The world according to Goldman Sachs

Ahead of the Davos summit, Goldman Sachs president Gary Cohn talks to The Sunday Telegraph about the outlook for Europe, the US economy and whether 2012 holds any rays of hope.

The Goldman Sachs headquarters building is seen December 16, 2008 in New York
Although the Occupy Wall Street protesters have been corralled and "moved on" several times by the New York Police Department, Goldman Sachs is not keen to advertise itself. Photo: Getty Images
For the headquarters of one of the biggest banks in the world, the outside of 200 West Street is deliberately anonymous. Outside, guards patrol in the freezing air and the pavement bollards, masquerading as decorative street furniture, are the type of urban landscaping designed to prevent a terrorist attack. If any reminder were needed, from the upper floors there are views of the reflecting pools that mark Ground Zero.
Although the Occupy Wall Street protesters have been corralled and "moved on" several times by the New York Police Department, Goldman Sachs is not keen to advertise itself. "It's not as if we've got to signal to people where the ATM machines are," says one senior figure as he accompanies me to the lifts.
Gary Cohn, the president and chief operating Officer of Goldman, is on floor 41, the executive floor. His office, relatively modest for a man who can pick up the phone to almost any CEO in the world, is a couple of doors along from Lloyd Blankfein, the chairman and chief executive.
The two men are close and on the company's website they are positioned as number one and two on the list of executive officers (and it's not alphabetical). When Blankfein emailed colleagues about the "big short" – when Goldman bet at least some of its financial muscle that the American housing market would fall in 2007 – Cohn was on the "cc" list.
Cohn comes from Shaker Heights, Ohio. His accent and demeanour (he is 6ft 3in tall and weighs 13 stone) is straight from the Central Casting folder titled "Wall Street titan, firm handshake". He has been called "abrasive" and "risk-taking", and some have questioned whether he will ever succeed Blankfein to the top job. His ability to run a business and provide Goldman clients with the type of service only many zeros on a cheque can buy is legendary.
At the end of the month, Cohn will be Goldman's leading representative at the World Economic Forum at Davos – the Alpine business and political gathering that brings together the global-elite class. Also there will be European leaders, members of the World Bank, the International Monetary Fund, financial regulators, Middle Eastern and Asian rainmakers and fund holders. Cohn will be in back-to-back meetings, seeing clients and attending sessions with titles such as "Big Banks: Curse or Cure for the Global Economy?" Last year, his comments on the dangers of ill thought-out financial regulation became one of the major themes of the week-long event.
Mapping out the key issues on the global stage, Cohn is in expansive mood when we meet last week. He talks about the sovereign debt crisis and the role of the European Central Bank (ECB); the American economy and a possible surprise on the upside; how regulation coming out of the US could lead to a liquidity drought in the eurozone; and how Goldman has worked to understand the difference between what it "can" do and what it "should" do. There is almost a whiff of morality in the air.
After years in the spotlight as the Vampire Squid and Doing God's Work, legal actions and Congressional inquiries, Goldman is looking to set off on a different trajectory.
"Am I ashamed of where I work? Absolutely not. Am I proud of Goldman Sachs? Absolutely." Cohn is the case for the defence.
America: looking nervously across the Atlantic
There was a stage last year, August 6 to be precise, when the wheels appeared to be coming off the US economy. With its $15 trillion (£9.7 trillion) debt racing ever upward and the economic outlook gloomy, Standard and Poor's downgraded the country's AAA credit rating – a move akin to the Royal Society announcing that, now they had looked at the details, the Earth was indeed flat.
But, as Warren Buffett said, it's never paid to bet against America. At the end of 2011, the US consumer confidence index jumped to 69.9 from 55.7 in August. Over the same four-month period, the unemployment rate fell from 9.1pc to 8.5pc. Car manufacturing is up and growth forecasts look stronger.
It is no time, though, to hang out the bunting. "On the US economy I feel pretty good in isolation," Cohn said. "Things aren't great, but if you look at what has been going on the data has surprised on the upside. I think it will continue to surprise on the upside a little bit.
"But you can't look at the US in isolation. When you analyse the US I think the biggest issue is what is the contagion or spillover effect out of Europe? I think that Europe is one big issue that is out there that causes us to be very tepid about what is going on here in the US."
Cohn says that although many of Europe's problems are contained in Europe, even the mightiest economy in the world is in hyper-wary mode. If Europe keeps coughing and wheezing, America worries it may catch a cold, particularly as the dollar slowly climbs against the euro.
