Getting More For Doing Less: Bank Board Directors

Executive compensation is an art rather than a science. It is not as if numbers are fed into a computer and the correct compensation pops out. More discretion is involved than meets the eye. “Since the financial crisis,” The New York Times reported in 2013, “compensation for the directors of [America’s] biggest banks has continued to rise even as the banks themselves, facing difficult markets and regulatory pressures, are reining in bonuses and pay.” [1] Just five years after the financial crisis, it is interesting how the banks' respective managements decided to spend the TARP money from Congress and even more money from the Federal Reserve Bank. Also of note, board and upper management compensations seemed to be going in different directions in spite of both being presumably tied to the same firm performance. Even a performance-incentive approach tied to firm-performance can accommodate a lot of latitude, such that banks differ in how much they pay their respective boards. The discretion permits inside collusion and even outlandish demands by "celebrity" members whose advice does not necessarily come up to celebrity status.  

At $488,709 in 2011, Goldman Sachs had the highest director-pay of any American bank. Some of the bank’s 13 directors made more than $500,000 because they had extra board responsibilities. As the directors were paid in stock, 2012 promised to be an even better year for the board members. Compensation experts have stated that banks must pay premium dollar to pay such figures for what is essentially part-time work in order to get the best advice. However, JPMorgan, the largest American bank, gave its directors “only” an average of $278,194 in 2011. Bank of America paid its directors $275,000 each. Equilar reported that the average compensation for a director at one of the six largest American banks in 2011 was $328,655. This compares with $232,142 at almost 500 publicly-traded companies, according to Spencer Stuart, in spite of the fact that regulations had narrowed the responsibilities of bank boards.

One would think that compensation would reflect changes in the number of tasks even more than macro indicators of bank performance. “I get you have to pay up for sophisticated board, but what is that complexity worth?” said Timothy M. Ghriskey, co-founder of the Solaris Group, a financial services shareholder that voted in 2011 to reject a pay plan for top executives at Citigroup. “Does it take $200,000 or $500,000? The discrepancy between a board like JPMorgan and Goldman is confusing.”[2] I submit that it is confusing only from a rationalistic standpoint. 

The differential indicates that the matter is far more subjective than meets the eye. Collusion between upper management and its board may be happening. So when a compensation expert claims that a certain level is necessary, the claim can be questioned rather than taken at face value. In fact, the false-necessity may be a subterfuge used by insiders seeking to enrich each other. You scratch my back, and I’ll scratch yours. The dispersed stockholders are left with less.

In short, it can be doubted whether the director compensation levels at banks are necessary or even in the stockholders’ interest. The excess probably reflects the difficulty facing stockholders in holding the insiders accountable. Accordingly, one consequence of corporate governance reform may be reining in the pay for what is really a part-time job with fewer and fewer responsibilities. If very wealthy or renown board members demand a premium, it is not justified in terms of corporate governance unless the advice is more valuable. 

See Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.

1. Susanne Craig, “At Banks, Board Pay Soars Amid Cutbacks,” The New York Times, April 1, 2013.
2. Ibid.

Bank of America Exploited State Tax-Rate Differentials in the E.U.: Systemic Risk and Federalism Blindsided

In 2012, the corporate income tax rate was reduced from 26% to 24 percent. With the comparable rate in Germany at 29% and France at 33 percent, Britain stood to reap the revenue-benefits of a significantly lower tax rate within the European Union. That the 24% rate would be pared down to 21% in 2014 suggests that everything else equal, the state of Britain was set to reap a sustainable competitive advantage over other E.U. states with respect to attracting business, and thus jobs. The move was not without risks, however.
The move by the British could have triggered reduced rates in other states, resulting in a “race to the bottom” wherein corporations would get away with less tax and the governments would have to cut back on basic services due to insufficient revenue in the coffers. In early 2013, for example, Bank of America moved billions of pounds of complex financial transactions through London from Dublin in order to apply the loss carry-forwards on the underlying investments to the state with the higher tax rate. At the time, the corporate tax rate in Ireland was only 12% so the loss deductions could have benefited the bank more if applied against profit in Britain. As a result, that state stood to collect less in tax from the bank and the bank stood to pay less in tax--all due to the rate differential between the states of Ireland and Britain.

