Doubts about China inside Goldman Sachs reflected a vigorous debate during the mid-1990s concerning the best long-term prospects in Asia. Some in the firm thought we should focus on the region’s other developing economies, the so-called Asian Tigers of Hong Kong, Singapore, South Korea, and Taiwan (not to mention other rising economies like Thailand, Indonesia, and Malaysia). These countries boasted growth stories that were every bit as spectacular as China’s but less volatile, with more immediate business opportunities in some cases. Struck by the energy, enthusiasm, and determination of the people, I was an ardent proponent of China’s potential. I simply did the math in my head: as successful as all those countries were, together they had about one-third the population of China.
Initially, however, China was something of a sideshow. We focused our earliest efforts on building relationships in Hong Kong. We could see several benefits in doing so. China was courting the colony’s business leaders prior to the Handover. These merchant princes could read the writing on the wall and had been cultivating ties to the mainland and investing in all sorts of projects. They had thriving businesses we could work with, and we could use them to piggyback into China.
The most important businessman in Hong Kong was Li Ka-shing. K.S., as friends call him, had come to Hong Kong as a refugee, and in his early 20s he started a business he named Cheung Kong, or Long River, after the Yangtze River. He made and sold plastic combs and soap boxes, progressing to toys and plastic flowers. He thrived and soon began investing in real estate and eventually emerged as the biggest developer in the colony. In 1979 he acquired the venerable conglomerate Hutchison Whampoa, with interests in ports, retailing, and property, and subsequently expanded into new areas like telecommunications while building a portfolio in China. By 1990 he was a billionaire and considered the richest man in Hong Kong.
One day in 1991 I went with Moses Tsang, Goldman’s man on the ground in Hong Kong, to meet K.S. for the first time. We were whisked in a private elevator to his offices in the Central District, high over the city. K.S. greeted us warmly, and we chatted amiably in a side area of couches and chairs before moving to a large round table set for lunch with elegant menu cards.
K.S. had two sons, Victor and Richard. Victor worked at Cheung Kong, while Richard, the youngest and still in his early 20s, was in the process of launching Star TV, a pioneering satellite programming venture focused on China and other Asian countries. I don’t remember now whether either of them was present, but we were joined by K.S.’s key deputy, Canning Fok, a former Hong Kong high school classmate of Moses’s, who had arranged our meeting. Before we went in, Moses had mentioned that K.S. was raising funds for Richard’s TV business.
I was impressed by K.S.’s direct manner and incisiveness as we engaged in a wide-ranging conversation about markets and economic conditions in Hong Kong, China, and the U.S. He was shrewd, sophisticated, and global in outlook. He was staunchly anti-Communist but a realist and immensely pragmatic. As I would learn in time, he was also a wise businessman who appreciated the value of a conservative balance sheet with plenty of cash and liquidity in a world he knew from personal experience to be uncertain and frequently volatile.
Sure enough, the subject of Star TV, which was being developed out of Hutchison Whampoa, popped up. Straight out, K.S. asked Goldman Sachs to spend $2 million to buy advertising on it. He certainly did not need the money, and the amount in absolute terms was trivial for him. I saw it even then as a symbolic gesture, but one that was very important to him because he wanted his son’s first business venture to succeed.
By nature I’m pretty straightforward, but I hedged, saying that we would have to get back to him. This was for a very good reason: I had absolutely no authority to make such a commitment on behalf of the firm. We were a conservative partnership, and I knew this would lead to a difficult discussion within the management committee, of which I was a member. But I didn’t want to offend the most powerful businessman in Hong Kong.
After lunch K.S. walked me to the elevator and rode down with me, a gesture of such politeness and familiarity that I soon found myself adopting it with Asian visitors back home. I thanked him for the lunch and told him I was grateful for the opportunity and that we would weigh and examine it.
“Thank you, Mr. Paulson,” I remember K.S. saying as I slid into the car. “I am pleased Goldman Sachs will be taking the advertising package from Star TV.”
