Wednesday, March 23, 2011

Chasing Goldman Sachs by Suzanne McGee

Chasing Goldman Sachs: How the Masters of the Universe Melted Wall Street Down . . . And Why They'll Take Us to the Brink AgainI read an interesting article in Rolling Stone magazine online a while back that laid out the role that the investment bank Goldman Sachs played in bringing the U.S. to its knees in financial crisis in 2008. Ms. McGee mentions that article later on in her book, and seems to take a less tinfoil hat view of what came to pass during the meltdown, referring to it at times as "the perfect storm."

One of the points I'd never really considered before was the idea that investment banks like Sachs, Morgan, Lehman Brothers, and Merrill Lynch actually fulfilled the role of being a financial utility, providing businesses with access to capital to operate and expand, among other things, much like AT&T provides communication services, or Edison provides power. People who operate utilities tend to run their businesses in a very stable, risk-averse manner, so as to ensure the availability of their crucial components in our economy, and up until around the 1980s, the investment banks operated in much the same way. The partners in those banks had their own fortunes invested in the business, and would think long and hard before putting too much of it at risk.

As the financial landscape changed over time, so too did the behavior of the investment banks. Because so much of their business has been woven tightly into our entire economic system, they really shouldn't have ever been allowed to escape the bounds of the Glass-Steagal act, which kept commercial and investment banking safely in their respective places.

If you're old enough to remember the dot-com boom of the 90s, you may recall that many of the people stepping up to talk about the New Economy from our government, the Federal Reserve, and investment banks believed that due to the highly technical nature of the internet based businesses, and that intellectual property greatly outweighing the "old" brick and mortar methods of placing value on a business, most of the old rules should no longer apply. In the end, gravity never fails, I'm afraid.

If you weren't involved in buying stocks like Google, Amazon, and making a bundle getting in at the IPO and out within the week, you weren't as smart as Wall Street. Greenspan had a phrase for it, "irrational exuberance". As time went by, the investment banks became heavily involved in raising venture capital for anything related to computing and the internet, and putting together public stock offerings for many of these businesses, even before they had posted a single dollar's worth of profit. Goldman and friends became deal-makers and shakers, rather than stodgy old investment bankers, and the profits they made just lured them on to more and more irrational deals. The dot-com bubble came crashing down around us all a few short years later, and everyone vowed never to get taken in by a "bubble" again. How quickly they forgot.

The "bubble" that caused the financial meltdown, without delving too deeply into the financial and technical aspects of derivatives and CDOs, centered around the housing "bubble". Once again, people threw wisdom out the window and believed that things could only get better indefinitely. The government caused a part of the problem when it lowered restrictions on approving mortgages, creating the "subprime" market, and when it also lowered the amount of cash reserves that banks were required to have on hand to offset their in-house loans. The mortgage companies, brokers, and commercial banks were a huge part of the cause when they realized how much money was to be made by financing, re-financing, and re-packaging loans for people who could never have gotten a home loan in the past.

The poor, sweet, duped, innocent people, aka homebuyers, were also responsible for buying homes they knew in their hearts they couldn't afford, and racking up home equity debt by treating their properties like ATMs. And the investment banks couldn't resist taking advantage of the situation by taking those pesky loans off the hands of the loan makers and packaging them as collateralized debt obligations, which they sold off for huge fees to the people who run your pension plans. Ratings agencies, like Moody's, who tell you whether a bond or other investment is risky or not, jumped on the bandwagon, taking fees for classifying the required amount of these investments as AAA. Of course, just like playing blackjack in Reno, you can buy "insurance" to keep from going bust, and one of the biggest companies in that business, AIG, wrote a ton of policies that they conveniently didn't have the cash to back up.

When somebody finally realized that housing prices couldn't really truly go up and up and up forever (what in the world were you smoking, people?), the tinsel was off the tree, and some of the institutions involved began to take big write offs on their balance sheets. Due to the intertwined nature of all of the players in this game, the entire house of cards could have come tumbling down had not the government in its infinite wisdom consented to bail out - with YOUR money - those businesses deemed "too big to fail".

This is a really well written bit of history from Ms. McGee, and she does a great job of tarring all of the players with a big, wide brush, rather than just picking on one particular villain. Worth the read, especially for the cautionary attitude you should gain about that next "bubble" they claim will never come.

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