How Goldman Sachs landed on top

How healthy is the firm today?

It’s the largest investment bank still standing after the financial meltdown, with revenues last year of $22 billion and profits of

$2.3 billion. The 30,000-employee firm routinely heads the rankings of stock and bond underwriters, and it manages nearly $1 trillion in assets for itself and its clients. Goldman’s dominance is only likely to grow now that many of its longtime rivals have disappeared. While Bear Stearns and Lehman vaporized during the credit crisis and Merrill Lynch was merged into Bank of America, Goldman Sachs didn’t merely remain independent—it grabbed its humbled rivals’ biggest clients and best employees. It all added up to another triumph for a firm that was founded in 1869 by a Jewish immigrant from Bavaria. Shut out of the clubby, largely Protestant world of stock and bond trading, Marcus Goldman established a profitable, if unglamorous, niche buying and selling short-term corporate IOUs, known as commercial paper. By the turn of the century the firm was pioneering the market for initial public offerings, handling the stock market debuts of such companies as Sears, Merck, and Ford Motor.

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How did Goldman become so dominant?

By creating an aggressive corporate culture that took nothing for granted. Because the company started outside the cozy Wall Street establishment, it hired the smartest, most driven people it could find, who learned to exploit market loopholes, snatch business from rivals, and win favors from friends in high places (see below). Under the legendary Sidney Weinberg, who led the firm from 1930 to 1969, Goldman took the then-unorthodox course of hiring top business graduates and forging those young bankers into ad hoc teams that would work around the clock for clients—earning the firm a reputation for sterling service and a fiercely loyal client base. Those clients often repaid Goldman in a very tangible way.

What was that?

They alerted the firm to emerging economic trends, such as the soaring price of commodities during the 1970s. Goldman was quick to invest in grains, metals, and oil, making a killing when inflation took hold. Goldman also jumped early on the dot-com bandwagon, taking scores of Internet companies public, awarding shares of hot offerings to corporate executives as a way of winning their business. And Goldman was an early adopter of so-called proprietary trading, a highly profitable but controversial strategy in which firms risk their own (or borrowed) money to buy and sell stocks, bonds, and commodities. Instead of making a commission, the firm’s profits or losses derive strictly from its own trading prowess. Thanks to proprietary trading, Goldman profited hugely from subprime mortgages, both as the housing bubble inflated and after it exploded.

How did it profit from the bubble?

Timing is everything. During the housing boom, Goldman snapped up billions of dollars in subprime mortgages, which it packaged into complex securities called collateralized debt obligations. It sold the CDOs, usually at a substantial markup, to pension funds, insurance companies, and hedge funds. But when Goldman’s contacts in the housing industry reported that subprimes were going sour at an alarming rate, Goldman reversed course, using its own money to bet that subprime CDOs would fall in value. In many cases, Goldman was betting against its own clients. In other words, says financial columnist Ben Stein, “Goldman was injecting dangerous financial products into the commercial world’s bloodstream for years,” then placed bets that showed it knew it was selling “a horrible product.”

Did it get away with that?

Yes, partly because of its friends in Washington. During the housing boom, Goldman borrowed billions to bet big on CDOs and other housing assets. It had previously faced a strict regulatory ceiling on that borrowing, but during the boom, Goldman’s lobbyists convinced regulators to waive the limits. Goldman proceeded to borrow as much as $28 for every $1 of its own capital, which gave it enormous profits when it bet right—but risked ruinous losses if it was wrong. And when housing went bust last year, setting off the financial crisis, Goldman quickly reorganized as a bank holding company, giving it access to $10 billion in federal bailout funds. Its application was fast-tracked by the Treasury Department, then headed by former Goldman CEO Henry Paulson, and the New York branch of the Federal Reserve, then headed by former Goldman chairman Stephen Friedman.

Will it pay any price for the meltdown?

It might. Goldman is under federal investigation for allegedly

stifling competition in the market for credit default swaps. It’s also getting scrutiny for the $10 billion in bonuses the company paid last year after receiving about the same amount in federal support. But even if Goldman is found at fault, the likely fines will amount to little more than a rounding error on its balance sheet. The fact is, Goldman is seen by Washington regulators as “systemically important”—that is, so big and intertwined with other financial firms that its failure would set off a worldwide financial tsunami. As a result, Goldman enjoys an implicit assurance that if its bets go wrong, the federal government will come to its rescue. If its bets go right—as they did in this year’s second quarter, when the firm earned a record profit of $3.44 billion—its employees will enjoy a big payday. The bonus pool for just the first six months of the year stands at $11.4 billion, or an average of $770,000 per employee.

‘Government Sachs’

The nation’s capital has been a second home for Goldman executives ever since the 1930s, when Goldman boss Sidney Weinberg advised President Franklin Roosevelt on reviving the business sector. Since then, a high post at Goldman has frequently led to powerful positions in Washington. The roster of Goldman alumni who have made the jump includes John Whitehead, Goldman’s co-chairman in the 1970s and ’80s, who served under Ronald Reagan; co-CEO Robert Rubin, who became Bill Clinton’s treasury secretary; and former CEO Henry Paulson, who served as treasury secretary under the second President Bush. All of them made decisions that, intentionally or not, wound up benefiting Goldman. Such connections lead Wall Street wags to call the firm “Government Sachs.” Wall Street executive Christopher Whalen uses harsher language. He calls the firm “a political organization masquerading as an investment bank.