All The Devils Are Here: Unmasking the Men Who Bankrupted the World (31 page)

In his memoir,
On the Brink
, Paulson recalls the moment when he went to talk to Corzine after the coup had been completed. Corzine had just learned his fate; he’d been informed by John Thain, Goldman’s CFO and Corzine’s close friend. (In 2007, Thain was named chief executive of Merrill Lynch; during the worst weekend of the financial crisis, he negotiated its merger with Bank of America.) “Hank, I underestimated you,” said Corzine, according to Paulson. “I didn’t know you were such a tough guy.”

In fact, there was a lot about Hank Paulson that was surprising. He was a devout Christian Scientist, whose worst vice was too many Diet Cokes. Despite a nine-figure net worth, he inveighed against conspicuous consumption. He was almost absurdly frugal, a trait he inherited from his father, an
Illinois jeweler. He and his wife, Wendy, whom he married during his second year at Harvard Business School, were avid conservationists and fanatical bird-watchers. Though they obviously lived in New York, the Paulsons’ homestead was in the Midwestern prairie, on a farm in Barrington, Illinois. It was where Paulson had grown up.

As a leader, Paulson was cut from a very different cloth than, say, Bob Rubin. He once told his alumni magazine that “I’m not an inspirational leader. I’m just not.” He didn’t lead by charm, or by leading people to his way of thinking by asking, “What do you think?” Rather, he was a force of nature, and his management style was marked by a kind of brutal pragmatism. His preferred mode was revving into action rather than sitting back, waiting, and patiently strategizing. He was direct to a fault, utterly lacking the verbal slickness that dissembling requires. At about six foot two with a build that still mildly resembled the Dartmouth football player he’d once been, and a gravelly voice to boot, Paulson had an aggressiveness about him that made people think he was much bigger than he was, and which could intimidate people into silence. These qualities also led some people to underestimate Paulson, as Corzine had. But doing so was a mistake: he had a mind that was surprisingly detail-oriented, nuanced—and clever.

He also had an astonishing work ethic. “Hank is a heat-seeking missile,” says a former Goldman partner. “If you say Motorola might do a financing, he calls Motorola seven thousand times. He doesn’t stop.” (Paulson would always tell the firm’s bankers that they had to have something new to offer with each and every call.) He hated—
hated
—losing, whether he was on the ski slopes or trying to land a deal.

Unlike his predecessor, Corzine, or his eventual successor, Lloyd Blankfein, Paulson was an investment banker, not a fixed-income trader; he had spent the early part of his career doing banking deals out of Goldman’s Chicago office. (Prior to joining Goldman, Paulson had served as an assistant to John Ehrlichman in the Nixon administration.) He became a partner in 1982, eight years after joining the firm, rising to be co-head of the firm’s investment banking department and then its chief operating officer before taking over as CEO in 1999.

Investment banker though he was, Paulson did not try to turn back the clock. He saw clearly that trading and fixed income weren’t just the future of the firm—they were the present. The last hurrah for the investment bankers at Goldman had been the Internet bubble, which burst in early 2000, not long after Paulson took control of the firm. When it collapsed, the business
changed in ways that hurt Goldman. Clients demanded low-priced loans in exchange for banking business, and Goldman found itself at a deep disadvantage, up against full-service banks like Citi and J.P. Morgan. Paulson had to lay off nearly three thousand employees and reduced his old investment banking division by 10 percent. A sentimentalist he was not. Never again would investment banking—the raising of capital for companies—be a sizable component of Goldman’s results.

In fact, in the years after Paulson took over, the investment bankers who had risen to the top of the firm—and were jockeying to be Paulson’s heir apparent—were pushed aside. Thain, for instance, left to run the New York Stock Exchange. By 2003, it was clear that Paulson’s heir apparent was a trader: Lloyd Blankfein, who ran the fixed-income, currency, and commodities division. In June of that year, Blankfein, then forty-nine, became a Goldman board member; in December, he was named president and chief operating officer. (Paulson, however, always made a point of saying he wasn’t going anywhere. “There is no fear, and for those who want me to go, no hope,” he told
Fortune
in 2004.)

