Money and Power (7 page)

The brothers-in-law Sam Sachs and Henry Goldman were said to be “a study in contrast.” Sachs w
as conservative both in his risk taking and in his formal attire: even on the hottest days of the year he was said to wear “a thin alpaca office coat.” He also wanted to build the partnership based upon its past successes—a responsible enough approach to preserving his capital. His son,
Paul Sachs, once remarked about his father’s satisfaction that a deal the firm was working on with a partner they did not know particularly well had fallen through. Their first impression of the potential partner had been negative. “
From the very first moment,” Paul Sachs revealed, “[we were] disturbed by the moral[ity] of these men and while I do not deny that the business might have proved satisfactory enough, we are as a matter of fact glad to have seen it fall through because as we progressed our first unfavorable impression was at every meeting strongly emphasized.” Goldman, by contrast, worked in his shirtsleeves and often would tell his nephew
Walter Sachs, “Money is always fashionable” and relished trading railroad and
utility bonds—usually at a profit—but risking his partners’ capital nonetheless. The tension between Goldman and Sachs—between prudent risk taking and preservation of capital—would from then on become an integral part of the firm’s DNA.

As with other Wall Street firms started during this era, using the
actual DNA of the Goldman senior partners to perpetuate the firm became essential, too.
Walter Sachs, for one, was part of that grooming from a relatively early age. After graduating from Harvard College in 1904 and then enduring a year of Harvard Law School, Walter joined Goldman in 1905 as a clerk, going from office to office around the firm doing the menial tasks asked of him. The following spring, he accompanied his father, then the senior partner of the firm, on a trip to Europe, where he served as secretary: sending cables and dispatches and writing letters for his father’s signature. When Samuel Sachs returned to the United States that summer, and to Goldman’s downtown offices, Walter Sachs stayed behind
in Paris, on sanctioned leave from Goldman, in order to receive some additional real-world experience working as an unpaid intern in the offices of two French banks. In early 1907, Walter Sachs continued his banking education in Berlin. He returned to New York at the end of 1907. While in the midst of this banking whirlwind—which was not uncommon for the sons of banking patriarchs looking to educate their children in the ways of the banking system—Samuel Sachs had promised Walter Sachs a trip around the world once he had completed his var
ious tours of duty. Unfortunately, fate intervened in the form of the
Panic of 1907, and Samuel Sachs cabled his son in London: “
My boy, you come home and go to work.” Walter Sachs’s full-time career at Goldman, Sachs & Co. began on January 2, 1908. He was told to sell
commercial paper to New York, Philadelphia, and Hartford banks. After his first day, he came home with the paper unsold and decided he must be a failure.

In addition to encouraging sons to join the family business, Goldman, Sachs & Co. also sought alliances with other banking partnerships, and particularly with Lehman Brothers, a successful family-run business with origins in retail merchandising and cotton trading in Montgomery, Alabama. As it turned out, Henry Goldman’s best friend was
Philip Lehman, one of the five Lehman brothers who ran Lehman Brothers when Emanuel Lehman died in January 1907.

As they took control of their firms after the deaths of their fathers, the two friends began to discuss ways to expand their businesses. Philip Lehman suggested to Henry Goldman that the two firms think seriously about getting into the underwriting business together. Indeed the two men even considered starting a new firm—Goldman & Lehman—dedicated solely to underwriting corporate securities. “But,” according to Birmingham, “the pressures, both practical and sentimental, not to abandon their respective family firms were strong, and so at last they decided to collaborate in underwriting as a side line. Each house would continue
with its specialty—Lehman with commodities, Goldman, Sachs with
commercial paper—and the two friends would go in as partners in underwriting ventures, splitting the proceeds fifty-fifty.”

Goldman already had had a taste of the underwriting business in April 1906, when the
United Cigar Manufacturers’ Corporation asked the firm to raise $4.5 million through the selling of preferred stock. On May 3, Goldman and three other firms underwrote an unspecified amount of 4 percent, fifty-year bonds for the state of Alabama. By the time
Philip Lehman broached the idea with Henry Goldman of the underwriting joint venture, Goldman Sachs knew it was a business it wanted to be in.

