The Greg Smith op-ed in Wednesday's New York Times, that excoriating farewell letter by a now-former Goldman Sachs (GS) employee, has rocked Wall Street. It is one thing to be called a "vampire squid" by a snarky young reporter from Rolling Stone magazine looking to make a name for himself, and quite another to be called out by a senior executive inside the London office as he heads out the door. But can Smith's letter give us any insight into the future of the big investment banks? What should you be doing with these stocks?
Anyone who has ever traded either with or against Goldman Sachs in any derivative market, as I have done, will say that Smith's moral disgust at the firm's mercenary business practices is honest. Both CEO Lloyd Blankfein and COO Gary Cohn started out as traders. Cohn spent his early years, during the 1990s, building the Goldman Sachs oil commodity business and sat on the board of the New York Mercantile Exchange, where I roamed the floors during my career.
Goldman's business in other more recent derivative markets was patterned exactly as Cohn laid it out in the oil pits -- take every advantage and leave no profitable trade undone. The bank's success following this model was unprecedented until the financial collapse in 2008.
But no one resigned in loud protest before things began to get tough -- and that, to me, seems to be the point. Since 2008, Goldman Sachs and most of the other banking giants have been trying to unsuccessfully recapture the magic of the early years of the 2000s. But it's been about more than the moral shame that's been heaped upon them -- the bailouts, Occupy Wall Street, Matt Taibbi articles and Carl Levin rants about "[expletive] deals" in Washington committee hearings. There's also been the real financial disaster that has continued to plague Goldman and the other investment banks -- the market that sustained these guys has really turned against them.
You see it in so many obvious ways, and most clearly in the stock prices themselves: Goldman has done best, but its shares are still down 50% from it's the 2007 high. Others, like Morgan Stanley (MS), Barclays (BCS), Deutsche Bank (DB) and Royal Bank of Scotland (RBS), are still down closer to 80% from their highs.
Almost 200,000 workers have been fired from investment bank rolls in 2011, with the worst at Bank of America (BAC), which laid off 30,000 employees. Bonuses have been slashed. Jamie Dimon, CEO of JPMorgan Chase (JPM), has been leading the fight against Dodd-Frank reforms and the Volcker rule. Although many of these restrictive regulations won't go as far as they were intended, the banks have still had to divest or altogether sell many of their most lucrative proprietary trade businesses.
The clients are getting the message, too -- they're not so gullible as to buy every lousy financial product that Goldman has been proffering since 2008. While profits from the commodities and fixed-income trading desks have continued to be strong, most other derivative desks inside the investment banks have been suffering. With profits slowing and bonuses waning, it may be of little surprise that high-paid executives inside the IBs have gotten even more opportunistic in their treatment of remaining "muppets" (which, according to Smith, is what managing directors have routinely called their clients).
Greg Smith is just one voice, but it another of the death rattles that I have heard since 2009 in the profit model of the investment banks. That is the primary reason I have stayed away from all of these stocks as investments, and why I continue to do so.
These guys at Goldman are smart. I expect them to figure out new ways to make a good buck in financial services. But until they find a few new mousetraps instead of trying to save the remnants of the old ones, I will remain on the sidelines in all of these issues.