The changing phase (face) of IB

Why I Am Leaving Goldman Sachs

TODAY is my last day at Goldman Sachs. After almost 12 years at the firm - first as a summer intern while at Stanford, then in New York for 10 years, and now in London - I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world's largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.

It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs's success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients' trust for 143 years. It wasn't just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

But this was not always the case. For more than a decade I recruited and mentored candidates through our grueling interview process. I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video, which is played on every college campus we visit around the world. In 2006 I managed the summer intern program in sales and trading in New York for the 80 college students who made the cut, out of the thousands who applied.

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm's culture on their watch. I truly believe that this decline in the firm's moral fiber represents the single most serious threat to its long-run survival.

Over the course of my career I have had the privilege of advising two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia. My clients have a total asset base of more than a trillion dollars. I have always taken a lot of pride in advising my clients to do what I believe is right for them, even if it means less money for the firm. This view is becoming increasingly unpopular at Goldman Sachs. Another sign that it was time to leave.

How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.

What are three quick ways to become a leader? a) Execute on the firm's "axes," which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) "Hunt Elephants." In English: get your clients - some of whom are sophisticated, and some of whom aren't - to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don't like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It's purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client's success or progress was not part of the thought process at all.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as "muppets," sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God's work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don't know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client's goals? Absolutely. Every day, in fact.

It astounds me how little senior management gets a basic truth: If clients don't trust you they will eventually stop doing business with you. It doesn't matter how smart you are.

These days, the most common question I get from junior analysts about derivatives is, "How much money did we make off the client?" It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave. Now project 10 years into the future: You don't have to be a rocket scientist to figure out that the junior analyst sitting quietly in the corner of the room hearing about "muppets," "ripping eyeballs out" and "getting paid" doesn't exactly turn into a model citizen.

When I was a first-year analyst I didn't know where the bathroom was, or how to tie my shoelaces. I was taught to be concerned with learning the ropes, finding out what a derivative was, understanding finance, getting to know our clients and what motivated them, learning how they defined success and what we could do to help them get there.

My proudest moments in life - getting a full scholarship to go from South Africa to Stanford University, being selected as a Rhodes Scholar national finalist, winning a bronze medal for table tennis at the Maccabiah Games in Israel, known as the Jewish Olympics - have all come through hard work, with no shortcuts. Goldman Sachs today has become too much about shortcuts and not enough about achievement. It just doesn't feel right to me anymore.

I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without 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. People who care only about making money will not sustain this firm - or the trust of its clients - for very much longer.

Greg Smith (the writer )is resigning today as a Goldman Sachs executive director and head of the firm's United States equity derivatives business in Europe, the Middle East and Africa.

Source: NY Times

The global credit crisis

I stumbled upon this primer on the credit crisis. I love the way the animated file explains the concept in a very lucid way.

Must see for beginners!

Insightful readings on the US downgrade

Here are some links to good readings on the recent downgrade of US Sovereign rating by Standard & Poor's.

Happy Reading!

The Basics

US Treasury's response to the downgrade

A good presentation on the situation

The big ERROR!

20 years of Economic Liberalization

All through my learning days, I have kept hearing and taking about the economic liberalization measures taken in 1991 by the then Finance Minister Dr. Manmohan Singh. I came across this piece, written by C Rangarajan (who was the Deputy Governor of RBI during 1991) that was published in The Financial Express in 2001, to mark the 10 years anniversary of "opening up" the economy. It is a fascinating article! Happy Reading.

As an aside, came across this paragraph from the budget speech of 1991 read out by Manmohan Singh:
Ever since my appointment as Finance Minister, I have had to spend long hours in office. This has quite naturally made my wife very unhappy. The House will agree that it is not good for the health of our economy if the Finance Minister of the country has strained relations with his own finance minister at home. I propose that the total exemption from payment of excise duty currently available to utensils made of aluminium, copper and stainless steel be extended to certain other household items particularly tiffin boxes.

The Indian version of yield-curve conundrum

Alan Greenspan coined a term called ‘yield curve conundrum’ to describe what he thought was an anomaly in the US treasury market then. As the Federal Reserve with Greenspan at the helm of affairs kept raising the Fed rate, long term rates ironically kept low resulting in a flat to inverted yield curve. The impending slowdown in US was one key fundamental reason for the long term rates to remain relatively low. Yet, the generic long term demand for US treasuries by global central banks and long term liability managers kept the long term rates subdued despite the increasing inflationary pressures in the economy. For a period too long, the long term rates seemed to react to anything but events and policies mushrooming in US.

A similar conundrum, albeit differently, is what we are experiencing in the Indian bond market for some time now. Reacting to a domestic slowdown resulting in contraction of output and falling prices, the Reserve Bank of India has rightly been easing its monetary clutches in the economy by cutting all rates it could – CRR, Repo, Reverse Repo and SLR. Though the central bank embarked on the easing during mid-2008, it intensified the rate cuts towards the end of CY2008. After an initial logical fall in the long term yields, we have experienced a reversal in the trend during the last few weeks starting mid-January 2009. The key reason for this conundrum is the supply of long term bonds to fund the accumulating fiscal deficit. An already fragile bond market has depicted its non-willingness to keep absorbing higher supply without paying lesser price for them. Yield, henceforth, have been moving northwards. With the supply calendar looking to increase with coming months, where are we headed in terms of interest rates in the system?

