The Closing Bell
April 22, 2010
By John R. Taylor, Jr.
With the SEC suit against Goldman Sachs, an age has come to an end. This action is symbolic: like the closing bell at the old-time New York Stock Exchange. An American saying, “it’s not over until the fat lady sings,” covers it pretty well. She’s singing. The crisis that broke the financial market’s back was spawned way back in 1986 with the Tax Reform Act, which led to much higher levels of corporate borrowing, followed by the Drexel Burnham invention of junk bonds. It only then reached its prime after the Graham-Leach-Bliley Act effectively repealed Glass-Steagall in 1999, in the post-bubble recovery that began in late 2002 as the SEC was financially starved and defanged. The Financial Times noted earlier today that the top three US banks grew dramatically, expanding their assets from under 10% of all bank assets in 1990 to over 40% by 2009 while increasing their capital bases by a far smaller
percentage. With equity capital of around 3% or 4% the top six US banks have assets equal to 60% of the US GNP. The investment banks expanded their leverage to the point that the capital supporting their asset structure was less than 2%. Although the collapse began in 2008 and took many victims, the basic philosophy underpinning the financial system has continued unaltered through this recovery. In the last twelve months, the financial sector has rallied 58% while the S&P has rallied only 42%. Wall
Street has not changed its stripes and will not while the incentives remain the same.
There are many factors underlying the growth in the financial sector of the US and the global economy, and many arguments both for and against the growing sophistication and centralization of financial decision making. Academics and financial leaders will battle over these issues in the years ahead and this process should eventually lead to a deeper understanding of leverage and market correlations and will find a better way to balance the insurance of depositors’ risks with the gains bankers can make by escalating those risks. However, the situation today is already critical, but mostly in a political sense.
That is why the fat lady has sung and the SEC has acted. It is not that Goldman is the ogre that has broken the rules. Everyone has followed this same path, and there weren’t any rules either. There is only one critical difference between Goldman and the others: Goldman is the best, the most efficient. Because it is the best of the breed, the political focus will fall on them. The others will be tried only in the shadow of Goldman, after the show trial is over. Although the public relations team of Goldman came out with a very well reasoned document making their case to those of us who use the firm’s services. Of course, this has gotten great play in the financial press, but it is all beside the point. The issue is not the actual case brought up by the SEC but the entire structure of Wall Street – the fact that a 31 year old derivatives salesman is sometimes paid more than 100 times more than a manufacturing executive in Peoria. The inequality of the system is the issue or, putting it another way, the jealousy of the lunch-pail voter is the political dynamite that cannot be ignored.
The Obama team has been chastised as being in the pocket of Wall Street. Although they argued that they helped the banks only to help middle-America, the argument was too tenuous to strike home with the average voter, and the banks then bit the hand that saved them by continuing their old ways even more brazenly than before. In a political sense Wall Street has become the tar-baby, anyone caught hugging them will be smeared with a wretched sticky mass. Even the Republicans, who have said no to every issue the Democrats have brought up since Obama took power, are forced to join this witch hunt. Congressional hearings on the seamy undersides of financial power and goings-on will become popular news as the banks are forced to turn conservative, cutting gearing and slowing the economy.
h/t Teddy KGB