Even more fabulous than the sky-high forecasts, as Clusterstock lays out. This is not actually hugely surprising, given that three of their biggest competitors went out of business or were acquired in the last year; as financial markets unfroze, Goldman, which had one of the cleanest balance sheets, was bound to see a hefty increase in their profits.
Still, the populists are bound to make hay out of this, and it's hard to blame them. It is true that Goldman probably did not need the federal funds it accepted; Bernanke and Paulson pushed healthy banks to take funds as well as sick. The idea was that if only the sick banks got money, that would send a strong signal to the market that they were in danger, and trigger the very run the feds were trying to prevent.
On the other hand, as Matt Yglesias and others have pointed out, whether they want to be or not, banks like JP Morgan and Goldman have gotten a great deal out of the government interventions. For starters, they were the first and biggest beneficiaries of having the financial markets not collapse. And now they enjoy an implicit guarantee that Uncle Sam will not let them fail because they are simply too important. That is a very valuable and profitable guarantee to have.
I genuinely don't know what to do about this. The libertarian answer is that the government should make a credible committment not to bail out banks. I'm pretty sure that's a bad policy idea, but leave that aside; the government can't make that committment, because politicians cannot committ their future counterparts to action. And I guarantee that if there is another crisis, politicians will intervene rather than risk another Great Depression.
Nor is the answer simply regulation. A lot of that revenue is perfectly sound, boring stuff we want them to do, like underwriting equities. I don't know where the government would get the legal authority to cap either their volume, or the salaries they pay their workers. But that doesn't stop it from rankling.
Copyright © 2010 by The Atlantic Monthly Group. All rights reserved.
I dunno, I find it hard to blame the party benefiting from government iodiocy/largesse/short sightedness, etc. I think the farm subsidies are dumb but I sure as hell don't blame a farmer for cashing his USDA check. Same with Goldman. (Note my ideology doesn't have an automatic assumption that a small time farmer is somehow more morally valuable than a huge financial corporation. Yours might. If so, kudos to you.)
The difference is that Goldman has substantial influence within the government. The small time farmer is just taking advantage of something outside of his or her control, while Goldman is big enough both economically and politically that they should at least be suspected of having something to do with the "government iodiocy/largesse/short sightedness."
I would argue small businesses such as farmers typically have much more influence than big business. Because of their numbers, small businesses typically can deliver money and votes to politicians while big business can deliver only money.
If you look at industries dominated by small businesses (e.g., real estate brokerage, community banking, farming, auto dealerships), small businesses have been able to use and abuse the regulatory process to an extent that would make the likes of Goldman blush.
13 or so per cent of GDP worth of treasuries don't sell themselves either.
They were selling themselves pretty well last fall, judging by their plummeting yields.
I think the answer to this and many other such conundrums is acknowledging the issue of scale and going all Teddy Roosevelt on the finance houses, along with many others. That is, beyond a certain size these places become unregulatable and cannot be allowed to fail. Therefore, we find some way to limit how big they get, so that government does not have to grow too large in power and size to match them, and so that if they do mess up, they don't take the entire economy down with them. It would also tend to make such companies stress operational efficiency and be less wasteful, in general. There seem to be some inherent characteristics of large corporations, not unlike those of large living organisms, that render them suboptimal and dysfunctional. We simply need to recognize that and act on it. Finding ways to utterly divorce their influence from the political system would make sense too, in terms of extending time limits on the revolving door, and increasing compensation on the governmental side, and getting their money out of campaigns. Money is not speech, talk is free, let's get real about it. This COULD be an area where conservatives/libertarians and progressives arrive at a reasonable consensus... were both sides to set their ideologies and biases aside and concentrate on what works. Were I advising Obama, this is the direction I would head in '12 if there is still economic difficulty... run as the Democratic 21st Century Teddy Roosevelt, be firm yet diplomatic on the foreign policy side, and emphasize SMALL business and entrepreneurship and trustbusting domestically, leaving the opposition with essentially no room to maneuver.
I've been saying things like this for ages here.
I'd like to know if anyone has ever done an analysis of the break-up of MaBell, and the rise of small tellicoms, followed by the rise of the net. Too big to fail, like monopoly, should mean the company gets disassembled in some way; down in to parts that are more entrepreneurial, and subject to failing.
The big mystery is why (almost?) no one in the public sphere is pushing this.
I don't why 1 big company doing X or 10 smaller companies doing X is any different. If all the banks are about to fail you need to bail them all out - you can bail out 10 big ones or 100 smaller ones but you will need to bail them out.
