Higher Taxes Better than Forced Charity

Kevin Drum points to a report in the New York Times that Goldman Sachs is weighing an increase in charitable giving requirements for its senior staff. Kevin poo-poos it:

I think it’s great if corporations support charities or set up charitable foundations of their own. It’s also great if corporations urge their employees to give to charity. But that’s as far as it goes. Charitable giving isn’t a smokescreen for indefensible behavior, and in any case it’s not charity if you’re forced to do it at the point of a gun. Bankers who make millions ought to feel obligated to give some back to the community, but if they don’t, that’s their business, not Goldman’s.

While I think Kevin is definitely right about the limited PR upside here, I think he’s wrong that “it’s not charity if you’re forced to do it at the point of a gun.” That is, I don’t think anyone in need really cares whether or not the food, shelter, or research money or whatever it is that benefits them comes from the end of a gun or not.

Anyway, anyone who hasn’t been lobotomized knows that’s not really Goldman’s objective here, so the debate as to whether Goldman’s charity is valuable irrespective of it’s intent is sort of moot. Rather, Goldman’s play here is much more of an attempt to “self-regulate” before the government, bowing to common sense and popular outrage, does something about an unsustainable situation. To wit, the issue isn’t just that bankers pay themselves obscene amounts of money, it’s that the pay and incentive structure of the banking industry encourages recklessness behavior that endangers the wider economy while providing dubious societal good.

While greater charitable giving requirements would provide some marginal good on the charitable perspective,  they wouldn’t do anything to address the incentive problem. Luckily for us — but not as much for banking executive —  we already have in a place a system called the “tax code” that can helps push income distribution in a socially beneficial way while also shaping incentive structures.

The situation that Goldman fears are regulations on payment structures that reduce incentives for reckless investment and changes to the tax code that significantly increase the marginal tax rates on the upper extremes of the income spectrum to something closer to our historical norm.

Taken together, these would policies would both limit behavior that endangers the economy and help ensure that at least some of banking profits are funneled into a socially beneficial direction.

(By the way, the most likely outcome of this policy is that Goldman just pays  even more to account for the difference of the charity requirement. After all, the banking industry has notoriously argued it must maintain absurd bonuses to preserve its talent. If Goldman starts lowering its real compensation levels, how can it retain talent?)

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 TheStreet.com. “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.