August 1, 2014 by Speakers' Spotlight
Greg Smith On How To Make Capitalism More Transparent
In 2012, a Goldman Sachs vice-president, Greg Smith, set the media world alight, and caused much anguish among financial institutions, when he resigned from Goldman Sachs in the most public way possible: an explosive reveal in The New York Times, which claimed the Goldman culture to be “toxic and destructive.” In this interview with Real Leaders, he reflects on this time and shares his vision for the future of big finance:
What made you take on one of the most powerful financial institutions in the world? What did you hope to achieve?
First of all, I wasn’t trying to take on one institution – I was trying to do what I thought was the right thing. My message is not just about Goldman Sachs, which is very similar to many of the other major banks that survived the financial crisis. Some of it has to do with my generation, versus my parent’s generation. I grew up being very idealistic. Parts of big finance have become a golden goose that many know has serious ethical problems, but no one’s willing to talk about it. This became increasingly uncomfortable for me.
To a large extent I drank the Kool-Aid at Goldman Sachs. I was one of the heads of the summer intern program, used to fly to Stanford twice a year and recruit new people. I was very proud of what I would call the “old culture” of banking, that was focused on the long term, and where you aspired to develop ten year relationships with people. In the early 2000’s, the majority of regulations that kept this old banking system in place, got overturned. Derivatives got deregulated and leverage limits disappeared, which was actually a symptom of a much larger problem – that the industries with the most money effectively controlled politicians, who changed the rules in order to get more campaign contributions.
With less rules, the old world model of, “Let’s first do right by the customer and the profits will follow,” turned into, “Let’s make five times more profit today, because we’re only in this business for another five or six years.” There was an attitude of not caring what happened next. And it wasn’t illegal either, as long as they followed the letter of the law.
It was a scenario of drawing a line between what’s legal and ethical, and what was being done beyond that line, that many know is unethical. It was usually justified because their bosses were doing it or they were getting paid a lot of money to do it and customers weren’t going to realize anything for a long time. This became something I didn’t want to do anymore. Much has been made of the letter I wrote, that was published in the New York Times, but this came at the end of five months of writing my thoughts down and realizing that I could actually do something positive. I thought that if companies were not willing to change this culture internally, maybe forcing the change would work, because frankly, the systems are far too complex for politicians or the public to fix. I came to believe that people within the finance industry could become a part of positive change. It was almost like a calling, that it was the right thing to do. If I hadn’t done it I would have felt I’d done the wrong thing by not speaking up.
Where does your idealism come from?
I am not sure but possibly from my upbringing in South Africa. I come from a Jewish family where my mother set a good example for us growing up. I always tried to be one of the kids who spoke up when I saw something being done wrong, instead of keeping my mouth shut. My upbringing in South Africa also made us see a lot of injustice and terrible inequality which I have thought has had a strong impact on me and the way I look at the world
Can you give an example of the real world effects of casino style Wall Street speculation?
During the European sovereign debt crisis I saw the panic being used as a reason to confuse investors and drum up business. I saw the very direct and very real world effect on hundreds of thousands of citizens in Greece and all over Europe, who were protesting on the streets, while behind the scenes the major banks were helping the governments gerrymander the books and make things look rosier than they were. This was not a game anymore and brought financial issues into the real world very clearly. Banking is a vital service in society but the industry lost sight of what banking was. Previously it was about giving loans and helping people invest, but by 2012, 75 percent of revenues were being generated in a casino-style trading environment, which did not have any societal benefits.
Is the secretive world of big finance finally opening up?
No, I don’t think so. I’ve devoted time to understanding how the process works between banks, politicians and the public and what I’ve concluded is that the opaque system as it is today has purposefully been created.
At worst there are politicians and regulators taking campaign contributions to keep quiet or change the laws, and at best there is just not enough knowledge around the intricacies of finance. It seems purposefully so, because the more murky things become, the more money banks can make, without people directly being able to accuse them of doing wrong.
In 2010 President Obama passed a massive financial reform bill, yet most people don’t know that only two thirds of that bill has ever been implemented. All the major structural causes of the financial crisis, such as derivatives, proprietary trading and being too big to fail, are all still in existence. They have not been fixed and close to $500 million of lobbying money has been spent trying to kill these bills. I have spent time trying to advise some politicians in Washington DC, as well as regulators like the Federal Reserve, the U.S. Securities and Exchange Commission and the Office of the Comptroller of the Currency. I have been trying to bring a “no spin” approach of what’s right and wrong in banking and ways in which it potentially risks bringing down the whole economy.
