Washington Turns to the Dark Side

I listened to the conference call that Goldman held to report its earnings in August 2008, at which time Mr. Blankfein denied the company would need additional capital or that it would turn itself from an “investment bank” to a bank holding company subject to more stringent federal regulation. But when Lehman’s bubble burst and it appeared AIG, Goldman’s largest counter party might collapse, Goldman began losing customers and losing the ability to finance its short term credit needs like other, weaker banks. On September 21, 2008 they converted to bank holding company status. I imagine that Blankfein, hearing Paulson’s words only a month after falling under regulation by the Fed, must have sighed with deep regret. Once you take money from someone bigger than you (think: Mafia), they own you. And Blankfein must have felt he was in the presence of a Godfather that day.

The story has played out pretty much as would a gangster drama. As a bank holding company, and having received a $5BB infusion from Warren Buffet, Goldman Sachs neither needed nor wanted TARP money. They were the first bank to repay the loan, in May and at a sizeable profit to taxpayers. Now after three highly profitable quarters of earnings, the Mob is back, asking for more. Congress is being asked to levy a special tax on banks by the President, and appears only too willing to do so. The President has been attacking them in a desperate attempt to win public support as his popularity plunges, and yet, to date, Goldman stock has retreated only about 10% from its recent highs. I fear that in the coming months, with a midterm election approaching, anti-bank rhetoric will grow in its stridency. Sure no one feels sorry for overpaid bankers. They have also contributed to their own unpopularity with loan shark tactics applied to credit card users, and “gotcha” fees from which no one is immune. But we need well run, if over paid bankers, just as we need overpaid longshoremen, to keep the economy moving. Still Democratic incumbents, having failed to achieve their promised reform of health care, are anxious to find an issue with which to club Republican challengers. Since most voters blame “banks” for the financial crisis, they are an easy target for political rhetoric. In point of fact the near implosion of our economy of 2007-present can just as easily be laid at the feet of politicians themselves, who have lavished special tax treatment on home ownership and facilitated lending to people not qualified to own a home especially through vehicles like FNMA and Freddie Mac. These latter two “quasi-governmental” lenders , unlike most private banks, have failed to repay Uncle Sam one cent of the $950BB of credit extended to keep them afloat.** Last year I railed about the role of crooked appraisers and real estate agents who gladly nudged buyers into more home than they could afford. There is a long list of people who profiteered from a distorted residential real estate market, but due to their political clout, not a word of ire has been cast in their directions. Perhaps this is due to the enormous vote buying in which they engage. Witness the following, taken directly from the Realtors Political Action Committee web site:

“Since 1969 RPAC has been promoting the election of pro-REALTOR® candidates across the United States. During the last federal election cycle alone, RPAC contributed over $12 million to pro-REALTOR® candidates to Congress, making it the number one trade association political action committee in the nation. Why has RPAC been successful? Because RPAC is not a charity. RPAC is a business”.

Sure, banks and investment banks facilitated the sale of mortgage backed bonds to investors, mostly sophisticated institutions around the world. Sure, many of these were effectively junk bonds that rating agencies like Standard & Poors and Moody’s awarded their “AAA” stamp of approval. The Bankers were only one cog in a vast mechanism that led to a seizure of the financial system. They performed their function, to create a liquid market for securities that finance desired social goals, in this case home ownership for all. Should they be singled out for random punishment? Well, if you are a politician in hot water, dealing with a public who is largely ignorant of finance, the answer is yes.

Here’s how Martin Wolfe a commentator for the Financial Times sees it:

“The politics of this are easy to understand. The rescue of the financial system has succeeded. But borrowing by every sector, except government, is negative. How far this is because the financial sector does not wish to lend or the non-financial sector does not wish to borrow is unclear. I assume both forces are at work. As the McKinsey Global Institute reminds us in a recent report, deleveraging can take many years. The contrast between strong finance and a weak economy is inevitable in the early stages of the post-crisis recovery. It is also desperately unpopular.

However understandable the politics, it is far less evident that the proposed change is good policy. One issue concerns the process. After a couple of years in which the world has focused on very different remedies, the most powerful government of all has introduced new and unsettling ideas. If the ideas are good, this uncertainty need not be that costly. But if the result is to make it more difficult either to pass reform in the US or to agree reform with other countries, the costs could be high. The uncertainty injected into the financial system, at a time when predictability has returned, could be the biggest cost of all.”

In the last paragraph Wolfe is referring to the likely unworkability of the Obama-Volcker plan to separate speculative functions from traditional banking, reminiscent of how U.S. banks operated until about a decade ago. I myself have been in favor of a return to something like the Glass-Stegall system enacted in the 1930’s, so am not sure I disagree with the intent of the President’s general direction. I also happen to view Paul Volcker as one of the better minds in finance. But it is most unfortunate that the President has chosen to approach a possibly desirable reform effort in demagogic terms, and apparently without coordination with other major economies around the world. If we learned one thing from the Crisis, it is that the United States financial system is inextricably enmeshed with the world financial system. It is foolish to try and go this alone. The whole affair seems a deliberate turn to a convenient political theme destined to replace the failed efforts at health care reform as we move into election season-hardly a way to approach meaningful reform of the very important banking sector.

As a result of the apparent shift by the President’s party to the Dark Side, the outlook for investing, particularly in the financial sector has become most unsettled and difficult to predict.

footnotes:
  *Paulson threatened banks into using bail out fund
 ** Track the Federal bailout money