Hello and welcome back to Dry Powder. 

Thanks for being a part of Puck, our new media company covering the nexus of Wall Street, Washington, Silicon Valley, and Hollywood. And thanks for reading Dry Powder. If you're enjoying these private emails, consider sharing the subscription link with a friend.

In today's column: Lloyd Blankfein, David Solomon, Sandy Warner, Hank Paulson, and the behind-the-scenes story of how Goldman Sachs, the most prestigious bank on Wall Street, became smaller than its peers—and what it can do to regain its throne.

Enjoy,

Bill

Of Mice and Goldman

How the most prestigious bank on Wall Street became smaller than JPMorgan Chase, Morgan Stanley, and Citi. And the M&A deals that could put it back on top.

Back in May 1999, Goldman Sachs went public to great fanfare after years of internal debate among its partners about the wisdom of such a step. The top brass had been utterly devoted to the idea of remaining a private partnership, but they quickly got with the program, especially after the top top partners figured they were suddenly going to be worth hundreds of millions of dollars each after the I.P.O. That point was further driven home after the first day of trading, when the Goldman stock increased by some 30 percent. 

Abracadabra, Goldman Sachs was worth more than $30 billion, and was trading at nearly five times its book value. It was the most feared and revered investment bank in the world and its high multiple of book value reflected the esteem in which investors held the firm and its ability to make money hand over fist, regardless of market conditions.

Nearly 23 years later, however, Goldman trades for around 1.1x its book value, below that of its two principal competitors: JPMorgan Chase, which trades at 1.7x its book value, and Morgan Stanley, which trades at nearly 1.9x its book value. At around $120 billion, Goldman’s market value is also significantly below its big competitors. JPMorgan Chase is valued around $440 billion; Morgan Stanley is valued at $185 billion, some 53 percent more than Goldman. Bank of America, which bought Merrill Lynch during the 2008 financial criss, has a market value of $380 billion. Even the much diminished Citigroup has a market value of $130 billion, some $10 billion more than Goldman’s.

Goldman still oozes prestige on Wall Street. Year after year, it retains its crown as the go-to M&A adviser—a considerable achievement—and it is always a leading underwriter of debt and equity securities. It is still harder to get a job at Goldman Sachs than it is to get into Harvard. Becoming a partner at Goldman Sachs remains the brassiest of brass rings on Wall Street, as long as you don’t include the opportunities that exist for the best and the brightest at hedge funds or private-equity firms. This is partly why I titled my 2011 book about the firm, Money & Power: How Goldman Sachs Came to Rule the World.

The realignment in market cap doesn’t quite square with Goldman’s reputational glow. But it does reflect the fact that Goldman’s competitors made aggressive strategic moves during and after the financial crisis while Goldman stuck to its knitting, as people like to say on Wall Street. JPMorgan Chase, of course, is a Franken-firm, a combination of many firms over many years, most notably of JPMorgan and Chase, in January 2001, and then of both Bear Stearns and Washington Mutual in 2008. Bank of America is also a conglomerate–the product of one bank merger after another over the decades, capped off by its 2008 acquisition of Merrill Lynch. Morgan Stanley, despite having the aura of a purebred, has over the years made a number of important and transformative acquisitions: DeanWitter, in 1997; Smith Barney, starting in 2008; and most recently ETrade, in 2020. The competitors’ moves ended up paying off in dramatic fashion, making the moats around their firms wider and wider, while Goldman’s inaction has left it more vulnerable to competitive insurgents. 

The reasons for Goldman’s strategic indifference are many and varied. First, at 153 years old, it is one of the most aged investment banks and its culture is particularly insular, despite having some 40,000 employees these days. It rarely hires laterally, with some important exceptions, including the hiring of David Solomon, the current Goldman C.E.O., who came over as a partner and the head of Goldman’s leveraged finance business from Bear Stearns just after the firm went public. (Around that same time, it also hoovered up the heads of M&A at Merrill Lynch, Morgan Stanley, and Salomon Brothers.) Goldman prefers to indoctrinate its waves of new employees in “The Goldman Way” to avoid their picking up bad habits that Goldman thinks other firms possess, such as being too internally competitive and not sufficiently client-focused. 

Goldman may be great at advising on deals for other companies, but it has a surprisingly lousy record of making its own acquisitions pay off in a meaningful way. Its acquisition of Spear Leeds & Kellogg, then a leading market maker, in 2000? Disaster, flushing some $6.5 billion down the drain. It has made a few tuck-in acquisitions that seem to have worked out okay (it’s hard to know for sure from the outside)—with names such Ayco, Boyd Corporation, United Capital Financial Advisers, and Clarity Money—but nothing that was meant to be particularly transformative. 

