Goldman Sachs in the Great Depression

The Stock Market Crash of 1929, the panic that led to the Great Depression, was not the best time to be a banker. It was an even worse time to be a trader as strategies that worked in the boom years now produced only losses. Goldman Sachs was both a banking and a trading organization, shepherded into the latter business by its chief executive Waddill Catchings. His creation, the Goldman Sachs Trading Corporation, invested the firm’s equity capital and the investments of clients in the stock market using leverage. The crash took those investments down to nearly zero. It took years for Catchings’ successor Sidney Weinberg to restore the firm’s standing.

Roaring Twenties

The 1920s were an exuberant era in America, and in American finance in particular. Not only was the economy performing well but the common man seemed able to participate in that prosperity to a higher degree than was previously possible. This expansion was peculiarly characterized by consumer spending; this seemed to set it apart from earlier booms. The decade ushered in the modern American economy.

In financial markets, the public flocked to invest more of their money as stock prices rose. The range of investment products offered to individual investors was growing, especially with respect to the stock market, which had previously been virtually inaccessible to ordinary people. Now they could even buy stocks with borrowed money. Closed-end funds kept sprouting up and still had no trouble finding new investors during the boom. These investment trusts were set up by banks and were listed on the exchange. So easy were they to access and so sought after were they that the funds’ shares often traded above their net asset value.

Catchings

Goldman Sachs entered this era of plenty on an unsteady footing. Henry Goldman, whose pro-German views got in the way of his fellow partners’ desires to participate in syndicating loans to Allied governments during the First World War, had departed the firm. His departure, after thirty-five years at Goldman Sachs, caused money and clients to exit the firm. The remaining partners looked outside the Goldman and Sachs families for a new chief executive, a first for the company.

To manage their firm, they secured Waddill Catchings, an ambitious and experienced man but also a self-assured risk taker. The partners must have thought this was the ideal man for the times though and he wasn’t only hired from outside the founding families but was hired from outside the firm altogether. Judged to already be on an illustrious career path, Catchings was a Harvard Law School graduate who had experience leading reorganized companies.

GSTC

Waddill Catchings was initially suspicious of the investment boom underway but this caution gave way as the decade went on. Catchings wanted Goldman Sachs to enter the investment trust business, a party to which it was late. To do just this, the firm established Goldman Sachs Trading Corporation (GSTC), an investment trust, in 1928 just as the twilight of the era’s prosperity drew near. As it was being drawn up, the contemplated size of the new venture grew from $25 million to $100 million. Of this amount, Goldman Sachs retained 10% in the form of GSTC shares. Goldman would also be paid 20% of GSTC’s net income as a management fee.

The remaining shares were sold to the public at a 4% premium and were still oversubscribed. Thereafter, they quickly doubled in value to $226, twice the trust’s book value, partly because of investor enthusiasm perhaps but also because the firm was a heavy buyer of its own shares. By acquisition of another firm, the assets of GSTC reached $244 million within three months of the initial issue.

Under Catchings, Goldman Sachs attempted to wring more profits out of GSTC and that meant managing more money. However, doing this by simply issuing more GSTC shares would also dilute its stake in the trust by an equal degree. So, a new trust, Shenandoah Corporation, was formed in July 1929. This new vehicle issued both common and preferred stock; GSTC took most of the common stock and other investors bought the preferred stock. The one-third of the capital structure comprised of preferred stock, that in some ways resemble debt financing, allowing Goldman Sachs to leverage the investments it managed.

Just twenty-five days later, Blue Ridge Corporation was established by Shenandoah Corporation and copied the Shenandoah model. Shenandoah kept most of the common stock and preferred shares were sold to the public. Blue Ridge’s preferred stock made up 44% of its structure. The effect of these nested companies, Blue Ridge within Shenandoah and Shenandoah within GSTC meant that Goldman Sachs was able to leverage its investment holdings even further. The result was that small increases in share prices could translate into larger increases in the value of Goldman Sachs’ investments but large losses were also magnified.

