Smith's Wednesday's New York Times op-ed, written as he left his employer of 12 years, describes the firm's environment as "as toxic and destructive as [he's] ever seen it". It rewards dumping unprofitable Goldman-owned investments and getting clients to trade what brings in the most profit for the bank. It often ignores interests of clients, referred to by managing directors as "muppets", with grave consequences. "The decline in the firm's moral fiber represents the single most serious threat to its long term survival," he writes. If character is destiny, banks' path ahead will be littered with obstacles more deadly than exploded swaps.
Banks relentless search for profits has racked up immense "collateral damage". Investment banks have injured individuals and institutions of every stripe. Institutions include the Greece whose books Goldman cooked; Jefferson County, Alabama, and many European cities devastated by risky derivatives; colleges like the University of Virginia and Harvard who have held cut-rate sales on private equity; and pension funds and others who sued for fraudulent trades. Hurt individuals include veterans overcharged by JP Morgan Chase, Occupy Wall Street protestors unfairly arrested after JP Morgan's huge donation to local police; millions abused in foreclosure and mortgage scams; and hundreds of millions globally impoverished by the crisis. Bank profits and bonuses hit all time highs, even after inflicting this widespread harm.
Of course, the culture of predation extends to institutional and individual investors. Yet few bank insiders and private wealth clients have shared their experiences. This critical relationship at the heart of the risky, dysfunctional financial system -- where clients give money and banks often invest it as they like -- must be examined.
Our family's experience provides a glimpse into sector once touted as a replacement to manufacturing, one whose "innovative products" represented a major American competitive advantage.
Since several years before the crash, our family has worked with Wall Street banks who helped invest foundation money and assisted in other capacities. Sometimes the relationships have been positive and responsive. But too often dealings have reflected banks' priority on their own profitability. The culture and practices described by Smith viewed from the outside look no better.
In the mid 2000's when we were investing, skepticism over mutual funds led many clients to consider allocating equities to index-based, low-fee exchange traded funds. Investment advice was becoming commoditized. Thus bankers developed model portfolios that allocated 15 to 70 percent to "alternative" investments -- like hedge funds, private equity and real estate -- saying it would dampen volatility and boost gains. Bank often earned 3 to 7 times more than on ETFs (now clearly just part of their profits), and only later did we learn that these products destabilized economies and hid predatory practices. But at the time "absolute returns" -- no negative years -- and mid-teen performance on private equity were said to be well worth the fees and lack of liquidity. Banks then exaggerated investor experience to make them appear "sophisticated", i.e., aware of the risks since shown to be so opaque they have devastated economies.
Enter 2008. A reported 15 percent of hedge funds close and banks quickly slash the leveraged buyout allocation to near zero (although sales, except at a steep discount, were near impossible for owners). Yet less than two years later banks again marketed portfolios with high alternative allocations, and placed investors in stock and bond products of even greater risk. JP Morgan recently rocketed into the top 10 stock and bond fund managers, but their new products often use complex derivatives profitable for them and potentially destructive for others.
With us, banks have pushed investments through a dynamic of belittling, evasion and distraction that make celebrity divorces look like models of healthy communication. Pre-crash, one bank evaded repeated questions on increased correlation of assets that would have saved us -- and lost them -- significant money. Repeatedly, quarterly reports were sent later than promised and requested information excluded. Banks have changed benchmarks, and highlighted positive returns while burying information on poorly performing assets. Investments put into our accounts on a discretionary basis have rapidly tanked. Banks avoided answered questions when the responses could highlight product risk, and have provided misleading risk information. Despite being told not to pitch proprietary products and to focus on ETFs, financial institutions repeatedly recommended bank-owned hedge and other funds and structured notes. Recommendations were rarely provided in the requested format outlining charges and non-bank-owned, low-fee options. They have steered us from gold, foreign currencies and US Treasury Inflation Protected bonds that earn them little, though these investments would have provided high returns and true diversification. The result? We've stayed in risky products longer, racking up bank fees while depressing our returns. Our family and many others are still very fortunate and wholly undeserving of pity. But practices causing almost universal harm must be fixed.
As a start, banks should be required to disclose their company-wide profit on the sale and management of investments. Forward-looking risk/return analysis, concise and comprehensive reporting, and a clear explanation of conflicts of interests should also be mandated. But insiders and clients must publicly discuss their experiences also, and the media and government investigate to help evolve this dysfunctional system. Bank profitability too often comes at a heavy costs to humanity. Banks don't do business with puppet characters but with people deserving of complete information and unbiased advice.