Blankfein had joined Goldman via its acquisition of J. Aron, the commodities trading firm. An up-by-his-bootstraps kid from the Bronx who put himself through Harvard and Harvard Law, Blankfein had joined J. Aron as a gold salesman in 1981, the same year Goldman bought the firm. The two organizations couldn’t have been more different. While Goldman was becoming a white-shoe firm, J. Aron was a tough, street-savvy, highly entrepreneurial trading shop—“street fighters,” in the words of Dennis Suskind, the former J. Aron executive who hired Blankfein. It had the classic traders’ rough-and-tumble culture. Blankfein himself later joked that at J. Aron “we didn’t have the word ‘client’ or ‘customer,’ we had counterparties—and that’s because we didn’t know how to spell the word ‘adversary.’ ” For years, J. Aron had its own separate elevator bank at Goldman’s headquarters at 85 Broad Street, preventing the staffs from intermingling. “It created a feeling inside J. Aron of ‘us against the world,’ ” says a former Goldman managing director.

As soon as Goldman acquired J. Aron, profits plummeted. Despite being new to the firm, Blankfein played a key role in rebuilding it. He proved that he had a sixth sense about making money and a rare ability to manage traders. His power began to grow. In 1997, he became co-head of Goldman’s entire fixed-income department. As he rose, he lost weight (about fifty pounds), quit smoking, and shaved his beard. He also repurposed his rapier-sharp wit into an engaging, self-deprecating sense of humor. Says a former
Goldman trader: “Lloyd got really refined, but he used to be just a killer.” Blankfein had all the verbal dexterity Paulson lacked, and although he wasn’t physically prepossessing, tough-talking trader types were drawn to him. One partner described it as a bit of a “sun god phenomenon.”

As Blankfein rose, he pushed hard to complete the transformation that had begun under Rubin and had accelerated under Paulson. What this meant, broadly speaking, was that Goldman no longer sat on the sidelines dispensing advice. The new Goldman was at the center of the action. It had a proprietary trading operation and a large private equity business. It used its money to invest alongside clients, to get trades done—and, sometimes, to compete with clients or trade against them. In the trading business, Goldman wasn’t just hedging its risk, but actively seeking to profit for its own account. In other words, instead of trying to avoid conflicts of interest with clients, Goldman embraced them—and made money from them. It was an attitude that one competitor in 2004 described as “somewhere between mercenary and pragmatic.” Hedge fund managers and private equity executives alike complained that while they no longer trusted the firm, they did business with Goldman because they had to—the firm was so dominant and so much better at everything than everyone else that you pretty much had no choice. By 2004, trading accounted for 75 percent of Goldman’s profits, while investment banking had shrunk to about 6 percent. Soon there was a widespread cliché: Goldman was just a giant hedge fund that was engaged in proprietary trading and investing for its own account.

Goldman always insisted that it had something no hedge fund had: customers. And that was true. As Goldman’s chief financial officer, David Viniar, explained it on a 2003 call, “There is a small percentage of our trading that is purely proprietary and there is a small percentage that is purely customer driven. But the great majority of what we do will be driven by trading with customers where customers ask us to do a transaction, or we’ll hedge something for them and then we may hold a position for a while or we may lay it off in pieces to the market. It’s very hard to break out what is proprietary and what is customer.”

And when Blankfein insisted that nothing had changed and that Goldman recognized that its success was due to its client franchise, well, that was true in a way, too. It was customers that instigated the transactions that put Goldman at the center of the action. Goldman might earn a fee from a deal or make its money by putting its own capital to work as part of the deal, or both. It might be on the other side of a trade in order to satisfy a client, to
offset another risk elsewhere in its book, or because Goldman thought the other side was where money could be made. The many facets of Goldman’s involvement might help clients, because it might get a trade done that would otherwise be difficult, or it might hurt them in ways that were hard to see from the outside. Or maybe both. At one point, Goldman’s bankers—whom Blankfein began to refer to as the “front of the house,” meaning they were the salespeople for the firm’s products—were told that they should sell more derivatives. But if a banker asked Goldman’s foreign exchange desk for a price on a currency swap, neither the banker nor the client had any way of knowing how much profit margin the trading desk was building in. Was the client still a client to whom Goldman owed some sort of responsibility, or was the client now merely a counterparty? In this new era, Goldman’s first duty was to its own bottom line, which accrued to its shareholders. Clients were a means to that end, not an end in and of themselves.

