For me, one of the most frustrating aspects of the financial crisis has been throwing drugs at the patient without working to cure the disease itself.
Massive amounts of money has been put into structurally flawed institutions such as AIG and Citigroup while no structural changes have been made to prevent other financial institutions from going down a similar path. Institutions that are “too big too fail” are not our only problem.
Goldman Sachs, which would likely have failed but for a government rescue, has become a lightening rod on the Internet. One example of the outrage stems from the fact that the firm’s trading group blatantly defies statistical odds by making a profit almost everyday the stock market is open. Is this really trading or a license to steal money out of the stock market? In a recent month, their trading group only lost money on one day.
Another issue with Goldman has been compensation. Even people with free market pro-capitalism views are outraged that individuals that would have been jobless but for a government bailout are now walking away with millions of dollars in bonuses only months later. Of course, this is one example of what happens when government intervention mixes with capitalism. If the government would have allowed Goldman to fail, the firm would have collapsed under its own weight and the individuals that benefitted on the way up would have suffered greatly when Goldman was shutdown.
But if the government let Goldman fail it would have destroyed the financial system!
This leads us back to the “too big to fail” problem doesn’t it? If a financial institution is so large that its failure could materially impact the financial system, it should not exist. I’m becoming somewhat optimistic that Congress is finally starting to look at attacking the disease (from New York Times).
Senator Bernard Sanders, the Vermont independent, is taking aim at banks that are considered too big to fail. “If an institution is too big to fail, it is too big to exist,” Mr. Sanders said in a statement. “We should end the concentration of ownership that has resulted in just four huge financial institutions holding half the mortgages in America, controlling two-thirds of the credit cards and amassing 40 percent of all deposits.”
“Goldman Sachs has done irreparable harm to this economy,” Mr. Sanders said. “Let them gamble without any support from the federal government. That they are getting insured” — through implicit government assurances — “is beyond comprehension.”
Bernard Sanders identifies himself as a socialist. Meanwhile, I would identify myself as a conservative or libertarian. It’s shocking that we agree on any subject. This is a big opportunity for the politicians on both sides of the aisle.
I’m not so sure I agree with his methods of permitting Tim Geithner to pick the institutions that are too big to fail, but I do support principle of breaking up institutions that are too big to fail. I would prefer more objective criteria.
Obama ran his campaign on change. Here is his chance for big change and it is a unique opportunity for Obama and Congress to bring liberals and conservatives under one tent (I’m not saying that all liberals and conservatives would agree with this proposal, but generally it should get bipartisan support).
If by the end of his term the big money center banks ceased to exist in their current form, that would be real change. Each large money center bank could be broken up into multiple regional banks. I can envision a situation similar to the Standard Oil or AT&T breakup.
Assuming the legislation was implemented properly, the excuse of bailing out a financial institution because it is “too big to fail” would never happen again since by definition this kind of financial institution would no longer exist in the United States.
So I’m becoming a little optimistic. Breaking up the large money center banks is intuitive and it is an idea that seems to be gaining traction. Regarding Goldman, there is a lot of chatter and outrage directed at the firm. I wonder if Goldman has been too smart and too cute for their own good. Perhaps laying low and not maximizing profits would have been a better (albeit less profitable) long term strategy. The bloggers (and now even the conventional media) are tenacious in their efforts to uncover any action by Goldman that is or could be construed to be unfair or unjust. I wouldn’t bet against the anti-Goldman sentiment. At a certain point, the politicians might see that they have more to gain by joining the anti-Goldman camp than standing behind Goldman. Goldman has a lot of political allies. But politics is dirty and an ally can turn to enemy at anytime.
In terms of trading, the XLF ETF may look much different in a couple of years. I smell progress.
Now if other simple fixes such as prohibiting Fannie and Freddie from owning mortgages for more than a short holding period before sale to third party investors and requiring individuals to put 20-30% into their houses was put in place, we might actually start curing the disease. This is a lot easier than throwing drugs such as quantitative easing at the patient (which ultimately may buy a little time, but the patient still dies in the long run).