Financial Turmoil: Merkel Blames the United States and Britain
Posted by Joerg Wolf in International Economics on Saturday, September 20. 2008
Chancellor Angela Merkel has revived Germany's campaign of a year ago for global regulation of financial markets to prevent another crash like the past week's. [She] criticized the US and British governments for obstructing Germany's efforts in the first half of 2007 to bring greater transparency to the markets.
Yep, it is "We told you so"-time again.
• Germany's state-owned KfW lender is called the 'dumbest' bank for transferring 300 million euro to Lehman Brothers on the same day it declared insolvency, reports the IHT.
• SuperFrenchie concludes from the US response to the market turmoil: The United Socialist States of America (USSA)
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Subscribe to one of our RSS-Feeds or to our newsletter, which is emailed twice per month.Really who wasn`t surprised by the US governmental decision to virtually nationalize failing banks? US government - the synonym of "free market" - going communist?
Apart from that, the KfW proves again how good the state is at running a bank. Considering that the board responsible for keeping track of the market consists out of (probably highly unqualified and just as unmotivated) representatives of each party of the Bundestag, you can easily guess how much of a change we will see here in the future.
There is no difference between what the Fed and the Treasury did then any bankruptcy court would do. Except on the scale of the money necessary to keep these organizations solvent and the degree of actual control the government will have. These loans are based on warrants which will be repaid before the bond holders and before the share holders. A similar situation arose when Chrysler got Congress to approve loan guarantees and then in the late 80's the government redeemed those warrants for a huge profit.
And coming from Superfrenchie I find the ludicrous as he still has not figured out the difference between a resident and a citizen.
And when you consider how much influence the government has over the value of the underlying assets, home values, it starts to look like a pretty sweet deal for Uncle Sam. The people who lost out are those who don't own homes and didn't reap the benefits of the rising values but will have to pay the inflated prices later.
uh, time to sign a new deal
http://www.iht.com/articles/2008/09/17/opinion/edcohen.php
http://www.ft.com/cms/s/0/82b3aaf2-84e6-11dd-b148-0000779fd18c.html
I read also that Sarko will make a discourse soon
seems that the "free markets" options of the net era are over, sure we need regulations and transparencies
I see some stuff that could be described as a market failure, but I see stuff that could better be described as a regulation failure. So far, it seems many regulators got caught in the same herd mentality as the rest of the market. And so far, it is the market, not regulators, who brought most of the current problems to everyone's attention in a way that couldn't possibly be ignored.
Still: It is far too soon to be looking for something to blame, when we don't yet know exactly what is happening or even if the worst is yet to come.
Ok, cut the socialism crap. I'm going to give a very brief lesson on what is happening. It's not comprehensive, but it will give all you Econ 101 dummies a start.
In the post-Enron fallout a new accounting rule was set up called 'mark to market'. What it says is that you may not value assets according to what you think they could be sold for down the road but what you could get for them RIGHT NOW.
There have been some very complex financial vehicles derived from subprime mortgages, such as credit default swaps, etc (which actually is probably one of the easiest derivatives to understand). Anyway, the market for these derivative vehicles dried up (for reasons to complex to go into after 2 glasses of wine). If you can't sell an asset, the mark to market rule values it at ZERO.
And everybody's books go KABOOM!
What Paulson is doing is buying up all that paper and creating a market for it. It will be auctioned. It's going to be a huge unwind, but some people may actually make money off it. What you must keep in mind is that the underlying value does exist - the houses. The pricing signal has been completely lost and Paulson intends to restore it.
And I really don't want to hear that short sellers are being punished or scapegoated. Remember that trader in France earlier in the year who lost his firm lots and lots of moola? Like 40 million euros I think. They brought in their best traders to unwind his position - and lost another 30 because they were unwinding after they had already been shorted. This is why the short sellers have been locked out.
Good night and shove the schadenfreude.
Absolutely, the 'mark to market' reforms to GAAP (US accounting standards) are part of the problem. They are making a bad situation worse. There is a good WSJ article on this, "Maybe the Banks Are Just Counting Wrong"
However, there is still the underlying problem that the US built too many buildings, or the wrong kinds, etc.