Back home my colleagues wasted no time in telling me that K.S. had put one over on me. But we were late to Hong Kong, and I had concluded that if we were to catch up and accomplish what we wanted to, we needed to make a commitment. I expected that it would lead to the opportunity to invest in future deals with K. S. Li and his family and to compete for investment banking business. In the U.S. some clients were nervous if you wanted to invest with them. In Hong Kong it was the opposite. Putting your money on the line alongside your clients’ earned you their trust and admitted you to the club. I viewed this as a first step in that direction. That was what I tried to explain to the Goldman management committee. It wasn’t an easy sell. As a firm that focused primarily on institutional and corporate clients, we had no interest in advertising to the general public. But eventually they went along, and we donated our Star TV advertising to the Children’s Cancer Foundation in Hong Kong.
As it turned out, one of the first significant deals we did in Hong Kong took place shortly afterward when we helped Richard Li sell Star TV to Rupert Murdoch. That came about after a chance meeting between John Thornton, then head of banking in Europe out of London, and Richard Li at a World Economic Forum–related event at Davos in 1992. A little later Star began talking to our people about raising funds through a private placement—an opportunity that would not have arisen without our decision to buy advertising. Jumping on this opening, John flew to Hong Kong to persuade Richard that he would be better served by finding a strategic investor. He had in mind Rupert Murdoch, with whom Richard and K.S. had previously failed at least twice to reach an agreement. John turned for help to Brian Griffiths, who was vice chairman of Goldman Sachs International. Lord Griffiths sat on the board of Times Newspaper Holdings, the parent company of Murdoch’s Times in London. The three had dinner, and John managed over the next few weeks to bring Richard and Rupert to a meeting of the minds, while keeping Pearson PLC, a rival U.K. media conglomerate, in play as a competing bidder. The deal, announced in July 1993, had Murdoch buying 63.6 percent of HutchVision Limited, the parent of Star TV, for about $525 million. (He would buy the remainder two years later.)
The deal was a stunner. It brought Murdoch to Asia and instantly elevated Richard Li in the public eye, confirming that he had the makings of a shrewd businessman. He’d made several times over the initial investment and was launched on a high-flying career.
We subsequently did quite a lot of work for K.S. and his companies, helping him to finance, buy, and sell a number of businesses. Making a simple $2 million commitment didn’t win us these other assignments. K.S. was too good a businessman for that: we had to earn every bit of work we did for him. But it did get us a seat at the table so we could compete for the business, and it helped to make our name in Hong Kong, and later in China.
This isn’t to say we got the deals we wanted or that the ones we got all worked out so well. Oriental Plaza, the Beijing mega-development on the prime piece of real estate right next to Tiananmen Square, would go through numerous iterations as it became increasingly complicated and controversial. The billion-dollar-plus project broke ground in September 1993 but came to a halt the next year amid protests from preservationists and resistance from McDonald’s, which had earlier signed a 20-year lease and opened its first franchise in Beijing on that very site. Eventually, matters were sorted out. McDonald’s agreed to move. K. S. Li, who had replaced C. H. Tung as the lead investor, pressed ahead, and the development opened for business in 2000. Along the way, our near–20 percent stake was whittled away to almost nothing, and we made very little.
The circuitous path of Oriental Plaza was not atypical for the deals we encountered when we first started. We discovered quickly the need to be very selective about the business we pursued and never to take anything for granted. That’s a wise approach the world over but nowhere more so than it was in China during that early period of rapid economic change. As the country opened to foreign investment, almost every transaction was debated at the highest levels of government; the decision making was complex, diffuse in that it involved the approval of many officials, and opaque to outsiders like us. Many memoranda of understanding were signed that went nowhere; informal negotiations took place with officials who lacked proper authority or couldn’t “sell” projects to their superiors. Moreover, China lacked a strong adherence to the rule of law. Instead, the rule of men was the norm, which meant that building strong personal relationships was essential for doing business. For this reason, I traveled frequently to China, especially in the early years. Over time we learned to identify the most viable transactions, involving the right clients and the support of the right Chinese advocates. But on any number of occasions as we were learning to work in China in the early days, we were disappointed by abrupt and bewildering changes in direction. The rug could be pulled out from under you at any point.
