Why Michael Lewis Is Wrong About Goldman Sachs

Apr.22.10 | About: Goldman Sachs (GS)

I have been a big fan of Michael Lewis ever since I listened to that Monday morning, firm-wide sales call in November of 1989, in which the senior management of Salomon Brothers did its very best to downplay the veracity of Michael Lewis’s depiction of the firm’s “big swinging dick” culture in his newly published book, Liar’s Poker. However, during Tuesday night’s Charlie Rose Show, I could not believe what I was hearing come out of Mr. Lewis’ mouth about Goldman Sachs & Co. (NYSE:GS). In effect, he likened Goldman’s current civil litigation with the SEC over the Abacus-2007-AC1 synthetic CDO to Salomon Brothers’ 1991 US Treasury bond auction scandal, which resulted in the ouster of top management, the payment of an enormous fine, the separation of its customer and proprietary businesses and an eventual sale to what later became Citigroup (NYSE:C).

Although Mr. Lewis has racked up an impressive array of prescient insights ranging from sports to the collapse of LTCM, he could not be more wrong about the current situation at Goldman. I would argue that the facts of the case are likely to show that Goldman was simply acting as an “honest broker” between a couple of its customers. To employ Mr. Lewis’ Liar’s Poker terminology, these two customers, ACA and Paulson & Co, basically had plans to “blow each other up”[1], as someone had to lose on the trade unless they were hedging their own exposure. As it turned out, Paulson & Co did some very savvy homework on the US mortgage market and got the better end of the trade. However, in another market environment, where the Abacus CDO maintained its coveted AAA credit ratings, Mr. Paulson would have likely lost $1 billion.

The current Goldman crisis revolves around representations made by a relatively junior salesperson, Fabrice Tourre, who seems none too dissimilar from the admittedly inexperienced Mr. Lewis in his own days as a junior bond salesman in Salomon’s London office. However, at the heart of the Salomon scandal was a very senior bond trader, Paul Mozer, who clearly broke securities law, and the complete failure of senior management to react to Mr. Mozer’s actions and ensuing lies. Hence, CEO John Gutfreund lost his job along with Tom Strauss and John Merriwether, Salomon paid a $290 million fine and Mozer spent four months in jail. Of course, many are now predicting that the SEC’s lawsuit against Goldman will result in the ouster of current CEO Lloyd Blankfein. I find these predictions to be extremely specious at best, as Mr. Blankfein has repeatedly demonstrated both adroit trading and management skills, which seemed to elude the Salomon Brothers of old.

As Mr. Lewis should also recall, in the aftermath of the Salomon Treasury bond auction scandal, my old Tokyo boss, Deryck Maughan was anointed by Warren Buffett to run the firm. One of Deryck’s early signature decisions was to separate the firm’s customer and proprietary businesses and provide detailed breakouts of the two units’ profitability in quarterly earning reports, in order to make the firm appear “more transparent”. This decision eventually became the death knell for Salomon, as the move soon revealed that the firm’s proprietary activities were extremely volatile. Hence, investors eschewed the stock and its share price languished, making it a ripe target for the acquisitive Sandy Weill’s Travellers Group in the fall of 1997. Tuesday night, Mr. Lewis was arguing for an end to the “opacity” with the US financial system. Well, in the case of Salomon Brothers, “opacity” was about the only thing that kept the firm going.

Thus, Mr. Lewis’ suggestion that Goldman be broken up into a public, customer-driven entity and into a private, proprietary trading partnership makes no sense whatsoever, as it will simply result in the death of a highly talented and storied financial firm which weathered the worst financial crisis since the Great Depression with only one quarterly loss compared to Salomon successor Citigroup’s nine consecutive quarterly losses. Although I understand the current populist need, driven in large part by the Obama Administration, to find at least one culprit for the US mortgage crisis other than Rep. Barney Frank himself, Goldman is hardly the appropriate target.

So, Mr. Lewis, in spite of my great respect for your deep and often hilarious insights over the years, I fully expect that your latest catch phrase of “breaking up Goldman” will suffer the same fate as those who ended up doing “equities in Dallas” [2] , while at Salomon Brothers.

[1] Blowing up a customer — Successfully convincing a customer to purchase an investment product which ends up declining rapidly in value, forcing the client to withdraw from the market. en.wikipedia.org/wiki/Liar's_Poker

[2] Equities in Dallas — A particularly undesirable job within a finance firm ("He belonged to the dreaded equity department, the sleepy backwater in which lurked such career stoppers as Equities in Dallas." p.49). en.wikipedia.org/wiki/Liar's_Poker

Disclosure: No positions