The unspeakable in pursuit of the inedible
- Oscar Wilde's definition of fox hunting.
To read the financial media after Goldman Sachs announced its results for the
second quarter felt rather like reading about the chap who turned up wearing
his birthday suit to a funeral. America was in mourning for its lost economy,
bust through the shenanigans of the Fed and millions of greedy, vacuous
Americans and yet, here was a firm - a bunch of financial men for goodness sake
- who dared, nay even boasted, about their ability to make money. Surely, fumed
the great unwashed, such a travesty cannot be allowed to happen in the Land of
the Obama-magic?
First perhaps, a quick background check: your columnist was
never in the employment of Goldman Sachs, directly or indirectly. Indeed, my
record as a columnist shows more than an ordinary slant against the firm, in
the sense that I simply do not believe the accounting logic employed by the
firm that is behind much of the financial magic. My record will also show a
consistent spewing of vitriol against former employees of Goldman Sachs (my
diatribes against Hank Paulson being particularly familiar to regular readers
of Asia Times Online) who found jobs in the United States and with governments
around the world, in effect forming a micro group that guides global economic
policy on a rather grandiose scale.
All that though, is firmly in the class of debates between opposing
capitalists; put a couple of socialists in our midst and we capitalists do tend
to strike out together against the common enemy; much like a pack of dolphins
will attack a Great White shark. Thus it is that I find it both correct and
timely to write an article defending the profits of Goldman Sachs, this quarter
in particular.
Last week, I wrote about the sheer idiocy of the many pronouncements made by
New York Times columnist Paul Krugman. A day after Goldman Sachs posted its
bumper profits of US$3.44 billion for the second quarter, in the process
setting aside some $1.65 billion as bonuses for its own employees, Krugman was
at it again:
The American economy remains in dire straits, with one
worker in six unemployed or underemployed. Yet Goldman Sachs just reported
record quarterly profits - and it's preparing to hand out huge bonuses,
comparable to what it was paying before the crisis. What does this contrast
tell us?
Reading that opening paragraph, for a second (and just
a fleeting second mind you), I thought perhaps Krugman would be on to something
new - that Americans being a resourceful, innovative bunch of people would
always use their skill sets to come out of any crisis; and that Goldman Sachs
could well be seen as the appropriate role model with which to do so ... sadly,
that wasn't to be, as Krugman was instead wearing his Lenin glasses, and really
had no time for profiteering capitalists, as he calls them:
First, it
tells us that Goldman is very good at what it does. Unfortunately, what it does
is bad for America. Second, it shows that Wall Street's bad habits - above all,
the system of compensation that helped cause the financial crisis - have not
gone away. Third, it shows that by rescuing the financial system without
reforming it, Washington has done nothing to protect us from a new crisis, and,
in fact, has made another crisis more likely.
Krugman lost me
on the first point: Goldman Sachs makes most of its money trading; that is,
selling stuff for more than it costs to buy it. Almost by definition, that
cannot be bad for anyone unless of course both the buyers and sellers that
Goldman caters to are preternaturally stupid. The latter issue is debatable,
but not quite what Krugman is criticizing here, so we can move on.
On his second point, I am not sure what it is that Krugman is criticizing
exactly - that people who make money shouldn't be paid for their effort; or
that people who make a lot of money shouldn't be allowed to make more of it.
Both are dumb arguments and generally not worth debating.
It is on the third point that Krugman actually makes sense, and ironically in
so doing ends up contradicting his earlier opposition to the US (George W Bush)
government letting big firms like Lehman Brothers fail (self-contradiction
without shame is an Orwellian talent that communists possess in great measure
and one that Keynesians will have to brush up on now that they are in charge of
the world's largest economy).
When the US Federal Reserve and Treasury rolled out blank checks galore to the
rescue of banks, along with the governments of the United Kingdom and the rest
of Europe, they embarked on a series of moves that guaranteed the persistence
of moral hazard for another two generations. Bankers had become the most
protected species on the planet (see
The New Brahmins, Asia Times Online, March 29, 2008). Fear about
failing banks led governments into a series of protective steps that were bound
to be capitalized on by at least one bunch of intelligent people, if not the
next.
