Geely Buys Volvo: Goldman Gets The Upside, You Get The Downside

By Simon Johnson

Geely Automotive has acquired Volvo from Ford.  This is a risky bet that may or may pay off for the Chinese auto maker – after first requiring a great deal of investment.

Goldman Sachs’ private equity owns a significant stake in Geely, with the explicit goal of helping that company expand internationally.  Remember what Goldman is – or rather what Goldman became when it was saved from collapse by being allowed to transform into a Bank Holding Company in September 2008 (which allowed access to the Federal Reserve’s discount window, among other advantages).  Goldman’s funding is cheaper on all dimensions because it is perceived to be Too Big To Fail, i.e., supported by the US taxpayer; this allows Goldman to provide more support to Geely (and others).

Our Too Big To Fail banks stand today at the heart of global capital flows.  People around the world – including from China – park their funds in the biggest US banks because everyone concerned believes these banks cannot fail; they were, after all, saved by the Bush administration and put completely – gently and unconditionally – back on their feet under President Obama.  These same banks now spearhead lending to risky projects around the world.

What is the likely outcome?

We know that risk-management at the megabanks breaks down in the face of a boom (remember Chuck Prince of Citigroup in July 2007: “as long as the music is playing, you’ve got to get up and dance. We’re still dancing”).  We know there is a growing boom in emerging markets – including through the overseas expansion of would-be multinationals from those countries.  This is most notably true of state-backed firms from China, but there is also a more general pattern (think India, Brazil, Russia, and more).

The big global banks, US and European, are charging hard into this space – Citigroup is expanding fast in China and India (areas where they claim great expertise); and the CEO of HSBC has moved to Hong Kong.  Many investment advisors are adamant that China will power global growth (never mind that it is less than 10 percent of the world economy), that renminbi appreciation is around the corner, and that the value of investments in or connected to that country can only go up.

There is a very good reason why, between the 1930s and the 1980s, large US commercial banks were severely constrained in their risk-taking activities.  By the 1930s US policymakers had learned the very hard way that we do not want the banks that run our payments system (with the implicit or explicit backing of the government, depending on how you look at it) to be engaged also in high risk equity-type investments – this is really asking for trouble.

The problem is not that all such banking-based risky investments go bad.  Far from it – we’ll first get an apparently great boom, which will suck in all kinds of financial institutions, our future Chuck Princes.  As long as the market goes up, the executives and traders involved will do very well – lauded as geniuses and paid accordingly. 

And if some of them fail, so what – failure is essential to a market economy.  But here’s the key problem with having so much of our economy in the hands of financial firms that are Too Big To Fail.  When the next emerging market crash comes, we’ll have to make the 2008-2009 decision all over again: should we rescue our big troubled financial institutions, or should we let them fail – and cause great damage to the economy?

In our assessment (13 Bankers: The Wall Street Takeover and The Next Financial Meltdown, out today), based on the details of financial deregulation over the past 30 years, the prevailing belief system of top bankers, and the big banks’ incentives to take risk, we are all heading for trouble.  The “financial reform” legislation currently before Congress and still prevailing pro-banker attitudes at the top of the Obama administration are really not helpful.  The country’s course was set by a fateful meeting at the White House last March; a resurrected, unreformed, and still crazy system – symbolized by 13 bankers – is in the driving seat now.

At best, this will be another very nasty boom-bust-bailout cycle.  At worst, we are heading towards a situation in which our banks are so massive that when they fail, there is no way the government (or anyone else) can offset the damage that causes. 

This time our government debt (held by the private sector) will roughly double – increasing by 40 percentage points of GDP – as a direct result of what the banks did.  We’ve lost more than 8 million jobs since December 2008 – for what good reason?  Next time could easily be worse.

