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Where Does Goldman Sachs Go From Here?



John L. Weinberg, the semiretired senior chairman of Goldman, Sachs & Co., had planned to take a day or so off around Thanksgiving. But he changed plans when he learned the turmoil that had engulfed the firm two months earlier with the sudden resignation of his successor, Chairman Stephen Friedman, had reached crisis proportions.

In the wake of huge trading losses and the failure of a costly, poorly executed overseas expansion strategy, Goldman was firing employees by the busload, and many top partners were unexpectedly taking early retirement. The firm's vaunted collegial culture, nurtured by Weinberg and his father Sidney before him, was fracturing. Work in some areas of the firm's lower Manhattan headquarters nearly halted as traumatized employees who had just been dismissed were escorted to the door, a scene repeated at other Goldman offices in the U.S., Hong Kong, London, and elsewhere.

A heavyset, grandfatherly figure who could pass for an old-fashioned New York cabdriver, Weinberg was the embodiment of the old, family-oriented Goldman culture. He felt furious and heartsick, say several current and former employees: furious at what he felt was Friedman's unconscionable betrayal, and heartsick that by aggressively pursuing trading for its own account, the quintessential white-shoe Wall Street firm had strayed from its original mission of putting client interests before its own. That shift of emphasis was behind many of the firm's troubles. "John was so mad he couldn't see straight," says a former colleague who, like most current and former Goldman partners interviewed for this story, declined to be quoted on the record.

SHARED WOES. So Weinberg, who refused to comment, drove from his home in Greenwich, Conn., to 85 Broad St., where he walked the halls in an attempt to calm people down and to remind them that Goldman's focus should be mainly on its clients. By all accounts, Weinberg's appearance had a palliative effect. But it has not cured what ails Goldman.

To a large extent, Goldman's woes are shared by nearly every other Wall Street firm. Like the others, Goldman got clobbered in 1994 by the sharp increase in interest rates, which devastated bond portfolios. Overseas, Goldman suffered huge losses in Japanese warrants and currency trades. Sources at the firm say earnings at Wall Street's last remaining major private partnership plunged to $508 million from the staggering $2.3 billion earned the year before.

Jon S. Corzine, 48, the affable, mild-mannered former fixed-income chief who was appointed chairman upon Friedman's retirement in mid-September, blames much of the financial reverses on "a classical cyclical downturn." He and others point out that many parts of its business are quite healthy. It enjoyed a good year in mergers and acquisitions and equity underwriting, including initial public offerings, maintaining its No.1 global rankings in those businesses. Among its credits was a $3 billion equity underwriting for TeleDanmark, the largest international equity offering in history.

Yet when pressed, Corzine admits that many of its recent setbacks indicate much broader managerial problems. He says everything relating to how Goldman is managed--from compensation, planning, proprietary trading, costs, and risk management, to the partnership structure itself--is on the table. Controls are an especially big concern. "Institutionalizing the managing of costs and growth is going to be a permanent mind-set at Goldman Sachs," he says. As many observers see it, Corzine, who seems to enjoy widespread support from partners, plans nothing less than a wholesale reengineering of the firm.

What makes his admissions especially striking is that for years Goldman had been regarded as the best-managed firm on Wall Street--smarter, tougher, and richer than anyone else. Its family-like culture of teamwork made it one of the most harmonious and agreeable places to work, as well as the most profitable, on the Street.

Like other firms, Goldman had suffered from occasional snafus. In the early 1970s, the firm was the target of numerous lawsuits charging that it withheld material information from commercial paper investors on the financial condition of Penn Central Corp., which failed in June, 1970. Goldman was ordered to reimburse investors. And in early 1987, the firm was devastated when partner Robert Freeman was charged and later pleaded guilty to trading on insider information.

Its current woes, though, seem more systemic and pervasive: the overly aggressive foreign expansion binge, a bloated cost structure, excessive reliance on risky proprietary trading, and serious internal rifts, the latter exemplified by Weinberg's criticisms of the firm's direction. Says one Goldman officer: "Last year, we could walk on water. Now, we have to swim in it like everyone else."

