Goldman Sachs, Best in the Business

[Cross-posted at Organizations and Markets]

The business of political capitalism, that is. Like Enron, Goldman operates primarily in the nebulous world of public-private interaction. It is the US’s most politically powerful financial firm, skilled at navigating the byzantine regulations governing the virtually nationalized US financial sector. Goldman’s eye-popping $3.4 billion second-quarter earnings shouldn’t surprise anyone; as Craig Pirrong notes, these earnings reflect good old-fashioned moral hazard, with Goldman exploiting its too-big-to-fail status by taking on huge amounts of risk:

Goldman knows it is too big to fail. How does it know this? Well, the government bailed out AIG not so much for AIG’s sake, but for the sake of big AIG counterparties — most notably Goldman. Moreover, given the conventional wisdom that the government’s primary error in the financial crisis was its failure to bail out Lehman — a piker compared to Goldman — it doesn’t take a rocket scientist to figure out that it won’t repeat that mistake in the future, and let Goldman go down. So Goldman knows it can get bigger, and take more risk. It is the classic heads Goldman wins, tails the sucker taxpayer eats the loss gambit. If nobody steps in to rein in the firm, it will continue to add risk, thereby enhancing the value of the Treasury put hiding in the equity entry on its balance sheet.

Somebody should be stepping in — but nobody is. Why not? Partly, no doubt, it is Goldman’s political heft. It is likely too that important policy makers don’t want to crack down on a major source of risk capital to the markets in the fear that this would impede a recovery. Even though in reality, that risk capital is your money and mine, with the exception that we have no chance of capturing the upside, and are left with a good chunk of the downside. This is a piece with the hair-of-the-dog strategy being pursued by Treasury and the Fed.