The very difficult question is, is the 'mark to market' problem a failure of regulation, or a failure of markets? Some of the people supporting 'mark to market' were manifestly pro-market people who argued that the markets would do a better job of valuing these assets than the traditional accounting methods that the Japanese abused in the 90's, and the US Savings & Loan industry abused in the 80's.
It could be argued that even today, the markets would value these assets correctly, if it weren't for the fact than no-one today dares deviate from GAAP, thus breaking out of the negative feedback loop (vicious circle).
That is to say, no public company dares to deviate. Privately held companies have ways of avoiding mark-to-market and other catch-22 situations created by accounting. In a totally free economy, privately held companies would be in an ideal position to restore some liquidity without putting taxpayers on the hook.
But we don't have a totally free economy. Free markets still make some people nervous. Human psychology seems to value the illusion of control and central authority, even if it is a illusion or worse, a reality traced in blood and oppression.
"It could be argued that even today, the markets would value these assets correctly, if it weren't for the fact than no-one today dares deviate from GAAP, thus breaking out of the negative feedback loop (vicious circle)."
What a load of crap. Bush has committed US taxpayers to buy $700 billion of the shitpile of worthless securities. Believe me, that is only the beginning. This will cost us 3X his fraudulent Iraq war.
This is the Bush/McCain philosophy: privatize profits and socialize losses. For what we are paying in this bailout (nationalization) America could have made Social Security solvent for 100 years and provided adequate healthcare to every citizen.
David, they aren't worthless securities. There are underlying assets backing up the securities, the problem is that nobody can assign a precise vlue to those assets and therefore nobody wants to buy them.
I have been following a blog named the Irvine Housing Blog whish shows the problem in a nutshell from the demand end.
During the great real-estate bubble of 2004-06 the Irvine housing market went gaga, nutso, and the cow jumped over the moon. A lot of loans were written in those years, a lot of equity was borrowed upon, and house prices went through the roof.
Let's take a typical 4 bedroom house in Irvin. In 2006 it may have been *worth* 800K, and a loan may have been granted for 100% of that value. Today the same house may be worth between 550 and 600K and sliding. Let's say it will be worth 450K at market bottom. That is what the bond is worth. It's not worthless.
Some paper is going to be worthless or next to, because not all paper is created equal. A first mortgage of 80% on that house has first call on the equity, so on a face value of 640K it's actually worth about 70% of that if the price goes to 450. The 2nd mortgage or HELO holder has an asset worth virtually nothing.
The problem is nobody knows which is which, where is the good paper and how to value it. So there is no market, and 'mark to market' values it a zero as Pamela pointed out. Banks with a lot of zero-valued paper on their books are bankrupt regardless of the fact that much of their paper actually has significant value.
One more thing which ought to be pointed out is that all local real estate markets are not created equal. Southern California got seriously overheated, as did some others. Las Vegas, possibly some in Florida. Others moderately overheated, but not too many. So there is a lot of decent paper out there from non-bubble markets in the midwest, most of the South, possibly the northeast, etc. It's not all like Irvine.
At the same time some places may be actually worse than Irvine, particularly some of the most far-flung LA basin suburbs like the ones out near Palm Springs. Values seem to be down 50% in some of these places. Places with extremely long commute to large metropolises seem very hard-hit, closer in localities less hard hit.
Or simply a matter of inches considering the neighboring cities of Newport Beach, Corona Del Mar and the older parts of Huntington Beach saw slight declines on average but in many places no decline and a rise in value. Where I live, Zillow is consistently $50-$100K below actual selling prices which has created some sticker shock on people trying to score bargains in beachfront and builtup housing.
Now assets derived from retail properties have essentially cratered throughout California which gives the appearance then that all real estate is devalued. I only wish I could figure out a way to buy some of these undervalued assets because they are going to make the government a ton of money in the future.
Don,
There is also a lot of dodgy real estate in Phoenix and elsewhere in Arizona, which may be a problem for McCain if they can link him to any of it. There was some MSM coverage of this in the past, but it didn't really make a big splash, possibly because McCain has been better than most about resisting quid-pro-quo from his home state lobbyists. But maybe they will find something. On the other hand, if they do make a big splash, that will put Rezko back in the news.