We learned this lesson firsthand in our efforts to help build the Chinese power industry. From the start this opportunity had looked like a no-brainer. The fast-growing economy made increasing energy demands that China was struggling to meet, especially in areas like Shandong and Guangdong, two densely populated coastal provinces that were rapidly industrializing and relatively open to foreign investment. Guangdong, across the border from Hong Kong, suffered frequent brownouts—an untenable situation for factories working round the clock to manufacture goods being shipped all over the world.
We devised a solution, borrowed from the U.S. In simple terms, the idea was to sell a stake in one power plant to a group of foreign investors who would become owners of the plant in tandem with the government. This new ownership group would use the proceeds to finance the construction of additional power plants. The financing was straightforward, but we knew arranging the deals would be tricky. Provincial governments were generally more willing to experiment than were central government agencies, but it would still require political courage and savvy maneuvering to push ahead, as the country had never sold part of a state-owned power station to foreigners before.
Tom Gibian, a Goldman Sachs project finance specialist, identified suitable power plants, and by early 1993 we had committed with a well-connected state-owned investment entity, China Venturetech Investment Corporation (CVIC), to invest in electric generating projects. Our efforts in Shandong moved ahead quickly. In November, after winning approval from the China Securities Regulatory Commission (CSRC), China’s version of the U.S.’s Securities and Exchange Commission, we and CVIC announced that, along with other investors, including K. S. Li and U.S. engineering and construction concern Bechtel, we would pay $180 million for a 30 percent share of a 1.2 million kilowatt power plant, Shandong’s biggest. It would be run through a new company jointly owned by the investors, the power corporation of Shandong Province, and Shandong International Trust and Investment Corporation.
Then the lights on the deal went out. At a conference in Beijing, Gibian gave a presentation that laid out the structure of the deal in detail, including the expected returns for investors—just under 13 percent annually over the first 12 years—necessary to get the deal done.
In the audience was a woman named Li Xiaolin, a young power industry bureaucrat, who happened to be the daughter of Li Peng, the country’s premier, and a leading conservative opponent of rapid reform. The next thing we knew, we had been instructed to pull the deal. As we were told, Li Peng was unhappy about the high rate of return to the foreign investors. The Shandong power deal was canceled in December 1993.
We came away with a crucial lesson: many officials could approve a deal, but it took only one well-placed official in a consensus-ruled system to kill it. We subsequently learned to spread our efforts wide to every conceivable person or agency that might have an interest in whatever we were focused on and to work relentlessly to bring them to our side. For a complex, groundbreaking transaction like the Shangdong deal, in a politically sensitive area where the premier had a keen interest, we should have sought the approval of the State Council, which is composed of China’s senior government ministers. Even today the Chinese are not great at coordinating among themselves; and in the early 1990s the government approval process for novel policies was very much a work in progress.
Li Peng’s intervention also served as a graphic reminder of the intersection of power and family ties in China as the economy was being remade. Apart from being premier, Li had had a long association with the power industry, and his daughter and one of his sons would become heavyweights in that sector as well. This was the first inkling I had of the growing influence of the children of Party leaders. Capitalizing on family connections was common. Many sons and daughters of Party leaders, the so-called princelings, were bright, able, and held productive and legitimate jobs. But many did not, and rampant nepotism had become an open sore, enraging the Chinese public; its patent unfairness stood in stark contrast to the Chinese tradition of strict meritocracy that governs ordinary citizens, whose futures are determined by their performance in a brutally competitive exam system.
As frustrating as it was at the time, our Shandong power setback did reveal a rewarding aspect of doing business in China: the Chinese have a great sense of honor and stick to their word when a commitment is made. A CEO has every right to kill an unfinished deal that he decides isn’t in the best interests of his company. Just so, a head of state can back out of an agreement that doesn’t serve his country well. When such a reversal occurs, few countries would see a need to do anything more than offer a quick apology, if that. But China is different. Even as Li Peng flabbergasted us by killing the deal, others assured us that we would get Shandong’s future business when that became possible. Liu Hongru, a forward-looking and committed reformer who was the head of the CSRC and in charge of handing out the first mandates to take Chinese state-owned enterprises public, promised that we would handle the power company’s IPO. And, in fact, we were awarded the mandate in 1994—although it was no walk in the park. Shandong International Power Development Company finally listed in Hong Kong in June 1999 after a very long, difficult process that involved no fewer than three failed road shows, in which bankers and company management traveled to many distant cities to interest investors in the offerings.
