Thoughts on Goldman Sachs, Too Big to Fail, Money, and Credit Based Economies
I recently had an email conversation surrounding the following blog post, which you should read before continuing:
After you’re done there, here is my response to a friend of mine. Think of it as an extended comment on the referenced blog.
I completely agree with “this 67 page report is irrelevant.” Goldman Sachs had to do it for PR, so they did all the window dressing and enacted nothing of substance. Even the good things to come out of the report, like focusing more on clients (or at least disclosing when they’re betting against them), were supposed to have been done back in the 1990’s after the junk bond, pardon, high yield crash, and resulting S&L crisis.
All that being said, one of the comments showed a lot of insight into macroeconomic financial policy. You simply can’t break up the big banks without providing an equal amount of net capital or dollars (purchasing of government debt) into the system that would result from credit contraction. In the first world war and 1920’s, Germany financed itself by buying its own debt and monetizing it. This eventually killed Germany and produced Hitler.
If you break up the banks without providing the support, you get massive asset devaluations and a Great Depression. If you break up the Federal Reserve, you leave the printing presses in the ever-so-capable hands of congress and the President, which hasn’t worked except in singular, unsustainable instances in the history of the world. If you put us on a gold standard, you get a world that lacks the ability to respond effectively and in a coordinated way during a crisis- and we will always have a crisis. You also entice extreme amounts of protectionism and nationalism, which also led to two world wars and a Great Depression.
Forcing banks to hold more equity should be done by investors and bondholders. It actually IS done to a large extent by the market, but it’s ineffectively handled because of an apparent lack of long-term focus of the average investor. People have a nice way of forgetting crises about 5 years after they happen. I haven’t read the papers that were referenced, but they need to consider the following: banks have the ability to take on debt extremely cheaply. Think about it this way: I pay 1% on a money market over $500,000. That is the same as me getting a loan from that depositor. If I were an average business in today’s environment, I would have to pay about 6.5% for that same amount of debt, except I wouldn’t even be able to get it because I have too much debt-to-equity, ironically. Equity, then, might not be expensive relative to the general market for all businesses, but it is extremely expensive relative to the rest of the bank’s capital structure. If you want banks to hold more equity, we need to make it much more expensive for them to hold deposits. Imposing huge FDIC insurance fees is one alternative.
The assertion that banks have a goal of being too big to fail is a preposterous one. Stockholders suffered extensively and have continued to suffer massively in the institutions that were systemically important. Lehman got wiped out. AIG was effectively wiped out. Bear Sterns was basically wiped out. WaMu was wiped out. Merril lost over 2/3 of its value before acquisition. Citi shareholders lost nearly all their value- down from over $50.00 at one point to $4 today. Bank of America emerged a little better, but they still took a killing. The ONLY people making money in these stocks were the shorts and now are people who took a risk and bought once the values had signaled near-insolvency. All former shareholders felt plenty enough pain not to want to have to go through the same thing again. Too Big to Fail is not a myth; however, it’s not a strong incentive in-and-of-itself. If you want people to be more careful when creating financial empires, install huge FDIC premiums, require far more equity capital, and put a law in place that states that the heads of any bailed out organization will be jailed for life and all their assets and their families’ assets will be seized.
As a student of economics, we know that size matters. It creates huge efficiencies and allows companies to invest in things that smaller ones can’t. It even allows customers who would otherwise be forced out of the banking system to hold accounts and get loans, because the costs are insignificant to large organizations- just look at Bank of America. Goldman’s assertion that its size is an asset doesn’t stem from the implicit government guarantee that comes with that size, but rather the scale and scope that is necessary to create profit and support clients’/communities’ economic vitality in a system based on credit.
If we don’t want to have a system based on money and credit, we can all go back to bartering and walking to the stream for our daily water. Because of the ugly side of capitalism, one day we’ll probably be back there for a while, anyway 
