Goldman’s profits

Goldman received $13bn from the government as its hedges against AIG wouldn't have paid out, since AIG didn't go bust. By deciding to bail out all the other (apparently) unhedged counterparties through AIG, surely they had to compensate Goldman, who would otherwise have been penalised for their own prudence and superior risk management. Obviously it's not ideal that the taxpayer funds this, but rewarding failure and screwing the successful really would be a bad state of affairs.

Am I missing something?

Russ, I agree with your view on Goldman Sachs. Goldman Sachs took very risky positions and lost, and the company should have declared bankruptcy. But, though the magic of federal government bailouts both directly with Goldman Sachs and indirectly with AIG, the company survived to make large profits and pay very large bonuses to economically undeserving executives. These overpaid executives have excellent political skills, but not so good risk identification and management skills. And, the government's intervention rewarded these fools handsomely. It also kept others from benefiting from Goldman's mistakes. This keeps the vicious circle going with idiot politicians using taxpayer money to bail out foolish executives in bad times and foolish executives using a portion of their bailout-funded bonuses as campaign contributions to keep idiots in political office.

I think this is more a political crisis more so than any economic crisis. What I mean is that, the actions of the political class, the culture of corruption, the cronyism and out right bribery finally spilled over into the real economy. The "prevailing view" is that the "greed" of Wall Street caused the crisis, but I think it's the "greed" of Washington that caused it. Washington has been pushing for more housing for years, it was only a matter of time before they put together the perfect storm. Specifically, I'm thinking of Freidman's article in Critical Review.
http://www.criticalreview.com/crf/pdfs/Friedman...

1. HUD directives, beginning in 1994, which spurred subprime and
nonprime lending and securitization by the GSEs.
2. Regulations that had, starting in 1936, mandated minimum ratings for
a growing number of investments.
3. The 1975 S.E.C. decision to confer NRSRO status on the three
extant rating firms.
4. The loose-money policies of the central banks, begun in 2001.
5. “No-recourse” laws passed by different states over the years.


The banks, with those kinds of incentives, did what any rational person would do. But I also think, that most of them deluded themselves with the "prevailing wisdom" that housing was risk free and that housing prices would never fall. Taking everything together, I still see most the the fault for this, in the political class. Of course you can't have crony capitalism without immoral politicians.

I don't think GS profits are justified nor do I think JP Morgan's were. From what I've read, a lot of banks were forced to take taxpayer money, I know some were told they couldn't even pay it back. I'm not sure, now, who all has paid back what and who is still forbidden to pay back the money. The banks are full of smart people, It's not to hard to imagine that they could take that taxpayer's money and turn a profit buying and selling reduced price assets, especially with the Fed buying up the most "toxic" ones. I think you could give a monkey a few hundred billion in taxpayers money and put him on e-trade and make a few billion. Of course that is an over simplification, but I think it's a sound hypothesis.

Sorry if it double posts, the first one didn't show up on my end.

Without painting the private sector as lily-white, let's not forget that a big part of the trouble they got into was done "with our money" in the form of pay for the legislators who encouraged loans to people who couldn't pay them back. When you get it sorted out as to just who was responsible for what, and therefore whose money is at risk, maybe there is still a moral argument for capping pay.

But not a good managerial argument, because the camel's nose should not be allowed in the tent at all.

I am against capping pay. I'm in favor of letting bad decision-makers go out of business.

Hi Russ, I've got a great name for a future book about Goldman Sachs (that you should write) - False Profits. The only silver lining in the large black cloud of this depression is that the political thievery is on open display. I wish I could believe that something good would come out of this ugly situation, but the malefactors appear to be profiting obscenely, with no sign of retribution in the offing.

Russ, do you reject GS' assertion that the real beneficiaries of the AIG bailout with respect to their $13B were their CDS counterparties (and, technically, AIG's unsecured creditors when any collateral held by GS was released)? If so, on what basis do you reject it? If not, why do you contend that they benefited from the AIG bailout?

They all benefited. They were all lending and backing up each other. It really was something of a Ponzi scheme with you and me left holding the bag.

Sounds like that's a "no."

I think this would have been a better foundation for the article than the $13B. It does beg the question, but since we can't know what would happen to firms' financial contracts if implicit government guarantees of some firms were pulled, some question begging is to be expected.

"What's the virtue of saving crony capitalism?"

Fantastic line. But I'm not so sure about this one:

"The latest rescue of Wall St has taken hundreds of billions of dollars from average Americans and given that money to some of the richest people in human history..."

Correct me if I'm wrong, but don't rich people and rich corporations pay almost all the taxes in America?

Rich people pay a large share of the income tax. Their share of the payroll tax is much smaller. Payroll taxes are a significant share of government revenue. I'll try to look it up and post on it.