You can disagree with our analysis – provide your own facts and figures, and we’ll have that debate here or elsewhere; the more public, the better from our perspective.  And you should certainly want to improve on our policy prescriptions.  We put forward some simple ideas that can be implemented and would help – our versions can also be communicated and argued widely: if banks are too big to fail, making them smaller is surely necessary (although likely not sufficient).

But don’t ignore the question.  Don’t assume that this time Goldman and its ilk will avoid getting carried away – they are just doing their jobs, after all, and their job description says “make money”; system stability is someone else’s job.  

And also don’t presume that, just because the big banks and their friends seem to hold all the cards, they will necessarily prevail in the future. 

In all previous confrontations between elected authority and concentrated financial power in the United States, the democratic element has prevailed (see chapter 1 in 13 Bankers; also Monday’s WSJ, behind the paywall).  This can happen again – but only if you stay engaged, argue this out with everyone you know (including your elected representatives), and help change the mainstream consensus on banking definitively and irrevocably.

29 thoughts on “Geely Buys Volvo: Goldman Gets The Upside, You Get The Downside

  1. As always Simon you make a great case.
    I feel like Tier-1 Capital and Leverage need to exceed 15% and must be less than 12:1, respectively.
    Additionally, I would note that TBTF regulation needs to be appended with a strict proclamation that if something like the recent fiasco happens again NO BANK (Commercial or Investment) will be able to circumvent Mark-To-Market “rules”. As someone who does not believe in Across-The-Board Capitalism I was stunned when I learned that these MegaBanks were positioning the argument in DC about how what they had on their books was ACTUALLY worth much more than it was listed at the time AND should consequently be listed at an elevated price. Are you kidding me? If any law of Capitalism is sacred I thought Mark-To-Market would be.

  2. I fully support standing up against the 13 bankers, but that could only help if we simultaneously stand up against those regulators who so much helped those 13 to become who they are… otherwise it reads like just another silly vendetta…

    Though you are loath to admit it, perhaps because they´re buddies of yours, there are such things as regulators too stupid to regulate.

  3. Mr. Kwak wrote:

    “At best, this will be another very nasty boom-bust-bailout cycle. At worst, we are heading towards a situation in which our banks are so massive that when they fail, there is no way the government (or anyone else) can offset the damage that causes.

    This time our government debt (held by the private sector) will roughly double – increasing by 40 percentage points of GDP – as a direct result of what the banks did. We’ve lost more than 8 million jobs since December 2008 – for what good reason? ? Next time could easily be worse.”

    Anyone care to speculate about what the dystopian scenario would look like, following the theoretical collapse of the global financial system?

  4. Remembering that news account very well, the signficance of that meeting with the Obama Administration by the bankers was very telling: “The country’s course was set by a fateful meeting at the White House last March…..” Although with the two years since, Simon, I think Treasury Secretary Geithner might have read a few of your blogs (or at least heard some of your arguments through NPR). Even Geithner seems to be coming around to a similiar assessment of the dangers surrounding the banking system, although with tepid suggestions in resolving the “doom loop” (Treasury Secretary Timothy F. Geithner Remarks before the American Enterprise Institute on Financial Reform).

    You guys at the top should propose more “meeting of the minds” debates and discussion, while the less positioned players take up the suggestions of “move your money”, move your stocks portfolio (referring to the shareholders rebellion of 2008).

  5. Responding to your final paragraph, with the exception of Ron Paul, our elected representatives are bought-and-paid-for. And despite overwhelming public opposition on issues such as illegal immigration and health care mandates, Washington, D.C., goes along its merry way and does as it pleases. Why would you think for one instant that changing the mainstream consensus would make one iota of difference? Not to mention that there is no such thing as a mainstream consensus. This is pure rhetoric, sound and fury signifying nothing, and I am duly contemptuous.

  6. Why worry about overseas? We already have trillions in exploding debt between private capital debt loaded onto companies that can’t pay it, commercial real estate about to go bad, and lagging pension obligations. The next crisis is already loaded up on the books for 2012.

