blankfein. “The individuals do sometimes, but while it requires the utmost humility from us in response[,] I feel very strongly it binds clients even closer to the firm, because the alternative of [‘]take ur money to a firm who is an under performer and not the best,[’] just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run.” Needless to say, Blankfein did not respond to Kraus.

——

O
N
O
CTOBER
11,
Moody’s—one of the three large bond-rating agencies—downgraded $32 billion of publicly traded mortgage debt that had been originally issued in 2006, the second large and sweeping ratings downgrade by Moody’s in six weeks. Swenson shared the news with Montag and Mullen. “This will eventually filter into downgrades in CDOs,” he wrote, adding that one of the ABX indexes sold off “by a point” after the news, meaning more profits for Goldman. “ABS [asset-backed securities] Desk P and L will be up between [$]30 and [$]35mm today,” he added. Mullen responded, “Nice day.” There was also a discussion of other, more technical consequences of the Moody’s downgrade that Swenson thought would result in interest payments on some of the bonds “being shut off,” or not being paid, which would lower dramatically the value of the securities and mean big profits for anyone—like Goldman—betting they would lose value. “Sounds like we will make some serious money,” Mullen responded. Concluded Swenson, “Yes we are well positioned.” Actually, the profit news that day was even better than Swenson had originally thought. Instead of the mortgage trading desk making between $30 million and $35 million as a result of the Moody’s downgrades, the desk actually ended up making $110 million, $65 million of which came from “yesterday’s downgrades which lead to the selloff in aa[-rated bonds] through bbb[minus-rated bonds] today,” Swenson wrote to Mullen, taking the proverbial “victory lap” that Wall Streeters are so well trained to do, even at Goldman Sachs, the champion of teamwork. “Great Day!” Mullen replied.

Inevitably, though, since trading is a zero-sum game where for every winner there is a loser, at the same time that Goldman was raking in profits, some of its clients, or “counterparties” as they were known on the trading desks, were bound to be suffering. Worse, apparently, some of
Goldman’s European salespeople, who had helped to sell the firm’s “axes” earlier in the year, did not feel they were getting the recognition they deserved for pushing the deals out the door.
Yusuf Aliredha, Goldman’s London-based co-head of European fixed-income sales, wrote to Sparks on October 17: “Dan, Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant. Aggregate loss for our clients on just these 5 trades alone is 1bln+. In addition team feels that recognition (sales credits and otherwise) they received for getting this business done was not consistent at all with money it ended making/saving the firm.”

Aliredha then described five 2007 CDO deals that Goldman had created and then sold to investors that now had come back to haunt the firm, at least if unhappy clients were any gauge. One of the five was the ABACUS deal, completed just a few months earlier by
Fabrice Tourre and
Jonathan Egol. Aliredha seemed concerned that
ABN Amro, the big Dutch bank that had shared with ACA around $1 billion of mortgage-related risk on the deal, was not happy. “At the time this was the biggest axe for Egol & Fabrice as the portfolio was predominantly subprime BBB names picked by ACA,” he wrote to Sparks. “ABN was the only intermediary who was willing to take ACA exposure.… Not sure what the total amount of collateral that’s been called so far, but it must be at least $200–300MM on this trade alone.” In other words, Goldman was cleaning up and its clients—sophisticated investors to be sure—got killed.

——

I
N AN
O
CTOBER
29 internal presentation to the Goldman tax department titled “Contagion and Crowded Trades,”
Craig Broderick, the firm’s chief risk officer, explained how the firm had navigated the rough waters in the credit markets and had reached port safely. He started by commenting that the “overall market events since Jan[uary] of this year—but largely concentrated over the summer period—are as dramatic and interesting as any I’ve seen in 25+ years in the business. I use the word ‘interesting’ only because we’re past the worst of it at least as far as our own exposure goes[,] [but it was] pretty scary for a while.”

He acknowledged that the firm’s willingness to mark down its long positions “gave rise to all sorts of stories about how we are marking our books” and to questions about the “significant differences in marks vs. competitors” and that “there are a lot of disputes with clients,” but he viewed Goldman’s mark-to-market prowess as a singular accomplishment. “Best success here was on our marks and our collateral calls,” he continued. “First mover advantage, most realistic marks, competitors unwilling to mark fully given implications for their own trading positions.”
The next day, Blankfein asked Viniar and Cohn how the “review of the mortgage and [CDO] books” went. Viniar responded, “Extremely well. You will be very pleased.”

