CHAPTER TWO

A Market Education

IWAS AN ODD CHOICE for Goldman Sachs when the firm hired me, at the age of twenty-eight, to work in its storied arbitrage department. Nothing about my demeanor or my experience would have suggested I might be good at such work. The stereotypical personality type of the arbitrageur was, in those days, forceful and confrontational. I was then, as now, a low-key, not manifestly aggressive person. As for my qualifications, I don’t think I’d even ever heard the phrase “risk arbitrage” before I started the job search that led to Goldman Sachs. But as it happened, arbitrage and I turned out to be a pretty good fit.

Arbitrage in its classic form is nothing more complicated than attempting to profit by buying something in one market and then selling it at the same time in another market for a price differential. As practiced in the years before the Second World War, when communication advantages were still possible, classic arbitrage meant trying to capture discrepancies in different financial markets. To take a simple example, the British pound might have been trading at $2.42 in London and $2.43 in New York. If an arbitrageur could buy pounds in London and sell them in New York simultaneously, he would be assured a profit of $1 for every $242 he put up. The only risk in this kind of arbitrage is not completing the transaction fast enough. During the first half of the century, many firms made a steady income from the minor price differentials for the same currencies and securities trading in different markets.

As global communications improved, however, the profit went out of traditional arbitrage. Once everyone knew in real time what the pound was trading at on various markets, the discrepancies became, for the most part, too small to be worth exploiting. But in the years after the Second World War, Gustave Levy, the man I would work for a couple of decades later at Goldman Sachs, helped develop a new business known as “risk arbitrage.” In classic arbitrage you buy and sell the same thing simultaneously. In the simplest form of risk arbitrage, you buy one stock—call it A—that will be converted into another stock—B—once an already announced event, such as a merger, is completed. At the same time as the purchase, you sell B in order to “hedge” the transaction and lock in your profit. There’s an element of risk, because the conversion of A into B isn’t certain—the deal might fall apart rather than close.

Since the 1950s, risk arbitrage on Wall Street has meant buying securities that are the subject of some material event, like a merger, a tender offer, a breakup, divestiture, or a bankruptcy. As a hypothetical example, Big Company might announce a friendly takeover of Acme Industries at the price of one half of a share of BigCo’s stock for every Acme share. Say BigCo is trading at $32 per share. The stock of the target company was trading at $13 before the deal was announced and rose to $14.50 after the announcement, based on its being worth $16 per share once the deal is completed (one half of BigCo if it remained at $32). In a risk arbitrage transaction, you would buy shares of Acme and “sell short” the number of BigCo shares you would receive when the takeover closed. Short selling in this context means selling something now that you don’t yet own to hedge against market risk—in other words, to protect yourself against the possibility that by the time the item you’re buying (A) is converted into the item you’re selling (B), B will have gone down in value. (To sell something you don’t own, you have to borrow it for a fee.) Then when the deal closes, you simply take the shares of BigCo you received in exchange for your Acme shares and deliver them against the short, replacing what you borrowed and closing out the position. Your profit is the difference between the transaction price and the price you initially locked in. Movements of the BigCo stock subsequent to your short sale don’t matter—if BigCo goes down 5 points, it doesn’t affect you because you’ve already sold the BigCo stock short, locking in the spread against the Acme stock you’ve bought.

However, you receive the profit only if the transaction goes through. If the deal breaks up, you are left with a position that you bought at a deal premium (Acme) and a short position (BigCo)—with almost certain losses on one or both. In this type of transaction, the potential profit is much larger than in a classical arbitrage trade—$1.50 for every share costing $14.50 in my hypothetical example. But the risk is also much greater, since the takeover might fail to close for any number of reasons. In practice, such transactions become enormously more complicated and more interesting.

Gus, a great financial innovator with the gentle disposition of an active volcano, had developed this kind of transaction after World War II in response to anomalies produced by the wartime boom. During the Great Depression, a number of railroads had filed for bankruptcy, leaving the prices of their shares and bonds badly depressed. During the war years, however, the railroads had been operating at full capacity and, as a result, were flush with cash. Coming through bankruptcy court, they were due to be reorganized in ways that would unlock their real value. Arbitrageurs like Gus would buy the stock of such technically insolvent companies and wait for them to be restructured.

By the end of the 1950s, that kind of opportunity was also becoming rare. But in the mid-1960s, around the time Gus and his protégé L. Jay Tenenbaum hired me as the junior man in the arbitrage department at Goldman Sachs, the risk-arbitrage business was picking up again, thanks to a wave of takeovers and mergers. By the end of the decade, Goldman Sachs was making significant profits in the context of the times—several million dollars a year—using its own capital for these transactions. Because the work was risky, complicated, and highly profitable, it had also acquired a certain mystique. Firms like Goldman didn’t want their competitors to know how they went about the arbitrage business. In 1966, the year I was hired, L. Jay was quoted in Business Week: “Asking about our arbitrage operations is like walking into a couple’s home and asking about their sex life.” While arbitrage is still a big business on Wall Street, it has become much less secretive.

I’ll try to explain what we did in those days by describing an arbitrage transaction I actually worked on in 1967. Although this deal was in many ways typical of the hundreds I was involved in during my first several years at Goldman Sachs, I remember it well for reasons that will become clear. It was a merger of two companies that were traded publicly: Becton Dickinson, a medium-sized manufacturer of medical equipment, and Univis, a somewhat smaller company that made eyeglass lenses. Under the terms of an announced friendly takeover, Becton Dickinson would buy all outstanding shares of Univis for about $35 million in stock. Shareholders in Univis would get a .6075 share of Becton Dickinson for each share of Univis they held.

At the time the deal was announced, on September 4, 1967, Becton Dickinson was trading at around $55 a share and Univis at around $24½. If the merger was to be completed, A, or Univis, would become B, or Becton Dickinson, and a Univis share would be worth $33½—at the price of Becton Dickinson when the deal was first announced (.6075 x $55). To decide whether to engage in arbitrage, we had to estimate the odds of the merger coming to fruition, what we would make if it did, and what we would lose if it didn’t—my framework, you might say, for dealing with most decisions in life.

Such an announced merger could fail to be completed for any number of reasons. It might be called off after either side performed its “due diligence” of examining the other’s books in detail. Or the shareholders of either company might reject the terms of the transaction as not favorable enough. The Justice Department or the Federal Trade Commission might decide that a combination of the two companies was anticompetitive. Regulatory issues might surface. One of the firms might have a history of announcing deals and not completing them, and simply change its mind or be too unwilling to make accommodations on specific matters that arose after the initial agreement in principle. We would weigh and balance the different factors to decide whether or not to take an arbitrage position.

The first order of business was rapid, intensive research. I had to examine all the publicly available information I could obtain. I had to talk to proxy lawyers and antitrust lawyers. Then I had to speak to officers at both companies, much as a securities analyst does. I almost never had all the information I would have liked. Seldom did I have enough time to think everything through.

But even with as much information and time as I might have hoped for, risk arbitrage would have fallen far short of science. Many of the notes I put down on my legal pad weren’t quantitative or measurable points of data. They were judgments. And once I finished all my analysis and reached a point of relative clarity, a correct answer wouldn’t simply present itself. The final decision was another judgment, involving my sense of a situation. We might pass up a transaction where the numbers looked promising simply because of a feeling that two companies didn’t make a good match or because we didn’t trust some of the people involved.

But recognizing the essential component of experienced feel in this kind of judgment is different from not having a framework and making decisions in a nonsystematic way or on the basis of instinct. Some arbitrageurs at other firms operated on a far more ad hoc and subjective basis, their decisions driven by bits of information, trading activity, and gossip. At Goldman, our decisions were driven much more by analysis. We always tried to think of everything that could possibly go wrong with a deal and then tried to evaluate how much weight to accord to such risks in our analysis. Despite the all-too-human tendency to lose sight of one’s own disciplined framework, we tried our best to be cool and hardheaded. Emotion, like instinct not moored in analysis, could be misleading. If you became frightened easily—or were greedy—you couldn’t function effectively as an arbitrageur.

In merger transactions such as Becton-Univis, our projected loss would typically be much larger if the deal fell apart than our projected gain if it went through. That meant that the odds had to be substantially in our favor for us to choose to participate. But how greatly did they have to be in our favor? Someone who had been to business school would have recognized the charts I made on my yellow pad as expected-value tables, used to calculate the anticipated outcome of a transaction. After a while, organizing my analysis according to these tables became second nature and I’d do them in my head. But I still constantly scribbled notes and numbers on a legal pad—a lifelong habit with me.

