Not from me, but from Breakingviews.com, which as a specialized business newsletter has more credibility than I do. Their site is subscription only, but the NY Times reprinted the letter here. The basic gist: hey CEOs, instead of paying obscene bonuses, you should use your current profits to build strong balance sheets so the taxpayers don’t need to bail you out again.
My headline refers to the $100 million bonus that Andrew Hall, the head of Citigroup’s Phibro commodities trading group, is reputedly due this year. This bonus is in addition to the $100 million he was paid last year. Mr. Hall has a profit sharing formula to determine his pay, and his group is very profitable; hence the huge paydays.
When I say that such a large bonus should not exist, I am not referring to the controversy of whether a bank that has received so much taxpayer aid should honor Hall’s contract and pay such a large bonus (although they probably shouldn’t) or whether it is in any way appropriate for a society that pays teachers and firemen $50,000 per year to pay a guy $100 million to speculate in oil futures (duh: it isn’t appropriate, and in fact is obscene).
No, I say that such a bonus shouldn’t exist because economic theory says it shouldn’t. Under classic microeconomics [as I learned in Professor Bresnahan’s Firms and Markets class), if a firm is making outsized profits, other firms will see those profits and enter the market. The competition will reduce returns until profitability is in line with the industry.
If Phibro is repeatedly paying Hall $100 million per year, it’s safe to say that their profits are awesome, and thus outsized. There certainly isn’t a lack of traders and capital on Wall Street, all chasing returns. Hedge funds alone have $1.4 trillion in capital. So why isn’t the competition battering Phibro? I don’t know the answer, but here are a few possibilities:
- There is some sort of barrier to entry. It’s not capital, because plenty of people have that, but maybe there is a regulatory hurdle. Perhaps the few entrants in oil trading have figured out a way to maintain an oligopoly and thereby restrain competition.
- Maybe everyone in the oil trading business is insanely profitable, but only Hall has the sort of contract that pays him such a huge sum. It could be so easy that if I started swapping a few oil futures, I too could make millions.
- Or, it could just be that Hall and the folks at Phibro are really that much better than anyone else in the industry.
Again, I don’t why, but I do know that the only way a person should be able to consistently make that much money is if they are an absolute superstar or if they have figured out a way to restrain trade, which is usually illegal. Given the ways of Wall Street, if I had to pick one of those answers, I’d guess the slimy one.
If you have the time, I recommend reading this Rolling Stone article. It places Goldman Sachs at the center of every financial bubble since the Great Depression, and details how the firm has profited greatly from the travails of the average investor. I don’t necessarily agree with the author’s focus on Goldman. I think all the big investment banks have been doing this; Goldman just does it biggest and best. But I do think that the banks have been manipulating prices and selling securities that they knew were crap. And, as mentioned by John Talbott and Simon Johnson in my new favorite article, if there were just one criminal investigation that started to subpoena internal emails, we would see all kinds of nefarious behavior exposed. In fact, just yesterday the Commodity Futures Trading Commission came out with a study that blamed last year’s crazy oil prices on financial speculators, rather than on operating supply and demand.
The Wall Street Journal ran a great article on Thursday about how a small investment firm in Austin made a clever trade at the expense of some of the biggest Wall Street firms. Amherst Holdings wrote credit default swaps on a specific pool of mortgages, which had $29 million in loans outstanding out of an original pool of $335 million. Because these remaining loans were the dregs of the pool, everyone assumed they would default. So JP Morgan and Bank of America and their pals were willing to pay 80-90% of the face value for insurance that would give them 100% on default, apparently assuming that their own genius would allow them to book a risk-free 10-20% return.
Because people can buy these swaps without owning the underlying bonds, Amherst wrote about $130 million of the swaps, pocketing $104 million to $117 million. With the proceeds, Amherst went and paid off all $29 million of the mortgages. Therefore, there were no defaults, the swaps expired worthless, and Amherst got to keep all the proceeds. Genius! According to the WSJ, the big banks are “seething” at being outwitted by a Texas runt, and are complaining to various authorities. Wait, aren’t these the same banks who are lobbying against regulation of credit default swaps? And now they are complaining to the authorities? Stop crying like whiny little babies and take your losses. Welcome to the new world, masters of douchebaggery.
