Chasing Goldman Sachs

Title: Chasing Goldman Sachs – How the Masters of the Universe Melted Wall Street Down and Why They’ll Take Us to the Brink Again

Author: Suzanne McGee

Publisher: Crown Business 2010 (First)

ISBN: 9780307888310

Pages: 421

A great book on the American economy that does not economize on words!

Wall Street is the synonym of America’s financial muscle, where the most lavishly paid bankers and traders in the world decide the direction in which corporate enterprise moves. Occasionally, hiccups arise in the banking community which soon acquire dimensions that the government is forced to intervene in the market to set things right. Such a thing happened in 1929, which led to the Great Depression that had lasting influence on the further course of world history. Minor crashes and failures occur often, but an event that nearly matched the cataclysm of 1929 happened in 2008 when all on a sudden, major investment banks collapsed losing their own and public money. Nobody could see it coming and Wall Streeters found themselves stranded in a situation where liquidity was drained off the market, and calls for repayment of clients’ money were repeatedly made. Lehman Brothers collapsed, while Merril Lynch and Bear Stearns were merged with their competitors who were themselves propped up with federal funds. At no time in history was the free market enterprise of America had to swallow the bitter pill of the government owning major stakes in almost all of the behemoths that ruled over Wall Street till just a few weeks ago. Goldman Sachs, which was the largest corporation, didn’t fail, but was badly wounded in the bloodbath. Suzanne McGee examines the events that led to this sorry state of affairs. It narrates in shocking detail how the companies blindly emulated Goldman Sachs to beat them in their own game of making larger profits and offering greater returns on equity. Wall Street’s basic function was to provide capital for business and to handle mergers and acquisitions. This fundamental objective was ignored by bankers who wanted to make great profit from every transaction and to obtain astronomically high bonuses. This mad chase after Goldman Sachs finally stumbled on the sub-prime mortgage crisis, pulling the national economy itself to the brink of disaster. Being a financial journalist and having written for many Wall Street journals, McGee does a fine job of finding out what went wrong.

A valuable contribution of the book is its neat description of the changes that took place in the U.S. money markets over the decades that finally resulted in the 2008 crash. Even though the story is told backwards, the presentation is appealing and concise. Readers would’ve preferred the normal chronology, but a book on Finance is ought to retain some of the complexity and confusion of the parent field which it tries to open up. Most of the investment banks were operating on partnership basis in the 1950s and 60s. This had its advantages. Managers were very careful before taking big investment decisions, as they were playing with their own money. Such shrewdness was complemented by good work ethics and a cordial customer relationship. But the system put brakes on innovation. Cash was not easy to come by, for quickly finalizing deals and reaping large profits. The commission on trade was fixed across all firms and the companies need only to ensure the volume of trade for assured profit margins. In the 1970s, the stocks crashed and volumes dwindled. Government intervened and the commission on trades was made flexible. The customer was permitted to negotiate with the firms for a deal. This slashed the margins of the investment banks and resulted in cut-throat competition to gain and to retain customers. At this point, they transformed into equity-based companies and shedded their partnership vesture. Their stocks were also traded in the stock exchanges just like their clients’ did.

Becoming a limited liability company was a watershed moment in their history. Infusion of cash, particularly of the investing firms and public, threw away the lid on risk appetite. Managers could take riskier decisions which they were reluctant to pursue when their own money was at stake. At the same time, profitability turned out to be the prime concern. If a firm is unable to pay its stockholders a decent return on equity, its image was tarnished and people moved their investment elsewhere. The age old tools of trade like exchange of shares, leveraging and underwriting fledgling companies were not money-spinning opportunities. It was around the 1990s that first witnessed the emergence of high risk, high yield products such as junk bonds and collateralized debt obligations (CDO) that became popular among banks. All of them wanted to make money quickly. Investors were often kept in the dark about the exposure they were about to make in a high risk investment. In order to tide over the minor correction in the markets at the turn of the millennium, government infused greater liquidity in the market by reducing interest rates. More mortgages and home loans were disbursed, which gave rise to a market in derivatives of the loans such as CDO. More banks followed the leaders in picking up portions of this pie and the American economic system neared the edge of the precipice.

A detailed analysis of what went wrong is followed which rather looks like a post mortem examination. Greed, recklessness and negligence are attributed to be the root causes which acted on unlimited capital, limited liability and incentive compensation. If a surgeon had indulged in as much risk, he would sooner be denied his license and possibly would have had to face criminal charges of negligence. Unlimited funds were allotted for the bankers to sell mortgage backed securities that earned huge profits, but whose quality was very low. Being a public listed company, the liability was limited in case of a flop, but the financial incentives for the individuals and the company in the case of a flip was astronomical. We get to know about bankers who drew incentives which were more than 100 times their annual salary. The regulators were also at fault, as they couldn’t fathom what was going on down under and continued to enjoy the music while it lasted. In a setup like America where the budget of the regulators are sourced from the contributions of the companies they oversee, it is no wonder that the regulators as mute spectators while deals with ever greater profits to the originators made Wall Street a gold mine for the lucky few. There was a strong lobby that called for less regulation and more free trade, who counted on the creativity and innovation of the bankers to set the rules of the game. If the regulating bureaucrat was smart enough to understand the flow of business, he would have quit the government offering a measly pay packet and himself would have joined leading Wall Street firms, they argued logically. But the explanation of the meltdown raises other disturbing questions. If the reason for the catastrophe is the fear of getting behind the competitors and the greed for pecuniary benefits, these are the fundamental instincts of any human being, and how can we rule out the possibility of such a scenario occurring again in the future?

Readers feel that the author could have cut the number of pages by at least a quarter, without losing the force and flow of the argument. This book about economy does not in any way practice economy of words. But the diction is simple yet elegant, though interspersed with American slang. A decent glossary is given, but which is not readily accessible. Attached at the end of the main text, many readers get to know about the presence of glossary only after reading the text in full! It would have been better if it could be incorporated in the beginning of the book. A good index is a must for books of this kind and that which is provided amply serves its purpose.

The book is recommended for followers of the business columns and to laymen who plan to make some money out of the bourses.

Rating: 2 Star