The basic inputs in an arbitrage expected-value table are the price you have to pay for a stock; what you will get for the stock if a deal goes through (the potential upside); what you will have to sell it for if the deal doesn’t go through (the potential downside); and finally—the most difficult factor to assess and the heart of risk arbitrage—the odds that the transaction will be completed. With the help of some papers from Goldman’s archives, I’ve re-created an expected-value table for Becton-Univis. After the merger was announced, Univis stock traded at $30½ (up from $24½ before the announcement). That meant the upside potential from an arbitrage trade was $3, because a Univis share would be worth $33½—.6075 of a share of Becton Dickinson—if the deal went through. If the deal didn’t go through, Univis would be likely to fall back to around $24½, giving our investment a downside potential of around $6. Let’s say we rated the odds of the merger being completed as slightly better than six to one (about 85 percent success to 15 percent failure). On an expected-value basis, the potential upside would be $3 multiplied by 85 percent. The downside risk would be $6 multiplied by 15 percent.

$3 x 85 percent = $2.55 upside potential
– $6 x 15 percent = – $0.90 downside risk
————————————————————
Expected value = $1.65

The $1.65 was what one could expect to earn by tying up $30.50 of the firm’s capital for three months. That works out to a return of approximately 5½ percent, or 22 percent on an annualized basis. A lower rate of return than that would have been a red light. We figured that it wasn’t worthwhile to obligate the firm’s capital for a return of less than 20 percent per annum.

I’m simplifying in a variety of ways. You also had to factor in the risk that a merger would break up under conditions that would cause the target stock you’d bought—in this case Univis—to fall lower than its preannouncement floor or that would drive the acquiring company’s stock—the Becton Dickinson shares you’d sold short—higher. Or, even worse, both could occur at the same time. And you wouldn’t just make the decision to invest in this sort of deal and wait for the result several months later. The odds of a merger reaching closure changed constantly over time, as risks emerged and receded and share prices fluctuated. We had to stay on top of the situation, recalculating the odds and deciding whether to commit more, reduce our position, or even liquidate it entirely. And, of course, an arbitrageur would be involved in many such deals at any one time. You had to do a lot of them, because arbitrage is an actuarial business, like insurance. You expect to lose money in some cases but to make money over the long run thanks to the law of averages.

In the case of Becton-Univis, the positive expected value prompted us to take a position—we sold short 60.75 shares of Becton Dickinson for every 100 shares of Univis we bought. As I explained, selling short the acquiring company—which we’d do by borrowing shares for a fee—was a hedge against the market risk. If the stock prices of both companies went down while the merger was under way—perhaps because the sector or market weakened—our profit would still be locked in, as long as the deal went through.

Goldman’s trading records—which the firm graciously made available to us for this example—show that on my recommendation, we initially bought 33,233 shares of Univis at an average price of $30.28 and a total cost of just over $1 million—a significant amount at that time. We also sold short 19,800 shares of Becton Dickinson, into which the Univis shares would be converted. After increasing our positions in the interim, we stood to make around $125,000 if the merger closed. By the end of the year, Becton had risen to around $60, causing Univis to climb to $33¾.

Unfortunately, the deal didn’t work out as we hoped. The merger fell apart in January because an unexpected decline in quarterly earnings at Univis prompted Becton Dickinson to pull out. When the merger went sour, the stock of Univis fell, not only back to its preannouncement price of $24½ but all the way down to $18. As a result, we suddenly had a loss on our books of $485,000. We also faced a second loss on our short position, because Becton Dickinson shot up to $64 after the deal fell apart. We would have to buy Becton shares for $64 in the open market to replace the ones we’d borrowed and sold short at $55, which was going to cost us an additional $190,000. Everything that could go wrong had gone wrong. This was it: the dreaded arbitrage perfect storm.

By the end of January, we were down some $675,000 on the deal. That was a lot of money back then, more than we made on any other arbitrage transaction that year and a noticeable slice out of the firm’s yearly profits. Gus Levy, who always had terrific insight into deals in retrospect, was furious. He stalked around the trading room muttering that we should have known better than to think a merger like that would go through. L. Jay joked afterward that he’d been to “Univis University.”

But a critical point was that while the result may have been bad, the investment decision wasn’t necessarily wrong. After a deal broke up, we’d always reexamine it, looking for clues we might have missed. But even a large and painful loss didn’t mean that we had misjudged anything. As with any actuarial business, the essence of arbitrage is that if you calculate the odds correctly, you will make money on the majority of deals and on the sum total of all your deals. If you take a six-to-one risk, the foreseeable risks will occur and you will lose money every seventh time. Other times deals will break up for reasons that you could not reasonably have foreseen (a potential that also needs to be worked into your calculations). To an outsider, our business might have looked like gambling. In fact, it was the opposite of gambling, or at least of most amateur gambling. It was an investment business built on careful analysis, disciplined judgments—often made under considerable pressure—and the law of averages.

Flux and uncertainty made arbitrage quite nerve-racking for some people. But somehow or other, I was able to take it in reasonable stride. Arbitrage suited me, not only temperamentally but as a way of thinking—a kind of mental discipline. I took naturally to being rigorously analytical in weighing probabilities. I described this as being like a mental yellow pad. Risk arbitrage sometimes involved taking large losses, but if you did your analysis properly and didn’t get swept up into the psychology of the herd, you could be successful. Intermittent losses—sometimes greatly in excess of your worst-case expectations—were a part of the business. I accepted that, though some in our business did seem highly stressed much of the time. Having Gus Levy remind you of all the reasons you were a moron wasn’t always the most pleasant way to begin a day. But not only could I live with risk without becoming a nervous wreck; risk taking actually comported with my way of looking at the world.

Did arbitrage suit me because I instinctively thought the way an arbitrageur thinks? Or did I learn to think in terms of probabilities by practicing arbitrage? Arbitrage certainly reinforced my instinct to look at issues probabilistically. But that instinct had been formed long before I got to Goldman Sachs. The arbitrage business I learned there was consistent with the way I thought about life, as a process of weighing odds in a world without absolutes or provable certainties. This outlook was rooted in my basic temperament and shaped by the intellectual influence of various teachers and friends. Looking back at my life up to that point, I think you could trace the development of the mental processes and temperament of an effective arbitrageur.

   

I GREW UP with the influence of my two grandfathers, Morris Rubin and Samuel Seiderman. As I look back, I think both of these men affected me in ways I wasn’t really aware of while they were alive.

Morris Rubin was my paternal grandfather. He was born in 1882 in Minsk, Russia, from which he fled as a teenager to avoid being drafted into the Czar’s army—somehow, as a young Jew, he didn’t think the Russian military would be a terrific career choice. Morris arrived at Ellis Island as a penniless immigrant at the age of fifteen. The first question he asked was Where can I learn to speak English? He found work delivering milk and in 1906 married Rose Krebs, my paternal grandmother. Born in Poland, my grandmother Rose was the opposite of my grandfather Morris in every apparent respect—taciturn where he was exuberant, a worrier where he was a perennial optimist. They began their married life in a tenement on the Lower East Side of Manhattan.

Sometime after their first child, my father, Alexander Rubin, was born in 1907, Morris and Rose moved to Flatbush, Brooklyn, a rung up the socioeconomic ladder from the Lower East Side. The family did well until the early 1920s, when my grandfather became gravely ill with an infection contracted following a tonsillectomy. After he was on disability for a couple of years, Rose felt that her husband was dying. A doctor told her that his only chance of survival was to live in the sun. So the Rubins picked up and moved to Miami, Florida. After just a few months there, Morris completely recovered.

My grandfather was a little man with a huge force of personality and tremendous commercial instincts. His arrival in Miami coincided with a big Florida land boom and he quickly made a good deal of money speculating in real estate with large leverage. For a short time in the 1920s, Morris Rubin was a wealthy man. Then came the Florida land bust, which preceded the stock market crash of 1929 by a couple of years and wiped him out. This was an enormous psychological blow. In 1930, he arrived at my father’s Columbia Law School graduation unshaven and unkempt, having driven from Miami with a pistol in the glove compartment of his Chevy. Financially ruined and distraught that he couldn’t help his eldest son open a law office in New York, he couldn’t decide whether to attend my father’s graduation or shoot himself.

