"Don’t set Goldman free, Mr Geithner"

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.

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  1. Stevie b.

    Yves – for me, your ongoing comments on Goldman have been a revelation – thank you and please keep banging on about this and don’t let up!

  2. Independent Accountant

    Goldman should be told in no uncertain terms to spin off its bank. Any entity that holds a bank should be subject to TARP. Not only this, but Goldman, Blankfein and Viniar should all be indicted for securities fraud. If Obama really wants to ingratiate himself with the pitchfork carriers, he can purge Treasury of all Goldman “alumni”. Let the Goldman and “former” Goldman blood flow.

  3. AP

    Goldman controls our government and this country; no-one is going to tell them they have to do anything anytime soon.

    Thanks for the hard work, Yves, let’s hope it’s not in vain.

  4. craazyman

    I had made a few anonymous posts (none were attacks) but registered so I could continue to participate in this excellent blog.

    What a nauseating situation this is and thank you for covering it thoroughly and insightfully.

    I am a financial writer/researcher with more knowledge of all this than the average American by far, but not nearly as much as evidenced in these stories and many comments.

    The more one knows it seems, the worse it all smells. And I learn more every day by reading the linked stories and comments.

    I hardly feel I am a citizen of the U.S.A. anymore, instead I’m a tax slave of some financial oligarchy, covering their speculative rears while they debase the currency and pay themselves massive bonuses.

    This is not a democracy worthy of the name. These folks are reprehensible, ethically bankrupt and with the consciousness of a bacteria colony. A little strong to be sure, but with a certain truth to it.

  5. Richard Kline

    What I find particularly outrageous in this discussion of ‘to TARP or not to TARP’ is the presumption, no the presumed certainty, that Goldman Sachs _gets to decide_. That is, the make a choice and then tell the government where to sign. This is the meaning of corpocracy, that private wealth dictates to the state and the state caters to said directive. It is odious to watch the Secretary of the Treasury do what a for-profit CEO tells him.

  6. Kyle Napierkowski

    Yves, thanks for this eye opener — I didn’t think through the situation enough beforehand and just assumed that it was silly to not take Goldman’s money. Gapper is a smart dude and brings up all the most applicable points in his argument, particularly the connection to Fannie/Freddie’s quasi-gov status.

    Keep it up!

  7. Siggy

    The Treasury should accept the money from Goldman. The bonds raised by Goldman that carry the FDIC impramatur should be assumed by an entity not affiliated with Goldman. The Treasury and the Federal Reserve need to petition Congress for what amount to a re-enactment of Glass-Steagell.

  8. Kirill

    Goldman plays by the book and we should not punish this corporation for rules that were set up by the government. We must rise up against Obama and The Treasury as they are wasting time. Even though I do believe Obama has every intention to do what’s best for our country he does not know what the best alternatives are. This administration needs to go after the root causes of these issues and stop avoiding the inevitable.


  9. Cat

    Consider that the first of the banks out from under the TARP will be the first freed up to buy/gut/rape the weaker banks still under the TARP. All we lack now are those “stress test” results (read “death warrants”) to know who has been selected for slaughter.

    Let the games begin.


  10. Doc Holiday

    I hate being a registered card carrying member of the blog-world;nonetheless, life must go on…

    This financial farce, incompetence and fraud is obviously disgusting and a threat to America's future. The roots of this issue go back at least a decade (+) but the crystalized point of TOTAL & utter retardation was when TARP was spun out in a mindless (mis-informed) panic — which added chaos to the prior period of systemic corruption. That was the perfect storm which we continue to float upon today, with retarded and un-educated politicians, zero accountability, zero regulation and Trillions of dollars lost in the shadows. If there is a difference between Somali Pirates & Wall Street, it's probably because a smoking gun held by The Invisible Hand is the same gun used for Russian Roulette.

    If we go back about a year to Lehman's crash, that was really the point where Treasury (Paulson of Goldman) began usurping powers from congress and began a casino game of antitrust violations and unconstitutional activities. Treasury was and is currently just rolling the dice and playing with 100 year old models that have no rational basis in reality — capitalism is broken and now we have something else which is being made up on-the-fly.

