Too Much Profit at Goldman and Morgan?

By Justin Fox Monday, Jul. 27, 2009

During three decades as the head of financial-services consulting firm Greenwich Associates, Charley Ellis had a front-row view of Goldman Sachs' rise from also-ran to king of Wall Street. He then spent a decade working on a history of the firm, published last year as The Partnership: The Making of Goldman Sachs. So what is Ellis' explanation for Goldman's spectacular rebound — it turned a $5.2 billion profit in the first half of the year — from the financial crisis?

"The most obvious is people," he says. "They recruit the most extraordinarily talented people, the most gifted in leadership." Then, he continues, Goldman brings these talented leaders together in by far the most team-oriented environment on the Street. (See 25 people to blame for the financial crisis.)

This explanation for Goldman's success hasn't been getting a lot of media play lately. Fox News talker Bill O'Reilly instead refers to the firm as an assemblage of "swine." Rolling Stone writer Matt Taibbi, showing more creativity if not sympathy, calls the firm a "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

The name-calling is fun — and, to some extent, merited. But Goldman's place at the top of the Wall Street heap can easily be explained. Same goes for JPMorgan Chase, Goldman's somewhat less controversial partner in profit. The No. 1 reason these two banks are doing so much better than their rivals is that they're better at what they do than their rivals are.

In his book, Ellis traces Goldman's successful management approach to the firm's slow recovery from near failure and mortal embarrassment after the 1929 stock-market crash. (An investment fund it launched was one of the era's biggest disasters.) Goldmanites had no choice but to stick together and look to the long run. The firm's now pilloried entwinement with Washington (some call it Government Sachs) began in those days too, after managing partner Sidney Weinberg made the rare-for-Wall Street move of backing Franklin Roosevelt in 1932. That led to a key role for Weinberg in the World War II industrial-mobilization effort, where he got to know top executives at every major manufacturing firm in the land. After the war, these executives began to reward puny Goldman with business, most notably the giant 1956 initial public offering of Ford Motor. (Watch an interview with Ford CEO Alan Mulally.)

JPMorgan Chase has an even longer and more storied history. It's a direct descendant of the House of Morgan that dominated Wall Street a century ago. But it's also an agglomeration of Chase Manhattan, Chemical Bank, Manufacturers Hanover, First Chicago, National Bank of Detroit, Bank One, Bear Stearns and Washington Mutual, among others, and this mishmash has only come together as a coherent whole since renowned details guy Jamie Dimon took over as CEO in 2005. "The teamwork culture at JPMorgan Chase is really Jamie Dimon," Ellis says.

The teams at Goldman Sachs and JPMorgan Chase avoided giant missteps in the lead-up to last fall's panic and are now wresting market share from wounded competitors and raking in billions. They've already paid back the bailout funds they got in October, which means they're exempt from compensation limits and can disburse their gains to employees in the form of titanic end-of-year bonuses. That's how capitalism is supposed to work, right? (Read "Hooray for Boring Banks.")

Well, yeah, except that Goldman and JPMorgan played right along with many of the Wall Street practices that led to the crisis. They fought regulation — of derivatives, for instance — that might have prevented it. And their big profits can be traced not only to skill but also to the government's decision last fall to bail out the financial sector just as the troubles that toppled Lehman Brothers and WaMu and forced Bear Stearns, Merrill Lynch and Wachovia into shotgun marriages began to endanger Goldman and (to a lesser extent) JPMorgan. "No one should be confused about the extent to which the public sector has provided a foundation for financial recovery," White House economic czar Larry Summers said after Goldman and JPMorgan reported their stellar second-quarter earnings.

The lesson Summers draws from this is that Washington must "insist that reforms be put in place so that the mistakes of the past are not repeated." That makes more sense than singling out Goldman and JPMorgan for being too good at what they do. The question, though, is whether such reforms can actually be enacted. In the past, Goldman and JPMorgan — and the rest of the financial industry — put their highly talented employees to work dismantling any regulation that might get in the way of higher profits. If they try that again, maybe "swine" and "vampire squid" will prove too kind.

Source