Matt Yglesias

Paulson’s Funny Business

Felix Salmon brings us what looks to me like a blockbuster scoop about Hank Paulson’s inappropriate hanky-panky with Goldman Sachs. From Andrew Ross Sorkin’s Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves (don’t think this one needed the subtitle):

If all that weren’t enough to deal with, [Lehman president Bart] McDade had just had a baffling conversation with [CEO Dick] Fuld, who informed him that Paulson had called him directly to suggest that the firm open up its books to Goldman Sachs. The way Fuld described it, Goldman was effectively advising Treasury. Paulson was also demanding a thorough review of Lehman’s confidential numbers, courtesy of Goldman Sachs.

McDade, though never much of a Goldman conspiracy theorist, found Fuld’s report discomfiting, but moments later was on the phone with Harvey Schwartz, Goldman’s head of capital markets. “I’m following up at Hank’s request,” he began.

After another perplexing conversation, McDade walked down the hall and told Alex Kirk to immediately call Schwartz at Goldman, instructing him to set up a meeting and getting them to sign a confidentiality agreement.

“This is coming directly from Paulson,” he explained.

In a separate incident Paulson held a secret meeting (in Moscow!) with the Goldman board at which he gave them a private briefing of his views on the economic outlook. I can’t think of any non-corrupt possible rationale for that, but it also doesn’t seem like a huge deal. This other thing, by contrast, you could imagine being on the up-and-up (understanding Lehman’s books was a legitimate policy issue and arguably Goldman was better-equipped to do it than the government) were there not the appearance of corruption granted by Paulson’s past as a Goldman guy. But at the same time, it’s a very big deal. And when you put the two anecdotes together you have a very, very ugly picture—something that strikes me as easily worthy of some congressional hearings.

It’s Not the TARP, It’s the Guarantee

You don’t get a ton of opportunities, as a liberal, to write “this is a good point from The Wall Street Journal editorial board,” so let’s note that The Wall Street Journal editorial board is making an excellent point about the farcical nature of the idea that if Goldman Sachs repays its TARP money that it’s no longer a ward of the state. They observe that Goldman has benefitted mightily from the Maiden Lane III vehicle from the Fed, and from special post-Bear access to the Fed’s discount window, and from the FDIC’s new broader debt guarantees. But beyond all that:

The larger issue going forward is whether Goldman is “too big to fail,” which means that everyone knows the feds will ride to the rescue if it gets into trouble again. Before Bear Stearns, investment banks were allowed to fail, a la Drexel Burnham. But after last autumn, no one will believe it. And Goldman will hardly mind if that’s what the marketplace believes, because such an implicit taxpayer guarantee will let it borrow more cheaply and thus make more money. Think Fannie Mae again. Even now on the taxpayer dime, Goldman is still trading on its own equity account — risky banking behavior.

The point is that Goldman and other banks can’t have it both ways. If they want taxpayers to save them, then they have to take fewer risks and become smaller.

My main dissent would be that this puts too much agency on Goldman’s shoulders. There’s an inherent time-consistency problem such that even if Lloyd Blankfein and Barack Obama and Ben Bernanke all swear mighty oaths to never bail Goldman out again, nobody will believe them and nobody should believe them. It’s not an issue of whether or not, subjectively, Goldman executives and shareholders “want” taxpayers to save them, it’s an issue of the fact that Bush/Paulson/Bernanke/Obama/Geithner have set a new series of precedents about to handle the potential collapse of large, complicated financial institutions. So instead of it being “if they want taxpayers to save them, then they have to take fewer risks and become smaller” it’s given that taxpayers will save them, then have to take fewer risks and become smaller.

Exactly how to do that, of course, is controversial. But I think it’d be good to see a mixed approach. On the one hand, more prudential regulation. On the other hand, regulation to discourage massive scale. And with two hands working together, some kind of sliding scale such that risk-regulation gets stricter the bigger you get. Thus far, though, we’ve heard only a little from the administration about risk and not much of anything about scale. This is troublesome, since the political “window” in which the will might exist to enact meaningful new rules is not going to stay open forever.

Shareholder Value

It’s interesting how, in the hands of a mildly talented PR department, just about any management decision whatsoever can be spun as a defense of shareholder interests:

The financial giant Goldman Sachs spent tens of millions of dollars to bail out two senior executives last fall who were short on cash, according to the bank’s proxy statement filed on Friday.

In an unusual move, Goldman bought back stakes in some internal investment funds from Jon Winkelried, the bank’s co-chief operating officer, and Gregory K. Palm, its general counsel.

Both executives are among the largest shareholders in the bank, owning more than a million shares each, and directors were concerned that a large sale of Goldman shares by the two men would alarm investors during a period of market turmoil, according to a person briefed on the matter.

An alternative strategy would have been to just let the executives sell their shares and then have Goldman allocate the tens of millions of dollars to share buybacks or other direct means of using cash to reassure investors. But that wouldn’t have produced a personal windfall for powerful managers, so it didn’t happen. Alternatively, if you’re in the grips of the neoclassical faith then it must be the case that this is Goldman acting responsibly rather than its managers looting during a crisis from a firm that would be going out of business absent government intervention.