Investment bankers become venal pricks when they hang around traders

The revelations in the “resignation-by-op-ed” by a Goldman Sachs VP named Greg Smith are of the dog-bites-man variety.  Although Smith’s missive may very well damage the firm, I’m skeptical.

Here’s an excerpt of the letter by Goldman VP Greg Smith:

“Make the client the focal point of your business again ….. [w]ithout clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons.”

According to Smith, what Goldman is doing is both morally wrong and short sighted, although the short sighted part is only an issue for those who stand to lose if the long term viability of the firm is compromised by its present actions.

The culture among traders of client manipulation that, according to Smith, has recently come to dominate Goldman, was memorably described by Michael Lewis in his first book Liars Poker, about his experience at Salomon Brothers in the early 1980s. (From that book: After Lewis managed to successfully unload some troublesome assets onto a unsuspecting client, he received a phone call from a higher up awarding him the coveted title of “big swinging dick.” It brought tears to his eyes.)

Salomon eventually blew up but not because clients pulled their funds after realizing it wasn’t acting in their interests, but instead because they apparently mishandled the junk bond business. Which brings me to a more general point:

The predatory culture of trading firms going back to Salomon is well known, and these firms don’t seem to live or die in accordance with whether they live up or down to this reputation.

However much this bad publicity will cost Goldman, I doubt many of those costs will result from clients suddenly realizing that Goldman is screwing them over. My understanding is that many of Goldman clients are institutional investors (pension funds, who arent likely to be completely naive. I doubt that sophisticated institutional investors are ignorant of the fact that Goldman’s interests are not entirely aligned with their own. The key phrase is “not entirely aligned”. Client-server relationships entered into in a voluntary way by knowing participants will typically involve some overlap of interests. If interests did not align at all, it is unlikely the relationship would have formed in the first place. In areas where interests are not aligned, the client would have to assume from the beginning that Goldman or any other firm would act in its interests and not the client’s. At the very least, investor clients would take adv ice of any firm with a grain of salt.

Since I’m on the market to buy a house, I think of an analogous situation as a realtor and his / her client. Obviously my realtor’s interests are not entirely aligned with my own. I would be a fool to think or act like they were. Its in a realtor’s interest to get deals done because that’s the only time she gets paid. So a buy side realtor will naturally be less concerned with getting the lowest possible price for her client. And a sell side realtor will naturally be less concerned with getting the highest possible price for her client. (Levitt did a study in which he found thqt realtors wait a bit longer and get more money when they are selling their own houses han when they are selling a client’s house.) If a realtor tells me “you’re unlikely to find a home like this for x price in x neighborhood,” I’m going to consider it in light of the conflict of interest that exists.  I know that my realtor will naturally tend to be more eager to close a deal than to get the lowest possible price.

Yet I retain my realtor because I believe her services are valuable to me.  Simply because she doesn’t fight for the cheapest price possible doesn’t mean that I would be better off without her services.  Our interests are in fact in substantial alignment.   My realtor is (presumably) highly motivated to find me the kind of house that I want for a price I can afford because that is the surest way for her to consummate the deal and get paid.

I imagine that Goldman’s clients would be in a somewhat analogous position with respect to the storied investment bank.  If Goldman provides a service that they cannot get elsewhere, then it is worth it to them to retain Goldman.  I don’t know much about the financial industry, but I imagine there is considerable overlap in interests between client and server, as with realtor and her customer.


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