All The Devils Are Here: Unmasking the Men Who Bankrupted the World (21 page)

Weinberg was a Wall Street giant—Mr. Wall Street, the press called him. He rebuilt Goldman as a place where the relationship between a corporate client and its Goldman Sachs investment banker was paramount. More often than not, that investment banker was Weinberg himself. As late as 1956, when he was sixty-five, Weinberg served as Ford’s investment banker when the automaker went public. At the time, it was the biggest IPO in history, and it finally catapulted Goldman Sachs into Wall Street’s top tier.

The senior partner who succeeded Weinberg was Gus Levy, a gruff, no-nonsense trader who had built the firm’s trading department more or less
from scratch. In the early 1950s, Levy had been one of the innovators in risk arbitrage, and the firm had one of the leading “arb” desks on Wall Street.

For most of its modern life, Goldman Sachs has been a firm with two cultures—a genteel investment banking culture, represented by Weinberg, and a rough-and-tumble trading culture, exemplified by Levy. In many ways, the two men could not have been more different. Yet Levy, a college dropout who joined Goldman at the age of twenty-three, completely shared Weinberg’s beliefs in how Goldman Sachs should act as a firm. A Goldman man, whether banker or trader, worked impossibly hard, eschewed flashy cars and clothes, and was utterly devoted to the firm. He was maybe just a little smarter than his Wall Street peers, but he didn’t make a big show of it. His Goldman colleagues were his closest friends. He didn’t tell tales out of school. He took great pride in his work, but it was a quiet, understated pride. Senior executives at Goldman did not have palatial offices with private bathrooms. The rugs and furniture were a little shabby. The firm’s offices in lower Manhattan lacked so much as a single sign identifying it as Goldman’s headquarters.

Most of all, Levy subscribed to Weinberg’s lifelong belief that acting ethically on behalf of its clients was the single most important thing Goldman Sachs did. Anything that created even the appearance of a conflict with its clients was not just discouraged, but forbidden. That’s why, for instance, when corporate raiders like Carl Icahn and T. Boone Pickens began their takeover attempts in the late 1970s, Goldman refused to advise them, despite the substantial fees they were paying. The hostile takeover movement, the firm believed, was not in the best interest of its corporate clients. A few years after Levy died, in 1976, one of his successors, John Whitehead, set down a list of Goldman’s fourteen business principles. The first one began, “Our clients’ interests always come first.”

Levy was also Bob Rubin’s mentor. Rubin started his Goldman career on the risk arbitrage desk, which he quickly found he had an affinity for. Levy soon realized it as well, and began both encouraging Rubin—in his gruff, no-nonsense way—and talking him up with the other Goldman partners. Within five years, Rubin himself was named a partner.

Rubin had the rarest of skills: he could rise through the ranks of Goldman Sachs faster than just about anyone ever had before without arousing either jealousy or animosity. He was admired equally by superiors, peers, and underlings. On the surface, he appeared to be the opposite of prideful. In meetings—even meetings filled with important partners—he made a point of soliciting
the opinion of the most junior associate, and then seeming to hang on his every word. He had a way of making his bosses want to see him do well. His colleagues were drawn to his almost preternatural calm. When a problem arose and he was asked his opinion, he invariably responded, “What do you think?”

“There is no one better at the humility shtick than Bob,” says one former colleague who remains a Rubin admirer. “The line ‘just one man’s opinion’ was something he would utter a dozen times a day.” He inspired intense loyalty.

He also delivered the goods. In 1981, when Goldman Sachs bought J. Aron, a commodities firm whose executives then included Goldman’s current CEO, Lloyd Blankfein, Rubin was put in charge of overseeing the new acquisition. With his help, the firm began to move its business in a direction that made it vastly more profitable. He pushed Goldman to begin trading options, which it had long shied away from, even hiring Fischer Black, the MIT professor and coinventor of the famous Black-Scholes options pricing model. Goldman’s options trading desk soon became immensely profitable as well. As co-head of the fixed-income research department in the mid-1980s, Rubin helped transform the fixed-income division from a second-tier player into a worthy competitor to such bond strongholds as Salomon Brothers and First Boston. By 1990, he was the co-head of the entire firm. (He shared the title with Steve Friedman, who had also run the fixed-income department with him.) By the time Rubin left for the Clinton administration in 1993—where he spent two years as the head of the National Economic Council before becoming Treasury secretary—Goldman had become the envy of Wall Street. Rubin departed for Washington as the most admired man at the most admired firm.

In August 1996, a year and a half after Rubin became Treasury secretary, Bill Clinton appointed a lawyer named Brooksley Born to be the new chairman of the Commodity Futures Trading Commission. She was a formidable figure in Washington legal circles, a longtime partner at Arnold & Porter, with a practice that dealt with regulatory and financial services issues. She was also a player on the national legal scene, a co-founder of the National Women’s Law Center, a member of the board of governors of the American Bar Association, and an adjunct professor at the law schools of Georgetown and
Catholic University. After Clinton won the presidency, she was rumored to be on the short list for attorney general.

As a female law student in the early sixties, Born had faced her share of slings and arrows. When she became the president of the Stanford Law Review—the first woman to do so—a dean told her that “the faculty stood ready to take over the law review if [she] ever faltered,” as she later recounted in the
Washington Post
. Although she graduated first in her class—another first for a woman at Stanford Law—the school declined to recommend her for a Supreme Court clerkship. She wangled tea with Justice Potter Stewart, who told her point-blank that he wasn’t ready for a female law clerk.

Perhaps as a result, she had a steely side. Though always polite and cordial and collegial, she was tough when it came to things she cared about. She took her new post with the same resolve that had long characterized her.