In the event, Goldman Sachs fully tapped the government-guaranteed funding
market, and issued for itself a lot of cheap long-term financing; that was in
turn ploughed back into the purchase of deeply distressed securities, many of
which were trading below their statistically implied probability of defaults
and asset recoveries. The end result was electric - a massive rally in the
prices of such securities, which acted as a growth driver, pushing up its fixed
income to three times what it was this time last year. (See
Easy bets with other folks' cash, Asia Times Online, May 23, 2009 for
more on this trend.)
Krugman has always held that allowing Lehman Brothers to fail was a monumental
mistake made by the George W Bush administration. In contrast, the bankruptcy
of Lehman has showed a lot of positive results: talented people working for
Lehman were snapped up by other banks, the company's useful assets and
franchises were purchased by other firms and in general, the unwind of its
asset book to pay for excess liabilities has gone to plan. In contrast, firms
that have been saved by the US (and other) governments have shown no particular
urgency to get anything fixed: witness last week's indifferent results from the
likes of Citibank and Bank of America where it was one-off (extraordinary)
items that helped to push profits rather than useful, regular, recurring stuff
as in the case of firms that went to the brink and came back (such as Goldman
Sachs and JP Morgan).
Somewhere towards the end of his article, Krugman finally gets to the major
reason why he is upset with the firm:
Goldman's role in the
financialization of America was similar to that of other players, except for
one thing: Goldman didn't believe its own hype. Other banks invested heavily in
the same toxic waste they were selling to the public at large. Goldman,
famously, made a lot of money selling securities backed by subprime mortgages -
then made a lot more money by selling mortgage-backed securities short, just
before their value crashed. All of this was perfectly legal, but the net effect
was that Goldman made profits by playing the rest of us for suckers.
Much like John Maynard Keynes himself, who famously misstated economic theories
and laws that he then "disproved", Krugman is twisting facts here. While it is
true that Goldman Sachs bet against the subprime mortgage-backed securities
business, it was itself a minor player in the sector; indeed its short
positions were used by bigger rivals to package new securities that were sold
to European banks; a turn of events that left Goldman Sachs dangerously exposed
to significant trading losses had mortgage-backed securities NOT fallen off the
cliff as they did in 2007.
Then, Krugman caps himself in Keynesian glory with this statement:
What's
clear is that Wall Street in general, Goldman very much included, benefited
hugely from the government's provision of a financial backstop - an assurance
that it will rescue major financial players whenever things go wrong ... You
can argue that such rescues are necessary if we're to avoid a replay of the
Great Depression. In fact, I agree. But the result is that the financial
system's liabilities are now backed by an implicit government guarantee.
Having engineered an idiotic system that forces government (read: taxpayers) to
shoulder the burdens of a dysfunctional financial sector, Keynesians and their
companions are now up in arms that someone should dare to make money off their
largesse.
How about explicit non-guarantee?
What the world's Keynesians do not understand is the results of their own
actions. In particular, when you issue blanket guarantees, there is by
definition NO intent to reform; therefore banks and other recipients of
largesse simply sit around and try to make money on what they have rather than
on what they should be doing correctly.
This is the main reason that bank balance sheets are still swollen and no
meaningful de-leveraging has occurred.
If the entire world's Keynesians were really disgusted by the prospect of
Goldman Sachs and its companions on Wall Street making billions of dollars,
they have to simply learn to walk away - admit that it is generally a mistake
to issue blanket guarantees, and then go ahead and sever the umbilical cord
with the world of finance.
Here is what that will cause: inevitably, one or two of the world's largest
banks will fail; governments should step in and rescue retail depositors, but
leave everyone else hanging by the thread of their now-worthless securities
where the payout will depend on the liquidation value of the firm's assets.
Immediately, all of the world's financial firms will look to improve the
quality of their asset books and generally eschew assets that are illiquid
and/or longer-term (exactly what happened in the fourth quarter of last year).
When this happens and the price of these risky asset goes to new lows,
financial firms that are well-funded and stocked with truly intelligent people
- and perhaps Goldman Sachs will be one of these firms - will find it quite
profitable to engage in those lines of business, and particularly, on their own
terms.
Overall, the system will be forced to decrease its leverage, and thereby force
a contraction of economically useless activities. As the author Ayn Rand put it
so well in Atlas Shrugged (a novel about the politics of the rich being
forced to pay the indolence of the poor, a topic I shall return to in a future
article), it was never the job of governments to shoulder the burden of
companies simply because they were considered too big to fail. Keynesians do
not have the courage to tell Atlas what they should: go ahead buddy, shrug.
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