FDIC deals with the failure of smaller banks, and it's a relatively smooth process.
10 smaller companies doing X means competition, and the sure knowledge that if you screw up, you loose.
One big company doing that same business that's too big to fail means if you screw up, we bail you out, shake our finger at you while saying, "Don't do that again," and set you back on your feet. Not very free market anymore, is it?
jmo3, I though of one place where one big bank vs. 10 smaller banks might be a difference -- strings on corporate management. Having a big bank like Goldman put together a deal on it's own may keep a company from having to deal with the problems of having five or ten banks with strings on their management, keeping them more nimble.
That said, this is already a problem for small growth companies, with a hodgepodge of lenders, angel investors, etc., each with varying degrees of say in how the company is run. Too many cooks can quickly take an entrepreneurial company and turn it into a swamp.
zic already said it, so I'll just say:
/agree zic
Size isn't my biggest issue with firms like Goldman. I think there's an inherent crookedness in a firm trading its own book with its prop desk while acting as an investment bank, a prime broker, etc. at the same time -- especially when government agencies that are supposed to regulate the firm are infested with its alumni. I know about the alleged Chinese walls, but the whole arrangement reeks of crony capitalism. If Goldman wants to do prop trading, let it split off the rest of its company and become a big hedge fund like a D.E. Shaw or something.
When tens of thousands of our smartest citizens are spending their energies gaming the system, it can't be good for the economy as a whole.
Time to make Goldman1, Goldman2, Goldman3, etc... until each one is not too big to fail and they all have some healthy competition. Breaking up monopolies/monopsonies has precedent...
Underwriting equities may be boring, but it is rentastically profitable. (Which is why Google had their IPO via a Dutch Auction.)
I'd be interested in hearing ideas from people on how Goldman and others could be broken up. Divide the different parts of the same company based on function (i.e. brokerage, underwriting, etc.)? Take all existing departments and split them into two? Separate out fund management? Or should we limit growth by saying that each department can only handle so many deals per year? That might make for an interesting fourth quarter in the markets.
It's easy to say that we simply shouldn't let them be so big, and in theory I can see the appeal. But I'm having a hard time imagining it in practice. Ideas?
Highly progressive corporate tax rates.
Highly progressive payroll tax
Company turnover tax that kicks in at say $1 billion
etc. etc.
If splitting a company up results in significantly higher returns on investment, what do you think would happen?
"Which is why Google had their IPO via a Dutch Auction."
If you mean that Google would have paid more than 2.8% if they'd done a traditional (U.S.) IPO, what basis do you have for this claim? There are plenty of newspaper articles saying that Google would otherwise have paid 7%, but that's pretty ridiculous for an offer size of more than $1 billion.
Given that Google forced the underwriters to use a method that they didn't like and weren't familiar with, it seems fairly likely that Google could have negotiated at least as good a fee if it had given in on the choice of issue methods.
But I agree with your overall claim that US IPO underwriting fees (which average around 7%) are extremely high. Follow-on equity offering fees are lower but still high enough for the deals to be highly profitable for the underwriters.
Not only are they too high, but they leave an awful lot of money on the table -- underwriters historically have set prices below "market," as seen by the jump in share prices on the secondary market immediately following the IPO. It's possible they do this to benefit their issuer clients (which they claim), but it's also possible they do this to benefit their institutional investor clients (which is evident from the securities analyst scandals from a few years ago). That the I banks fought so hard against the dutch auction model seems to indicate there is at least some of the latter going on and they directly benefit from underpricing shares.
A lot of people share your suspicions regarding investment banks, auctions, and money left on the table, but it helps to look at the international evidence (something that we Americans don't always bother to do). High initial returns have been even more common for IPOs in countries where shares were allocated only to retail investors through a sort of lottery system where the underwriter had no ability to control who got the shares. In other words, the spread of the US IPO method and the allocation of shares to institutional as well as individual investors has generally led to less rather than more "money left on the table."
As for auctions, they've been tried in more than 20 countries and have been rejected (by issuers, not investment banks) in pretty much all of those countries. Auctions have led to some pretty dramatic problems for IPOs in country after country, so the resistance to them in the US isn't necessarily just an investment bank conspiracy.
"A lot of that revenue is perfectly sound, boring stuff we want them to do, like underwriting equities. "
GS is not reporting monster profits because of equity underwriting. This is ridiculously inaccurate and misleading. Think about that for one second- is this an environment where lots of companies are going public and raising capital? Not a lot of that revenue is sound boring stuff like underwriting, ~5% of their total revenue in 2Q came from equity underwriting (736m out of a 13700m total).