It wasn’t long before she was focusing her attention on derivatives. In the years since Wendy Gramm had ruled that they didn’t constitute futures, the business had exploded. Sumitomo, a large Japanese commodities dealer, had been caught using over-the-counter derivatives as part of an effort to corner the copper market. The Procter & Gamble and Orange County debacles were still fresh on people’s minds. After she had been in office for a while, Born also began to hear rumors that firms were using swaps to doctor their quarterly financial statements.

As she looked more closely, she realized there was some question as to whether the grounds for the Gramm exemption still applied. After all, it was only supposed to pertain to one-of-a-kind derivatives between sophisticated counterparties. Yet swaps had become so commonplace that many of them were practically standardized and used off-the-shelf contract language. If derivatives were becoming standardized, Born wondered, shouldn’t they also be traded on exchanges? Shouldn’t they be classified as futures? And shouldn’t they be regulated?

Although the Sumitomo market manipulation case had been exposed before she took office, the agency conducted its investigation—and imposed a hefty fine—on Born’s watch. The experience made her realize that “we were trying to police a very rapidly growing part of the market for manipulation and fraud, but we knew nothing about the market,” she later said. “There were no record-keeping requirements. No reporting requirements. It was totally opaque.”

Born was in many ways a political naïf. She ran an agency with fewer than six hundred employees. She lacked both the power base and the political
skills to sway members of Congress or her fellow regulators. All she knew was that derivatives were a gigantic market and that some bad things had happened in the past, and that meant, in all likelihood, that bad things might very well happen in the future. And no one in the government had a clue. Born and others at the CFTC started calling derivatives “the hippopotamus under the rug.”

About a year into her tenure, Born hired a top Washington litigator, Michael Greenberger, to be the director of the CFTC’s division of trading and markets, which made him one of her top deputies. The hiring itself suggested what a tin ear she had for politics: Greenberger had never been involved in commodities, and so had no natural allies on the agriculture committees that oversaw the CFTC. He and Born had gotten to know each other serving on the board of an agency that helped the homeless. But he was no rube—he had spent his career involved in complex litigation and had argued several cases before the Supreme Court. Like his new boss, he also knew how to be tough when he needed to be. Not coming out of the commodities industry, he later said, gave him an advantage over just about anyone else who might have taken that job. “Because I was not dependent on the futures business, I really did not care what the futures industry thought of me.” Not long after he came on board, Greenberger had a meeting with Born. “I remember her telling me that we have a lot of things to do, but that I had to start focusing on over-the-counter derivatives,” he says.

Thus it began.

That Bob Rubin worried about derivatives was not the result of some conversion experience that took place after he joined the government. He had felt the same way during his years on the fixed-income desk at Goldman Sachs. It’s not that he hadn’t traded in derivatives—what was an option, after all, but a kind of derivative?—or that he didn’t understand their value as a hedging device. But he had always had a healthy fear of them, because he understood better than most that in a crisis, their combination of excessive leverage and counterparty exposure could make them an immensely destructive force.

“I remember Bob at Goldman in the 1980s,” says a former colleague. “He was always the guy saying, ‘I’m not sure how much principal risk we should be taking with the derivatives book.’ When it got to be a $1 billion book, the traders wanted $2 billion. Bob would agree reluctantly. By the time Bob
left, it was probably a $10 billion or $12 billion book. But Bob was always worried.”

His fear stemmed from something almost no one else in government could claim: actual experience with a derivatives meltdown. It happened in the late 1980s when a sudden, unexpected shift in interest rates—unforeseen by Goldman’s risk models, needless to say—wreaked havoc on the bond and derivatives markets. “Bonds and derivative products began to move in unexpected ways relative to each other because traders hadn’t focused on how these securities might behave under the extremely unlikely market conditions that were now occurring,” Rubin writes in his memoir. “Neither Steve nor I was an expert in this area, so our confusion was not surprising. But the people who traded these instruments did not fully understand these developments, either, and that was unsettling. You’d come to work thinking,
We’ve lost a lot of money but the worst is finally behind us. Now what do we do?
And then a new problem would develop. We didn’t know how to stop the process.” He concludes: “What happened to us represents a seeming tendency in human nature not to give appropriate weight to what might occur under remote, but potentially very damaging, circumstances.”

Once he got to Washington, Rubin found himself surrounded by people who viewed his lack of enthusiasm for derivatives as an amusing eccentricity. Most of the young turks he brought with him to Treasury were gung-ho about derivatives. His core group of young assistant secretaries—including a thirty-seven-year-old Treasury wunderkind named Timothy Geithner—approved of derivatives. Larry Summers used to tell Rubin that his attitude about derivatives was a little like a tennis player who wanted to keep using wooden rackets when everyone else had moved to graphite. And of course there was Greenspan, whose enthusiasm for derivatives knew no bounds. During the derivatives battles in the mid-1990s, dozens of officials from the Fed and Treasury—including Greenspan—testified in favor of unregulated derivatives and argued that the best thing the government could do was stay out of the way. Despite his qualms about derivatives, Rubin never once said anything publicly to contradict the Clinton administration party line.

Oddly enough, it was the SEC that sent the first shot across the bow: in December 1997, it proposed that the investment banks it supervised put their derivatives businesses in a separate unit, and register them—voluntarily!—with the agency. Under this plan, derivatives dealers would have capital requirements (but they would be lower than the parent firm’s!) and they
would have to use risk models to calculate the riskiness of their derivatives book (but they could use their own internal VaR!). In fact, the derivatives transactions themselves wouldn’t even be regulated by the SEC. The plan was called “Broker-Dealer Lite.”