Friday, July 17, 2009

Kroog Versus Goldman Sachs

Paul Krugman may be somewhat more polite than Matt Taibbi when it comes to, well, everything, but the two men pull few punches when it comes to Goldman Sachs's record-breaking $3.44 billion quarterly profits, how they got that much money, and what the company plans to do with it.
The American economy remains in dire straits, with one worker in six unemployed or underemployed. Yet Goldman Sachs just reported record quarterly profits — and it’s preparing to hand out huge bonuses, comparable to what it was paying before the crisis. What does this contrast tell us?

First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.

Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.

Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.
And he's dead right on all three points. What goods has the company produced? What innovations has it given to the market? What has it provided to America other than the nagging feeling we've all been had?

Let’s start by talking about how Goldman makes money.

Over the past generation — ever since the banking deregulation of the Reagan years — the U.S. economy has been “financialized.” The business of moving money around, of slicing, dicing and repackaging financial claims, has soared in importance compared with the actual production of useful stuff. The sector officially labeled “securities, commodity contracts and investments” has grown especially fast, from only 0.3 percent of G.D.P. in the late 1970s to 1.7 percent of G.D.P. in 2007.

Such growth would be fine if financialization really delivered on its promises — if financial firms made money by directing capital to its most productive uses, by developing innovative ways to spread and reduce risk. But can anyone, at this point, make those claims with a straight face? Financial firms, we now know, directed vast quantities of capital into the construction of unsellable houses and empty shopping malls. They increased risk rather than reducing it, and concentrated risk rather than spreading it. In effect, the industry was selling dangerous patent medicine to gullible consumers.

Goldman’s role in the financialization of America was similar to that of other players, except for one thing: Goldman didn’t believe its own hype. Other banks invested heavily in the same toxic waste they were selling to the public at large. Goldman, famously, made a lot of money selling securities backed by subprime mortgages — then made a lot more money by selling mortgage-backed securities short, just before their value crashed. All of this was perfectly legal, but the net effect was that Goldman made profits by playing the rest of us for suckers.

And Wall Streeters have every incentive to keep playing that kind of game.

The huge bonuses Goldman will soon hand out show that financial-industry highfliers are still operating under a system of heads they win, tails other people lose. If you’re a banker, and you generate big short-term profits, you get lavishly rewarded — and you don’t have to give the money back if and when those profits turn out to have been a mirage. You have every reason, then, to steer investors into taking risks they don’t understand.

And the events of the past year have skewed those incentives even more, by putting taxpayers as well as investors on the hook if things go wrong.

All of Wall Street works that way. Goldman Sachs just had the least shame about it. As such, it made the most money off of us. Wall Street has every incentive to keep playing that game, and the Obama administration has every incentive to perpetuate it. Despite some evidence that the White House is finally getting tough with banks and the infinite bailout money spigot is off, all you have to do is look at Goldman Sachs and its "business as usual" mentality to see that nothing has really changed.

It's unfortunate. It means down the road, we'll be right back into financial crisis mode. When the next crisis hits, it'll finish us.

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