In his first inauguration speech, President Franklin D. Roosevelt observed that the titans of Wall Street “have fled from their high seats in the temple of our civilization”--an apt description for the lashing of Wall Street leaders this month in front of the House Financial Services Committee. Chairman Barney Frank and the members of his committee were less eloquent than FDR in their criticisms of the current Wall Street CEOs, but the point was the same--the public has lost faith in the leadership of our financial community. How have we come full circle over 75 years after FDR? And how can Wall Street avoid a future return to this ignominious position in our society?
If March 4, 1933, and February 11, 2009, marked the nadirs of public confidence in Wall Street, then the years 1928 and 1999 marked the zeniths, when Goldman Sachs sold shares to the public for the only two times in its history. In December 1928, the partners of Goldman Sachs sold shares in a subsidiary called Goldman Sachs Trading Corporation--for its day, a complex, highly leveraged instrument with many layers that made transparency all but impossible. By the time of Roosevelt’s inauguration in 1933, the shares were nearly worthless. For the next 70 years, burned by that experience and FDR’s excoriation in 1933, the firm’s partners retreated to their roots as a private partnership, using their own personal capital with only modest leverage to advance their role as a financial intermediary.
By 1999, Goldman’s reputation had recovered to its previous zenith--to the point that a public offering again was possible. Its partners had debated the merits of such a change for years, and, even when the decision was made to go forward, the decision was reached only after vigorous debate and much disagreement. In favor of going public were those partners who saw a need for a larger capital base to allow the firm to compete in the increasingly globalized economy with the larger players both in the U.S. and overseas. Furthermore, once a public market was established for its shares, Goldman would have a currency other than cash with which to acquire other businesses and grow into financial services it could not afford to enter as a private partnership. On the other side of the argument were those partners who were worried about the impact that transition to a public firm would have on the firm’s culture. Heretofore, the firm had been known for its low ego and gang-tackling ethos, with aggressive personalities kept in check by the partnership potential that was strongly linked to both productivity and cultural fit.
What neither the firm’s partners nor outside observers were able to foresee was the resulting change in the firm’s risk tolerance. Goldman Sachs was the last of the major Wall Street houses to go public. (Donaldson, Lufkin and Jenrette had been the first in 1970.) As of May 4, 1999, all of Wall Street were now playing with other people’s money (whose acronym, OPM, is not coincidentally pronounced “opium” in financial circles). When Goldman was a private partnership, its partners faced unlimited personal liability when making capital allocation decisions; post IPO, their much more limited liability was identical to that of any other senior executive in a public corporation. One of the largest market participants was now prepared to play without the self-imposed restrictions that had been present in its earlier form.
The consequences of the Goldman IPO have been eerily similar to 1929--increasingly complex financial instruments and increased leverage. Those conditions have been among the key factors that have brought us to a world strikingly similar to what it was in 1933--a stock market crash that has led to an economy that could be entering a Depression.
Shortly after his inaugural address, FDR began substantively rebuilding America’s trust in Wall Street with his New Deal securities legislation (the ’33 Securities Act, the ’33 Banking Act and the ’34 Securities Exchange Act), which, among other things, created the Securities Exchange Commission. Certainly, a major rethinking of our securities regulation is in order today. If we are to avoid repeating history yet again, however, it might also be wise to restrict Wall Street to private ownership so that the risks are born by the participants and their risk tolerances are accordingly restrained. When FDR said during that same 1933 inaugural address “that the only thing we have to fear is fear itself,” he had it only partially correct: We should also fear financiers operating with other people’s capital.
William R. Gruver, a former general partner at Goldman Sachs, is the Distinguished Clinical Professor of Management at Bucknell University.