David Solomon, scapegoat

Good morning. Rates keep on chugging higher. The 10-year yield hit its highest point since 2007 yesterday. Re-accelerating growth and a surge of Treasury supply are weighing on long bonds. One side effect: with growth hot and recession delayed, the yield curve is beginning to un-invert. In the past month, the 10-year/2-year spread has tightened 40 basis points, to minus 66bp, driven almost entirely by a rising 10-year. Signal or noise? Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Everyone hates David

There has been a lot of press coverage this summer about how the chief executive of Goldman Sachs, David Solomon, is not a very nice person and a lot of his coworkers don’t like him much. A long WSJ article said there was tension with other partners over strategy, pay, and personality. An absolutely brutal New York Magazine piece characterised Solomon — in the words of various unnamed current and former Goldman execs — as “a jerk”, “not likeable”, “a prick”, a “short fuse”, and so on. The FT has reported that senior execs are heading for the exits. The Economist sums up the hurt feelings by declaring that “Goldman Sachs has a David Solomon problem”.

I don’t quite know how much credence to give all this. Investment banking and capital markets, Goldman’s businesses, are full of smart, aggressive people who think they should be in charge of everything and have journalists’ phone numbers. Having written pieces about other banks that are a lot like the WSJ piece, I know it matters a lot who the anonymous sources are, and unless you wrote the piece, you can’t know this. From the outside, to know how good a story of this sort really is, you just have to wait and see how things play out.

I agree with Rupak Ghose, who recently argued over in Alphaville that Solomon has, by most objective measures, done a pretty good job as Goldman’s CEO. The stock has performed well relative to most peers during his tenure and the bank has held or increased market share in its core businesses. We can debate the degree of Solomon’s responsibility for the group’s disastrous misadventures in consumer banking, which he did not initiate, but did push hard over the objections of other executives. Everyone agrees, however, that while consumer banking was a bad bet, it was not a terribly big one.

My suspicion is that, to the degree Solomon has a target painted on his back, the reasons might have as much or more to do with structural tensions built into Goldman’s business as it does with his personality.

There are two notable tensions, one historical and one financial. The historical tension, the less important of the two, is that the structure of the global finance industry has changed, and Goldman Sachs is no longer the Big Dog, as it was 15 or 20 years ago. That honour goes, variously, to the big private equity houses, the huge asset managers from whom the private equity houses are increasingly indistinguishable, and the large hedge funds. Goldman, now a heavily regulated bank, is less dynamic, less profitable and less influential than these non-banks. I was struck by this quote in the New York Magazine piece:

“I don’t feel like the place is really Goldman Sachs,” says one of the former partners, whose ex-colleagues now call him daily to complain. “Goldman had that sort of magical cachet of being the smartest guys in the room, and it doesn’t feel that way anymore.”

It is undeniably true that Goldman, and the premier investment banks generally, don’t have the cachet they once did, but it’s hard to see how that is Solomon’s fault. The world has changed steadily since the financial crisis, and Goldman has not been among the big winners from the change. For some people at the group, that penny seems to be dropping only now.

The more important tension is between Goldman’s partners and its shareholders. It is quite simple and obvious, but that makes it no easier to resolve. From the point of view of public market investors, Goldman’s returns are not that great. At the same time, the bank’s partners demand very high pay, and giving it to them is a drag on those returns.

Since 2010 (a year I picked to keep the wild fluctuations of the financial crisis out of the picture), return on tangible common equity at Goldman has averaged a bit over 11 per cent, and tangible book value per share has grown a bit under 8 per cent (my calculations, using S&P Capital IQ data). More than half of the increase in TBV/S is due to share count reduction from share buybacks.

Gerard Cassidy of RBC points out that Goldman’s growth in tangible book value per share plus dividends puts it on top of the banking league table over the past five years — and beats JPMorgan, for example, over five, 10, and 20 years:

The problem is, for Goldman’s volatile, leveraged business, investors don’t think beating the diversified banks is enough. That is why the stock struggles to trade consistently above 1x tangible book value. This may be irrational, but there it is. The company is targeting an average Rotce of 15 per cent to 17 per cent through the economic cycle, and if it achieves that, the valuation will surely rise. But that remains a ways away.

So Solomon sits at the fulcrum of the tension between restive investors and avaricious partners. When the bank tries to achieve some operating leverage over salary expense (which is half of total expenses) by keeping bonuses down, the employees don’t like it much. The extreme volatility of results in the past few years can only have exacerbated these tensions, as has the slow-dawning realisation that Goldman bankers and traders aren’t the biggest Big Shots any more.

Every business faces a tension over splitting the spoils among employees and owners. But at Goldman it is particularly acute because the business is so dependent on employee talent, which is easily portable to other companies. Harmonisation of interests by paying the partners in shares is no help, because the employees understand all the relevant trade-offs perfectly, and will require more pay if it comes in shares, increasing dilution of other shareholders.

Other big banks (JPMorgan, Morgan Stanley, Bank of America) don’t suffer the same problem to the same degree because they have higher returning businesses outside of investment banking and capital markets, which keep investors happy without taking skin off the noses of the traders and investment bankers. Goldman’s consumer car crash has demonstrated how hard these businesses are to build without a big head start. Goldman probably just has to be Goldman.

Maybe Solomon is an abrasive guy. But my guess is that anyone in his seat at this moment would be pretty unpopular.

One good read

“It sounds corny, but money is just not that important to Carl [Icahn] . . . It’s winning that’s important.”