    The question thus remains as to why Treasury would continue to back Goldman, i.e, on the surface there appears to be a direct partnership which smacks of collusion and corruption, because why else would Goldman be granted a competitive advantage, which no one else has? That type of abuse of power is not what free markets are intended to be about, yet there seems to be a willingness to adjust the rules for those that have political connections, much like Mother Russia and the system formally known as Communism, where the state provided favors for friends!

  11. Nemo

    Does anybody in the media or the blogosphere ever bother to read the term sheets before writing?

    The terms of the TARP capital injections are quite clear: Any recipient may pay back the money if they can perform a private Tier 1 capital raise of sufficient size. Goldman has now done so. You may not like these terms — I certainly do not — but they are right there in black and white. So I am little confused what exactly people are proposing Treasury actually do to refuse the money.

    I suppose one of the regulators could block the repayment on regulatory capital grounds. Is that the proposal?

  12. Doc Holiday


    I didn’t see repayment terms in your link, but then again, it’s time for lunch and my blood sugar may be low.

    FYI (from the internet): Goldman’s announcement goes counter to a meeting U.S. President Barack Obama had with a group of bank executives last month.

    Obama’s concern was that it would be “very bad” if banks gave the funds back, only to have them subsequently seek more bailout funds if economic conditions deteriorated further, according to the source.

    Wayne Abernathy, an executive at the American Bankers Association and a former Treasury official, said Goldman’s plan will be a test case to see if Treasury tries to hold up the repayment.

    “We haven’t had a big bank actually blaze that trail,” Abernathy said. “I think we’ll be looking to see to what extent Treasury facilitates the exit or inhibits it.”

    Abernathy said the government has two roadblocks it can put up. One is that the bank has to get the approval of its regulator to pay back the funds. The second is that Treasury has the opportunity to write regulations on how a bank can repay the money.

    Also see: 1. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG’s operations.

    2. Congressman Spencer Bachus (AL), the top Financial Services Committee Republican, issued the following statement:

    “Goldman Sachs’ announcement that it intends to return $10 billion in TARP funds to the Treasury – and the fact that taxpayers can expect a substantial return on their investment – is welcome news for those of us who support an exit strategy from government intervention in the marketplace.”

  13. marsha donner

    can someone explain how the banks are in such good shape yet there is 1-2 trillion being set aside to 'help' them>
    or…how the legacy assets are going to be held to maturity and therefore not an obsticle to solvency…yet PPIP is needed at the taxpayers' risk??

    Help me understand this paradox and how the congress, media, blogs, etc are not blowing this into better view?

  14. Yves Smith

    I Nemo,

    First, the redemption language clearly says they cannot redeem any sooner than three years from the closing date. So without going into details, Gapper is right, Goldman has no business talking about returning the money now.

    Second, bank regulator can raise capital requirements based on their assessment of balance sheet risks. Bill Black has written about this issue and argued it should be done in many cases.

  15. Nemo

    Yves —

    With due respect, you are mistaken. Quoting from that section of the term sheet:

    Senior Preferred may not be redeemed for a period of three years from the date of this investment, except with the proceeds from a Qualified Equity Offering (as defined below) which results in aggregate gross proceeds to the QFI of not less than 25% of the issue price of the Senior Preferred.
    The definition of a Qualified Equity Offering is a couple of paragraphs down:

    “Qualified Equity Offering” shall mean the sale by the QFI after the date of this investment of Tier 1 qualifying perpetual preferred stock or common stock for cash.So on the contrary, I am right and Gapper is wrong.

    I agree that the regulator can do whatever they like. But refusing to allow them to repay the money on the grounds of actual capital requirements is a little different from refusing it because the authorities just don’t want them to do it, IMO.

  16. Anonymous

    Smokescreen folks: Am I the only one who questions HOW they went from needing a taxpayer bailout to making a billion+ ??? Think back to last week, one of Goldman's employees, a code programmer left, taking the code with him (actually emailing it to an account in Germany). So what does Goldman do? They call in the FBI to arrest this guy, stating that someone could use the code for market manipulation. Everyone is crying about the risk that Goldman must have had to take to get such big rewards. Ya, right…. What is the risk, if you can manipulate the market -zero risk.

    Where are the mainstream journalist on this one? Are they all paid off as well as the SEC who should be saying "what do you mean you can manipulate the markets with this code?"
    Do you really need anymore proof that Goldman, The Fed, the spineless SEC and even the FBI are in the pockets of Goldman??

    This isn't America anymore, it's a Goldman Dictatorship.

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