This one is for folks graduating from college in 2008…
The 2007 calendar year was one in which America’s financial system more or less collapsed, though we didn’t realize how thoroughly until early in 2008. It was also a year in which Wall Street paid out record bonuses, a total of $38 billion at just a handful of banks (source). One of the firms that paid out $billions, Bear Stearns, essentially went bankrupt last week, but is being bailed out at taxpayer expense (story).
It has gotten to the point where only a fool would refrain from high-risk bets at any large Wall Street firm. If the strategy randomly succeeds, the bankers can transfer $billions into their personal checking accounts as bonuses for a job done well. If the roll of the dice isn’t favorable, some $billions in compensation can probably still be extracted while the general public absorbs the loss through taxes.
[I had my own interaction with Bear Stearns in January 2008. One of their brokers had figured out that I was semi-rich. He sent me an email:
“I wanted to first of all wish you congratulations, and hope that you have a moment to learn about our team here at Bear Stearns. Our group specializes in working exclusively with founders and corporate executives who go through liquidity events.
“From your resume, I have seen the previous accolades and imagine that at some point you have utilized someone to guide you through one of these transitions. However, this also may be a good inflection point where Bear Stearns could act as a good conduit as 2007 has ended and you have sold another business venture where liquidity is created.”
This was shortly after two Bear Stearns hedge funds blew up, wiping out 100 percent of the $20 billion that investors had pledged to their care. Bear Stearns itself had pocketed $billions in fees from these investors in the preceding few years, so all was not lost, but being a Bear Stearns client didn’t seem like a good way to beat the index. My reply:
“Thanks, but I think I did a lot better than Bear Stearns did for its customers last year. Because I wasn’t smart enough to choose or run a hedge fund, I had my money parked in boring Vanguard funds, mostly index funds.”
]
Actually, I think that Bear Stearns omitted bonuses to its higher-ups for 2007. The larger point is, I think, that beginning with Clinton, and continuing with a vengeance under Bush, de-regulation of financial institutions left the system vulnerable to incredible fads that only a fool would not understand would blow up. When a private equity firm can put $50 million on the table and borrow $10 billion to buy a perfectly well-functioning company, strip and re-organize its assets, then send it public for a profit of several-fold, and maintain the illusion that the whole thing “added value” to the economy — then it’s time to stop smoking so much dope. The banks were able to loan huge amounts to the most highly leveraged transactions. Any high school kid surely knows that leverage can work for, or against, you.
I’m currently reading Bogle’s* Battle for The Soul of Capitalism. What a great gig Wall St. has – be a legal, international 24 hr casino, backed by the US Government and our taxes. This is no longer investment and efficient capital markets – it’s speculation and gambling with other people’s money.
* Founder of Vanguard
The Federal Reserve’s bailout really isn’t using “taxpayer’s money” and said money it is at very, very low risk. The Fed had very little choice but to assist in trying to add liquidity to Bear.
Commercial paper of all grades was (and is) being dumped onto the open market by investors in reaction to the current subprime issues and conditions are precarious at best, so a firm the size of Bear going under would only add to the chaos.
I didn’t notice the author of the NYT piece complaining about the Fed lowering rates repeatedly or of their other injections of liquidity. I’d enjoy knowing how the Fed “helped force the marriage of BofA and Countrywide”…
And the author asserting Bear to being akin to Drexel Burham is over the top and smacks of a hatchet job.
I wonder if she (the author) bought BSC stock last year sometime? 🙂
I have believed for quite some time that any firm that benefits from having what amounts to government insurance against its failure should pay for this benefit in the form of premiums into an insurance fund or, substantially less efficiently, agreeing to government regulation and oversight of its activities. As is pointed out in the blog posting, not facing the full consequences of failure encourages risky behavior on the part of both firms and individuals in the firm. Heads I win, tails the government and taxpayers lose. The argument, after the fact, is that government intervention is necessary to keep our financial system functioning, which is good for all taxpayers. True, but it would be far better if firms were encouraged to exercise prudent behavior by market forces before their behavior led to a threat to taxpayers.
If action by our monetary authorities in cases such as Bear Stearns did not cost taxpayers anything, then the government would provide the same guarantees to all firms all the time, costlessly, and we’d all be better off.
Kenbb99,
“Heads I win, tails the government and the taxpayers lose” ?
Hardly. The fallout of Bears collapse is a plethora of folks who lost the bulk of their savings (including many, many Bear execs). Not to mention the scores of stock-holders.
By your suggestion, the Fed should have stood by and watched Bear collapse and the financial sytem go even more haywire.
That’s sorta like cutting off your nose to spite your face.
A decent book well worth reading along these general themes: “A Demon of Our Own Design” by Richard Bookstaber (ISBN-13: 978-0-471-22727-4). Bookstaber was at Morgan Stanley in the 80s selling portfolio insurance, which he points to as one of the key factors in the 87 crash, and at Salomon during LTCM’s rise and fall, urging Salomon — right before LTCM blew up — to copy LTCM’s model.