What opportunities have arisen as a result of your decision to expose Goldman Sachs and the world of finance?
I must stress that Goldman Sachs is just one bank among many doing very similar things. Everyone has seen the $13 billion JP Morgan settlement, the Libor fixing scandal, the FX trading scandals and countless others. People said I couldn’t say the things I said, that Wall Street wouldn’t be happy, but the truth is Wall Street is made up of both banks and investors. Investors don’t want to have the wool pulled over their eyes or have hidden fees extracted out of their accounts. People forget that trillions of dollars of public investments are wrapped up in things like teachers pension funds, charities and endowments. These investors are a vital part of Wall Street too, and should be just as much a part of the dialogue as banks.
What I’ve been trying to do, aside from helping with some of the regulations, is to help empower investors, who’ve been very receptive as they’re worried and befuddled by this opaque system. The answers you get from investors with $100 million pension funds who still do business with these banks, is that they’re too scared to ask questions or that there’s no competition, or they have no other choices.
The two classes of investor, considered the least sophisticated by large financial institutions, are public investors, such as pension funds and charities and surprisingly, ultra high net worth individuals. This is not because Wall Street perceives them as not being smart, but because they know that these CEO’s and business leaders spend 99 percent of their time focusing on running their own businesses, not watching and understanding their investments. They’ll extract as much money from a high net worth investor as possible, up to a point that the person does not get suspicious. In my mind, that’s not banking. Banking should be about trust and fiduciary duty.
There seems to be an ongoing trend of people exposing the secretive dealings of large corporations and institutions. Julian Assange and Edward Snowden come to mind. What is causing this?
I wouldn’t associate myself in the same category as those two individuals, more in the category of the millennial generation. Some people will say that capitalism is about doing anything as long as you don’t go to jail and if the person on the other side of the transaction is foolish enough to fall for it. It’s a case of “buyers beware,” and they should have known better.
Business needs to have more idealistic leadership, where you do things right by the customer and know that profits will follow. Over the long run you will do far better. We live in a world where its all about the short-term, maximizing your personal bonus and exiting the industry leaving whatever mess is left behind for someone else to clean up.
I’m hopefully part of a movement that is steering us back towards doing the right thing with customers, having a long-term mindset and having transparent earnings that your investors can understand. Ironically, openness will actually increase stock valuations. If investors have greater transparency into where banks’ revenues are coming from, they will value the stocks at higher levels.
Leaders who have a long-term mindset and an ethical framework of capitalism realize that brand is important, customer loyalty is important, and not only important for six months or the next quarter, but for ten or even a hundred years, to guarantee the future existence of your franchise.
The Silicon Valley mentality is a good example. They make a lot of money but they create a product that actually does something, it actually adds some kind of value that changes the world in a meaningful way. The financial industry at times moves money around in ways that people don’t understand, and extract a fee to do that, until they’ve got a $10 million bonus in their pockets. Young people have realized this and become disillusioned. They want to live their lives along a moral framework.
Some people think they can change the system slowly from the inside and others, like you, decide enough is enough and accelerate the process. How do you suggest people begin this change?
Our parent’s generation was about loyalty to a company, regardless of what the company was doing. Our generation has a loyalty to values. I saw someone in the Christian Science Monitor write about this.
When the money is so great and people are caught up in a system, it’s very hard for people to voluntarily change the game en masse. To find a solution you’d think we might need to elect politicians, who’ll do the right thing, but I don’t have a lot of faith in politicians because of the powerful lobbys and big money that’s around to defeat new legislation.
Change must come from people within the industry, who have a long-term mindset and who are not trying to hurt their industries, but rather make them stronger, more stable and more sustainable. I think it’s people’s moral obligation to try to change their organization for the better.
Most people, behind closed doors, will admit that the ingredients of our financial crisis still exist and there are many bubbles still being inflated. Another worrying fact, that most people don’t know, is that almost 80 percent of stock traded on the NYSE is done by computer. This doesn’t create a stable environment for the average investor. Companies are making billions of dollars profit by placing computers on a stock exchange and effectively extracting money.
Computers are able to buy stocks in a split second, long before any manual purchase by an investor, and they’re effectively making an immediate profit of one cent, millions of times over. At the end of the year they have billions of dollars profit. Why is it fair that some wealthy hedge funds can place their computers closer to the stock exchange than others, to take advantage of latency times on networks?
