Resist The Urge To Punish Success

By Mark Gimein
Sunday, July 19, 2009

Money can't buy love? For proof, look no further than Goldman Sachs. Last week, the firm reported a spectacular quarterly profit -- close to $3.5 billion for the bank and about $385,000 in compensation for each employee for the first half of the year -- and right on cue, the braying began for the heads of the Goldmanites. Earlier this month, Rolling Stone's Matt Taibbi, in a comprehensive exercise in conspiracy mongering, primed the pump of outrage with his article "The Great American Bubble Machine." Now a chorus of supporters has chimed in, shocked that in a recession the evil Goldman could turn such profit.

The rhetoric of outrage has come full circle: Before, the villains were the banks that were stupid and greedy enough to fail; now the villains are those -- a small club, basically just Goldman and J.P. Morgan Chase -- that have been smart and greedy enough to succeed.

What began as an effort to keep the financial industry from repeating its mistakes has turned into, as at other points in history, an attack on the idea of trading profit. It is no longer enough that the banks should be reformed; the opportunity to make this kind of profit should be eliminated.

This now-fashionable line of attack is badly misguided. Goldman and J.P. Morgan are reaping great rewards as the last firms standing in a game in which everyone else has been cowed or crushed. Yes, they're able to do that partly because the government has kept the financial system afloat. (Would anyone really prefer that it had not?) But the essence of the outcry is that we must punish Goldman for having been right. This is a mistake.

Goldman-haters like to weave a narrative that connects the dots between Goldmanites and former Goldmanites who are supposed to rule the world in a one-degree-of-Goldman Sachs fashion. The list expands until, as Taibbi says, it becomes a list of everything, like those lists of members of the Trilateral Commission and the members of the Council on Foreign Relations so beloved by an earlier generation of conspiracy theorists.

The real objection of Taibbi and others is that Goldman, except for one bad quarter at the nadir of the financial crisis, has turned a profit. Big profit. Or, as some folks -- such as economist William K. Black, writing in the New York Times' Room for Debate blog -- like to say, obscene profit. (What obscene means no one is sure, except that they know it when they see it.)

The argument that if a company made a huge profit, it must have rigged the game has been made at just about every bank in periods of high profit. Occasionally -- as with the technology-stock boom, from which most banks walked away unscathed -- it turns out to be right.

More often, it turns out to be wrong. Drexel Burnham Lambert, which was supposed to have the junk bond market all figured out, is no more. Neither is Bear Stearns, which ostensibly had the secret to turning mortgages into infinite cash. In almost every case, the theory that a speculator has cheated in some mysterious way is proved untrue in some spectacular way.

Some markets have been successfully gamed and manipulated for the profit of a few key players. The Internet public offerings market -- in which Goldman was certainly a major player, though not, as Taibbi claims, any more culpable than others -- is one example.

The California energy market that was essentially cornered by Enron, Reliant Energy and a few other companies with catastrophic results was another. (That, by the way, was a market designed by government experts.)

There is nobody at this point who thinks regulators shouldn't play a big role in preventing this. Nor is it unreasonable for companies that benefit from what is essentially an implicit federal insurance plan in times of crisis -- and yes, that does mean Goldman -- to pay for it.

The attack on profit per se, however, goes beyond this. It takes aim at the wrong target, serves the wrong interests and will lead to wrong results.

The weak links in the financial system are not mainly the speculators who are reputed to be collecting obscene profits. They can just as well be government-sanctioned institutions -- think Fannie Mae -- that are supposed to be content with what are thought to be reasonable profits for what is ostensibly a socially desirable role.

Those institutions manage to combine a thoroughgoing incompetence with a vested interest in hiding what profit they do make -- again, think Fannie Mae -- and making the financial system as opaque as possible.

Worse, the attack on profit in itself creates the bizarre assumption that those who are making less in profit are operating more ethically. Nothing that we have seen since the great bank collapse should give anybody a reason to think that. The collapse of the mortgage bond market is a case in point. Goldman was certainly a player in this, but it was not the lead player by any means.

Who drove the mortgage bubble? Lenders such as Bank of America, Washington Mutual and Countrywide; investment banks such as Bear Stearns, Lehman Brothers and Britain's Royal Bank of Scotland that were leaders in mortgage-backed securities; and one-stop shop Citigroup, which packaged derivatives.

Conventional wisdom says that Goldman's profit must be the result of a formula that involves excessive risk. Former labor secretary Robert Reich points to Goldman's "value at risk" calculations to conclude that the government should limit Goldman's risk-taking.

How quickly we forget that just a few months ago, nearly all the formulas that were intended to explain the behavior of the bond markets and provide banks with the tools to manage their risk turned out to be useless -- or worse. A regulatory regime whose goal is to limit profit, in the hope of thereby limiting risk, is one that merely codifies the same bogus and incompetent thinking about risk that held sway in the financial industry during the mortgage bubble.

Does the financial system need reform? Yes, obviously, both in how bonds and mortgages are traded and at the ground level of how banks deal with their customers. But the way to do it is to keep banks from again making the kinds of idiotic blunders that have left half the banking industry defunct or on life support. The way to keep everything from again going wrong is not to punish Goldman for having been right.

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