Goldman and Public Coffers: Free at Last?By DeltaHedged • Jul 22nd, 2009 • Category: Featured Article
Today, Bloomberg reported that Goldman Sachs repaid the government for warrants issued at the height of the financial crisis, generating a whopping 23% percent return for US taxpayers. Apparently, Goldman decided to retire their warrants amidst political outrage at its decision to earmark $11.4B in employee compensation over the first half of this year.
At first glance, this seems decidedly legal and somewhat fair. Goldman no longer relies on taxpayer money to conduct business. It can allocate its revenues any way it wants. I’m surprised that shareholders haven’t yet demanded higher dividends or capital gains, but they too are private actors, seemingly acting on behalf of their own best interest without effect to the public writ large. Furthermore, financial institutions like Goldman need to pay the highest dollar to attract top talent. Large bonuses are an important instrument that will allow Goldman to attract the talent it needs to navigate the admittedly opaque and potentially volatile waters of the post-financial crisis markets.
Alas, such arguments ignore the delicate fragility of the financial markets today and distort the inherent relationship between Goldman Sachs and the US taxpayer. For long after this crisis has passed, and long after Lord Lloyd Blankfien has retired to the manor of American politics that befits the leaders of this Great American Corporation (see Henry Paulson, Jon Corzine, Bob Rubin), few will remember the murky relationship between Goldman and public coffers. This post is intended to clear up this obfuscation.
First, imagine a world when the federal government fully adhered to the neoliberal, free-market ideology no doubt peddled by members of both the Bush and Obama administrations prior to the crisis. This counterfactual is one of no bailouts, no debt guarantees, no TARP, no Public-Private partnership, no receivership for Fannie and Freddie, and certainly no capital injections of any kind. I challenge my readers to come up with a situation in this world in which Goldman would not fail. Here’s the point that is often lost in the mainstream account of the financial crisis:
Goldman benefited from the positive externality of having the government virtually guarantee the solvency of its biggest trading partners.
Without bailouts of Citi, Bank of America, AIG (see below), and other key systemic actors within the financial sector, the entire system would have collapsed. Period. Every independent investment bank would have declared bankruptcy. Only after fast-track approval to become a bank holding company did Goldman stand a chance to survive. I would even venture to say that “healthy” firms like JP Morgan would have also failed, if for no other reason than their counterparty exposure to the entire financial system as a whole (lending to hedge funds, other banks, etc.), plus the rapid deterioration of their balance sheet brought on by the initial declared bankruptcies.
This brings me to the DeltaHedged’s first image of taxpayer-Goldman relations:
By bailing out other firms within the industry, taxpayers restored confidence to the financial system, thereby saving Goldman’s existence.
Secondly, Bloomberg’s 23% return figure ignores the money funneled to Goldman via the AIG bailout. Because of the secrecy inherent to AIG’s balance sheet and its complex web of trading partners, it is impossible to know the exact dollar amount Goldman received from the Treasury’s bailout of AIG. Forbes estimates that Goldman received approximately $12B. Goldman insists that it fully hedged its counterparty risk to AIG. Assuming this is the case, Goldman still benefited from the AIG bailout for the argument advanced above - had AIG’s other trading partners failed to be made whole, Goldman would have suffered. Moreover, this $12B can be seen as another taxpayer subsidy to Goldman, or a reward for trading against a failing insurance giant. Was this included in the notional of the warrants? This leads me to my second image of taxpayer-Goldman relations:
By bailing out AIG, taxpayers insured the solvency of one of Goldman’s biggest trading partners. Furthermore, taxpayers’ $12B passthru to Goldman via AIG rewarded Goldman for being part of a collateral-demanding consortium that crippled the insurance giant in the first place.
Thirdly, it’s entirely possible that Goldman is still too big to fail. Goldman’s VAR is reportedly the highest in Goldman’s history. The bank prides itself on risk. Does this mean that Goldman could once again be too big to fail? Possibly.
History teaches us a lesson about the survivors of financial crises: they are often the next ones to go. Remember, the bailout of Long Term Capital Management in 1998 arguably sewed the moral hazard that led to the current bailout of the financial system. In this sense, Goldman has one of the best guarantees in the world. Which brings me to the third and final image of taxpayer-Goldman relations:
By virtue of repeated bailouts in the face of cataclysmic systemic collapse, firms like Goldman will continue to operate with impunity, taking ever-bigger risks, knowing that the taxpayer will shoulder the downside and they will retain all upside.
The goal of this article was to give the reader a better appreciation for the complicated relationship between taxpayers and Goldman Sachs. I do not want to pick on Goldman - indeed, several of my close friends from both undergrad and graduate school are members of their illustrious roll. But it is important that readers understand the multifaceted relationship that Wall Street and Washington has. It is one that will continue to evolve. But today, the fortunes of Wall Street, America, and the world are inextricably intertwined. The example of Goldman serves to illustrate this point. I do not boast the epistemic hubris to know how the future will unfold. I simply know that the world five years from now will look far different than the world today. And that makes for one of life’s best reality tv show. Stay tuned.