Money and Power (58 page)

Kevin Maxwell recalled “conversations between Robert Maxwell and Mr. Sheinberg when the talk was of driving the share price up to £4, £5 even £10.” Robert Maxwell “believed Mr. Sheinberg when he said he would do this, as he believed Mr. Sheinberg was assisting him as his client,” he told the DTI. When Kevin Maxwell questioned this, his father told him he knew nothing and that “the great Mr. Sheinberg knew everything, as was his belief from the many deals done since 1986.” Kevin Maxwell did not regard this to be a wrongful manipulation of the market but, rather, using a market maker to counteract those who were manipulating the price of Maxwell shares downward. Kevin Maxwell concluded that “[i]t was plain that Mr. Sheinberg must have come to the view at some time that Robert Maxwell was fixated on the share price and as a result moved from someone carrying out a trade to someone who would scheme against his client. Mr. Sheinberg had lied to Robert Maxwell.”

For his part, Sheinberg told the DTI that “there was never any agreement with Robert Maxwell to cause the price to rise,” that “he always followed his own trading strategy and never described it to” Maxwell, that “it would have been irrational to commit himself to a fixed trading strategy,” that he “may have spoken to Robert Maxwell about the share price going to £4, £5 or even £10, but that was in the context of what might possibly happen if there was a large short position,” and that “he did not speak daily with Robert Maxwell.”

In other words, there was total disagreement between the two sides. Goldman told the DTI that the firm made approximately £23 million
from its dealings with Maxwell. Sheinberg told the DTI that Maxwell was not a “sucker” but rather a “trader’s trader,” and in DTI’s words, “someone who would decide quickly whether or not he wanted to deal and who traded on instinct and impulse.”

The fallout from Maxwell’s sudden death and the subsequent unraveling of his financial empire cast yet another unwelcome light on Goldman Sachs, leading Friedman to reach the wise decision that 1993 would not be a good time for Goldman to consider an IPO. “
I could see the Maxwell thing wasn’t resolved,” Friedman said. “You could see where it was going. But that took a lot of time, a lot of attention. It was very, very painful.” With Maxwell, Goldman had failed to follow, in dramatic fashion, one of the cardinal rules of trading and market making: know your customer. “Of all the reputations smudged by the scandal, that of Goldman Sachs, an American investment bank, was the brightest,”
The Economist
reported soon after Maxwell’s death.

——

B
EFORE LONG
, 1994 would bring a whole new set of problems to 85 Broad Street. As 1993 was drawing to a close, the idea of retiring was on Friedman’s mind. Whether he wanted his legacy to be the $2.7 billion in pretax profits or whether he was just exhausted from grappling alone—without his wingman—with the ongoing fallout of Goldman’s numerous scandals and the job of running a hugely complex, global enterprise remains unclear. There is no question that being the sole senior partner of Goldman Sachs was taking its toll on Friedman. Where he once could divide up international travel and flag-waving with Rubin, in 1993 Friedman was on his own. There were also questions raised about both his physical and his mental health. People would often come up to him and tell him he didn’t look well. He knew he felt tired but began to think there was something more to his chronic fatigue. Occasionally, when he would travel, Friedman would experience heart arrhythmia, where his heartbeat would speed up dramatically and uncontrollably. Understandably, this ailment made him very nervous about flying, something that others noticed.

But Friedman kept forging ahead and, for the longest time, failed to have his ailments checked out medically. He also knew that Sidney Weinberg had died soon after retiring and Gus Levy had died in office, so to speak. “
I had no desire to die in the saddle and no desire to get greener and greener in the saddle,” he said. “But, also, hey, there’s a lot of other stuff out there in the world. And I’d like to have time to think about it and explore it. It’d be kind of sad if you were just doing the same thing over and over.”

Whatever the reason—health, fatigue, exasperation, a feeling of accomplishment, or perhaps some revisionist history—Friedman decided at the beginning of January 1994 that he wanted to retire at the end of the year. “I wanted to do it young enough so that I could do something else with my life,” he said. “I always thought it would be kind of a sad thing if you had nothing but life inside one firm.” He told his wife. He told Robert Rubin, then at the White House, over dinner in Washington. And he told
Robert Katz, Goldman’s general counsel, who following tradition had come to Goldman from
Sullivan & Cromwell and who had helped Friedman put out the Freeman, Eisenberg, and Maxwell fires. The crucial piece of the strategy—much like Whitehead’s years earlier—was not to tell anyone about the decision, including the other Goldman partners, lest it risk making Friedman a lame-duck executive. Instead, he would drop amorphous hints here and there that he might be starting to think about moving on.