  7. I my experience with a large American corporation, capital outflows have been happening for decades. The company I worked for viewed America as poor investment opportunity because of its aging, product saturated economy, slow growth rate and high costs of doing business.

    This is not part of a plot. It is simply a realpolitik corporate strategy chasing profits by minimizing costs and targeting growth potential.

    The point being, if we don’t act politically to maintain the American economy it will continue to deteriorate and wither. Our debt will overtake us, our ability to consume will dribble away and we will have a lower standard of living. Probably in environmental squalor….not the worse case of pollution….but the maximum amount the global corporations judge tolerable.

    Multinational globalization with their indifference to the quality of life in individual nations means Americans need to decide whether we want to be a vibrant nation on our own terms where Americans do their best to control their own destiny or just another place for multinationals to strip mine in their race to the bottom for profit advantage.

    If we want to work together to preserve a decent, sustainable standard of living for America, we must reform our political and economic systems so they not only promote economic vibrancy, but also the most important commons of all, our environment and our national quality of life. On this basis, neither the Democrats or GOP are minimally acceptable as our leadership. Nor are our CEOs, especially our financial wizards.

    If this sounds gloomy, just look at what’s actually happening out there.

  8. “In all previous confrontations between elected authority and concentrated financial power in the United States, the democratic element has prevailed (see chapter 1 in 13 Bankers; also Monday’s WSJ, behind the paywall). This can happen again – but only if you stay engaged, argue this out with everyone you know (including your elected representatives), and help change the mainstream consensus on banking definitively and irrevocably.”

    Perhaps the administration will adopt “real change and reform” if they lose enough seats in Congress.

  9. Were not a significant percentage of the 8 million jobs that were lost, jobs that would not have existed were it not for the existence of free money? We never should have been able to employ as many carpenters and stockbrokers and golf course designers as we were. And for that reason, those jobs are not coming back to the same numbers anytime soon.

  10. Maybe I’m just naively optimistic, but I do believe new banking reglations will end up coming out of this mess and they will be sufficient to deal with the future. The only pessimistic view I have is whether or not the new regs will be in place before the next bubble has become too big to wind down.

    My evidence for this is what happened during the Great Depression. The Depression started in late ’29 early ’30 and nothing was done by the Hoover Administration to regulate the banking industry or prevent runs / collapses from occuring. Unlike Obama, Roosevelt was elected specifically to deal with these issues along with huge majorities in congress and even with that momentum it took 6 months for Glass-Steagall and the Securities Act, over a year to establish the SEC and they were still tinkering with the laws 7 years later when the Investment Company Act of 1940 was passed.

    Meanwhile the country suffered through the depression for more than 3 years before the momentum for reform was great enough to elect FDR and make these changes. The mis-information is starting to fade, the bankers are over-reaching with their bonuses and statements, and with health care out of the way, this issue will become more important as the elections roll around – and the public is not on the bank’s side. Whatever passes will not be perfect, Glass-Steagall was modified over the years, new regulations were added etc. and I think that will happen again. Even if Dr. Johnson could write the law he wants to see and that passed, I think he shows enough humility to understand it may need tweeking later on, may have unintended consequences.

    This doesn’t mean the bankers won’t fight like hell against it. But the health reform passage has renewed my belief in the country’s ability to actually do things of great import and under great pressure.

  11. ABC news reported this news as Chinese buying another American brand.
    In this case it is a Swedish brand.
    Another scare tactic buy junk journalism.

  12. YOU also get the downside with bailouts of M.otors and Chrysler.
    BTW, G.M. reports its 2009 annual report will be “delayed” because of
    the difficulties of “asset valuation”.

  13. ok. so TBTF banks should not give out loans because it can be risky. so TBTF shouldn’t invest outside the US? just wanted to check.

  14. I think opponents of these policies need stronger arguments and more effective organization, drawing together the broad spectrum of Americans and indeed world citizens who are adversely effected by these policies.

