Perspectives - The Wall Street Bonus Scandal

There has been a lot of controversy about the enormous bonuses going to various folks in the financial industry. The population at large is pretty angry that bankers are handing out tens of billions of dollars after running the world economy into the ground and then accepting bailout money from the taxpayer. There is a lot of pressure from the public to curtail those bonuses, and lawmakers are marching to the beat. Of course like any good public lynching, the media has been fueling the public’s fire and casting an A-List of evil culprits in Goldman Sachs, Citibank and a host of other Wall Street and City names. And while I agree the public has a right to be mad about the kind of sums these companies are paying out, I believe there is a lack of perspective from the media, the politicians and the public in general. In fact, a 360-degree view of the bonus scandal is appropriate.

There are essentially 2 views currently being debated in the Press: one that vilifies Goldman Sachs and others for paying such vast amounts of bonus to so few in an industry principally responsible for the collapse of the global economy, and the other that defends these bonuses in the name of capitalism. In fact, some would argue this is about socialism taking on capitalism. Unfortunately, nothing can be more inaccurate than labeling either of these views as socialism vs. capitalism. It is over simplistic journalism that is popular and convenient given we are going into a big election year on both sides of the Atlantic in 2010. I would like to offer a couple of different perspectives on the bonus fiasco.

Lets first look at those who defend Wall Street and Goldman Sachs. I am a staunch believer in free market capitalism and the principles that come with businesses pursuing the creation of shareholder wealth. As a good friend of mine recently said, “I am no populist against capitalism or people making money. I have no problem with private businesses who make obscene amounts of money paying huge bonuses. I am in full agreement that helping companies raise or allocate money in capital markets is a valuable function in a capitalist economy.” But the problem with defending Wall Street, Goldman and the others is that all of these businesses are making money due mostly to massive taxpayer subsidies.  The Government handouts is driving their financial results, and that handout comes out of your pocket and mine.  You and I are paying the bonuses that Lloyd Blankfein and every other Goldman banker is receiving this year.  That is not capitalism any more than the relationship between the Russian oil oligarchs and the Kremlin.

  

Let's consider Goldman Sachs for a moment.  Yes they repaid their TARP money with interest.  But here are the three taxpayer subsidies that Goldman either took and has not repaid or continues to take each and every day right from your pocket (and mine).

1. $15 Billion in AIG bailout money. The Government Accountability Office (GAO) was tasked with investigating the AIG bailout.  Their recent report confirmed the CDS's that Goldman held when AIG was at the point of default were close to worthless at market value, and if AIG had gone into bankruptcy Goldman would still be waiting in line as an ordinary creditor to receive something back for AIG's counter-party default.  Instead, Tim Geithner (in his role as NY fed Chair at the time) approved Goldman being paid in full from the $88B in taxpayer money that we (the people) put in.  We, the taxpayer, are the senior creditor here, (equivalent to debtor-in-possession financier), and should be repaid ahead of everybody else as a condition of the bailout.  Instead Geithner and Paulsen engineered a deal to pay off Goldman. Since Goldman is now solvent again and about to pay out $20B in bonuses, why should we not simply take back the $15B owed to us (out of their bonus pool) and make them wait for their $15B until after we get our $88B back first.  That's how capitalism works. 

2. Too-big-to-fail (TBTF) guarantee.  Standard & Poors recently admitted it would re-rate Goldman's debt down two categories lower if it weren't for the implicit Government guarantee that lies behind Goldman's business.  JP Morgan and Citibank would be 3 notches lower.  That artificially higher rating enables Goldman to enjoy a lower cost of capital which across a capital base of hundreds of billions is worth billions in extra profits.  That taxpayer guarantee amounts to free insurance we provide for which we receive no compensation - if they fail, we pick up the losses, if they win they enjoy the profits.  We should charge a premium for accepting this risk just like every other insurance company does.  This is money that Lloyd Blankfein is arguably stealing from taxpayers each and every day.

3. Zero-cost of funds from the Fed.  Goldman is currently borrowing reserves at the Fed discount window at a zero interest rate.  Mixed with their other sources of funding they reported a record low 0.69% cost of capital in Q3.  Most banks operate at about 2-3%.  They take that money and then invest it in Treasury bonds yielding 2%, or they invest it in riskier asset classes through their hedge funds and asset management arms.  Think about this for a moment...we are letting Goldman borrow our taxpayer money at 0% and then lend it back to us at 2% interest, or play the casino to win even bigger gains (and if they lose, we pick up the tab - see TBTF above).  That's a direct taxpayer subsidy of their business model and it leads to billions in risk-free profits at taxpayer expense. 

Goldman Sachs are not the only ones taking these types of taxpayer subsidies. JP Morgan, Citibank, Bank of America, the list goes on and on.

But lets look at another view. Regardless of how wrong you might think Goldman Sachs are to take this government subsidy and make a mint, they have broken no laws. In fact, they have done nothing wrong but adapt to the new rules of the game. Rules that the Government changed last year when it stepped in and bailed out every major financial institution except Lehman and Washington Mutual. One cannot help but wonder why those two companies weren’t deserving of the Government’s generosity with our money?

No, this view is a bit different in that it lays blame at the feet of the elected officials who have proven over the past several years to be incompetent when it comes to the economy. It does not matter what political affiliation you have, or whether you are angry with Wall Street or not. The fact of the matter is the politicians have put us in this situation with their policies and they continue to make more policy blunders at our expense. Yet few in the Media are holding this group accountable for 1) having allowed the crash to happen right under their noses and 2) reacting to the crash with a sequence of actions and policies that have hurt the people and, arguably, helped the very Bankers everyone wants to lynch. In essence, the same people who were responsible for the various financial oversight committees, watchdogs and metrics that failed us are the ones overseeing the recovery attempt. It makes no sense.

Through its many ignorant policies the Government is essentially funneling your money to Wall Street without getting any benefit whatsoever. If you make money 'free', then how can you object to bankers using it to make more money? The US Fed and Treasury are basically acting as agents in between you and Wall Street so that you don't notice how your tax dollars are getting shoveled by the truckload into the likes of Goldman, BofA, Citibank and others.

So do you blame the Banker who adapts to the rules and shamelessly exploits them to make heaps of money, or do you blame the elected Officials who incompetently created this situation not once, but twice? Perhaps a good analogy is an American Football one. The rules state that you have 4 downs (attempts) to advance the football 10 yards down the field. You can do this as many times as you need until you score, but if you fail to advance the ball 10 yards in 4 downs or less, the other team gets possession of the ball. Straight forward. But if the Officials change the rules in the middle of the game stating you can have as many downs as you like to advance the ball, no consequence, well, then its not really Football anymore, is it? And what would you do as a team? You would run the score up. You just keep playing until you score, and then do it again. Is it the right thing to do? Well, the rules say so. But it isn’t very sportsmanlike. But again, it is the new rules.

People have every right to be mad at Wall Street but I think it should have nothing to do with misplaced populist anger. We should report the true facts behind what is going on and hold all of those responsible for this mess accountable. That includes the elected Officials that are not qualified to do this job. It also includes the so called independent Board of Directors who would sit by and allow management to abuse a broken system. Regardless of which view you want to take, don’t fall into the trap of blaming capitalism for the mess a handful of incompetent officials and unethical bank executives have created. There is an old saying that goes something like this: “Hate the player, don’t hate the game”.