“I’m shocked, shocked!” to paraphrase Louis Renault, the French prefect in Casablanca, who professes surprise at the existence of gambling at Rick’s Café, as he collects his winnings. To think that unethical behavior goes on in Wall Street, especially since dealings there are supposed to put the customer first!
That is the gist of what amounts to the exit interview from an ex-Goldman Sachs vice president, one Greg Smith, who asserted in an op-ed piece in Wednesday’s New York Times that he was quitting the firm dubbed by its critics as the “vampire squid” because of the alleged declines in the Wall Street powerhouse’s ethics. When the 30-something Smith joined as a summer intern, Goldie had the reputation of putting clients first, he wrote. But in the past decade, its culture degenerated into an amoral strategy of how much it could wring out of its customers, he contended. And so Smith said he was washing his hands of this dirty business.
As if Wall Street’s greedy thrust for the maximum profits is something new. Lloyd Blankfein, Goldman’s (ticker: GS) chief executive, may have famously asserted that the firm was doing “God’s work” as bankers. But it wasn’t for nothing that Jesus threw the money changers from the temple nearly two millennia ago.
Smith, identified as the ex-head of Goldman’s U.S. equity derivatives operations for Europe, the Middle East and Africa, decried his former firm’s lack of focus on client’s needs in favor of its own profits. This was presented an aberrant situation that has emerged only during his tenure.
But to assert that was unique to Goldman Sachs in the 21st century is to ignore history. The firm took decades to live down the collapse of Goldman Sachs Trading Corp. in the 1929 crash, a utility holding company that exemplified the bubble of the time.
Nor was the so-called Big Short – in which Goldman shorted mortgage-backed securities even as it peddled them to its customers – a new phenomenon on Wall Street. Also in the 1920s, National City, the predecessor to Citigroup, packaged bad Latin American debt for sale to customers, in this case mainly small investors. In the last decade, Goldman and the rest of Wall Street sold mortgage securities by the billions, but that was to investors sophisticated enough to believe it was indeed possible to make triple-A-rated silk purses from subprime sows’ ears.
What’s new isn’t that Wall Street sells stuff to an innocent public that blows up. The real change is firms such as Goldman went from making money from executing trades for customers to trading against those customers.
As one market veteran relates: "The transition that Wall Street has gone through over the last 40 years has been the center of power shifting to trading and investment banking from client relationships. (‘Customers Man’ as it was known in the 'Fifties) The national sales manager was king and many went on to run their firm.
“Today many of the firms are run by ex-traders or investment bankers who they feel that the customer base is secondary to profits,” he continues. “Concurrent with the shifting of power, many firms became giant hedge funds or what the industry call ‘prop [for proprietary] trading’ department. The customer base was very important to ‘prop’ traders because they can gain an advantage by using client investment flows.”
Joan McCullough of East Shore Partners traces this back to “when the whole freakin’ Street went rogue. By the early 'Nineties, it was all over for the client,” as she puts in her inimitable way. Here’s her retelling of what she saw then:
[And bein’ a listed geek from way back, many punks won’t even know what I’m talkin’ about because it’s ancient history. But I believe that recollection of from what is no doubt considered the primitive era … kicked off the erosion … albeit quite stealthily … when they dropped the commission schedule, i.e., pennies per share to be charged for exchange executions. This was back in the ''Seventies. And Goldie was one of the biggest sponsors of discounting commissions to the clients. First it was “full old”. Then “Less 20% off full old”. Then 30%. Then 50%. Then they threw that out altogether and we went to flat pennies per share, say a dime. Somewhere between a dime and a nickel, Equity Trading became a cost center instead of a profit center for the firms. And tainted the culture of the Research guys at the same time. To where their goal was to tout stocks exclusively with a view towards garnering investment banking biz as opposed to researching and grading them the old-fashioned way. Because there was no money in that, no sir because the pennies per share continued to shrink.
So as night followed the day, the client became the enemy. Because at that point, the client was dictating to US. Uh-oh. So war was waged on these guys on a daily basis. With a smile no less.
It’s maybe 1993. I’m on a desk at Bear. Agency guy is here. Prop guy is 20 feet away on the same dais.
We got a big order to buy whatever. Next thing you know, the offers are lifted in N.Y. and elsewhere. [In other words, the stock was being bought aggressively.]
We are all standin’ there with our gobs open, foul-mouthing whatever CUSTOMER who, having been shown our order, freakin’ RAN AHEAD.
About two minutes later, it was determined that Bear had run ahead of Bear.
I was stunned. And thought immediately “well, that prop guy is gonna’ be fired on the spot”. Because in my so-far employ in various trading desks, it had been punishable by death to screw the client.
When I left about 10 years later, that prop guy was still there and makin’ seven figures, dictated by his P&L.
That was my introduction into how cutthroat it had become. I could write you a book just citing how many times clients were bagged. Not for sport, mind you. For lack of a better description, if there was a dirty end of any stick, they were supposed to get it, not us. ]
So, it’s not as if this anything new or unknown in the market. Whether the firestorm ignited by Smith’s resignation from Goldman burns out or continues remains to be seen. Barry Ritholtz writes on his blog, the Big Picture, that he suspects the meme has run its course. As the election campaign gets into high gear later this year, with the likely Republican presidential candidate a symbol of wealth and Wall Street, don’t count on it.