As Li Peng’s involvement in the Shandong deal taught my partners and me, Chinese leaders were intimately involved in the minutiae of the economy and the changes the reform program was producing. It was the inevitable legacy of a command economy—the top people were involved by design—and reflected the importance of the direction-setting decisions they were making for the country.
As a result, it was easier in the 1990s for foreign businessmen to meet senior leaders and develop relationships. That was not so later on. It was next to impossible, for example, for a businessperson to gain an audience with Hu Jintao after he became general secretary in 2002. It was a bit easier to see Premier Wen Jiabao, although I don’t believe he discussed specific transactions. This shift was not just a matter of personal style but the result of a great sea change: as the economy boomed, it was no longer necessary for the country’s leaders to court the foreign CEOs, who were beating down doors to build a business in China. The top leadership also had more help. The government was becoming professionalized as more capable and experienced officials populated the ministries and senior ranks of the state.
One of the senior leaders I saw frequently in the 1990s was Zhu Rongji, then vice premier running the economy day-to-day. Our meetings generally concerned financial or economic policy matters. He was smart, well briefed, and focused on finding solutions.
Zhu Rongji had come by his stature the hard way. After a tough childhood in Hunan Province, he had graduated from the prestigious Tsinghua University as an engineer in 1951 and landed a job with a central government planning agency. Always outspoken, he’d been purged twice during Mao’s political upheavals. But he was a man of fortitude and persistence. After the Cultural Revolution he returned to Beijing and worked for an economic reform commission before moving to Shanghai as mayor in 1987. There he set up China’s first official stock exchange since the Communists had come to power. He also led the effort to turn Pudong, the Singapore-size expanse of vegetable farms and marshes east of the Bund, into China’s spanking new financial center, complete with the country’s tallest skyscrapers.
Zhu was direct and no-nonsense and, at least with me, a good listener who took blunt advice well when he thought it was in China’s best interest. We were advising the country on its sovereign credit rating in 1993, and I sat in on the meeting with the U.S. rating agency Standard & Poor’s. I felt that Zhu had not addressed one of the agency’s concerns about China as directly as he might have. To the dismay of one colleague, I explained this to Zhu in a matter-of-fact but respectful way after the meeting. He was silent, which my colleagues took as a bad sign. But Zhu was pragmatic to his core, and at a subsequent meeting with Moody’s Investors Service he handled the same question frankly and adroitly.
Zhu and other Chinese leaders were keen to list state-owned enterprises on the world’s stock markets. Privatization was still a somewhat new concept then, but the Chinese were quick to see its potential for raising capital and restructuring industries. Zhu had already met with our Brian Griffiths, who had led Margaret Thatcher’s privatization and deregulation efforts from 1985 to 1990, as well as with other Goldman executives. In my first meeting with Zhu, he asked us to do a feasibility study of which industries would be the best candidates. And he asked me how long it would take to list a company on the New York Stock Exchange.
“Between six months and two years,” I replied.
But getting Chinese companies ready for public listings was a daunting task—one far more difficult than I would have imagined. China’s state-owned enterprises had grown out of the ministries that, under Communist Party rule, had owned all the property and assets of the nation and had overseen all of its commercial operations and activities, from oil and gas exploration and drilling to farming, manufacturing, and mining. The state determined what businesses to be in and set quotas for production. Product quality, managerial controls, and accounting were neglected.
