By Simon Johnson

Goldman’s Big Guns Fire Dud To Defend Megabanks

April 15, 2013 12:56 pm Category: Bloomberg View, Economy, Memo Pad 19 Comments A+ / A-
Goldman’s Big Guns Fire Dud To Defend Megabanks

April 15 (Bloomberg) — The six very large U.S. bank holding companies — JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley — share a pressing intellectual problem: They need to explain why they should be allowed to continue with their dangerous business model.

So far their justifications have been weak, and the latest analysis on this topic from Goldman Sachs may even help make the case for breaking up the financial institutions and making them safer.

Legislative proposals from two senators, Democrat Sherrod Brown of Ohio and Republican David Vitter of Louisiana, have grabbed attention and could move the consensus against the modern megabanks. Under intense pressure from Democratic senator Elizabeth Warren of Massachusetts, Federal Reserve Chairman Ben S. Bernanke conceded recently that the U.S. still has a problem with financial institutions that are seen as too big to fail. Pressed by Republican senator Chuck Grassley of Iowa, among others, Attorney General Eric Holder is sticking to his story that these companies are too big to prosecute. Cyprus offers another vivid reminder of what happens when banks become too big to save.

In this context, it is no surprise to see the financial sector wheel out its own intellectual big guns. A frisson no doubt rippled through the financial-lobbying community last week with the release of a report (PDF) from Goldman Sachs’ equity research team, “Brown-Vitter bill: The impact of potential new capital rules.” This is the A-team at bat, presumably with clearance from the highest levels of management.

Yet instead of providing any kind of rebuttal to the proposals in Brown-Vitter, the report may strengthen the case for breaking up the six megabanks, while also requiring that they and any successors protect themselves with more equity relative to levels of debt. Read the report with five main points in mind.

First, notice the lack of sophistication about bank capital itself. The authors write of banks being required to “hold” capital, as if it were on the asset side of the balance sheet. They go on to construct a mechanistic link that implies that “holding” capital prevents lending.

Banks don’t hold capital. The proposals are concerned with the liability side of the balance sheet — specifically, the extent to which banks fund themselves with debt relative to equity (a synonym for capital in this context). Higher capital requirements push companies to increase their relative reliance on equity funding, thus increasing their ability to absorb losses without becoming distressed or failing. If the transition is properly handled, there is no reason that more equity funding would translate into lower lending.

Second, the Goldman Sachs analysts seem completely unaware of the recent book by Anat Admati and Martin Hellwig, The Bankers’ New Clothes, in which those authors — who are top finance professors — debunk the way many bank representatives (including the authors of the Goldman Sachs note) look at issues around capital.

More equity relative to debt on a bank’s balance sheet means that equity and debt become safer: The bigger buffer against losses helps both.

Goldman Sachs makes much of the implications for return on equity, without mentioning any adjustment for risk. Bankers are generally paid based on return on equity without proper risk adjustment. Naturally, they like a great deal of leverage, but the reasoning they use to justify this is fallacious (see Chapter 8 in Admati and Hellwig).

Admati and Hellwig make the broader case that we can run our system much more safely. Goldman Sachs made a big mistake by refusing to take them on directly.

The bank is correct in its assessment that bank equity is higher than it was before the 2007-08 crisis, but this is the natural reaction to a near-death experience. Over the cycle, big banks will again become more leveraged (meaning they will have less equity relative to debt). As a result, Goldman is far too optimistic in its projection of the capital levels that will be needed when the next crisis hits. Current — and likely future – - levels of equity capital are insufficient for our intensely interconnected financial system.

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Goldman’s Big Guns Fire Dud To Defend Megabanks Reviewed by on . April 15 (Bloomberg) -- The six very large U.S. bank holding companies -- JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co. April 15 (Bloomberg) -- The six very large U.S. bank holding companies -- JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co. Rating:

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  • charleo1

    In Jan. of 2009, the fallout from the collapse of the housing bubble, on
    Wall Street, was just hitting main street. And, business owners, large, and small,
    were canceling orders for new merchandise, jettisoning employees, and battening
    down the hatches, in preparation for the economic storm everyone knew was
    going to hit. The question was not whether it was going to be bad, but how bad.
    By the summer of ’09, after nearly two trillion dollars was allocated to shore up
    the big banks, and patch some of the gaping holes torn in State budgets, as funding
    streams, dependent on a healthy churning, of buying, and selling of real estate,
    dried up. Job losses, that had peaked as high as 800,000 per month, had slowed,
    to a less frightening, but still sobering 150-200,000, per month. So, just as the
    economy was improving, the calls to find, and fix, and regulate, and monitor, those
    institutions, we were being told, were too big, and too important to the economy to
    be allow to fail. So, just as many Americans, rightly called for measures to prevent
    such a disaster in the future. The Right Wing started in telling one of the fattest, lies,
    since Nixon assured Americans, he was not a crook. Or, George Bush said, there
    is no doubt Saddam Hussein has weapons of mass destruction, to use aganist
    America, and our allies, or to give to terrorists. So, in what is becoming a sort of
    business as usual, tradition for Republicans. In this, provably false, fairy tale, Wall Street doesn’t need more regulation. No! No! Quite the opposite. In fact, it was the
    Democrats, being the Socialists, and wealth, redistributionists they alway are.
    Forcing the banks to loan trillions, and trillions to poor, non-Whites, and illegal
    aliens, that couldn’t repay their loans. In this way, they can absolve Wall Street,
    while blaming the government for interfering in an otherwise perfect free market.
    These guys would have probably accused the Police, and FBI, of forcing one,
    Al Capon, an honest, hard working entrepreneur, and pillar of the community, into