    To do this:

    1. The enormous cost of these policies must be demonstrated and emphasized in simple and clear terms. The problem needs to be phrased in terms of people’s pocketbooks, their take home pay, their savings and retirement funds, and the profits of the many small and medium sized businesses suffering from these policies.

    2. The use of terms like “investment”, “growth”, “innovation”, and “research and development” to promote and defend these policies needs to be aggressively confronted and debunked. It needs to be made clear that the trillions of dollars spent on housing in the 00’s and goofy telecom and Internet schemes in the 90’s represents trillions of dollars not spent on critical human needs such as energy production, more efficient energy systems, transportation, and so forth. We see the consequences of this in rising energy prices and a declining standard of living. Yet another bubble, whether involving investments in China or blinking gadgets here at home, would represent further disastrous diversion of trillions of dollars from productive activities.

    3. The framing of the problem as one of “deregulation” versus “regulation”, the “free market” versus the “government” needs to be rebutted and avoided. Quite clearly, these are policies of huge government subsidies to a few giant politically connected banks. The fact that these banks have stockholders and the executives are not civil servants (they are in fact paid far more than civil servants and subject to less strict rules) does not mean they are not intimately connected with the government. It is certainly true the policies have been and continue to be promoted with labels such as “free market”, “deregulation”, “private sector” and so forth, but the reality is otherwise. Many businesses and people outside of a small and shrinking charmed circle are suffering from these policies, but are misled by the “free market” rhetoric. The implicit and explicit claims by the banks to represent the “free market” or “private sector” should be aggressively challenged and debunked; they are almost laughably absurd at this point.

    4. The long standing tactic of blaming the failure of policies labeled as “free market” and similar terms (emphasis on labeled), with the failure then used to promote further policies labeled as “free market” or “deregulation”, on the government should be recognized and aggressively countered. Blaming the government for fiascos that follow policies labeled as “free market” is not unusual. It happened after the Savings and Loan fiasco of the 1980’s, the Internet bubble, the Great Depression, the California electricity market “deregulation” fiasco of 2000, and a number of other cases. Rather, this long history of “crying wolf” should be pointed out simply and clearly, that the purported “free market” policies are frequently selective deregulation combined with increases in government subsidies for politically connected firms, and once again that the aggresive use of labels such as “free market” does not mean the policy actually is “free market”. Certainly not in the case of the current Too Big to Fail policies nor the sharp increase in FSLIC guarantees during the Savings and Loan “deregulation” of the 1980’s.

    Drawing a clear distinction between the present policies fraudulently promoted as “free market” or “deregulation” and actual “free market” or “deregulation” policies will enable opponents of these policies to reach out to private citizens, businesses, and organization across the political spectrum, all of whom are suffering greatly from these policies.



  15. If you let things fall apart they will. If you leave maintenance of our economy up to those who don’t care about it will fall apart. The less the multinationals depend on the US market, the less they will care about it, the less they’ll be willing to do to maintain it, and so the more important it is that our elected officials take action to compensate for this loss of interest by the big companies. Unfortunately, our elected officials would rather take bribes (aka “donations”) from these very same comapnies, than do the job we elected them to do, which is to look out for the interests of all of the American people rather than just the highest bidders.

  16. Had to pay pretty dang near full price for the book (“13 Bankers”), but was able to get it on Sony eReader.

    Now I wish I could get Brad Delong’s “The End of Influence”…

    Off to reading…

  17. “Goldman’s funding is cheaper on all dimensions because it is perceived to be Too Big To Fail, i.e., supported by the US taxpayer; this allows Goldman to provide more support to Geely (and others).”

    This is the scariest part of all.

  18. This is a great point. Thanks Tom. A lot of “wealth” created over last couple of decades only existed on paper and in people’s imagination, an illusion brought about by artificially inflated real estate prices, unrealistic stock prices, and free money courtsey sophisticated Ponzi schemes. No wonder we can’t seem to find that money or those jobs.