This story makes Morris Rubin sound like someone for whom financial success was terribly important. But having gotten past that crisis some years before I was born, my grandfather developed an extraordinary sense of equanimity about his lost fortune. By the time I was a little boy, everyone knew him as an irrepressibly affectionate little man with a thick European accent and a joyful attitude toward life. He greeted everyone with a bear hug. Most days, Morris would be out in the garden in back of his house on Prairie Avenue, just a mile from ours in Miami, tending his mango and avocado trees. After his crisis, he still dabbled in the stock market and real estate. But he had somehow changed his way of thinking so that his happiness wasn’t contingent on being wealthy or successful. My grandfather transformed himself into someone whose identity wasn’t tied to his net worth. Though he would never again be rich, he didn’t lament his losses. He had enough to live on, and there were greater pleasures in life.

My mother’s family had been in the United States for many generations. My grandfather Samuel Seiderman was a lawyer, an investor in real estate, a political activist, and a major figure in his Brooklyn world. He knew everyone; his close friend Emanuel Celler was elected to Congress in the 1920s and remained there for five decades. My grandfather was also a founder of a synagogue in Crown Heights, where he lived. Samuel’s wife, my grandmother Ella, presided over the proper Victorian house they built for themselves. Her parents, my great-grandparents, the Schneiders, had been very successful in their own right and lived in the house next door.

My grandfather Seiderman’s great love was politics. He was closely involved with “Boss” John McCooey, the power broker who controlled Brooklyn’s Democratic political machine for the first few decades of the century, through the Madison Democratic Club. At the club’s headquarters in Crown Heights, McCooey would hold court several nights a week, receiving supplicants for jobs, union cards, health care, or other kinds of assistance. He dispensed favors and collected votes in return.

After McCooey died in 1934, he was succeeded by my grandfather’s friend Irwin Steingut, the Speaker of the New York State Assembly and a close ally of New York’s governor, Herbert Lehman. When Irwin Steingut died in 1952, his power and positions passed to his son Stanley Steingut. For many years, my grandfather ran the club for the Steinguts while they were away at the legislature in Albany. Family legend has my grandfather and his colleagues sitting around in the basement of what I remember as their enormous house at 750 Eastern Parkway and choosing judges.

My grandfather Seiderman died in 1958, when I was a sophomore in college, but his influence remained with me: he had made politics seem appealing and his example had helped seed my desire to become involved in the world. I always had a sense of my grandfather as a large presence in his community, mostly from my mother, who admired him enormously. My parents made the point that he was deeply engaged in politics but never dependent upon it financially, and they thought he was effective in his political work partly because he didn’t need anything from it.

I remembered this years later when I became involved in politics, although my focus was on psychological rather than financial independence. Relying on politics for your sense of who you are greatly impedes your ability to remain true to yourself, your views, and your values. Feeling you can walk away allows you the freedom to decide how much to accommodate to the demands of a political environment. And financial freedom—though neither necessary nor sufficient—can help contribute to psychological autonomy.

My mother grew up in her father’s Democratic political milieu. She saw Franklin D. Roosevelt inaugurated in Washington, D.C., in 1933—staying during her visit at the Jefferson Hotel, where I subsequently lived for my six and a half years in Washington. Unlike my father, my mother had a stable, cosseted childhood. The family was prosperous enough to send her on a trip to Italy during the summer of 1930—though by the time my grandparents died, the family money had been greatly diminished.

My mother met my father at a dance at the Waldorf-Astoria hotel in 1933. As he tells the story, he was there with a law client of his who was being honored for a large donation he was giving to a hospital. He and his client were sitting at the head table, and the client was saying that he had made a big mistake by not marrying. My father should avoid such a mistake—in fact, he should ask this young woman sitting nearby to dance. My father looked at the woman and said he didn’t feel like dancing.

Then he looked up at the balcony and saw my mother. “Now, there’s a girl I’d like to dance with,” he told his client. My mother’s father, who was also at the head table, overheard this remark.

“You’d like to dance with that young lady?” Samuel Seiderman said. “That’s my daughter.”

My parents are in some ways an example of opposites attracting. My mother has a positive outlook and a comfortable sense of self. When problems arise, her attitude is that everything will work out for the best. My father has a strong and incisive analytic mind, and he is confident in what he does, but he is also something of a worrier. He doesn’t like to leave important details to others, whether they’re about business, health, or family. These descriptions are as accurate about them in their nineties as I gather they would have been in their thirties. They’ve been happily married, despite the differences in their outlooks on life, for nearly seventy years.

   

I WAS BORN IN 1938, when my parents were still living in Neponsit, Queens. When I was three, we moved to an apartment in Manhattan on West Eighty-first Street across from the American Museum of Natural History. I went to Walden School, a progressive private school on Central Park West, a few blocks from our apartment building. Walden stressed creative expression, cooperation, and social concern. It was the kind of place where the students called their teachers by their first names. My third grade teacher, whom I remember fondly, was Thora.

After graduating from Columbia Law School, my father joined the law firm of the father of one of his classmates, which became Rubin & Hetkin. The firm specialized in real estate but also had as a client The New Yorker magazine, whose board my father’s partner came to join. My dad’s specialty was challenging property-tax assessments. My father also kept a hand in what little was left of his father’s businesses after the crash. One of these was a money-losing mica mining operation centered in the town of Sylva, North Carolina. Mica was an essential strategic mineral used as a wire insulator for airplanes. In the 1930s, it came cheaply from the East Indies and so wasn’t worth much. But when World War II broke out in Europe, that supply was threatened. My father wrote to the War Department, offering to give the mines to the government for free. After Pearl Harbor, the War Department got in touch with my grandfather, asking him to go to North Carolina to run the mines. He volunteered my father, who had spent several summers working in the mines, and my father’s job for the duration of the war became running the operation, supplying sheet mica to the government at a fixed price. When I was four, we moved to the nearby town of Asheville, North Carolina.

The North Carolina Highlands was a beautiful place, but poor and remote. The people in the town called my father “Jew man” and “Mr. Jew.” It was a bit much for my mother, who felt as if she’d woken up in the wrong century. She rather quickly moved back to Manhattan with me and my sister, Jane, who was born in 1942. My father would come home by train every few weeks for a visit. The mining operation roughly broke even, and my grandfather sold it for a pittance after the war.

When I was nine, we moved from Manhattan to Miami Beach. Florida meant a calmer, more pleasant life for my father, who also wanted to be nearer to his father. After we moved, he continued to do some legal work, built a shopping center, studied stocks and investments, and played golf. My mother also played, and she had a shelf full of local club trophies.

I have only dim memories of not wanting to change homes and of trepidation about my new school. At North Beach Elementary, my new teacher, Miss Collins, introduced me as the new boy. “Robbie Rubin has gone to a private school in New York and has never learned script,” she announced to the class. “So let’s all be very nice to him.” As a result, I assume, of this suggestion, I was elected president of my fourth-grade class on my first day. My protests that I didn’t know how to be class president fell on deaf ears. Far-fetched though it may sound, I think you can draw a line from that day to my becoming Secretary of the Treasury forty-eight years later. I wasn’t the class president type, but in a funny way the designation stuck with me. Though I was never a class leader, I held class positions intermittently throughout my school years, including senior class president—which later helped me get into Harvard, and so on down the line.

For a kid like me, Miami Beach was an easy place to grow up. I rode my bike a mile to school every morning and added to my enormous collection of painted lead soldiers. For a while, I had a morning paper route delivering The Miami Beach Sun. I read Hardy Boys mysteries and listened to The Lone Ranger, The Phantom, and The Shadow on the radio. I was a regular participant in basketball and baseball games at Polo Park. To this day, I can summon the starting lineup of the 1954 Brooklyn Dodgers: Roy Campanella, Gil Hodges, Jackie Robinson, Pee Wee Reese, Carl Furillo, Duke Snider, Junior Gilliam, Don Hoak, and whoever might be pitching—Don Newcombe, Preacher Roe, or Carl Erskine.

The rabbi at our temple was an interesting man named Leon Kronish, who tried to get a group of us involved in Jewish thought when I was a junior in high school. Rabbi Kronish told us he didn’t believe in God in a conventional sense. His point wasn’t to shock us, but rather to engage us in ethical and philosophical debate. Those discussions were my first exposure to the term “humanism.” But more than any specific ideas, what I took away from talking to Rabbi Kronish was a sense of questioning and of intellectual exploration—qualities that would become core to my being in later years.

