Wall Street, R.I.P.: The End of an Era, Even at Goldman
By JULIE CRESWELL and BEN WHITE
Published: September 27, 2008
WALL STREET. Two simple words that — like Hollywood and Washington — conjure a world.

Goldman Sachs’s headquarters in New York. The company, a golden child of the financial sector, faces a very different future and mission amid seismic changes wrought by the credit crisis.
Lloyd C. Blankfein led Goldman’s securities division before becoming chief executive in 2006.

Carlos Barria/Reuters
Warren E. Buffett, a longtime Goldman client, invested $5 billion in it. He will receive an annual dividend of $500 million.
A world of big egos. A world where people love to roll the dice with borrowed money. A world of tightwire trading, propelled by computers.
In search of ever-higher returns — and larger yachts, faster cars and pricier art collections for their top executives — Wall Street firms bulked up their trading desks and hired pointy-headed quantum physicists to develop foolproof programs.
Hedge funds placed markers on red (the Danish krone goes up) or black (the G.D.P. of Thailand falls). And private equity firms amassed giant funds and went on a shopping spree, snapping up companies as if they were second wives buying Jimmy Choo shoes on sale.
That world is largely coming to an end.
The huge bailout package being debated in Congress may succeed in stabilizing the financial markets. But it is too late to help firms like Bear Stearns and Lehman Brothers, which have already disappeared. Merrill Lynch, whose trademark bull symbolized Wall Street to many Americans, is being folded into Bank of America, located hundreds of miles from New York, in Charlotte, N.C.
For most of the financiers who remain, with the exception of a few superstars, the days of easy money and supersized bonuses are behind them. The credit boom that drove Wall Street’s explosive growth has dried up. Regulators who sat on the sidelines for too long are now eager to rein in Wall Street’s bad boys and the practices that proliferated in recent years.
“The swashbuckling days of Wall Street firms’ trading, essentially turning themselves into giant hedge funds, are over. Turns out they weren’t that good,” said Andrew Kessler, a former hedge fund manager. “You’re no longer going to see middle-level folks pulling in seven- and multiple-seven-dollar figures that no one can figure out exactly what they did for that.”
The beginning of the end is felt even in the halls of the white-shoe firm Goldman Sachs, which, among its Wall Street peers, epitomized and defined a high-risk, high-return culture.
Goldman is the firm that other Wall Street firms love to hate. It houses some of the world’s biggest private equity and hedge funds. Its investment bankers are the smartest. Its traders, the best. They make the most money on Wall Street, earning the firm the nickname Goldmine Sachs. (Its 30,522 employees earned an average of $600,000 last year — an average that considers secretaries as well as traders.)
Although executives at other firms secretly hoped that Goldman would once — just once — make a big mistake, at the same time, they tried their darnedest to emulate it.
While Goldman remains top-notch in providing merger advice and underwriting public offerings, what it does better than any other firm on Wall Street is proprietary trading. That involves using its own funds, as well as a heap of borrowed money, to make big, smart global bets.
Other firms tried to follow its lead, heaping risk on top of risk, all trying to capture just a touch of Goldman’s magic dust and its stellar quarter-after-quarter returns.
Not one ever came close.
While the credit crisis swamped Wall Street over the last year, causing Merrill, Citigroup and Lehman Brothers to sustain heavy losses on big bets in mortgage-related securities, Goldman sailed through with relatively minor bumps.
In 2007, the same year that Citigroup and Merrill cast out their chief executives, Goldman booked record revenue and earnings and paid its chief, Lloyd C. Blankfein, $68.7 million — the most ever for a Wall Street C.E.O.
Even Wall Street’s golden child, Goldman, however, could not withstand the turmoil that rocked the financial system in recent weeks. After Lehman and the American International Group were upended, and Merrill jumped into its hastily arranged engagement with Bank of America two weeks ago, Goldman’s stock hit a wall.
The A.I.G. debacle was particularly troubling. Goldman was A.I.G.’s largest trading partner, according to several people close to A.I.G. who requested anonymity because of confidentiality agreements. Goldman assured investors that its exposure to A.I.G. was immaterial, but jittery investors and clients pulled out of the firm, nervous that stand-alone investment banks — even one as esteemed as Goldman — might not survive.
“What happened confirmed my feeling that Goldman Sachs, no matter how good it was, was not impervious to the fortunes of fate,” said John H. Gutfreund, the former chief executive of Salomon Brothers.
So, last weekend, with few choices left, Goldman Sachs swallowed a bitter pill and turned itself into, of all things, something rather plain and pedestrian: a deposit-taking bank.
The move doesn’t mean that Goldman is going to give away free toasters for opening a checking account at a branch in Wichita anytime soon. But the shift is an assault on Goldman’s culture and the core of its astounding returns of recent years.