Do you think it is worth it for the Obama campaign to attempt that linkage? Maybe they have already?
Come on David, "...privatize profits and socialize losses," is hardly the most original thinking I've seen from the left in the last few days. In fact that must be #1 or #2 on insipid slogans stuck to the monitor to be repeated endlessly without a wit of intelligence or originality. Especially considering that the argument of buying worthless securities is exactly what the sackcloth and ashes crowd, except it was the Republicans, said during the Chrysler Loan Guarantee era but faded radically when the government recouped on an investment it made with no cash involved at all. But I suppose that when it is a Democratic congress and a Democratic president doing the Bailout Shuffle its the XI Commadmant of the caring coterie. Thou shalt only blaspheme and misrepresent when it can be blamed on the Republicans.
David,
Your math doesn't add up. To make social security solvent (as defined by GAAP) through about 2050 would require fully funding the social security trust fund, which is currently full of nothing but IOUs to the Treasury to the tune of $2 trillion dollars. Funding the social security shortfall (expenses minus tax receipts) for the 58 years after that (until 2108) is difficult to project, but would certainly require additional trillions. Then add in the money for 100 years of health care, which because it is "free" utilization will skyrocket (unless you plan on rationing?). I don't think you could do it for the cost of several bailouts and several Iraq wars combined.
Worse still, if you believe the securities are worthless, then even without the bailout plan, the "real economy" will take a big hit as soon as the rest of the world catches up to your advanced understanding. That will further reduce tax revenues available to social security and health care.
Good morning John!
"It could be argued that even today, the markets would value these assets correctly, if it weren't for the fact than no-one today dares deviate from GAAP, thus breaking out of the negative feedback loop (vicious circle)."
Visibility to the price/value signals got lost the nanosecond these things were sold inside structure investment vehicles and everybody trusted the rating agencies to correctly value them.
We now know the rating agencies' computer models were wrong.** The most glaring example is that they never accounted for the idea that once a house price dropped below the mortgage amount, people would just mail the keys to the bank and walk. Another is that Moody's knew for a full year that there was a basic error in one of their algorithms used to price the SIVs. Not only did they not correct it, they continued to use it for pricing.
Some people really need to go to jail.
** And people still trust all those models predicting global warming. sheesh
The comparison with the global warming models is perfect. The partially free markets we have today will do a far better job of throwing out their failed models than will the mostly-government-sponsored global warming community.
Incidentally, anyone who still thinks we can "solve" global warming with carbon caps has to model economic and population growth for the next 50+ years, in order to calculate what the cap should be. Good luck with that.
There is some interesting and useful research being done on the global warming question, but the climate models are utter crap, and the population and economic models are only a little bit better.
"Moody's knew for a full year that there was a basic error in one of their algorithms used to price the SIVs. Not only did they not correct it, they continued to use it for pricing."
Interesting, I hadn't heard about that. Failing to correct it seems like a (simple?) case of fraud when you get down to it.
I did read that in some cases the economist/software engineers who had programmed the models, where no longer available to maintain them, and no one left in the industry knew how to maintain the models or even understood them.
Perhaps this was due in part to the incredible competition for talent that happened during the Internet boom. I am sure Wall St. could pay big money for computer talent, but couldn't always offer the other perks (ability to be your own boss, start your own company on a shoestring budget with no oversight; a chance to be known and respected on the Internet, chance to enter the lexicon and capture the public imagination like e.g. Google.)
The culture of the IB's is a very curious one. The traders are the Masters of the Universe, software engineers and maintenance guys are the scum below their feet. They do pay well but the price to be paid is getting screamed at pretty constantly and very low status in the workplace. Very high stress.
Software engineers can get much higher status (at somewhat lower pay) in other industries, with much less stress. Or they can go consultant and raise their pay - elsewhere.
With that kind of pressure and competition - very little gets written down. Writing stuff down can help out your competitors in a hypercompetitive atmosphere such as I-banking. Plus no credit is given for writing documentation - only new systems.
It should surprise no-one that they were unable to retain what should have been valued employees or to get new ones to fix their model under these working conditions.
"Interesting, I hadn't heard about that. Failing to correct it seems like a (simple?) case of fraud when you get down to it.