People seldom think of Miami Beach as being part of the Deep South. Yet, growing up, my sister, Jane, and I attended segregated schools and our Woolworth’s had “colored” and “white” water fountains. Jane registered her protest by drinking from the “colored” water fountain and sitting in the back of the bus. I can’t remember ever hearing expressions of racial prejudice from the people I grew up with, but neither was there any evident awareness of the immense injustice being done to so many.

My parents are sociable and always had a large circle of friends in Miami Beach. They enjoyed the kind of social life that was then normal there, playing golf and cards and spending time at the cabana club at the Roney Plaza Hotel. Yet both of them are thinking people, interested in politics and the wider world. We always had a lot of books around the house.

Then as now, I was an avid and eclectic reader. Even at the busiest times, when I was at Goldman Sachs or in Washington, reading has been an integral part of my daily life—history, biography, unusual voyages or lands, or whatever caught my imagination at our local bookstore. For example, not too long ago, I picked up Adam Nicolson’s history of the King James Version of the Bible, which provided a graphic look at an era and described a deep commitment by many people, and Simon Winchester’s book about the creation of the Oxford English Dictionary. I’m usually reading two or three books at the same time and often go back and reread parts of books. When I went down to Washington to join the Clinton administration in 1993, for instance, I took with me two famous books about Africa that I’d read a decade earlier: The White Nile and The Blue Nile by Alan Moorehead, as well as Philosopher’s Holiday, a collection of lively essays by Irwin Edman, which I first read as a teenager. Edman was a professor of philosophy at Columbia when my father was a student there in the 1920s.

By the time I entered Miami Beach Senior High School, I had begun to fish. My friend Bobby Birenbaum and I used to fish in creeks and canals—mostly in places that are dense with hotels and condominiums now. As we got a bit older, we took our rods and tackle all over the place. Most often, we’d drive down to the Florida Keys. The Keys were different then—we could fish off the old bridges for mangrove snapper and sometimes catch something more exotic. My mom didn’t want our fish in the house, but when we caught enough, we’d sell them to a local smokehouse for pocket money.

Fishing became a much more important part of my life in the late 1980s, when I first visited Deep Water Cay on Grand Bahama Island and saw people casting with fly rods. Fly fishing has been a passion of mine ever since—it gives me a feeling of total absorption and removal from the here and now. I can spend eight hours stalking bonefish on the saltwater flats in the Bahamas, or casting to trout on a river or creek, and the time just disappears. My mind focuses completely on the wind, the water, what kind of flies to use, and where to cast. Whatever external concerns I bring with me quickly evaporate.

Back in Florida, we fished with old-fashioned spinning rods. On weekends, Bobby and I would sometimes rent a small skiff with a 10- or 15-horsepower engine to cast for barracudas and dolphin in the Gulf Stream. Or we’d go around the mangrove swamps and back into the Everglades to fish for snapper or sea trout. Once we motored far in and then ran out of gas. Instead of the motel where we expected to be sleeping, we spent the night in the boat, fighting off mosquitoes and wondering how we were going to get back to civilization. The next day, the people we’d rented our boat from sent out a search party that found us. Luckily, no one phoned my parents until after we’d been rescued.

   

ANYONE WHO IS HONEST about having done well will acknowledge the enormous role played by chance. Chance certainly played a big part in my getting into Harvard. My grades were good but not outstanding, and I came from a regular public high school. I’ve always had the feeling, though with no substantiating evidence, that a particular fortuitous incident may have made the difference. My father and I ran into a lawyer he knew at a Harvard Glee Club concert. And this friend of my father’s introduced me to his friend, the Harvard dean of admissions, who was passing through Miami.

When I arrived at Harvard in the fall of 1956, I felt overwhelmed. Half my class came from academically intense prep schools that were feeding grounds for the Ivy League. And much of the other half came from top-notch public high schools. I, on the other hand, had taken four years of French in high school, and when I got to Harvard I couldn’t pass the exam to get out of the entry-level course. In math, I couldn’t even get into the entry-level course because I hadn’t had calculus, and I had to take remedial math.

On the first day of orientation the freshman class met in Memorial Hall. The dean of freshmen tried to reassure us by saying that only 2 percent of our class would fail out. I looked around and thought that everyone else was lucky, because I was going to fill the entire quota by myself. One of the first people I met was a kid from Staten Island whom I saw looking through the course catalogue. But he wasn’t looking at courses. He was looking at the prizes listed at the end of the book, to see which ones he might win. I thought, What a curious way to go through life. I was looking through the same catalogue for courses I might be able to pass.

The dominant emotion of my freshman year at Harvard was anxiety. For solace, I read a little inspirational book that my dad sent me, A Way of Life by William Osler. The book was an address that Osler, a professor of medicine, had delivered to students at Yale in 1913. Osler’s message was that the best way to deal with the fear of failure was to live your life in “day-tight compartments.” At some point, you should climb to the “mountaintop” and engage in self-reflection. But on a daily basis, you should close the door to your larger worries and focus on the task at hand. I tried to take this advice and block out questions about whether I was capable of doing the work at Harvard.

To everyone’s surprise, especially mine, my grades that year were good—so good that my academic adviser called me in for a meeting. He asked if I was okay.

“Why shouldn’t I be okay?” I asked him.

“Well,” he responded, “you’ve done very well and nobody thought you would. Are you sure you’re not overstraining yourself?”

Even after freshman year, I still had a tenuous feeling about being at Harvard. At the beginning of my second year, the teacher of an English literature class was trying to figure out what books to assign that everyone hadn’t already studied. He asked for a show of hands of those who had read various books—classics of English literature by Charles Dickens, George Eliot, and William Makepeace Thackeray. The other students, graduates of places such as Groton, St. Paul’s, and Andover, put up their hands as he named more and more obscure titles by these authors. My hands remained in my lap. It wasn’t only that I hadn’t read these books; I had never even heard of most of them.

For most of those who came from prep school, Harvard was just the next step in their intellectual development. For me, it was all so new, so completely different, that I was forced to rethink everything. Sophomore year, I took a yearlong introduction to philosophy course with Raphael Demos. Professor Demos was a genial little Greek man with white hair and a wonderful gift for engaging students in basic questions. His style was unadorned simplicity. Demos would walk onto the stage in the lecture hall, turn over a wastepaper basket on a desk, and use that as his lectern. He communicated a feeling of vast respect for those philosophers he regarded as great thinkers, such as Plato, Aristotle, Kant, and Spinoza. Trying to understand what these authors were saying was very challenging for me. Then, some way into our yearlong course, Professor Demos assigned the work of several authors whose thinking was not so rigorous. They were easier to understand, but we quickly became aware of the fault lines in their logic. We then went back to Aristotle and Kant with new appreciation for their intellectual power.

Although Demos revered philosophers such as Plato who believed in provable certainty, he instilled in us the view that opinions and interpretations were always subject to revision and further development. He would turn to Plato or one of the other philosophers to demonstrate to us that proving any proposition to be true in a final or ultimate sense was impossible. Demos encouraged us not only to understand the logic of the analysis but to find the point at which the edifice rested on hypothesis, assumption, or belief.

These ideas struck a chord with me; I even considered majoring in philosophy. Although I didn’t ultimately do that, my year with Demos spurred my developing tendencies toward skepticism and critical thinking. I often encapsulate my Demos-inspired approach by saying, “There are no provable absolutes”—a stance bolstered by the larger Harvard ethos of that period. The mind-set among my classmates was one of not accepting dogma, of questioning authority—and in retrospect, I’d say the most valuable development I took away from college was the attitude of never taking propositions at face value, of evaluating everything I heard and read with an inquiring and skeptical mind. But the seed that Demos cultivated and that Harvard nurtured didn’t lead to just skepticism. Once you’ve internalized the concept that you can’t prove anything in absolute terms, life becomes all the more about odds, choices, and trade-offs. In a world without provable truths, the only way to refine the probabilities that remain is through greater knowledge and understanding.

Years later, when I discussed this with Alan Greenspan, he told me that the assertion “All is uncertain” is inherently contradictory because it asserts that uncertainty itself is certain. I didn’t choose to debate the matter with Alan at the time, but one answer is that he was right—the basic assertion of uncertainty is unprovable. But that just leaves us back where we started—nothing is provably certain.

Academically, my plan at Harvard was conventional. Most people who were headed for law school, as I loosely assumed I was, majored in government. I started doing that and then switched to economics. In those days, the focus in economics was largely conceptual, and I found it difficult but engrossing; later, when the field had become much more rigorously econometric, I would not have had adequate math to major in it.

