The Vampire Squid of Wall Street Is Hemorrhaging

(cross posted at EconoMonitor)

Government Sachs posted its second quarterly loss since it went public in 1999. No doubt that has sent Washington scrambling to try to plug the leak. (Wouldn’t it be fun to listen in on Timothy Geithner’s incoming phone calls from 200 West Street, NYC, today?)

Lloyd “doing God’s work” Blankfein blamed the “uncertain macroeconomic and market conditions”—conditions created, of course, by Wall Street. And since Wall Street refuses to let Washington do anything to improve those conditions, expect much more hemorrhaging among Wall Street’s finest.

The big banks are toast, as I’ve been saying for quite some time. There is no plausible path to real profits with the economy tanking. Only jobs—millions and millions of them, as well as comprehensive debt relief will stop that.

As I wrote a couple of weeks ago:

“US and European banks probably are already insolvent. When Greece defaults and the crisis spreads to the periphery that will become more obvious. The smaller US banks are in trouble because of the economic crisis. However, the biggest banks that caused the crisis are still reeling from their mistakes during the run-up to the crisis. They were already insolvent when the GFC hit, and are still insolvent. Policy makers have pursued an “extend and pretend” approach to hide the insolvencies, however, the sorry state of these banks will be exposed when the next crisis begins to spread. It is looking increasingly likely that the opening salvo will come from Europe, although it is certainly possible that it could come … The economy is tanking. Real estate prices are not recovering, indeed, they continue to fall on trend. Few jobs are being created. Defaults and delinquencies are not improving. GDP growth is falling. Household debt as a percent of GDP is only down from 100% to 90%. While declining debt ratios are good, it is still too much to service. Consumer debt fell from $12.5 trillion in 2008 to $11.4 trillion now. Total US debt is about five times GDP and while household borrowing has gone negative, debt loads remain high. Financial institutions are still heavily indebted—mostly to one another. At the level of the economy as a whole, it is still a massive Ponzi scheme—that will collapse sooner or later… No real economic recovery can begin without job growth in the neighborhood of 300,000 new jobs per month and no one is predicting that for years to come.
Isn’t it strange that Wall Street has managed to remain largely unaffected? Finance is an intermediate good. It is like the tire that goes on a new Ford automobile. Auto sales are collapsing but somehow tire sales to auto manufacturers are doing just fine? Does that make sense? Banks are making no loans, yet, they remain profitable? Not only are the financial institutions NOT doing any of the traditional commercial banking business—lending—they aren’t doing much of the investment banking business either (remember that the last two remaining investment banks were handed bank charters so that they could scoop up insured deposits as a cheap way to finance their business). How many IPOs have been floated? Corporate debt issues? Not much happening in those areas. Trading? [Not much there, either].”

In sum, the big banks aren’t doing much lending while investment banking business is tanking. Goldman reported that investment banking revenues were down 46% from the previous quarter. Its return on equity this year has been barely 3%–one-tenth of what it reported 5 years ago. JPMorgan Chase also reported falling revenues and while some of the other biggest banks reported profits they were due to “one time accounting gains”—in other words, book cooking.

They’ve cooked the books for so long now, they are completely burnt. The main way they’ve generated fake profits was by reducing loan loss reserves. There’s nothing left in the kitty to move to the profits column. Finally, the commodities and equities bubbles are over—at best they might hold steady before they finally collapse.

Goldman’s only hope is to find willing suckers who want to feed the vampire squid. But maybe the era of screwing customers is over. It has been Goldman’s specialty since 1999. Indeed, the date is significant—and not only for the title of the great Prince song. By going public in that year, Goldman’s entire culture was changed.

As a partnership it couldn’t share directly in the pump-and-dump dot.com speculative bubble. It could not sell its own shares. So it went public to join the biggest stock bubble the US had ever seen. And by rewarding top management for pumping up share prices, it changed the incentive structure from one in which developing relations with customers made sense as a winning business strategy to one in which “maximizing share-holder value” was the main raison d’être.

Interests were then perfectly aligned by including stock options in CEO bonuses. “Pump-and-dump” short-termism took over corporate culture at the top investment banks. It was then a very short step to move away from forming relations with customers to the same sort of short-term “you’ll be gone, I’ll be gone, so what the hell let’s just screw everybody and party like its 1999” treatment of customers. And off we were into partnerships with John Paulson to create synthetic toxic waste sold to Goldman’s customers and profiting doubly by betting on their failure.

To be sure this was not the first time the investment banks had adopted such a strategy. They tried it out back 70 years earlier, in 1929, creating investment trust subsidiaries that manufactured essentially fake stocks in pools of equity of worthless subsidiaries. They even sold stocks in yet-to-be-thought-of schemes. You can think of all this as the 1929 version of toxic waste synthetic derivatives. Then pumped-and-dumped them. And banks like Goldman even bought some of the pools because it was such a booming good business. (For a good history of all this, read JK Galbraith’s “The Great Crash”, which devotes a whole chapter to the Vampire Squid. Indeed, behind every big financial crisis you find the Squid. Its motto should read: “Crises-R-Us”.)

As my colleague Bill Black says, the more fraudulent the scam the more appealing it is precisely because with fraud the profits are a “sure thing”. Of course they are fake—but until the curtain is lifted the banksters make out like gangsters.

We know how all that turned out in October 1929—both the banks and the customers watched as equity prices plummeted, finally falling by some 85%. While this was not the only cause of the Great Depression, it certainly played a significant role.

President Roosevelt came in with the right set of priorities: first you shut down the banks and fire the banksters, then you can reform the financial system. President Obama came in, accepted Goldman’s choice to run the Treasury, and then set out to ensure that Wall Street would be isolated from any damage its frauds had wrought. Reform? Forget it. Impossible with the banksters running the show. Recovery? Impossible with banksters running the government.

Has anyone noticed it is October? It will be interesting to see what things look like come Halloween. Will the big bank frauds make it through the month? Or will they be hemorrhaging like it is Friday the 13th?