Goldman’s client franchise gave it another big advantage: customer trades gave the firm extraordinary insight into what was happening in the market. Blankfein would speak of being “so close to clients that you can see the pattern better than anyone else.” What he meant, although he didn’t put it this way, was that Goldman had become the house in the casino: it could see all the cards, whereas the other players could see only their own hands.

Goldman always defended its transformation as not only smart, but necessary. At a meeting of managing directors in London in the fall of 2007, Blankfein told the assembled crowd that, without the change, “we would have been irrelevant.” And if that was an overstatement, it was certainly true that Goldman would have been a far smaller firm. But it was also true that Goldman’s single-minded focus on maximizing profits made its partners extraordinarily wealthy. In 2003, Paulson made $21.4 million while Blankfein made $20.1 million; in 2004, the men made $29.8 million and $29.5 million respectively, according to company filings. Not very long ago, a million-dollar payday was considered a sterling year. Now bonuses of $5 million, $10 million, $15 million were not uncommon.

And the more Goldman grew, and the more the men at the top of Goldman earned, the more jealous the rest of the Street became.

There was one key way in which Goldman Sachs
didn’t
change—and this had as much to do with its success as the many ways in which it did change. Goldman Sachs practiced risk management with an unblinking rigor that no other firm on Wall Street came close to matching—not even J.P. Morgan,
which had practically invented modern risk management. The firm most certainly did not take VaR—or any other modern risk model—as gospel; a former risk manager says the phrase “The model says so” was potentially a firing offense. When it came to managing risk, Goldman had what can only be called a kind of humility, a belief that the model was only as good as its inputs and that faith in the model had to be balanced with the informed judgment of human beings. Goldman understood that risk could bring rewards, yes, but it could also bring disaster.

There were several specific things that the firm did differently than its peers. Goldman was a stickler for using what’s known as mark-to-market accounting, meaning that it marked its books, every day, at the price at which securities traded in the market. CFO David Viniar traced this discipline to the old Goldman Sachs partnership. “People came into the partnership at a certain value, and they left the partnership at a value,” he’d say. If a trader said there wasn’t a price for a particular position, Goldman might force him to sell a little bit, just to see what the price was. There was no pretending.

Goldman also carefully monitored its access to cash, which is critical for an investment bank. Unlike commercial banks, which have government-insured deposits, investment banks are wholesale funded, which basically means they have to constantly raise capital in the markets. If the markets shut down for an extended period of time, they’re dead. That’s why Goldman kept what was basically a piggy bank full of short-term securities—$40 billion in 2004—set aside in case of emergency. “We asked how much money, under the most adverse conditions, could disappear on any given day,” Paulson writes in his memoir. That was very different from the VaR standard for calculating potential daily losses. VaR assumed normal markets rather than adverse ones.

There were also several squishier aspects to Goldman’s approach to risk management. At most Wall Street firms, the back office—made up of the controllers and risk managers and accountants—is a kind of no-man’s-land. Back office employees don’t produce revenue, are paid less, and are generally treated like inferiors. But at Goldman, this organization was called “the Federation,” and it was powerful. It included a separate group of controllers who independently checked traders’ marks. At its helm sat Viniar, who himself sat on Goldman’s privileged thirtieth-floor executive suite, right next to Paulson and Blankfein.

But the single most important thing was this: at Goldman, people talked to each other, all the time, about what was going on in the firm and on the
trading desks—both the good and the bad. Viniar once joked that his teenage son said to him about Gary Cohn—Blankfein’s longtime consigliere, who became chief operating officer and president in 2006—“You two are like camp counselors. You talk to Gary more than me or Mom.” Says a former trader who once had to confess big losses to Cohn: “I told him bad stuff and he handled it. If the guy who ran a desk told the president of most other firms the news I gave Gary, he wouldn’t handle it.” Information didn’t get stuck in silos, and because Blankfein came from the trading business, he could have a conversation with traders and understand it. Those simple acts—a trader telling his manager that something was wrong, the executive understanding what the trader was saying—would turn out to be disconcertingly rare among Wall Street’s highly paid and supposedly accomplished elite.