ESSAY

A brief history of Goldman Sachs

Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall July 16, 2010. Goldman Sachs Group Inc shares opened…
Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall July 16, 2010. Goldman Sachs Group Inc shares opened…
Image: Reuters/Brendan McDermid
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Marcus Goldman, who started what became Goldman Sachs 150 years ago, was the original Interstitial Man. Dressed to the nines in a Prince Albert frock coat and a silk top hat, Goldman set up shop on Pine Street, a narrow canyon just north of Wall Street, and made a fabulous business for himself and his family by buying and selling the chits of the small businesses that had sprung up around lower Manhattan after the Civil War.

Goldman had arrived in New York in 1848, when he fled his small village in Germany and opened a clothing store in America. Other young, Jewish immigrants, who would become among the leading American bankers of the era, did the same. The Lehman Brothers opened their store in Montgomery, Alabama, in 1850. The Lazard Brothers opened their store in New Orleans, also in 1848. Marcus Goldman chose the coal country of Western Pennsylvania in order to outfit the sturdy men who ventured into the mines. Two years later, though, he moved the business to Market Street, in Philadelphia. Soon thereafter, he met and married his wife, Bertha, and fathered five children. His business as a clothing retailer was thriving. But Bertha grew tired of Philadelphia and, in 1869, insisted that the family moved north, to New York City.

After 21 years in the retail clothing business, Goldman knew well what merchants like him needed most of all: cash. He used the family’s move north to start something new—buying small business IOUs at a discount, say, providing store owners 90 cents in cash for each $1 owed to them. Then, once he had accumulated enough IOUs in his silk hat to push it further up on his head, Goldman would make his way uptown to the banks where he would negotiate to sell the papers he been accumulating for more than he had paid for them. The difference between the buying and the selling was his profit. His first year, Goldman bought and sold some $5 million worth of IOUs, and pocketed a profit of around $250,000, or 5% of the face value of the notes he had bought and sold. He quickly became a very rich man, and the Goldmans moved into a ninety-foot tall, twenty-five-foot wide brownstone mansion at 649 Madison Avenue, at what is now the corner of 60th Street.

That formula—getting a fee for being the middleman—is more or less what Goldman Sachs, now a publicly traded firm with 37,000 employees and a market capitalization of around $75 billion, has been doing ever since. The products and services that Goldman provides its clients have changed considerably over the years and become more sophisticated—M&A advice, underwriting debt and equity securities, derivatives origination and trading, and yes, Goldman is still buying and selling what is now known as “commercial paper”—but Goldman makes the bulk of its money from the fees paid by clients for providing the capital and services they need and want. (It also makes a boatload of money these days from buying and selling companies in its private-equity funds.)

It’s not nearly as benign or as genteel as it sounds. Wall Street has always been a dangerous place, with small, undercapitalized partnerships going in and out of business all the time. And Goldman Sachs has had its share of close calls that almost wiped the firm off the face of the Earth. In February 1884, for instance, one of the pieces of paper Marcus Goldman carried around in his top hat went awry. By then, he had invited his son-in-law, Samuel Sachs, to join him as a partner in his firm, which was buying and selling $30 million of commercial paper per year. A Mr. Frederick E Douglas had purchased a $1,100 note from Goldman & Sachs, as the firm was then known, written on the account of an “A Cramer” and endorsed by a “Carl Wolff.” Goldman was selling the six-month note for Wolff, with Douglas being the buyer. But, it turned out, Cramer’s signature had been forged, Wolff ran away, and the note became worthless. Douglas sued the Goldman partners in superior court, in New York, on the grounds that Goldman “had, by implication, guaranteed the note to have been made by Cramer.”

This was one of the first legal examinations of the role and the responsibility of a financial intermediary in a transaction between a buyer and a seller. Would the jury hold Goldman & Sachs responsible for the IOU as if it had been an underwriter of the paper—the role of an underwriter of a security being one that Goldman Sachs would soon pioneer two decades later—or would the jury hold Goldman blameless and rely on the tried-and-true concept of caveat emptor, or buyer beware? The judge instructed the jury to find for Douglas “if they believed the defendants to have been acting as brokers for Wolff at the time of the sale of the note.” In the end, the jury found a verdict for Goldman and the firm was spared liability for the fraud. Had the jury found differently in March 1886, the tantalizing possibility exists that the Goldman Sachs we know today might have been an early victim of the plaintiffs’ bar.

Over the years, Goldman had other existential crises as well. There was the dramatic saga of the Goldman Sachs Trading Company, which nearly bankrupted the firm in the wake of the stock market crash of 1929, and the ensuing Great Depression. A few years earlier, after Marcus Goldman’s son, Henry, was forced out of the firm because of his publicly articulated support of the Germans in the lead up to World War I, Goldman Sachs recruited its first outside senior partner, Waddill Catchings, a Harvard-educated popular economist in the mold of a Tim Ferris or a Suze Orman. Big mistake.