Then the firm had a bit of good fortune. Thanks to the marriage of a distant relative to
Samuel Hammerslough, a former peddler who had moved to Springfield, Illinois, to become a men’s clothing merchant, Goldman met Hammerslough’s cousin, Julius Rosenwald. Rosenwald had a successful clothing manufacturing business that was merged into
Sears, Roebuck. In June 1906, he approached Henry Goldman, his “cousin” and friend from his days living in New York, and asked him whether Goldman would be willing to lend Sears $5 million. Sears had just built a new manufacturing facility and needed money for working capital to make the company’s investment worthwhile. Legend has it that Goldman had a better idea for Rosenwald: Why not take Sears public, through an underwritten offering of equity by the new Goldman and Lehman joint venture? Rosenwald would get rich in the process and the business would be financed with equity, rather than with debt. While if the equity performed well—which it certainly did for the longest time—equity would be more expensive than debt, it would also put the company less at risk in the near term should the economy falter (which it did during the financial
panic of 1907). Before making the suggestion about the IPO, which could prove risky for his firm if the deal did not go well, Goldman had the good sense to review Sears’s financial performance. In 1904, Sears generated $27.6 million in revenue and $2.2 million in net income; in 1905, the numbers improved to $37.9 million in revenue and $2.8 million in net income. Considering that in 1897, Sears had a net worth of $237,000, the company had grown exponentially in fewer than ten years. In short, Sears was a great candidate for an IPO.

The offering would be unusual on a number of fronts. First, it would be the first large IPO Goldman and Lehman would lead together. There had been plenty of IPOs in the prev
ious years—for steel companies, railroads, and oil companies—but rarely, if ever before, had a retail mail-order business ventured into the public markets. As a Jewish firm,
Goldman had not previously had much success breaking into the ranks of the underwriters for the big industrial companies that were run by old-line WASP executives such as
Andrew Carnegie and
John D. Rockefeller Jr. The Sears IPO would bring together, for one of the first times, Jewish bankers willing to underwrite the securities of a Jewish-owned, prominent national business. It was Henry Goldman’s good fortune to be friendly with Julius Rosenwald at the very moment Goldman Sachs was venturing into the underwriting business.

Together, Goldman and Lehman underwrote $30 million of Sears’s common stock and $10 million of Sears’s preferred stock, with a 7 percent dividend. Goldman priced the IPO at $97.50 per share. “
It was more or less blazing a trail …,”
Walter Sachs said in 1964 of the Sears offering. “[T]his type of business, to my mind, was really a creative invention of my uncle, Henry Goldman. I think he was one of the two or three geniuses in our firm over a period of a hundred years.”

Before long, according to Birmingham, the Goldman-Lehman underwriting partnership was the “hottest young underwriting team.” Goldman had also enlisted
Kleinwort, Sons & Co., a British merchant bank, to help underwrite these deals and to sell the securities to investors in Europe. Together, they underwrote fourteen major offerings, including those for
Underwood Corporation, in 1910; what became
May Department Stores, in June 1910;
Studebaker Corporation, in February 1911;
F. W. Woolworth Company, in 1912;
B. F. Goodrich Company, in 1912;
Diamond Rubber Company, in 1912; and
Continental Can Company, in 1913. Goldman also helped to finance B. F. Goodrich’s acquisition of Diamond Rubber Company, also in 1912. “
That Sears business was the thing that began to give us this very great reputation in industrial securities,” according to Walter Sachs. Goldman’s financing of Woolworth also enhanced the firm’s reputation. “
Frank Woolworth all of a sudden became a very rich man,” Sachs said. He built the
Woolworth Building, in Manhattan, then the tallest building in the world. The architect was
Cass Gilbert. After the building opened, Woolworth gave a celebratory dinner. “The story goes that Gilbert was on Woolworth’s left hand, and Goldman was on Woolworth’s right hand,” Sachs remembered, “and he stood up and asked them to stand, and he put his right arm on Goldman and his left arm on Gilbert, and he said, ‘These are the two men who have made this wonderful building possible.’ ”

——

H
ENRY
G
OLDMAN’S GROWING
stature on Wall Street was such that his views were sought—along with those of
J. P. Morgan himself—in January 1914 by the two cabinet members in the
Wilson administration
tasked with designing the architecture of the Federal Reserve System after the passage of the Federal Reserve Act in 1913. Here, at the inception of the government’s regulation of Wall Street, Goldman Sachs was already advising politicians how to do the job. In a hearing in New York on January 6, Henry Goldman told the secretary of the treasury,
William G. McAdoo, and the secretary of agriculture,
David F. Houston, that New York City needed to have the most powerful and well-capitalized Federal Reserve bank in the system. He thought the New York Federal Reserve Bank should be on a par with the
Bank of England, given that New York was the credit capital of the country. He told the Reserve Bank Organization Committee that unless the New York Federal Reserve Bank was made supremely important, “it will do no more exchange business with New York than at present unless the New York bank is strong enough to handle it.” Morgan concurred with Goldman’s view—and, of course, the New York Federal Reserve Bank did become the most powerful reserve bank in the system, and Goldman Sachs remains to this day one of the bank’s most important affiliations. (The current president of the New York Fed,
William Dudley, is a former Goldman partner.)

