This AP news story talks about how no bank is willing to discuss how it spent its share of the $350 billion in federal funds paid out so far under the TARP program. It seems that no restrictions were put on the money and that there is no accounting mechanism in place. The fear is that most of this money was paid out as executive bonuses. How could the executives of banks pay themselves all of this money? I would think that a better question is “How could the executives of banks NOT pay themselves all of this money?”
Suppose that you are running a bank and it gets $1 billion from the Feds, no strings attached. You could use this to improve the long-term health of the bank. Given the poor economic conditions in the U.S. right now, we would have to assume that $1 billion invested in a bank would yield a long-term return of less than $1 billion, let’s say it is $900 million. Under the best possible assumptions, an executive would keep his job at the bank for 10-20 years and be in a position to collect a share of that $900 million. But the executive might be approaching retirement age or be looking to change jobs. Wouldn’t it be smarter to pocket his or her share of the $1 billion right here and right now?
Why did anyone ever think that any of that TARP money would be used for any purpose other than higher bonuses for employees of banks?
The only reason they wouldn’t do this is because 1) it may not maximize personal gains on the funds and 2) would be easier to trace, and therefore open to more scrutiny. Wouldn’t it be more efficient to vote yourself a huge bonus based on increase in stock value and then use the funds to buy back shares on the market? I’m sure these greedy geniuses can figure out significantly more elaborate schemes than my 5 seconds of thought on the matter. Few of these institutions have bad balance sheets, so why not use the money to steal, er, incentivize even more from the voiceless institution? Taxpayers are getting fleeced, like usual.
I think you said it all right here: “How could the executives of banks NOT pay themselves all of this money?”
Exactly. Let’s cut through the hyperbole and go through a simpler example that shows why this is true but not in the way people think. Imagine you owned a bank, or any other enterprise for that manner. Say you had 100k cash and were going to pay yourself 50k as a salary. If I loaned you even 1 dollar, would I be technically correct in saying, where is that $1 going? It’s going to your salary!
The point is money loaned through the TARP program is used to shore up the capital ratios of the designated institutions. So you are adding, say, $10 billion into a pool of capital they already have. Now the hope is they will utilize this extra capital to lend,and there can be good arguments for why they are or are not doing this, but please, let’s not boil this down to people who were being paid and somehow that particular money was being paid out of one pile of cash instead of another, identical pile of cash. Coming from someone in the industry, I can absolutely guarantee you that there were no compensation meetings at wall street banks that increased bonuses more for people simply because they received this TARP loan. Nobody was saying, oh we were going to pay X but since that loan came in we are doubling compensation for everyone! That is simply incorrect.
“Wouldn’t it be smarter to pocket his or her share of the $1 billion right here and right now?”
Anytime someone loans a company money, through a bond offering or otherwise, why don’t the executives just pocket “their share” of the money? It’s not their money. There is no share. Let’s look at the balance sheet. If I have 1 billion in equity, and the government loans me 10 billion. I have…1 billion in equity! Their share has not changed, because THIS IS A LOAN. They cannot pay themselves a higher proportion of it, because it would be immediately obvious from the financial statements. Uninformed people keep thinking this is some sort of a giveaway. While there are good arguments to be made for why you can describe this as a bailout, nothing changes the fact that this is a LOAN and the banks pay the government interest for it. It’s not some sort of free equity that executives just go ahead and distribute to themselves. Again, that is just ridiculous. I can tell you that the banks are eager to get rid of this loaned money and pay it back as soon as calm returns to the market.
People completely misunderstand the purposes of a $10 billion dollar capital injection into a given bank. Obviously a $10 billion dollar loan is not a hugely significant factor of long term credit creation. That is perhaps a beneficial side effect, but the main purpose was to prevent a collapse of perception, and therefore a run, on the bank. They key here is without a shoring of confidence such as this, many of the banks would have ceased to exist. It is not the difference between mediocre vs vibrant lending. It was the choice between survival of these banks and continued lending, vs no lending at all if the banking system collapsed. The latter case was a real, and potentially catastrophic outcome.