It was increasingly easy to see why. According to an internal Goldman document about the quarterly performance of the mortgage group, Birnbaum was still printing money, although the pace at which he was doing it had—understandably—slowed in the fourth quarter. Nevertheless, the profit numbers were astounding, especially compared to the financial bloodbath occurring across the rest of Wall Street. Through October 26, Birnbaum’s group had made $3.7 billion in profit, more than offsetting losses of around $2.4 billion in the rest of the mortgage business.

——

P
ICKING UP ON
the idea
Fortune
had explored a few months earlier, the
New York Times
explored the idea of how Goldman had done it. “
For more than three months, as turmoil in the credit market has swept wildly through Wall Street, one mighty investment bank after another has been brought to its knees, leveled by multibillion-dollar blows to their bottom lines,” observed reporters
Jenny Anderson and Landon Thomas Jr. “And then there is Goldman Sachs. Rarely on Wall Street, where money travels in herds, has one firm gotten it so right when nearly everyone else was getting it so wrong. So far, three banking chief executives have been forced to resign after the debacle and the pay for nearly all the survivors is expected to be cut deeply.” Meanwhile, Blankfein—the
Times
predicted—would easily top the $54 million in compensation he had made in 2006 and likely would receive as much as $75 million. (In the event, it was closer to $70 million.)

The paper then explained how the “notoriously nervous” Viniar called for a “mortgage risk” meeting in his “meticulous” thirtieth-floor conference room in December 2006. “After reviewing the full portfolio with other executives, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses,” the
Times
continued. “With its mix of swagger and contrary thinking, it was just the kind of bet that has long defined Goldman’s hard-nosed, go-it-alone style.” When the mortgage market crashed in July, Goldman had already off-loaded much of its mortgage-related risks, the paper continued, quoting
Guy Moszkowski, an analyst at Merrill Lynch who covered the investment banks. “If you look at their profitability through a period of intense credit and mortgage market turmoil,” Moszkowski said, “you’d have to give them an A-plus.” Anderson and Thomas then reported: “This contrast in
performance has been hard for competitors to swallow. The bank that seems to have a hand in so many deals and products and regions made more money in the boom and, at least so far, has managed to keep making money through the bust.… Goldman’s secret sauce, say executives, analysts and historians, is high-octane business acumen, tempered with paranoia and institutionally encouraged—though not always observed—humility.”

The article also made the important points that Goldman’s “flat hierarchy” encouraged “executives to challenge one another” so that “good ideas can get to the top,” and that the firm’s risk department had as much status, authority—and compensation—at the firm as did the rainmakers, a claim no other Wall Street firm could make. “At Goldman, the controller’s office—the group responsible for valuing the firm’s huge positions—has 1,100 people, including 20 Ph.D.’s,” the
Times
continued. “If there is a dispute, the controller is always deemed right unless the trading desk can make a convincing case for an alternate valuation. ‘The risk controllers are taken very seriously,’ Mr. Moszkowski said. ‘They have a level of authority and power that is, on balance, equivalent to the people running the cash registers. It’s not as clear that that happens everywhere.’ ”

Anderson and Thomas went so far as to compare Goldman Sachs at the end of 2007 to the power and influence that J. P. Morgan & Co. had between 1895 and 1930. “But, like Morgan, they could be victimized by their own success,”
Charles Geisst, a Wall Street historian at Manhattan College, told the paper. “Mr. Blankfein of Goldman seems aware of all this,” the article concluded. “When asked at a conference how he hoped to take advantage of his competitors’ weakened position, he said Goldman was focused on making fewer mistakes. But he wryly observed that the firm would surely take it on the chin at some point, too. ‘Everybody,’ he said, ‘gets their turn.’ ”

Not surprisingly,
Lucas van Praag had spent a considerable amount of time “working with” the
Times
reporters to make sure Goldman’s perspectives were incorporated into their front-page article as much as possible. This was hardly surprising, of course, as nearly every piece of responsible journalism involves such give-and-take. The Sunday afternoon before the story was to run, van Praag briefed Blankfein, in writing, about what was coming, providing a rare glimpse into how Wall Street executives try to manage the journalists who cover them. For starters, van Praag explained that “we spent a lot of time on culture as a differentiator” with Anderson and that “she was receptive.” But, alas, he also reported, “Tomorrow’s story will, of course, have ‘balance’ ([i.e.,] stuff we don’t
like). In this instance, we have spent much time discussing conflicts, and I think we’ve made some progress as she a[c]knowledges that most of her sources on the subject are financial sponsors which fact, unless edited out, is included and gives context.” (The story did mention that some private-equity firms worry that Goldman’s huge private-equity fund had become an unwelcome competitor.)