The huge majority of their revenues come from trading, market making, and fixed income services. If you actually read the story you linked in your first line, it would become quickly apparent how ridiculous the line I quoted.
"I genuinely don't know what to do about this."
The libertarian answer is not only that the government should send a message that it won't bail out banks, it is much more than that. The government should not be artificially lowering their cost of capital by guaranteeing this debt TLGP and other such programs. None of these firms would be able to raise the capital which they have unless their borrowing was backstopped by the FDIC. The question of whether the government should be able to cap the pay of bankers is a moot point. Almost none of this pay would have existed without government aid and subsidy. The common perception that bankers and the financial industry do not want regulation is nonsensical. In some cases, there are things where they would rather have the government involved- this is true. But as a whole, they benefit massively from government influence. This should not be surprising when GS was the leader in political contributions, and has had 2 alums recently serve as Treasury Secretary. How is there any question over what to do about this? Of course when you give the government massive powers of intervention, some wealthy and well placed company is going to come along and abuse that for its own good.
The problem boils down to shareholders. Why do shareholders let Goldman(or any company for that matter) pay such huge bonuses? And then they wonder what happens when you get a Bear Stearns like situation. Where they don't have any extra cash in emergency situations. As even the Oracle of Omaha learned with Solomon Brothers, IB's are huge money pits. They are horrid long-run investments.
Since when are politicians restricted from committing their future counterparts? Our gov't signs treaties that it is expected to comly with even when power changes hands. Passing laws requires future politicians to obey them. What is our constitution if not a commitment by people long dead that all future politicians have to play along with?
Sure, there are some some playing with the rules on the edges, and rules can always be changed at a later date, but there is little blatant disregard.
I'm not saying that this is a good policy idea (or bad one), but I don't see any substance in the objection.
As to companies that are "too big to fail" I don't see the libertarian objection to breaking them up as long as those companies are publicly traded instead of privately held. A publicly held company can be broken up, since it is already broken up between all its shareholders (also the details of how to break one up are likely to be hairy, but no more so than a large bankruptcy). I am assuming that the rules for breaking up a company are well known in advance, there is a reasonable amount of transparency in the process, a way for an appeal by wronged parties, and that the trigger for such a breakup is well known in advance and not arbitrary (say, when company value exceed a certain, very small, percent of GDP)
Breaking up a privately held company is more difficult, since it actually requires taking part of that company away from someone and giving it to someone else, but do we have any privately held companies that are "too big to fail"?
One doesn't need to 'break up' Goldman. One would insist on regulating their 'asset' portfolio, i.e., in order to get the FDIC guarantee, speculative proprietary position that don't have anything to do with facilitating customer transactions, will not be allowed.
The rest, underwriting stock and bonds, clearing customer trades, executing for customers... would stay and the hedge fund part would go. The hedge fund part could even be spun off, though it probably wouldn't remain a corporation at all.
Why is the "the libertarian answer" not to have these banks pay premiums for this implicit "too important" to fail guarantee? The same way regular folks pay premiums for their insurance plans. Seems like a free market (and oh yeah fair) solution to me.
"I'd be interested in hearing ideas from people on how Goldman and others could be broken up. Divide the different parts of the same company based on function (i.e. brokerage, underwriting, etc.)? Take all existing departments and split them into two? Separate out fund management? Or should we limit growth by saying that each department can only handle so many deals per year? That might make for an interesting fourth quarter in the markets.
It's easy to say that we simply shouldn't let them be so big, and in theory I can see the appeal. But I'm having a hard time imagining it in practice. Ideas?"
This is not quite so complicated. If the Fed, FDIC, and Treasury ceased to providing so much liquidity to the market (or in another sense, ceased to help GS provide that liquidity for everyone else- their program trading accounts of an enormous % of all NYSE trades- this is really the core of their business), GS and similar banks would very quickly be out of business. Not only would the assets they own drop in value, but they have enormous counterparty risk through hedges to a host of other institutions which would fail. Let them go into bankruptcy, and have other investors pick through the different divisions such as asset management, investment banking, etc, and acquire the most attractive groups. Or we can continue to prop them up and deny reality until a bigger crash comes.
Calvin,
Why do shareholders let Goldman(or any company for that matter) pay such huge bonuses?
The employees will leave for those companies that will pay those bonsues. There was a brilliant comment a while back from someone who was a manager at one of these firms and they did everything they could to pay these people as little as possible without them leaving. They pay the oil trader $2 million a year because at 1.8 million he'll walk.
