Wednesday, January 13, 2010

Beat The Drum Loudly

'Tis the season to be jolly, fa-la-la-la-laaa. Seriously, if you're a banker this week is like Hanukkah, Christmas, Kwanzaa and Ramadan all rolled into one. Yep, it's bonus week on Wall Street and I've got a prediction that will hopefully redeem my woeful 2 for 4 performance this weekend in the NFL wildcard games; the big guys, specifically your Citigroup, Bank of America, Goldman Sachs, JPMorgan Chase and Morgan Stanley, will announce astronomical bonuses for their employees, the public will be scandalized, there will be an outcry in the media, people will call for heads to roll, even Obama will be forced to make a statement, then, it'll all be forgotten again. However, there is a silver lining as Providence has blessed us with coincidence. The Financial Crisis Inquiry Commission (FCIC), whose task it is to root out the "cause" of the financial crisis of 2008-09, is to hold its first public session today (Wednesday) - and if it's only a shadow of it's Depression era predecessor, the Pecora Commision, some good may come of the financial crisis after all.

What is our obsession with creating forces that are hell bent on destroying us? While the financial terrorists don't bring the bang to the party that the jihad kind do, or at least try to, the bankers' methods are far more insidious. Much like a parasite eating away at their host, no check that, more like a parasitoid, the financial industry is slowly sucking the life out of the western capitalist system that has run the world for a couple hundred years. Finance doesn't produce anything, its job is simply to efficiently allocate capital. As Paul Volcker said "I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence". Yet the industry's share of pretax profits in the American economy rose from 13% in 1980 to 27% in 2007 (it maxed out at almost 40%). Now we have seen the result, crisis, financial weapons of mass destruction, call it what you will. Additionally, we see less being produced, as energy, both monetary and human, is sapped  from other industries to support bankers, who now have a taste for the high life to sate. Take the example of General Electric. In 1980, GE garnered 92% of its profit from manufacturing. In the first quarter [of 2007], profit from GE's financial businesses, which extend credit from personal loans to factory purchases, represented 56% of profit.

So, how does a bank increase its profits when, after all, it's a simple business when done the right way? Just like all investing - the casino kind done by the boys upstairs - you simply increase the risk tolerance in your calculations. Fortunately for bankers in the last 20 years we've had a large percentage of the population, what was the middle-class before so much of the economy was taken over by finance, who have aspired to live like those in the top 1% of society. In order for them to attain it, banks were there to supply them with the necessary credit. As luck would have it, government was pleased with this arrangement, so pleased in fact they encouraged lending to people who couldn't afford it (check this out from '96), otherwise people wouldn't be able to buy huge homes and flat-screen TV's and might have to pay attention to the real world.

After a down year in 2008, Goldman Sachs set aside $16.7 billion for compensation in the first nine months of 2009. In good years, the firm dedicates about three-quarters of its compensation budget to year-end bonuses. Thanks to tax payer help, this'll be a great year, the firm is expected to report later this month what could be record profit of about $12 billion for 2009, according to analysts’ estimates, compared with $11.7 billion in 2007. Knowing the public will be pissed, they are already planning their disinformation barrage, with things like charity give aways and selling the fact that bonuses will be more stock (which they'll equate to employees having a stake in long-term success - can you say meme?) option heavy. Even if the public is convinced that something must be done, in the end they know they've got the ace up their sleeve - complete control of the government.

In the UK, the government's decision to impose a one-off supertax on bankers' bonuses has been met with a spit in the face from the big banks. Most British banks, polled in an anonymous survey, said they would absorb all or part of the cost of the one-off 50% tax by inflating their bonus pools, even at the risk of irritating the government and their own shareholders. Yep, that's right, instead of using the extra cash they earned off using tax payer support to rebuild their precarious capital positions - the reason they needed to be bailed out just over a year ago - they'll just use it to double the bonuses of the workers who created the crisis.

Of course the rational for paying these clowns Bozo-sized money is that these banks need to retain talent, as they may bolt to another team, I mean bank. You see, as Bill George, a director of Goldman Sach said, "The shareholder value is made up in people and you need the people there to do the job. If you don’t pay them for their performance, you’ll lose them. It’s much like professional athletes and movie stars." Oh, that's why they deserve bonuses that will average $595,000, with most of the executives earning seven-figures along with some eights. (Yes, I know Goldman CEO Lloyd Blankfein didn't take a bonus last year, but he did get $67 million the year before). Dude, Hollywood would make a lot more Ishtars and sports would have a bunch of JaMarcus Russell clones if all crappy movies and players were rewarded for failure. If a Major League baseball player had a batting average to compare with the past record of guys running the show like Robert Rubin and Larry Summers, they'd be hitting below the Mendoza Line, definitely not making my fantasy team. Rubin's only real achievement was to make the formation of the TBTF Citigroup (Citibank+Travelers Group) possible by playing a key role in having Glass Steagall abrogated. Well, good for him at least as he did become a main executive officer there, of course before the US government gave them over $300 billion to play with at the end of '08 - a decision which he of course helped to make being one of Obama's main advisors.

