It’s not a good idea to stand in front a stampede and try to talk the cattle into stopping, or to argue with a bunch of lemmings headed for a cliff that follow-the-leader is not a good idea.
Still, we ink-stained wretches of the fourth estate do have responsibilities. So before investors and policy-makers sign onto the idea that bigger is better, that the last two investment banks left standing should find shelter in the arms of big, commercial banks, let me try to make a few contrarian points.
First, and most important, this is not a very good time to make decisions about the future structure of the financial services industry.
Calm heads have yet to prevail; the ordinary investor is quite properly seeking shelter from the storm by buying safe government IOUs: and we do not yet know for certain where Treasury Secretary Hank Paulson will draw the line in deciding which enterprises get a federally funded lifeline, and which are left to drown in their own errors — Freddie, Fannie and AIG get saved, Lehman Brothers is allowed to go bust, Merrill Lynch is forced into the waiting arms of giant Bank of America.
But we do know a few things about what has made America’s capital markets work well enough over time to assure that resources are efficiently allocated, that new businesses get funded, and that badly run or obsolete businesses get starved of capital so that they no longer place a drain on the nation’s resources. Not perfectly, and not always, but well enough and often enough to underwrite a high and rising standard of living.
So we should be careful before we wave a fond goodbye to Goldman Sachs and Morgan Stanley, the one fighting to remain independent, the other said to be negotiating with Wachovia to shelter under its not-terribly muscular arms if worst comes to worst.
The question of the survival of these firms is important to more than their shareholders and employees: it is a question of the survival of innovation and entrepreneurship at the heart of the financial system.
Now, I have nothing against large commercial banks. They do a reasonable job of collecting deposits from small customers, aggregating them, and lending the resultant pools of money to businesses, profiting from the difference between what they have to pay depositors and what they can charge commercial borrowers.
But as the history of Citigroup suggests, when these banks expand into unfamiliar businesses, the management problems become complex, corporatism overtakes individualism, and at best workmanlike management replaces entrepreneurial daring.
Which brings me to Goldman Sachs, the poster boy for hard-driving financial capitalism. Its share are being driven down, and there is a perception abroad that it wouldn’t be a bad thing if these masters of the universe got their comeuppance, as did Lehman, which went broke, and Merrill Lynch, which finally found a buyer.
That lumps together noncomparable companies. At the time of its takeover by Bank of America, Merrill Lynch had almost six times as much tied up in problem-area loans — residential and commercial real estate, and leveraged loans to hedge funds — as it had capital.
When Lehman went under, its ratio of shaky loans to its own capital was 3.4 times. Goldman Sachs, on the other hand, saw hard times coming and cut its problem loans from 2 ½ times its own money to a mere one times those funds. Management matters.
In more ways than one. One reason so many of the financial institutions which have disappeared or might have gotten into trouble is because they have hesitated to recognize that some of their decisions have been just awful.
They have stuff on their books at valuations that are no longer close to reality, despite the general accounting rule that all assets should be on the books at their current market value — marking to market is the term accountants use.
So instead of taking their medicine in one gulp, they dribble out write-downs every quarter. Goldman, on the other hand, marks its assets to market every day. And more or less gets it right: in the vast majority of their recent sale of mortgage assets, they realized prices equal to or in excess of the values Goldman had assigned to these assets.
This is not a pitch for Goldman Sachs. I have no way of knowing whether in the long run it will benefit more from being one of the last banks of its kind, with less competition, than it will be hurt by the slowing of economic activity and deal-making.
But I do know that if we end up without these independent sources of ideas and risk-taking, the nation will be the poorer.
Examiner columnist Irwin Stelzer is a senior fellow and director of the Hudson Institute’s Center for Economic Studies.