But from the outset, Friedman’s strategy ran into trouble. He had hoped to designate Henry Paulson, a highly respected investment banker from Chicago, as the firm’s sole next senior partner. Friedman and Paulson were simpatico—as an M&A banker and client banker would be—and Friedman had a deep regard for how highly Paulson’s clients respected him and eagerly sought his counsel. “
Hank would be the first guy to tell you that he’s not Mr. Smooth,” Friedman said. “He just happens to be a terrific talent and I noticed early on that here was a young investment banker and the leading CEOs in Chicago were leaning on him.” CEOs would ask to speak with Paulson privately after a meeting and not just rely on him to “deliver the firm” by making sure an M&A team or equity–capital markets team was available. “That’s heavy and he had good judgment,” Friedman said. “And he was smart and it used to irritate the merger guys because after he’d heard their pitch at board meetings a few times he could do it himself just as well.” Starting in 1990, Paulson was one of the three co-heads of investment banking at Goldman, with Willard J. “Mike” Overlock, who had been running the merger department, and Bob Hurst, who had been running the investment banking services group. They were known as the “Three Nots”—“Not Here, Not Smart, and Not Nice.” Paulson was “Not Here,” in that he lived in Chicago. He also spent huge amounts of his time building up Goldman’s presence in Asia, especially in
China, where early on he befriended the country’s leaders and perceived its potential as a land of business opportunity for clever investment bankers. The “Not Here” name stuck, even though he spent plenty of time in New York, too.

Just as Friedman was deciding to retire at the end of 1993, coincidentally
Paulson told Friedman he was thinking of leaving Goldman. They were having a conversation one weekend, and Paulson was at his modest home in Barrington, Illinois, on a plot of land he had bought from his family’s nearby farm. “
Not because I wanted a promotion,” Paulson said, “but I’d had opportunities to do a couple other things. I was questioning whether I might want a different career, as much as I liked Goldman Sachs.” He had been approached about being the dean of a few business schools and about being a senior executive at an industrial company. He also thought about indulging his lifelong passion for conservation, bird-watching, and fishing. He also dreamed of writing novels. “I’d have liked to be another Faulkner, of course,” he said. Knowing Paulson’s potential departure might foil his own plans and be a major loss to the firm, given his moneymaking skills, Friedman invited Paulson and his wife, Wendy, to have dinner with him and his wife, Barbara, in New York. At the dinner, Friedman dropped a few not-so-subtle clues. “I might not be here forever,” Friedman told Paulson. “I’m looking to you for the future.” But Paulson missed the message, especially since Rubin and Friedman had only started running the firm at the end of 1990. “So, you’ve just got to understand from my perspective I thought, well, that just meant he wasn’t going to go out with his boots on like Gus Levy,” he said. In any event, Friedman could not sell the idea of Paulson to Katz, who didn’t think Paulson had enough political support on the
Management Committee at that time to be the sole leader of the firm.

So Friedman took a new tack: he started to urge pairs of partners to work together on various projects to see if any two of them could gel the way he and Rubin had. He pushed Paulson together with Corzine to work on various projects, and he pushed Winkelman to work with
Roy Zuckerberg, the head of equities. This felt a bit awkward to Paulson. “
I would come to New York, work, and then get out of New York,” he said. “I didn’t go out to dinner with other people on the Management Committee. I didn’t socialize. I didn’t politic.” Friedman kept urging Paulson to be more sociable. “He started saying to me, ‘Well, I’d like you to get to know Jon Corzine better,’ ” Paulson recalled. “ ‘I’d like you to know Jon Corzine. Spend time with Jon Corzine.’ And I was little thick. And then finally he said, ‘You like Asia. He likes Asia. Why don’t you two take a trip together through Asia?’ ” Paulson and Corzine traveled to Asia together to wave the Goldman flag. Paulson went alone; Corzine traveled with an entourage.

Paulson missed this message, too. “We were both interested in Asia,” he said of his trips with Corzine, “and with his understanding of the trading and the sales side, I took it as the two of us going around and
sending the right signal to people there. Not that ‘We should be cooperating better or working better together when we made these business decisions in Asia.’ It hadn’t occurred to me that we were going to be joined in some way to help run the firm.”