I did read that in some cases the economist/software engineers who had programmed the models, where no longer available to maintain them, and no one left in the industry knew how to maintain the models or even understood them."
I was a software developer for 30 years, the last 10 in telecom. You are correct - the people who coded the models left and I will tell you why. Because they knew the business rules they were being told to code to were crap and in some cases illegal. The 'stars' of Wall Street have been the 'quants', the math guys from MIT who got a pass because everyone thought they were brilliant. They are. In math. I know several software developers who simply hung it up on Wall Street because when they questioned the underlying fundamentals they were told to develop for were in various ways punished.
For those of us who love the art and the craft of systems and code, to employ it in the service of dishonesty on any level is grotesque.
I gave up a career I dearly loved because I was told to essentialy cook the books or else. I took a 60% pay cut and left. I came home and started to work with my husband. Those people who gave me that ultimatim? Well, some have already gone to prison and the rest have been spending their salaries - what's left of it - on lawyers.
I win.
Book recommendation: "Fooled by Randomness".
I should not overclaim my personal expertise. I live in London and have worked in banking, but not for an I-bank. But I know quite a few people who do. Get a couple beers into them and the stories which come out are - interesting. Hairy-breasted machismo in Armani suits.
I've interviewed for I-bank slots and nothing in my experience contyradicts the stories I hear.
Fact is that the development jobs (creating the models) can be quite rewarding if stressful. But maintaining the code is much less prestigious and even more stressful, particularly when you consider the impact of a boo-boo. In such environments the most rewarding strategy can be endless procrasitination, whinging, and delay. This because you will rarely or never get rewarded for accomplishing anything but if you screw it up the hammer comes down.
So if you never deliver they keep on employing you and the billion £ shithammer never comes down. At least until they chuck whatever Big 5 consultantcy is currently ruining the project and hire the next one to ruin it in another way. Then a few heads may roll. But then you just move to nother floor at Canary Wharf and repeat, probably with a pay rise.
It;s not fraud however. Incompetence, yes. I-banks aren't known for their management style. They don't need to - anytime they need to change they can fire their current set of monkeys in suits and hire a new group of monkeys. And that is precisely how they look at it, also. Not that that attitude is confined to I-banks - one sees it all over.
Nice -- stories right from the belly of the beast!
Wall Street is only one model for entrepreneurial capitalism. Silicon Valley is another. And it seems to me that Silicon Valley understands much more than Wall St. about software development and nurturing that talent.
Wouldn't it be funny if the west coast became the new center of American financial innovation?
As a libertarian, I am against the bailout; as a practical libertarian, I am cautiously in favor of certain elements of the bailout. But there is an untold story here. One of the results of the bailout is to protect the Eastern Establishment. We saw this in differing response to the Oklahoma City bombing, and to Katrina, as compared to 9/11. Or the difference between Enron and (for example) Morgan Stanley. Of course, it is difficult to make objective comparisons since each of these incidents are unique in their own way.
This bailout will stoke anti-east coast sentiment in the US. Sorry, no civil war, but these tensions will out in one way or another.
Here's the proposed legislation, courtesy of the Wall Street Journal.
http://blogs.wsj.com/economics/2008/09/20/treasurys-financial-bailout-proposal-to-congress/
Why is not anyone commenting on Merkel's criticism of the US and Britain, who did not supported Germany's proposal's for more international regulation?
Several reasons, Joerg.
The events this week have been so overwhelming that everyone doesn't yet know what to make of it. We may have seen the beginning of a depression - or dodged it at huge cost. Huge cost anyway, but we don't have the slightest idea whether it's 100 billion or ten times that.
Who Angela Merkel blames seems kinds small compared to that. Who knows, she may have been right. I don't think so, not because she wasn't right about more regulation being needed but because regulation last year was much too late to avert the bad loans problem. In 2004 or 2005 would be more like it. It was the 100% financing which did it along with a bunch of other things. The ratings & insurance agencies, etc.