In short, a bank that had made horrible acquisitions in 2008 was able to “play the rates” to get some kind of “silver-lining” benefit at the expense of the E.U.’s state governments. Because of the disproportionate fiscal role of those governments in the E.U., business could effectively play them off against each other. Were there a federal corporate income tax, the benefits of shifting carry-forward losses from Dublin to London would have been mitigated because the more of the tax bill in Europe would have been unaffected. Therefore, in addition to forestalling more of a fiscal balance within the E.U. to the benefit of the euro, the reliance on state tax in the E.U. could be exploited by corporations such that less tax revenue would be collected.
In terms of business, Bank of America’s taking advantage of differential tax rates illustrates a sort of “operating at the margins.” Did this redeem the bank? Lest it be forgotten, the bank had screwed up rather unroyally in acquiring Merrill Lynch and Countrywide in 2008, given all the real-estate debt and financial derivatives held by those institutions. That is to say, any cleverness in minimizing the tax bill within the E.U. could not possibly make up for the colossal blunders at the hand of Ken Lewis and the board in 2008. The bank was even then too big to fail, meaning that there was systemic risk to the financial system (and economy) should the bank have collapsed, so any cleverness at working tax differentials should not distract us from the big picture concerning not only that bank, but also any large bank as being too big to fail and yet fully capable of making huge blunders that could compromise even a large bank's very existence. In other words, expertise in reducing the tax-bill in the E.U. does not make up for greater ineptitude because the low-probability, very high systemic risk is simply too dangerous; the Great Depression of the 1930s illustrates what could happen.
As for the E.U, it was (and is) vulnerable fiscally because its reliance on the states to collect and spend tax revenue. The E.U. Government, like the early U.S. Government, has evinced the weakness of dependency (on its states). The reticence of state officials to cede more governmental sovereignty to the Union has been at least part of the problem, with banks like Bank of America being able to exploit differential state tax-rates as a result. The welfare of the whole--the Union--has suffered as a result.  

Sources:

Jill Treanor, “Bank of America Makes Derivatives Switch from Dublin to London,” The Guardian, 28 January 2013.

Dan Milmo, “Corporation Tax Rate Cut to 21% in Autumn Statement,” The Guardian, 5 December 2012.

See also: Skip Worden, Essays on the E.U. Political Economy and Essays on Two Federal Empires.

Bank of America: Downsized From Smallness?

Three years after the near-meltdown of Wall Street in September 2008, Bank of America announced that 30,000 jobs would be eliminated. That amounts to nearly 10% of the bank’s total work force. Over all, BOA was planning to cut $5 billion in annual expenses. The reason is transparent: continued losses stemming from the bank’s acquisition of Countrywide in January 2008 in spite of the fall of the U.S. real estate market and the related losses on sub-prime mortgage-backed CDOs. What could Ken Lewis have been thinking? At least in the case of his acquisition of Merrill Lynch, which was agreed to in principle in September 2008, the investment bank had already sold its $30 billion of toxic assets for over $7 billion in July 2008.

While the $29 per share price for Merrill seems excessive given that the investment bank was trading at only $17 at the time of the agreement, Fleming’s negotiating strategy (stressing the long run value over the short term market volitility) on Merrill’s side, Thain’s preference for a 10% stake/$30 billion line of credit from Goldman, and the sheer strategic fit between BOA and Merrill can explain Lewis’s offer-price being at a premium over the market price. Even so, with Lehman poised to file, the Goldman option would have been insufficient (or would likely have dissolved on the Monday of Lehman’s filing as the market tanked) and Thain would have taken $17 (or even down to $10) in the wake of Lehman’s filing.