John: Your analysis seems reasonable, but suppose that I were running a bank that had been doing okay before TARP, i.e., we had adequate funds to do our business. The government loans the bank $10 billion. I don’t have any use for this money because I was doing fine before, so I pay it all out as bonuses to employees (starting with me), which are well deserved because our lobbying efforts resulted in the government giving us $10 billion. You tell me that it is a loan that has to be repaid? It is a loan to the bank, not to the employees. The bank has to repay this money someday, somehow. That’s not my problem, just as Merrill’s bankruptcy wasn’t Stan O’Neal’s problem after he pocketed his $500 million or so in bonuses. Nor was Fannie Mae’s insolvency a problem for the executives who paid themselves billions in bonuses over the preceding decade (let’s assume that they were smart enough not to invest in Fannie Mae).
I’ll take my $1 billion in bonus for 2008 and let the next guy worry about how to pay back the TARP money…
If anything, what happens is the opposite of what you describe. Banks that do well don’t want to take TARP money because they know the public outcry and scrutiny is simply not worth it.
Banks cannot simply pay out money from loans to employees and leave it for “someday”. The financial statements banks produce are too transparent…there is seriously no way to do this in a realistic world without shareholders being up in arms immediately.
Nobody is being rewarded for lobbying efforts. This infusion was not the result of months of successful, sinister inside lobbying by the wall street elite. This was a desperate emergency measure that was enacted as financial systems around the world deteriorated at an alarming pace…let’s try to remember that this is the context in which the loans were extended.
I am always disheartened to hear arguments like this. Somehow always assuming the worst intentions for the agents involved here is not a productive or realistic approach. The CEOs are the easy scapegoats, but this is a poor framework for the public to think about the issues involved.
People always make this classic mistake…that CEOs, or anybody else for that matter always optimize their actions to maximize expected return. That they would be willing to do some sort of crazy plan of knowingly driving their firm to ruin just so they can pocket an extra 20 million. In fact, this is not the case. They optimize for expected utility, a function that without a doubt depends on financial returns, but that is not the only input. Their legacy and reputation is (believe it or not, for those who are cynical) hugely important to them.
Most of the CEOs involved in these cases had close to a billion of net worth. In the case of Dick Fuld or James Cayne, almost all of this was in stock (yes, they each lost a billion each in the collapse of these institutions). For people to assume that men like these, who were CEOs of their firm for more than a decade, who had worked for years with colleagues and friends who also had their net worth in stock, are just out there trying to orchestrate a pyramid scheme so that they can just get another 30 million dollar bonus before the collapse is simply not true. No CEO would do anything of the sort…the resulting humiliation would be unbearable. These people have the burden of knowing they were at the helm when good friends of theirs, people they had known for decades had their retirement savings and net worth wiped out. To think that somehow this means nothing to them, that they are not hugely pained by this, that they will not live out their days in regret, and that in fact this was their plan all along(!) is insulting to these individuals. After the first 500 million is made, they are not in it for the money. They are certainly not going to do things that ensure the scorn of society and their fellow employees just so they can pocket another $20 million bonus. We can make good arguments that terrible mistakes have been made, but let’s not imagine that all of wall street is just one giant scheme of paying everyone now and worrying about the losses later.
Wall street, working with companies, entrepreneurs, and home owners has worked with society for decades to successfully create value and jobs. It is an essential component of efficiently allocating capital and ensuring that lasting wealth is created and a higher standard of living is obtained for everyone. Mistakes have been made by everyone (let’s not forget that for every bank that made a reckless loan, a reckless public willingly obtained a loan as well. how many times have I run into average people who thought they could never lose speculating on real estate? home prices NEVER go down!) We will figure out the mistakes and move forward. TARP was an essential component of keeping the system running. It was not paid out in executive bonuses. And Wall Street CEOs are not intent on making out like a bandit with this money and leave their successors holding the bag. They know this is a difficult time in history, perhaps the most difficult. They know the responsibility that they have and that history will look at how they navigated this crisis. They will act accordingly.
John Doe: a few simple questions:
If the current TARP recipients are so responsible and honorable, why won’t they (and Paulson) disclose where the funds are going and what they are used for? AFAIK, not a single institution has been forthright about the $350B already dispensed. If they have nothing to hide, why hide it? Why is Paulson, who is clearly a member of the Club, being so elusive?
Unfortunately the Madoff scandal is a perfect and so sad example precisely of “just out there trying to orchestrate a pyramid scheme so that they can just get another 30 million dollar bonus before the collapse”. Is Madoff is only one? Certainly not. Are all bankers participating in TARP as amoral as Madoff? Certainly not. However, how can you justify the billions of dollars of compensation already paid out when in fact they were already running a pyramid scheme based on housing values?
