JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), State Street Bank (NYSE:STT), Morgan Stanley (NYSE:MS) and Bank of America (NYSE:BAC) are all taking the opportunity to raise big money by selling shares into this bear market rally. They are also all talking about paying back the "TARP" bailout money with which they were endowed at taxpayer expense. The sudden desire to give back these funds, once so fervently coveted, seems to arise mostly from fear that restraints will be placed on excessive executive compensation.
The last I heard, giving all of these banks their TARP allocations was going to save the world. These are allegedly "systemically important" institutions that cannot be allowed to fail. Now, apparently, they are going to pay back this allegedly critical bailout money, for which former Treasury Secretary Henry Paulson got on his knees to beg for, in front of certain female members of Congress.
Does that mean they will now be allowed to fail, if their executives engage in another series of unprofitable fiascoes? Or, does it simply mean that, with Federal Reserve lending rates so low, and the spread between the rate at which they borrow and lend so high, that the profits, yet again, will go to the executives, while the losses, if there are new ones, will, yet again, go to the taxpayers?
In other words, in practical terms, what does paying back this TARP money actually mean? The truth is that these “bad boy” banks are getting bailed out in a million different ways that go far beyond TARP. How about the FDIC guarantees for their bonds, and hundreds of billions in trades, exchanging toxic mortgage bonds for treasury bills at the Fed?
How about the TALF, and the myriad of different "loan windows" that the Federal Reserve has now opened up for them. Will they now escape close scrutiny over overly risky bad behavior in the financial markets simply because they pay back a small part of their bailout which happens to be the most publicly visible?
Do we award them a “get out of jail free” card? Do we now free them from the close supervision over oversized bonuses and other dangerous behavior that other banks will have to endure? Do we let them jump around the sandbox again, unfettered, free to ride roughshod over their shareholders, and the world's economy just as they have in the past? Should we allow this even though their past behavior put the entire world’s financial system at risk?
In short, shall we allow them to play their games with the world’s money, again, while sucking down all the profits, and sticking losses to the taxpayers in America, Britain, or other countries?
It goes without saying that, in a “free” economy, the government should never arbitrarily limit someone’s income. Free markets should be sufficient in themselves to discipline all pay rates, and enforce strict risk management.
But what happens if the market is not free? What happens if an oligarchic consortium takes control of the financial system? What happens when supposedly “free” markets don’t do their job because they are not really free?
These are important questions, because that seems to have happened, in the United States of America, in the U.K., and in other nations, over the last 23 years. The Wall Street titans, and their counterparts in many other nations, seem to have obtained control over various governments. Executive pay and perks have skyrocketed. Shareholders periodically complain vociferously, but have never been able to make any headway or do anything about it. They may own the companies, in theory, but in actual fact, in America, at least, shareholders really have very little power in large public companies. Corporate governance statutes currently do not force publicly owned companies to suffer much shareholder interference in their affairs.
Once an entrenched group takes control of a particular company, it is almost impossible to dislodge them. As evidence of this, I would note that it is extremely difficult for a shareholder, or even a large group of shareholders, to force companies to include an alternate slate of directors in a proxy statement.
Instead, most proxy statements merely involve voting “yes” on issues and officers and directors chosen by those same officers and directors, or simply abstaining from casting any vote at all. It is exceptionally difficult for shareholders to put alternative directors up for election.
Since the directors set their own pay rates, as well as that of the officers, it is exceptionally difficult for shareholders to control executive pay or, for that matter, anything else concerning the administration of the companies they invest in. This is a key factor that needs to be changed.
Another, even more important problem is that huge and, often, irrational risks continue to be taken by financiers both here and abroad. Although profits go mostly into the pockets of the executives who take the risks, the rest of us are forced to absorb the losses.
Extreme risk taking behavior, both on Wall Street, and in corporate America, has caused a huge number of real estate, stock, bond and commodity market booms and busts, in a very compact period of time, over the last 23 years, and, somewhat less frequently, over the last century before that.
Huge up and down volatility in the financial markets causes societal instability. Governments, therefore, have not only the right, but the responsibility, to step into such a situation with stringent regulations.
That being said, it is unwise to shackle capitalism, and government bureaucrats are even worse than Wall Street magnates when it comes to running an economy. The former Soviet Union is an example of that. Whenever a nation gets closer to true capitalism and a free market, strong economic growth is the result.
Having one of the most capitalistic economies in the world, in times past, was largely responsible for the buildup of America’s economic strength. Moving away from the discipline of true capitalism has caused most of America's weakness, now.
Unfortunately, true capitalism has been replaced, in recent years, by crony capitalism, represented by the likes of Henry Paulson, Benjamin Bernanke, and a host of others who were largely placed into high office thanks to lobbying by a small group of oligarchic titans on Wall Street.
Crony capitalism, especially as it has increasingly been practiced, over the last 23 years, has brought us to the precipice of disaster. Once the Wall Street financial oligarchy took control of the government, we were doomed.
True capitalism disciplines its players. Crony capitalism does not.
True capitalism allows even the most politically connected companies to go bankrupt. Crony capitalism favors and subsidizes some institutions over others.
