Muppets get no respect

Written by John Osbon on March 20, 2012

By now, Greg Smith’s resignation letter from Goldman Sachs, delivered via the New York Times op-ed page, ranks high in the pantheon of dramatic stage exits. His message about Goldman culture was straightforward and distressing:  “It makes me ill how callously people talk about ripping their clients off.”

I spent 20 years in big Wall Street firms. So did I see what Smith saw?

Profits first

Let’s start with the obvious: a public company with a 10:1 debt ratio (down from 30:1) is under intense, continuous pressure to produce profits for its shareholders and repay debt.

This ownership structure and financing model describes most Wall Street firms. I don’t think it’s a model that favors clients – neither individuals nor institutions. Client interests are simply not the same as the firm’s interests, and often they are directly opposed.

It’s a simple chain reaction: Investors buy GS stock to earn a return. If profits fall, the stock price falls. If the stock price falls, shareholders sell. If shareholders sell, the price falls further and executives are held accountable. So leaders of the firm have full motivation to keep profits and the stock price as high as possible, even if it comes at a cost to clients. Whether this happens callously, as Smith asserts, or with a gentle touch, the impact on clients is the same.

Yes, it sounds familiar

While working on Wall Street, starting from the bottom up to managing director, I can honestly say that, in my experience, what Greg Smith says is completely familiar and has been going on for some time, or at least since 1986, the year Morgan Stanley went public.

When a manufacturer and distributor of financial products also acts as intermediary between suppliers and users of capital, it’s easy to see how more money for the firm means less money for the client. In my experience it was a huge, continuing challenge to unite the interests of clients and the firm. There was always was, and still is, a conflict of interest.

Conflicts can be profitable. As a trader friend put it, “If there’s no conflict, I’m not interested.”

Follow the money

Are conflicts of interest a threat to you? There is a simple test of how well your interests are aligned with those of your money manager: just follow the money. It sounds simple, and it is.

How does the firm make money? How much? Who gets it? Does the firm make more when you make less? Why is this arrangement in your best interest? Could you get similar products or performance with less expense, more transparency, and less conflict of interest? Is the firm’s first allegiance to you?

As I described in a recent post, I structured Osbon Capital as I did because I believe that a private firm for private people, operating in one business only, unencumbered with voting shareholders and debt, is the best way to deliver money management service.

Have a laugh, but not at your own expense

Now back to the Smith letter. Credit the New York Times with pointing out its humor value, with a sampling of reactions from satirists: “Andy Borowitz offered a mock memo from Lloyd C. Blankfein, the Goldman chief. ‘Mr. Smith comes across as a man of conscience, ideals and high moral standards,’ Mr. Borowitz wrote. And as you read his words, you no doubt asked yourself this troubling question: how could Goldman have hired such a person?”

Among the most popular spoofs was a resignation letter from Darth Vader on The Daily Mash. “After almost 12 years, first as a summer intern, then in the Death Star and now in London, I believe I have worked here long enough to understand the trajectory of its culture, its people and its massive, genocidal space machines,” the mock article said. “And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.”

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