Jedi Mind Tricks: Finance Edition

It makes me feel better about myself that Felix Salmon is similarly perplexed about this:

The government has told Bank of America it needs $33.9 billion in capital to withstand any worsening of the economic downturn, according to an executive at the bank.[…]

[…]But J. Steele Alphin, the bank’s chief administrative officer, said Bank of America would have plenty of options to raise the capital on its own before it would have to convert any of the taxpayer money into common stock.

“We’re not happy about it because it’s still a big number,” Mr. Alphin said. “We think it should be a bit less at the end of the day.”[…]

[…]Mr. Alphin said since the government figure is less than the $45 billion provided to Bank of America, the bank will now start looking at ways of repaying the $11 billion difference over time to the government.

In addition to the obvious that TARP repayment will be contingent on a bank’s ability to survive without assistance from other government programs (like loan guarantees), the notion that a difference between the amount of TARP money already provided and the amount of additional capital the government thinks BoA needs somehow demonstrates a clean bill of health is flatly insane. I’ll be the first to admit that the techno-jargon bandied about in banking can be confusing, but even I have no problem understanding that the government is trying to tell BoA that it needs $35 billion more than it already has on reserve. As Felix Salmon notes:

It seems to me that BofA is in some weird state of denial here, where a $35 billion capital shortfall can be considered evidence that it actually has more regulatory capital than it really needs. What’s more, the bank now seems to be happy going on the record with this kind of analysis. Which doesn’t instill in me a great deal of confidence in its management.

More frightening, the spin seems to be working.


High Incomes Produce High Costs

I’m really not sure what to say about Gabriel Sherman’s piece in New York magazine documenting the petulant outbursts of Wall Street bankers, other than to echo the general observation that the disconnect in understanding between bankers and everyone else is truly remarkable. I do want to make one particular point though concerning the notion that living in New York necessitates obscene levels of pay.

“You can’t live in New York and have kids and send them to school on $75,000,” he continues. “And you have the Obama administration suggesting that. That was a very populist thing that Obama said. He’s being disingenuous. He knows that you can’t live in New York on $75,000.”

That was an argument I heard over and over: that the high cost of living like a wealthy person in New York necessitates high salaries. It was loopy logic, but expressed sincerely. “You could make the argument that $250,000 is a fair amount to make,” says the laid-off JPMorgan vice-president. “Well, what about the $125,000 that staffers on Capitol Hill make? They’re making high salaries for where they live, maybe we should cut their salary, too.”

A similar point is made earlier in the article when noblesse oblige is recast, or perhaps more accurately, reinterpreted, as trickle down economics, but you really can’t make this type of argument without acknowledging that the absurdly high incomes of bankers help create the “cost structure” for “not optional” expenditures like “40,000 private schools and “a summer home within an hour or two commute from Manhattan.” The whole enterprise becomes a cyclically developing self-fulfilling prophecy to meet the ever expanding incomes of the ultra wealthy. If the ultra wealthy are simply very wealthy, then the costs of the services these people consume will go down, and so too with them, the costs of living for everyone else.

Obviously, there are also a lot of other ways to respond to these arguments — for example, I think it’s more likely that an entire office of Congressional staffers makes $150,000 than one does alone, or that nobody is talking about capping income, or that even if a staffer did make $150,000, it’s not likely to produce pervese incentives that topple the financial system, etc. — but I always think it’s important to make this point anytime someone who’s fabulously wealthy complains about the need to spend money on luxury items.

UPDATE: In the article, you get the clear sense that many bankers — at least those interviewed — held firmly to the belief that their money-like-substance creation was inherently valuable, and that the public will rue the day the bankers left. So just in case you were wondering, you’ll want to know that on average, managed funds performed more poorly between 2004 and 2008 than market composites.

Banks: TARP Imperils Ability to Overpay Executives

Via Kevin Drum, we get some context Goldman Sachs’ “noble” desire to pay back $5 billion in TARP funds.

Back in September, Goldman Sachs received a $5 billion capital investment from Warren Buffett that requires interest payments of 10%.  A month later they received a $10 billion capital injection from the Treasury that requires interest payments of only 5%.

So this should mean that if Goldman is animated by shareholder best interest, it would pay off the Buffet loan first, right? After all, the interest will cost the company — and shareholders — much more the longer it sits on the books, so this should be a no-brainer. Analyst Richard Bove sheds some light.

“If you were thinking of shareholders first, you would get rid of the most onerous amount first, and that would benefit shareholders. … However, if you pay off TARP you are eliminating all of the restrictions on paying management,” Bove told “You shouldn’t be diluting existing shareholders to pay off TARP so you can pay management more money.”