Especially serious has been the defection of key employees and a shrinking in the depth of Goldman's management. One of the firm's biggest losses is Mark O. Winkelman, regarded as one of Wall Street's preeminent fixed-income traders. And some former partners fear that the departure last fall of Howard A. Silverstein, regarded as perhaps the premier investment banker for the insurance and financial services industry, will have severe repercussions. In recent years, Silverstein is said to have generated more than $100 million in earnings a year for the firm. Charles A. Davis, who cultivated hundreds of corporate clients as head of investment banking services, may also be tough to replace.

The spate of retirements could potentially drain hundreds of millions of dollars from the capital account. While Goldman insists it has more than enough capital, others say that the problem may be less the amount of capital than the growing uncertainty about the amount of capital it will have on hand in the future to support its business.

Many of Goldman's current problems can be traced to the firm's increased emphasis on proprietary trading and principal investments, which, beginning in the 1980s, produced sharp debates within the firm. The issue came to a head under John C. Whitehead, the patrician co-chairman who preferred a client focus. He prevailed over Stephen Friedman and Robert E. Rubin, now Treasury Secretary, when the two co-headed Goldman's fixed-income activities.

When John Weinberg, who succeeded Whitehead and shared his views, retired in 1990, Rubin and Friedman became co-chairmen and moved the firm strongly toward proprietary trading. "They had a different vision," laments one former officer. "They took Goldman away from client relationships as the quintessential agency firm and moved it in the direction of being a global superpower, playing in the high-stakes, high-reward proprietary trading game."

Shortly thereafter, at the urging of Friedman and Rubin, Goldman set up the Water Street Fund to invest its own capital in distressed securities. But in gaining a control position in senior debt, it forced restructurings that wiped out equity and subordinated debtholders, many of which were Goldman clients. Weinberg was deeply offended by the fund, sources say. It was a case, says a former officer, of "Goldman wins, client loses." In 1991, the fund was disbanded, and the partners who managed it quit the firm to go out on their own.

SCHIZOPHRENIC. More recently, Goldman got into a jam with some of its clients because its Whitehall Street Real Estate LP fund, which invests in distressed real estate, pushed Cadillac Fairview, a big Canadian real estate developer, into Canadian bankruptcy court. That didn't sit well with several parties who are Cadillac Fairview investors and Goldman clients. They felt the firm was merely trying to scoop up bargain assets. Goldman sources say things have been patched up. Says one former partner: "There was always a schizophrenia between trading and [serving] clients."

Despite these problems, Friedman, 57, defends proprietary trading. "I've always believed in the principal investments business," adding that "it has been an excellent business, with an acceptable [risk] profile." And he points out that Gustave Levy, the chairman who died in 1976, was himself an aggressive trader.

Emphasis on proprietary trading and investment was in part behind Goldman's massive overseas expansion in the early '90s. Largely because of the overseas thrust, Goldman's expenses surged 40% from yearend '92 to '94. Like many Wall Street firms, Goldman was anxious to exploit opportunities in Latin America and Asia. It had regretted moving too slowly into some businesses, such as mortgage-backed securities, and into Europe so late, according to Friedman. "Our conservatism meter was too slow for too many years." Adds partner Jaime E. Yordan, who was in charge of Goldman's Latin American business: "We thought there were major things happening in a lot of different places around the world, and that if we missed them, the opportunity cost to the franchise would be substantial."

Goldman pushed ahead with a huge staff increase, hiring hundreds of bankers from other firms. By 1994, for instance, Goldman had built up a Hong Kong staff of nearly 500. To many observers, it seemed Goldman was "flying by the seat of its pants," as one former partner puts it. Friedman was so optimistic about the prospects for Asia that he told the staff there on a 1993 visit that he regarded Hong Kong as his "legacy," according to a former staffer. Friedman denies this.

SKINNY FEES. Goldman has been especially active in China, even taking the highly unusual step of investing $100 million of its own money in power plants and real estate projects. Yet the firm overplayed its hand, says a former employee. The partners in New York, he claims, "got greedy. They asked for too much for the investors, and the Chinese decided [the deals weren't] in their interest," and backed out of them.

