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4.0 out of 5 stars A Partnership No More, 11 Nov. 2011
This review is from: The Partnership: The Making of Goldman Sachs (Paperback)
The title of Charles Ellis's book refers to the fact that, from its 1868 inception up until the firm's IPO in 1999, Goldman Sachs was run and owned solely by the partners at the firm.

This book chronicles the story of Goldman Sachs from its early days right up to the present crisis. Two themes run throughout the pre-IPO years: an unrelenting drive to service the needs of the client, and the many synergies from expanding into new products which allowed the firm to grow to the size it is today. For example, the firm's push into research gave institutional investors added incentive to use Goldman Sachs for executing large block trades of stock, while the firm's block-trading salesforce allowed it to quickly shift new underwritings of stocks and bonds from the firm's investment banking division. The firm is well known for its "Business Principles", formerly drawn up in the late 1970s, the first of which states: "Our clients' interests always come first".

These two themes reversed with the firm's IPO in 1999, and to me this is a great example of the problems with modern finance. Due to lower brokerage costs and commissions, financial firms are forced by the search for profits to expand themselves into risk-taking investments themselves, instead of acting as a disinterested intermediary between firms and investors. This means that what were once synergies between different departments now become conflicts-of-interest, as information derived in investment banking becomes of enormous value to the firm's traders. Of course, firewalls are put in place to stop such information leakages occurring, but such conflicts are bound to hamper the firm's stated mission to protect its clients' interests first of all, especially when the firm ends up taking positions opposite to its clients for its own account (which is what happened with the Abacus CDOs in 2009).

The partnership governance structure was a great way to make sure all employees of the firm were pushing in the same direction, as all partners were fully liable for any losses. The current limited liability structure leads to perverse incentives: since any loss is limited, employees have an incentive to take risks which might not be profitable if they had a full share of the downside.

It's a shame that this book doesn't fully flesh out these problems with the current-day Goldman Sachs, but I was impressed by the book's treatment of the firm's early years -- when it was, in fact, a partnership.
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