It’s Not the TARP, It’s the Guarantee

You don’t get a ton of opportunities, as a liberal, to write “this is a good point from The Wall Street Journal editorial board,” so let’s note that The Wall Street Journal editorial board is making an excellent point about the farcical nature of the idea that if Goldman Sachs repays its TARP money that it’s no longer a ward of the state. They observe that Goldman has benefitted mightily from the Maiden Lane III vehicle from the Fed, and from special post-Bear access to the Fed’s discount window, and from the FDIC’s new broader debt guarantees. But beyond all that:

The larger issue going forward is whether Goldman is “too big to fail,” which means that everyone knows the feds will ride to the rescue if it gets into trouble again. Before Bear Stearns, investment banks were allowed to fail, a la Drexel Burnham. But after last autumn, no one will believe it. And Goldman will hardly mind if that’s what the marketplace believes, because such an implicit taxpayer guarantee will let it borrow more cheaply and thus make more money. Think Fannie Mae again. Even now on the taxpayer dime, Goldman is still trading on its own equity account — risky banking behavior.

The point is that Goldman and other banks can’t have it both ways. If they want taxpayers to save them, then they have to take fewer risks and become smaller.

My main dissent would be that this puts too much agency on Goldman’s shoulders. There’s an inherent time-consistency problem such that even if Lloyd Blankfein and Barack Obama and Ben Bernanke all swear mighty oaths to never bail Goldman out again, nobody will believe them and nobody should believe them. It’s not an issue of whether or not, subjectively, Goldman executives and shareholders “want” taxpayers to save them, it’s an issue of the fact that Bush/Paulson/Bernanke/Obama/Geithner have set a new series of precedents about to handle the potential collapse of large, complicated financial institutions. So instead of it being “if they want taxpayers to save them, then they have to take fewer risks and become smaller” it’s given that taxpayers will save them, then have to take fewer risks and become smaller.

Exactly how to do that, of course, is controversial. But I think it’d be good to see a mixed approach. On the one hand, more prudential regulation. On the other hand, regulation to discourage massive scale. And with two hands working together, some kind of sliding scale such that risk-regulation gets stricter the bigger you get. Thus far, though, we’ve heard only a little from the administration about risk and not much of anything about scale. This is troublesome, since the political “window” in which the will might exist to enact meaningful new rules is not going to stay open forever.