Not everyone thinks that the Goldman money machine is going to be entirely constrained. Last week, the Oracle of Omaha, Warren E. Buffett, made a $5 billion investment in the firm, and Goldman raised another $5 billion in a separate stock offering.
Still, many people say, with such sweeping changes before it, Goldman Sachs could well be losing what made it so special. But, then again, few things on Wall Street will be the same.
GOLDMAN’S latest golden era can be traced to the rise of Mr. Blankfein, the Brooklyn-born trading genius who took the helm in June 2006, when Henry M. Paulson Jr., a veteran investment banker and adviser to many of the world’s biggest companies, left the bank to become the nation’s Treasury secretary.
Mr. Blankfein’s ascent was a significant changing of the guard at Goldman, with the vaunted investment banking division giving way to traders who had become increasingly responsible for driving a run of eye-popping profits.
Before taking over as chief executive, Mr. Blankfein led Goldman’s securities division, pushing a strategy that increasingly put the bank’s own capital on the line to make big trading bets and investments in businesses as varied as power plants and Japanese banks.
The shift in Goldman’s revenue shows the transformation of the bank.
From 1996 to 1998, investment banking generated up to 40 percent of the money Goldman brought in the door. In 2007, Goldman’s best year, that figure was less than 16 percent, while revenue from trading and principal investing was 68 percent.
Goldman’s ability to sidestep the worst of the credit crisis came mainly because of its roots as a private partnership in which senior executives stood to lose their shirts if the bank faltered. Founded in 1869, Goldman officially went public in 1999 but never lost the flat structure that kept lines of communication open among different divisions.
In late 2006, when losses began showing in one of Goldman’s mortgage trading accounts, the bank held a top-level meeting where executives including David Viniar, the chief financial officer, concluded that the housing market was headed for a significant downturn.
Hedging strategies were put in place that essentially amounted to a bet that housing prices would fall. When they did, Goldman limited its losses while rivals posted ever-bigger write-downs on mortgages and complex securities tied to them.
In 2007, Goldman generated $11.6 billion in profit, the most money an investment bank has ever made in a year, and avoided most of the big mortgage-related losses that began slamming other banks late in that year. Goldman’s share price soared to a record of $247.92 on Oct. 31.
Goldman continued to outpace its rivals into this year, though profits declined significantly as the credit crisis worsened and trading conditions became treacherous. Still, even as Bear Stearns collapsed in March over bad mortgage bets and Lehman was battered, few thought that the untouchable Goldman could ever falter.
Mr. Blankfein, an inveterate worrier, beefed up his books in part by stashing more than $100 billion in cash and short-term, highly liquid securities in an account at the Bank of New York. The Bony Box, as Mr. Blankfein calls it, was created to make sure that Goldman could keep doing business even in the face of market eruptions.
That strong balance sheet, and Goldman’s ability to avoid losses during the crisis, appeared to leave the bank in a strong position to move through the industry upheaval with its trading-heavy business model intact, if temporarily dormant.
Even as some analysts suggested that Goldman should consider buying a commercial bank to diversify, executives including Mr. Blankfein remained cool to the notion. Becoming a deposit-taking bank would just invite more regulation and lessen its ability to shift capital quickly in volatile markets, the thinking went.
All of that changed two weeks ago when shares of Goldman and its chief rival, Morgan Stanley, went into free fall. A national panic over the mortgage crisis deepened and investors became increasingly convinced that no stand-alone investment bank would survive, even with the government’s plan to buy up toxic assets.
Nervous hedge funds, some burned by losing big money when Lehman went bust, began moving some of their balances away from Goldman to bigger banks, like JPMorgan Chase and Deutsche Bank.
By the weekend, it was clear that Goldman’s options were to either merge with another company or transform itself into a deposit-taking bank holding company. So Goldman did what it has always done in the face of rapidly changing events: it turned on a dime.
“They change to fit their environment. When it was good to go public, they went public,” said Michael Mayo, banking analyst at Deutsche Bank. “When it was good to get big in fixed income, they got big in fixed income. When it was good to get into emerging markets, they got into emerging markets. Now that it’s good to be a bank, they became a bank.”
The moment it changed its status, Goldman became the fourth-largest bank holding company in the United States, with $20 billion in customer deposits spread between a bank subsidiary it already owned in Utah and its European bank. Goldman said it would quickly move more assets, including its existing loan business, to give the bank $150 billion in deposits.
Even as Goldman was preparing to radically alter its structure, it was also negotiating with Mr. Buffett, a longtime client, on the terms of his $5 billion cash infusion.
Mr. Buffett, as he always does, drove a relentless bargain, securing a guaranteed annual dividend of $500 million and the right to buy $5 billion more in Goldman shares at a below-market price.
