Sunday, October 4, 2009

A Short Answer For Simon Johnson

No one is better than our good friend Simon Johnson at being so smug and yet so completely, embarrassingly wrong. In a post titled, "A Short Question For Senior Officials Of The New York Fed," Johnson writes:

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman’s shareholdings. Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People’s Daily; CNBC). US banks or bank holding companies would not generally be allowed to undertake such transactions - in fact, it is annoyed bankers who have asked me to take this up. Would someone from the NY Fed kindly explain the precise nature of the waiver that has been granted to Goldman so that it can operate in this fashion? If this is temporary, is it envisaged that Goldman will cease being a bank holding company, or that it will divest itself shortly of activities not usually allowed (and with good reason) by banks? Or will all bank holding companies be allowed to expand on the same basis. (The relevant rules appear to be here in general and here specifically; do tell me what I am missing.)
Answer: There is no waiver. There is no regulation that prohibits Goldman from engaging in this kind of transaction. Bank holding companies can elect financial holding company (FHC) status, which allows them to engage in a broad range of financial activities, including private equity investments in nonfinancial companies. Virtually every BHC has elected to become an FHC. Under 12 U.S.C. § 1843(k)(4)(H), FHCs are allowed to make "merchant banking investments" in nonfinancial companies, on a principal or agency basis, through affiliated private equity funds or other invesment funds. (Private equity affiliates are dealt with at length in 12 C.F.R. § 225.173.) Goldman carried out the investment in Greely Automotive Holdings through one of its private equity funds, GS Capital Partners VI Fund LP. I find it very difficult to believe that any serious bankers, no matter how "annoyed," wouldn't have known this. The FHC designation was what the whole Gramm-Leach-Bliley debate was about in the first place! Who in banking doesn't know this? I also find it difficult to believe that senior officials at the New York Fed waste their time answering questions that a first-year MBA would know. How many times does Simon Johnson have to demonstrate that he has absolutely no clue what he's talking about, and frequently makes things up, before everyone stops taking him seriously? He's like Ben Stein, but with the veneer of credibility.


Anonymous said...

Yep, I'm starting to fall out of love with SJ - he got a few ideas of some potential importance, like "the banks have capture the political economy of the USA" but apart from pronouncing everything he sees as woefully inadequate, he doesn't offer much by way of feasible reforms to the banking system that even a super hero politician capable of wresting us free from the clammy embrace of Goldman Sachs, could implement.

Anonymous said...

Now I'm really confused. I just read 12 U.S.C. § 1843(k)(4)(H) and it says in no uncertain terms that a condition of ownership is "during the period such shares, assets, or ownership interests are held, the bank holding company [== financial holding company in this section of the law] does not routinely manage or operate such company or entity ..."

If Goldman's intent is for its private equity firm to run the business for a period of time -- rather than simply prepare it for resale -- then the purchase is a clear violation of the law to which you link.

Please explain your view that "merchant banking activity" can include running a non-financial business.

Anonymous said...

At least Simon knows that there is no such thing as Greely Automotive Holdings.

Simon van Norden said...

You're the first person I've heard suggest that Simon Johnson was a banker. I think Simon would be pretty surprised that anyone would confuse him with one. Professor: yes. Economist: yes. Banker: come on!

Remind me: what bank did you think he used to work for?

Economics of Contempt said...

Simon van Norden,

Umm, I never suggested that Simon Johnson was a banker. Johnson said that it was "annoyed bankers" who had asked him to take this issue up, and that's who I was referring to.

Anonymous said...

SJ trotted out this sorry example on Bill Moyers tonight during the "Let's lynch Geithner" segment.

Economics of Contempt said...

Anonymous @ 3:43 PM,

Apologies for not responding. I don't see any evidence that Goldman is intending for its PE affiliate to run Geely -- and in fact that would surprise me, since Chinese companies almost never cede control to outside investors.

But even so, there's a classic exception-that-swallows-the-rule that would allow Goldman's PE affiliate to run Geely. Under § 225.173(d), a PE affiliate is allowed to run a nonfinancial company if, pursuant to the § 225.171(e) exception, running the company is "necessary or required to obtain a reasonable return on the financial holding company's investment." There are several other similar exceptions as well.

But the moral of the story is that "merchant banking activity" can in certain circumstances include running a non-financial company. (Yes, I realize this is slightly ridiculous, but I'm not the one who wrote Gramm-Leach-Bliley!)

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