mathgeek

Why It's Better to Bail Out Borrowers than Banks

Felix, while I prefer to keep the details private, I was living fairly close to the fire in this chain of events... and it was all about psychology. Everyone, from market participants to the media was playing the game of "whose next?"

While Leman was alive, the focus was there. The moment Leman fell, the focus shifted to WaMu and Wachovia... and please remember... WaMu was wiped out in less than two weeks not by losses... but by panic deposit withdrawls. As soon as WaMu went under, the pressure shifted almost instantly to Wachovia and Morgan Stanley.

What the regulators realized they needed to do was to draw a line underneath the financial system and say, this far, and no further. That is why TARP funds were crammed down all of the largest banks... the government needed to make it clear that the government would not allow either speculative attacks nor a deposit runs to close any more major institutions.... Period.

And, for better or worse, it worked. Almost overnight, speculation about who would be the next to go ended and that phase of the crisis ended. Now, its not at all clear that WaMu or Lehman share or bondholders were treated fairly... why let them hang while protecting Citigroup, for example? But the decisions were not made on principle, they were made in response to a chain of events, and by the time WaMu and Wachovia were gone, the Fed realized that they had to stop what had basically become a rolling bank run, and consistancy of policy was far less important than changing the psychology... and at the point, the train had already left the station on bailing out borrowers. The Fed needed to credibly back the remaining financial institutions, and they did.

Why Capping Pay Is Likely to Work

Anandakos,

I think that you, like Felix and so many of the people on SA have what I like to call an Eddie Lampert problem. In short, because you are intelligent, and in some cases, have made a lot of money making big directional bets on firms, you severely underestimate what it takes to run a large company. Perhaps Dilbert's pointy haired boss put it better: Anything I don't understand must be simple.

Insiders at Sears discuss a raft of basic problems that any halfway competent retail executive knows how to fix, but are destroying Sears. Bankers keep ATMs running, service millions of loans, run a network of retail stores (we call branches) larger than most large retail companies... not to mention trying to manage exposure to vast currency, interest rate, and other markets. If you really think any joe off the street... even one that is intelligent, hardworking, and can manage an enterprise of this level of complexity well... frankly... you know not of what you speak.

Yet, here we go saying that every bank executive in America (really the world) was incompetent and should be fired. Great rhetoric, horrible basis for decision making. First of all, think a minute about what you are saying... Everyone was incompetent? Really? ALL of them? How is that even possible... surely some should be competent, if only by chance. Or, is it a more reasonable and realistic assumption to belive that something extradordinary happened in the environment that no reasonable person would have anticipated? Is it more reasonable to understand the pressures and constraints of regulated banks (and despite the other favorite talking point of the day, banks are regulated... heavily)... which led inevitibly to business models allowing banks to remain competitive with unregulated entities. But then, thats a lot less fun than making jokes about how these people expected to get paid a lot of money to destroy the industry.

Its a bit of a strech, but blaming banking executives for this crisis is not really so far from blaming a drought on the incompetence of farmers.

I am not saying that compensation is not out of hand in many cases. But, as a general rule, executives at major banks are paid a fraction of what they could earn at private equity firms, hedge funds, and other money management jobs, or in fact at private investment banking firms... it is no accident that Goldman wants out of these restrictions as quickly as possible.

Ultimately, regardless of moral indignation, the question has to be about consequences. Its seems many of the people on SA are happy to gamble putting these huge, complex, and immensely important institutions in the hands of people without adequate experience... To which all I can say is... sincerely... I wish us all the best of luck, we're going to need it.















On Feb 04 12:13 PM Anandakos wrote:

>
> Think,
>
> I believe you are making a fundamental mistake about what banks are
> and should be. Because banks drank the Wall Street Kool-Aid they
> abandoned their traditional role and adopted the behavior of investment
> banks (leverage!). The regulators were drinking too, so they allowed
> them to act like investment banks, even encouraging them.
>
> This was a disastrous error, and like the last time it was allowed
> in the 1920's, led to exactly the same sort of excesses. The so-called
> "talent" you want to reward subsumed the depository function into
> large casino capitalist enterprises and poisoned the well for all
> and sundry.
>
> Depository banks should be free from political interference -- we
> don't want the kind they have in China and Japan. But also they should
> be strictly regulated and prevented from engaging in behavior that
> can eviscerate their capital adequacy. Such institutions would not
> and should not make a gazillions of dollars in profit. So they don't
> need the sort of buccaneer "leadership" that unlimited compensation
> attracts.
>
> Those folks have a perfectly valid place in American capitalism:
> as entrepreneurs, private equity managers, and venture capitalists.
> But they should not run depository institutions because their gambling
> ways put the government's insurance programs at risk. Let them reap
> huge gains and suffer huge losses on their own, without the taxpayer's
> implicit, explicit, or fantasy backing. And caveat investor when
> dealing with them.
>
> Banks serve the vital function of providing credit to businesses
> and citizens, and obviously they need to make a profit to increase
> their regulatory capital allowing greater loan making capability.
> But they should NEVER engage in non-depository activities. They also
> need to be forbidden from becoming "too big to fail". The only real
> value I can see in Wells-Fargo and Bank of America having become
> truly "national" banks is that people can visit an ATM in a different
> state without having to pay a fee.
>
> Thus they will not need enormously compensated CEO's. There are plenty
> of people running local banks and credit unions profitably for low
> six figure salaries who are completely capable of running larger
> enterprises so long as the "financial engineering" element of the
> mega-banks are not present. Let them.
>
> By the way, credit unions offer the same fee-free "foreign" ATM access
> through their national co-op. Smaller banks could do the same thing
> if they wanted to offer the service to their customers.
>
> On Feb 04 11:23 AM Think! wrote: