Considerable Resistance at Zero

Monday, September 5, 2011 7:00 PM

Surprised by the collapse of shares in banks? Shouldn’t be.

After their rescue, the big investment banks became profitable again only - only - because of the largesse of governments (aka working people and taxpayers) globally. The banks fed at the banquet of negative real rates and unlimited stimulus spending while happily earning fees for, among other things, restructuring debt in businesses and economies they had helped imperil. The banks even paid each other to resurrect their own balance sheets that they might again appear healthy.

Were any bank executives punished for the greatest destruction of wealth in history? No. Anyone to prison? Nobody. Lifetime bans from the industry? Not one. Clawbacks? None. Maybe the people running the banks were only unimaginably incompetent. But if so, why had they been paid so much? And if they were innocent (and just reckless and woefully irresponsible) then surely the value of their talents would have been marked down after their bailout. But, no, that didn’t happen either.

With the collective sincerity and earnest gratitude of converging weeds, the banks began their familiar cycle again, merrily resuming the ritual poaching of rival staff to bid up industry compensation. New rules on bonuses? No problem there, just boost base pay. Shareholders (and taxpayers) be damned, that’s what they did. And the very executives who might have gone to prison were all too happy to take credit when their companies became profitable again, even when they must have known how illusory was their recovery.

Now we learn that these banks will face a new wave of litigation to punish their conduct in creating the last credit crisis. To judge by the news coverage, the investment banks are not protesting innocence so much as floating a new reason why they should be let off the hook: if compelled to pay damages, it would destabilize the financial system and maybe the banks would need to bailed out again.

Could any defense be more cynical? Hard to conjure one, but let’s give the banks’ PR people a couple of days and see how creative they can get.

Why would the banks fail again? What happened to the profits? Or more to the point, what happened to the revenues?

Lots of the money got stuffed in pockets. Bank executives paid themselves every chance they got. In fact, they never stopped awarding themselves bonuses, even at the depths of the crisis. Pay sometimes dipped relative to earlier excess but it never sank to levels in other industries, even in sectors that had proven better managed and more robust. Aside from the handful of chiefs who declined pay (or deferred it to a future when it might appear less outrageous), bonuses for many continued unabated or bounced back and even raced to new highs.

“We have to pay them,” goes the argument, “or they just leave and work for someone else. And then the whole enterprise would be worthless.” Which might make some sense, except that the banks appear headed to zero value again anyway. Net-net, that means the bailouts simply siphoned taxpayer money to bank employees, many of whom had already profited enormously from the businesses that have now been exposed as shams. To compound the miserable irony, most taxpayers bailing out the bankers had never benefited from the boom but were badly wounded in the bust.

We can also feel terrible of course for the many, many hard working people at banks who played no role in creating their employers’ problems, especially any staff involved in productive, responsible businesses inside the failed banks. Unfortunately, though, the plight of those employees - many of whom have or will lose their jobs - doesn’t change the calculus in assessing the parent companies in toto, and it certainly cannot absolve the executives in charge.

When an enterprise woos investors to subsidize outflows to insiders until nothing’s left - apparently a work in progress again at the banks - it demands urgent scrutiny. Are they Ponzi schemes? Probably not at the top, as such a verdict would imply a deliberate design which, let’s face it, is not a forte of large investment banks. Are they aggregations of mini Ponzi schemes where senior executives have simply failed to rein in business managers below them? It’s self-evident, at least, that the banks brim with arrogant, self-obsessed managers throughout, devoid of loyalty and intent on looting.

Only a triumph of optimism over experience could lead to faith that the banks will fix themselves without some kind of dramatic intervention. In the meantime, investors appear to have whiffed the foul reality of the situation and decided to run for the exits.

Who could blame them?

Next week: Market structure in the disparate worlds of credit and equity. Isn’t it time for grownups to intervene?

© Copyright 2011 Eli Lederman

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