I suppose you could make the argument that the best interest of shareholders would be best met by the PR boon associated with unshackling the company from more rigorous government oversight, but I think given the financial industry’s history over the past couple years,  it’s pretty safe to assume this isn’t the true motivating factor. Further, this logic would be rendered even more incredulous when you consider that TARP money aside, financial firms are still the benefactors of significant government aid.

Even as they clamor to exit the most prominent part of the bailout program by repaying government investments, firms continue to rely on other federal programs to raise even larger amounts of money….The Federal Deposit Insurance Corp. has helped companies [] borrow more than $336 billion through the end of March, by guaranteeing to repay investors if the firms defaulted. And financial firms hold more than $1 trillion in emergency loans from the Federal Reserve.

Goldman Sachs declared a “duty” to repay the Treasury after posting a first-quarter profit. The chief executives of several large banks at a meeting last month urged President Obama to accept repayments. But no company has similarly pledged to leave the government’s other aid programs.

The explanation appears to be simple: Only the capital investments by the Treasury require the companies to make significant sacrifices, such as restricting executive pay.

I’m aware that the strict government oversight is legislatively codified in the TARP bill, but Congress ought to pass a law extending the jurisdiction of these powers to cover banks currently relying on government loan guarantees. The legislation should be written loosely enough to allow leeway in determining who is subject, but the recent spate of news suggesting banks are all of a sudden “profitable” is insulting to one’s intelligence. After all, if Goldman was doing well enough to pay off the TARP funds, why did they need to raise $5 billion in stock to do it?

Finally, these measures represent a significant gamble by the part of the banks that the populist rage engendered by the AIG bonus mess has finally subsided. They might be right to assume that the more complicated nature of the situation won’t result in the same level of outrage, but it’s not a lock. It’s hard to speak for “the public”, but I can tell you that I’m not yet comfortable enough with the idea that finance should return to its status quo to let this slide — and Barney Frank is no fool.

How to Show A Profit While Failing

Wells Fargo should consider auctioning this.

I was at dinner with my family this past weekend, and my brother, whose roommate works at Wells Fargo, was remarking on the good news that Wells Fargo had posted a record profit. Likewise, we’re seeing today reports that Goldman Sachs had turned an impressive profit in the first “quarter” of 2009. I didn’t make too much noise at the table, but I did casually mention a substantial amount of banking “profits” this quarter — especially at Goldman — were the result of government AIG payouts. What’s more, despite rumblings that some banks intend to pay back TARP funds, most of these banks are really only in business because of government guarantees that they aren’t permitted to fail. In other words, don’t pop the champagne yet.

Along these lines, we learn today that Wells Fargo will probably have to raise another $50 billion in capital. According to a report by KBW:

“Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”

Similarly, while Goldman still managed to post a profit in first quarter, it’s significantly lessened by the fact that Goldman employed some accounting sophistry to exclude massive write downs in December.

I say all of this without a particular recommendation in mind, but at least to offer a reminder that a) we’re not close to being out of this yet and b) comabat this emerging meme that bailouts are somehow impeding recovery.

Call The Wahmbulance

There’s been a lot of discussion around the office today about this Op-Ed in the New York Times written by former AIG employee Jake DeSantis that doubled as his letter of resignation as an Executive Vice President of AIG’s Financial Products unit. DeSantis, who intends to take his bonus of $742,006.40 and give it to charity, feels that since he (according to him) had nothing to do with the CDS business that sunk the AIG ship, he has been treated unfairly by the media, the government, and AIG CEO Edward Liddy. And there’s some level of truth to this. Not all of AIG’s employees were involved directly with making billions of dollars in bets they had no money to cover.

But, let’s not forget that AIG’s heretofore Financial Products division — which rewarded DeSantis lavishly over his career — was made artificially profitable by the horrible bets made by “other” people he worked with or near. These bets were not backed by real, actual money anyone had anywhere, but before they imploded, they profited AIG — and Jake DeSantis — enormously. Without getting to heavily into the metaphysics of the matter, you could argue that this money AIG used to pay DeSantis’ absurdly high salary never existed in the first place. So there’s that. But more concretely, Jake DeSantis would not even have the opportunity to work for $1 if the government had not ponied up $170 billion to keep the knee-breakers at bay. That is, were it not for this hulking heap of taxpayer cash, Jake DeSantis would be completely out of the job, which, I’ll add, is precisely what is supposed to happen in a capitalist free market economy. Instead, you have a situation where a variety of factors have made the “let them fail” course the worst of all possibilities, and Jake DeSantis still has a job and an opportunity to turn things around. All things considered, this is fairly good fortune for someone working at arguably the most odious culprit in the ruination of the American economy, and you’d think it would be enough to curb any desire to loudly bitch about unfair treatment. But I suppose not.

