By Wallace C. Turbeville, the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co. who writes at New Deal 2.0
William D. Cohan’s op-ed piece in the July 7th New York Times had the same title as this article, but for the word “Don’t.”
At first glance, I thought the Times piece might be a report on New Age self actualization for investment banks. But the title suggests something more troubling. The whole point of financial reform is that Goldman (and the others) should no longer be permitted to be Goldman. A return to business as usual is the last thing we need.
Mr. Cohan is a student of Goldman, but he profoundly misreads the firm’s role in the Wagnerian drama we know as “The Great Recession.” He begins by imploring us all to “fess up” to the fact that financial reform would have been impossible had the Administration and Congress not “demonized” Goldman.
“Demonization” is a popular word in today’s political discourse. It suggests unfairness. Mr. Cohan does not dispute the facts asserted by the Administration and Congress. Instead, he points out that underlying ethical flaws were shared throughout Wall Street. They arose from the shift toward a business model that rewards taking imprudent risks with other people’s money. Mr. Cohan says that “Goldman Sachs did nothing differently in the years leading up to the crisis than did other firms of its stature.”
Anyone who has raised a child is familiar with a common excuse for bad behavior. The proper response to “Everyone else is doing it” is a stern demeanor and the answer: “Maybe, but so what?”
But let’s give the article a generous interpretation. While the casual reader might interpret the shared lapse in ethics as an excuse, perhaps it is not intended to be read this way. We will assume that Mr. Cohan intended not to excuse Goldman but to find fault with political leaders who unfairly singled out the firm.
It seems obvious that the example of a single firm is a more effective rhetorical device than calling out generalized bad behavior. Politicians used this device and public opinion was successfully mobilized. The job got done. I believe that the public understood that the bad behavior was widespread, and that Goldman was merely one example.
Was it unfair to make Goldman the example? The article argues that Goldman was just like all the other firms. It was not.
Goldman was actually better at executing a certain investment banking business model than anyone else. It became a leader in the industry, admired by competitors, the media and politicians. The problem was that the business model, so effectively executed by Goldman, turned out to be bad for America. The model inherently risks the survival of critically important institutions. It is also nearly impossible to use the model and, at the same time, maintain business ethics conforming to the shared values of the society.
Goldman historically promoted its commitment to ethics when soliciting clients. I am convinced that Goldman people genuinely believed this commitment to be true. It may even be the case that ethics were taken more seriously at Goldman than at its competitors. But seeking business based on ethics carries with it a responsibility. Pursuit of a business model with inherent ethical challenges has consequences that are unavoidable, especially to a firm which has held itself out to clients as particularly ethical.
Goldman’s success was envied up and down Wall Street. The pressure to keep pace with Goldman’s earnings drove other firms to emulate its model. At a minimum, managers at other banks were driven to take greater risks hoping for greater rewards as proof to shareholders that they measured up to the Goldman team.
It is ironic that Goldman was first to foresee risks of a deteriorating market and acted to defend itself. Goldman’s aggressive preparations, including the extraordinary demands to AIG for collateral, may have actually contributed to the intensity of the panic. Goldman was so prepared that, when the tsunami finally hit, the only real threat to it was a total systemic collapse. Congress and the Fed stepped in with cash to avoid catastrophe and Goldman, now even more powerful compared with competitors, immediately prospered. The real irony is that Goldman was greatly responsible for the problematic business model; yet, because management pulled the plug so effectively, the value of the bailout to Goldman shareholders was disproportionately large.
Mr. Cohan suggests that it was unfair to use Goldman as an example because of its relative ethics and its effective response to the danger. Those points may be relevant if the real issues were incompetence and larcenous intent. Instead, the core concern was and is the dysfunctional business model that generated massive profits for the firms but devastated the society.
Goldman was not just like all of the others. It was the leader. Becoming the leader involves a trade that should be well understood at the highest levels of Wall Street. Investment bankers often engage in businesses with underdeveloped rules of conduct. Pushing the envelope may be risky, but the rewards are more than worth it. If a firm is a leader, its profits and the wealth and power of its managers are virtually limitless. If it turns out that the business has consequences to society that are intolerable, even if the consequences were unforeseen, the leader will be the example held out to the public. Management is held to a high standard, but the pay scale more than reflects the level of difficulty.
Is this an unfair trade? I don’t think so.
Finally, Mr. Cohan concludes that we should “lay off the firm and allow Goldman and the rest of Wall Street to return to some semblance of normalcy.” Besides unfairly demeaning the entire financial reform effort, this statement suggests that our problems have been solved.
In fact, it would be a monumental error if financial reform ends with the passage of the legislation this month. James K. Galbraith points out in testimony to the Commission on Deficit Reduction that focusing on Medicare and Social Security as a means to reducing deficits is misguided. Economic growth is the only sensible solution. He cites the need to restore the financial sector’s role of capital formation for productive purposes, i.e., commercial lending and equity investment. The current legislation focuses on curbing dangerous behaviors and on procedures to deal with financial panics. It does not reconnect Wall Street capital to the engine of economic growth: productive and innovative businesses which employ American workers.
No one wants to drive Wall Street out of business, certainly not politicians whose campaigns rely on it as a source of funds. But the economy will not prosper unless Wall Street reengages with the broader economy. Current bankers will keep their Hamptons estates under the new regulations. But their successors may not be able to afford mansions if 10-20% unemployment is the new American reality. Wall Street’s attention must turn away from churning derivatives on existing products and instruments and toward growth of the economy and jobs. If more government intervention is needed to force this turn, so be it. Neither the public nor its political representatives should feel regret if this means Goldman and the other banks must fundamentally change.