I'm beginning to think that listening to politicians citing the results of Ouija Boards as economic theory is not going to be very educational or helpful. Or the fact that just 16 months ago the Germans knew many of its own banks, IKB Deutsche Industrie Bank for example, had plenty of this debt but Merkel did nothing to stop the trend except to allow transfer the debt to the state banks and then complain that the guys with the calculators didn't understand what they were purchasing. No one was twisting the arm of German or European banks to invest in these instruments and then to complain that they weren't transparent enough to ascertain the risks is risible. There is such a thing called "due diligence" in regards to purchase and sale which appears to be sadly lacking on both sides of the Atlantic.
I don't mean to be rude, Joerg, but frankly, Merkel jumping up and down saying "I told you so" is not worth our time.
So many of us on this side of the pond have been yelling for so long (mark to market, loan origination regs, CRA, etc.) that she's kind of behind the curve.
It's hard to get worked up about Merkel's comment because as an opinion and citation of blame, it doesn't mean a damn thing where the discussion as to how to prevent a collapse of the banking system is concerned.
David is right to call this a 'bad investment' on the part of the Treasury, but they and the Fed are the garrantor of last resort of the currency. What is certain is that I'm not sure we can afford to see the banks pancake. There is an ever-present need to have operating credit to run a business - i.e. to cover the gap between paying salaries and invoices being paid. If he or anyone has another idea, I'm sure the Treasury would like to hear it.
I will say this about Merkel's comment: it's rich. German investment operations were free to make money worldwide while German banking rules limit severly the profitability of similar assets in Germany which might not do a thing for the homebuyer (who by some miracle has to come up with a 40-50% down payment), but shileded their own morgages from risk.
I spent 15 years on Wall Street and, while I am not proud of my tenure there, I know a bad deal when I see one. And Paulsen's plan is a terrible deal for the US taxpayers. Basically Paulsen is committing to purchase the toxic securities and loans at a premium over their market value. This way the banks don't have to mark them to market - wiping out what little capital they have left. The banks get liquidity and the taxpayers get....nothing, not even an equity stake in the the financial instutions. (Hey, at least we own 80% of AIG).
Furthermore, who determines the price of the securities to be purchased? Who determines which institutions will benefit from this sweetheart deal? Why that would be the US Treasury Dept. in its sole discretion. Here is the most disturbing clause in Paulsen's proposal:
"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."
Welcome to the USSRA (United Socialist State Republic of America).
Finally, as I wrote on my blog, over the weekend Paulsen has now extended the commitment of US taxpayers to bail out foreign banks as well. No doubt Phil Gramm - McCain's economic advisor and Vice Chairman of Swiss bank UBS - had a hand in this.
David is correct about a lot of this I'm surprised to admit. There are a lot of free-loaders in this 'deal', and not just Wall Street bankers.
There are a lot of stakeholders here, and not only in the US. Everyone should have to pony up, perhaps even to the point of IMF and/or World Bank involvement.
At very least the US taxpayer should get an equity stake in the institutions being bailed out. And the taxpayers of any other government which decides to pony up to fix this crisis of course - fair is fair.
That shouldn't exclude the foreign banks which Paulson has decided to bail out - as explosive as it may be politically for the US government to own a big share of European banks will be.
Perhaps the answer would be for the countries involved to advance the funds to bail out their own banks - and take the equity stakes themselves.
I can't believe I'm writing this. I think David makes some good points. Somebody smack me. But David, I'm not sure about a couple of your points. First:
"Basically Paulsen is committing to purchase the toxic securities and loans at a premium over their market value. This way the banks don't have to mark them to market - wiping out what little capital they have left."
I think we don't yet know how the purchase price(s) are going to be set. I think this is to be worked out between the asset managers an Treasury, e.g., reverse auction. And mark to market is one of the things that got us into this mess in the first place.
Second: "Paulsen has now extended the commitment of US taxpayers to bail out foreign banks as well.".
I think that's a bit overstated. I think it's foreign banks who have headquarters in the U.S. (?)
Having said that - if this goes through as is, we will have just created a forth branch of gov't with no checks and balances. Ok, one check. A blank one.
Yup, Pam. Sure sign that the world may be coming to an end, when you or I start out to bash David then read it agans and say waitaminutethere.
McCain is not coming to grips with the real issues here. Well, neither is Obama but I think he';s doing better.
This is not a year to be pounding on the old culture wars theme. There are more serious issues facing the country.
