Text size

PITY POOR GOLDMAN SACHS. WELL, MAYBE not exactly poor, after raking in a stunning $3.44 billion in profits in the June quarter. But not since the public wanted to pillory the oil companies for having to pay four bucks a gallon at the gas pump has such opprobrium been heaped on a company as last week, when Goldman reported its blow-out earnings.

Of course, the rabble already was roused by a polemic in a rock-and-roll rag blaming Goldman for virtually every financial catastrophe since the South Sea Bubble, especially the current housing bust. With so many miscreants participating in arguably the biggest financial catastrophe in history, it's all but impossible to point to the chief perpetrator (although Michael Lewis makes a good case for American International Group in his excellent piece in Vanity Fair, "The Man Who Crashed the World").

In truth, there was a suspension of disbelief all down the line: by mortgage brokers who arranged loans for delusional borrowers who bought houses they both knew they couldn't afford; bankers who collected, pooled and sliced and diced the junk mortgages into triple-A securities; ratings agencies who provided that Good Housekeeping Seal of Approval to those defective products; investors who credulously bought these mortgage-backed securities with gilt-edged ratings and junk-bond yields; sellers of credit-default swaps who never thought they'd have to pay off on the insurance they'd written. And don't forget Fannie and Freddie, which leveraged the implicit (and later explicit) backing of Uncle Sam to use cheap credit to balloon their balance sheets. And it was all fine, of course, because house prices never went down.

No less an authority than Alan Greenspan, the former Federal Reserve chairman, saw no problem with this because, firstly, scattering all these loans to the wind meant the risk was dispersed and therefore nobody needed to worry about the all these dubious loans threatening the financial health of any one institution. Moreover, there was no need to worry about bubbles; though they inevitably burst, the damage can be contained by reinflating a new one.

In that, Greenspan had empirical evidence on his side, after having reflated successive burst bubbles over his tenure. The Fed had done just that after the 1987 stock-market crash, which led to the commercial real-estate and junk-bond booms and busts of the late '80s. And after the dot-com bust of 2001 (which was helped importantly by Fed pumping to stave off the supposed Y2K threat), Greenspan countered by slashing rates to 1% by 2003 and leaving them at preternaturely low levels for a couple of years, which inflated the housing bubble.

Now, two years after the first hiss of air coming out that bubble with the swoon of a couple of Bear Stearns hedge funds, and trillions of dollars later, it seems that Goldman's boffo numbers are signaling the financial crisis is over.

Having repaid its capital injection under the Troubled Asset Relief Program, Goldman allocated some $11.4 billion for compensation in this year's first half, which works out to an annualized $770,000 for each chief, cook and bottle-washer at the firm.

Those 770 G's don't sound outrageous compared with the average Major League baseball player pulling down $3 million. Or compared with any of the New York Mets, who would be overpaid at minimum wage these days. Or compared with what Michael Jackson is raking in after what may have been the best possible career move left to him (see Elvis).

Goldman's profits and compensation wouldn't cause such a stir were the firm not the recipient of massive government subsidy for the key raw material for its business -- free, or nearly free, money. While Goldie repaid the TARP money, it has been able to issue bonds backed by the Federal Deposit Insurance Corp. under its Temporary Liquidity Guarantee Program.

As Andrew Bary detailed in these page three months ago ("How Do You Spell Sweet Deal? For Banks, It's TLGP," April 20), Goldman probably saved up to $600 million by issuing FDIC-backed debt with yields reflecting Uncle Sam's guarantee. "TLGP, not TARP, is the feds' biggest source of largesse to financial firms," Bary concluded.

Goldman took that largesse and made the most of it, generating $3.44 billion of profit in the second quarter, mainly as a result of massive trading gains. Indeed, Bianco Research points out that Goldman appears to behave like a giant credit portfolio. Since the peak of the credit cycle in early February 2007, the price of Goldman shares (ticker: GS) has moved in lock-step with corporate investment-grade and junk-bond spreads. Goldie's stock plunged in last year's crisis and rode up the credit recovery this year, which was fueled by the massive liquidity injection by the government via the Fed's myriad facilities -- TARP, TLGP, etc., etc., etc.