According to reporter Greg Farrell (p. 183), Bank of America tended to deal with problems “by finding the quickest, near-term solution and lunging in that direction.” BOA “was not an organization that had the patience for deep, strategic thinking. It was an opportunistic company that preferred action of any kind to inaction.” Although much of the bank’s empire-building had taken place under McColl, the preceding “legendary” CEO, Ken Lewis’s acquisitions of LaSalle, Countrywide and perhaps even Merrill Lynch (to some extent) evince the sort of short-sighted and opportunistic lunging-without-thinking that can go with empire-building. Cutting 10% of the work force may be interpreted as a response to the market’s implicit verdict on Lewis’s shopping spree following Fleet. The losses stemming from Countrywide are evident enough; the case of Merrill Lynch is a bit harder to weigh.

Although Merrill proffered great synergy with BOA and could be picked up on the cheap, Lewis’s rushing to a deal over a weekend (with only about 12 hours for due diligence!) can also be considered as excessively risky, especially considering the history of hidden CDOs at Merrill (Semerci hid $30 billion then unfairly blamed them on his predecessor at Fixed Income). Had Merrill unloaded all of its toxic assets back in July? If so, what caused the $15.31 billion loss of Merrill Lynch announced only after the BOA shareholder vote on the acquisition in December 2008? Furthermore, did Lewis knowingly keep the mounting losses at Merrill from his shareholders as they were preparing to vote? At the very least, failing to disclose the mounting losses in real time was risky, even reckless, given what could be expected—namely,  the $50 billion potential liability that would face the bank from a stockholder suit. Even if Lewis decided not to disclose “non-material” losses because they were in line with Merrill’s results in 2007, was the CEO manipulating his stockholders while puffed up in the vainglory of empire-building? Furthermore, the condition of the market in September 2008 was not exactly ripe for making a deal to acquire a major financial institution. Lewis and Thain knew Lehman would go belly up when signed their agreement at 1am on Monday, September 16, 2008. 

As risky and perhaps even foolhardy as the Merrill acquisition may have been for Lewis, his acquisition of Countrywide defies any good sense. That he was being paid millions of dollars at the time suggests that the dysfunction at Bank of America may include corporate governance. Specifically, deferring too much to the CEO at the expense of the shareholder interest evinces a lack of accountability. Although BOA had a history of duality—splitting the chairman and CEO positions between two people—still the CEO may have too much influence.

Finally, a vital matter of public policy should not be ignored. Although it could be argued that Bank of America is being forced by its own history and the market to downsize, the question can legitimately be raised whether the market can or should be relied on to take faulty banks too big to fail down a notch. The very existence of Bank of America may involve more systemic risk than we should be prepared to accept. Relying exclusively on the market for the correction is, I contend, insufficient. The market can be insufficient in downsizing to a suitable size, or irrational exuberance can take hold such that a 10% reduction becomes a free-fall. That a bank such as Bank of America of over $1 trillion in assets is allowed to exist as a concentration of capital is itself a systemic risk. In other words, something is seriously wrong with the market mechanism for a bank such as BOA to have been able to become so big in spite of its modus operendi or corporate culture.

Sources:

Greg Farrell, Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America (New York: Crown Business, 2010).


Steven M. Davidoff, “For Bank of America, a Looming $50 Billion Claim of Havoc,” New York Times, September 28, 2011. 

Banking on Buffett’s Bank

Beyond wondering what could Ken Lewis have been thinking when he ok’d Bank of America’s purchase of Countrywide, it might be worth pondering why the Dodd-Frank Financial Reform Law of 2010 did not mandate splitting up banks such as Bank of America, which with over $1 trillion in assets are too big to fail. In other words, is simply increasing their reserve requirements tantamount to gambling with the financial system in a reckless manner? Should the elected representatives of the people and the states in the U.S. House and U.S. Senate, respectively, have displayed more fortitude in resisting the banking lobbyists even when that industry was known to have been culpable in the 2008 credit crisis?