Pamela,
Second: "Paulsen has now extended the commitment of US taxpayers to bail out foreign banks as well.".
I think that's a bit overstated. I think it's foreign banks who have headquarters in the U.S. (?)
That was yesterday.
According to "Calculated Risk" the treasury fact sheet now says:
"Asset and Institutional Eligibility for the Program.
To qualify for the program, assets must have been originated or issued on or before September 17, 2008. Participating financial institutions must have significant operations in the U.S., unless the Secretary makes a determination, in consultation with the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets."
It´s down to "significant operations in the U.S." Or whatever else Paulsen decides.
The dog that didn't bark in the night.
What dog? Consider. whenever a fiscal crisis brews up internationally the first thing which is done is the US is asked to contribute support - either directly or through support in the IMF and/or the World Bank.
Over the past decade or so we've been seeing a new thing - wealth is accumulating in sovereign wealth funds globally. Capital has shifted globally. Last week the US had it's own crisis & the dog didn't bark. All those funds based in Dubai benefit from US policing of the international waterways do they not? And in many other ways as well. But they saw no necessity to help the US in this crisis. It was in fact - unthinkable, wasn't it?
Without anger or bitterness let me point out one crucial fact - what this crisis is showing is that the strength of the US is not infinite. People have been taking certian things for granted that they cannot imagine a world in which the US doesn't do certain things free gratis.
The US did many of those things not out of altruism but because the US benefitted more from those things than anyone else did.
That is no longer true, yet it is still the US only which patrols the sea lanes, guarantees Europe's security (almost only, at least 70%), and bears more than it's share of keeping the international financial markets liquid an stable.
People have been pointing out for decades that the US hegenomy is eroding. Well last week we saw a major erosion - and nobody stepped in. You hear me, China? Lula of Brazil did contribute some schaudenfreud:
"And what have we heard from the new centers of wealth and power - China, India, Brazil, Russia, the Gulf states - about America's financial agony over the past week? Zilch. Well, not quite. When asked about the crisis, Luiz Inácio Lula da Silva, the Brazilian president, said: "What crisis? Go ask Bush.""
Listen people. The tectonic plates are shifting. The US is going to have to give up doing certain things. If you want to get those services you're going to have to pay them -and man them - yourselves. It's going to have to be a sharing arrangement, the fecklessness of the past decade just won't do the job. Blaming Uncle Sam won't keep the train on the tracks. In fact it's causing the train to go off the tracks.
http://www.iht.com/articles/2008/09/21/opinion/edcohen.php
"Perhaps the biggest looming fight is over Democratic efforts to require the program's participants to curb what they pay their executives."
"Mr. Paulson is resisting efforts to limit the pay of executives whose firms participate in the program and plans to fight it "hard," according to a person familiar with the matter. He fears that provision would render the program moot, since many firms might choose not to participate."
Source
Regardless of how you feel about executive pay, I think we can agree that it has virtually nothing to do with the causes of the current crisis, or the solution to it. How does limiting executive pay protect taxpayers or homeowners?
I'm sure Dems are in love with the symbolism, but they could pay a huge price for cluttering up this legislation with side issues. I am hearing echos of the Homeland Security debate in 2001-2 in which Dems tried to hold back the legislation in order to ensure that the entire homeland security department would be unionized. They were seen as playing politics with national security, and paid a price in the mid-term elections in 2002.
Well, not quite, John. This is a public bailout, and it's obscene to contemplate that the public funds would go in part toward continuing the code of self-enrichment which currently prevails on Wall Street.
If it were necessary to get the best performance that would be another thing. But let's not forget that the incentives for these people lie in maximizing their own gains (first) the gains of their shareholders (second) and bondholders (third). The public figures in only as a distant fourth, if at all.
I m not advocating that we bind the mouths of the kine who tread the grain, but compensation for their labors in fixing the system which their class so thoroughly screwed up to great public expense should be measured in the houdreds of thousands, at most the low millions. Not in hundreds of millions as before. If billions are to be made let them earn it the honest way - by investing wisely in a sound financial system.
Hmm. On the one hand, you're declaring the end of the US hegemony. On the other hand, your position on executive pay seems to assume we can still dictate terms...do you see the problem?
