The Joy of Sachs
Paul Krugman
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.
Let's start by talking about how Goldman makes money.
Over the past generation, ever since the banking deregulation of the
Reagan years, the US 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 GDP in
the late 1970s to 1.7 percent of GDP 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 sub prime 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.
I won't try to parse the competing claims about how much direct
benefit Goldman received from recent financial bailouts, especially the
Government's assumption of A.I.G.'s liabilities. What's clear is that
Wall Street in general, Goldman very much included, benefited hugely
from the Government's provision of a financial backstop, an assurance
that it will rescue major financial players whenever things go wrong.
You can argue that such rescues are necessary if we're to avoid a replay
of the Great Depression. In fact, I agree. But the result is that the
financial system's liabilities are now backed by an implicit government
guarantee.
Now the last time there was a comparable expansion of the financial
safety net, the creation of federal deposit insurance in the 1930s, it
was accompanied by much tighter regulation, to ensure that banks didn't
abuse their privileges.
This time, new regulations are still in the drawing-board stage, and
the finance lobby is already fighting against even the most basic
protections for consumers.
If these lobbying efforts succeed, we'll have set the stage for an
even bigger financial disaster a few years down the road. The next
crisis could look something like the savings-and-loan mess of the 1980s,
in which deregulated banks gambled with, or in some cases stole,
taxpayers' money, except that it would involve the financial industry as
a whole.
The bottom line is that Goldman's blowout quarter is good news for
Goldman and the people who work there. It's good news for financial
superstars in general, whose paychecks are rapidly climbing back to
precrisis levels. But it's bad news for almost everyone else.
New York Times
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