Unfortunately, as the economy gets better, the crisis recedes into memory and the public just wants to get on with their lives. One example of changing things would be to educate retirees on how financial markets work, who could then apply pressure to fund managers who control the hundreds of billions of dollars of retirement money. If the public doesn’t understand these things, the problems can go on forever.
We’re seeing more and more black swans, hard-to-predict and rare events in history. These are only supposed to happen once every few hundred years, but are now happening once every ten years. It’s not a healthy sign.
We need to make finance simple again, make it transparent, regulate derivatives, get rid of proprietary trading, makes banks smaller and educate the public. Yet, banks have a vested interested in keeping things complex.
Are you planning to set up a new company to achieve this or would consulting as an individual be more effective?
I am already consulting to and advising some investors on how to invest their money efficiently at lowest possible cost and without hidden fees. Another goal of mine has been to talk about and promote the Dodd-Frank Act in the U.S., which is aimed at protecting consumers and improving accountability, in particular the Volcker rule, designed to eliminate casino-style betting and speculation that played a key role in the 2007-10 financial crisis. I’m also trying to speak to as many students as I can around the world about finance. The students expect me to tell them not to go into finance, but I actually tell them finance is great. The reason I went into finance is because I was interested in speaking to the smartest investors in the world.
Young people should go into finance, but with their ideals intact. When they see things happening that are not in line with what they believe, they can make a huge difference from the bottom up, by changing the ways things are done and speaking up.
Do you think that large amounts of money can still be made in an ethical manner? Profit is usually made at the expense of others, that’s the nature of capitalism, but do you think people have to adjust their expectations?
I’m absolutely a capitalist, and every one of your readers is a capitalist, but I think we need to define what free market capitalism really is. There are a few principles you have to have in place for capitalism to work: an even playing field where everyone has an equal shot at making money, no-one taking short cuts, and no-one with inside information. Everyone needs to understand the rules and it all needs to be played out openly where everyone can see it. In finance two thirds of money is made behind closed doors, unregulated, no one sees these things publicly. That’s not capitalism anymore; it’s a rigged system.
New kids, right out of college and university, start copying what their bosses are doing and the cycle continues. This doesn’t happen over a few days, but over many years, so leaders should check their business principles daily to ensure they’re not surprised to find how far the culture has strayed in ten years time.
Entire civilizations and cultures have eroded from bad financial judgments. Are there any lessons from history from which we can learn?
If we could go back in time to the 1990s and ask people if Arthur Andersen would still be around in the future, or ask the same about Enron, people would have bet significant money that these were real brands, pillars of business that would be around for a very long time. We forget that it can disappear in a second. Once you’ve lost hold of your culture, your ethos and what you’re in business to do, things can unravel quickly.
Look at the big banks that are incurring billion dollar settlements, you would think the financial media would be calling for the leaders’ heads, but instead they’re praising them by saying how well they’ve survived the crisis. Because they’re making huge profits, it’s assumed they must be the best in the business.
The real test would be whether customers trust them, this is more important for forecasting long-term success, not by measuring quarterly profits. You should be asking whether you have a strong enough ethos in place, with a strong enough customer base to ensure you’ll still be doing business in 50 or 100 years time.
If you only see your customers as a tool for profit you’re getting into very dangerous territory.
How do we create a world that is both economically prosperous and has conquered our numerous challenges, such as runaway consumption and resource scarcity?
The more that businesses can move into products and services that are net positive to the world, the more there will be profits to be made in these new spaces. Look at the many new and innovative environmentally impactful businesses that have emerged. Look at Tesla (founded by South African Elon Musk) – a company that makes electronic cars, or any of the many businesses that are trying to look towards an energy and environmentally sustainable future. It shows the public is hungry to do things the right way. Show people a great product that’s good for the world and you’ll make a lot of money. Things that people recognize are essential for our collective greater good get people excited. The first movers into that space will capture huge pieces of the pie and build mindshare with consumers.
What characteristics do you consider essential in a real leader?
I was once told about a leadership idea that I found very powerful called the “authenticity test” or “onstage/offstage test”. Does the leader act the same way and treat respectfully all employees of the company, from the post officer, janitor and first year out of college, through to the CEO or chairman of the board? Is the leader the same authentic person in his or her personal life as in professional life? I have often found that leaders who pass this test are not only the most admired leaders up and down the chain of command, but they are often also the most successful and effective. Because they are real and show their true selves at all times. Seeing the CEO of the company devote five minutes of undivided attention to the newest member of the team seems like a simple idea, but it has a profound impact on the culture of a place and sets the right tone from the very top down.