In a week when President George W. Bush has appointed Goldman Sachs chairman Hank Paulson as Secretary of the Treasury, to the cheers of commentators, it’s worth looking at the economic views a successful investment banker might be expected to have, and how those views have typically changed over the decades.
Start first with a conventional definitional question. Those of us between 30 and 100 are used to thinking of bankers as falling into two different species, commercial bankers and investment bankers, their existence split irrevocably asunder by the Glass-Steagall Act of 1933. Japan has the same distinction (imported there by General Douglas Macarthur’s occupying forces after World War II) and Britain traditionally had a similar one, between retail “clearing” banks and the “merchant” banks, much less well capitalized, that undertook the more complex and risky transaction. Only continental Europe retained a tradition of universal banking in which large well capitalized banks undertook both lending and capital markets activities.
The traditional distinction between small, nimble and intelligent investment banks and dozy behemoth commercial banks was also a creation of Glass-Steagall, and of the period after 1914 in which international merchant banking became a very difficult business, in which organic growth of capital was impossible. The largest capitalization of 1820 was the Rothschild partnership, which had more power both in the lending and the capital markets area than any other bank, while in 1900 a similar position of dominance was taken by J.P. Morgan and Co., even though by 1900 some other banks, such as First National City Bank, were in terms of balance sheet larger.
When asking about the economic views of successful bankers, therefore, we are asking about the views of those bankers who dominated financial markets, whatever their institution’s capitalization. Those people might be merchant/investment bankers such as Nathan Meyer Rothschild (1777-1836), they might be universal bankers such as J. Pierpont Morgan (1835-1913), they might be purely commercial bankers such as Citibank’s 1970s titan Walter Wriston (1919-2005), or they might be modern universal bankers such as Paulson himself, head of an institution that is both among the most important players in the international capital markets and a source of financial advice to the world that is universally heeded. They would not include say the dim Quaker chairmen of Barclays Bank in the 20th Century, who ran a large institution but had little influence on financial policy or the markets.
Some things never change. In 1819, when asked his views on a possible resumption by Britain of the Gold Standard, Nathan Meyer Rothschild remarked “I do not think it can be done without very great distress to this country; it would do a great deal of mischief, we may not actually know ourselves what mischief it may cause.” Not only was he wrong (Britain resumed specie payments in 1819, with immense success for the next 95 years) he was “talking his book” – trying to protect his immensely profitable business of dealing in foreign exchange, which would be decimated if gold based payments became the norm.
Similarly Paulson’s predecessor Jon Corzine was adamant that the Fed should bail out the collapse hedge fund Long Term Capital Management in 1998, a bail-out that seemed entirely unnecessary to all those who hadn’t lent LTCM money, and which brought a level of moral hazard to the system that may have led to the Enron collapse and will certainty bring further disasters in the years ahead.
More recently, Paulson and Goldman Sachs in general have been strong supporters of privatizing social security. This does not represent a deep philosophical commitment to the free market – around two thirds of Goldman Sachs partners’ very substantial annual political donations go to Democrats – but simply a recognition that, if private social security accounts were introduced, Wall Street would find ways of making money from them, some of them doubtless even legitimate!
In terms of the entities with which they do business, on the other hand, bankers’ views have changed considerably. J.P. Morgan, when questioned in 1912 by the lawyer Samuel Untermeyr of the Pujo Committee of the U.S. Senate as to his lending requirements, remarked that “The first thing is character. Before money or property or anything else. Money cannot buy it…because a man I do not trust could not get money from me on all the bonds in Christendom.”
This is not an attitude that one can expect to see emanating from a modern trading desk. To traders, security is everything, and the possession of ample liquid collateral the most important feature of a trading partner. This indifference to what the customer is doing with the money, whether he is investing it in sound business assets or squandering it in a metaphysical Las Vegas like the derivatives market – or even the real one – is an important feature of modern finance. Products such as credit derivatives, immensely profitable ways by which Wall Street can shuffle credit risk around the world – grow up and form an important part of the Street’s revenue basis before being properly tested. In 2005, $18 trillion of credit derivatives were outstanding – well more than U.S. Gross Domestic Product – but they are still so new that nobody really knows whether they will work in a downturn. The fees attached to them however are very real indeed and have successfully been turned into large bonuses for the Wall Street parties involved
In terms of economic policy, bankers’ views changed markedly as a result of the New Deal. Before 1929, bankers were almost universally conservative, with only a few Jewish houses being attracted by social ties to the right fringe of the Democrats. After 1933, once Wall Street saw that everything had changed, bankers’ political views changed also. Joseph P. Kennedy, successful arbitrageur in the 1920s, chairman of the Securities and Exchange Commission in the 1930s, was only the first of a succession of bankers who betrayed what only the naïve believed to be their economic interests – in reality, the fees available from doing business with the government, and the tax loopholes that could be written into legislation if you had the right friends, far outweighed the theoretical benefits of small government, low taxes and the free market.
The most successful free market Secretary of the Treasury, Andrew Mellon, was famously an industrialist rather than banker; his real money came from Gulf Oil and Alcoa, while the Mellon Bank was of huge importance in Pennsylvania politics and the Pittsburgh economy, but cut little ice in the boardrooms of Wall Street. Successor banker Secretaries of the Treasury, Douglas Dillon (Kennedy/Johnson), Bill Simon (Nixon/Ford) Donald Regan (Reagan), Nicholas Brady (George H.W. Bush) and Robert Rubin (Clinton) varied in their politics, but only Simon and Regan could be described as free marketers, even by the most generous definition.
By the time of Brady and Rubin, Wall Street’s economic views were well honed; it had little or no interest in lower taxes, let alone a simplified tax system, and not much interest in smaller government, believing instead in a government that undertook grandiose financial schemes from which money could be made. Wall Street believed in bailing out deadbeat Third World countries in order to protect bankers from loss (Walter Wriston claimed “countries can’t go bust” in the 1970s). For Wall Street, the Federal budget should be balanced through raising taxes, not because financial prudence was itself attractive to it – they had all done far too much lucrative business with conglomerates and leveraged buyouts for that – but because raising taxes would cause interest rates to decline and bond prices to rise, which in the long run is where Wall Street’s money is made.
This survey of past Wall Street occupants of the Treasury Department offers useful pointers as to where Paulson’s priorities are likely to lie. He will have no problem with inflation, but will oppose rising interest rates, being happy with low real rates of return for investors provided deal-generation remains active. He will favor any World Bank or International Monetary Fund schemes that appear necessary to bail out major Wall Street creditors; in particular the governments of Brazil and Mexico can breathe easier as a result of his appointment. If he sees any signs of tightening liquidity in the capital markets, he will favor the most draconian measures to balance the federal budget and restore the bond markets to their customary rude health. Since spending cuts are difficult, politically unpopular and not within his purview, he will therefore favor tax increases.
In his first years in office, Bush favored tax cuts and was relaxed about the budget deficit; the last thing he wanted, therefore, was a Wall Street Treasury Secretary. Now if he increases taxes, it will appear like a political defeat, and will be trumpeted as such by the media and democrats in Congress. Much better to get ahead of the curve. A Wall Street Treasury Secretary, intoning with the utmost unctuousness the utter irresponsibility of not raising taxes in the current fiscal position, is just the ticket.
Prepare yourself, therefore, for the draconian and economically damaging Tax Responsibility Act of 2007. Wall Street will love it!
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.