And then you hire someone equally intelligent to do the same job for 300k. The traders at these companies are doubtless bright and capable people but there's no evidence anywhere that I've seen they're uniquely gifted.
Indeed, there's a huge amount of evidence to the contrary, including more than 30 years of studies that say no one consistently beats any market. The only thing you lose when overpriced employees walk is relationships, but if you can do the job way cheaper because you pay your employees 90 percent less, you'll win the business back.
Is there evidence that I'm missing that says these guys are worth that kind of money? And saying that everyone does it so it must be right isn't an answer. Everyone was betting on mortgages, too, and Internet startups with no marketable products.
This is not to say I expect the CEO of any investment bank to experiment with 90 percent pay cuts.
To them, "everyone else does it" is full justification. Following the herd allows them to excuse their failures by saying that everyone made the same mistake.
If you try something radical that fails, you just look like an idiot, which is why so few people have the courage to make contrarian bets, even when they say they "knew" that housing or tech was overvalued.
Besides, if a CEO cut salaries 90 percent and the firm thrived rather than tanking, his board might think it a great idea to cut his salary by 90 percent.
Andrew,
If you could pay the guy 300k and make it work, you would stand to earn tens if not hundreds of billions of dollars. The fact that no one has done this tends to make me think you're wrong.
, which is why so few people have the courage to make contrarian bets
A few perhaps, but don't you think one person would have tried to make it work... if it is as easy as you claim?
Megan is correct, these implicit "too important to fail" guarantees are valuable. If the banks don't have to pay premiums on this insurance plan then such an arrangement is tantamount to a tax payer subsidy. Doesn't sound very libertarian to me.
Nationalize them, or at least put their most productive workers in economic work camps; they're too smart not to be working for the state.
If we're going to go socialist, we might as well go all the way, not this half-assed crap...
The God of Libertarians says "Take what guarentees you want, and pay for them, in full." 73,d&52 hangs the banks on that hook.
The guarantee on an ordinary financial institution which takes deposits has proved to be under-priced. Since there are systematic risks in under-pricing that guarantee, its price should always be on the high side of the reasonable range of premiums.
No financial institution can ever have a 100% likelihood of being deemed "too big to fail". So the premiums for that status cannot be infintely high. Instead, the premium charged should rise as an increasing function of the predicted likelihood that in the event of a crisis, the government would treat the institution as too big to fail. Charging the appropriate prmiums to, e.g., Bank of America and Godman Sachs, would reduce likely burdens on the taxpayer appreciably, greatly reduce the banks' bonus pools, and induce shareholders to consider the virtues of dividing the entity into smaller parts.
Charging the appropriate prmiums to, e.g., Bank of America and Godman Sachs, would reduce likely burdens on the taxpayer appreciably, greatly reduce the banks' bonus pools, and induce shareholders to consider the virtues of dividing the entity into smaller parts.
Aha, match costs to risks!
You, sir, are full of win.
The reason the government can't credibly rescind the implicit promise to save them is the scale of these firms; as you have noted, their failure would have systemic consequences. The question then becomes how to reduce their scale, at least relative to the rest of the industry, through libertarian means. A simple solution which, like most libertarian positions, doesn't stand a snowball's chance in the foreseeable political environment is to eliminate corporate personhood and the associated limited liability. From a libertarian perspective, there's no compelling reason to grant firms such privileges*.
These are the source of the systemic criticality of large corporations for two reasons: (1) corporate charters impose a barrier to entry into a market; (2) limited liability does not eliminate the risk associated with a transaction, it simply externalizes it, and compensating for externalities is acore legitimate market function of government.
*Taking off on a tangent, perhaps in place of complete elimination, incorporation could be reduced to a similar position to that of patents and copyrights, which is to say that they be granted sparingly for a predefined period of time in exchange for publicly releasing information about a novel organizational structure
What's wrong with Willem Buiter's suggestion of taxing size (not just in the financial sector, but *any* sector where "too big to fail" might apply), because of its now-especially-obvious externalities (i.e. the political system can't resist intervening)? Such a tax could be introduced gradually over time, and would obviously have to be reviewed occasionally to make sure it was still sufficiently high to hurt (esp. at the relevant size of company). It would be a plain-vanilla Pigovian tax, and what's wrong with that from a libertarian point of view?
A simple solution which, like most libertarian positions, doesn't stand a snowball's chance in the foreseeable political environment is to eliminate corporate personhood and the associated limited liability. From a libertarian perspective, there's no compelling reason to grant firms such privileges*.