As the economy had opened up, SOEs had grown like mad. But they remained under government control and were weighed down by all the baggage of the state, including expensive cradle-to-grave care for workers and their families. Companies maintained hospitals, schools, restaurants, stores, and even, in some cases, cemeteries for their employees, and they were proud of the services they provided. I remember Brian Griffiths remarking after a visit to one of these companies that it resembled nothing so much as a medieval village, and, as he put it, “You can’t float that on the New York Stock Exchange.”
By the 1990s, while the fledgling private sector of the economy—foreign-invested ventures, SEZ exporters, and the township and village enterprises—thrived, most of the SOEs had become bloated and inefficient, debt ridden and money losing. They had almost no knowledge of modern business practices and offered such primitive disclosure that it was almost impossible to measure the extent of their economic losses. Managers had been given greater responsibility to make business decisions, but they often had neither the training nor the temperament for the task. Companies lacked focus and squandered resources. In the first flush of freedom, executives frequently made misguided or corrupt decisions, creating inchoate conglomerates, speculating in real estate, and acting as quasi-banks to extend credit ill-advisedly to other companies.
To make matters worse, the state-owned banks that loaned to these lumbering SOEs were for all practical purposes defunct. They had little knowledge of modern lending, investing, or risk-management practices and had no idea of the extent of their bad loans, or even how to value their assets or measure their losses. Moreover, the banks were regulated at the local level by the same officials who directed them to lend to the SOEs. You can imagine how ineffective it was to have provincial politicians overseeing the banks and inspecting the adequacy of their capital while they were simultaneously seeking loans for their pet projects.
Zhu wanted to overhaul the way the SOEs were managed, eliminate their special privileges and subsidies, and encourage the development of professional managers to invigorate the state sector. Selling shares to the public and “strategic” stakes to leading international companies, he felt, would not only raise capital but also force the SOEs to adopt global accounting standards and become better run. He also recognized that to reform the SOEs, he would have to reform the banking system that, essentially, provided the companies with the corporate version of an iron rice bowl: unending credit and absolute loan forgiveness.
At the time, governments around the world were undertaking privatizations for a variety of reasons—from restructuring assets to make their domestic industries more competitive to raising money, paying down debts, or broadening share ownership. Germany, for one, was eager to create an equity culture. Some governments took the view that their companies would perform better with market discipline than under state ownership and control.
The Chinese embraced a model of their own design. To begin with, they were uncomfortable with the term “privatization,” which didn’t completely square with “socialism with Chinese characteristics.” They preferred to use the terms “corporatization” and “capital restructuring.” Government leaders chose to maintain control of companies whose shares they sold in a wide range of industries, keeping them under the Party, which handpicked company leaders. I didn’t know then if this was a temporary or long-term plan. But over time, their reluctance to surrender state control has become clearer, and that desire, firmly rooted in politics and ideology, carries negative consequences to this day. Too many of the country’s biggest businesses, descended from massive government ministries, stalk the Chinese landscape, creating problems for the government as it attempts to develop best-of-class global companies and to shift to a different economic model that is not so dependent on government investment and exports. And these companies are not being run according to Zhu’s plan to make them modern, efficient, market-driven enterprises subject to real competition.
China’s interest in privatizations drew the attention of investment banks the world over. For quite a while, Goldman had to play catch-up. British firms like Jardine Fleming, Schroders, and Barings, with their colonial histories in Hong Kong, initially had the upper hand, along with Wardley, the merchant banking arm of HSBC, and Peregrine Investments, a well-connected local start-up. But we sensed the vulnerability of the old-line firms. They were already in decline before the Handover, which would end their historical edge. Among our U.S. competitors, Merrill Lynch and Morgan Stanley had also established themselves ahead of us.
Much of what we did in China in those early days was educational. We might as well have been running a school—indeed, at times it felt as though we were. Even as our bankers sought to build relationships and sniff out business opportunities, they conducted seminars and conferences, gave tutorials in which they explained the benefits of privatization, analyzed Chinese industries, singled out the companies that could be floated on overseas exchanges, and explained such technical details in the IPO process as due diligence, book building, and managing a road show.