Where was I? Oh yes, the good that can come, but only with everyone's help. Get pissed off. Populist anger sounds ugly with it teabagger baggage but as long as the torches are lit and pitchforks sharpened, bankers scare easily. Mention this stuff whenever you can, to whoever is listening. Obama and his inner circle of financial advisers must be made to understand that we're not happy and the only way to regain our trust is to get on the anger bandwagon and make sure something is done. Get your money out of any bank that is 'Too big to fail', put in your community bank or a credit union. Not only have these TBTF 'banks' made their profits on the back of government loans and asset guarantees, we've allowed these casinos to reclassify themselves as banks, even though they are doing the same gambling once only done in investment firms, so they can borrow money practically for free to play the tables. This creates rent seeking behaviour, it's only human nature. By increasing the risk of trades and investments, one can increase the size of both profits and of course the inevitable losses that will also come. Profits equal bonuses for the workers, losses simply means more government money, so which investment method would a rational individual choose? Tell me as you describe efficient markets that function with perfect information.

The odds all seem to be against the FCIC, the big guns of banker lobbyists lined up against an $8 million budget, c'mon, their website is still under construction! Much has been made of the revolving door between Wall Street and Washington that exists to the point where political staffers and lobbyists are indistinguishable, theare all working towards the big bank payday. At the same time, the US Supreme Court is loosening restrictions on corporate election financing which is sure to increase the influence of political contributors. The committee charged with making the banking rules, the Senate Banking Committees, is known as a money committee for good reason. It's a place to put rookie senators who need help raising funds for the next election. Hmmm, I wonder if taking contributions from banks makes politicians beholden to them? Worse yet, the chairman of the committee, Chris Dodd, is stepping down, likely to be replaced by Tim Johnson. Oh, he represents South Dakota, where Citi has it's credit card division, and, surprise, he's come out against bank legislation. The foxes are truly running the henhouse.

Yet somehow in 1933 Ferdinand Pecora was able to stir a nation by making them interested in obscure financial details at a time when the industry arguably had even more power than today. Thanks to his intense questioning, the hearings of the Senate Banking and Currency Committee led to many of the financial reforms implemented in that era, setting the stage for unprecedented economic growth as America secured its place as a world superpower. For a salary of $255 a month and with a staff of only three, his grilling of the biggest and richest names of finance led to revelations of misdoings that caused a turnaround in the public's perception from that of respected bankers to equating them with gangsters, and thus becoming banksters. In a time before television, as well as one where the public and bankers believed they deserved to be placed on a higher pedestal, Pecora turned the proceedings into an exhibit of fraud, greed and manipulation which brought the masters of the universe down to Earth and therefore under control. Chairman of today's FCIC, Phil Angelides, has a mountainous task ahead of him, but one that must get done, and we should all get behind him.  At a time when America's preeminent position on the globe is being challenged and questioned, many of the practices that must come to light mirror the financial misdeeds of the Pecora era. We have a system where the incentive is to pump up the risk in order to increase rewards without fear of the negative consequences. The voices in favour of taking action against the banks are growing, Paul Volcker, Joseph Stiglitz, Paul Krugman and Simon Johnson to name a few while at the same time that the window of opportunity is closing as we are being presented with our last best opportunity. We need more than parsed apologies, we need to know exactly how trillions of dollars of wealth was gambled away and to achieve true reform as a result. Finance, much like America, needs to be saved from itself but it will only happen if we all get out there and beat the drum loudly.


loanbuilder said...

Great Article Shane...You have defined many of the problems and conflicts of interest that should shock the average citizen. But the average citizen is now desensitized to the the BILLIONS in waste, fraud and bailouts. And they certainly have no confidence that any Govt agency will fix the problem. The Great Train Robbery called TARP has already happened and the politicians are just part of a show trial to make the dumbed down complacency of Americans stick. The problems with the Banking System has been well defined. It's the solutions that are hard to implement. Especially with the paid for shell governance we receive from Congress!

Out of anger with my own industry of mortgage banking, I started a Blog called It's more of a practical Blog for those engaged with the Process of Short Sales and Loan Modifications. I have attempted to talk to the Treasury about reigning in the Bankers and force them to help those losing their homes. I have come to the belief that the Treasury is powerless to help the average citizen. It's ALL a show. The Bankers are in Charge!

Keep up the good work!

ManhattanChronicles said...

I have some friends on Wall Street and they all tell me that the bonus is a percentage (about 20%) of the money each guy creates fir his firm. Then how come can you say that WS bonuses reward failure? I am not a banker, nor an economist or MBA. Just curious.

Shane said...

@loanbuilder thanks for coming by, hope you make it a habit. I have to agree with you about the people becoming desensitized to these astronomical numbers, it seems like we went from million being a big number, to billion, then trillion in a matter of 10 years! Wrote something about it awhile back: $50 billion. Like your blog btw, I'll be back.

@Manhattan curiosity is what this blog is all about my friend so no worries about the question, it's good to have someone ask instead of attack. Sounds like your friend was talking about the lower level gamblers, er, I mean 'bankers' who trade (many of whom have bonuses determined as a percentage of salary or as you said, as a percentage of profit creation) the ethics of these bonuses is debatable. Being rewarded to take risks is one thing, but having no negative consequences for failure is another. This inevitably leads to short term thinking that puts the future at greater risk. I'm under the impression that the higher ups have minimum bonuses written into their contracts.

The part of my post your alluding to was trying to focus more on the failures of the highest executives, your Blanfeins, Rubins, Dimons, Goodwins and Thains of the world. Many of these men have presided over companies or held posts in governments at times when their organizations have made colossal mistakes, yet have been rewarded with giant bonuses and even more prestigious positions. If this was a true capitalist system, without the cronyism that exists (think good old boys club) these guys would be working in the equivalent of the 'A' leagues in baseball or out of the game all together as their 'teams' would've folded long ago.