Now again, DeSantis’ argument makes a certain, small amount of sense, but in the words of Lao Tzu: give me a fucking break, man.

Breathe Please

I understand that Congressmen will jump at any opportunity for sanctimonious grandstanding, but this AIG thing has really gotten out of hand. We now have Republican Congressman calling for Tim Geithner’s resignation — even Democrats are getting in on the act, criticizing Tim Geithner for failing to adequately direct his attention to the potential political problems %0.01 percent of AIG’s TARP funds might cause. The man is trying to save the banking system. I’m not suggesting that Treasury’s response can’t be criticized, or that the bonuses aren’t tone-deaf and well, outrageous, but of all the things to blame on Tim Geithner, is our chief complaint going to be inattention to politics? Anyway, this is all a long way of introducing what I sincerely hope doesn’t become the next outrage, Citi’s $10 million remodeling of their executive suite.

Citigroup said in a statement that the construction is part of a global space-saving initiative. The bank plans to reduce its office space worldwide by more than 10 million square feet to help save $15 billion over the next few years, according to a company official who declined to be identified. Pandit has already slashed Citigroup’s dividend and sold units to free up capital. He said in November that he would cut 52,000 jobs, about 15 percent of the firm’s headcount as of Sept. 30.

“Senior executives in our corporate headquarters are moving from two floors to smaller, simpler offices on a single floor,” the company’s statement said. “Based on estimates made when the project was initiated, we expect to generate savings in the next few years well in excess of the project costs.”

Jesus, Mary, and Joseph — they’re downsizing office space to save money. Might there be a more propitious time to take on such an endeavor? Probably, but who cares? They’re consolidating. I mean, where do we draw the line here? Am I supposed to leap to high dudgeon if it’s discovered that Citi is using two-ply toilet paper instead of tree bark? Seriously though, AIG isn’t going to be the only firm paying bonuses and Citi isn’t going to be the only firm that takes on renovations. Let’s take a deep breath here and put things in perspective.

Bankruptcy or Bonuses, Which Would You Rather Have?

Megan McArdle has a post up on the tax system, but says this in the post:

I’m not angry and bitter; I’m about as mad as I am at the prospect of people who bought homes they can’t really afford getting a bailout while I continue renting–which is to say, not very.  Life is rather too short to spend it getting angry at remote strangers.

I guess a lot of this was discussed following the famous Santelli rant, but it’s worth noting that as yet (Senate vote is pending — who knows what they’ll do to it), there are no people who bought homes they can’t really afford getting a bailout. In fairness, Megan seems to acknowledge as much (“the prospect of”), but were this prospect to become a reality, it wouldn’t change the fact that the two are pretty wildly different. On the one hand, you have financial service firms who were instrumental in magnifying the damage of the housing bubble wistfully dolling out bonuses financed by $300 billion from taxpayers, that in many cases will be larger than whatever “bailout” homeowners receive. Of course, this $300 doesn’t include the other ways that people in the financial services have been bailed out, like today’s announcement from the Treasury Fed committing $750 billion buying mortgage backed securities (this was in addition to $500 billion already spent).

On the other hand, the so-called “bailout” for homeowners allows bankruptcy judges to alter the terms of a mortgage once the lender and the bank have already tried to adjust the mortgage voluntarily. In other words, the “bailout” results in the decrease of a home’s mortgage (and asset value, I’ll add) after you go to bankruptcy court. The way people have been describing this, you’d think Barack Obama was going to come strolling down your street with a t-shirt gun loaded with wads of cash to make it rain on your irresponsible neighbors. In reality though, nobody wants to go to bankruptcy court, but I bet there are a lot of people who wouldn’t mind receiving “retention” bonuses when they’re quite lucky to even have a job. The two aren’t even remotely close. (I know people are arguing that there’s demand for these AIG workers elsewhere, and that if their departure could bring to bear disaster. To which I would ask, $173 billion isn’t disaster?)

I say all this fully understand that there are sound policy reasons to be bailout banks and homeowners, and I think these issues of fairness are secondary, but to suggest the level of unfairness is symmetrical is ludicrous.

UPDATE: Also want to point out the obvious that whatever you might say about owners buying homes they couldn’t afford, it’s not as if these people bought their homes on a credit card. That is, someone else looked at their finances and decided to give them a loan. Now, whether they were given a loan under the assumption the house could be sold several years later at a higher value, whether the loan officer just didn’t care as long as they qualified, or whether the bank legitimately thought their new debtors could afford the home is basically immaterial insofar as the powers that be gave the loan a green light. Of course, this doesn’t absolve the homeowner of total responsibility, but it’s a bit of a stretch to suggest that this whole operation was the result of homebuyers run amock.