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Missing the Old Goldman Sachs

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Seventy Goldman Sachs (NYSE: GS  ) employees were promoted to "partner" status on Tuesday. The Wall Street bank does this every two years, escalating a small group of employees to what has been called the most coveted job title in finance.

Congratulations to you all.

How will life change for the new group of Goldman partners? They will have more responsibility. More eyes watching them. There will be more meetings, more luncheons, and a higher obligation to reflect the firm's values.

But mostly, they're just going to be making a lot more money.

Being elevated to a Goldman partner is largely ceremonial. After going public in 1999, Goldman is no longer a partnership, after all.

Some background here. Before 1999, Goldman was owned by its partners. And by owned, that meant taking part in both the firm's successes and losses. Lisa Endlich's 1999 book, The Culture of Success, describes how aligned partners were to Goldman's fortunes:

In a private partnership none of the assets of partners are shielded from liability, and the individual partners are exposed down to the pennies in their children's piggy banks. Large trading losses or lawsuits could pose a threat to the firm's capital and ultimately its existence. The actions of a rogue trader could spell personal bankruptcy.

Goldman's partners don't have anywhere near this kind of alignment of interest anymore. No major Wall Street bank does, as they've all gone public. For partners, upside is theoretically unlimited, and downside is capped.

Here's a good example: After Bear Stearns imploded in 2008, former CEO Jimmy Cayne said, "When you lose a billion but you still have several hundred million left, then it's your heirs that get hurt, not you." Back in the partnership days, Cayne would have been left penniless. With today's structure, he's still magnificently rich.

So, which system worked better?

For risk management, I don't think there's any comparison -- the partnership wins. During Goldman's partnership days, partners scrutinized each other's activities like a hawk, lest the guy down the hall took a risk that threatened you with personal bankruptcy. "The partnership was a small, intimate organization -- a fraternity in the very best sense of the word -- in which no one was above criticism and the more senior partners regularly challenged their leaders," Endlich wrote.

Goldman (and most of its competitors) ditched the partnership model for two reasons. Partners needed liquidity to cash out the investments they had made in the firm. And the firm itself needed a permanent source of capital that didn't disappear when a partner left or retired. Last year, CEO Lloyd Blankfein told Charlie Rose:

We are a big financial firm. We're not just big in the United States. We are one of the biggest in every country of the world ... We could not do those activities unless we have a balance sheet that had permanent capital. That was why, reluctantly, with much observation, much regret and tears, the firm stopped being a partnership in 1999.

Fair point. But there's a rebuttal.

The market currently values Goldman at 0.8 times book value. As a partnership, it would be valued at book value. That's incredible: It's not even clear that being a public company is a financial benefit to Goldman's partners.

So then the question becomes, why is Goldman valued below book value? It might be because "those activities" Blankfein talks about scare the daylights out of investors. Before Goldman went public it was mostly a consulting firm, advising clients on mergers and helping companies go public. In 1998, traditional investment banking and asset management made up 72% of revenue, while trading made up 27%. Ever since, it has emphasized trading. By late 2009, trading was 81% of revenue.

Becoming a public company allowed Goldman to transform itself and take greater risks than it could before. Who has that benefited? Not the financial system. Probably not its clients. And, amazingly, maybe not even its partners and shareholders.

Before Goldman went public, former senior partner John Whitehead said, "Everybody here knows we have restraints on capital. Capital should be a restraint. It helps you make selections. You have to make choices." I wonder if Goldman made the wrong one.

To read more about Goldman Sachs, and help you figure out whether it's a buy today, I invite you to read our premium research report on the company. Click here now for instant access.

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10/25/2016 4:01 PM
GS $175.55 Up +0.43 +0.25%
Goldman Sachs CAPS Rating: ***