The financial overhaul bill creeping toward law is more than a thousand pages, but it has a simple story line. President Barack Obama and the Democrats have decided to turn Goldman Sachs Group Inc. and a few other financial giants into organizations that resemble ATT Corp. in the 1950s.
Government rules will establish quasi-monopolies, and discourage competition. In exchange, the affected firms will be exposed to constant bureaucratic meddling, but will have the ability to manage this by influencing political appointments.
Obama and his team have made a show of threatening the big firms, and this might have given the impression that the financial revisions will hurt their value. But for old-time ATT shareholders, the deal was a net positive for many years. The same will be true today for the big financial companies.
It is clear that many investors understand this. While Obama has been bashing the big financial institutions, markets have noticed that the proposed legislation probably is good for their bottom lines.
On Nov. 21, 2008, Goldman Sachs shares closed at a little more than $53. The bailouts and the pending bill have been very good for the company. Last week, the shares closed at almost $160.
Even looking at recent events, the Goldman share price has done nothing to suggest that the government action will harm the firm. On Dec. 11, 2009, the House passed its version of the financial overhaul bill, and the share price of Goldman closed at $166. On April 14th, with the Dodd bill steamrolling toward the finish line, the share price peaked at about $185.
The recent price drop wasn't occasioned by news of the Dodd bill, but rather by the announcement that the Securities and Exchange Commission had filed a lawsuit accusing the firm of fraud regarding a specific mortgage securities instrument.
The shares of JPMorgan Chase & Co. and the other big financials have shown similar movements.
Why might the Dodd bill be good for the bottom line? Former Federal Reserve economist Larry Lindsey observed in a memo to House Minority Leader John Boehner of Ohio that, "Needless to say, the large Wall Street firms are not complaining; they will permanently benefit from having lower borrowing costs." Lowering borrowing costs will, of course, increase profits. That's why the big financials have performed so solidly during the period that the financial reform went from possible to almost certain.
An April 20 letter that seconded the Lindsey analysis by Charles Plosser, the president of the Philadelphia Federal Reserve Bank, explained how it will work.
The Dodd bill will establish a set of companies that will be implicitly established as too big to fail, or TBTF. These firms will, according to Plosser, have an advantage: "when stock and bondholders of TBTF firms win, they profit, but when they lose, they become eligible for a government bailout."
This will lower the cost of capital for the firms so designated, since lenders will understand that the U.S. government will be there should calamity ensue. If you lend to a little guy, you lose if he runs into trouble. If you lend to a big guy, you get your money back from taxpayers.
Over time, the big banks will get bigger and bigger, as they capture business from smaller firms that don't have the benefit of the implicit government guarantee.
For Goldman Sachs, that is the good news. The bad news is that there is a cost associated with becoming one of the government's favored financials. The Fed will be granted almost unlimited power to micromanage systemically important institutions. If the Fed believes that a firm's actions increase the risk of a financial meltdown, then it can order a halt. But even this eventually will be a net positive for the bottom line.
Think about it, if the big firms are all investing in the same things and have imitative strategies, then the systemic risk is heightened because their positions are highly correlated. To manage systemic risk, it will be essential to require firms to focus in unique areas. The Fed will inevitably allow some firms to do this, while others do that. Each institution will dwell in its own unique space, with everyone making monopoly profits.
There is one precedent for such an intrusive arrangement. The Federal Communications Commission is the government body that regulates telecommunications and media companies. For many years, the FCC micromanaged the activities of telephone, cable and broadcast companies, with near-monopolies in their regions and markets. While the modern FCC has done a fine job of guiding those sectors toward increased competition, for many years, it acted to prohibit competition. The regulator was the monopolist's best friend until the 1960s, when MCI Inc. was first allowed to compete in the long-distance telephone business.
The Dodd bill will turn Goldman Sachs into the equivalent of ATT, JPMorgan into a cable-TV company, and the Fed into the FCC. That will be a bad deal for the big guys only if they do a poor job of managing the politicians. That seems unlikely because the Fed will look at monopoly profits as a source of financial industry capital and stability, and will be unlikely to take FCC-like action to limit them.
A number of news reports covering the financial overhaul bill have mentioned that Goldman Sachs employees were, according to the Web site Opensecrets.org, the second-biggest contributor to Obama's presidential election campaign in 2008, and yet they find themselves in the crosshairs of reform.
If you think through the economics of this plan, though, those contributions look like a savvy investment.
Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.