Who Financed Goldman's Record Bonuses?

The Guardian published a much-ballyhooed article this weekend about a Goldman Sachs staff meeting in London where employees were told that they could look forward to record bonuses if the company registers its most profitable year ever. The bank, which repaid its TARP funds last week is rumored to have had a record first half, although it has yet to complete its second quarter and report results. Before everybody gets out their pitchforks, a moment of rational reflection is in order. First of all, whatever boob in attendance at the staff meeting that actually leaked this news to the press, amidst a worldwide recession where the finance industry's excesses have launched a political firestorm, should be canned. Once that's out of the way, we can talk about what exactly is wrong with the picture.

First of all, it helps to analyze how it is exactly that Goldman Sachs has managed to make so much money. The folks at GS are savvy traders, no doubt. But the real answer is that a host of government subsidies kept the investment bank alive during some of the most nauseating turbulence in the credit market's history. The $10 billion in TARP funds was chump change compared to the trillions in liquidity for illiquid assets that the Fed added to the market last year via its new lending facilities (TSLF, TAF, PDCF etc etc.) By taking over the roll of financing illiquid assets, when the Fed lowered interest rates to zero, it essentially reduced the cost of funds on ALL collateral to zero, not just treasuries, thus boosting profits substantially for the banking system. Meanwhile, spreads on illiquid products continued to trade at historical wides, which, as long as I've been in the market, has been unprecedented during an easing cycle. Furthermore, the Fed bailed out AIG, which meant that GS actually got to collect on its margin calls directly from the Fed. Although GS has made repeated claims that it was properly hedged and would not have had material exposure had AIG failed, I'm not buying that claim. Sure, Goldman might have hedged, but where did it get its hedges? Would those counterparties have survived a failure of AIG and would GS have been able to collect from them without a government guarantee? Last, but not least, GS was allowed to issue billions in FDIC-guaranteed debt at a greatly reduced cost from where its debt was trading at the time. One thing's for sure, if GS is paying record bonuses, that means at least our deposit insurance fund is safe for another year or so.

The Goldman record-bonus story illustrates precisely the flawed thinking behind Paulson and Bernanke's notion that if you bailout the financial sector, you bailout the economy. The economy is still struggling mightily. If it weren't for Fannie and Freddie, that are now direct wards of the government, it would be impossible for consumers to get a loan of any kind. As it is, the financial press is filled with reports of consumers and businesses getting cut off from credit. Yet Goldman Sachs made boatloads of money trading commodities, currencies, and fixed income. What the government did instead of boosting lending to the economy, was subsidize Goldman's, and in fairness, the other banks' trading operations, so they could go on to pay bankers a bunch of money. When populist furor initially erupted, those "in the know" kept saying that the average American didn't understand how finance really works and that they were too stupid to get why it was important to bailout the banks. But couple the Guardian article with the one in today's FT entitled "Bankers' pay soars as struggling groups aim to halt talent exodus," maybe the American public understood the picture after all.