The risk still remaining in August 2011 was evident when Bank of America’s stock price went down to $6. According to the New York Times, “the speed of the descent and the surge in the cost of insuring the company’s debt awakened memories of the financial crisis, when companies like Bear Stearns and Lehman Brothers found themselves short of capital.” To be sure, BOA’s capital held at $218 billion at the end of June 2011 by one key measure, though some investors did not trust the bank’s numbers. Of course, when there is a run on a bank, a capital figure is almost irrelevant, as are claims that additional capital are not necessary. Fortunately, Warren Buffett ignored such an asseveration from Brian Moynihan, the bank’s $9 billion loss over the previous 18 months, and the bank’s increased reserves ($18 billion from $4billion in January 2010) for investors of soured CDOs. Not wasting time scheduling a meeting with Moynihan, Buffett went to the board and soon had a deal wherein the investor would put down $5 billion in exchange for preferred stock paying a guaranteed 6% annual dividend and warrants good for ten years for 700 million shares. Like Buffett’s $5 billion deal with Goldman Sachs, which netted the investor over $1 billion as of mid-2011, the BOA deal looks like a money-maker for him. In exchange, the bank gets a huge vote of confidence, which regardless of any capital needs, was of great value to the bank (as the other deal had been to Goldman even though that bank had not yet needed $5 billion in additional capital).

Tossing around $5 billion to Goldman (and $3 billion to GE, which had been relying on the repo market) and $5 billion more three years later—in both cases to buttress a bank too big to fail—ought to make clear to the rest of us that merely allowing the $1 trillion club of banks to continue to exist is itself of such systemic risk that high stakes gambling is necessary to avoid catastrophe. My point is that through our elected representatives, the American electorate has a choice; we need not accept the presupposition that economic liberty requires that even banks whose very existence represents systemic risk have a right to continue to operate as going concerns. To put it differently, Warren Buffett was 80 years old when he put together the BOA deal.

Isn’t there something precarious about an empire the size of the U.S. relying on an old man to keep a major bank from imploding due to the financial fallout stemming from a stupid decision to acquire a mortgage servicer on steroids? Had anyone from BOA bothered to do what Larry McDonald did while he was at Lehman—Dick Fuld’s Lehman for Christ’s Sake!—namely, simply going a restaurant near Countrywide’s headquarters in California to chat at lunchtime with a few of the many brainless salesmen wearing gold watches and driving new sports cars bought from the double commissions on the known-to-be junk mortgages—BOA’s managers and board would (hopefully) never have agreed to ingest the leprosy, let alone play with it and touch it. Strangely, Ken Lewis had a reputation at the time as an expert on M&A; after all, that is how he had expanded BOA. Nevertheless, Lewis on Countrywide seems a lot to me like Lee at Gettysburg (what could possibly been in the confederate general’s head as he disregarded Longstreet’s objections to Pickett’s charge?—Lee might as well have used a firing squad on the division and saved the Union army the trouble). I think we are too enamored with authority that comes with position, whether in corporations, government or religion.

In summary, relying on one rich old man to prevent the financial system from imploding from the demise of a bloated, misguided bank like BOA does not sound very prudent to me. We might as well make every American city into Las Vegas and paint the towns red. Forgive me but I have to ask, Do we really know what we’re doing, folks? Minding the store might mean slapping some hands (or worse) when our elected representatives get to playing too much with the self-absorbed banking lobby.

Sources:

Nelson D. Schwartz, “Buffett to Invest $5 Billion in Shaky Bank of America,” New York Times, August 26, 2011. 

Ben Protess and Susanne Craig, “Buffett’s Bank of America Stake Viewed as a Seal of Approval,” New York Times, August 26, 2011.

Should Citi Be Broken Up or “Prodded”?