All of this was absolutely essential. As smart and capable as the Chinese were, few officials in government ministries, or frankly in the country’s fledgling financial system, had any grounding in classical economics, much less hands-on experience in modern banking or capital markets. But they were absolute sponges, taking notes, soaking in information, constantly pressing for more details, more analyses.
We rapidly built up our Hong Kong office to serve as the hub of our Asian activities outside of Japan. The region was booming, and by 1994 we had several hundred bankers and support staff managing our operations throughout Southeast Asia. We began to build our China team. Just as we did elsewhere, we looked for talented young professionals we could train to become outstanding investment bankers.
Some competitors hired employees for their language skills rather than their banking aptitude, or picked up natives of Taiwan and Hong Kong because they were “Chinese.” We looked for ones who could thrive in our competitive but collegial Goldman culture.
We sought out bright mainland Chinese like Liu Erh Fei, who had earned degrees from Brandeis University and Harvard Business School as one of the first Chinese students to study abroad. Erh Fei was the first of our serious hires of Chinese bankers and very helpful in building our early mainland relationships. When he left in 1993, we hired Cherry Li, who had taught English at the Beijing Foreign Language Institute—Erh Fei had been one of her students—before switching to economics. Smart and dedicated, she had worked for the State Council’s Economic Reform Commission under reformist premier Zhao Ziyang and had been an early recruit at the CSRC. After a short stint in our New York headquarters to learn about our culture and our business, she opened our Beijing office in February 1994. We added a Shanghai office that November, but the bulk of our work in China continued to be run out of Hong Kong.
The business climate in China was frustrating. We were able to underwrite bonds for a number of government issuers, and we found some advisory work, but the equity offerings were slow in coming. In January 1994 the CSRC announced a second batch of 22 candidates for overseas listings that included several power companies, but by the time the last company from the first batch had listed in Hong Kong in June 1994, IPOs of Chinese companies were having a much harder time attracting investors. One reason was the poor quality of the assets being offered in some of the later companies.
Another reason for our frustration was the volatility of the Chinese economy, which had begun overheating after Deng’s Southern Tour. After credit controls were eased, bank lending for investment jumped 50 percent in 1992, and inflation hit 15 percent the following year. Speculative real estate projects mushroomed in Guangdong and Hainan, the island south of Guangdong and China’s southernmost province. Zhu Rongji, who had become vice premier in 1991, gained greater control over the economy after Li Peng suffered a heart attack in April 1993. Zhu’s challenge was to find a way to calm the economy without losing ground on reform. His approach was to tackle both the immediate crisis and fundamental problems in the economy.
Zhu took direct charge of the central bank and instituted a 16-point austerity plan to curb bank lending and restrain price rises. He pushed through the first phase of a revamping of the financial system by setting up three new policy banks and pressing the other banks to be more commercial and less policy oriented in their loan choices. He overhauled the tax and fiscal system and made foreign exchange reforms. Zhu was tough-minded, threatening, it was said, to “chop off the head” of any bank official who did not obey the new rules coming out of Beijing. Zhu and his reformist colleagues had a battle on their hands. Excessive expansion of the money supply and a credit bubble helped push inflation above 24 percent in 1994, before Zhu’s stringent measures took effect and led the economy to a soft landing, with inflation falling to 8.3 percent in 1996 and 2.8 percent in 1997.
Meantime, the bottom fell out for Goldman Sachs in 1994—but it wasn’t China’s fault. A global bond market meltdown, triggered by rapid interest rate hikes by the U.S. Federal Reserve in February 1994, caused our poorly managed trading business in London to blow up. We were soon losing $100 million a month. This firm-wide financial crisis was compounded by our partnership structure, which allowed retiring partners to take half their capital with them. Many did. The firm was on the edge of going under.
Then, in September, in the midst of this crisis, Jon Corzine and I were appointed to lead the firm as chairman and vice chairman, respectively. Jon and I disagreed about a lot but not about the need to act fast. We had to make tough decisions and cut staff by 13 percent worldwide. I tried to protect our business in Asia, especially China, but we had to slash hard to ensure our survival, and in the end I’m not sure we were worse off by cutting back, because we had grown rapidly around the world and hired a lot of the wrong people.