  19. Bzzzt!! Jeff Merkeley, junior senator from Oregon, is neither bought nor paid for. At least, not yet.

    I expect him to adopt a pro-American, anti-TBTF position (& he has been involved in bill-writing headed that way). Who knows? Maybe he can even lead the charge to impeach the SCt CJ who perjured himself in Senate testimony. (Don’t hold your breath… that would be tilting at windmills in this bought and paid for DC)

  20. Haven’t read 13 Bankers yet, but that is clear error by Kwak & Johnson (assuming that’s what they said.) A moderately careful reading of the history of the constitutional debates along with a look at how corporations were conceived by the colonists here and in England should persuade one that the framers had NO INTENT WHATSOEVER FOR CORPORATIONS TO HAVE THE SAME POLITICAL RIGHTS AS NATURAL PEOPLE. If still in doubt, read the 18th century philosophers, with whom the architects of our constitution were familiar.

    It took a bought and paid for SCt decision in the 19th century to give corporations any lawful political rights. Now the right wing prostitutes on the SCt have extended the unconstitutional rights given over 100 years ago.

    That doesn’t sound like the body politic did very well in the controversy. Thinking things will get better for the body politic and more difficult for the corporations strikes me as too much smoking of a substance declared illegal some 90 years ago — had to keep those Negroes, as African Americans were then called, in line.

  21. Neither the Supreme Court, the President or the Congress will implement the will of the people, except those new ‘people’ created by the Supreme Court, the ones with all the power and the money.
    Government of the people, by the people for the people is soooo passe in post GW Bush America.

  22. To me, the best way to engage with the banksters is to starve them of blood by denying them rents. Engaging with the legacy parties will not help, and has opportunity costs that are too great for those of us who are more marginalized than the poster (much as I respect his work).

    The Move Your Money folks have the right idea, but it needs to be generalized: We need to move everything we can away from the rentiers, not just our money, especially food, transport, and the news.

  23. Has anyone ventured a guess on the status of the TBTF’s holdings (especially CDO’s and other securitized debt, including any recent stuff they’ve created from thin air to support bonuses)? What if stress test were done this year? The estimate of 4,000,000 new foreclosures equalling (by a low estimate $40 trillion in defaulted debt, maybe much more)puts them is vast jeopardy, as well as anyone who owns the CDS on that stuff, not to mention the large number of commercial mortages scheduled to likely fail, credit cards, bankruptcies, other personal debt (mostly securitized) that will fail to be collected). But maybe they’ll be fine so long as they get nearly free money from the FED (it’s almost as though Treasury has relocated a large division of their money printing machine in Wall Street), and can gamble endlessly on the world economy, engaging in the stiffling of the world economy my endless deception and arbitrage. What new devices have they created through their quants to deceive and infect us with?

    And, as a last question, with them supporting takeovers of iffy corporations like Volvo by Goldman, how much of the world economy will they end up controlling so long as we sponsor their thievery. It is more than a bit terrifying. While the public is living a gradual economic death spiral (look at the crippled states with no budget solutions) and them continuing to reap endless absurd bonuses, where are we really going. Where are Obama, Treasury, the FED, and, most importantly, Congress, in providing us with a solution and some peace of mind that we have a real future as citizens?

  24. Yes, you are so right in so many ways. Since when did we have a true free market. It’s been a hundred years. The “tweaking” of regulation, like the tax code, has put us in the hands of the attorneys a back roomers and taken away any hope of understanding the complex ways in which we can be economically raped. But, get this straight, touted “deregulation” didn’t actually accomplish anything but create a black hole in our economy with the bankers at the center, sucking us all in with their clever rigged games an schemes.

