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How Goldman changed

The promotion of former trader Lloyd Blankfein to CEO marked a new era in the storied bank

NEW YORK -- Almost four years ago, a former gold salesman ascended to what is perhaps the most prestigious perch in American finance.

The transition looked seamless. Lloyd Blankfein became CEO of Goldman Sachs Group Inc., replacing Henry Paulson who left to lead the Treasury Department. In its own way, however, it was seismic, with the tectonic plates underlying the iconic investment bank already in motion.

On Wall Street, leaders come from where the money is. Mr. Paulson had been a banker cast from a well-recognized mould at Goldman: a tough, competitive player who spent years getting to know companies and their executives inside-out while advising them on mergers, acquisitions, and stock offerings.

Mr. Blankfein hailed from a different tribe. He had spent his career in the firm's vast and growing trading business, where it bought and sold every financial product imaginable. Bonds, stocks, currencies, commodities, mortgages, and their increasingly complex derivatives all passed through Goldman's global trading desks. The firm matched buyers and sellers and sometimes made eye-popping profits by placing its own bets.

The promotion of a trader to the firm's top job marked a new era which would have far-reaching effects on Goldman. Goldman had begun to emphasize complex trades and wagering its own capital over its traditional focus on deal-making for companies.

Now, that shift is nearly complete. By last year, trading and Goldman's own investments accounted for three-quarters of the firm's $45-billion (U.S.) in revenues. Investment banking of the kind practised by Mr. Paulson represented just a tenth. The 141-year-old firm has never been more profitable, nor has it ever been as controversial. A quick glance over the allegations that have dogged Goldman lately - that it helped mask Greece's debt; bet on a housing collapse in the U.S. even as it helped clients wager the opposite; engaged in complex transactions that hastened the demise of AIG - reveals they all flow from its function as a trader and middleman in markets.

One allegation is more old-fashioned: according to The Wall Street Journal, the SEC is investigating whether an independent director on Goldman's board passed information to a hedge fund now embroiled in a massive web of alleged insider trading.

Last week came the bombshell: the SEC accused Goldman of civil fraud in a 2007 deal. The firm created a complex bet on the direction of the housing market at the behest of a hedge-fund client and sold it to other investors. Regulators allege the firm hid key information - particularly the hedge fund's role - and therefore misled investors. Goldman denies the allegations.

The latest accusations are especially uncomfortable because they go to the heart of what Goldman has become: a firm that makes most of its money by touching many different parts of a trade, taking on risks to serve the wishes of different clients and pump up its own gains.

Few in finance would dispute that Goldman excels at what it does, but its multiple roles can provoke fear rather than loyalty. "Like a lot of people, we are nervous when someone from Goldman calls up" and suggests doing a trade, says John Taylor, who heads FX Concepts, an $8-billion currency hedge fund in New York.

Perhaps Goldman's traders have already made the very bet they're suggesting and are now seeking an exit, he says. Such caution applies to every bank on Wall Street, but especially to Goldman. "We're more wary with them, because we know they have more power and they're smart," he says.

The dominance of the trading business within Goldman - which includes "proprietary" trading, executed on the firm's behalf - also comes with a cultural shift. On the investment banking side, "you protected your clients and you protected your market share," says one former Goldman investment banker. "On the trading side, it was all about making money."

Of course, investment bankers, too, want very much to make money. But the time frame and approach - executives wooed over years of lunches and dinners, not rapid-fire trades during the course of a day - are poles apart.

The banker recalls how he would hesitate before putting an executive with whom he had assiduously built a relationship on the phone with different parts of the firm. The executive's request might meet with a peremptory no, or be handled less than adroitly, or leave the client feeling hoodwinked. The salespeople in the trading arms, too, know their customers well, he says, but "there's a certain point at which there's a trade being sought."

Long-time Goldman watchers say the change is plain. "The dominant part of the firm, which was investment banking, with its values and criteria and ethos, is now superseded," says Charles Ellis, author of The Partnership: The Making of Goldman Sachs.

Goldman says continuity is paramount. "The culture of the firm has remained constant and revolves around putting our clients' interest first," a spokesman said in an e-mail. "We consider our investment banking franchise to be the front end of the firm. Our relationships with corporate and governmental clients are key to our overall success."

Indeed, it was investment bankers who built Goldman from a middling player into a modern powerhouse, a tale Mr. Ellis un-spools in his book. One such banker was John Weinberg, the son of Goldman's legendary leader Sidney Weinberg. John Weinberg came to epitomize Goldman's rise to the status of trusted counsellor to Corporate America, summoned to address boards in moments of crisis and opportunity. He patiently courted companies like GE - visiting the offices every month for twelve years - and built enduring ties with top executives. Jack Welch, GE's former CEO, later said "I never dealt with Goldman Sachs - I always dealt with John."

By the time Goldman went public in 1999, Mr. Weinberg had retired and the world had changed. When touting its shares to investors, the firm emphasized less-volatile businesses like investment banking and asset management over trading, noted Brad Hintz, a financial analyst at Sanford C. Bernstein & Co. "But that 'emphasis' didn't last long."

Most of Goldman's peers in investment banking were heading in the same direction, beefing up trading, and exploring areas like private equity and real estate. By 2005, the firm faced a choice, according to Mr. Ellis' retelling. Mr. Blankfein, then-chief operating officer, addressed an internal meeting in London in what some at Goldman dubbed "the fork in the road speech." He argued Goldman had to combine its roles as an adviser, financier, and investor, or risk irrelevance. By focusing more on putting its own money to work, new conflicts would arise, but Goldman was skilled at managing them, he said.

The stars of the Goldman of this era weren't the investment bankers, but previously unknown traders like Mark McGoldrick. Investing Goldman's own cash, Mr. McGoldrick roamed the globe in search of downtrodden assets, snapping up everything from airplanes to the bonds of a South Korean liquor firm. He was phenomenally successful. His team - the "special-situations" group - reportedly made $4-billion in profits in 2006. Mr. McGoldrick personally took home about $70-million in 2006, more than Mr. Blankfein. Within Goldman's trading operations, one group in particular - fixed-income, currency, and commodities, or FICC - cashed in on the boom fuelled by low interest rates. Included in its sprawling reach were mortgages and a dizzying array of derivatives. Decimated by the financial crisis in 2008, it came roaring back to life. Last year, FICC trading accounted for $23-billion in revenues. It's also home to the controversial transaction now in the SEC's sights.

As lawmakers wrestle with how to repair the financial system, they are reining in trading of opaque derivatives, which will make them less profitable. It's no stretch to imagine that in the corridors of Goldman's headquarters in Manhattan, the search for new lucrative corners of finance is well under way.

© 2007 The Globe and Mail. All rights reserved.

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