Crony Capitalism

News item:

Goldman Sachs surprised even optimistic analysts with a $3.44 billion profit for the three months to June, almost 90% more than the previous quarter. Profits were also up at JP Morgan Chase, which announced second-quarter profits of $2.7 billion on July 26th, which were 36% higher than a year ago. (“The World this Week”, The Economist, July 18–24, 2009, p. 8.)

Why should anyone be surprised that two of the nation’s largest financial institutions have prospered in the wake of taxpayer bailouts, facilitated in the case of Goldman Sachs by a revolving door between Wall Street and the U.S. Treasury? Three recent secretaries of that executive branch department—Robert Rubin, Hank Paulson and Timothy Geitner—have intimate and longstanding ties with the same newly adopted ward of the state.

Neither should it be surprising that Goldman Sachs’s record second-quarter profits flowed from unprecedented risk-taking: the firm’s “value-at-risk number—an imperfect but popular measure of risk appetite—hit a new high” during the same three-month period (“Keeping Up with the Goldmans,” The Economist, July 18–24, 2009, p. 71)—nor that more than 72 percent of the $15.8 billion in profits the company has earned so far this year has been paid out in salaries and bonuses to officers and staff (“Going Overboard”, The Economist, July 18–24, 2009, p. 72).

Now fully confident that it is “too big to fail”, Goldman Sachs is free to pursue high-risk profit opportunities with impunity knowing that it can retain the payoffs from such strategies if they succeed and shift losses to the taxpayers if they do not. Bailouts subsidize moral hazard; they are inimical to the operation of a market-based economy that allocates scarce resources to their highest valued uses by punishing rather than rewarding poor business decision-making.

Meanwhile, two of Goldman Sachs’s rivals, UBS and Citigroup, find themselves to be in dire financial straits as the result of losses of business to ... Goldman Sachs. Another hard-pressed lender, CIT, likewise is on life support nowadays, with its ultimate survival apparently depending on the sufferance of bondholders.

As Nobel laureate George Stigler once said, the intended effects of government policies should be deduced from their actual effects. Barack Obama, like George Bush before him, has been captured by the interests of a few favored Wall Street firms. The change we can believe in is being counted at the offices of Goldman Sachs and JP Morgan Chase.