I’m sorry if I don’t share your respect for these individuals. Their previous and current actions do not substantiate the trust you bequeath them. Provide us tangible, provable actions and I’ll be convinced. Until then, they deserve to be under a microscope not hidden behind a veil.
David:
They are not disclosing where the funds are going because unfortunately, the answer to such a question is not obvious at all.
Take a bank that has 100 billion dollars in capital. Now the government lends 10 billion. Now the bank has a pool of 110 billion dollars.
The next day, the bank pays for electricity, utilities, security, catering, loans, employees, consultants, and a million other things. These cashflows are drawn from the same $110 billion pool. Now, you tell me, where did the government’s 10 billion go to? How does such a question even make sense?
Lawmakers always hear people try to explain that this is a difficult question, and then they are lampooned for being “elusive”. Everyone wants a clear answer–this billion went to X or Y. Well, life is complicated.
Now a more sensible thing to do is to explain that by increasing the pool of capital from 100 to 110 billion, the tier 1 ratio of the bank is improved, leverage in the institution has decreased and lending can be undertaken at a faster pace. But the problem is that lending happens all the time, whether it is from a 100 billion dollar pool or a 110 billion dollar pool. The only sensible metric is to compare how a bank would have lent if they had gotten the 10 billion vs NOT getting the capital infusion. That difference would measure how much more incremental lending was undertaken as a result of TARP. Unfortunately this alternate universe explanation is somewhat difficult to explain, and lacks the cheap satisfaction of watching someone like Paulson squirm when he tries to answer a nonsense question like this.
It is unbelievable to me that people believe that a Madoff pyramid scheme is the same thing as what people were doing with mortgage lending. I certainly do not condone what was happening in mortgage lending, but this is just not right.
Let’s not overcomplicate what was happening. Banks were over eager to lend money to individuals. Those people did not pay the money back. The banks took huge losses. How in the world is this a pyramid scheme? These billions of compensation you talk about? Do you know how much of that was stock? How did Dick Fuld, CEO of the bankrupt lehman brothers who held a billion dollars of Lehman stock, or James Cayne, CEO of the purchased Bear Stearns who also held a billion dollars of his own stock, orchestrate a pyramid scheme so that they could put 95% of their net worth into…the same pyramid scheme? Why would these guys invest their own compensation into their own “pyramid scheme”? Madoff certainly did not do that.
There is a very clear fundamental difference between losing money in a pyramid scheme where the only thing you are doing is taking new investor money to pay old investors, and losing money in the course of economic risk taking. Lending is a vital mechanism in this economy, and it involves risk. When it is done poorly, people lose money. Nobody should look at both situations and see that people lost money while the CEOs got paid and assume they are equivalent situations. The difference is intent. It is not a pyramid scheme if these bankers were lending money to homeowners and believed that it would be paid back but were not. I guarantee you none of these guys people seem to hate so much ever imagined that people would default on their loans to the degree we see happening now. They were wrong, but it was not a pyramid scheme.
This vilification of CEOs is just not productive. To imagine that the economic depression we face right now is the result of these individuals is a complete fallacy. We all need to look towards ourselves, and not find a convenient scapegoat for these problems. Every time i read an article spending time trying to figure out why these fat cats are responsible for all our woes, I grow more pessimistic that we will all come out of this anytime soon. What a complete waste of our time.
Instead, we need to recognize that we are a hugely arrogant people. Our inability to appreciate and respect risk, to know the bounds of our abilities is what starts these destructive bubbles…not CEOs. We create our own pyramid schemes, not banks. It is what leads every average joe to think that in 1999 they were all of a sudden an expert in tech stocks and could do no wrong. It’s what leads people to be so sure that real estate can never go down, that it’s always a good investment. It’s what leads people to buy 10 houses because they think they are real estate geniuses and can flip them tomorrow at a huge profit to other, equally delusional real estate geniuses. And yes, it’s what allowed wall street to assume the risk was not that great in this lending because for the past 10 years, everyone paid their mortgages on time…until they didn’t.