OK, the justices didn’t exactly mention me in their decision, but they did unanimously (according to Scotusblog) rule against the Indiana pension funds who were whining that they hadn’t gotten enough money for their secured debt. The highest court in the country has thus decided that the Obama administration did not violate the rule of law in pushing through the Chrysler bankruptcy. Read here my post saying just that. Of course, some argue that this issue is too political for the Court to be focused just on the law, but if that were the driving issue here, wouldn’t this conservative court be likely to rule against Obama, not for him?
In the wake of the financial meltdown there has been continued tension between Main Street and Wall Street; between the working class (and the politicians who represent them) and the financiers (and the lobbyists who represent them). Despite the commentary from populists such as me who have been railing against Wall Streeters continuing to pay themselves huge bonuses, some of this tension has been between legitimate positions of free markets versus genuine concern about greed and income inequality.
But now the financiers have gone too far. First was an article last week saying that some big banks are looking at participating in the government’s PPIP (Public Private Investment Program) in order to buy their own toxic assets. Wait…so they are going to borrow cheap money from US taxpayers, and then use it to buy their own assets, with US Treasury backstopping on their losses? That is appalling without even considering the obvious conflict of interest regarding what price the assets are sold for. You have got to be kidding me.
Then today’s NY Times reports about the extensive lobbying effort that the big NY banks have launched to limit regulation of derivatives. You remember derivatives – the financial “weapons of mass destruction” that were a huge cause of the meltdown? The big banks make a ton of money on derivatives, and they don’t want that gravy train derailed. And since when they lose money, the taxpayers bail them out, they are clearly in support of the status quo. So they formed a lobbying organization and hired a big-name lawyer to lead the charge, paying him over $400,000 for four months of work. Now they are lobbying Congress to water down any sort of regulation of derivatives.
For banks that received taxpayer bailouts to now be spending money lobbying to avoid regulation on the very products that caused them to require bailouts? No way. It is time for Congress, and for the Obama administration to say “Fuck you, Wall Street.” The big banks make billions in profit on unregulated derivatives? Too damn bad. So maybe some traders will only make $2 million per year instead of $10 million. Tough shit. The Treasury Department-Wall Street axis of greed has to stop, and it has to stop now. President Obama, it’s time you step up to the plate on this.
Added bonus links: 1) Paul Krugman on how Reagan-era decisions on deregulation set the stage for financial catastrophe; and 2) a hilarious piece on Harvard Business School students taking a pledge to serve “the greater good” instead of their “narrow ambitions.” The money paragraph is the last one, with a quote about principles from a woman who is taking a job at Goldman Sachs, one of the leaders of the lobbying effort excoriated above. Oh, HBSers, it’s such a shame that you don’t understand irony.
This is the last post in my series inspired by President Obama’s inaugural call to “set aside childish things” and start pulling together for the good of the nation. And in this post, I hope to speak less of specific acts of greed and more of a general attitude that has pervaded our society over the past couple of decades. This attitude – one of “I want it all, NOW” – was perhaps not among the childish things of which the president was thinking, but its consumptive nature and its impatience certainly strikes me as childish. In fact, it reminds me of nothing so much as Veruca Salt from Willie Wonka and the Chocolate Factory (the first movie, of course, not the remake), whose constant claim of “Daddy, I want it now!” led to her falling down the garbage chute after being judged a “bad egg.”
I wrote last week about how this attitude played out in spending, with people buying houses and cars and TVs that they couldn’t afford. But it also had a dramatic impact on economic and policy decisions, or often decisions put off. Examples include:
- Asking for lower taxes while demanding more government services
- Expecting cutting edge medical treatments while complaining about ever-higher health care costs
- Unwillingness to invest in infrastructure
- Refusal to address the impending catastrophes of Social Security and Medicare
- Managing companies for quarterly earnings instead of for the long term
I could go on and on. But don’t listen to me; the NY Times magazine put it much better a few weeks ago:
“The norms of the last two decades or so – consume before invest; worry about the short term, not the long term – have been more than just a reflection of the economy. They have also affected the economy. Chief executives have fought for paychecks that their predecessors would have considered obscenely large. Technocrats inside Washington’s regulatory agencies, after listening to their bosses talk endlessly about the dangers of overregulation, made quite sure that they weren’t regulating too much. Financial engineering became a more appealing career track than actual engineering or science.”
Frank Rich added his own take, typically overwrought, but still relevant, here. But whether the phenomenon is described by the Times or by me, the process is still the same. When we, the public, all think like Veruca Salt, then our business leaders will think the same way, and we will elect politicians who will implement Veruca Salt policies. So unless we want the whole country to go down the garbage chute, let’s be less Veruca Salt and more Charlie. Instead of wanting it all now, we can aim for getting most of it soon. Remember, Veruca was sent down to the furnace, but Charlie ended up owning the whole factory.