In one instance, he says, Goldman's Asian bankers had negotiated another $100 million deal, this time with provincial authorities to privatize a Shandong power plant. But that fell through in early 1994 because Goldman was demanding sovereign loan guarantees on top of an already agreed-upon 20% return--something China's State Council decided was too pricey.

Another problem Goldman didn't bank on were the skinny commissions in the highly competitive Asian market. One former Hong Kong staffer says Goldman took on deals to make a name for itself, such as the privatization of Singapore Telecom, in which Goldman's profits fell far below expectations. Friedman admits Goldman may have erred by embracing what he called the "seamless web" argument--that in order to get into certain profitable businesses, a new entrant has to engage in certain unprofitable businesses. More recently, Goldman let go or sent home perhaps as many as 100 people. Referring to China, Corzine says: "We have had many things that worked, and we have had many frustrations, but we are positive on China."

Goldman did no better in Russia. In early 1992, the Russian government appointed Goldman its adviser on foreign investment, giving the firm good reason to believe that it would have the inside track on privatizations. But it soon got caught in the middle of a government debate on the role foreign companies could play in this process, sources say.

Goldman had been selected to work with Leonid Grigoriev, head of the Committee on Foreign Investment, who, like Goldman, favored deals with special access for foreign investors. Another faction, led by Anatoly B. Chubais, insisted on procedures that didn't provide special access. He and others had misgivings about Goldman receiving fees from foreign companies while advising the Russian government. By the fall of 1992, Goldman's fate was sealed when Grigoriev's committee was disbanded. Says Anders Aslund, a Swedish economist and adviser to the Russian government in 1992 and 1993: "Goldman Sachs really thought they could run policy, and you can't do it like that in Russia, so they were punished." Last December, Goldman more or less gave up and moved its Russian business to Frankfurt.

PESO PUMMELED. Goldman now has some egg on its face in Mexico as well, though not to the extent it does in China and Russia. For one thing, in the wake of the Dec. 20 peso devaluation, deals it touted have plummeted in value. Like many other firms, Goldman admits to having been caught unawares. Friedman, for one, acknowledges being shocked by the size of the devaluation. But he says that by that time Goldman was positioned "cautiously" in peso-related holdings. Says Corzine: "We're not going to walk away from Mexico. But we have to think differently about how to manage currency risk today than we might have anticipated 16 months ago."

Not all of Goldman's problems have been in emerging markets. In late 1989, the firm set up a new entity in London called Goldman Sachs Asset Management and plunged into fixed-income and currency management. But by the end of 1993, the fund had raised just $3 billion, a drop in the bucket compared with what other brokerage firm asset-management operations manage.

But that wasn't the only problem. Pressured by proprietary traders in London, the fund, which was designed as a low-risk bond fund, began taking more currency risk than the fund managers were comfortable with, say several former Goldman employees. When the Fed raised U.S. rates in February, 1994, and the European bond market tanked, the fund suffered unusually big losses. Many investors withdrew their money and fund assets fell by half, say the former employees. Goldman says the returns last year were positive.

That wasn't the only black eye Goldman got in Britain. In the wake of the 1991 death of Robert Maxwell and the collapse of his media empire, Goldman had to pony up $120 million, according to press reports, to satisfy claims by the Maxwell pension funds, who claimed shares bought by Goldman in Maxwell companies really belonged to them. In 1993, Goldman was fined $256,000 by the Securities & Futures Authority, the largest fine ever levied by the SFA, for breaching its capital requirements in the Maxwell transactions.

Despite these overseas misadventures, Corzine remains committed to the global strategy, albeit in slimmed-down form. He adds that "we probably could have been wiser in our pacing."

While the missteps were embarrassments, it was Friedman's abrupt departure that has most destabilized Goldman. For all the years he spent at the firm, he apparently had not thought much about succession. He had promised his wife he would retire in mid-1993. But when Rubin left to become Bill Clinton's economic adviser, Friedman decided to stay on and his pace became even more grueling. He did not delegate some of those duties to a new co-chairman because he couldn't decide on one. At least one former partner attributed this to Friedman's alleged inability to share power. "Hogwash," Friedman retorts.