We as a people look at a pattern that has been true for 50 years, and assume things will play out the same going forward. It’s this tendency that allowed parents to pass down crappy truisms to their kids like “real estate is always a good investment” and for all of us to underappreciate the risk we were taking as a society. Everytime we make these assumptions that we know what will happen in the future, our resulting actions make the system more unstable. This is the lesson we as a society need to learn and move on with, to grow a more lasting prosperity. If what we take away from this episode is, wall street CEOs are scam artists and regulation was the problem instead of understanding that we all had a destructive part in this, then we are sowing the seeds for the next great bubble.
I have told people I know they should be prepared in case this depression lasts for 10 years. “Oh, no way that is happening. Next year it’ll be better.”
They are so sure, I guess. I can tell you where the microscope really needs to be.
I have no sympathy whatsoever for those CEOs who lost fortunes. They are big boys playing a big boys game. If they didn’t understand risk management they shouldn’t have been in that position. If they hadn’t diversified their personal portfolios earlier it was due to greed and poor judgment – or maybe the wealth created by their position came so fast it outstripped all other investments. Easy come, easy go. Same lack of sympathy goes for individuals who were heavily leveraged in real estate speculation. But what about the vast majority of Americans who exhibited more adult behavior, refused the constant solicitation of cheap credit and are now paying for these mistakes?
You claim that comparing lending practices to a pyramid scheme is absurd, yet you disingenuously fail to mention the trillions of dollars of mortgage backed derivatives. Is it really so different or just more sophisticated? Sure in derivatives new money isn’t going out to old money but as we’ve seen it is still just a house of cards. Why did you conveniently forget that in your over-simplfication?
Look – I’m a CEO too. You can google me since I’m not hiding behind a pseudonym. I know the buck stops at my desk. The lack of accountability is one of the reasons we’re in the mess. How can you rationally condone it’s continuation on such a vast scale with so little tangible results?
John Doe: much of what you write makes sense, and shows that you have a good knowledge of the industry. (much more than I know)
But I think you are seriously deluding yourself, by saying “This vilification of CEOs is just not productive. To imagine that the economic depression we face right now is the result of these individuals is a complete fallacy.”
I live in the Midwest, my household income is very near to the national median. I don’t know a single person that flipped houses. Personally I haven’t been injured too badly by this economy (retirement account down about 10%), but I see hard times ahead. You mention a 10 year depression, I think you are close to the mark.
When I think banker CEO, my mind immediately jumps to WaMu, lending $720,000 to a guy that makes $14,000 per year. (http://www.nytimes.com/2008/11/26/opinion/26friedman.html?_r=1 ) I guess there aren’t any laws against that, which seems a shame. But to have a CEO “running” this company and making a huge salary, seems criminal.
I was pleased when I saw that the banks receiving TARP funds were having “executive compensation limits” imposed on them. That turned to rage when I learned the details, the limit was around a million. My suggested limit would have been about a quarter of that. Now I hear that some of these banks are handing out bonuses, I’m further outraged. My view is that they would be unemployed if not for the bailout, and a bonus is for doing a good job. They should count themselves lucky just pulling the salary, until the tarp funds are repaid.
You are right, the actions of the mortgage industry weren’t a Ponzi scheme. Maybe closer to a pyramid or multilevel marketing scheme? The method of giving out “liar’s loans”, etc to anybody that could fog a mirror, and then passing the shaky loan on to another company. Classic. Yeah, those CEOs were just being good businessmen.
One of the profs at work was cleaning out his office, so I snagged some books from the hallway. I’m going to read this one: “1877: Year of Violence”, by Robert Bruce. (the others go on Amazon) I hadn’t heard much about the 1870’s depression, but the blurb on the back sounds very topical: week after week the news was bloodshed, terrorism, wholesale crime. … in PA mining regions, the militia had to be called out time after time, rioting from coast to coast, class warfare. 2011?
Hey John:
Appreciate your response and perspective. A few things…
To reiterate my point: we cannot continue to believe that our problems are solely due to a handful of individual CEOs. Without a doubt, they share in the blame for this crisis, but along with the rest of us.
The problem with relating personal experiences, people you know, etc. is that it is not always representative of what is actually happening throughout the country. I am not surprised that living in the midwest, you do not personally know a lot of people who were engaged in real estate speculation. Many places in the Midwest were very responsible. But go to Florida, Las Vegas, California, etc. and you will see that unfortunately, too many people were indeed doing this. And these are the real estate markets that were hardest hit, and they are places with the greatest population density.