My senior honors-thesis tutor was Thomas Schelling, the economist famous for applying game theory to international relations and thereby explaining the doctrine of nuclear deterrence. Schelling had just come to Harvard from Yale, and I was his only tutee. I spent the summer between my junior and senior years in Cambridge with no job, sleeping on a broken couch in the living room of a shared apartment, and working on my thesis to get a head start. Researching and writing in the stacks of Widener Library every day were among the few projects I really enjoyed at Harvard. My paper was about the relationship between inflation and economic development in Brazil—a subject that attracted me in part because Latin America seemed a potentially fruitful area for entrepreneurial involvement. I found plenty of data and analysis from English-language sources to test various hypotheses about inflation. In 1995, when I met the Brazilian finance minister, Pedro Malan, he’d done his research. He said that his ministry had looked up my Harvard thesis and that my conclusions were largely on the mark.

Socially, Harvard was made up of subcultures. I wasn’t really a part of any of them, but I liked to think of myself as someone who hung around coffeehouses—which in those days didn’t mean Starbucks but places with a bohemian atmosphere and not particularly good coffee. I didn’t actually go to coffeehouses very much, but occasionally I would stop by the Club Mount Auburn 47 or some other club, where people would sit around and some would-be Joan Baez would sing. I liked the sit-around-and-ponder-the-issues-of-life atmosphere.

One of the intellectual movements swirling around in the coffeehouse culture of those days was existentialism, and I related to that in some way. But my version of existentialism didn’t have much to do with whatever I read of existential philosophy. Instead, I would describe it as an internalized sense of perspective. During my years at Harvard, I developed a feeling that, on the one hand, the here and now mattered a great deal, while on the other hand, in the totality of time and space, in some ultimate sense, that significance shrinks. How much will anything that happens today matter a hundred thousand years from now? Somehow, this internalized duality allowed me to maintain an intense involvement in whatever I was doing, while at the same time retaining a sense of perspective and a feeling that I could always opt for an entirely different kind of life.

Not until senior year did I really develop some sense of belonging at Harvard. In reality, my anxiety proved to be unrealistic early on in my college career. But holding on to it, while detrimental in some ways, may have been useful in others. Worry, if it doesn’t undermine you, can be a powerful driver. After thinking I wasn’t going to cross the finish line, I graduated from Harvard in 1960 with the unexpected distinctions of Phi Beta Kappa and summa cum laude, as well as a summa minus on my senior thesis.

After graduation, I sent a tongue-in-cheek letter to the dean of admissions at Princeton, to which I had not been accepted four years earlier. “I imagine you track the people you graduate,” I wrote. “I thought you might be interested to know what happened to one of the people you rejected. I just wanted to tell you that I graduated from Harvard summa cum laude and Phi Beta Kappa.” The dean wrote me back, “Thank you for your note. Every year, we at Princeton feel it is our duty to reject a certain number of highly qualified people so that Harvard can have some good students too.”

   

DURING MY SENIOR YEAR, I had applied to Harvard Law School as well as to the Harvard Ph.D. program in economics. I was admitted to both but couldn’t decide which to do. In fact, I wasn’t at all sure I wanted to do either, at least just then. I went back up to Cambridge in the fall and spent three days at the law school, but I wasn’t ready to roll up my sleeves and cope with the stress of it after having just finished four intense years of college. Everyone else was buying books and looking serious, and that wasn’t for me. So I went to speak to the assistant dean of the law school and told him that I was going to leave.

“You just started,” he said. “You can’t just drop out. You’ve taken a place somebody else could have had.”

I told him that I was dropping out anyway.

“If you drop out, I won’t readmit you unless there are some extenuating circumstances,” the dean said.

We talked some more, and the dean said that if I’d go to see a psychiatrist and the psychiatrist said that I was making a reasonable decision, he would readmit me the following year.

So I went to see the psychiatrist. He told me that when he had been about to begin medical school, he had taken a year off instead and traveled abroad. He said that I was fine—but that perhaps the dean ought to come see him if he found what I wanted to do so troubling.

A few days before law school started, I had run into some college classmates who were on their way to England for a year. One was going to study at Oxford, which sounded appealing. I was too late to apply to Oxford or Cambridge, but I discovered that I might still get into the London School of Economics for that year. I applied by cable, emphasizing my Harvard credentials. The LSE cabled back, accepting me. Then I called my parents and said I had a surprise for them. I was dropping out of law school and going to London.

The only impediment to my immediate departure was that I had to go home to Miami first to meet with a representative of my draft board. Graduate study provided a military service deferral, but the school had to be recognized. My interviewer at the draft board was a southern businessman of an earlier era.

“Well, I don’t know anything about the London School of Economics,” he said. “The trouble with boys of your race is they don’t want to go to war.”

“I have no objection to war,” I told him obsequiously. “I just want to study at the London School of Economics.”

“How do I know this is a respectable institution?” he said.

I offered to get him a letter. So the chairman of the Harvard Economics Department, Arthur Smithies, had to write a letter stating that the London School of Economics was a recognized academic institution.

Before arriving in England, I had never been abroad, unless you count one family trip to Mexico and an elementary school excursion to Cuba. My year in Europe was enormously enlarging—and I’d recommend a postcollege year abroad to anyone who has the opportunity. Just before I left, I had a conversation with a worldy woman in Miami who was a friend of my parents. She told me that I should just open my pores and absorb everything I could. And that, in some reasonable measure, was my approach.

Harvard was an American culture, albeit a cosmopolitan one with quite a few foreign students, especially in the graduate schools. The LSE, on the other hand, was a truly international culture, with students from all over, especially from Commonwealth, former Commonwealth, and soon-to-be former Commonwealth countries. I met Indians, Africans, Australians, and West Indians. The political spectrum these students represented was much wider than what I’d encountered previously. Many described themselves as socialists, reflecting the broad-based support socialism had in both the developed and developing worlds at that time. I thought then, as I do now, that the concept of state direction of economic activity and state ownership of economic resources was likely to be highly inefficient. But debates around those issues also helped form my own interest in the problems of poverty and income distribution.

Meeting people with experiences and opinions so different from what I’d been exposed to was mind-opening. Issues that people at Harvard took to be about standards of living and economics, my Third World friends took to be about dignity and respect as well. For instance, people from the developing world wanted their own steel mills and airlines in order to show that they were just as good as the English and Americans, despite arguments that this was an economically inefficient allocation of resources for low-wage countries. Such arguments were a lesson in how fundamentally different an issue can appear from different perspectives. But the more important lesson, which would strengthen for me as time went on, was the overwhelming importance of recognizing and respecting the dignity of the individual. That respect is a fundamental value in itself. And sensitivity to the basic psychological need for such recognition is also essential to dealing effectively with all sorts of management and policy problems, whether in running a Wall Street trading room or in constructing and implementing international economic policy.

I was enrolled in the LSE as what was delightfully known as an “occasional student.” Working toward a certificate rather than a real degree, I had no real responsibilities at the university. I would go to lectures and write papers for a tutor, but I spent most of my time just talking to people. The sense of freedom was marvelous. In my lodgings on Earl’s Court Road, I could make dinner at midnight, sleep late, and then wake up and read all day if I felt like it. Or I could go to a lecture that looked interesting and then meet a friend and play squash. I worked on my French, carrying a little vocabulary booklet with me on the Underground. I was also a bit of a political tourist, going for instance to a rally in Trafalgar Square for a protest of the assassination of Patrice Lumumba, who’d been elected Prime Minister of the Republic of Congo. I didn’t join in the protest, just watched with interest.

I also got to know an international crowd of people my age who lived in the neighborhood around Earl’s Court Road. There were some faux aristocrats and a few real ones from places like Malta and Poland. With my LSE friends, I sat around and talked about politics, economic systems, and the meaning of life. With the Earl’s Court crowd I went to parties, and once boating on the Thames. I went to Austria as part of an inter-university ski trip with students from Oxford, Cambridge, and Trinity College Dublin—the first and last time I skied. At the same time, I also continued to explore—in my own limited way—the strain within me that identified with the beat generation and its expatriate predecessors of the 1920s and ’30s in Paris. I read a bit of Jack Kerouac and a lot of Henry Miller, which seemed especially fitting in Paris over the six-week-long Christmas vacation. I checked into a cheap hotel on the Left Bank, where some people I knew from Harvard were staying. During the day, I’d go to cafés and sit around talking or reading.

