The Wall Street Journal’s editorial page this morning reminds us that Goldman Sachs is still operating under an implicit government guarantee that puts taxpayers on the line for any losses while its partners enrich themselves from profits.
Of course, if the feds do let CIT fail, this will only confirm that the only certain survivors in the current market are banks big enough that the government figures it must bail them out. Just ask the many small banks that have been rolled up by the FDIC at a rate of two a week since the beginning of the year, with eight so far in July alone. That can only strengthen the likes of Goldman, which apparently needs no help printing money anyway.
Goldman’s traders profited in the second quarter from taking advantage of spreads left wide by the disappearance of some competitors (Lehman, Bear Stearns) and the risk aversion of others (Morgan Stanley). Meantime, Goldman’s own credit spreads over Treasurys have narrowed as the market has priced in the likelihood that the government stands behind the risks it is taking in its proprietary trading books.
Goldman will surely deny that its risk-taking is subsidized by the taxpayer — but then so did Fannie Mae and Freddie Mac, right up to the bitter end. An implicit government guarantee is only free until it’s not, and when the bill comes due it tends to be huge. So for the moment, Goldman Sachs — or should we say Goldie Mac? — enjoys the best of both worlds: outsize profits for its traders and shareholders and a taxpayer backstop should anything go wrong.
What’s worse, letting CIT fail might not help this situation at all. Rather than clearing the way for market discipline to reassert itself, CIT’s failure might only reify the policy of Too Big To Fail.
Financial firms that are deemed too small to be rescued will find credit hard to come by and expensive, which will incent them to grow or sell themselves to a systemically important firm. In short, we’re increasing the concentration of financial power and hence systemic risk in the largest Wall Street firms that led us into this mess.
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