I was recently on vacation, which gave me a chance to reread John Stuart Mill’s On Liberty. This is a classic of the individual liberty movement, and I thought this might be an apt time to revisit it, what with the government nationalizing some financial institutions and making major investments in others, and almost certainly about to heavily reregulate the financial markets.
My expectation was that Mill would provide ammunition for those arguing against government involvement, but I was wrong. In fact, Mill clearly supports a government that is active in many affairs of its citizens, as long as there are definite and specific limits to that activity. As Mill says, “the fact of living in society renders it indispensable that each should be bound to observe a certain line of conduct toward the rest.” (p 70, all quotes from the Norton edition)
But let me take a step back. The money quote that summarizes all of On Liberty is this: “the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others.” (p. 10) Mill’s basic position is that people should be allowed to do and say as they please, as long as they don’t harm anybody else. If left at this, Mill could easily be read to support a fully Libertarian position.
But Mill doesn’t leave it at that. Instead, he teases out a pretty broad definition of “harm,” and thereby a broad set of circumstances under which government can interfere in individual affairs. Continuing the quote from above, Mill notes “this conduct consists, first, in not injuring the interests of one another.” (p. 70) This sentence alone seems to support regulation of Wall Street, since virtually every trade has a counterparty whose interests are affected. Mill goes even further, claiming that the state can compel certain behavior from individuals: “to bear his fair share in the common defence, or in any other joint work necessary to the interest of the society of which he enjoys the protection.” (p. 12)
For Mill, the default position is to give people freedom, but he recognizes that a civil society involves so many interactions that the default may be infrequent, and thus there is significant warrant for government action. So while there are plenty of reasons to disagree with government policy on the financial bailout, John Stuart Mill is not one of them.
Today’s Wall Street Journal reported that commercial real estate developers are aggressively lobbying for a government bailout, trying to get into a $200 billion program designed to “salvage the market for car loans, student loans and credit-card debt.” Because the developers have a ton of debt coming due next year, and the frozen credit markets will prevent them from refinancing that debt, they want the government to step in. If they cannot refinance the debt, then their lenders will take over the high-rises and malls and hotels that the developers currently own.
This is where the bailout madness must end. Real estate developers are in a completely different league than banks or car companies or consumer debt. The bailouts for those industries could at least be defended, since credit and employment and consumers are essential for the economy to work. But allowing developers to keep the speculative properties they built does nothing for the economy. It doesn’t prop up employment or consumer spending. All it does is shift dollars from taxpayers to a few very wealthy and connected developers. If developers were erecting new buildings, at least they could claim to support construction jobs, but in this economy, not a lot of new buildings are being built.
Here are several of the problems I have with a bailout of developers:
- As noted above, there is no economic benefit
- Developers usually finance each project separately, so even if they lose one to the banks, it won’t bring down their whole firm
- Developers push strongly against government regulation (zoning, height limits, etc.) when they are building, standing on the spurious rubric of “property rights.” So why don’t they rely on their precious freedom now instead of turning to the government?
- The same issue of the WSJ also had a piece on how some real estate developers saw the crash coming and conservatively boosted their cash reserves, and are now sitting pretty. So why should we bailout the developers who were not so prescient?
Finally, I should note that generally speaking, developers are wealthy and sophisticated individuals or families. They weren’t talked into these investments by shady mortgage brokers, and they already have plenty of resources to deal with their problems. In fact, let’s look at the three named developers in the article. There is William Rudin, whose family “is a large Manhattan office building owner.” If you are a large owner of Manhattan high rises, then you are very very rich. The Related Cos, a major developer has, according to its web site, a $10 billion real estate portfolio, and this privately held company remains under the control of rounder and CEO Stephen Ross. Vornado Realty Trust is a huge landlord, publicly traded, with a market cap of $9 billion. Vornado CEO Steven Roth was paid $1 million last year and exercised options worth $68 million. On December 8 of this year, he exercised more options, with a net gain of $13 million. Do these guys need a bailout?
The government can’t keep giving money to every industry that asks for it. Let’s draw a line, and let’s draw it at the hugely wealthy individuals who don’t need and who won’t help the economy.
And I thought I was was harsh in saying that we should tax Wall Street folks on their bonuses from the last few years. The NY Times is reporting that if anger against big banks continues to grow, the next step will be criminal indictments. Which, by the way, I would support.