Most of the business that was supposed to be made more sound, safe, accountable, etc. by Sarbox had instead moved to London. Oops. Now they are "under regulated" (according to the believers in Sarbox) plus we are now only taxing their US presence, not their global presence.
"fixing the system which their class so thoroughly screwed up" Class warfare and collective punishment, is it? Why should companies (however few there are) that did not require a bailout, be punished? Why should future companies, that don't currently exist and therefore cannot possibly be responsible in any way for the current problems, be punished?
It seems to me that a blanket limitation of executive pay on publicly traded companies will mean that existing companies will be favored vs. new companies. Existing companies have brand recognition, confer social status, etc. so whoever runs them is "compensated" in ways that are impossible to regulate. One of the ways that new, unproven companies have to compete with these intangibles and attract talent, is compensation. Without this ability, it will be that much harder to displace the old guard, and it will reinforce the tendency towards oligopoly.
We have already seen self-defeating populism in the move to (temporarily, or so we are told) suspend short selling. Now this "Short Contagion" is spreading. But the short sellers were among the first to raise the alarm on Enron, on Fannie and Freddie, and so on. As a "class" they outperformed most of the regulators, at least as far as detecting the problem goes. Yet they are being punished, "temporarily". Are you in favor of permanently banning or dramatically limited short selling in the future?
I am probably over-simplifying things a bit, but I think you see the problem. We need to focus on effective action, not revenge. It seems to me there are plenty of existing laws and regulations that were violated, and these violations will be the basis for punishing the guilty, without stooping to mindless lashing out.
I'm not advocating limiting pay on all publicall-traded companies. I doubt anythng like that is comtemplated.
No, what I'm saying is that the management of a bank which dumps a bunch of trashy bonds on the government should not be allowed to go back to the good old days of billion-dollar option pools and other such sweet deals while so doing. Not right away. It should be enough that they get to survive, but not make any billionaires.
This bailout is an obscenity. A neccessary obscenity I may grant you, but it would be a worse obscenity if the lion's share of any gains to be made were not the Treasury's gain. Because it's the taxpayer who will be shouldering the risk.
OK, as I re-read your comment "I'm not advocating that we bind the mouths of the kine who tread the grain" it dawned on me that I had probably overstated what you were proposing.
But what exactly are you proposing? The shareholders, including the government, will force executive pay to be in line with what they see as the executive's value. Why would shareholders not do this? I suppose in the past they might have been too passive, but now? So, if shareholders are going to get aggressive on executive pay, the only rationale for some sort of limits beyond what shareholders impose, is the belief that the government knows better than the shareholders what is good for them. Specifically, it is the belief that Congress knows better, since in this thought experiment, all executives responsible for the problems have been fired or jailed, and Treasury and the regulators, acting as shareholders, have already optimized executive pay from their point of view.
What is the basis for believing that Congress knows better? What if someone who can steer a disgraced company back to respect and profitability really is worth their weight in gold?
John, I have a big problem with the way this whole Masters of the Universe thing went down.
Wall Street pushed up it's earnings and bonuses by leveraging to historically high levels (Lehman was at 30-1 or more). Other IB's were at comparable levels. One can point out that government regulators allowed this to happen, but then ask yourself who lobbied tirelessly for the capital requirements to be relaxed? The IB industry.
Moreover, the IB's didn't HAVE to leverage to that degree - they could have left it at 10-1 or 12-1.
What happens when you run a firm at such gearing? Record profits - as long as something doesn't go wrong. When something goes wrong - bankruptcy. Not just for the firm however; the Great Depression shows what happens when highly-leveraged banks are allowed to go to hell in their own way. Bankruptcy, mass unemployment, Hoovervilles, bindlestiffs, and other nastiness for Main Street.
We learned something from 1929. Not enough obviously, but we learned that the public has to intervene in a liquidity crunch like this - even if it costs a whole bunch of public dollars, as this may.
One more thing, I suppose. I see the attitude of many of the people at the IB's as symptomatic of a deeper sickness in the US economy. A disrespect for the 'smaller' folk out there. Not just the folk who sweep your sidewalks and pick up your trash (bad enough). But disrating competent professionals who weren't part of the 'Masters' class.