I’ve always thought—probably quite incorrectly—that if my life had taken a different turn, I could have lived the kind of life that those weeks in Paris, or the pre-1960s coffeehouse culture of Cambridge, represented. As the years went by, even as I became part of the establishment, I continued to feel that I could always opt out of the system if I wanted to. I could just say good-bye, put on a pair of frayed khakis, and check into a little hotel in St.-Germain-des-Prés. People who have never seen me without a pinstripe suit may find this somewhat incongruous, but I felt then, and feel even now, that I could comfortably opt for a more relaxed, unstructured existence. That feeling may not be realistic, but my belief in this possibility has been a mental escape hatch in times of pressure. At stressful times in my career, I’ve returned to that idea of sitting around in cafés, reading, and having long discussions about philosophy and life. Sometimes even now I think I could just spend my life fishing, reading, and playing tennis.

Over Easter I went to Italy, and in the summer I drove around Norway, Denmark, and Sweden with a friend named David Scott. I was considering the possibility of staying in Europe for another year when I read a passage by a onetime expatriate, who wrote something to the effect that “if you’re abroad too long, you start to rot.” That, combined with the possibility that my parents wouldn’t be too keen to underwrite another year of undirected foreign activity, made me think it might be time to come home. I said good-bye to Europe when David’s red Austin Healey was stolen in Frankfurt while we were having lunch.

Part of the reason I had such a good time living abroad was that I wasn’t particularly worried about the future. In the back of my mind, I knew I would probably go to law school, either at Harvard or at Yale, where I had also applied and been accepted. I didn’t necessarily want to be a lawyer, but law school seemed to keep a lot of options open. Thanks to that psychiatrist, Harvard had readmitted me. But I ended up enrolling at Yale, which seemed broader and more interesting, and also less intense. My idea, which was somewhat of an exaggeration, was that at Harvard Law School you sit around and discuss contracts and at Yale you sit around and discuss the meaning of good and evil.

   

IN FACT, my experience at Yale Law School, where I enrolled in the fall of 1961, did have some of that quality. In addition to classes and the library, I spent a lot of time discussing issues ranging from the Vietnam War to the nature of the good life. In law school, I had more than ample opportunity to apply the view I had developed at Harvard that all propositions were, when driven back to their core, unprovable. You can have strong moral beliefs developed through your upbringing or education, or through intense religious faith, but none of them are provable.

You can never tell who may come along in life to influence you. Early in my first year, I ran into a third-year student, George Lefcoe, whom I had met briefly when we both lived in Miami. He stopped his bicycle on the street during orientation week to offer me a bit of upperclassman’s advice. George said that doing well in law school was important because it brought recognition, and recognition brought happiness.

I thought that understanding of human nature had the disadvantage of being wrong. “You’re telling me that doing well and getting recognition makes you feel good,” I responded. “But my experience is that it doesn’t work that way.” I told George that I had graduated from Harvard with strong credentials, which had brought one kind of satisfaction, but not the feeling of wholeness or fulfillment he was describing.

Years later, I would still be making the same point in job interviews at Goldman Sachs. When I’d ask interviewees why they wanted to work for us, the more honest ones would admit that at least part of the reason was to make money. I cautioned that they would find that making a lot of money might satisfy them in some ways but wouldn’t fulfill whatever had driven them to want that money in the first place. Few of them paid any attention. But years later, some of them came to me after doing very well financially to complain of being bored or unsatisfied with their lives.

Every place I’ve worked—Goldman Sachs, the White House, Treasury, and now Citigroup—I’ve seen people who seem to be seeking the Promised Land of satisfaction through some kind of position or accomplishment. Most often, what I was trying to say to George Lefcoe all those years ago still seems to me to have held true. The only place people find fulfillment is within themselves. And too often, that’s the last place they look.

That argument with George was the beginning of a yearlong dialogue. We spent endless hours walking the streets of New Haven, talking about law, philosophy, and life. George had a much more developed philosophy than I did at that age, and he loved to be cynical and provocative. Another participant in some of these conversations was Leon Brittan, a graduate of Cambridge University who was studying at Yale on a fellowship. After returning home, Leon went on to become a prominent Tory politician. The three of us once took an especially long walk in New Haven, with George arguing that reading fiction was a waste of time because whatever was gained could be learned more efficiently from nonfiction. Leon responded that fiction can often capture reality better than nonfiction. The argument became heated, and although my view was closer to Leon’s, I tried to keep the peace.

George sympathized with an approach to legal analysis called legal realism, which was very influential in shaping the ethos of Yale at that time. Legal realism held that the language of statutes or prior decisions didn’t dictate outcomes because it could be interpreted in different ways. Judges’ decisions were a product of policy views, beliefs, biases, and all sorts of subjective influences—the famous formulation being that decisions were dictated by what the judge had eaten for breakfast that morning. With this approach, you’d consider the statute, the facts of the case, and a judicial decision. When you asked whether the language of the statute had dictated the decision the judge had made, the answer would almost always be no. The words of the statute could fit two or more different conclusions. Legal realism was another way of challenging certainties and reexamining assumptions, and the atmosphere at Yale furthered my own intellectual development along these lines.

At Yale, I made a group of lasting friends who also enjoyed lengthy discussions of the issues of the world. Leon Brittan, for example, had a much more nuanced view of the earliest stages of the Vietnam War than anyone else I knew. He believed that the United States should stand up to communism but was afraid that our involvement would be so divisive as to create serious social disruptions at home, and that the negatives of American involvement might outweigh the positives. That was a remarkably astute analysis, especially in 1962.

Toward the end of my year at LSE, I had briefly met a junior at Wellesley named Judy Oxenberg, who was passing through London with a girl I’d been dating back at Harvard. They were on their way to spend a summer in France. When I arrived at their boardinghouse to take her friend out to dinner, Judy answered the door and I thought to myself, My God, she’s beautiful. The next evening I fixed her up with a friend from Canada, and the four of us went out.

When Judy arrived at Yale to do graduate work in French, at the beginning of my second year at the law school, I invited her to dinner. Judy’s real passion was for the performing arts, and, in addition to her French studies, she was taking classical voice lessons at the Yale School of Music. I decided that holding on to such an accomplished and attractive woman in the graduate environment of Yale—which in those days had few women—was unlikely. So I decided to fix Judy up with friends of mine, on the theory that they would return the favor by fixing me up with women more on my own level.

Luckily, that plan never went into effect and we ended up seeing each other exclusively. Judy had different interests from mine; she was immersed in theater, music, and literature, and in that context I was a bit of a heathen. But both of us shared something more important—a sense of curiosity about everything around us, from the people we knew to world affairs to the books the other person had read. We also tended to have the same reactions to people and shared a somewhat irreverent sense of humor. People’s interests often evolve in unexpected ways. Over the years, Judy developed a good sense of politics and spent four years as New York City mayor David Dinkins’s commissioner for protocol and friendly confidante. Meanwhile, I became a bit of a theatergoer. And there is something else we have in common: while both of us have led active civic lives, we are both relatively private people and have not taken much part in the social whirl.

By November, Judy and I were engaged. We were married that March, at the end of Easter break, in Branford Chapel at Yale. There were fourteen people at the wedding, including both sets of parents. We took a one-day honeymoon—borrowing a car from my law school classmate Steve Umin, whose devotion to music and theater matched Judy’s and who has become a lifelong friend. The next day I was back in the library, preparing for exams.

   

I ENTERED LAW SCHOOL not really intending to practice law but feeling that it would be good training for whatever I might do and would help to keep open a broad array of options. I didn’t have any career path in mind, but I had a vague sense of wanting to do something financial and entrepreneurial. In the back of my mind was the idea that I might eventually return home to Miami and go into the real estate business, perhaps drawing on my father’s knowledge in some way. But I felt I should go to a big law firm for a time, to see what it was like. Lots of our friends were headed to New York, and Judy and I never really considered moving to any place else.

I interviewed at several firms, and decided to go to Cleary, Gottlieb, Steen & Hamilton because it had a more comfortable environment and was somewhat smaller than most major firms, but with an establishment practice. I thought the hours would be a little shorter, and Cleary had a reputation for paying higher bonuses in addition to the starting salary—that year, $7,200—that was uniform across the major law firms, antitrust laws notwithstanding.