Every time this comes up, I point out that limited liability is the flip side to equally-artificial principles of responeat superior (by which employers are made responsible for torts committed by their employees, even when the employer has done nothing wrong) and agency law (by which employees are shielded from liability for taking actions at the direction of their employers). Nobody has bothered to make clear to me why the latter two artificial rules are good but limited liability is bad.
I'm just an engineer, so I'm not well-versed in the intricacies of business tort protections you mention. Either of those situations, if explicitly entered into as part of the employment contract, would seem to be legitimate (freedom of contract), but I see no reason why they should be the default legal position. Summary: I think all three are bad.
I'd also add the "duty of fair representation" to the list of unwarranted default legal positions imposed on contracts. It is the ultimate source of the free-rider problem which union advocates lean on as justification for union/closed/agency shop laws. The unionizers are not wrong, given the current law; the free-rider problem is a classic externality. However, the need for active correction of externalities, as in this case, imposes a continuous reduction on economic efficiency; a one-time economic cost from restructuring the legal framework to eliminate the externality altogether eventually pays for itself from the savings of the economic drag of either the externality or its compensating legislation.
Additionally, isn't the agency law, as you describe it, essentially the discredited Nuremberg defense? It would seem that any attempt to delineate the domains of the two would encounter the Sorites paradox.
Employers should, of course, be liable for their employees' actions when directed and not when undirected, akin to the concepts of conspiracy & accessory in criminal law. A quick reading of the Wikipedia entry for respondeat superior (note the 'd' in the first word) suggests that this is in fact the case, and the employer is indemnified when they've "done nothing wrong."
If you, and/or your publication
wish to avoid the suspicion that
you are advocates for the banks,
do not offer a rationale which
boils down to:
"Them's Gods, and no matter what
they do, ye dastn't say Boo, or
they'll just do something worse."
Of course the laws can be changed,
back to what they were before the
banks bought new ones, or forward
to new laws crafted for a 21st
century, computer driven economy.
I'm sure you know all the variations
on that theme; What I want to know
is: At what point in the next loss
of control of the current system
will the costs stop being measured
in dollars, and start being measured
in deaths ?
So Goldman was healthy the whole time, participated in the Treasury program anyway for the good of the system, did what we want a bank to do in terms of keeping a clean balance sheet, and returned its public money (presumably with interest). And for this it should be punished?
And if Goldman really is too big to fail, don't we WANT it to be very profitable, so that the implicit guarantee is never seriously put into issue?
Megan,
1) Why do you insist on calling everyone who is concerned about Goldman Sachs a "populist"? A casual perusal of dealbreaker.com would indicate that there are plenty of finance sector employees who grossly resent the privileges Goldman has been granted.
Further, many of us who have complained about Goldman Sachs have worked for elite Wall Street firms ourselves. We are not populists. Please stop calling anyone who demands accountability a "populist." It's a tiresome attack on Western ideals of civic responsibility.
2) Why do you continually refer to the advantages Goldman in oblique ways, such as:
"It is true that Goldman probably did not need the federal funds it accepted; Bernanke and Paulson pushed healthy banks to take funds as well as sick."
Goldman is said to have paid back the $10 billion in TARP funds.
But you continually elide the fact that it received $12.9 billion in TARP funds from AIG, which it has no intention of paying back.
Further, it has received nearly 30 billion additional assistance from the FDIC.
So out of approximately 50 billion US government dollars, they have paid back 10 billion, or 1/5 of the gross they have received. That leaves them with $40 billion from the government.
Nice work if you can get it, but your lame defense of Goldman means you are no libertarian, Megan.
3) Please tell us how much Goldman Sachs paid last year in taxes.
Additionally, isn't the agency law, as you describe it, essentially the discredited Nuremberg defense?
I suppose if your employer tells you to go kill Jews, you probably shouldn't. But if you're a salesman who is told to "go sell this product," and you convince somebody to sign a contract to buy the product, and that somebody pays, but your company then goes bankrupt and doesn't deliver, agency law protects you from having to compensate the buyer. That's really only fair; there's no reason that an employee should be liable if his superiors told him to sell something it later turns out they couldn't supply. The salesman is just the instrument of the responsible party, not the responsible party itself.
Respondeat superior makes an employer liable for (among other things) torts committed by someone acting within the scope of his employment. So if a delivery driver zones out and runs over someone while making a delivery, the company can be held liable even if they have all kinds of safety training, regular drug screens, background checks, carefully maintained cars, GPS speed monitoring, etc. So here, even though the employer has taken every precaution against bad driving, it's still on the hook.