Look at the crisis that hit the ratings agencies, being unable apparently to update their rating models because they had let the people go who did this work. Perhaps they weren't fired, though perhaps some were. But low status, low pay raises, getting crapped on by the greenest of trainee traders, etc. So they left, and weren't asked to come back because (apparently) they weren't important.
There is a LOT of this going in the US economy these days, and not only the US, I see it in Germany, the UK, and probably everywhere else. Skilled people have become commodities, important company-related skills are massively underpaid, and formerly valued employees are given no time or resources to update when things change - they just dump them and hire someone else with the required skills. Middle America, Middle Germany, Middle Britain. Discard them like the trash when convenient.
And these are the very people who are being required to bail out the Masters class this week.
OK. To not do would be cutting off my nose to spite my face. But I want to see the 'Masters' take a very short haircut this time to drive in a few basic lessons - with a piledriver. Caution is good, shit happens, and middle-level professionals form any company's institutional memory. Cut them in the name of efficiency and bad things happen when the economic ecosystem shifts suddenly.
Billion dollar bonus pools for I-bankers who manage to shifts the costs onto Joe Public would send exactly the wrong dang lesson!
Another issue the Congress is bringing up are the taxpayr getting warrants for shares in the participating banks, which I think is utterly necessary. If the public is going to hazard $700 billion there should be the possiblity of the public making a righteous profit from it's risk - like any good capitalist.
Excessive executive compensation puts such gains at risk. There is a serious moral hazard risk here. Why should executives be able to cream off billions of any gains before the public gets it's return? Should not the public shareholders have the right to limit executive compensation as private shareholders can (in theory)?
Here I agree with you, the Treasury should absolutely be in a position to profit from the bailout if it succeeds.
I say Treasury, rather than taxpayer, because I have little faith that any of the profits will actually be returned to the taxpayer.
As a shareholder, the Treasury will certainly have power to impose limits on compensation, or defer it, or structure it in other ways so that executives don't get to skim the cream too much. And the other shareholders will want this too.
Still, assuming that much of the current management will be fired or in jail, you will need to spend something to hire their replacements, and a couple of hundred-thousand per annum for a high stakes, make-or-break job, might not be the best approach.
How much of this is going to be high stakes, high risk do you think?
I think that it's going to largely be a matter putting this all together and reorganising this into a form which makes more sense to the market. A large part of the crisis is that the information of what these securities are has been lost. I suspect that the real work will be to put the information back into the product. It should be easier for one entity to do with millions of these bonds than for scattered owners to do.
What they may do is end up selling first mortgage bonds at a small discount and "gambler's" bonds (seconds, etc) at higher discounts. Much of the seconds in some areas (California, parts of Florida, Arizona, maybe New Mexico) may be virtually worthless because of steeply declining house prices. Even the firsts in these areas may sell at a steep discount. Othr areas of the country will have stronger local housing markets and the securities will sell at better prices.
But this is information-gathering, not a high risk thing if you get the information first.
oh good lord. I'm watching the testimony before the banking committee by Paulson and Bernanke.
Just put this crap up on ebay and be done with it.
There are obviously a number of people here who have a much better grasp of the current crisis than I do, but I have a question:
Several years ago during the height of credit-fest and while deleting my daily ration of spam for penis enlargers, counterfeit Rolex watches and home loan offers, it occurred to me that something was seriously out of whack.
Penis enlargers, counterfeit Rolex watches and home loans.
Did no-one else find the home loan spam highly improbable and and somehow ominous? Were there not more reliable metrics suggesting there might be problems? Were there not people within the industry extrapolating worst-case scenarios from the frenzy and suggesting corrections and making contingency plans (other than golden parachutes for execs)?
WTF?
When they started flogging 100% mortgages and 125% mortgages I found it ominous, whether sold by the internet or by supposedly respectable High Street banks. Because those kinds of mortgages depend upon prices always going up, and sooner or later prices were going to fall and people walk away from the mortgage.
Just wait a while, folks, when all this is over, the Iraq war will be much, much cheaper than expected. Expressed in Euros. Or Turkish Liras or the solid Renmimbi Yuan. lol
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