All of which suggest a modest proposal: If Goldman now can wring out nearly $14 billion in annualized profits a year, why not have the government give it a portfolio to manage that's six times its current size? Then the federal government could generate $100 billion a year, which would cover the $1 trillion tab the Congressional Budget Office reckons government-run health-care will cost over the next decade. That's about the only credible way that health-care reform would pay for itself.

And it would be a lot less painful than the tax increases proposed to pay for health-care reform. As the table in D.C. Current shows, the top marginal income-tax rate could be as high as 58.7% for residents of New York City after counting city, state and federal levies under the plan being considered by the House of Representatives (which would include lots of Goldman bankers and traders). That would be the effect of a proposed surtax starting at 1% for couples with adjusted gross incomes over $350,000 to 5.4% for those making over $1 million, along with reversion of the top bracket for ordinary income to 39.6% from 35% in 2011. Moving to bucolic Oregon or blue Hawaii would still mean a top marginal rate over 57%, followed by New York and California just below that.

Not that that conjures much sympathy for Wall Streeters, but the real burden of these higher taxes falls on small businesses, most of which file 1040s, not corporate returns. Moreover, many of them felt doubly beleaguered with CIT Group (CIT), a lender to thousands of small- and medium-sized businesses, failing to win further federal assistance, most notably the company's reported request to issue FDIC-backed debt of the sort that has benefited Goldman and other Wall Street firms so handsomely. Evidently, CIT was deemed not too big to fail. And unlike California, it can't issue IOUs once it's tapped out.

Indeed, some of CIT's creditors might actually be rooting for CIT to go bust. According to Bank of America-Merrill Lynch's Situation Room research report, a portion of CIT debt is held by creditors who are hedged through protection from credit-default swaps. Thus, they would face no risk from a default or would actually welcome one since their CDS insurance would then pay off. BofA-Merrill estimates a net CDS exposure of $3.46 billion, versus $33.5 billion of unsecured CIT debt. While that represents less than 10%, those holding credit protection might profit from a CIT bankruptcy .

While the specter of a CIT filing loomed, by Friday, Goldman, JPMorgan Chase, Morgan Stanley and Barclays were working on a $2 billion-$3 billion package for CIT, Dow Jones Newswires reported. But CIT may need as much as $6 billion to avoid bankruptcy. A filing would most seriously crimp smaller retailers who rely on CIT for working capital.

It's clear that the government's massive exertions have gone a long way to stabilize the financial system and, in some cases, reverse the worst effects of the crisis. The Fed's cut in its fed-funds target to 0-0.25%, along with massive injections of liquidity, has brought the key three-month London interbank offered rate all the way down to a hair over 0.5%. Although Treasury yields are up from their lows, investment-grade corporate bond spreads have narrowed sharply while mortgage rates have come down.

And those efforts are evident in the stock market as the first returns of the current earnings season helped erase the June-early July swoon with a 7% rally last week. That put the Standard & Poor's 500 right up to the 940 resistance level, around where it topped out in early June and where it started 2009.

But the monetary and fiscal stimuli have been far more successful in boosting the stock and credit markets, and by extension, Wall Street, than arresting the decline in the economy on Main Street. ISI Group points out the decline in payrolls over the past 18 months has been a record, some 3.1%, about half-again the plunge in the early 1980s. Meanwhile, productivity was at a record high in the first quarter -- good for profits, less so for the wage slaves who are working more for less.

Yet, the declarations of the end of the recession are growing by the day. And as each day passes, we are by definition one day closer to its end (not to mention our own). Even Dr. Doom, Nouriel Roubini, was quoted as saying that he had upgraded his outlook last week. Roubini, however, reiterated his long-held view this recession would last two years; it's in its 19th month and so has five months to go.

But, he emphasizes, the recovery will be a meager 1%, far below the economy's potential growth of 2.75%, because of the debt overhang among households. Roubini adds the labor market is very weak, with unemployment likely to hit 11% next year, up from 9.5% currently, with the potential of the second phase of a W-shaped recession starting in late 2010.

Wall Street should enjoy its good fortune while it lasts.