Will More Caution Equal Less Profit for Goldman Sachs?

Daniel Sparks, former head of the mortgages division at Goldman Sachs, testifies before the Senate.
Daniel Sparks, former head of the mortgages division at Goldman Sachs, testifies before the Senate.

Regardless of the legal and political outcomes of today's Goldman Sachs (GS) hearing, it's undoubtedly shaking up the company's rank and file -- and could ultimately end up diminishing the long-term performance of the firm.

After all, the first, and longest, part of the Senate hearing today bore down on four former and current Goldman employees from the mortgages division, not the C suite. The testimonies, starting with Daniel Sparks, the former head of the department (pictured), and including the baby-faced 31-year-old Fabrice Tourre, a vice president at the firm, could well act as cautionary tales for current and would-be employees. Who wants to end up testifying before a Senate panel on deals they sold at the age of 27?

"Very few go into this business thinking that one day you want to be in front of a Senate committee and justify actions detailed in a binder that is bigger than the documents for my house," says Matt McCormick, a portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati.

Selling 'a Shitty Deal'

At the heart of the SEC's case -- and of the Senators' questioning today -- is the allegation that Goldman sold its clients investments that it also had bet against. Chief Financial Officer David Viniar testified that he doesn't necessarily think that's a conflict of interest. But in various emails, one executive called one of the investments "a shitty deal," while another said the firm had managed to "make lemonade from some big old lemons" and a Goldman salesperson described one of the securities the firm was selling as "junk."

In any case, it became very apparent during the hearing that Goldman's view of the world was quite different from that of lawmakers'. For instance, Sen. Jon Tester, D-Mont., expressed surprise that it didn't "click" for any of those testifying that "there was something fundamentally wrong" with how these products were structured, rated, and sold. And as Sen. Carl Levin, D-Mich., rebuked Sparks: "You ought to have some regrets, and you probably do, but won't admit to it."

Consequences of Stopping to Think

Watching former and current colleagues squirm at the televised hearing must surely make Goldman employees think not just about what is profitable for the firm, but also about the fairness of their deals and overall consequences of their actions. "They might feel like they need to be a little more circumspect," McCormick says. After all, Tourre and Goldman are being sued by the Securities & Exchange Commission for fraud, a lawsuit that both say they will fight aggressively.

But if the focus on Goldman and its employees' actions leads its staff to take pause and become more cautious, it could also have a negative effect on future results. Goldman's reputation as the most profitable investment bank on Wall Street is based largely on profits reaped from aggressive trading, especially in recent years.

In addition, Goldman's damaged reputation already has cost it at least one client. According to the Associated Press, Germany's BayernLB bank has cut its business ties to Goldman Sachs because of the SEC's fraud case against the investment bank. And its business relationships could suffer further. While in the past it was perceived as an advantage to be working with Goldman, "in the future it could be perceived to be a liability if this kind of focus continues," McCormick says.