——

B
UT MUCH OF
this social calculus quickly got pushed to the back burner as the firm’s traders started to stumble—badly—racking up huge losses during 1994 of as much as $100 million, or more, a month. “
I don’t like the feel of this,” Friedman remembered thinking. “Our trading is not right and they think they’re better than they are. They did real well in 1992 and 1993 but I think they were shooting fish in a barrel.” Especially on the heels of the huge profits the year before, these ongoing losses rattled the firm and raised the question for the first time about how the loss of Rubin was affecting Goldman. “They were a great pair,” one partner said of Rubin and Friedman. “They trusted each other, liked each other, collaborated. They complemented each other. Bob understood the sales and trading much better than Steve. It didn’t seem that disruptive when Bob left, because the firm went on to have these fabulous years. But the thing that disrupted the transition was when we had the significant trading losses.” By the early 1990s, Goldman “
hardly lived up to its century-old image as a staid investment bank making money through old-line relationships,”
Steven Drobny observed in
Inside the House of Money,
his 2006 book about how hedge-fund traders make money. “Rather, it turned into one of the biggest proprietary risk-takers among investment banks, with its traders making huge bets with the firm capital in global fixed-income, foreign exchange, commodities and derivatives.”

What tripped up Goldman’s traders was a massive wrong-way bet on
interest rates. “
Credit spreads just blew out,” Paulson explained. Recalled another Goldman partner, “In December 1993, the Fed raised interest rates, and it just completely fucked up the firm’s trading position. And the firm didn’t really know what the risks were.” Goldman’s biggest losses were in the fixed-income arbitrage “book” of
Michael O’Brien, who was running trading in London. He was heading up a firm of proprietary traders composed, in large part, of people who came from J. Aron. Christian
Siva-Jothy worked for O’Brien as a proprietary trader in London at the time, having joined Goldman from
Citibank in March 1992. He found the trading culture at Goldman diametrically opposed to that of Citibank. During his first week at Goldman, he placed a $50 million bet involving
deutsche marks and Swiss
francs. It was Siva-Jothy’s largest trade ever. That first week, O’Brien came by and asked him how things were going. “I’m short 50 mark Swiss,” he told O’Brien.

“I like a guy who averages into his positions,” O’Brien deadpanned before turning and walking off.

“It was a bit of a free for all at [Goldman] in the early 1990s,” Siva-Jothy explained, “but the opportunities were there. There were no limit structures per se, no value-at-risk system. It was just kind of get on and do it and hope for the best.” He described the attitude at the time among Goldman’s proprietary traders as “suck it and see,” which translated into English roughly as “if you want to try a big position, try it” and “make mistakes but learn from them.” He recalled a moment during Goldman’s 1993 bonanza when one trader went on the internal squawk box and said, “Buy
Bunds,” a reference to German federal government bonds. When a broker wanted to know how many Bunds he should be buying, the reply came: “I said buy Bunds. I’ll tell you when to stop.”

Another time, Goldman’s chief economist in London,
Gavyn Davies, came by the proprietary trading desk to offer his macroeconomic view of the world. One trader cut Davies off and “with his boots up on the desk,” told him, “With all due respect, Gavyn, I do my own research. I was in quite a few bars in Spain last weekend and let me tell you something—they were empty.” He followed this bit of trenchant analysis with another: “I’ve got another rule that I live by: ‘If you can’t drink the water, sell the currency.’ ”

Siva-Jothy said he found the Goldman approach “incredibly powerful” and a “wonderful environment in which to work” but also “it was to have its downside as we discovered in 1994.” Siva-Jothy realized that at some point in 1993, it seemed like every trader at Goldman in London had become a proprietary trader. “There were 500-plus prop traders at Goldman Sachs then and they all had the same position,” he said. He made “well over $100 million” in profits that year “and I was a bit full of myself.”

The dynamic began to change in December 1993. Siva-Jothy had made a massive bet that the British
pound would rise against the
yen. “It was over £1 billion, which was the biggest position I’d ever run,” he said. The bet paid off in December and January as the pound rose in value. He was up about $30 million on the trade. “People were starting to say, ‘Christian is going to do it again,’ ” he recalled. He was so confident, he even added to his position by selling puts.