"The highest-level issue is the euro/dollar relationship and the value of the dollar. We are in one of those environments where basically every central bank in the world has been trying to lower the value of their currency, and to do that some other currency has to rise.
"The US has benefited from having a relatively weaker currency. But in the last three to four weeks you have seen the dollar/euro relationship change. We were stuck at 1.35ish [to the euro] and now we're at 1.27. People at the highest level are thinking what would happen if it traded 1.20, 1.10, parity? What does that do for US exports versus European exports – it has a pretty dramatic effect.
"If you look at the S&P 500 today and consider how much of the earnings of major US companies are non-dollar earnings, what happens to those earnings in those economies outside the US?
"US-domiciled multi-national corporations are likely to see their European earnings deteriorate as the euro loses value against the dollar and those earnings are repatriated. This will adversely affect trade."
On the other side of the same coin, as Cohn surveys 2012, is the issue of US domestic politics. As the next presidential election hoves into view, Wall Street and Main Street could once again engage in a degree of hand-to-hand combat as politicians hunt down the swing vote.
"The other side is the US political environment towards business, towards big business [and] towards regulation – whether it be the health-care industry, the banking industry, the defence industry," Cohn said.
"The issue is how the government overlay is going to affect 2012 and is Congress going to be functional, is the President going to be overly consumed with election rhetoric versus governing, where do we think we will end up from a regulatory process in this year and what does that mean for the US economy?
"Government downsizing has been slowing down. But that might not continue. I am very concerned about that because, for example, the financial services industry is the biggest tax-paying industry in New York City and New York State, and you look at the performance of hedge funds, private equity and big money-centre banks, and you look at the amount of earnings they have had, or rather the lack of earnings, and therefore the lack of compensation and therefore the lack of taxable income - I am quite worried that government tax receipts
are going to be much lower than people projected."
George Osborne, who needs City taxes, might like to take note.
How do you solve a problem like Europe?
There's a radio advert running in New York selling cheap financing for cars. In it, an ebullient salesman demands to know why a country with an economy the size of Indiana – Greece – is causing a global economic meltdown. "If Indiana said it had a debt problem would the world leaders be quaking in their boots? I don't think so," he bellows. Forget about it, and get a good loan deal instead because interest rates are really low.
Cohn admits he has moved significantly on the dangers of a eurozone break-up. Two to three years ago, he felt the currency could flounder. Now, after a year where European politicians have battled the markets to keep the project on course, he says the threat of break-up is more evenly balanced.
I ask Cohn whether, at the end of the year 2011 compared with the beginning of the year, he is more or less confident about the chances of the euro surviving with all its members.
"I am probably about equally confident," he answers.
"It's funny, if you had asked me that two or three years ago, then I didn't think the euro could survive. Last year was a test where there could have been some situations where it just didn't work. People could have easily thrown in the towel, but I think the conviction to keep the euro together is very strong. I think over the course of last year if anything it got stronger. It is very, very difficult to break it apart."
Cohn once wondered whether some of the peripheral countries might fall out of the bottom of the currency. He then considered whether Germany and other, more strongly financed nations, might "pop out" of the top. "Then you realise none of that is going to work. I'm in the mode where I think the euro is going to last." He pauses, and laughs. "Until it doesn't".
The eurozone will ultimately, Cohn argues, have to look to the ECB. "The solution has to come from the ECB," he says. "At the end of the day that is the central bank of Europe. That is the entity that can create more currency, more euros.
"Right now one would argue that in essence they are doing that by allowing many of these auctions in debt and liquidity facilities to exist. So whether they are being criticised for being over-involved or under-involved they are involved. When you do a half-a-trillon-dollar liquidity facility in essence you create more currency and more liquidity."
Cohn says he understands why many in Germany argue that using the ECB as a "big bazooka" simply allows countries off the hook of fiscal discipline. But there is, of course, a flip side.
"Look at the huge windfall that the German economy has had by being able to export with a much lower currency than they would have had as a Deutsche Mark-based country," he says. The German economic miracle is being sustained, to an extent at least, by the fact that Greece, Italy, Spain and others can't get their economies in order.
London – it's complicated
One of the main boardrooms at 200 West Street has a table in the shape of a half- circle. On the wall are television screens to allow for virtual meetings to be held with senior executives not based in New York. The other half of the table, with the same set-up, is in Goldman's London headquarters on Fleet Street. The microphones are not mutable – to stop whispered individual conversations getting in the way of the main meeting.
Two years ago, much talk circled about Goldman's commitment to the capital, about whether it might consider moving operations elsewhere given the UK Government's position on "super-equivalence" on European Union regulation and the machinations of the Independent Commission on Banking. But the eurozone crisis and plans for a financial transaction tax (FTT) in at least France and Germany has strengthened the capital's claim to be the long-term centre for global financial institutions.
