This is a continuing Q&A on the financial crisis with Max Fraad Wolff. Max's work regularly appears in the Asia Times, The Prudent Bear and many other international outlets. His work can also been seen regularly on his site GlobalMacroScope.com. Based in NYC, he does contract research on international financial risks and opportunities while teaching in the New School University's Graduate Program in International Affairs. See Max's related column on HuffPo today. See part 1 of this series here.
ZE: Goldman is in the news today for getting a big new favor from the government. Henry Paulson was the CEO there up until he became Treasury Secretary, and spent his whole career there, right? Is this a Cheney-Haliburton situation? Was it coincidence that Paulson bailed out the markets before Goldman was harmed? Or was Goldman actually in a better position on its merits to survive this mess?
MFW: The answer is we don't know yet but, it feels like a little of both. Goldman was in better shape -- because they extensively shorted the mortgage backed securities (MBS) that they traded. Goldman has made many savvy decisions and was seen as the best of breed heading into the turmoil. On the otherhand, the US Treasury has largely been staffed by Goldman guys and that never hurts a firm. Robert Steel left Goldman to work as Paulson's right hand man overseeing financial regulation and assistance to financial firms. Mr. Steel is now at Wachovia and in talks to buy Goldman's only surviving rival, Morgan Stanley. The timing and decisions on the bail-outs killed all the other rivals Bear Stearns and Lehman Brothers and fire sold Merrill Lynch. Now huge bail-outs and regulatory overhaul leave Goldman as the likely last man standing -- even if no longer as an investment bank. Many folks see "Wall Street" as a monolith. This is not correct. There are various firms, cu ltures, business lines and alliances. There are rivalries, competitions, animosities and mutually exclusive needs all over the place.
ZE: In this crisis, we hear "Wall Street went too far and now Wall Street needs to be bailed out otherwise Wall Street will melt down." But there's really no such thing as "Wall Street," right? What are the different industries and different kinds of players involved in this drama?
MFW: You make an essential point. Wall Street is a place, few headquarters are left there. Midtown east has long been the capital of American finance. The bottom line is that all across America local realtors, appraisers, mortgage brokers and banks made all these bad loans. People love to blame exotic greedy special places and people. This is silly and it's scapegoating. It is neither fact-based nor productive. Financial firms did make money buying, selling, trading, restructuring and rating mortgages and bundles of mortgages. The size and global access of financial firms also allowed global money to pour into mortgages. This made the bubble much bigger and more international. The investment banks issued many and exotic securities made up of interest and principle payments from mortgages. Investment banks and others got caught assuring and owning enough of these to lose tens of billions of dollars and many were destroyed. Today's announcement that Morgan Stanley and Goldman Sachs are becoming bank holding companies marks the death of that business model. Folks might also remember that the banks that made all these bad loans did that to make money. People borrowed because their wages wont buy them anything like a middle class life. I hate to rail, but credit can't replace wages. Thus, credit market fixes won't alone solve macro problems. No matter how much money we spend. The borrow-to-be-middleclass model is fundamentally unsound. This bail-out may save our essential banks. It won't make them lend to a broke public and it wont raise wages, savings or incomes.
ZE: OK...so let's start with the investment banks. I keep hearing that there were five of them, and now there are two. What did these companies do, and why did a bunch of them just die?
MFW: As of this morning there are no large standalone American investment banks. In March 2008 there were five large US based investment banks. They were Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs. Today Morgan is in talks with Wachovia -- among others -- and Goldman remains. However, they have changed their regulatory identity to bank holding companies. The investment banking business is defined by issuing securities for private firms and municipalities. Investment banks act as agents selling ownership stakes -- stocks -- or loans to investors on behalf of clients. This is called underwriting activity. These banks give clients access to investor wealth buy designing, valuing and selling ownership or debt for companies and municipalities. Investment banks generally also make a market and trade in the securities that t hey and other investment banks have issued. This is referred to as broker/dealer activity. These firms also advise on mergers, acquisitions, restructuring and private placements. Investment banks are central to making investor wealth available to firms and towns. These firms are also central to the function of stock and bond markets. They trade for clients and for their own speculative accounts.
ZE: Let me make sure I understand: Investment banks would basically organize people who wanted to borrow money -- everyone from town governments to national governments to corporations -- and they managed a market in which investors could come and buy...what? Bonds? But you said stocks. So were they basically converting boring old municipal debt into flashy, exciting "investments?"
MFW:These banks create ways for corporations to access the world's investor wealth. People buy common shares in hopes of profit distributions, dividends and also capital gains or share price increases. They buy bonds for income, yield and safety of investment. Towns issue "munis" -- municipal bonds -- to build, roads, schools. These firms issue and make possible trade in these vital markets.
ZE: And now why is there no market for that anymore?
MFW: There are many and large markets for stocks, bonds, etc.... The market for securities backed by US home mortgages and other instruments have been seizing since July 2007. This has sent shock waves and losses out from these central markets all over the world. The losses on the mortgage investments were so great for the four out of five of the big investment banks that they went bust or are being bought at sometimes fire sale prices. Many other aspects of their business were viable, but they were done in my the mortgage-backed investments.
ZE: Well, at least America will always have Goldman-Sachs!