Goldman Sachs Group

Founded in 1869 by Marcus Goldman, a European immigrant, Goldman Sachs is one of the nation's oldest and most prestigious investment banking firms. Goldman has created a reputation among both employees and outsiders as a top investment bank. The firm is legendary for its secrecy, and rarely lets the media see what is going on behind the scenes.

In a chapter called "In Goldman Sachs We Trust" in his classic book about the 1929 Wall Street Crash and the ensuing Depression -- The Great Crash, 1929 -- John Kenneth Galbraith described the role Goldman's leverage-based investment trusts played in causing the historic crash: "It is difficult not to marvel at the imagination which was implicit in this gargantuan insanity."

Goldman was also what journalist Matt Taibbi describes as the "IPO king of the Internet era. Of the 24 companies it took public in 1997, a third were losing money at the time of the IPO. In 1999, at the ehight of the boom, it took 47 companies public, including stillborns like Webvan and eToys...In 1999, the average Goldman IPO leapt 281 percent above its offering price, compared to the Wall Street average of 181 percent. ... How did Goldman achieve such extraordinary results? One answer is that they used a practice called "laddering," which is just a fancy way of saying they manipulated the share price of new offerings."

In 1998, the firm's partners voted to change its status from private partnership to public. The move was designed to help the company generate stock "currency" that would allow it to acquire other banks and keep pace with the competition, as well as allow partners to cash in their chips while the market was high. Turmoil in the world financial markets led the firm to withdraw the IPO, and soon thereafter (early 1999) co-CEO Jon Corzine resigned. (Observers said Corzine was pushed out by Henry Paulson, John Thornton and John Thain). Paulson took over as CEO, and Thornton and Thain were named as President and COO. IPO-related filings revealed that the firm's trading revenues were greater than its investment banking revenues in the previous five years. For example, in 1999 the firm earned 43 percent of its revenue from trading. The size of its trading revenues surprised some who had expected the firms Mergers & Acquisitions and underwriting businesses to constitute its core revenue stream. (Analysts warned that Goldman's dependence on proprietary trading made it vulnerable to market downturns).

On May 4, 1999 Goldman finally went public: In the second largest U.S. IPO to date, the firm raised $3.66 billion, issuing 69 million shares. (The offering valued Goldman at $33 billion). The firm's 222 partners were immediately its largest shareholders.

In late 2000 Goldman purchased Spear Leeds & Kellog, one of the key market makers (trade execution businesses), for $ 6.5 billion. (Along with Merrill Lynch and Morgan Stanley Dean Witter, Goldman Sachs had been pushing for a central electronic market to take the place of specialists like Spear Leeds on the Nasdaq and NYSE). The company then purchased Benjamin Jacobson & Sons, another specialist firm, in early 2001, combining its operations with Spear Leeds.

In June 2001 Goldman acquired online investment bank Epoch Partners (a joint venture owned by Ameritrade, Charles Schwab, TD Waterhouse and three venture capital firms).

The acquisitions signal the firm's intent on stabilizing and expanding the fee-based revenue stream created by asset management (versus the more volatile trading or banking services).

When Paulson left, his chief executive suite was taken over by Blankfein, who came out of Goldman’s securities division. Blankfein's star had risen by pushing a strategy that increasingly put the bank’s own capital on the line to make big trading bets and investments in a variety of businesses. According to the New York Times between 1996 and 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." Anticipating that the housing bubble would pop, beginning in late 2006 the firm put in place "hedging strategy...that essentially amounted to a bet that housing prices would fall." Goldman thus limited its losses as their rivals posted ever-bigger write-downs on mortgages and the complex securities tied to them. (Cresswell and White, "Wall Street, R.I.P." 9/27/2008)

2008: The Crisis

As the 2008 credit crisis infected the entire market, investors (particularly some hedge funds already burned by the collapse of Lehman just months before) began to pull out of Goldman Sachs, too, esp. as its stock took a plunge. Shortly thereafter, the firm announced that it would convert itself into a bank holding company. By changing its status (Goldman Sachs Group Inc. will be the new parent, and convert Goldman Sachs Bank USA into a state-chartered bank in Utah to purchase brokered and retail deposits from troubled institutions, either directly or from Federal Deposit Insurance Corp. receiverships), Goldman placed itself under the authority of the Federal Reserve and the Office of the Comptroller of the Currency, a drastic shift from periodic audits by the Securities and Exchange Commission. Morgan Stanley announced a similar move at the same time. With Merrill Lynch, Bear Stearns and Lehman Brothers going before it, the announcements signaled the end of the free-standing Wall Street investment firms.

With $20 billion in customer deposits spread between a bank subsidiary it already owned in Utah and its European bank, Goldman immediately ranked fourth among U.S. bank holding companies. It quickly moved to add more assets, including its existing loan business, to give the bank $150 billion in deposits. (As they come under closer scrutiny from the Fed, both Goldman and Morgan Stanley will have to dramatically reduce their equity-to-asset ratios. In exchange for becoming a holding company operating under greater oversight, they will get a deposit base to fund their business as well easier access to the Federal Reserve Board's discount window.)

In late September 2008, the bank was boosted by news that investment guru Warren Buffett would invest $5 billion of his company's money in Goldman Sachs, receiving preferred stock with a ten percent annual dividend yield, in return for the well-received infusion of capital. Unlike most preferred stocks which are callable after five years, the Goldman preferred held by Berkshire can be redeemed at any time at a 10% premium. Berkshire also received warrants to buy $5 billion of Goldman common stock at $115 a share, $10 below Goldman's share price when the deal was announced.

The shift also comes with higher margin requirements (the percentage of money loaned or invested that it is required to maintain) and reduced leverage. Under the Bank Holding Company Act, the bank has two years to make the full transition to compliance.

Although observers say the conversion results in greater oversight, there are other implications for regulatory policy that remain unclear: The announcement by the company (along with others in the industry such as JP Morgan, which announced a similar conversion) leaves the industry looking much like it did in the 1930s, before the Glass-Steagall Act separated investment banking from commercial banking. It is likely that the new Goldman will be forced to shed certain businesses. Observers expect Goldman to apply to become a financial holding company, which would give the firm the authority to engage in activities beyond just taking deposits and other bank-specific operations. "You have broader powers and can engage in any financial activity," a former Fed attorney told American Banker magazine. "Financial holding companies can do merchant banking or investment banking." (Steven Sloan and Joe Adler, "What Future May Hold For Two Converts," American Banker, 9/23/2008)

(The definitive sympathetic history of Goldman Sachs is Charles Ellis' "The Partnership," published in 2008).