For one, RBI will continue to ease benchmark policy rates against a very comfortable backdrop of near-zero WPI based inflation and contracting industrial output. Considering the most likely scenario of WPI inflation remaining at an average of -1% from now to the end of FY2010 (conservative estimate), and a real interest rate of not more than 2%-3% to tackle an extremely subdued growth outlook, the nominal benchmark rates will have to be cut to levels of 2% or less quite soon. With liquidity conditions expected to keep positive on a consistent basis through CRR cuts/OMO by RBI, the effective benchmark policy rate would continue to be the Reverse Repo rate. Thus one could expect at least 150bps of easing over the next few months.

Secondly, yields would be supported by comfortable liquidity in the money market. Fiscal spending, OMO and possible cuts in CRR will help the liquidity remain the positive regime over the next many months. It seems very unlikely that bonds would be sold to create liquidity for meeting credit demands in the economy.

Thirdly, generic demand from insurance companies, banks, mutual funds, and importantly FIIs will help absorb the incremental demand in FY2010. With rupee trading at 50-plus levels against US Dollar in the exchange market, a comfortable stance by the RBI to help currency appreciation will favour the foreign investors chasing risk free yields in the uncertain global investment regime. It seems highly likely that RBI will intervene more aggressively starting April to push USD/INR rates lower after FII buying into bonds. Weakening USD globally (backed by huge monetization of deficit by US government) and revival in investment flows will help the rupee appreciation cause too in favour of investing FIIs.

Fourthly, RBI’s holdings in outstanding government bonds have been steadily rising over the last 12 months. This trend will most likely continue and rather intensify as we move ahead. RBI’s holdings as a percentage of total outstanding has steadily increased from 4.3% as at December 2007 to 5.8% as at the end of September 2008.

Despite a heave supply side pressure on yields, it still looks likely that the long term yields would ease in the coming months responding to a temporary statistics-induced deflation and easing benchmark rates.

As a probable move in the near term, RBI could consider introducing a ceiling on the Reverse Repo absorptions under LAF to effectively bring in a zero interest rate policy without officially cutting interest rates. Subdued money market rates will help the yields ease helping the cause of broader interest rate regime in the economy.

We will have to wait for the April policy to see if RBI might want to embark on a dynamic path like this to manage the monetary objectives.

Can we read something here?

An interesting chart that I happened to stumble upon. Just as a background, equity market price corrections (reversal from a bull phase to a bear phase) must technically clear two parameters - the test of time and the test of price erosion. Now look at the chart below (for larger size, click on the image):


We seem to have fulfilled at least the price correction parameter. And time corrections could be evaded by incremental positive events and data flows. Looking at the latest set of data in US (I will elaborate on this part separately in a post later), we might well have seen the worst in US.

Ofcourse the chart reflects Dow. But then, hasn't the recent crash educated us already that India and US never de-coupled in a strict sense?

More bond supply to chew

Governments all across the world, including US and India, are all out to do everything they can (and more) to save growth. Between US and India, the difference just being that the US Fed Reserve Chairman and their Finance Secretary has to officially justify and testify what they are upto. Back home in India, we get to know about what has already been done. No questions asked. More like, no one to ask.

If we are unhappy about what is being done, we sell stocks and bonds. Quite simple. And so bonds have been bearing the brunt of these growth-saving-efforts. Government wants market to fund it another Rs.46,000crores over the next 6-8 weeks. Phew.. So much to absorb, literally. With this, the total amount of auctions has reached Rs.231,000crs (gross) for the current fiscal. Out of these, banks alone have bought Rs.164,000crs. Add the demand from insurance companies, primary dealers and mutual funds, fact is the supply might be short of the requirement!

Last few weeks, the yields have been surging, prices dropping. Does it hit my stop-loss as a bond buyer? Not really. I would look to add more. Underlying bullish trend still remains firm, the rally just being postponed for the time being.

Let's see why. Excessive supply of bonds is negative for the market in two ways. Firstly, the liquidity angle. Supply of bonds equals absorption of system liquidity. But only temporarily. Government is borrowing BECAUSE it wants to spend. So money has to flow back sooner rather than later. Also, if there is even a short term liquidity mismatch, RBI will step in swiftly to infuse money by buying more MSS bonds or cutting CRR or if need be, both.

Coming to the second impact, that of higher supply of bonds due to auctions. That is, demand being equal higher supply can be absorbed only by reducing prices. If you look beyond the obvious, the long and short of it is that MSS bonds are being replaced by Non-MSS bonds in the investors' portfolio. There is no NET increase in the stock of bonds available really. That is why buyers won't really feel the weight of auctions in these times.

To put numbers into this statement, the total amount of MSS bonds bought back during Oct. 2008 till date is Rs.65,040 crs. Total auctions during the same period was Rs.86,230 crores. Redemptions during the period was Rs.11,450crs. The net increase in outstanding bonds in the market, hence, is only Rs.9,740crs. During the same period, the net accretion to banking system's deposits was Rs.187,940crs. Incremental SLR demand on this comes to Rs.45,105crs. Now, compare 45,105 with 9,740 and you will know why the yields are so lower than what they were in October 2008. The demand side from other generic buyers apart from banks have not been considered in my calculations. (For basic readers of this blog, hope the math is not very confusing)

Point is, me thinks this situation will continue. Meaning, the pain of incremental supply is not really a lot. Look at the armory with the RBI. CRR is at 5%, can be cut to 3% without any hitch. That's about Rs.72,000crs of liquidity. Outstanding MSS is Rs.108,764crs. Add both, and there's a lot of money to be released if need be. Don't forget, we are already sitting on a surplus liquidity of Rs.43,000crs approx.

Now, if interest rates still have to come down by 150-200bps over the next few months (my views expressed in earlier posts still hold good), yields can only go one way - DOWN. And so, I'll look to buy more gilts through my favorite ICICI Pru Gilt Fund.