Thursday, July 16, 2009

Goldman, Fannie and CIT: Are Things Better Now?

The stock market views Goldman Sach's recent exceptional earnings report as a cause for celebration. The Dow Jones Industrial Average has popped up about 500 points so far this week, to a large degree on the strength of Goldman's earnings announcement four days ago. But, in the spirit of contrariness, we must ask whether things now are really better.

Goldman and a few other really large banks have the implicit guarantee of the U.S. government, whether or not they hold TARP money. Their creditors will be repaid. The events of the last year make clear that the anointed few cannot be allowed to fail, and Goldman is perhaps the most exalted among the anointed. By contrast, CIT, a major lender to small businesses, is told no bailout for you, because it's not deemed to have enough systemic impact to qualify for admission into this most exclusive of clubs.

Creditors therefore will be forgiven if they eschew CIT debt in favor of lending to Goldman and the other megabanks in the inner circle. After all, there's nothing like a sure bet. And, in spite of its Brobdingnagian budget deficits, the U.S. government is still a sure bet in the financial markets. Goldman, in turn, can receive the blessings of the ordered liberty of government in the form of lower interest costs on borrowed funds. This increases its profit margins and supports higher risk levels. Higher risks, if shrewdly evaluated, can produce greater overall profits--and Goldman's long been a shrewd player. Thus, the backing of the U.S. government gives Goldman and the other doyennes of the financial markets a synergistic dynamic that multiplies their profit potential. They seem to have, in essence, taken a page from Fannie Mae's and Freddie Mac's playbook: use the implicit guarantee of the U.S. government to secure lower funding costs and boost profits. No wonder Goldman's stock is doing well.

But shouldn't we be concerned? After all, Fannie and Freddie implemented their game plan all too well, taking on too much debt and too much risk, and facilitating a massive bubble in the real estate markets that ultimately made houses resemble tulip bulbs. Is there a possibility that the government guaranteed brotherhood of big banks will hog up capital desperately needed by the real, underlying economy in order to recover from this, the worst downturn since the days of Bonnie and Clyde? Might they not, as many of them did not long ago, misjudge systemic risks in the financial markets and create another asset bubble and bust (aided and abetted by the Fed's easygoing, tie-less attitude toward monetary policy)? Perhaps something like this is already happening in the oil market.

The federal government has significantly restructured the financial services industry over the last year. There are now fewer major firms, and the ones left standing can snap up market share formerly held by the ones that collapsed or were forcefed via mergers into larger firms. This consolidation of market power reduces competition and is good for the bottom line--monopolies and oligopolies are generally more profitable than competitive industries. What's disturbing is that the U.S. government's policies produced this outcome. Incentive compensation at Goldman is up, but the American electorate at large is experiencing higher unemployment, stagnating or falling salaries and wages, falling home values, and little prospects for improvement in the foreseeable future. As gratifying as Goldman's bonuses will be, they won't trickle down enough to significantly affect the larger economy.

No doubt financial regulators are cheered by the upbeat earnings reports from Goldman and J.P. Morgan Chase. But the stabilization and protection of the financial system seem to have become an end, rather than the means to a stimulating the recovery of the larger economy. The major banks have done little of consequence to revive the real estate markets. Virtually all lending for home purchases is the province of the newly nationalized Fannie Mae and Freddie Mac, and the FHA. Mortgage modifications for distressed borrowers are done between 8:30 a.m. and 8:31 a.m. on Sunday mornings just before bankers head for church. Lending by federally bailed out banks is, if anything, less active now than before the bailouts. Indeed, small businesses, key players in any revival of the economy, relied on the now-scorned CIT and other nonbanks for loans.

All across the land, little boys have stuck fingers in dikes to hold back the flood waters of the recession, and they desperately wait for assistance. Night is falling fast, and the waters are cold. High level federal officials drop hints about green shoots, but people at the ground level don't see any green in rising unemployment levels and falling real estate values. The federal government seems to be creating a class of oligarchs on Wall Street. But a battered economy won't recover because of the extraction of monopoly rents (as economists would put it) by, or an undue allocation of capital to, an ever smaller and more powerful group of banks.

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