John Gapper makes a fundamentally important point in his Financial Times comment today, that Goldman should not be permitted to wriggle free of TARP strictures by repaying the emergency backing of last November, at least not until Treasury has imposed structural reforms. Why? Whether Goldman formally has government funding or not, it has been designated as one of the “too big to fail” banks. Thus it can operate as if it has government backing and play closer to the line than it otherwise would.
Since Glass Steagall, the Depression era regulation mandating the separation of commercial and investment banking was passed in 1933, brokerage firms enjoyed higher profits than their government guaranteed brethren and were permitted to fail. But then the line got blurred, and finally erased, as banks pressed to get into more lucrative businesses. And as the brokerage firms became more bank-like (as in bigger users of capital and more active traders) in response to the bank incursion, they became bank-like risks to the system too.
Goldman has been very clever at having its cake and eating it too, and that has to come to an end.
However, despite the logic of Gapper’s argument, I doubt any serious structural reform is in the offing for the financial services industry unless conditions decay to the point where Treasury’s hand is forced. Geithner and Summers are clearly true believers in the what-ought-to-be-discredited model of finance-driven capitalism. They have been consistent enablers of the industry, taking tough stands only in the face of public outcry, and then on token issues (and the industry has dutifully played its part in this Kabuki drama, howling at how simply dreadful those requirements are).
From the Financial Times:
Should Tim Geithner let Lloyd Blankfein escape?
Mr Blankfein, the chairman and chief executive of Goldman Sachs, is eager for his institution to become the first big bank to shake off the stifling embrace of the US government. Mr Geithner, the US Treasury secretary, must decide whether to let him.
Mr Blankfein’s argument is seductive: it is Goldman’s “duty” to pay back the $10bn in taxpayer money it took last autumn when its future – and that of the global financial system – looked dicey. Goldman seems to be doing fine now: this week, it reported unexpectedly robust first-quarter earnings of $1.8bn.
It has spent recent weeks attempting to turn its repayment into a fait accompli. First, Mr Blankfein made a contrite speech assuring investors – to the irritation of its rivals – that Goldman was sadder and wiser and would buckle down to pay reform. Then he raised $5bn in capital from those investors to wave in front of the Treasury secretary.
But Mr Geithner should take his time. Not only is the future of Goldman and other taxpayer-backed banks unclear, given the unstable US economy, but Goldman wants to escape the burdens of political control while retaining the benefits of public backing. That does not seem like a good deal for the taxpayer.
There are obvious political risks in letting Goldman roam free while other banks remain bound by the troubled asset relief programme (Tarp). It would exacerbate suspicions that Goldman, with its long history of producing Treasury secretaries, gets special treatment. These were not soothed by the decision to pay off all Goldman’s credit default swaps with American International Group, now controlled by the state.
The bigger danger is the long-term precedent it would set. Goldman wants to bolt before Congress or Mr Geithner, who still operates as a one-man band while the nomination process for his senior staff meanders along, has the chance to change fundamentally how it operates.
Yves here. This is not a given. Regulatory measures could still be imposed on Goldman, TARP or not. Goldman is an integrated firm. Many of its businesses are regulated, and there is no reason to think rules devised for broker dealers, large credit market players, or “too big to fail firms” would exclude Goldman, whether or not it is on the dole. Back to the article:
So far, it has faced mildly irritating limits on how much it can pay staff but nothing on the scale of the 1933 Glass-Steagall Act, which imposed structural reforms on Wall Street after the excesses of the Jazz Age. It would never acknowledge it, but its political campaign is going just fine…
Mr Blankfein criticised Wall Street’s past pay practices as “self-serving and greedy” but Goldman is still putting aside 50 per cent of revenues – $4.7bn in the first quarter – for the bonus pool. Inside, it may feel “humbled”, as Mr Blankfein said, but it looks like the same old bank.
The same, that is, except for one thing – Goldman is now backed by the US government… Once it has repaid the $10bn, Goldman hopes to go back to paying employees what it wants, buying and selling more or less what it fancies and operating as before.
He is peddling an illusion. Even if Goldman repays the equity, the world has changed irrevocably because it is a government-backed enterprise.
That will formally be true for a year at least. As well as the preferred shares it took from the Tarp, it has raised another $28bn in bonds backed by the Federal Deposit Insurance Corporation and intends to carry on using the FDIC’s balance sheet.
More fundamentally, we now know unambiguously that Goldman is a “systemically important financial firm”. In other words, Goldman is too big to fail and would be bailed out by the US government if its balance sheet failed. That privilege should come with weighty conditions.
Note that Goldman’s status is a choice, not a tag it has unwillingly been given. It could avoid this by shrinking itself into an institution like a private equity group or a merchant bank, which can take all the risks it desires because its partners lose everything if it fails.
Goldman does not want to do that because it likes having the engine of its capital markets division and equities operations alongside its advisory and fund management arms. It calculates, probably correctly, that the pay-obsessed Congress is not sufficiently serious to put a new Glass-Steagall Act in its way.
But there is no clarity yet that Goldman or other Wall Street banks will be forced to pay an appropriate levy for government backing. Unless it is high, they have no incentive to be truly independent.
There is no need to look back far to observe how pernicious a combination of private ownership, implicit public backing and inadequate regulation can be. This produced the Fannie Mae and Freddie Mac fiascos.
If Mr Geithner cannot think of a sound structural reform to limit the size of Wall Street banks, he must at least make regulatory restrictions bite. He has talked of capping their leverage and their latitude to indulge in proprietary trading but not defined what this means in practice.
He ought to keep Goldman on the leash until he has set out the price it must pay for its newfound privileges. If he lets Mr Blankfein dash straight back to business as usual, Goldman will have won again.