In 2011, the office of the special inspector general for the Troubled Asset Relief Program published a report on the aid provided to Citigroup by the U.S. Government during the financial crisis of 2008. “Unless and until an institution such as Citigroup is either broken up,” the report concludes, “so that it is no longer a threat to the financial system, or a structure is put in place to assure that it will be left to suffer the full consequences of its own folly, the prospect of more bailouts will potentially fuel more bad behavior with potentially disastrous results.” The Dodd-Frank Act of 2010 was an attempt to provide such a structure, with the federal government’s role being oriented to upping reserve requirements for the biggest banks and ordering the liquidation of big banks in bankruptcy, rather than to break up the banks too big to fail. That is to say, rather than add systemic risk to the restraint-of-trade criterion of anti-trust law, Congress and the U.S. president decided in 2010 to allow the banks with $1 to $2 trillion in assets to decide whether to downsize of their own volition or continue to face the raised reserve requirements.

Philosophically, the American body-politic in very general terms tends to view the proper role of government as tinkering with the contours of markets to affect business incentives rather than intervening directly in a company, as in breaking those up that have grown too big (and powerful) for the public good. Making it more costly for a big bank to retain all its lines of business (i.e., its size) instead of breaking it up is believed on a rather subtle level by the society at large give due regard to property rights (i.e., economic liberty). The public tends to view such an approach as balancing property rights with the public good. More nefariously, the approach can also be viewed as a manifestation of the political power of corporations on K Street in Washington, D.C. over Congress and the White House. Actually, adjusting market incentives via regulation can be said to prioritize property rights and private wealth over the public good where the threat to the market mechanism itself and the financial system (not to mention the republic!) is particularly grave. The American orientation to the market mechanism in preference to "big government" tends to disregard this scenerio wherein an improbable systemic collapse is part of the equation.

The fear that the fall of Lehman Brothers would trigger the collapse of the American financial system “by Monday” led Congress to put hundreds of millions of TARP money up for a vote on a “fast-track” that is astonishing by Congressional standards, not to mention democracy itself. The American "approach" itself had to be temporarily put on hold, and by a Republican administration! Not to be outdone, the free market orientation held on in the form of no-strings on the bailout money.

It can be argued that TARP itself was not only insufficient, but also that it actually enabled the marginally-run banks that were too big to fail to endure and thus continue to inflect the system with systemic risk. In terms of the ensuing reform law on financial regulation in 2010, it can be argued that to enable a mammoth bank that is regarded as too big to manage to continue to exist by rejecting the break-up approach (or reinstating the Glass-Steagal Act) in favor of relying only on setting up differential reserve requirements (i.e., regulatory costs) based on total assets and otherwise helping to order the liquidation process of an already-defunct bank may be too detrimental to the public interest. In other words, the tremendous size of the banks and the associated systemic risk may make the market-oriented American approach too property-rights oriented for the public good. 

 In terms of unmanageable banks, I have in mind Citigroup in particular, which I will turn to below, though Bank of America could easily be added to this list, given Ken Lewis's "empire-building" moves to acquire Countrywide and Merrill Lynch. He might as well have hung a sign outside of headquarters in Charlotte, "Dump Your Crap With Us! We'll Buy It!" Being the biggest bank, as though a Walmart in the financial world, is not necessarily a good thing both on the firm level and in terms of systemic risk in the economy.

Referring to Citi, Gary H. Stern, former president of the Federal Reserve Bank of Minneapolis, said, “I ask myself, ‘Could I manage one of these places with lots of capable senior officers?’ and I think the answer is no.” That is to say, the bank had become too large to manage. Like blindfolding a car driver or putting a confused drunk driver behind the wheel, having a heavy piece of machinery running not fully under control can be to invite an accident. It is very risky, even self-destructive, merely to allow such a thing to go on. Relying on the CEO to “pull over” and by analogy reduce obstructions by reducing the vehicle’s size (maybe unhooking a trailer) can be viewed as a luxury that the public interest cannot afford.