    selling millions of dollars worth of bootleg liquor, to the Citizens of Chicago.

  • JDavidS

    Assholes like that know they can play “fast and loose” for two reasons… It’s other peoples’ money and the government will cover their ass if they screw up. Time to bring the hammer down on these clowns otherwise it’s not if, but when they bring the economy to its’ knees again. And then still collect obscene bonuses…

  • Eleanore Whitaker

    In the early 1900′s, Theodore Roosevelt found it necessary to stop the corruption of the Robber Barons who amassed wealth by placing their employees in grave danger and using unfair competitive practices. They created mega monopolies that Roosevelt realized was dangerous to all individual Americans. He pushed for the Sherman Anti-Trust Act. Did that stop these money grubbers? No. So, the Sherman Anti-Trust Act had to be reinforced by the Clayton Anti-Trust Act. For every piece of legislation created to rein in corruption on this grandest of grand scales, these money bois create a loophole. The bottom line is they are breaking the laws by looking for a way around regulations they know they must comply with. And all for the single minded obsession: wealth.

    Elizabeth Warren rightly has stated these banks are “Too big to jail.” But jail is the only thing that would teach them the virtues of honesty in business. Honesty? These greedheads haven’t had an honest day in their lives since birth.

    The government can no longer fine these money men. All that does is cost the average American double…the price of banking plus paying the fines for these greedy pigs.

    When men in business can no longer be reasoned with regarding ethics and principles, jail is the best reminder. Not a fine…those fines are recouped by continuous jacking of prices on the goods and services they sell to the rest of us. They don’t even blink an eye at a fine anymore. To them, it’s an amusing joke on the rest of us.

    • http://www.facebook.com/people/Jim-Myers/100001512942781 Jim Myers

      Jail time does seem appropriate. However, not one of the “Country Club” prisons reserved for the wealthy and powerful.

      They should be in a prison for common criminals, not the hard core murderers or rapists, but the same prisons everyday criminals face for common crimes, like felony theft, fraud, etc.

    • CPAinNewYork

      Great post.

  • CPAinNewYork

    It’s interesting that you decided to show a picture of the Goldman CEO, as he seems to prefer a low profile, This is understandable, since his firm stands accused, but unpunished, of selling investment instruments that Goldman’s own investment people thought were destined to fail. In fact, some in the “investment community” believe they were issued with the intention that they fail. I don’t understand that, but I don’t put anything past people like that.

    If you can believe the hypocrisy, Goldman actually has the gall to defend the practice by claiming that its sales and investment people are two completely separate areas of the firm and therefore there is no ethical breach or conflict of interest.

    • Independent1

      I guess if like the majority of Republicans you can believe Goldman’s outright hypocrisy, then it appears that you can also misguidedly believe that Ronald Reagan was a good president; when Ronnie Boy is without question the person who is most responsible for the dire situation that America is in today. How? by being the architect of the nefarious Republican notions (which virtually every GOPer has been promoting in spades since he was in office) that the rich are the benevolent givers of the world and that making them richer will trickle down and help the less rich prosper. And also the dumb notion that by giving the rich a big tax break, with the pitence of a break for the middle class, while also drastically cutting spending, will somehow magically spur the economy. Both notions that have been disproven time and time again but didn’t stop Ronnie and his Republican buddies from expanding the pay of CEOs from 42 times what a basic worker made when Ronnie took office, to them making 201 times a basic worker’s pay just within 10 years of him pushing his disasterous fantasies. And not only that, but if anyone has noticed, it was while Ronnie was in office that the semblence of a bond between a company and its workers (you work hard for me and I’ll repay you for that work), started rapidly to deteriorate with companies laying off often what had been their hardest, and often best paid workers, because of their focus on the bottom line; while also gradually removing almost every benefit a company once offered its workers, like pensions, subsidizing their 401ks, special perks, etc. etc.

      • DezJimmar

        @ Independent1: Amen to that! I have been saying that for years (though not as well as you expressed it here). Reagan’s words (government get out of the way) did not match his deeds. He raised taxes, raided Social Security, exploded the debt, etc. Everything that Republicans rail against. I will always classify Ronald Reagan as the worst president in my lifetime.