    Further, you are right, sound bites focused on a few loaded expressions don’t do the job. If we could get one major media outlet to run a series to educate the public, we might stand a chance of having the pulbic actually understand that Tea Parties are not a part of the solution, a well informed public is. It’s almost as though everytime some politician speaks, there should be something on the TV to tell us exactly who has given them money to say what they are saying so that we could understand the depths of the vast corruption that the big banks and corporations are having on our country.

  25. Investment bankers are betting on the developing world and surely they are making the right bet by doing so, in a way that will help the world economy grow.

    Growth in per capita GDP is largely a function of productivity which is in turn largely a function of technology. Mature economies grow relatively slowly because they have to invent new technology the hard way. Developing economies grow quickly once they have the rest of their act together enough to keep corruption, war and political instability from screwing them up, because they can adopt proven technology. Also, mature economies have most of the capital they need; they are in a replacement mode, while developing economies need capital much more urgently because they are in a creating infrastructure for the first time mode.

    The problem, then, is not that Goldman Sachs and its peers are investing heavily in developing economies. It is that in the course of doing so it will be inclined to take risks that are bigger than it should in the belief that it will be bailed out. These choices are invisible and aren’t even capable of being parsed on a deal by deal basis, only on a statistical trend kind of basis.

    The financial crisis hasn’t utterly failed in creating downside risk. Every single major free standing investment bank/major non-bank financial company in the U.S. has either become a bank (with more regulation including capital requirements), become government owned entities (like AIG’s non-insurance business, Fannie Mae and Freddie Mac) or have gone bankrupt (like Lehman and WaMu and IndyMac).

    People who invested in investment banks as equity holders have collectivley lost almost everything. Lehman’s subordinated debtors have also likely been wiped out. Derivative investors are now painfully aware of counterparty risk. While we bailed out a lot of general creditors of financial institutions, we didn’t by and large, bail out their shareholders. The bailouts of GM and Chrysler were even less kind, wiping out bondholders and other creditors as well as shareholders.

    Bond holders aren’t driving investment bank management decisions. They may lend at a little lower interest rate than they would have otherwise in the belief that they will be saved in too big to fail institutions, but at an economic moment when money is cheap, that hardly matters when we are looking at the spread between economic growth rates in mature economies and those in the developing world.

    What matters in changing decision making is getting the right incentives for management in these companies. They have had heads I win, tails you lose incentives ever since investment banks went public. There are several ways to do this (not necessarily mutually exclusive): Give shareholders more de facto political power (via new SEC regulations and financial industry reform); get senior investment bankers to have more skin in the game (with a combination of tax code changes, regulatory encouragement and changed attitudes in compensation committees); ditch stock option compensation because it doesn’t have a downside (via changes in the tax code); and create a credible threat of investment banker compensation clawbacks if their companies fail (something made possible in the 2005 bankruptcy reform but deserving broader applicability).

  26. The only reform needed is to prevent the transfer of risk to the taxpayer. If these TBTF institutions have their shareholders and bondholders on the hook when their investments sour, they will be forced to regulate themselves.

    Shareholders would flee institutions that took unbridled riskwith bondholders in hot pursuit. Counterparty risk becomes real and is imposed on the derivative traders and their backers. Not only does your investment contract go your way, but you better make certain that your counterparty is well-heeled (e.g. your oil future is with a company that produces oil).

    I personally would like to see a market system where risk and reward are properly coupled. It might dramatically shrink the financial industry — after all how many of these firms will stick around when they can no longer slough their risk?

  27. Steve – You sound like a politician. you’re not saying anything except saying it’s okay for the top 5-10% of Billionaires, who care nothing about the corporations they fund or optimize for lowest cost-denominator and highest returns to do what they’re doing. That will make them controllers of the Country’s and World’s destiny and the fate of Americans. Cash builds nothing; it doesn’t help society. So, why don’t you boil all of that gibberish to just one (1) sentence: I believe corporations and their billionaire financiers and benficiaries are part of a plot to simply realpolitik corporate strategy chasing profits by minimizing costs and targeting growth potential. That just about says it all.

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