Goldman's big rebound raises some eyebrows

NEW YORK -- On a clear day, Lloyd Blankfein can look through the windows of his office on the 30th floor at the tip of Manhattan and see the Linden housing project in the East New York section of Brooklyn. That's the rough neighborhood where he grew up, the son of a mail sorter at the local post office.

As head of Goldman Sachsgs today, Blankfein has come a long way from the projects to becoming one of the highest-paid CEOs on Wall Street. Perhaps he's come too far, because it's a place that many people who live in his old neighborhood might find hard to comprehend. After all, Blankfein and his fellow executives make eight-figure salaries running a company that devised and dabbled in the complex financial products that many believe caused the near-collapse of the global economy last year.

No wonder Goldman's recent feats, which in any other environment would have drawn applause, this year are attracting derision and suspicion. As the economy struggled to shake off the recession and unemployment approached 10%, Goldman did some of the best investment banking of its 140-year history, posting record quarterly revenue of $13.8 billion and 65% growth in profits.

Just months after many on Wall Street debated whether the investment banking industry it dominated was dead, Goldman has proved the naysayers wrong. Shareholders have chalked up big gains from the bank's banner performance in the first half of the year. Goldman's stock has doubled since January.

"Goldman's success lies in the culture of the firm — of stability, strength and focus. It's a culture that you cannot build overnight," says Thomas Marsico, founder and CEO of Marsico Capital Management, which manages $51 billion in assets and owns 13 million Goldman shares. "At a time when Lehman and Bear (Stearns) were gone, Citi was dealing with its financial issues and Merrill (Lynch) its new leadership, Goldman executed for its customers."

However, Goldman's profits stand in sharp contrast to what the rest of the country is facing, hobbled with hundreds of thousands of job losses each month and hundreds of businesses shuttering on Main Street. Goldman also set aside $11.4 billion in the first half of this year for compensation and benefits for its employees, a 33% increase from last year. At a time when there has been intense focus on bankers' compensation, including congressional hearings, Goldman's decision has been hard to swallow on Main Street.

After all, the belief is that Goldman and some of the other Wall Street banks might not still be around if they hadn't gotten government help. And the plight of taxpayers who are funding the bailout of financial institutions stands in stark relief to bankers' stratospheric pay. CEO Blankfein, for instance, earned in excess of $100 million in the past three years, even though he didn't take a bonus last year.

Last fall, Goldman, along with eight large banks, was given billions in taxpayer dollars to boost confidence in the financial system. This June, Goldman was one of the first firms to reimburse the government in full, paying back its $10 billion plus interest.

But critics accuse the investment bank of greed and profiting from others' weak spots, and they haven't been kind in characterizing Goldman. Nobel laureate economist Joseph Stiglitz at Columbia University likens Goldman's business to gambling, because in the last two quarters the largest growth came from its trading desks. In the second quarter, its revenue from trading and investing in stocks, bonds and currencies nearly doubled to $10.8 billion.

"Goldman's activity is of negative social value. Its recent profits came from trading, which basically amounts to profiting from insider information at the expense of others," says Stiglitz.

Blankfein bristles at such characterization of the firm where he has worked for 27 years and emphasizes his firm's vital role in the economy. "I believe in the high public purpose of what we do," he says of the firm's role as a facilitator and funder of businesses. "Our activities are, if anything, more important today than they were before." Other Goldman executives — managing directors James Esposito of bonds and Paul Russo from equities among others — say Stiglitz's charges are false because 90% of its trades are done for clients.

Vampire squid, KGB culture?

Goldman may be misunderstood on Main Street, and people have called the company different names. A recent Rolling Stone article called the firm a "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." And a 2007 New York Times column likened its culture to the KGB, the former Soviet Union's secret police.

But in the capital markets, Goldman's prestige has rebounded quickly in recent months. Like all financial institutions, Goldman profited from the housing bubble, but it pulled back before many of its competitors did and started selling its riskiest mortgage securities as early as late 2007. Despite a loss in the fourth quarter of 2008, Goldman was profitable for the year. Rivals Merrill Lynch and Citigroup had annual losses of $27 billion each.

Emerging stronger from the crisis, without the distractions at many of its competitors, Goldman was able to seize the opportunities that arose. For instance, President Obama's economic stimulus package provides subsidies to states and local governments that want to raise money via what's called Build America bonds to help promote jobs and revive local economies. Goldman was among the first to move, helping California raise $5.2 billion in April, one of the largest of these kind of bond issues.

Bill Lockyear, California's treasurer, says the state's well-known budget imbalances had shut down several thousand public works projects, including construction of mass transit, public parks and affordable housing. "This bond program allowed us to restart those projects," says Lockyear, putting more than 90,000 people to work.

However, stimulus measures will not last forever, and some question how sustainable Goldman's gains are, especially if the economy fails to rebound, which would dry up companies' need to raise funds.

Buffett to the rescue

It's not as if Goldman escaped the financial crisis unscathed. There was a period of chaos last year when Blankfein admits he was willing to consider any option to survive, including merging with Citigroup, which by contrast is today considered one of the weakest financial institutions, 34%-owned by the government.

However, eight days after Lehman failed and Blankfein was still figuring out a survival strategy, billionaire investor Warren Buffett called saying he would invest $5 billion in Goldman's preferred shares for a 10% annual dividend. That same night, Goldman raised another $5 billion from the global markets by selling shares.

Though that helped Goldman's capital position considerably, the market turmoil continued. A few weeks later, Treasury Secretary Henry Paulson called Blankfein along with eight other CEOs of the largest U.S. financial institutions and asked them to take government money to shore up the system. Goldman was given $10 billion. "At that point the country was facing a pretty chaotic situation," says Blankfein. "The message from Paulson and (Federal Reserve Chairman Ben) Bernanke was clear. … Everyone was expected to participate in the program, because what was at risk potentially threatened the system itself."

Focus on big pay

Along with taxpayer money came increased scrutiny, especially on Goldman's big pay packages. Blankfein, along with its top six executives, decided to forgo any bonuses last year.

However, even today, though Goldman has returned the government money, there is no letup of pressure on the firm. In the latest quarter, Goldman says in a public filing that regulators have raised questions about its compensation policies. Goldman wouldn't elaborate.

Part of Goldman's big pay comes from its history of being created as a partnership and sharing its profits with its employees. The company became a public company in 1999 and has continued its partnership structure. Goldman points out that its compensation structure, which is close to 50% of revenue, is not very different from its peers.

Still, Blankfein says, his firm is working harder to tie compensation to long-term performance. In a speech at this year's annual shareholder meeting, Blankfein said rather than just individual performance, compensation "should reflect the performance of the firm as a whole." He indicated that compensation will be more closely linked to profits in the future by being tied to longer-term stock incentives.

Despite his deep pockets and the fact that he leads one of New York's most prestigious firms, Blankfein says he has not forgotten where he comes from and is keenly aware of his company's role in the economy.

"I went to a fancy school. … But I grew up in a position to understand the stresses and strains of the real economy," says Blankfein, who won a scholarship to Harvard University after graduating from public high school at 16. His first job at 13 was selling peanuts and popcorn at Yankee Stadium. Looking out of his windows in the direction of the playgrounds of his childhood, he remembers just how far he has come, and how his family suffered, too.

Before Blankfein's father got his post office job, he drove a truck for a company that went out of business. "He was unemployed for a while," he says.