True capitalism would not permit excessive executive pay rates, and irrational risk taking, because those who engaged in such behavior would quickly lose their businesses and their careers would be destroyed.
Crony capitalism, however, bails out such people, so that they can do damage again and again.
The U.S. government, through the medium of its Treasury Department and the Federal Reserve, has done everything in its power, over the last 23 years, to subvert the functioning of a true capitalist economy. These measures, of course, have been couched in the usual concerns about unemployment and pain to the common man.
In truth, however, the government has been used, repeatedly, to protect the private fortunes of a few privileged individuals and the companies they control. The government has repeatedly acted to prevent the natural small panics, corrections and pullbacks that are essential to true capitalism.
True capitalism produces strong economic growth in the long term, but requires repeated small pullbacks, in the shorter term, during which inefficient and incompetent players are sequentially weeded out. Only well run rationalized companies survive in true capitalism. Bloated executive salaries do not.
The Federal Reserve has acted forcefully to stop true capitalism from being practiced in America, by trading against the market through its primary dealers, by moving interest rates up and down in an arbitrary and capricious manner, and by heavily favoring certain politically connected financial institutions over others. It has made sure that financial companies, in general, suck an outsized share of America’s resources out of the economy each year.It has also seen to it that favored financiers who make erroneous bets are able to suckle at the federal teat, whenever things go wrong.
Woe betide to me to suggest that financiers shouldn't be protected. I have tried that before, and have been shouted down by a chorus of voices who accept the official line of thinking. After all, doesn't Fed Chairman Benjamin Bernanke tells us that "banks are the key to the recovery"?
The problem, of course, is that financiers do not produce anything. They simply move paper from one place to another. They are not as important as Bernanke claims. American industry can and should become self-financing, as the wise management of Home Depot (NYSE:HD) has become. Favoring the interests of financiers over the interests of all other forms of American industry, over a period of decades, has hollowed out the American economy, and moved essential industries overseas.
We are now left with a little more than a shell of an economy, which proceeds forward mainly on the momentum of the past.
In other words, the current financial crisis is not the result of subprime mortgages or hundreds of trillions of dollars worth of credit default swaps being supported by a few billion dollars worth of real assets. These are all bad things, of course, but they are merely the symptoms of a far greater problem.
The real problem is several decades worth of incompetent, dishonest, and disreputable government, controlled by a group of oligarchs who answer to no one. Incompetent, dishonest and disreputable government is what caused the SEC, for example, to ignore explicit warnings about the fraudulent, but very well connected, Bernie Madoff for so many years. It is the ultimate cause of all our troubles.
Investment banks, and banks generally, should not be shackled with government regulations. However, neither should they be allowed to operate in a manner that puts us all at risk, simply because they've paid back TARP money. If we allow that, it will only be a matter of time before these same overpaid executives and their oversized institutions return to feed at the federal trough.
The cure for our troubles is not more government regulation, although we do need to fine tune some regulations. Examples of fine tuning would be new regulations designed to insure that no business entity is allowed to guarantee credit default swap (CDS) debts without adequate reserves to do so. In addition, persons who do not own the underlying bonds should not be allowed to buy credit default swaps.
In addition, the speculators and alleged "hedgers" on the futures exchanges should not be allowed to leverage themselves by 50 to 100 times the extent of their real capital. These changes would close the window to destabilizing speculation.
Most important, however, is breaking the back of the Wall Street oligarchy. No one bank or group of banks should be allowed to grow so large, or remain so large that its failure can bring down the entire system. No group of banks should have been allowed to become so powerful that they can effectively control the government, as they now do. The set of circumstances that has fed this onerous situation must be altered immediately.
In short, let the banks repay TARP if they want to. Let’s encourage them to do it as fast as possible. But, let’s also start take firm fast action to break up these companies. If JP Morgan Chase and Bank of America were broken up, at least 30 separate small but viable companies would remain, each following its own specialization within the financial system. Goldman Sachs, Morgan Stanley and State Street Bank could each be broken into almost as many.
Shareholders would probably benefit from such breakups, because the sum of the parts is worth more than the whole. Executives lower on the “totem pole” would also benefit, being suddenly elevated to top executive status. The current crop of top executives, however, would not benefit at all, because they would find themselves overseeing much smaller companies which could never afford to pay them their currently outrageous salary and perks. That is as it should be.
So long as the financial oligarchy rules every economic function and agency of the U.S. government, however, none of this will come to pass. At the heart of the oligarchs' power is the Federal Reserve. By removing most of its powers, restoring honest money, and relegating the Federal Reserve to interbank functions such as Fed Wire and ACH transfers, the base of the oligarchy will be broken forever. Until and unless this happens, it is likely that the United States of America will continue drift into economic decay.
I, and many others, had hoped that President Barack Obama would step up to the plate on this, and appoint people free of conflicts of interest. He has disappointed us. All his appointments, so far, have been from a crowd of loyal Wall Street “yes” men. This same crowd also supplied the previous Bush Administration. We desperately need new blood in government – people who have no connections to the remaining Bernie Madoffs who haven't yet been caught, or the Goldman Sachses, JP Morgan Chases, Morgan Stanleys, Bank of Americas et. al. We still hope for better things from President Obama.
Disclosure: Neither long nor short on any bank's shares.