Review of “Chasing Goldman Sachs,” by Suzanne McGee

By James Ledbetter
Sunday, August 1, 2010


How the Masters of the Universe Melted Wall Street Down . . . and Why They'll Take Us to the Brink Again

By Suzanne McGee

Crown Business. 398 pp. $27

I pity any author peddling a book about the financial crisis after the publication of "Too Big to Fail," "The Big Short" and dozens of other exhaustive investigations. Yet "Chasing Goldman Sachs" is an exceptionally lucid, well-written account of how and why the financial system broke down; readers need only beware that, despite its title, this book reveals very little about Goldman Sachs.

By now the stories of risky mortgages, underregulated banks and ludicrously complex investment instruments are familiar. Suzanne McGee's book takes the reader much deeper into the history and culture of Wall Street, which is the true cause of the financial disaster. The mortgage meltdown -- like Hurricane Katrina or any perfect storm -- could inflict as much damage as it did only because the conditions for destruction were already in place.

A contributing editor at Barron's, McGee encourages us to think of Wall Street's historical function as a money grid, a utility that ensures a reliable, efficient flow of money from Point A to Point B. This mundane but reasonably lucrative duty, she argues, used to make up the bulk of what investment banks did. However, beginning in the 1980s, several things happened that took Wall Street in a very different direction. One was the rise of a shadow banking system, in the form of hedge funds and private equity firms. These lightly regulated entities earned outsize returns by pursuing risky strategies that would have been unthinkable for most traditional Wall Street banks; over time, private equity firms and hedge funds became the Wall Street banks' best clients.

A second development was that investment banks found that they could make more money by implementing their own investment strategies than by advising corporate clients as they used to do. In the old days of the dot-com boom, for example, a firm such as Morgan Stanley would underwrite an initial public offering for an Internet company, taking a fee for selling shares to outside investors. Today, an investment bank is just as likely to make its own investment in the company, taking on greater risk for potentially greater reward.

The third and perhaps most transformative development happened mostly in the 1990s, when the largest investment banks -- Bear Stearns, as well as divisions of Citigroup, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley -- all became publicly traded companies. This move increased the capital available to the banks, but if it had any other positive effects, they are hard to find in McGee's account.

The drive to maximize profits to shareholders, to improve the return on equity -- the ultimate yardstick used when "chasing Goldman Sachs" -- led Wall Street firms into all sorts of behavior that separated their best interests from society's. Whereas the earlier structure of private partnerships encouraged bankers to keep track of the overall risks their firms were undertaking, the growth and profit imperatives of shareholder companies meant one thing only: Make more deals to generate more fees. As one former investment banker tells McGee, "We lost the checks and balances, a system that provided a kind of curb on excessive risk-taking, when we moved away from the partnership model." Public ownership also created a compensation-for-performance system that lavished eight- and nine-figure salaries on some bankers, whether or not the work they performed was ultimately beneficial to their clients or even their firms (in the case of the now-departed or forcibly merged Lehman, Bear Stearns and Merrill Lynch, much of it was clearly not).

The disturbing implication of McGee's masterful book is that even the more aggressive ideas for regulating Wall Street -- such as compensation caps and breaking up big banks -- seem unlikely to prevent future crises, even if Congress had chosen to include them in the recent financial reform package. Some of the system's weakness reflects human nature, but much of it, McGee concludes, is built into the fiduciary duty of public companies. As she demonstrates, any given investment strategy can be interpreted as reckless or prudent, depending on circumstances; shareholders seem likely to always demand that their bank be as aggressive as the next firm. Today's Wall Street does not encourage and barely allows anyone, as former Citigroup chief Charles Prince put it, to stop dancing as long as the music is playing.

James Ledbetter is the editor of The Big Money, the Slate Group's business news and analysis Web site.

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