"We are highly committed to London," Cohn said. "We have a big footprint, we have two buildings, we have the opportunity to build a third building, we've got a major hub, we've got a major capital commitment, we have a major human commitment.
"We are cautiously optimistic that from a regulatory and government standpoint London will be the right place to be. I think those countries [Germany and France] have at some point tried to entice people in, with different incentives. Right now I would say it is so unpredictable what is happening in Europe that it is better off to do nothing and stick with where you are.
"The bigger long-term risk to me is that many of the financial firms leave Europe completely – whether it be the UK or continental Europe – because it is such a tough regulatory environment that you move to other places in the world and try and cover Europe from a third location.
"[The FTT] will clearly have an effect. If you look at transaction taxes and you can execute in a jurisdiction with a transaction tax, or you can execute out of the jurisdiction, it just incentivises clients to transact at the lowest cost. At the end of the day all of these things get passed on to clients, they go on the cost of doing business."
London may have some upsides – and fear of change is playing in the city's favour for the moment – but it would be wrong to think that those critics who fear a gradual demise are in the wrong place. The balance-sheet tax and possible future compensation restrictions will be headwinds.
"On different days of the week I feel different levels of comfort as to whether the regulatory authorities in London want it to be the centre of commerce in Europe," Cohn says.
"The days when they are talking about no financial tax I'm applauding. And then when you read the newspapers all weekend about compensation you scratch your head."
Any nation doing anything on their own, whether it's on regulation or pay as David Cameron has suggested No 10 will, has a negative impact on attractiveness, not just for banks but for global companies.
"I don't get to dictate that many terms to my clients," Cohn said. "They get to dictate to me. I'm in a service business. I've got to provide them with the service they want.
"I am also in the business where I am as smart as my dumbest competitor. And so if my dumbest competitor happens to be smarter than me because they are an Asian-based bank that has none of these other fees, my prices don't look very smart. Even though I may be pricing them to just break even."
A tangled web being weaved
Cohn is a global expert on regulation. He turns to the subject with almost weary resignation, explaining that all rules might look fine at "100,000ft" but when you get out of the clouds and into the detail, things always become more complicated.
Under the coffee table he has a copy of the Dodd-Frank legislation, all 2,260 pages of it. He slaps it down on the table top for emphasis. And, yes, he has read every word.
Dodd-Frank, due to come into force in the summer, brings into being the Volcker Rule which bans proprietary trading, where banks take positions using their own balance sheet. One of the unintended consequences is in the government bond market – crucial for states to fund themselves – where banks act as market-makers and provide liquidity.
Under the rules, investment banks based in the US would face restrictions on how they operate in the bond market, meaning a significant reduction in liquidity. At a time when governments with ballooning debts need all the liquidity they can lay their hands on, such a move could have an adverse effect on global growth.
"The way that most of the government bond markets around the world work – and the US knows this because they exempted their own government bond market – is that you almost never get to buy and sell the same security," Cohn says.
"You buy a security and sell a like security. And that is the way you create efficient government bond markets around the world. To the extent that the regulators in the United States are not going to allow you to compensate traders for holding inventory, no trader will hold inventory, because it is all downside with no upside, so therefore the markets become very inefficient.
"The Japanese government has written a letter to the US, the Canadian government has written a letter to the US, in fact the Canadian government is threatening to invoke fair-trading agreements.
"If the Volcker Rule goes through as written and interpreted today, liquidity in all markets will dry up."
As The Sunday Telegraph reveals today, the Treasury in the UK has also raised concerns with the US after research by Barclays Capital revealed the dangers of the legislation. State Street Corporation, a US bank, has already announced it is pulling out of the UK and German bond markets. Goldman will not follow, for the moment at least.
"Our view is that right now it would be the absolute worst time in the world to have liquidity go down in any sovereign- debt market," Cohn said. "It would be totally irresponsible for us as a corporate citizen to shut down liquidity. So we've tried to maintain as liquid a trading book as possible.
"We also are hopeful that the regulation will end up in a place where it doesn't damage these markets. And this is now being understood – the lack of liquidity in credit markets and the lack of liquidity in government bond markets. We could not cut off liquidity right now, that would be terrible for the markets."
All over the world, in different jurisdictions and across nations, regulators are working at making the financial system as "safe" as possible.
Cohn fears that as banks are pushed out of markets, "shadow-banking" will flourish, creating risk under the radar of the regulators.