That wasn’t much to live on, even in those days. Judy and I had to get help from my parents to pay the rent on what our landlady called a “garden” apartment—in reality a basement in Brooklyn Heights. But living in the city suited us. We spent a lot of time wandering around, going to restaurants and attending theater. Judy had some parts in musicals. The job at Cleary worked out well for me. I liked the people and the atmosphere, which did turn out to be relatively collegial and less formal than those of its counterparts. Working at such a firm also had a certain cachet; I liked being part of an establishment organization—a predilection that coexisted, for the most part peacefully, with my sporadic countercultural inclinations.

I worked as an associate at Cleary for two years, doing research for big litigation, tax analysis on an estate issue, and background work on some corporate matters. I saw how this type of law could be highly engaging, but it wasn’t for me. Also, realistically or not, I figured my odds of making partner weren’t great. I still wanted to do something more entrepreneurial and have the possibility of major financial reward. When I look back, I’m surprised that I wasn’t more involved in the larger social and political issues of that time. In law school, I had engaged in endless discussions about Vietnam, civil rights, and problems of poverty. But it would be a few more years before I would become actively involved.

My career epiphany came while I was working, at a junior level, on behalf of a client called Hayden Stone, a Wall Street investment firm that no longer exists. Hayden Stone was the lead underwriter helping to take public a company called COMSAT. In meetings, the investment bankers were the ones figuring out how to do a big deal. When I’m forty, I thought, I want to be doing what those guys are doing, not what we’re doing.

I had also begun to pay more attention to the stock market, applying in a limited way my father’s highly analytical approach to investing. It was based on the method laid out by Benjamin Graham—probably best known for his disciple Warren Buffett—in Security Analysis, the classic book Graham wrote with David Dodd in 1934.

Graham and Dodd believed that, in the short term, the stock market is a “voting machine,” reflecting emotion and fashion more than rationality, but over the long term, the stock market is a “weighing machine,” valuing securities based on earnings prospects, assets, risks, and other fundamentals. They argue that you should invest only for the long term, and then only when the price is below the fundamental value calculated on the basis of these factors. My father analyzed securities this way and invested with the expectation of holding for a long time. If he sold a stock after only a few years, it indicated that something had gone wrong, or that the stock had risen so much as to be highly overvalued.

Today I believe even more strongly that this is the only sensible approach to investing in stocks. You should analyze the economic value of a share of stock the same way you would think about the economic value of the whole business. A stock, whether in a steel plant or in a high-tech firm, is worth the present value of the company’s expected future earnings, adjusted for risk and for other fundamental factors such as hidden assets on the balance sheet. Over the long run, the price of a stock will reflect this economic value, although the price can deviate dramatically from it for an extended period. Investors seem to lose sight of this reality periodically, with predictable results. Most recently, a large number of people incurred huge losses by following fashion, rather than valuation, in the period leading up to the dot-com and telecom collapses of 2000 and 2001. A separate but related point is that the greatest opportunities often lie in going against trends.

As a way of thinking about the market, the Graham-Dodd approach also played to my Harvard skepticism. To look at the market and try to find securities whose prices didn’t reflect prevailing views appealed to me. A well-established academic doctrine argues that markets are efficient, meaning that the price of a stock fully incorporates all known information and judgments about that stock. A corollary to this Efficient Market Theory is that nobody can outperform the market over time. But everything I’ve seen in my years on Wall Street—and a lot of more current thinking on finance theory—says that that is simply not so. By definition, most investors, even most professionals, are not going to be able to outperform the market. But a few will be able to, through some combination of better analysis, better judgment, and greater discipline.

All this interested me far more than the practice of law, so I sent my résumé to several investment firms. But I didn’t receive a single response, not even a note. Back then, a law degree didn’t mean much in the financial world. The dominant traders on Wall Street had gotten where they were on the basis of street smarts and savvy, while the investment bankers mostly came from society backgrounds or business schools. Moving from a law firm to an investment bank was a strange choice in those days. Although it was a step up in income—when I eventually found a job, my compensation went from less than $13,000 to $14,400 a year—some people told me that it was a step down on the social scale.

A month or so after my applications vanished into the void of Wall Street’s leading firms, my father was in town and I had lunch with him and a stockbroker he knew. The stockbroker mentioned that he had a friend at Goldman Sachs who was looking for a junior associate. That turned out to be L. Jay Tenenbaum, the partner who ran Goldman’s arbitrage department. So I went to meet L. Jay. Since I wanted to learn more about investing in companies, I told him that I was interested in either Goldman’s research department or its corporate finance department. He very accommodatingly sent me over to both departments. But as I later learned, he told the people who interviewed me there to discourage me from those areas because he wanted to hire me for arbitrage.

Through another friend of my father’s, I received a second introduction, which led to an offer from Lazard Frères to work in its arbitrage department. So by sheer coincidence, two firms offered me jobs doing something I’d never heard of. I had some doubts about whether I’d be suited to arbitrage. My understanding was that an arbitrageur, like a securities analyst, had to get on the phone and interview executives at companies about transactions. I wasn’t sure I could be so audacious. But those were the two offers I had, and I wanted to try something new. I chose Goldman over Lazard mostly because Goldman was considered the top firm in the arbitrage field—Goldman’s renowned partner, Gus Levy, had built the department—and also because the pay was slightly better.

In arbitrage, you might end up learning about subjects that a week before you’d known nothing about, such as political unrest in Libya, if that affected the prospects of a transaction involving one of the big oil companies. One deal we analyzed was the proposed liquidation of a holding company called the Roan Selection Trust. When you bought the stock, you were due to get about five or six different securities if the deal went through. You got cash, a warrant on stock in an American mining company, common stock in a Botswana mining company, and a Zambian 6 percent bond. We had to calculate not only the odds of the deal going through but what value to attach to each of those pieces, and how to hedge them to the fullest extent possible. When we first heard about the liquidation, we didn’t even know where Zambia was—because until a couple of years earlier it had been called by its colonial name, Northern Rhodesia. So one of the fellows on the trading desk called the consulate and asked, “Where are you?”

“Fifty-seventh and Madison,” came the reply.

And our trader said, “No, I mean where is your country?”

L. Jay Tenenbaum, who taught me the business, wasn’t intending to stay at Goldman Sachs forever. He was trying to clear the way for his own eventual retirement, even though he was only forty-four when he hired me. And his deputy, Bob Lenzner, who went on to a distinguished career in financial journalism, left shortly after I came. So everything sort of fell into place for me. If L. Jay had wanted all the credit for himself, he could have hidden me under a bushel. Instead, L. Jay looked out for my interests, and took every opportunity to promote my career with his partners at the firm until he retired in 1976. L. Jay took great pride in helping younger people he respected advance in the firm. Later, I felt exactly the same way when I had the opportunity to help talented people who worked with me at Goldman and in Washington.

L. Jay had learned the arbitrage trade as a gofer working for Gus Levy, who was an almost mythical figure by the time I joined the firm. Gus had grown up in New Orleans and had had to drop out of Tulane to help support his family when his mother could no longer pay the tuition. He’d made his way from being a Wall Street messenger to a job in the bond department at Goldman Sachs during the Depression. From those humble origins, he became the heir apparent to Sidney Weinberg, the legendary figure who had steered Goldman Sachs since the 1930s. Gus became a legend in his own right—senior partner of Goldman Sachs, chairman of the New York Stock Exchange, a major Republican fund-raiser, and a pillar of many New York civic institutions. What his list of accomplishments doesn’t fully explain is that from the mid-1960s until his death in 1976, Gus was almost surely the single most important person on Wall Street.

In the 1950s, Gus was one of the inventors not only of risk arbitrage, but also of block trading for institutional clients. Before that, an institutional investor who wanted to sell 50,000 shares of Coca-Cola—a small block by today’s standards—would sell them piecemeal on the open market, putting downward pressure on the price of the stock. Gus’s innovation was for Goldman to buy a whole block of shares, which might cost $10 million or $20 million, with customer commitments to buy some of the block and the rest taken into inventory for subsequent resale. The firm would take more risk by actually owning some of the stock on its books for a time. Per-share profit may have turned out to be lower, but Goldman’s trading volume and market share increased tremendously.

L. Jay and Gus were both men with tempers, which was pretty normal for trading rooms in those days, when most of the familiar Wall Street names were private, a large firm had a few hundred people at most, and few traders had college degrees. The environment was highly entrepreneurial and often seat-of-the-pants. For Gus, management was accomplished by yelling—all day long. The legend was that a decade earlier, he would regularly fire everyone in his office at the end of the day—but they’d all be back at work the next morning.