While the price tag for his blessing was steep, the impact was priceless.
“Buffett got a very good deal, which means the guy on the other side did not get as good a deal,” said Jonathan Vyorst, a portfolio manager at the Paradigm Value Fund. “But from Goldman’s perspective, it is reputational capital that is unparalleled.”
EVEN if the bailout stabilizes the markets, Wall Street won’t go back to its freewheeling, profit-spinning ways of old. After years of lax regulation, Wall Street firms will face much stronger oversight by regulators who are looking to tighten the reins on many practices that allowed the Street to flourish.
For Goldman and Morgan Stanley, which are converting themselves into bank holding companies, that means their primary regulators become the Federal Reserve and the Office of the Comptroller of the Currency, which oversee banking institutions.
Rather than periodic audits by the Securities and Exchange Commission, Goldman will have regulators on site and looking over their shoulders all the time.
The banking giant JPMorgan Chase, for instance, has 70 regulators from the Federal Reserve and the comptroller’s agency in its offices every day. Those regulators have open access to its books, trading floors and back-office operations. (That’s not to say stronger regulators would prevent losses. Citigroup, which on paper is highly regulated, suffered huge write-downs on risky mortgage securities bets.)
As a bank, Goldman will also face tougher requirements about the size of the financial cushion it maintains. While Goldman and Morgan Stanley both meet current guidelines, many analysts argue that regulators, as part of the fallout from the credit crisis, may increase the amount of capital banks must have on hand.
More important, a stiffer regulatory regime across Wall Street is likely to reduce the use and abuse of its favorite addictive drug: leverage.
The low-interest-rate environment of the last decade offered buckets of cheap credit. Just as consumers maxed out their credit cards to live beyond their means, Wall Street firms bolstered their returns by pumping that cheap credit into their own trading operations and lending money to hedge funds and private equity firms so they could do the same.
By using leverage, or borrowed funds, firms like Goldman Sachs easily increased the size of the bets they were making in their own trading portfolios. If they were right — and Goldman typically was — the returns were huge.
When things went wrong, however, all of that debt turned into a nightmare. When Bear Stearns was on the verge of collapse, it had borrowed $33 for every $1 of equity it held. When trading partners that had lent Bear the money began demanding it back, the firm’s coffers ran dangerously low.
Earlier this year, Goldman had borrowed about $28 for every $1 in equity. In the ensuing credit crisis, Wall Street firms have reined in their borrowing significantly and have lent less money to hedge funds and private equity firms.
Today, Goldman’s borrowings stand at about $20 to $1, but even that is likely to come down. Banks like JPMorgan and Citigroup typically borrow about $10 to $1, analysts say.
As leverage dries up across Wall Street, so will the outsize returns at many private equity firms and hedge funds.
Returns at many hedge funds are expected to be awful this year because of a combination of bad bets and an inability to borrow. One result could be a landslide of hedge funds’ closing shop.
At Goldman, the reduced use of borrowed money for its own trading operations means that its earnings will also decrease, analysts warn.
Brad Hintz, an analyst at Sanford C. Bernstein & Company, predicts that Goldman’s return on equity, a common measure of how efficiently capital is invested, will fall to 13 percent this year, from 33 percent in 2007, and hover around 14 percent or 15 percent for the next few years.
Goldman says its returns are primarily driven by economic growth, its market share and pricing power, not by leverage. It adds that it does not expect changes in its business strategies and expects a 20 percent return on equity in the future.
IF Mr. Hintz is right, and Goldman’s legendary returns decline, so will its paychecks. Without those multimillion-dollar paydays, those top-notch investment bankers, elite traders and private-equity superstars may well stroll out the door and try their luck at starting small, boutique investment-banking firms or hedge funds — if they can.
“Over time, the smart people will migrate out of the firm because commercial banks don’t pay out 50 percent of their revenues as compensation,” said Christopher Whalen, a managing partner at Institutional Risk Analytics. “Banks simply aren’t that profitable.”
As the game of musical chairs continues on Wall Street, with banks like JPMorgan scooping up troubled competitors like Washington Mutual, some analysts are wondering what Goldman’s next move will be.
Goldman is unlikely to join with a commercial bank with a broad retail network, because a plain-vanilla consumer business is costly to operate and is the polar opposite of Goldman’s rarefied culture.
“If they go too far afield or get too large in terms of personnel, then they become Citigroup, with the corporate bureaucracy and slowness and the inability to make consensus-type decisions that come with that,” Mr. Hintz said.
A better fit for Goldman would be a bank that caters to corporations and other institutions, like Northern Trust or State Street Bank, he said.
“I don’t think they’re going to move too fast, no matter what the environment on Wall Street is,” Mr. Hintz said. “They’re going to take some time and consider what exactly the new Goldman Sachs is going to be.”