"Someone is going to find a way to fill that void," he says.
"I look at all the broker dealers that are out there in the US – shadow banking, quasi-unregulated and not affected by Dodd-Frank because they are too small. They will find this too profitable not to be in. It will move from the highly regulated to the unregulated.
"My views on the risk of this popping out in the unregulated world are as high as they ever have been.
"Everything MF Global [the collapsed US broker] did in their sovereign-debt book would not have been stopped by Dodd-Frank or Volcker."
And will the web of regulation, from Basel III to the European Union and to America, cause a drag on growth?
"Absolutely," Cohn says. "At a time when we are basically going through pretty much a developed-world recession, when we are trying to be stimulative to economies, when you have central banks around the world with a zero interest-rate policy, when you have QE2 and QE3 and they are talking about more QE in Europe and all over the world, on the one hand central banks are trying to stimulate, on the other hand they are destimulating."
Pay day and a Goldman bounce-back
A ripple was sent around the global financial world when Goldman posted a third-quarter loss last October, only its second since it went public in 1999. As a mark-to-market firm, Cohn says that even though the losses are unrealised, it is important for Goldman to maintain transparency about the value of its assets.
"[The loss] clearly told you that Q3 was a bad quarter to be long assets," Cohn said. "We tend to be long exposure to facilitate our clients. If we were a non mark-to-market firm like our competitors it would look completely different. So, when some of that stuff comes back in the fourth quarter people will say, 'Oh, that's just because the marks moved back up.' Although of course they didn't say last quarter that the loss was because marks moved down."
There will be an effect on remuneration, with the bonus pool reduced to reflect the tough conditions of 2011. There is also likely to be some form of salary cap for many Goldman Sachs employees earning over £100,000.
In the UK, the pressure is on banking executives to rein in pay. Does Cohn feel there needs to be a fundamental rethink on how banks pay their people, that the gulf between Wall Street and Main Street is a danger for the whole system?
"I understand the public argument completely, I'm not myopic on this," he says.
"But I also understand the reality of losing people every day. And so, unfortunately, as a fiduciary for our shareholders, if there are individuals or teams that are very difficult to replace and losing them will cost millions of dollars of lost revenue, I am somewhat obligated to find a way to remunerate them in a way where they stay at the firm.
"It's not like I walk in every day and say, 'How can we pay our people more than everyone else?'. I walk in every day and say, 'How can we pay our people enough that they will stay?'
"I understand that people may say there is excess capacity in the system, but there is not excess capacity among high-level and highly skilled jobs. If you told me there was excess capacity of guys who have relationships with five FTSE CEOs, send them on over! I fight to keep those kind of guys every week."
After a difficult 2011, Cohn says that the first half of 2012 is likely to be quiet but then there could be a pick-up in activity. Goldman should be well positioned and Cohn predicts significant consolidation in the market.
"I believe we are going to see real consolidation in our industry," he said. "When we took market share in 2008 we said very publicly we didn't think we were going to keep it as firms got back on their feet.
"Right now I think the market share we are taking in 2011/12 we are going to keep because we are taking it from people that don't exist any more. A lot of people are trying to get out of the business.
"So, the equity business in continental Europe, I see three or four banks trying to sell their equity business. No one is going to buy it, those guys are just not going to be there.
"Our market global competitive base is going to be a lot smaller. If the French are going to have a transaction tax it's going to be tough for them to compete. If you talk about Sarkozy and France – in my opinion, he is clearly telling SocGen and Paribas that they don't want them in the derivative businesses they have been in."
To serve their clients better, Cohn says Goldman is moving from a "can we do this" to a "should we do this" model. Results include moving away from the use of controversial professional consultants who may have connections to public companies; declining to sell certain products to clients because, although legal, they have a high risk factor; pulling out of some "adversarial" positions where counterparties may object; and declining work which could be connected to "sanctioned" countries such as Myanmar, Iran and Sudan.
"We did for our clients what they asked us to do, which is the whole evolution of the client businesses standards committee which I chair," Cohn said.
"We were the best firm in the world at analysing 'can we do something'. We didn't have as many checkpoints on 'should we do something'. My whole world now is 'should we do something'. Those are very difficult issues."
There is a knock on the window of Cohn's office, a member of his staff reminding him of his next client meeting. One of the black sedans that queue outside 200 West Street to whisk Goldman executives to their appointments is awaiting his arrival downstairs.
Cohn takes his leave, the Goldman president whose next public outing is likely to be on the snowy slopes of Davos. There, he will rejoin the argument as the world considers, exactly, what kind of banking system it really wants.

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