Its best acquisition, arguably, came way back in October 1981 when it bought J. Aron & Company, the nation’s largest supplier of green coffee beans and a major trader of precious metals and commodities with more than $1 billion in revenues in 1980. Not only was the acquisition of J. Aron the largest in Goldman’s history, but it was also the only major acquisition the firm had ever made, aside from buying one or two small, regional commercial paper providers at the time of the Great Depression. (The deal was championed by Bob Rubin but opposed by Steve Friedman, who would later lead the firm together as senior partners before they both headed to Washington for top roles in government.) 

The purchase price, never fully disclosed, was somewhere around $150 million, a chip-shot by today’s standards, but at the time a big bet for the Goldman partnership, at about half the partners’ capital. In any event, after some initial stumbles, J. Aron was a big success, bringing to Goldman immense profits plus both Lloyd Blankfein and Gary Cohn, who together would go on to lead the bank for many of the years between 2006 to 2018. (Cohn left Goldman in 2016 after he failed to win the support of the Goldman board of directors to replace Blankfein, and then was scooped up by then-President-elect Donald Trump as his first National Economic Advisor.) 

The logic, it seemed, was: Why make big, transformative deals if you know you aren’t very good at integrating them and making them pay off? Especially when you appear to be so good at everything else.

Blankfein was indeed a finely tuned evaluator of risk. He once told me that he spent “98 percent of his time worrying about things with a 2 percent probability.” That’s some serious worrying. He and David Viniar, the Goldman C.F.O. at the time, greenlighted Goldman’s “Big Short” in December 2006 when the firm decided to hedge its balance sheet risk related to mortgage-related securities by shorting the mortgage market and “getting closer to home,” as the Goldman executives liked to say. The proprietary bet paid off massively for Goldman, making the firm some $4 billion in profit in 2007 at the same time that many of its competitors were going down the tubes, or were about to go down the tubes, because they had failed to perceive the same risks in the mortgage market that Blankfein, Viniar, and the Goldman Brain Trust had been able to discern (in part by mimicking the trades of their client, John Paulson, who made $20 billion shorting the mortgage market for himself and his investors.) 

But where Blankfein was long on risk perception, he may have been short on strategic insight when it came to Washington sentiment. While JPMorgan Chase, Bank of America, and Morgan Stanley saw the 2008 financial crisis as a rare opportunity to scoop up wounded competitors at distressed prices, Goldman sat tight, confident it had the superior hand. Part of that thinking was accurate. Goldman had weathered the 2008 financial crisis in far better shape than its competitors, many of which either disappeared or were bought up by the likes of JPMorgan Chase and Bank of America. And Blankfein had been rewarded richly for his stewardship of the firm during that rough period. In 2006, he received compensation of $54 million. In 2007, when the rest of Wall Street was floundering, Goldman’s board awarded Blankfein a bonus of nearly $68 million in cash, options and restricted stock—the largest bonus ever awarded to a Wall Street C.E.O. If it ain’t broke, don’t fix it.

And Blankfein saw nothing that needed fixing. Alas, in hindsight he misread how vastly the regulatory environment on Wall Street would change in the wake of the near meltdown of capitalism and the massive government bailouts funneled to the surviving Wall Street firms in order to try to restore them to their positions of worldwide prominence. Blankfein bet that, despite both the new Dodd-Frank law and the so-called Volcker Rule, somehow the new regulatory environment would represent, as he liked to say, a “secular” change rather than a “cyclical” change. In other words, he was hoping that soon enough things would return to normal and that Goldman would again be able to make the kinds of big proprietary bets that had seen it through the financial crisis. But hope isn’t a strategy, and Blankfein, for all his wit and raw intelligence, saw his hopes extinguished. 

The vastly changed regulatory environment required Wall Street firms to have more capital, to take fewer risks, and to move those risks swiftly off their balance sheets. It also required that they could no longer make large consolidating mergers without the approval of the Federal Reserve, which still, some 14 years later, has not been forthcoming. Washington regulators had decided to do everything in their power to make sure that Wall Street was never again responsible for a major financial crisis, and that meant Wall Street’s risk-taking would be curbed dramatically. 

Given the new reality, Blankfein could have bought Smith Barney, or some other large brokerage business, to give it more recurring revenue. But he didn’t. Instead, James Gorman, the C.E.O. of Morgan Stanley, did. It’s a move that is generally considered to be one of the main reasons that Morgan Stanley is worth 50 percent more than Goldman these days. Blankfein could have bought a regional commercial bank—say, PNC Financial or SunTrust—to expand Goldman’s deposit base, and give Goldman a vast source of available, cheap money with which to make more money. But Blankfein didn’t do that either. He just ran the firm well. Which made sense at the time, but today looks like a missed opportunity.

