Dear readers,
Two seemingly disparate stories have captivated Wall Street over the past two weeks. The first concerned the junior analysts at Goldman Sachs who created a “pitchbook” highlighting the horrors of their pandemic existence. The second was the group of Wall Street banks that disclosed billions in losses from their lending relationship to Archegos Capital Management, the secretive family office of one-time hedge fund star Bill Hwang.
The common thread between the pair: institutions building incentive structures that favour immediate profits and glory with little regard to how short-term bounties can ultimately harm a longstanding franchise.
Hwang, an alumnus of Tiger Management, had been using margin loans provided by the prime brokerage groups of such banks as Goldman Sachs, Morgan Stanley, Nomura, Credit Suisse and others.
Catering to the multiple needs of high rollers such as Hwang is a lucrative business. It is also one that is difficult to turn down when so many others on Wall Street provide the same product. Hwang was, however, a trickier case. He had been banned from the securities business a decade ago in Hong Kong over insider trading charges. “It’s pretty hard for me to defend why we loaned him so much,” said an executive at a bank with billions of dollars of exposure.
According to Financial Times reporting, Goldman had kept Hwang on a blacklist until bankers were able to convince the compliance department that he was worthy of being a client. The decision is even more poignant after the company, perhaps the most elite on Wall Street, had just been punished over its role in the 1MDB corruption scandal and its ties to Jho Low, the Malaysian businessman allegedly behind the looting at the sovereign wealth fund.
Goldman pledged that it would do better in vetting clients as evidence from the justice department showed that some at Goldman had expressed concerns about Low’s personal ties. But ultimately the commercial opportunity prevailed.
There is no element of criminality in the margin lending to Hwang. But the heavy leverage banks extended — as high as 20:1, according to the FT — appeared to be driven by Wall Street executives who knew they were being evaluated and compensated, annually, on their ability to reel in clients and revenue. Poor risk management might lead to a bad outcome years down the road but if a salesperson is shown the door for not hitting their commission quota before then, what’s the point of behaving responsibly?
One response is to claw back previously paid bonuses and salaries. Goldman, in the instance of 1MDB, took back cash from as far up as chief executive David Solomon. It is unclear if Goldman will avoid the heavy losses that have struck other Archegos lenders. But watch to see not just whether there is after-the-fact accountability but structural reforms.
Were Goldman youngsters crying for help really acting like entitled brats? The leading question seemed to centre on the character of investment banking analysts. It is more interesting to consider the business decision companies make by alienating their junior workforce. The last page of a slide deck the Goldman kids prepared offered constructive feedback on how to improve their experience (vice-presidents and managing directors could agree on pitchbook content in advance of meetings to avoid wasted effort, for example). These ideas received little attention but were intriguing.
The response from various companies has been to throw more money at analysts and recycle “protected Saturday” reforms that did not work the first time they were offered. The overall attitude is that the workers are like tyres to be worn to the ground and then replaced every few years.
The mistake companies make is that their junior ranks are the most talented, if green, people among their staff. They have the best test scores, degrees and drive. The evidence of this: those who fill the intermediate and senior ranks of investment banks almost never start as analysts. Entry-level hires tend to move on to greener pastures in private equity, hedge funds and entrepreneurship.
The mystery then is why, almost intentionally, investment banks alienate their newbies who, even in the best circumstances, are in a rush to finish their two-year programmes and get out of Dodge (virtually no graduates from Harvard Business School submit to enter investment banking at the rank known as “associate”). If they were to choose to remain, it would be a boon for banks, which struggle to attract top mid-level talent.
The answer is simple: in a historic deal boom, the focus has to remain on winning every merger, initial public offering, debt financing and associated fees no matter the collateral damage. There is little appetite to think strategically about talent and reputation. Of course, Wall Street has always operated this way and has mostly survived. Perhaps a generation with new values, attitudes and incentives will encourage banks to become more enlightened. But do not count on it.
Enjoy the rest of your week,
Sujeet Indap
US Lex editor