Goldman Sachs is an SDI--a "Systemically Dangerous Institution"

A report in New Economic Perspectives by William K. Black entitled U.S. Subsidies to Systemically Dangerous Institutions Violate WTO Principles describes how the TBTF banks in the United States have become dangerous to society and the economy.

Goldman Sachs is a Systemically Dangerous Institution (SDI) as described by William K. Black insofar as

1. Goldman Sachs received large government subsidies
--via bailout programs
--via massive purchases by the Fed of poor quality mortgage paper
--via borrowing more cheaply and having greater leverage as TBTF:

2. Goldman Sachs is not properly regulated;

3. Goldman Sachs was badly run with (potentially) large losses which could have caused cascading failures without government bailout;

4. Goldman Sachs is a ticking time bomb;

5. Goldman Sachs committed accounting control fraud in its inadequate or non-existent underwriting of mortgage securities that it sold to investors as highly rated when they were actually junk;

6. Goldman Sachs contains the ingredients for a recipe for accounting control fraud by maximizing income, maximizing compensation and maximizing real risks and/or losses.

Goldman Sachs is not a "systemically important" institution or only a LCFI--a "Large, Complex Financial Institution" but an SDI--a "Systematically Dangerous Institution."

When you read Black's essay, please substitute Goldman Sachs every time you see SDI (and make some small grammatically changes) and you will feel right at home. Here are some excerpts from William K. Black's article:

U.S. Subsidies to Systemically Dangerous Institutions Violate WTO Principles
By William K. Black - New Economic Perspectives

. . . .

Economists Argue that Subsidizing SDIs make Free Markets Impossible

The destruction of competition and the creation of a perfect environment for accounting control fraud inherent with SDI subsidies mean that free markets are impossible. The Stern (2011) authors are blunt on this point: “there was nothing free about these markets” (p. 21). SDIs create extreme market concentration and enormous income inequality.

Akerlof & Romer and financial regulators and criminologists’ discovery of the recipe that the controlling officers use to maximize reported (albeit fictional) reported income concur that the optimal strategy is to make or purchase loans with a negative expected value. This makes “markets” profoundly inefficient. Accounting control frauds are engines of mass financial destruction that destroy wealth at a prodigious rate. Accounting control frauds also cluster in the most criminogenic industries, regions, and products. This, and each of the ingredients of the fraud recipe, makes them the ideal weapon for hyper-inflating financial bubbles. Financial bubbles are damaging as they grow because they systematically misallocate assets and capital, but they can be catastrophic when they collapse if they have been allowed to hyper-inflate.

Accounting Control Frauds Spawn “Echo” Epidemics

George Akerlof’s seminal 1970 article on “lemon” markets presents several examples of anti-customer control frauds in which the seller deceives the buyer about the quality of the good. He added the powerful insight that these frauds could produce a “Gresham’s” dynamic because dishonest sellers would gain a competitive advantage over their honest rivals. At the extreme, the market would become perverse and drive honest sellers out of the marketplace. Criminologists have employed Akerlof’s insights to explain how control frauds deliberately create Gresham’s dynamics suborn “controls” (e.g., appraisers) and agents (e.g., mortgage brokers) into fraud allies in manner that produces limited risk of detection and prosecution. The CEO running a fraudulent nonprime lender simply creates perverse financial incentives that create intense Gresham’s dynamics. It is insane for an honest lender to pay bonuses to loan officers and brokers based on volume with no penalty for making bad loans – but it is optimal for an accounting control fraud to do so. In criminological jargon: control fraud is criminogenic. In plainer English: fraud begets fraud.

Accounting Control Fraud Erodes Trust and Can Cause Market Collapses

Economists and scholars from multiple disciplines have increasingly begun to find how valuable trust is in many contexts. It is essential to finance. The defining element at law of “fraud” is “deceit.” To commit a fraud a perpetrator gains the victim’s trust – and then betrays it. This is why fraud is the most effective acid against trust. Fraud by elites is the most destructive assault on trust. Fraud can cause market collapses long before it becomes endemic because of its ability to harm trust. Consider attending a conference or concert where everyone is given a bottle of water. If the public health authorities announce that one bottle in a hundred is contaminated, how many of us will drink our bottle. Markets collapsed in 2008 because bankers no longer trusted other bankers to tell the truth about the value of the assets they were selling. That lack of trust was rational, for deceit was the norm in the sale of “liar’s” loans.

Vigorous Regulation Can Block SDIs from Causing Crises – but SDIs Destroy Regulation

The Stern (2011) authors stress that the SDIs inherently create a regulatory “race to the bottom” (p. 41). More broadly, they understand that economic domination of this degree not only destroys free markets but free democracies. The SDIs will use political contributions and lobbying power to try to emasculate regulation and criminal justice systems because they recognize that only these public sector bodies can possibly restrain or remove the SDIs. The good news is that economists broadly agree that the SDIs confer no real economic advantages. They are too large to be efficient. Their domination is due solely to their receipt of huge governmental subsidies. That means that shrinking the SDIs in size would simultaneously increase bank efficiency and market efficiency while dramatically reducing fraud and systemic risk and restoring more functional and democratic government.
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Read the whole article here