        • Independent1

          What’s sad is that millions of Americans still think favorably of him,
          despite the absolute disaster that the policies he espoused have wreaked on America over the past 30 years. There was a time that I thought GWB2 was the worst president of all time, but after realizing that GWB2 and Cheney were just following through on many of Reagans misguided fantasies, I’ve come to consider Ronnie the worst president America has ever had. I know there have been some disasterous ones in the past, but I just can’t imagine that any of them have created the all encompassing distruction of our country that many people misguidedly following Ronnie’s example have perpetrated on America, during and since he was in office.

        • Barbara Morgan

          I think Reagan and Bush 2 are tied for being the worst Presidents this country have ever had with Nixon a close 2nd. They cut taxes saying that it would create jobs when all the tax cuts did was put more money in the pockets of the rich and more middle class and working poor in the unemployment line and drawing unemployment and having to receive food stamps to feed their families. I don’t understand why the anti trust laws and laws against monopolies can’t be used against these mega banks to break them into different companies doing different financial jobs and preventing them from ever being able to be a mega bank again. No bank, no company or corporation or financial system should ever be allowed to get to big to fail and to big to jail. If a bank is to big to fail and is to big to jail the head honchos for breaking all the financial laws they have broken then the lawmakers. law enforcement and proscutors aren’t doing their job and should be charged with incomplentence(not spelled right) and service the time in prison that these banks hand honchos should be doing. If they are ever sent to prison may sure they start the sentence the day they are sentenced and that they are not sent to a country club prisonbut one were they have to work in the fields to grow the food to feed the prisoners and other such jobs. There are people today that have been found guilty of financial crimes over 2 years ago and still haven’t started serving their sentences.It seems that today’s white collar crook gets to decide when he or she will turn theirselves in to start their prison sentence and how it will take them to get ready to go prison. Since most of the crimes they have been convicted of is the same as bank robbery they should be treated like a regular crook and start their sentences on the day they are sentenced.

      • CPAinNewYork

        If you interpret my posting as being favorable to the Wall Street crowd, then you have either failed to understand what I’ve written or you’re trying to set my post up as a straw man so that you have a vehicle for venting your anger at the Republicans.

        I don’t mind your venting your anger at the Republican Party or at the depredations of big business in general, but I do object to your trying to make me your foil. If you don’t have the intelligence or guts to make your argument on your own, then you should remain silent.

        Further, if you had read my previous postings in a running battle that I had with the likes of “Obozomustgo,” you would know that I strongly opposed Mitt Romney and his band of elitist bastards. If you had taken the time to read further, you’d know that I’ve written cautionary postings about the danger of a revolution in this country if those same elitist bastards’ agendas prevail.

        I don’t know your politics and I don’t care, but I do strongly object to your intellectual dishonesty.

        • Independent1

          I did not interpret your posting as being favorable to the Wall Street crowd, in fact, I thought anything but that. My intent in following up on your comment was to support your thoughts, so I’m sorry if somehow the wording of my comments came out objectionable to you. I’ve read a number of your comments to Obozomust go, and as far as I can recall have always been in full agreement with your rebuttles to him. I in fact had a very extensive running battle with him just a day or two ago,about his grossly misguided thoughts on gun control and his wild notion that somehow the federal government has actually encroached on the sovereignty of the states; so I fully appreciate your frustrations in trying to reason with him. Please be assured, despite how my comments may have come across, I was not trying to play off your words but rather trying to support what I thought were your thoughts about what I find very common among Republicans – being willing to support one act of hyprocrisy after another.

    • 1standlastword

      Goldman sold toxic products insured them at AIG and cashed in. The Goldman execs defended their practice stating that investors were informed in policy of the risk they were taking. I like David Stockman’ The Great Deformation. His thesis is the market purests like Greenspan are fakers. Really a free market policy would have allowed AIG to fail. Their assets would have been assumed and policies would have been covered and that is true Ayn Rand philosophy.

      Hank Paulson lied, pulled his pals bacon from the fire and transferred all the debt to main street.

      • CPAinNewYork

        You appear to have the makings of a good posting, but I cannot get past your poor grammar. Consider having someone re-write it for you and then re-submit it.

        • 1standlastword

          Oh don’t be so snarky!!! I don’t have a lot of time to write eloquent prose. You seem to understand that I’m bringing a factual statement to bear on your post…

          • CPAinNewYork

            Readers are entitled to well written posts.

  • jgsoliveira

    Too big to fail means you can laundry money for drug cartels and get away with it.

  • BenTheGuy

    Just about everyone associated with Goldman Sachs should be in jail, and that includes a lot of Obama appointees. Screw up the economy from the private sector, become a cabinet member so you can screw it worse from the public sector!

    As far as the rest, they would have been broken up naturally had the rich and powerful not conned the American people into TARP and bailouts and stimulii designed to preserve the status quo and protect the rich from the consequences of their actions.

    Goldman Sachs, unfortunately, was smart enough to get out with a huge profit before it all fell apart, but that doesn’t mean they didn’t crap all over the average citizen, and with pleasure.

    • CPAinNewYork

      I agree with you. Obama talks tough, but he’s definitely short on action.

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