Crash

The beginning of the end came in 1929. Nonetheless, that year actually began very well. The Dow Jones Industrial Average started 1929 at 300 and peaked at 381 on September 3. New common stock issues, which averaged $500 million per year in the past, had summed to $5.1 billion that year, with investment trusts dominating the list of issuers. In September 1929 alone, more than $600 million in investment trust securities were issued. The stock market crash came in October and though the Dow Jones Industrial Average eventually finished the year at 248, this was only after a strong recovery partially made up for some of the ground lost in the drawdown.

Some shares performed worse though. In the infamous stock market crash that began in October 1929, common shares in GSTC fell from a peak of $326 to a measly $1.75, down more than 98% from its initial offering price. The shares did so poorly because investment income fell so much that the company couldn’t make the required dividend payments on its preferred shares, which had priority over the common stock.

The virtual failure of GSTC stood a chance of ruining Goldman Sachs, not only because of its own investment in GSTC, but because of the damage GSTC sustained to its reputation. While the industry at large was reeling, its losses were mammoth compared to those of other firms. Of the $172.5 million lost by the fourteen leading investment trusts, GSTC accounted for 70%. GSTC was wound up, with much of its assets sold at substantial discounts, and the partners at Goldman Sachs parted ways with Waddill Catchings. He was replaced with a very different man, Sidney Weinberg.

Weinberg

Once as unlikely a candidate for the post as could be imagined, Sidney Weinberg had worked at Goldman Sachs since 1907, when he was a 16-year-old high school dropout bearing scars from knife fights in search of a job. He was hired as a janitor’s assistant. Paul Sachs, the grandson of the firm’s founder, promoted Weinberg from this post to a job in the mailroom. After this, Weinberg would eventually become a trader, a member of the New York Stock Exchange, a partner at the firm and, in 1930, the CEO of Goldman Sachs.

Weinberg had been the principal assistant to Waddill Catchings and was assistant treasurer at GSTC, but rather than sink his upward-bound career, the crash accelerated it. His knowledge of GSTC’s dealings helped secure his place as the firm’s next chief executive. He also secured directors roles at many of the firms GSTC had invested in.

He was leading a badly battered firm. In the crash, Goldman’s capital fell to levels it had crossed thirty years earlier; a generation’s progress was lost. Weinberg oversaw a period of recovery, but as with the broader economy, it came slowly. In the early 1930s, the firm hadn’t led or co-led a single underwriting. Nevertheless, the company fought to retain clients and settled legal cases arising from the failure of GSTC.

Recovery

In 1935, new business finally trickled in, marking an end to the firm’s decline. Still, this consisted of just three debt placements for less than $15 million in total. Consistent profitability would still be a decade away, indicating just how persistently difficult the Depression was for Goldman Sachs. Perhaps because work at the firm hardly abounded, Weinberg served under the administration of President Franklin Roosevelt, exercising a habit of Goldman Sachs executives obtaining prominent roles in public service that continues to this day. Weinberg also spent some of the Depression years as a member of the New York Stock Exchange Board of Governors.

Weinberg became very good at winning clients. Many of these came from his position on companies’ boards and from government service, where he frequently connected government officials, including President Roosevelt himself, with chief executives at other firms. In time, Ford became one of the most notable of these clients and Weinberg eventually positioned Goldman Sachs to underwrite Ford’s initial public offering in the 1950s. The janitor’s assistant turned CEO gave up day-to-day responsibility for the company in 1963. By the time Weinberg died in 1969, he was known as “Mr. Wall Street”. His obituary was printed on the front page of the New York Times, on a day that coincided with the Apollo 11 mission.

Lesson

Their lives prior to leading Goldman Sachs were very different, as were their tenures at the helm of the investment bank. Catchings’ caution did not survive the boom and when he committed himself to seizing the opportunity afforded by the mania of the 1920s, he did so boldly, imprudently, and belatedly. As a result, Goldman would barely survive the crash. Weinberg came to see the consequences, namely how quickly leveraged bets can unravel and just how slow and uncertain a recovery can be by comparison.

More from the Tontine Coffee-House

Learn how Business Week covered the Great Depression. Also read about the Depression’s effects on another American financial institution, the Federal Reserve. Lastly, consider subscribing to this blog’s newsletter here.