Thursday, December 06, 2007

Goldman's success

I had a post yesterday on Goldman's success. I said it wasn't just luck or skill but the uniqueness of its business model that explained its success.

In today's FT, John Gapper argues that the firm benefits from the edge it gets by engaging in activities that involve conflicts of interest:

Big investment banks run advisory, securities and investment businesses but keep them walled off from each other to avoid conflicts of interest and trading on inside information. Goldman has been more aggressive than any other bank in putting the three together – it often advises a company on a transaction, finances it and invests its own money.

That regularly puts Goldman in delicate spots. It swaps from advising on a sale to bidding for the property, or its private equity arm co-invests with another fund in a company its bankers have found for sale. It often faces accusations of conflicts of interest over its overlapping roles but it brushes them off by saying that its job is to “manage conflicts”.

It has got away with this because it is too powerful to ignore. Private equity firms grumble that Goldman advises them on deals and competes with them but they accept it because it has such a big network of corporate clients that they cannot cut it off. One day, however, this balancing act will blow up in its face.

Goldman’s skill, luck and edge have combined this year to produce its great escape. The three will not always align so well.

This is an argument that others have made, notably Philip Augar in his book, The Greed Merchants. Point is: such conflicts of interest are not unique to Goldman. Perhaps the conflicts are more acute in the case of Goldman because of its higher involvement in activities that entail its own capital.

Maybe Goldman benefits more from the access to information it has as a giant investment bank. But how come the others are not seeing such benefits? Because they are not as much into proprietary activities or have not developed as much expertise in these.

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