Catchings convinced his Goldman partners to underwrite a series of investment trusts, which were all the rage in the Roaring Twenties, and another financial product in a long line of clever Wall Street innovations designed to separate investors from their money. The idea was to create a shell company, or holding company, that would sell debt and equity securities to the public and then invest the money received—less management fees, of course—into the shares of other publicly traded companies. The conceit was that the professional managers at the investment trusts had special insight into the vicissitudes of markets and could pick outperforming stocks. An investment trust was akin to what a publicly traded individual mutual fund might look like if it also piled on the leverage to maximize potential returns (and magnify potential losses). In short, these investment trusts looked a lot like the hedge funds of today with far fewer sophisticated investment strategies. Goldman had the great misfortune of underwriting Catchings’ schemes at the height of the bull market that would soon end in calamity. There were allegations aplenty of stock-price manipulations and insider-trading (although that was not criminalized until years later) against several Goldman partners.

As the Goldman-sponsored investment trusts rose and fell, Catchings and his partners went from thinking they had gotten very rich to realizing Catchings had nearly bankrupted the firm. Soon enough, after suffering losses of $13 million themselves—nearly as much capital as the overall firm—the Sachs brothers, Walter and Arthur, dispatched Catchings with extreme prejudice (and a $250,000 settlement of his contract) and vowed never to have another outsider run the firm again—a plan to which the firm has stuck.

To succeed Catchings, the Sachses chose Sydney Weinberg, who had literally worked at the firm nearly his whole life, or at least since he dropped out of his Brooklyn middle school to take a job cleaning the partner’s spittoons. From there, he worked his way up to the corner office. While it’s true Weinberg had a role in manipulating the stock of the Goldman Sachs Trading Company (and engaging in a bit of insider trading to boot), he ran the firm (more or less) for the next 39 years with a keen eye for business and an iron fist for misbehavior. At one point, Weinberg simultaneously served on the boards of directors of 35 different companies—a feat without precedent before or since.

Despite Weinberg’s sterling reputation on Wall Street and in Washington, there was a view inside Goldman that by the end he had hung around too long. So, in the mid-1960s, Weinberg’s successor, Gus Levy, a trader who was born and reared in poverty in New Orleans before moving to live at the 92nd Street Y, engineered Weinberg’s removal from the firm’s offices at 55 Broad Street and dispatched him into his own suite at the famed Seagram’s Building, at 375 Park Avenue. (Goldman still has an office there.) It was quite the odd arrangement: the defenestration of Goldman’s senior partner by his successor to a location miles away from headquarters to make sure that Levy had the run of the place without Weinberg’s looming presence. (It almost worked; until he died, Weinberg still made the important decisions about pay and promotion.)

Levy transformed Goldman into a firm with rare expertise in both investment banking–Weinberg’s specialty–and in trading—Levy’s specialty. No other firm on Wall Street could match Goldman’s prowess in both disciplines at that time. But soon after Weinberg’s death, in July 1969, Goldman found itself facing yet another near-death experience.

Once again, the culprit was Goldman’s commercial paper business. In 1968, Goldman had underwritten nearly $100 million of short-term financing for the Penn Central Corporation, then one of the US’s largest railroads and one of its biggest companies. For years, Goldman had been trying to get Penn Central as a client. But the railroads were stubborn, and they stuck close to the white-shoe Wall Street firms and avoided the Jewish firms. Finally, Goldman broke through with Penn Central, winning a mandate to sell a slug of its commercial paper to investors. The problem for Goldman came in June 1970, when Penn Central filed for bankruptcy. It was then the largest corporate bankruptcy in American history. “Everyone hunkered down,” partner George Doty told me. “We had a rough couple of years.”

The investors who bought the Penn Central commercial paper that Goldman had underwritten were livid, understandably, as their losses mounted. What Goldman knew about Penn Central’s financial situation, and when it knew it, became the focus of numerous lawsuits brought against the firm by irritated Penn Central creditors. “Goldman Sachs continued to sell [Penn Central’s] commercial paper after [it] had received information about the financial condition of the [company,] which should have raised serious questions as to the safety of an investment in the company’s commercial paper, and Goldman Sachs did not disclose such information to its customers,” according to a lengthy Securities and Exchange Commission report on the matter. This was not good: Goldman had put its financial interests ahead of clients (and not for the first or last time, either.)

Initially, Goldman chose to fight the lawsuits in court. But when a jury returned a first verdict against the firm in the millions of dollars, Levy realized that additional jury verdicts against it would quickly drain the firm’s capital: the potential claims against Goldman totaled around $87 million; its capital was just $50 million. Bankruptcy loomed. (Today, by contrast, Goldman has shareholder’s equity of around $87 billion.) Levy deputized John Weinberg, Sidney’s son, to try to settle the outstanding lawsuits as expeditiously as possible. And by some miracle, he succeeded eventually settling some of them for pennies on the dollar. Goldman had again scraped by, but it was as close a call as the firm had ever experienced—even worse than the Goldman Sachs Trading Company crisis.