David Solomon, Blankfein’s successor, is now trying to play strategic catch-up. He’s been making noticeable efforts to edge Goldman into businesses that were once frowned upon at the firm as boring and low margin—such as making corporate and consumer loans, providing cash management services to corporations, and teaming up with Apple to get into the credit card business—and that in decades past Goldman had been content to allow to be the purview of the big commercial banks. After much fanfare related to its 2019 launch, the word “Marcus” does not appear in Goldman’s press release related to its 2021 earnings. (Presumably the performance of Marcus is tucked into what Goldman calls “Consumer banking” these days, a combination of its credit card business and its consumer lending business, both of which had revenue of $1.5 billion in 2021, up 23 percent from 2020. Goldman has not yet broken out the 2021 profitability of these businesses.)

Don’t get me wrong, like the rest of Wall Street, Goldman Sachs had a boffo 2021. In fact, it was a record year for the firm. Its net income was $21.6 billion, a record. (JPMorgan Chase also had a record year, making $48 billion of profit.) Its return on equity of 23 percent was the highest since 2007. The big driver of Goldman’s success last year, no surprise, was its investment banking business, where revenue was 58 percent higher than 2020. Its asset management revenues were 87 percent higher than 2020. Even the revenue in its so-called global markets division—essentially its trading operation, which has struggled in past years—was up 4 percent over 2020. Goldman’s record financial performance comes on top of its decision—for reasons that are still not entirely clear—to pay its employees $17.8 billion in compensation and benefits, one-third more than it did in 2020. Had it kept that expense flat, Goldman’s net income might have been around $26 billion. 

Despite this remarkable success, Goldman’s market value of $120 billion probably isn’t going to cut it long-term when its main competitors have so much more financial wherewithal. So how does Solomon get Goldman to bulk up to its peers? It needs a bigger balance sheet and a more diverse set of revenue streams. In other words, it needs to do something that is not in the Goldman DNA: a big deal. 

I’ve speculated before about why Goldman has not pulled the trigger on a deal for the likes of, say, Bank of New York Mellon, with a market value of $50 billion, which would get Goldman a bigger balance sheet, more deposits, and a healthy stream of recurring revenue, thanks to Mellon’s large investment management business. In many ways, it would be a perfect complement to Goldman since there’s no investment banking overlap to worry about and it gets Goldman more assets under management. But the fear of integrating a company of that size into Goldman—and possibly screwing it up—remains palpable inside 200 West Street. Or Solomon could pull the trigger on PNC Financial, at $87 billion, a large regional bank operating in 27 states. Then there’s State Street Bank, at $35 billion, which could also complement Goldman’s business lines since it is big in back-office servicing and investment management. 

If Goldman executives are worried about a culture clash, or an organ rejection, it seems to me that any of these three acquisitions would somewhat mitigate that risk. (You can never fully mitigate the risks of a large acquisition, of course.) Any of these three deals could also likely win the support of the Federal Reserve, which no doubt recognizes Goldman’s competitive disadvantages at this point. After all, none of these three, while large, would dramatically reduce the competition in the highly competitive financial services industry.

No doubt Solomon has already thought of these acquisitions—he’s a smart fellow—or has decided he would like to do one of them, or he has decided not to take that kind of risk, especially after Goldman performed so well in 2021. Goldman’s stock is off 15 percent from its all-time high, reached in November, and you’d think that Solomon would want to do something to get investors excited about the firm’s prospects in what surely will be a tougher 2022. 

I remember back in the summer of 2000, when the halls of JPMorgan were buzzing with the rumor that Hank Paulson, then the C.E.O. of Goldman, and Sandy Warner, then the C.E.O. of JPMorgan, were about to do a deal that would combine the two firms. We were thinking: checkmate. But it never happened. I guess the logic of not doing the deal was that there was too much overlap between the two firms and there would be too much carnage, especially in the investment banking divisions. But Sandy Warner was determined to sell out. A few months later, Chase bought JPMorgan and created JPMorgan Chase. 

It was a rough merger integration for sure, until Jamie Dimon came along after JPMorgan Chase also decided to buy Bank One, in Chicago, in large part to get Dimon, who was the bank’s C.E.O. The rest is history, and now JPMorgan Chase is our largest and most respected bank. As Solomon knows as well as anyone, you have to take a little risk to get the reward.

FOUR STORIES WE'RE TALKING ABOUT