Limited liability simply makes an exception to respondeat superior by saying that owners of a company are not liable for employee actions merely by virtue of their status as owners. Were you to eliminate both rules at once, the effect on owners would be nothing, but the effect on your company's victims would be negative, because they'd be left suing only the employee for wrongdoing.
But where's the line between the two types of action? That's the point of my referencing the Sorites paradox.
For your breach-of-contract example, the salesman is not a party to the contract, so obviously would not be the one held responsible; it's not the sale that is litigable, but the breach. If the salesman defrauded the customer by making statements he knew (or reasonably should have known) to be false, then he should be liable.
I'm sticking with my stance against the agency law, as you've described it.
Your original description of respondeat superior was misleading with the use of the term 'wrong'; torts are not about punishment (don't get me started on the abomination that is punitive damages), but about compensating a harmed party. I'm reversing my previous opposition upon further understanding of the principle, because respondeat superior does not appear to apply only to limited liability corporations. Why should owners of some companies be liable under respondeat superior but not owners of others?
The more I think about it, the more it seems your whole original argument was non sequitur. Since both of the legal doctrines you mentioned apply equally to private enterprise and to public corporations, how are either of them "the flip side" to limited liability?
All of the positive effects, without the coercive risk externalization, could be achieved through contracts between the owners (full liability) and investors (limited liability). The owners offer the investors the opportunity to share in the profits without risking more than the value of their investment; in exchange for bearing the remainder of the liability risk, the owners would reserve a greater share of the profits than their share of the equity (i.e., investor-equity is discounted at a contractually-agreed upon rate, say 75%, relative to owner-equity when apportioning dividends). This would be distinct from the current situation, in that the investors' risk would be explicitly, voluntarily assumed by the owners instead of implicitly, involuntarily externalized to the public at large.
The line is between contract and tort. A salesman participating in fraud is committing a tort and can be sued personally; a salesman (or, heck, a CEO) earnestly signing a contract that his company won't fulfill is an agent who will not be liable for the eventual breach. In the CEO's case, that's true even if he personally is the one who makes the decision to breach.
Why should owners of some companies be liable under respondeat superior but not owners of others?
I presume to encourage capital formation; few people would make any kind of investment if they thought they were putting their house on the line by doing so.
Note also that limited-liability status is trivial to achieve (fill out a form, pay a small fee), and also less robust than some people imagine (won't save you if the company is just a sham, won't protect you from your own torts).
Why should capital formation only be encourage for some enterprises?
The triviality of achieving limited liability is an aggravating factor, not a mitigating one.
All of the positive effects, without the coercive risk externalization, could be achieved through contracts between the owners (full liability) and investors (limited liability).
How? Limited liability concerns how the company and its owners relate to third parties. In your example, the "owners" could agree to indemnify the "investors," but that agreement would have no effect whatsoever on a judgment obtained by a third party. If the owners then went bankrupt after losing the lawsuit, the investors would be left with all the liability and nobody to collect from.
Since both of the legal doctrines you mentioned apply equally to private enterprise and to public corporations, how are either of them "the flip side" to limited liability?
"Private enterprise" (by which I assume you mean closely-held companies) can enjoy the benefits of limited liability just as public companies do.
And it's the flip side because the initial liability of the company (in tort) is artificial. The company didn't run you over; the delivery driver did. Presumably the company has some kind of policy against running over people which the delivery driver has violated. Why should the company pay for the stupid delivery driver in the first place? There's no need for limited liability in the absence of respondeat superior.
On the contract side, counterparties are free to demand personal guarantees from the owners or managers of the business, and thus defeat the limited liability shield prospectively. Such guarantees are common for small business loans. So the default limited-liability rule can be contracted around.
Agency law isn't really the flip side of anything, but it does shield the management of a company from the consequences of their (contract-based) decisions. Usually it's the management rather than CALPERS that's actually responsible for bad decisions, so usually they would be the ones you really want to get at. But their immunity has nothing to do with corporate limited liability and would require a wholesale rewriting of agency law.
I said all of the positive effects, as in the capital formation from many, small, uninvolved investors; I view protection from a judgment obtained by a third party as a negative effect.
You still haven't addressed why respondeat superior is the flip side, since it also applies to unincorporated businesses. Whether it's appropriate or not is irrelevant to a discussion of limited liability.
missed a tag so I'll repost
Andrew,
Everyone was betting on mortgages, too, and Internet startups with no marketable products.
Not everyone, John Paulson made billions betting against sub-prime mortgages.
hire someone equally intelligent to do the same job for 300k.