The numbers just do not lie. To imagine that somehow the vast majority of americans were NOT engaged in risky real estate purchasing, or taking out excessive credit is simply not true. If you look at the numbers published by banks and the government for median consumer credit expansion over the past 5-10 years, we are without a doubt living in a bubble of credit that staggering numbers (NOT the minority) of citizens were engaged in. Same for risky mortgages–the class of sub prime, no down, liars loans, reverse amortization mortgages, ad infinitum risky mortgages taken out by individuals do not paint a picture of 99% of Americans being prudent.
David:
The point of the CEO discussion is not that they deserve sympathy. You are exactly correct–they of all people understand the risks they take. The point is that they did not knowingly engage in a purposeful ponzi scheme as you allege, and that indeed the incentives were not as unaccountable as people believe. Having almost all your net worth in the company that is engaging in this lending is a pretty good incentive to make sure you try to do proper diligence. It turns out they took risks that were not prudent IN RETROSPECT, but enough with the ponzi scheme descriptions, that is a disingenous mischaracterization of the situation. Ponzi schemes are illegal and destructive. Lending money to people in a free world where someone is willing to part with money while the other person is willing to take it is different.
And my “oversimplifying” about derivatives? How am I being disingenuous exactly? I did not bring up CLOs, commodity indices, credit default swaps, first to default baskets or any of the other countless instruments that exist. I did not bring them up because it was not relevant to the discussion. I was trying to address your points directly. You asked why they are not disclosing where the 10 billion is going. I answered that. You claimed that Wall Street banks are running Ponzi schemes. I argued otherwise and that mistaking the two shows a fundamental misunderstanding of the concept. “Sure in derivatives new money isn’t going out to old money..”? Well, it turns out that is a pretty important part of what makes a ponzi scheme. Actually, it is the definition of the concept.
Let me run the risk of oversimplifying again: Have you, or anyone you know ever purchased, or been granted by the company they work for (very popular in tech companies) stock options? Well guess what, these are derivatives too. They are written contracts that derive their value from a stock. Mortgage derivatives derive their value from the underlying mortgages. If stocks go to zero as many did in the tech bubble, then a lot of the derivatives go to zero too. Similarly, if mortgages go to zero when people do not pay them back, a lot of the derivatives based on them go to zero as well.
So you claim mortgage derivatives are a house of cards…why exactly? They lost money because…the underlying mortgages lost money. Underlying mortgages lost money because people did not pay when they were supposed to. Stop me if I am being too simple here…
They are no more a house of cards than an actual mortgage loan is a house of cards, or that stock options are a house of cards in the event stocks go down. Regardless of what any random john doe (who reads a businessweek article and is all of a sudden an expert in global finance and derivatives) says, these are important instruments in the financial landscape and will continue to exist. Not all of them of course, but the important ones will.
It is a deep property of our civilization that unfortunately, other people’s actions always impact innocent bystanders. If I am a really safe driver, it indeed sucks that other more reckless drivers getting into accidents cause my insurance to go up over time. This is precisely why I am trying to shift the tone of discourse to examine the true underlying reasons for this debacle, so that we can better avoid situations like this in the future.
Lack of accountability is without a doubt a source of the issue–but it is not a notion confined to a handful of CEOs. There needs to be accountability for all of us. People are delusional if somehow they think that we should be putting just a handful of CEOs under the microscope, because somehow they alone were responsible for one of the largest credit bubbles in modern history. Wall Street, lest people forget, is a financial intermediary and therefore a reflection of society’s capital needs. It facilitates the flow of capital from people who have it, to people who want it. In a world where everyone wants a McMansion, their plasma screen TV, 3 cars, and credit card debt be damned because I can take out home equity from my home that was purchased with an adjustable rate mortgage, bad things tend to happen. The notion that the vast majority of Americans were acting responsibly is simply laughable, and is what perpetuates these bubbles time and time again. Tulip bulbs, canals, tech stocks, and yes housing–it is we the people who are responsible. Trust me, this industry sees everyone’s credit cards, debt, and mortgages go by all the time. Let’s just say, well, a lot of people over extended themselves.
The CEO blame game is the cheap way out because inevitably it is much easier for a mob to villify a few individuals than it is for the mob to turn on itself.