Goldman [Sachs] and the Winner Take All Society

 Editor's Note:  This is a reprint of a post from "Prophet Without Profit" submitted to GS666 by the publisher with permission to reprint. Our thanks as always for this contribution.

About the Author:  For more than 30 years, I worked as an attorney. In addition to a clerkship and law firm experience, I worked for some of America’s biggest corporations. I have a background in both law and economics. Unfortunately, when one works for a big corporation, one often has to self-censor some of one’s more provocative thoughts.  But…it’s a living.

Despite all the management books postulating the opposite, corporations actually prefer employees who think in a linear way.  Employers are actually afraid of “outside the box”, unconventional ideas.  But if anything, the current financial crisis suggests we live in a non-linear world which requires more, not less, questioning of conventional ideas.

Goldman and the Winner Take All Society

Finally, Goldman Sachs has gone too far. In A Reputation as Good as Goldman? Part I, we discussed Goldman’s selling of mortgage backed securities, and its role in the current Greek budget crisis. These activities clearly contributed to its self-inflicted reputational damage.

Perhaps the hubris went further. Does Goldman believe that its status as a favored Federal Reserve “too big to fail” firm will insulate it from government investigation? Last week Ben Bernanke put a dent in Goldman’s Teflon shield:

Ben S. Bernanke, the Federal Reserve chairman, told Congress Thursday that the Fed was ‘looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece.’

Mr. Bernanke said the Securities and Exchange Commission was also concerned about how derivatives — financial instruments that are largely unregulated and do not trade on public exchanges — have contributed to Greece’s problems. ‘Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive,’ he said. See In Greece’s Crisis, Fed Studies Wall St.’s Activities.

In Is Goldman Finally About to Be Leashed and Collared? Yves Smith observes and analyzes Goldman’s corporate culture. As a former employee, she reports on colleagues’ piggish and overly aggressive behavior. But in an otherwise excellent post, I believe she overlooks the role of current compensation systems.

Pay Practices and Reputation

In previously discussing the banking crisis, we pointed out a fundamental principal: you get what you incent.

Banks were interested in generating upfront fees. Incentives were predicated on “making the deal.” The best way to make a deal was to ignore the creditworthiness of the borrower. The banker who made the bad loan suffered no personal financial penalty. There was no “skin in the game.” Why not write as many loans to poor credits as possible? See Hard Truths from the Banking Crisis.

The Goldman culture incents a “winner take all” mentality. Since it is a public corporation rather than a partnership everyone is an employee. A highly mobile employee rather than an owner is far less concerned about the firm’s long term reputation. That employee wants to maximize current compensation; worrying about future consequences is for suckers. Drawing on this paradigm, we are not shocked by headlines excoriating the firm for trading against its clients’ interests, shorting the municipal bonds it helped underwrite, skirting EU rules, or tanking the housing market.

Goldman operates in a larger Wall Street and indeed general culture that encourages greed at the expense of overall civic good: (emphasis added by GS666)

* Successful hedge funds report individual earnings in the hundreds of million dollars per employee.
* Loyalty is dead. Employees change firms. Highly paid athletes change teams without a second thought.
* The media treats great wealth as reason for great celebrity.
* Compensation validates individual worth.
* Government backstops losses and allows gains to remain private.
* The zeitgeist promotes: “I better grab as much as I can now before the economy implodes.”

Does It Have To Be This Way?

Any alert Board of Directors should be asking some difficult questions. Why aren’t we concerned about the long-term firm reputation? What do we want the corporate culture to be? Just because we can legally do a transaction should we be doing it? How do we blend partnership-based personal accountability with a public corporation structure? How do we get employees to care about the long-term view? How do we meet the competitive threat of hedge funds and private equity without damaging corporate reputation? How does our compensation system comport with these concerns?

Yves Smith noted that it was as dangerous for anyone to get in the way of a Goldman employee and a profit making opportunity as it was to get between a predatory animal and its kill. Goldman has managed to get itself between a very worried Obama Administration and a very angry public. How ironic if the Goldman predatory lion becomes the Administration sacrificial lamb.
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