If you could pay the guy 300k and make it work, you would stand to earn tens if not hundreds of billions of dollars. The fact that no one has done this tends to make me think you're wrong.
which is why so few people have the courage to make contrarian bets
A few perhaps, but just as John Paulson could make tens of billions betting against sub-prime some enterprising your executive could make tens or even hundreds of billions if he could find a way to "hire someone equally intelligent to do the same job for 300k."
Dear Megan,
Another writer who would disagree with the premise that Goldman had hedged intelligently, or did not need to be rescued. This from Yves Smith, of Naked Capitalism, who wrote the following in The New York Times "Room For Debate" section today.
(Yves Smith has written the blog Naked Capitalism since 2006. She has spent more than 25 years in the financial services industry and currently is head of Aurora Advisors, a management consulting firm.)
"A Benefit for the Few
"The size of the Goldman bonuses masks a more important issue, namely that the firm was in very dire shape not long ago and was saved from collapse by official intervention, not merely the Troubled Asset Relief Program, but a host of special facilities created by the Fed to direct liquidity to the very markets that firms like Goldman are deeply exposed to and depend upon for their business to be viable, let alone profitable.
"Warren Buffet may have gotten a good deal when he pumped capital into Goldman, but the public didn’t.
"Goldman was in such acute distress that, as The Financial Times reports today, Goldman senior officers sold nearly $700 million of equity from when Lehman failed through April with the heaviest selling occurring when the firm was on TARP life support and while it was selling stock to the public. Put more bluntly, the executives were being cashed out by outside money.
"Lest you have any doubts, the insiders sold far more shares than the comparable period the year prior, when the firm’s stock was priced much higher. Goldman also received a capital injection from Warren Buffet’s Berkshire Hathaway shortly prior to the TARP funding. Needless to say, the terms Buffett got were vastly superior to the ones the taxpayer received.
"The logic of these programs is that the big capital markets players have become such crucial parts of the economic infrastructure that they cannot be permitted to fail. Yet they continue to enjoy a grossly asymmetric deal, socialized losses versus privatized gains. The stunning magnitude of the Goldman bonuses shows who this arrangement benefits, not the public at large, but a privileged few."
"It is true that Goldman probably did not need the federal funds it accepted"
I wouldn't be so sure. Goldman scrambled pretty quickly -- and paid a hefty vig -- to borrow billions from Buffett. As a highly-levered, stand-alone investment bank, it needed that capital. Who's to say it didn't need TARP's billions at the time as well? Also, would Goldman still be here if it hadn't been granted permission to become a bank holding company (and thus become eligible for government liquidity facilities)?
I genuinely don't know what to do about this. The libertarian answer is that the government should make a credible committment not to bail out banks. I'm pretty sure that's a bad policy idea, but leave that aside; the government can't make that committment, because politicians cannot committ their future counterparts to action.
The answer is simple: don't let banks become so large their failure represents a systemic risk.
Free markets must have winners and losers. The alternative is what happened last year: the taxpayers are the losers.
What's absolutely not surprising, is that Goldman is making money, or continuing the exact same trading activities it did before.
The firm is smart enough to adjust with reality (being a bank when being a bank helps create a mote around a theoretical chain reaction collapse).
So their VAR rises, and they do what they do best, the waves of fear no longer overwhelming. In other words, when the execs of firms like Bear kinda moved slow, Goldman was willing to do what was necessary to protect their own ass (tapping every resource, redefining the face of their business).
And it was annoying reading the cute, mocking commentary that so many put out, that, "Oh, I can't wait to get my Goldman toaster with my new checking account."
People always assume the devil comes at you with one thing, not realizing the person whispering in your ear to flee the devil, is the devil also, urging you into another direction less seemingly evil, but still under his control.
In effect, that is Goldman (the devil), doing whatever it takes (as any firm should) to handle its primary business...making money (the soul).
Seems you are damned if you are Merrill, Lehman or Bear, or damned if you are Goldman or Morgan.
Finn,
We don't mind that they're making money.
We mind that they're making money thanks to 50 billion of US taxpayer dollars.
Let's do the math:
10 billion through TARP (repaid)
12.9 billion through AIG (TARP money that will never be repaid)
30 billion in loans from the FDIC
Finn, they were flatlining before the TARP bailout. But don't take my word for it, read the FT, The New York Times, Kevin Phillips, Naked Capitalism's Yves Smith.
Or read today's FT article on just how "well" Goldman was position pre-bailout. They were dead. We resuscitated them for no reason at all.
