Friday, February 6, 2009

Let's Kill all the Bankers?

That seems to be the attitude in the news and in Washington lately.

Even Jon Stewart has gotten in on the act. In response to a comment by John Thain that he had to pay his best people, Stewart (on the Daily Show) shouted "You don't have best people. You lost $27 Billion. Do you live in bizzarro world?"

Even the President has gotten headlines by questioning banker compensation. The New York Times reported yesterday that "Mr. Obama also needs to deflect a growing populist outrage over sky-high pay among banks and other companies on the public dole."

All of the outrage being spewed at the "bailout" of the banks misses a basic point: it's an investment, not a handout! The financial institutions are not on the "public dole."

While it is true, if the supported banks fail, the government's recovery will be significantly less than the amount invested; the idea is to prevent the banks from failing.

The government has purchased non-voting preferred stock paying a dividend. The intent is for the banks to refinance and redeem the preferred, giving the money back to the government on top of the dividends paid while the preferred was outstanding. Some of the banks have also had to give warrants to purchase stock, giving the government participation in any upside.

Since the government, and we the people, have a vested interest in the survival of the banks the government invests in, the statements expressed are not particularly well thought out.

In fact, we want the banks to prosper and grow. We should not be demanding actions that could hamstring them and/or prevent their success.

A significant portion of the losses taken by the banks/investment banks receiving capital injections from the government are paper losses. A large part of these losses will turn out to be real, but some of the losses have been booked based on current markets, which are not functioning properly. The assets underlying those losses may in fact be worth significantly more than current market values. If that is true, then the government should get its money back faster.

While some areas of these banks clearly performed miserably, other areas were profitable. The bankers in those businesses need to be compensated.

Clients for many of the services provided by the investment banks are loyal to the banker, not the institution. If the banker leaves (and, contrary to some perceptions there is ALWAYS a market for people who bring business), the business leaves with him/her. That's why it's important to pay some of these bankers.

It's difficult for outsiders to conceive sometimes, but in investment banking, and in some other areas of finance, bonuses are multiples of salary, not fractions. If you cut a bonus to 50% from 500%, that's significant, but it's still a bonus.

Rick Bookstaber, on his blog, posted this last week, where he gives a clearer explanation of how people in the investment banking world are paid. He points out that the bulk of employee compensation is paid in bonuses, even for lower level staffers. One commenter questioned whether the practice continued after the investment banks became public companies. It has.

As for things like stadium deals, as a Mets fan I'm not particularly enamored of Citi's name and I find the logo for the first year of the field uninspired. That said, it's a marketing decision. Somebody at Citi felt branding the ballpark with Citi's name would bring greater recognition to the bank, and, presumably, profitable business. It might be a good idea for someone at Citi to revisit the analysis and present it to the proper people; but I don't think Congress should be focusing on such issues, as obvious as they may be.

The idea of Congress getting involved in banking decisions is beyond scary. The Soviet Union fell because of that kind of central planning.

The current problems don't mean the capitalist system has failed. There have been mistakes made, but it's not an indictment of the whole system.

Shakespeare's play, Henry VI, has the famous line: "The first thing we do, let's kill all the lawyers."

Let's not kill the bankers. We need the banking system to work so capital can flow and businesses can start running properly again. Then the government can get back its money, pay down the increased debt, and we will be that much closer to normalcy.

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2 comments:

Wolfgang said...

Well, if the financial crisis that we see now and in the near future does not mean that capitalism has failed miserably, I do not know, what should happen instead. I really would not feel much about investment bankers being killed, if you compare this to the people that will lose their lives due to the crisis. Of course, not in the western world...but surely in the less developed countries, that will be affected by the crisis and where affected by Wall Street before (e.g. due to the speculations on foodstuff as a stock market reaction for the rising interests in biofuels). Another point is: If there a bonuses, why aren't their maluses? Ok, economy is never logical, but shouldn't it be like that? Why not paying the investment bankers a fixed good salary for their work in the first place, with bonuses as an additional reward in case of success. At least it is not their money, they take. It is the money of normal people who keep the industry going along, allowing all of the financial business. When there was a boom in germany in the last years, the middle and lower incomes did not rise, so in fact you can say, that the investment bankers stole the money from the hard working people. You may should not kill them, but at least bring them to justice.

Lawrence D. Loeb said...

That's not how compensation is done in the US. In Germany there is a slight difference.

The bankers aren't paid by the workers but out of the profits of the banks they work at (or the capital of the banks, in the case of losses - to the detriment of shareholders).

What the heck do you mean bring them to justice?

The title was a play on Shakespeare's line from Merchant of Venice.

I find it amazing that people look for simple solutions and simple targets for blame. The current crisis took years to develop, required participation by parties all over the globe (from Chinese exporters keeping the proceeds of their sales in US Dollars to Dutch municipalities investing in US home mortgages to Icelandic citizens speculating in foreign currencies and so on ...).

The term "Investment Banker" gets thrown around a lot, and the meaning has been changed over time as anyone associated peripherally with an investment bank claimed to be an "Investment Banker." The term used to refer to financial advisors who assisted corporations in capital raising and in facilitating corporate transactions. Their firms typically had trading desks to make markets in securities and salesmen to broker market trades, but those individuals weren't considered investment bankers for a very long time. Eventually they were, by some.

The reality is that disintermediation has changed the way that funds are transferred from those with excess to those with a need. Banks have become more transaction oriented, despite the incredible growth in their balance sheets.

Capitalism lives on and keeps on evolving. These crises are unfortunate growing pains as the markets and regulators adjust to how the world is changing.

China has brought something like 200 to 300 million people into the world economy and India another 150 to 250 million. I look forward to another billion or so people having the opportunity in the coming decade to enter the modern economy. That can only happen through capitalism.