Hirsh: Can 'Government Sachs' Fix the Economy?

As it was in the beginning, so shall it be in the end: Goldman Sachs will be there.

Back in the '90s and through the mid-'00s, major figures from Goldman Sachs such as Robert Rubin, Gary Gensler and Hank Paulson stood fast against derivatives regulation (Rubin and Gensler) and lobbied successfully for higher leverage ratios so they could bet more of their capital on the market boom (Paulson). When those policies came to grief and Wall Street imploded, and the Feds scrambled to rescue stricken insurance giant AIG, Goldman CEO Lloyd Blankfein was reportedly the only bank executive invited to an emergency meeting at the New York Federal Reserve (convened by then-Fed president Tim Geithner).

Now Treasury Secretary Geithner—a Rubin protégé, of course—has assigned two more ex-Goldman men to fix the vast mess their colleagues helped to create.

They are Steve Shafran, a former favorite of Paulson's, and Bill Dudley, Goldman's former chief economist and now the successor to Geithner as head of the New York Fed. Shafran and Dudley have been given the mind-bending task of resurrecting the market for securitized assets, a policy that is linked to an effort to lure the private market back in to bid on the toxic securitized assets that sit like dead weight on major banks' balance sheets. This vast project is being designed in two parts. First, revive the asset securitization market, frozen since last year's crash, through the TALF, the Term Asset-Backed Securities Loan Facility (don't try to say this at home!), started up on Tuesday. This program will bundle triple-A-rated loans into new securities and market them. Second, begin to sell off the toxic assets to private funds, in hopes that some day the TALF-revived securitization market will create demand for the lower-rated assets as well. According to a Treasury spokesman, the TALF plan and the troubled-asset buy-up program are "operating on parallel tracks."

The key now is to bring in hedge funds and other hoards of private capital by giving them government guarantees limiting their potential losses. The pitfall is that if the American public, already riled to populist fury over Wall Street's postcrash perks, finds out what a sweet deal these new investors are getting—without any limitations on executive compensation like those imposed on banks—people might get more upset.

This is not to speak ill of Shafran and Dudley or, for that matter, Geithner. The plan his Treasury team is working on is intricate, and it may well be the only way to bring the private sector back in—and get the rest of us, the taxpayers, out. A Treasury spokesman says that Shafran and Dudley are not the only ones working on the plan, which Geithner is personally overseeing. "It's been a group effort," he says, adding that there are no price guarantees. The private funds and the government will "share" first losses and profits, though details haven't been fleshed out. Nor should we ignore the fact that Goldman's "best and brightest" have sometimes dug us out of holes in the past. Former Treasury Secretary Robert Rubin, for example, is often criticized these days (by me, among others) for quashing then-Commodity Futures Trading Commission Chairwoman Brooksley Born's 1998 proposal to discuss derivatives regulation. What is rarely noted is that Rubin, at the time, was in the middle of resolving the Asian financial contagion, and he was justly concerned with sending a chilling message to Wall Street.

Still, the omnipresence of Goldman Sachs does make one wonder about the insularity of this world—what economist Jagdish Bhagwati once called the "Wall Street–Treasury complex." Or as another joke has it, Goldman is so politically savvy in Washington, it should be called "Government Sachs." Is there no one else to fix the crisis but specialists from the company that helped create it? According to a new report out by the public advocacy group the Consumer Education Foundation, over the past decade Wall Street investment firms, commercial banks, hedge funds, real-estate companies and insurance conglomerates forked over $1.725 billion in political contributions. They spent another $3.4 billion on lobbyists.

"Our government has been misappropriated by Goldman Sachs," says Christopher Whalen of Institutional Risk Analytics, a long-time critic of Geithner, whom Whalen likens to Chauncey Gardiner, the clueless hero of "Being There," who is manipulated by everyone around him. And if Wall Street elites continue to make government policy, will the new regulatory controls we hear so much about—the ones that are supposed to prevent this from happening again—ever really be adopted?

This is the critical question. Despite continued public support for President Obama and early signs that Geithner's various rescue plans—including the $75 billion mortgage bailout scheme announced this week—may be starting to reassure the markets, there is little sign as yet that the administration is engaged in the kind of fundamental rethinking of financial safety and soundness that we need. The problem is not just that Wall Street giants like Goldman, Citigroup and AIG ran wild over the past 20 years, it is that they exist in their current form at all. These institutions are too big and too systemic to be allowed to fail according to normal free-market rules, and if they remain that way we will inevitably find ourselves in a situation where taxpayers must rescue them once again.

We have been through this nightmare before, almost step by disastrous step. From 1932 to 1934 the Senate banking and currency committee held hearings on the 1929 crash and found that commercial banks had misrepresented to their depositors the quality of securities that their investment-banking sides were underwriting and promoting. According to a history posted by the Federal Deposit Insurance Corp. on its Web site, among the culprits was First National City Bank (now Citigroup), which was found to have repackaged the bank's Latin American loans and securitized them without disclosing its own confidential findings that the loans posed adverse risks. Sound familiar? The response of the government in that era was decisive: the Glass-Steagall Act, which separated commercial banking from investment banking. It is a supreme historical irony that 65 years later it was Citigroup, grown monstrous again, that pushed hardest for the destruction of the Glass-Steagall reforms. And it had a big assist from Goldman grads such as Bob Rubin, who was soon afterward hired as chairman of Citi's executive committee.

As the new Consumer Education Foundation report concludes: "Glass-Steagall was a key element of the Roosevelt administration's response to the Depression and considered essential both to restoring public confidence in a financial system that had failed and to protecting the nation against another profound economic collapse." Even if we believe that the economic and financial system may be stabilizing five weeks into Obama's presidency, it's hard to conclude that fundamental confidence has been restored.

Perhaps the Obama administration will see the light and at some point forthrightly address the "too big to fail" problem that even Federal Reserve chairman Ben Bernanke said again this week was "enormous." But it is hard to imagine that a team composed largely of Wall Street's former finest will, all by themselves, push for the breakup of the firms that nurtured and enriched them. And there is scant evidence that Geithner is now soliciting advice from others on the outside, including the new panel led by Paul Volcker—a diehard skeptic of Wall Street's agenda—that Obama set up precisely for this purpose. Who is the Treasury secretary relying on? We don't really know, but certainly one close adviser must be Mark Patterson, Geithner's new chief of staff. Patterson is the former Washington lobbyist for Goldman Sachs.