But Henry Goldman’s conversation with the two secretaries that day also revealed additional morsels about Goldman’s character and the DNA of the firm he had helped to create. First, he referred to himself—quite proudly—to the secretary of the treasury as a commercial banker, saying that commercial banking was his principal business and specifically, “
commercial banking all over the world, issuing credits to commerce and industry in this country and abroad, to merchants in this country for use abroad.” He made no mention of his firm’s growing prowess in the underwriting of debt and equity securities. From a very early stage the firm wished to be seen as a solid pillar of
capitalism, not as an engine of speculation.

Goldman also seemed acutely—and presciently—aware of the risks local banks faced from a confidence perspective if they turned to a reserve bank as a source of liquidity other than in the normal course of business. While it was true that the Federal Reserve System was being created, in part, to combat the causes of the
Panic of 1907, Goldman seemed to have had an intuitive sense of the risks posed by actually turning to a reserve bank in an hour of need. “
The word ‘aid’ should be banished from our minds,” he told the secretaries. “ ‘Get aid.’ That means alarm.… It ought to be perfectly normal for a bank to go to a Reserve Bank and take discount, not in the sense of it being ‘aid.’ ”

After discussing what exact cities Goldman thought should house
the reserve banks, McAdoo and Goldman returned one final time to the subject of the Fed providing liquidity in a time of crisis. It is easy to imagine that instead of McAdoo and Goldman speaking in January 1914, it was Paulson and Blankfein speaking in September 2008. “
The reserve power that [the reserve banks] have through their ability to secure or to convert their resources into money when required, that is into circulating notes, is a power of transcendent importance here,” McAdoo told Goldman.

Goldman agreed with the secretary that the power to provide that liquidity was essential, and then returned to the idea he mentioned before about the message that tapping a reserve bank for that liquidity would send to the market. “I do believe that in business there are psychic factors which are so old and so ingrained in the human mind that no system can set them aside, and one is [the] capital strength of an institution,” he said.

——

N
OTWITHSTANDING THESE CLEVER
insights into the verities of a banking system built upon the confidence placed in it—is there any other kind?—by August 1914 and the outbreak of
World War I, Henry Goldman’s views in support of
Germany’s increasingly aggressive behavior were quickly becoming a problem for Goldman, Sachs & Co. For instance, when he had been vacationing in England before the start of the war, Sam Sachs—Henry’s brother-in-law—had reassured Goldman Sachs’s underwriter partners at Kleinwort that the firm “stood firmly behind
Great Britain,” only to discover, upon his return to New York, that Henry had become increasingly outspoken in his pro-German commentary. “He quoted Nietzsche to anyone who would listen,” Birmingham wrote of Henry Goldman.

The long-simmering tensions between Sachs and Goldman—once limited to their differences about business strategy and risk—now burst onto the public stage. The catalyst for the rupture between the two Goldman partners was a $500 million bond issue that Wall Street’s bankers had pledged to raise for the Allied war effort (the United States, of course, did not enter the war until 1917). The original plan called for the Wall Street firm
Kuhn, Loeb to head up the effort to underwrite the war bonds. But when its pro-German leader
Jacob Schiff said the Allies would have their money only if the finance ministers in
France and England gave him their personal assurance that “not one cent of the proceeds of the loan would be given to Russia,” all hell broke loose. Of course, neither France nor England could offer Schiff this guarantee in the time of war—especially since Russia was part of the Allied effort—and a Kuhn,
Loeb partners’ meeting was quickly held to decide how to proceed. “I cannot stultify myself by aiding those who in bitter enmity have tortured my people and will continue to do so, whatever fine professions they may make in their hour of need,” Schiff said. “I cannot sacrifice my profoundest convictions. This is a matter between me and my conscience.”