The government’s suggestion to limit executive compensation for firms accepting TARP money is ill-timed and poorly conceived. Don't forget that this limitation only applies to firms that take TARP money after February 5th -- which could mean no firms at all.
There is an important tenet in the investment world that is left out of these discussions. Investors, or shareholders, cannot watch their money once they turn it over to a manager or invest it in a bank.
And we know where “trust” has gotten us.

What is required is a “commonality of interest.” Executives and managers should make money only when their shareholders and investors make money. That certainly has not been the case over the last several years and not surprisingly, investors have suffered. But continuing to separate the interests of investors and executives is not the answer. Yesterday, Goldman Sachs announced it would like to repay its TARP loan so as not to be encumbered by the TARP rules. If that happens, Goldman execs will have no limit on their pay. Firms that take the loans will restrict compensation, and executives will not know if they will ever receive incentive compensation (which means it doesn’t incent anyone). So if a TARP bank exec does well, Goldman can offer the banker several times the $500,000 limit the employer can pay. So the employee takes the talent to Goldman Sachs. The taxpayers (shareholders of the TARP bank) get screwed again. The solution is to create an independent compensation board that works for the shareholders to compensate the executives properly. Its okay to punish greedy business people, and limit their pay, but to do it, at the expense of the shareholders, is frankly, idiotic.
More important, the financial markets have to get back to their primary role, which is capital formation. Little of that has happened since the tech bubble burst in 2000. In fact, it was because of that collapse, risk became anathema to institutional investors who sought out risk free, high, rates of return -- and actually believed they had found them. Bernie Madoff did nothing compared to the Ponzi scheme run by the banks on the American people. The banks discovered they could securitize mortgages and then arrange to finance the buyers of those securities with cheap debt. The supply of such paper became infinite when the rating agencies decided that any Mortgage Backed Security should be rated AAA because housing prices only go up. So we entered an age of unprecedented leverage. Look at these numbers from the balance sheets of Goldman Sachs and Merrill Lynch.
| December 1999 | December 2007 | |||
| Goldman | Merrill Lynch | Goldman | Merrill Lynch | |
| Short Term Debt | 32 | 20 | 638 | 460 |
| Long Term Debt | 20 | 57 | 122 | 180 |
| Shareholder's Equity | 10 | 12 | 35 | 39 |
Since the beginning of 2000, Goldman has seen its shareholder equity rise 3.5 times and its debt rise 16 times. Merrill’s equity rose about 3 times while debt rose over 9 times. Both firms experienced extremely large earnings during that time. The same leverage showed up at UBS, Bear Stearns, Lehman, and many other banks. But the leverage was almost entirely related to mortgage-backed securities and credit default swaps. Obviously, as these firms and to dig deeper and deeper into the home buyer pool, the credit worthiness of the homebuyers were constantly declining. But they were able, with the assistance of the rating agencies, to make believe that all borrowers were rated equally and that all securities carried little risk. Like a ponzi scheme, the earliest investors made money because there were later rounds of investors available to provide a never ending stream of liquidity. And then it stopped. And the resulting collapse was no different than what Mr. Madoff experienced.
[youtube=http://www.youtube.com/watch?v=j5j20NSFNcg&feature=related]
Suddenly, the riskless assets were worthless. The borrowings shown above were largely secured by those assets and so there was no reason to believe the banks were overleveraged. But it turns out they were in a massive way.
Now none of this “investing” had anything to do with capital formation, innovation, or sustainable economic growth. If only a fraction of this money had been invested in developing new medical treatments for major diseases, or electronic medical records or clean energy, we would all be better off. The cycle we lived through was about pure greed and material wealth. The fund managers engaged in these activities so they could hang impressionist art on their walls. Never mind the fact that the original owners (even, in many cases recent owners) of these works paid a small fraction of what this generation has paid. The instant gratification we crave extends to the desire to have “old wealth” the moment we get our hand on money for the first time. It is a fool’s errand and a terrible waste of money. Hedge fund managers in Greenwich own billions of dollars of artwork, and unemployment has reached historic highs. Society will be much better off when the Masters of the Universe hang pictures on the wall of the people they have helped employ or made healthier or whose lives they have improve and experience the same level of satisfaction they currently get from a Picasso.


No comments:
Post a Comment
This comments on this blog will be moderated by the authors who reserve total discretion on what they choose to allowon the blog. If you wouldn't want your mother or child to read what you wrote, then we probably won't put it up. Otherwise, we will try to have a healthy discussion. We welcome dissenting opinions, but reserve the final right to determine what goes up as comments.