The firm had one more serious brush with death in 1994. The year before, thanks to trading bets designed by Jon Corzine, who was on his way to becoming Goldman’s senior partner, the firm had made a record pre-profit of $2.7 billion, a financial bonanza for the private partnership and its partners. Steve Friedman, Goldman’s senior partner, made $46 million that year, an unheard of sum in those days. But the year after, Corzine and his fixed-income traders made a wrong way bet on interest rates, after the Federal Reserve raised rates in December 1993, surprising the markets and especially Goldman’s traders. Goldman started losing $100 million a month; partners watched their capital accounts swoon as the losses mounted. Goldman was in turmoil. Friedman retired suddenly, replaced by a combination of Corzine and Hank Paulson. Some 40 partners up and left, fearing that the partnership wouldn’t survive. It was an extraordinary bloodletting and a fascinating Darwinian exercise in smart—but terrified—bankers and traders voting with their feet. Once again, Goldman survived—but barely—and those partners who stayed made a fortune—of as much as $300 million each—when Goldman finally decided to go public in May 1999, many years after its peer group and after years of internal debate.

The years following Goldman’s IPO were a bonanza for the firm. It made money hand over fist. It hired the top bankers away from other firms. It built up its private-equity business. It perfected its position as the world’s top M&A advisor. Its trading desk exploded with gunslingers and rocket scientists. One part of Goldman’s trading operations—its proprietary trading desk, where the firm bet its own money–proved to be a godsend heading into the 2008 financial crisis. While some of Goldman’s competitors went down the tubes (Bear Stearns and Lehman Brothers) or needed to be rescued (Citigroup, Merrill Lynch, and Morgan Stanley) Goldman’s proprietary trading desk, with support from the top executives at the firm, had anticipated trouble in the mortgage market and make a huge, proprietary bet that it would collapse. Goldman bet right, and made a $4 billion trading profit on that desk alone in 2007, when the rest of Wall Street was suffering mightily.

But while Goldman weathered the financial crisis far better than any of its competitors, it lost the ensuing public relations battles on both Main Street and in Washington. This was yet another crisis for the firm, and one that it eventually overcame through the passage of time and by deciding to be somewhat more transparent about its businesses with the public and the press. Then, in 2018, came a new scandal—involving a group of two or three of its bankers in Asia and a corrupt Malaysian sovereign wealth fund—that while not as existential as Goldman’s other scandals, has once again dented the firm’s reputation and its market capitalization, which has fallen nearly 20% in the month of November 2018 alone.

The so-called 1MBD scandal has become the first test for David Solomon, who replaced Lloyd Blankfein as Goldman’s CEO on October 1, after Blankfein led the firm for 12 years. (Blankfein became CEO in 2006 after Hank Paulson became US treasury secretary.) It’s unlikely to be Solomon’s last test.

What must Solomon do to make sure Goldman survives for another 150 years? First, he needs to always remember that while he has been at Goldman Sachs for 20 years, and is no outsider like Catchings, all the three of the firms he worked at before Goldman—Bear Stearns; Salomon Brothers; and Drexel Burnham—are long gone. It could happen to Goldman. Second, he must face the reality that the so-called “light touch” regulatory environment that prevailed on Wall Street in the years before 2008 is gone, and is not likely coming back anytime soon, although the Trump Administration will continue to roll back some of the more onerous regulations placed on Wall Street in the wake of the financial crisis. What the new reality means for Goldman is that it needs to find new ways to make money, since the old ways—such as trading and making proprietary bets—are either dead or dying.

What Goldman really needs to do is to merge with a big bank, but that’s not a possibility at the moment since the Federal Reserve, Goldman’s prudential regulator, would have to approve such a deal. That approval is unlikely at the moment. (Solomon is sanguine that the Fed will eventually relent.) Merger partners for Goldman have been bandied about. Among them are State Street Corporation, PNC Financial Services, and Bank of New York Mellon.

In the run-up to Goldman’s 150th anniversary, the firm has hired The History Factory to collect from its thousands of alumni any Goldman memorabilia or documents they may have that can become part of the firm’s digital archive. Emails went out at the end of November to Goldman alumni worldwide. If the firm ends up portraying its history in an honest and transparent fashion—a big if, of course—the archive will contain ample examples of Goldman’s near death experiences as well as the fact that not a single one of its very few acquisitions over the years has worked out particularly well. That means, regardless of whether the Fed gives Goldman the green light for a big merger, the truth is it might be better off on its own.