The timing of Friedman's retirement announcement to his colleagues in early September couldn't have been worse. That same day, Goldman had to weather another huge trading hit. With 1994 already shaping up as terrible, many partners regarded their colleague as a captain who abandoned ship. Some sources say Friedman's resignation nudged many partners who had been considering retirement to leave. The result was an exodus that had not been seen in years. In all, 35 general partners "went limited" in 1994. Says one former partner: "He [Friedman] set an example for others. It was a signal event."

"I was pretty surprised," Corzine admits, although he insists that Friedman's resignation triggered those of no more than "a handful of other partners" close to Friedman. Yet he admits that the move has created a "multiple ripple effect" throughout the firm. "Any time there's a transition, the human connections get shaken. It takes time for the depth of connections to be reestablished, and we are well on the way to doing that."

The departure of partners may also have been accelerated by a meeting for new partners at a Westchester (N.Y.) conference center. These meetings are perhaps the most prestigious initiation rite on Wall Street. After years of toiling 16-hour days, they had caught the brass ring, and now could look forward to accumulating at least $5 million a year each for the rest of their careers.

But, according to one former officer, when a slide-show presentation disclosed to them details of Goldman's financial condition known only to partners, many of the inductees were incredulous and demanded a detailed explanation. They discovered that the firm's capital was eroding and that its leverage was far greater than they had imagined. And they realized that in addition to the Croesus-like rewards of being a Goldman partner, there were significant liabilities as well. Goldman's deteriorating finances prompted a draconian cost-cutting program aimed at reducing staff 15% to about 8,200 by Groundhog Day. Nothing was spared. According to one former staffer, Goldman eliminated everything from first-class travel and to leased plants. Even small plants were discarded to save the expense of paying an outside watering service.

Yet this has been just a prelude to a sweeping rethinking of the firm's management structure and methods. Says Corzine, referring to all Wall Street firms, including Goldman: "We all could do a better job...managing through peaks and valleys." In something of a reversal of roles, he says the firm was getting advice from corporate clients on how to manage corporate "downsizings." He hopes to beef up global asset management, despite the London troubles, and move into loan syndication.

"SKEWED." For all its trading setbacks, Corzine insists Goldman will always seek to remain a trading powerhouse. "I'm a trader. I believe in trading. I believe that Goldman Sachs will be one of the great trading firms." Yet he concedes concern about the expansion of proprietary trading: "We may have gotten the balance skewed. Trading should not be so dominant that it overwhelms other aspects of the firm's earning capacity. We did have more concentrated positions, in retrospect, than we would like to have had."

Corzine denies that the firm's leverage is excessive and insists that its $4.8 billion in capital is now more than adequate. One reason is a $250 million capital injection in late 1994 from Hawaii's family-owned Bishop Estate. "For the moment, we are not employing all the capital we have," he says. Still, many former partners and officers have speculated that it is inevitable that Goldman will have to go public to raise permanent capital. But Corzine says the "likelihood of us going public any time soon is pretty low. I don't think the partners want Goldman Sachs to be a public company. The partnership structure is an extraordinarily motivational force."

More broadly, Corzine says that one of his missions will be to "convey some emotional electricity about how I feel about the firm, its people, and its future." For a lesson in generating emotional electricity, it certainly wouldn't hurt to walk the halls with John Weinberg.

Getting Goldman Back on Track



Lax management Set up better mechanisms for succession, budgeting,

strategic planning, and risk control

Poor morale Restore traditional level

and erosion of of profitability; amend

collegial culture compensation plan

Weak earnings Cut overly concentrated

and capital risk; consider going pub-

uncertainties lic; expand such promising activities as asset management

and loan syndication

Excessive costs Downsize staff in the U.S. and overseas and reduce other


Overemphasis on Restore traditional client

proprietary orientation


and investments

Early retirements Persuade key partners to

of key partners remain in the firm; expand size of partnership

DATA: BUSINESS WEEKBy Phillip L. Zweig in New York, with Rose Brady, David Lindorff in Hong Kong, and Paula Dwyer in London

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