I thought the payroll tax was forced savings for retirement and not really a tax. Since the higher earners receive less than they pay in and lower earners receive more than they pay in, why is payroll tax relevant? You're basically saying it's all income tax. If it's all income tax, the higher earners still pay much much more in total - even if the amount that's called "payroll" tax is proportionally smaller with respect to their total income.

It IS all income tax in the sense that it all goes out the door to pay
for the stuff government does.

Okay. So, what's the point of categorizing it? Who cares if higher earners pay much much more of something called "income tax" and much less of something called "payroll tax" if the higher earners pay much more overall?

BTW, you're going to get into some hairy details. Any money earned on investments is not considered "employment" income and isn't subject to the payroll tax. So, people living off their capital aren't going to pay payroll taxes. A lot of "the rich" fall into that category.

What's the point? To confuse people, alas. And it's working. And many
people think their payroll tax goes to "their" retirement account. Not so.

Ah, the fabled "lockbox". I understand what you're saying. I also understand that payroll taxes create an obligation for the government - whether government is going to be able to meet that obligation in the future is another question.

If you consider all taxes paid on income the same, why not just look at the total effective tax rate instead of concentrating on categories? Who cares how much of it is called "payroll" vs. "income"?

http://www.cbo.gov/ftpdocs/98xx/doc9884/12-23-E...

2005 data (from G. Mankiw's Feb 26, 2009 post)

Lowest quintile: 4.3 percent
Second quintile: 9.9 percent
Middle quintile: 14.2 percent
Fourth quintile: 17.4 percent
Percentiles 81-90: 20.3 percent
Percentiles 91-95: 22.4 percent
Percentiles 96-99: 25.7 percent
Percentiles 99.0-99.5: 29.7 percent
Percentiles 99.5-99.9: 31.2 percent
Percentiles 99.9-99.99: 32.1 percent
Top 0.01 Percentile: 31.5 percent

Looks like earners in the top quintile pay 54.2% of all federal taxes. However, I don't think it's accurate to ignore the obligation payroll taxes create. When you factor in that obligation, the top earners pay even more in taxes.

Here's some tax share data. The top 25% pay 86% of federal income taxes and the top 1% pay 40%. Perhaps the numbers change if we consider payroll taxes, so I'll wait to see what Russ has to say.

Oy. Sorry, I got distracted in the middle of writing this. This data does NOT say that the top quintile pays 54.2% of all taxes.

What it says is the top quintile pays a higher percentage of its earnings in taxes and that taxes are progressive. So, even when payroll taxes are factored in, the top quintile pays significantly more.

Thanks Methinks.

Would also be interesting to see data on state level taxes (although I don't think it's relevant for our bailout discussion). Know of any?

Russ, thanks. I'd love to see some data.

yes, but that still does not justify that they get bailed out.


Prof. Roberts, this might be something for you:
http://www.facebook.com/group.php?gid=51818722129

And this begs for a reaction from you too :

http://www.facebook.com/group.php?gid=57629321527

geckonomist, I agree. I'm just quibbling with the point that the "average" American is footing the bill.

I'd like to know what Prof. Boudreaux thinks of your article. Not so long ago he claimed here that Goldman Sachs was always perfectly solvent and did not need at any point the government billions. Rather, these billions were forced upon it by the government.

And about your article: according to an article in the economist some time ago, GS received over 20 Bn dollar through AIG (slightly more than Deutsche Bank), not the lower figure you quote.

But I read somewhere else (FT, economist or WSJ) that GS claims it did not need any AIG money at all, because they had already hedged against an AIG default. Hard to believe, but we will never know.

Many banks that received TARP money didn't want it. That isn't what the piece is about. The piece about AIG. And Bear Stearns for that matter--I don't know what they owed GS when they were going down.

GS claims the AIG bailout was "immaterial" to them, partly because they had collateral for about 1/3 or a little more of the money. They claim that collateral was liquid but why am I skeptical? As you say, we will (probably) never know.

For the most part, they just did what they were supposed to do, and all they really could do--respond to the signals.

At least until the bailouts came along.

Goldman Sachs played the same game as Bear Stearns and Lehman Brothers—they made lousy investments financed with borrowed money.

No. This is the central concept of hedging and diversification.

They had some of the same reckless leverage, but not as much.

I'm trying to find out how much. I think they did have less. But not so much less. Anyone out there have consistent data over time for the different investment banks?

That information is highly guarded. The Fed system account manager (NY Fed) receives daily balance sheet and position information from all primary member dealers, and would have the full historical and financial picture, as well as effectively real-time snapshot info.

An aggregate picture can be found in the Fed z.1 report:

http://www.federalreserve.gov/releases/z1/Current/

The key difference between Goldman, Lehman and Bear is Goldman’s crap assets (probably) never exceeded their capital base.