By the time I got to know him, Gus had calmed down somewhat, but he was still quite a challenge. He had a sliding glass window in his office that looked out onto the trading floor at the old Goldman office at 20 Broad Street. Gus would slam open the window and bark out orders—or abuse, if he found out that Salomon Brothers had done more block trades than we had that day. Then the window would slam shut again. I once started explaining something to Gus with the words “I assume . . .” “Don’t assume anything!” he barked at me. “Find out!” Or he’d snap, “Do it now, you may not be able to later!” Of course, anyone might make such a comment. But coming from Gus, with his enormous intensity, such admonitions burned themselves into my soul, and I cite them to this day. Another time, soon after I’d arrived at Goldman, Gus called me into his office to discuss a memo I’d written proposing an arbitrage transaction. He dismissed it with a one-sentence remark that I didn’t understand. When I asked him what he meant, he snapped back, “We don’t have time for on-the-job training here.”

Gus also had enormous charm, which he would employ with the firm’s clients. One of the few times I was invited to a dinner at his apartment, he was hosting the visiting chairman of a major corporation. To hear Gus talk, you would think the chairman was the greatest genius in the history of American business and Gus’s best friend. But I’d heard Gus heap similar accolades on other CEOs. In a taxi on the way home, I asked Ray Young, one of the firm’s senior partners, “Ray, do you think Gus will remember those comments the next time he says the same thing to another big client?” Ray answered that Gus was being absolutely sincere—he meant everything he said when he was saying it. For that evening, the CEO in question was the center of his universe. That’s why Gus’s charm was so effective. Many years later, I met another person who had that kind of ability to focus his attention completely on someone without being insincere. That other person, even more persuasive in such moments, was Bill Clinton.

Despite his temper, Gus was a great leader who was truly supportive when times were tough. About individual transactions he could go absolutely crazy, as he did when we lost more than half a million dollars on the Becton Dickinson–Univis deal. “Anybody could have seen that was going to happen!” he’d shout. But those of us in the trading room knew that at the end of the day he would be fair about compensation and promotions. Gus understood that we were in a risk-reward, probability-based business and that a trader would do badly at times, either because the dice came up wrong or because people make mistakes. That made Goldman Sachs an environment where you could take rational risks. With all the ranting and raving—and there was a lot of it—in the final analysis, Gus supported risk taking and assessed people fairly based on their overall performance.

Gus himself was famously superstitious. You could hear him coming on the trading floor because of the “lucky” coins jangling in his pocket. Although one of his mantras was “It’s better to be lucky than smart,” Gus didn’t rely on luck. He began his workday at 5:00 in the morning and got to the office before 7:30, well ahead of everyone else—a point he was kind enough to remind us of from time to time—and then went to client dinners or charitable events every night. After Gus died, I always regretted that I’d never asked him what he, driving himself all day long every day, thought life was all about. I don’t know if he would have had an answer, but one answer I don’t think he would have given was money. By the time I knew him, he didn’t need more for practical purposes, and I don’t think his sense of self resided there. In fact, he gave away much of what he made.

The big crisis in those years was the Penn Central bankruptcy, which hit in 1970, the year after Sidney Weinberg died and Gus’s first year as senior partner. Goldman had sold commercial paper—short-term debt instruments—on behalf of the Penn Central railroad. When the railroad surprised everyone by declaring bankruptcy, investors who had bought Penn Central’s paper accused us of inadequate disclosure—because of negligence or intentional failure—about the company’s financial condition. The bondholders sued us for an amount that exceeded our capital. The claims may have been weak but they were not frivolous, and the partners’ entire net worth was at stake. I was not yet a partner, but I had ideas about how to respond to this crisis and told Gus, though this may have been presumptuous given my limited experience, that I thought we should consider whether our regular outside counsel was well suited to the rough-and-tumble of a jury trial. He decided to stay with our regular counsel, but to use a different lead litigating partner than would ordinarily have done our work, someone who was better suited to this situation. Thereafter, he used me occasionally as something of an unofficial adviser. That was my first experience dealing with a critical institutional crisis. Since then I’ve had to help manage through a number of these events, not just at Goldman Sachs but later in Washington and at Citigroup.

For a period of more than a year, Penn Central created immense anxiety at Goldman. As a private partnership, we faced unlimited liability, and some people worried whether the firm would survive. When the firm’s outside counsel, Sullivan & Cromwell, provided a letter saying it didn’t think damage payments would materially impair our capital, Gus carried it in his jacket pocket as a kind of talisman. I thought of that letter when I had to face the same concern about the firm’s survival after one of our partners was charged during the insider trading scandal of the 1980s and we obtained a similar letter from Wachtell Lipton, our counsel. In the end, the Penn Central matter was settled on terms that the firm could absorb. In fact, the settlement cost Goldman Sachs less than we eventually made in risk-arbitrage trades involving claims in the Penn Central bankruptcy.

Although some people found Gus impossible—and at times he was impossible—he was a giant figure for all of us who worked with him, and I still think of him often. He was less difficult with me than with the trading-room partners more directly under him—possibly because I was younger. After he died, Larry Tisch, a friend of his, told me that Gus had thought I’d run the firm someday—an idea that seemed far-fetched to me at the time.

Why did the arbitrage work at Goldman suit me? I think that there is an emotional answer and an intellectual answer, though the two are connected. The emotional answer is that my temperament was simply a good fit. Arbitrage was enormously intense; people at the firm used to think the stress was overwhelming and could drive a person insane. And there was immense pressure. But I was able both to apply myself intensely and, at the same time, to maintain a reasonable degree of equanimity. In my mind was the notion that I could walk away if I had to and go back to cafés on the Left Bank and read Henry Miller. Another calming thought was that a thousand years hence, no one would care whether some deal had gone through or whether my arbitrage career had worked out. Meanwhile, I was glad that other people at Goldman Sachs thought my job was so pressured. It meant respect from my colleagues, even though we traders didn’t have to work at night like the investment bankers.

The intellectual answer relates to the questioning and probabilistic mind-set I started developing at Harvard. In 1975, a colleague of mine at another firm explained an investment that he believed to be a sure bet. He was making a massive purchase of shares of Anaconda, a mining company whose shares were to be bought by Crane, another company that wanted to enter the copper business. I agreed that the proposed deal looked extremely likely to reach closure. However, not believing in certainties, only in probabilities, I made a large investment, but with a loss potential Goldman could readily absorb in the highly unlikely event the deal didn’t go through. Then the unexpected did happen—antitrust issues blocked the merger, and the deal fell apart. We took a big loss. But my friend took an unacceptably large loss, which included his job.

My approach grew from my basic makeup, from Raphael Demos’s approach to philosophy and my whole Harvard experience, from my debates with George Lefcoe in New Haven, and the ethos of Yale Law School. In arbitrage, as in philosophy, you analyze, look for holes in the analysis, and seek conclusions that hold together. However, while analytic rigor may be sufficient for philosophy, it’s not enough for arbitrage. In arbitrage—as in policy making—you also have to be able to pull the trigger, even when your information is imperfect and your questions can’t all be answered. You have to make a decision: Should I make this investment or not? You begin with probing questions and end having to accept that some of them will be imperfectly answered—or not answered at all. And you have to have the stomach for risk.

As well as my career was going at Goldman during my first several years there, I nevertheless felt that my prospects for partnership were slight. I thought I’d make some money, learn a good deal, and take my newfound skills to a smaller place to capitalize on them. But then life took one of its unexpected twists. In 1970, I was recruited by White Weld, one of the old-line Wall Street firms. A friend from law school worked there, which led the company to interview me when the fellow who ran its arbitrage department left. I called my parents and told them about the offer, which I assumed I would take. My father was unhappy about my leaving Goldman Sachs. “Maybe they’ll offer you a partnership,” my father said. “Dad,” I said, “you just don’t understand. They’re not going to offer me a partnership at Goldman Sachs.” Becoming a partner of the Goldman of that time was like catching the brass ring—a very low probability bet.

So I went to speak with L. Jay, who was upset that I might leave. And he went to Gus Levy. Gus wasn’t happy about having to deal with this problem, but after consulting with the firm’s management committee, he came back and offered to make me a partner at the end of the year. I was, to say the least, surprised. Becoming a partner at Goldman Sachs was not in what I considered the realm of realistic expectations. But on the first day of fiscal 1971, I found that I was one.