Goldman Sachs Group Inc.'s (NYSE: GS) $2 billion deal to finance Facebook Inc. combines the worst features of the last two speculative manias – the dot-com bubble of 1999-2000 and the Wall Street financing bubble of 2006-08.
At 25 times revenue and more than 100 times earnings, Goldman's Facebook deal smacks of the "dot-bomb" debacle. And the fact that this financing deal came to pass after a major Wall Street firm effectively drove a truck through two central features of securities regulation is more than a little reminiscent of the investment-banking shenanigans that fed into the global financial crisis.
The fact that history is repeating itself on Wall Street shouldn't surprise us. Nor should the fact that the Wall Street "rent-extraction machine" is once again operating in high gear.
One thing's for certain: One day the bubble will burst; and when that happens, the great bulk of the costs will be borne by ordinary Americans – as was the case back in 2008.
A "Classic" Wall Street Deal
The Facebook deal was a classic of its kind. Its $50 billion valuation was justifiable only by assuming massive future revenue growth, which is highly unlikely. Granted, the service already has 500 million users – and that may be only 7% of the world's population – but it's well over half the upscale affluent population that advertisers are interested in.
Then there's Goldman's typical insouciance about the laws that others must live by. For instance, there's a U.S. Securities and Exchange Commission (SEC) that's been around in its present form since 1960 – and that's existed in principal since 1934 – that says that companies with more than 500 shareholders must go public and disclose full information to shareholders.
Goldman's attempt to get round this rule by having investors buy shares in a holding company is transparent and needs to be stomped on. A market in which favored insiders get special deals while ordinary shareholders must put up with the leftovers is not one that's going to function well in the long run, and is certainly not one that I want to participate in.
Finally, there's the so-called "Volcker Rule," which prevents banks (which is what Goldman Sachs technically now is) from buying large-scale equity participations for their own account. Since that rule's actual implementation was delayed until 2013, Goldman's Facebook deal was technically legal – assuming that is the position can be sold before December 2012.
Another Bloody Boom on Wall Street?
According to Thomson Reuters statistics, global investment banking fee income totaled $84 billion in 2010, up 9% on 2009 and below only the peak years of 2006 and 2007. For comparison, 2002 fee income totaled only $49 billion.
There are very few businesses that have seen revenue nearly double in the past eight years. Wall Street's performance is even more stunning given that most of the players in the investment-banking business experienced the financial equivalent of a near-death experience in 2008.
The reality is that the flood of ultra-cheap money since 2008 has inflated another bubble – not only in the broader global economy, but in the investment banking business as well.
Not only is fee income on a strong upward trend – despite the deep recession in the G7 countries – market practices also are returning to the speculative excesses of the Internet days of 1999 and the investment-banking boom-and-bust era of 2006-08.
While a modest percentage of "deals" add genuine economic value, most of them – whether they are mergers, securitizations or derivatives transaction – are little more than organized looting. The investment banks play with complex deal structures and excessive leverage in order to extract "rents" from the productive part of the economy.
As usual, what is good for Wall Street is bad for the rest of us. While the U.S. stock market remains below its 2007 peak and housing remains depressed, other markets – and especially commodities – are at record levels.
This reality is bound to cause trouble, and in two forms:
- It will summon the scourge of inflation, first to emerging markets such as Brazil, India and especially China (where it is already accelerating), and then to the world as a whole.
- And, even more important, its collapse will cause yet another financial meltdown, during which we as taxpayers will be asked to bail out Wall Street yet again – and after which the world will go into another deep job-destroying recession.
This time, we need to say no to the bailout – and if much of Wall Street files for bankruptcy, so be it. We will be very much better off without most of it. And the modest amount of the investment-banking business that genuinely adds value can be taken care of by the surviving medium-sized banks and brokers that have remained conservative.
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