Russ,

They were actually better at hedging. They were also better at placing ex-employees in political offices and in regulatory institutions, which is a kind of hedge when government is all powerful.

Good luck getting that data. I don't think you will be able to get what you need. I don't think the Debt/Equity ratio is going to give you the true picture of risk.

Methinks-

Well, to your point about debt/to/equity ... you do need to look at their derivatives books and see about netting transactions. I believe that most FASB rules say that you can't net derivatives assets and liabilities because of the risk of default. So, if I owe you $1k and you owe me $1k ... I have to show the asset and the liability on my books.

Leverage is different than risk ... but it's a good place to start. You can talk about quality of assets (like having AIG owe you $100B) and how any loss to those derivative contracts is a dollar for dollar hit to equity. But that's a different story.

A good place to start there is to look at "Level III" assets in the fair value footnote to the financials. That's the most toxic crap sitting on their books.

M4liberty,

FASB is behind the curve in capturing reality. It relies on the bank to mark its book and the bank has a lot of wiggle room there and that makes comparisons very difficult.

Agreed and that's where a lot of the Level 1, Level 2, and Level 3 assets stuff comes into play. 1 is generally straight forward, 2 less so, and 3 has been affectionately referred to as "mark to make believe".

Audited financials can be bogus at times ... but that's all we have. Besides, most banks (and companies in general for that matter) disclose quite a bit of information in the footnotes. That's where the real information digging is done.

they won't and can't disclose exactly how they marked every one of their derivatives books in the footnotes, though, and that's the heart of the matter. Even if they did, it wouldn't be that useful to an analyst.

I'm sure you can get some kind of comparison and analysis to write a research report or an academic paper. However, I wouldn't rely on that information to put on a trade - let's put it that way.

Well, I'll say this... The fact that they have derivatives buried in their level 3 footnote with no description of what they are or how they're marked says that, if marked to any semblance of a market, they would adversely effect their bottom line. Sometimes non-disclosure is all you really need.

That footnote is basically what hedge fund managers like John Paulson keyed in on -- realizing that eventually real losses would result from those fantasy book values.

J. Paulson made a lot of money on his short. Great for him. I was pleased to hear it when it became public.

I just checked their (Goldman's) 2006 and 2007 10-ks. I figured these would have the highest leverage ratios.

2006 - 23.4x levered
2007 - 26.2x levered

The difference between 26.2x levered and 30x is kind of splitting hairs, right?

Russ-

Should be easy enough to pull the 10k's of each company over the last 5 - 10 years. Just take shareholder's equity over total assets.

Rule of thumb was that for the major commercial banks it was around 12-to-1. The pure play ibanks like Lehman, Bear, and Goldman were around 30-to-1.

Now, compare all of those figures to a company like Microsoft that has a leverage of about 2-to-1 (off the top of my head ... I know they had about $30B in cash on their last annual report).

I don't know, Russ. Maybe you can guide me through this: If the salaries of Goldman's top producers are the marginal revenues gained from producing the kind of financial instruments that would move the American economy out of recession, why would we want to cap those revenues? I guess a simpler way of putting it is: why would we want to punish success, when we are in need of success right now? (Are we getting success, though? That's the question...) Does that make any sense?

Don't get me wrong; I'm with you. The idea of crony capitalism prevailing right now fills me with revulsion. But there is something deeply sick about the government bailing out the banks and then grumbling when they make profits. Wasn't the whole bailout thing about compensating banks for a particularly bad spell in which profits disappeared?

Actually, I think it might be the other way around. They created the financial innovation that created the recession. Many of them should be out of work. Their "success" came from government not their own productivity.

Russ,

What's scary (and I have this from the horse's mouth - GS) is that the "innovation" that created such sloppy derivatives products where risk is increased rather than decreased, is continuing unabated. The government has a role in this. Regulators have been trying to control trading and leverage in every existing product. This pushes institutions to quickly create new, more sloppy derivatives. I fear the next blow up will come from these and it will make this little crisis seem like a walk in the park.

I guess I'm working under the assumption that the government's--that is, the Obama administration's and the Fed's--implicit strategy is to create another bubble instead of long-term, sustainable growth to get out of recession. Would they really scrap the current system of financial instruments and regulation if that's the case? Doing so would be a tremendous setback. I'm imagining the arguments now: "we" "need" to spread high risk investments around as widely as possible--how else can "we" invest in or subsidize "essential" green technologies? etc., etc.

They created the innovations, but only because regulations forced them to. I think that is just an example of the market, given enough time, to innovate in order to backdoor the regulators.

NPR publishes this year's token radical. Congratulations, may you score again next decade.

But why just GS? What about the rest of the survivors. Bottom line were were told that WS wealth was too concentrated and it is gotten much worse after the crash. I am not sure if any of the systemic problems have been addressed. Middle class is still destroyed and the barons have less competition.