Regulatory capture is what Goldman does well. Not hedging.
I said all of the positive effects, as in the capital formation from many, small, uninvolved investors; I view protection from a judgment obtained by a third party as a negative effect.
You cannot achieve the positive effects of capital formation without the negative effect of protection from judgment. The former is caused by the latter; it is precisely because third parties can't take your house that you are willing to buy a share of stock in a distant corporation. Your proposal, in failing to achieve protection from third parties, will also fail to find willing investors.
Why should capital formation only be encourage for some enterprises?
I don't understand this question. Absent corporate limited liability, capital formation is inhibited because investors don't want to risk everything they own to buy a share of stock. So capital formation is encouraged because of limited liability. And because limited liability is easy to achieve, the only reason a given enterprise wouldn't have it is because its owners didn't want it for whatever reasons of their own.
You still haven't addressed why respondeat superior is the flip side, since it also applies to unincorporated businesses. Whether it's appropriate or not is irrelevant to a discussion of limited liability.
Limited liability was created as a response to the risks incurred by non-managing investors as a result of respondeat superior. A blacksmith can plausibly be held responsible for his apprentice's mistake. It makes no sense to hold granny and her pension fund fully responsible for an error made by a locomotive signals operator. Hence: the two rules are mirror images, one imposing liability on people for acts they didn't commit (granny can lose her whole investment because somebody she's never met does something stupid), and the other relieving them of a part of that liability (but not more than her investment) under certain circumstances.
Except that my proposal explicitly puts the owners — who have control over the business — on the hook while leaving non-managing investors free and clear.
Not all businesses have limited liability. If capital formation is so dependent on protection from consequences of business actions, why isn't limited liability granted, by default, to all enterprises?
My proposal allows granny to enter an investment contract with the owners; her investment would still be the extent of her potential liability. The difference is that when the locomotive signals operator causes damages to a third party that exceed the assets of the business, the victims wouldn't be denied due compensation since the owners' assets are fair game.
If limited liability was a response to respodeat superior, it overcompensated; the harm done by limited liability exceeds the benefit.
The whole reason I brought up eliminating limited liability in the first place is that it is the reason these firms — through the enhanced ability to raise capital — have become so large that they are viewed as being too big to fail. Reducing their ability to aggregate capital is the whole point.
Any system is more stable with a larger number of smaller entities.
My proposal allows granny to enter an investment contract with the owners; her investment would still be the extent of her potential liability. The difference is that when the locomotive signals operator causes damages to a third party that exceed the assets of the business, the victims wouldn't be denied due compensation since the owners' assets are fair game.
If by your proposal you mean the creation of a new class of corporate entity with two classes of shareholder, then that entity exists: the limited partnership. You could eliminate corporations and require that businesses be limited partnerships with individuals or non-limited-liability entities as general partners. I'd have to think about the implications of that quite a bit, but it's not crazy on its face. It would probably hurt small business quite a bit more than big, because small business is more likely to fail, taking the owners down with it.
I understood your proposal to be that a pure contract between owners and investors be allowed to cut off the rights of third parties to get at the investors. That is not possible and would require a pretty radical rewrite of contract law. Sorry if I misunderstood.
Not all businesses have limited liability. If capital formation is so dependent on protection from consequences of business actions, why isn't limited liability granted, by default, to all enterprises?
Again, limited liability is so trivially easy to achieve, and available for such diverse capital and management structures, that any entity that doesn't have it is that way by choice, and any business that is trying to get capital anywhere other than the founder's home equity is going to be an LLC.
I had not previously been aware of the subtle distinction between a limited partnership and a limited-liability partnership; the former does seem to be exactly what I suggested.
The immediate implications I see as a result would be a reduction in the maximum firm size in any given industry; an individual general partner would only be willing to bear a finite liability risk, so beyond that scope multiple general partners would be needed to pool the risk. However, there should be diminishing returns on such risk pooling; each additional partner reduces the individual's share of the liability risk, but, as an agent of the firm, increases the total risk to be spread. At some point, the marginal GP would increase each GP's absolute liability risk.
Another limit to growth of such firms would be the managerial overhead; the more GP's, the more coordination is necessary. The number of interconnections grows quadratically ((N - 1) * N / 2).
In both cases, I view this as a good thing. Smaller firms can't pose systemic risk. Looking at both scenarios (LLC's v. only LP's), the LLC leverages the "more, smaller components leads to increased system stability" to the benefit of the firm, while the LP-only market would shift that stability from the microeconomic to the macroeconomic.