The curse of Goldman envy

Why did some banks get so badly scorched by the sub-prime debacle and others come through relatively untouched? What's the difference between Citigroup and JPMorgan? Morgan Stanley and Goldman Sachs? UBS and Deutsche Bank? Merrill Lynch and Lehman Brothers?

On the face of things, these companies may look quite similar to those they're paired together with. But Citi, Morgan Stanley, UBS and Merrill have among them written off $65 billion so far due to the credit crisis. Meanwhile, JPMorgan, Goldman, Deutsche and Lehman have only racked up write-downs totalling around $9 billion. The average share price performance of the first quartet last year was minus 36 per cent. The latter group was only down 5.25 per cent.

There are several reasons for this. One, undoubtedly, is luck. But something else explains a lot of the difference. The losers were infected by what one could call Goldman envy. The winners were more immune to the disease.

Goldman envy started to become a serious problem after the turn of the millennium, when that Wall Street firm started to pull away from the investment banking pack. Its profits per employee rose sharply as it deployed more of its own capital to big and sometimes complex bets – whether it was trading securities on its own account or investing in private equity.

Of course, it wasn't just Goldman that had competitors turning green. They also were agog over the burgeoning hedge funds and private equity groups that have been raking it in over the last few years and making ordinary investment bankers seem like poor relations. And many yearned for the juicy returns of Lehman Brothers' mortgage business.

One common response among those lagging behind has been to try to emulate the alpha males of the banking world – in particular by increasing their bets in the once-booming fixed income market.

Former Merrill boss Stan O'Neal would frequently berate his subordinates for not delivering Goldman-like results. Morgan Stanley's ex-second-in-command Zoe Cruz was constantly using Goldman as the yardstick for her firm's performance. And Citigroup executives described the megabank as a growth stock until just recently, putting its businesses under pressure to show commensurate earnings growth.

The snag is that mere desire doesn't turn a chimpanzee into a gorilla. Building successful operations takes time. Part of Goldman's success comes from the fact that its risk-taking approach – and the accompanying discipline of risk-management – derives in part from betting its employees' own money.

But desire can drive reckless growth. Take Citi and Merrill. Five years ago neither was a big player in underwriting sub-prime mortgage bonds and CDOs. But by 2006, they were at or near the top of the league tables for both markets.

The snag is that a bank is unlikely to manage things well when it's expanding rapidly and doesn't have experience. It may put the wrong people into place, not institute the right controls and implement the wrong incentive schemes.

The banks with the biggest problems seem to have made such mistakes. UBS, for example, quickly ramped up its residential mortgage business, but not because there was any strategic value in being in that market. Rather, it decided it wanted to bulk up in the hot securitisation business, and trading and underwriting residential mortgages and CDOs was the easiest part of the market to enter.

So why were other banks relatively immune to Goldman envy? Well, Lehman had a big, lucrative mortgage lending and structuring business for almost a decade. So it didn't need to engage in a break-neck game of catch-up. Deutsche arguably also had a more ingrained risk-taking culture. Meanwhile, JPMorgan had more market-savvy leadership in Jamie Dimon than, say, Citi had in Chuck Prince.

All this suggests two lessons for the future. If you are a chimp, don't try to kid yourself that you're a gorilla. And, if you see a chimp pumping itself frantically with steroids, sell its stock.

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