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Updated: August 11, 2010 15:45 IST

Enterprise of investment banking

D. Murali
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In an age that had no personal computers or Internet, email or adding machines, when business was developed solely with talent, imagination, and brains, Henry Goldman, the legendary progenitor of investment banking, was responsible for the initial organisation of many of America’s most successful publicly-owned corporations, writes June Breton Fisher in ‘When Money was in Fashion’ (www.landmarkonthenet.com). Among the companies that she mentions are Sears, Roebuck & Co; the Underwood Typewriter Company; May Department Stores; F. W. Woolworth; Jewel Tea; and the Brown Shoe Company. Until his retirement from Goldman Sachs in 1917, he was a hands-on director of all these concerns, for which he did not accept any pay, adds Fisher, about her grandfather.

While noting that investment banking, which survived intact for over a hundred years and only came to be truly challenged as a result of the economic meltdown of recent times, the author recounts how Henry saw the gold standard as a bulwark against runaway government spending, and for years cautioned governments, corporations, and his own family about the perils of relying on ‘soft money.’ He held little sympathy for those who lost everything because they insisted on living beyond their means, she informs.

“There would have been no seat in his boardrooms for venture capitalists and hedge funds managers of the here and now whose primary goal has been to grow their bank accounts by making money from money, regardless of the impact on society. He never forgot where the buck stopped, and where responsibility lay.”

District market

The book opens with a nineteenth-century photo of Trappstadt, ‘one of a number of small villages that dot the rolling green wheat fields and dense forests of the Bavarian countryside,’ where Henry’s father Marcus was born, as the eldest child of Wolf Goldmann, a farmer and a cattle dealer.

Stirring nostalgia can be Fisher’s description of the district market in Bamberg, nine miles away, held at the Maximiliansplatz, the largest square in the city. Every imaginable fruit and vegetable and vegetable was sold there – fat white asparagus and luscious strawberries, and mushrooms, potatoes, cauliflower, and cabbages harvested in fall, she begins. “Around the corner, overlooked by the Gabelmann, or Neptune Fountain, there was a large flower market where ladies from the surrounding manor houses sent their servants to fill baskets with roses, lilies, and marguerites…”

For a better life

And after the closing bell, what was the gossip that farmers had in the beer kellers on the street – ‘there were sixty-five of them within the city, some over a hundred years old’ – over a pint and a pipe? “The conversation was always spirited and spiked with acrimony about the peasants’ lack of representation in the government, the economic havoc wreaked by endless wars among Germany’s many feudal states, the punishing taxes from which only the rich seemed to benefit. And, not least, the ‘blood money’ extracted by the government to obtain papers allowing those from the less privileged classes to emigrate in search of a better life.”

Pushing a twenty-seven-year old Marcus to a new start in the US was his father, what with Bamberg newspaper running stories almost every day about the grand opportunities available to newcomers in America, the warm welcome they were receiving, the fairness and freedom of a democratic society, chronicles Fisher. “In fact, a recent article had told of an orphan boy named Levi Strauss from a nearby village who had left the Old World and peddled fabrics from a backpack when he got off the boat. Soon afterward, he made a fortune sewing work pants for gold prospectors heading out west…”

Business successes

One of the first investments Marcus would make in the US was to buy a sewing machine. He applied at “the First Bank of the United States for a $5 loan to buy one. He paid $2 down, promising to pay the rest in monthly instalments at 5 per cent interest. He used the balance of the loan to rent a storefront on busy High Street a few blocks from their home, where he started a new career as a tailor.”

His business in Philadelphia prospered. Yet, as the Civil War wound down, in 1869, Marcus took his profits out of the store and relocated to New York, ‘the city of progress, where opportunities seemed limitless.’ By buying promissory notes at a discount in the morning and selling them to banks in the afternoon, he enabled merchants to raise short-term working capital at attractive rates and, at the same time, to garner handsome commissions for himself, writes Fisher. “The notes, originally referred to as trade bills, later came to be known as commercial paper.”

Despite being a newcomer in the field, Marcus could earn as much as $5 million by the end of the first year. His ambition, though, was beyond that; he wanted to join the New York Stock Exchange, where far greater rewards could be realised by selling stocks and bonds. That dream was realised in 1896, when he joined the magic circle of 1,100 members by purchasing a seat for $15,000.

Henry vs Sam

Henry’s entry into the management of the firm happened when he was 43, with Marcus stepping aside. Interestingly, as one learns from the book, Henry was determined to achieve a role of leadership and dominance and prove all the predictions wrong, after years of being made aware that he was expected to fail.

His partner was a polar opposite, Sam Sachs. “Suspicious of everyone, wary, a worrywart, he was the very picture of a turn-of-the-century banker. He was deferential to ‘the establishment’ in society and finance; some called him a bit of a social climber,” reads a portrayal of Sam.

In contrast, “Henry liked to work in braces and shirt sleeves, a Havana cigar ever present in his hand. A creative, ambitious risk taker, his forte was trading railroad bonds, which were the hottest commodity of the time.” As new businesses started up every day, and the distribution of agricultural and manufactured goods was being revolutionised by the rapid spider-webbing of railroads across the country, Henry was itching to get into the action, narrates Fisher. “But Sam shrank away from that plan, leaning toward building the firm’s financial future by expanding its contacts abroad.”

Goldman and Lehman

It is over one of the many lunch meetings with Philip Lehman (the scion of a wealthy Alabama family that had made its fortune as cotton brokers), that Henry discusses the remarkable number of family-owned industrial and mercantile firms turning to Wall Street to raise capital for expansion, the book documents. “Henry observed that they represented a unique, untapped investment opportunity. What would Phil think about diverting some of the Lehman capital from commodity exchanges to underwriting issues for manufacturers and also the retailers who brought their products to market? It was a novel idea with huge upside potential that no one else had even thought of before.”

Accordingly, Goldman Sachs would come up with the clients and Lehman the money, with the two sharing the profits fifty-fifty, notes Fisher. “It was an opportunity for both firms to become full-fledged investment banks, and Phil was enthusiastic. When the waiter presented their bill, the agreement was sealed with a handshake. It lasted over twenty years.”

But how did they price the new securities? Henry believed that retail stocks should be calculated by their earning power, the rate at which they turned over inventory and generated cash, rather than by their physical assets, like steel and railway shares, explains Fisher. This, she continues, was an entirely new approach to financing commerce and probably the only way that start-up companies long on goodwill but short on material holdings could be marketed to an uninitiated public.

“It became known as the price/earnings ratio, and was determined by dividing the company’s closing market price by its per-share earnings. Even today, it is the most widely used method for assessing the value of a security…”

Recommended study over a quiet weekend.

**

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