Gretchen Morgenson of the New York Times writes that “(g)iven Citi’s close ties to Washington, we can only hope that the change of command [of CEO] also reflects a regulatory prodding to overhaul the company. And if that involves cutting this behemoth down to a manageable size, then taxpayers should definitely cheer.” Regulatory “prodding” can be viewed as woefully insufficient if we are to rely on an empire-building CEO to voluntarily bring his “behemoth down to a manageable size.” That is, the fact that Pandit had felt perfectly fine with Citi being beyond a manageable size does not bode well for taxpayers cheering any time soon on hopes that Mike Corbat might suddenly see the light as he entered the corner office on his first day as CEO. He was more likely to see the power of his new office over such an expansive empire than to reflect on how he could have less under him. The motivation of a CEO is crucial to the question of whether the American market-oriented approach is sufficient to deal with something on the order of systemic risk.

The “regulatory prodding” approach that tends to sway the American electorate as a whole, even if subtly, may be fatally flawed in that economic efficiency and even profit-seeking itself are presumed in the approach to be the exclusive or primary motivators of CEOs and even boards. In actuality, the empire-building motive of power may eclipse even greater profitability, and therefore be oblivious to the prodding of additional reserve requirements. That is to say, the "market-prodding" approach may fall short by treating non-financial motives as extrinsic to the business calculus. Such motives may ignore or even trump "new and improved" regulations designed to channel financial motives in business. A bank's CEO might say, "I'll put up the additional reserves! I don't want to cut off product-lines that otherwise tie into my overall strategy synergistically."  Translation: I want to expand my empire even if it costs more proportionately because I like the pleasure that comes from the additional sense of power. Nietzsche could hardly have put it better.

For our purposes, the following axiom can be set forth for business as a phenomenon as well as at the managerial level:

Business is not only economic or financial in nature; it is also political in the sense that power is in the mix.

Managers are motivated not just by financial considerations such as efficiency, cost-containment, and revenue maximization, but also by the desire to control, which is an application of power.

The market-oriented approach to regulation may not sufficiently take into account this axiom. Structuring the market mechanism itself may need to be supplemented by a more direct intervention in private companies so systemic risk is lowered to a level that does not present taxpayers with a "high risk, low probability" collapse of the financial system itself. The sheer continued existence of Citibank (and even Bank of America) may point to the inadequacy of the Dodd-Frank Act as “reform” adequate to the purpose, given what we learned, or should have learned, from living through the financial crisis in September 2008.

Source:

Gretchen Morgenson, “Citi’s Torch Has Passed. Now Find a Knife,” The New York Times, October 20, 2012.

Too Big to Fail: The Trillion Dollar Club

Banks with assets over $50 billion are considered “systemically important” according to the Dodd-Frank law of 2010. The act is geared to shoring up protection against systemic risk. The U.S. Government deems certain banks (and companies) systemically important if they are big enough to threaten the entire financial system should they fail. Such enterprises are subject to higher capital standards and stricter rules. Roughly three dozen banks in the U.S. had been classified as systemically important by mid-May 2011.

A major flaw in the law is its failure to sufficiently distinguish the banks having assets at just over $50 billion (the floor of systemically important) from the banks with assets over $1 trillion. For example, Bank of America ($2.28 trillion), J.P. Morgan Chase ($2.2 trillion), Citigroup ($1.95 trillion), and Wells Fargo ($1.24 trillion) can be clustered and distinguished from Huntington Bancshares ($52.95 billion), CIT Group ($50.85 billion), Zions Bancorp ($50.81 billion), and Marshall & Ilsley ($49.68 billion). If just one of the institutions in the over $1 trillion club fails, the financial system worldwide could be toast. In contrast, the system would be more likely to remain viable if just one of the banks with assets of around $50 billion were to fail.

Of the $50 billion club, Stephen Steinour, chair and CEO of Huntington, stresses, “We are not vital to the economic system of the U.S.” The chair and CEO of Bank of America could not make the same claim. However, Steinour is ignoring the possibility that Huntington could be a domino in a line of similar banks whose failures altogether could challenge the viability of the financial system; yet even this risk can and should be distinguished from the inherent systemic risk in just one of the banks in the $1 trillion plus club.  Furthermore, those big banks have grown even larger since before the financial crisis—meaning that their systemic risk is higher rather than lower after the crisis. At the end of 2010, the top ten banks in U.S. had 77% of the banking assets in the U.S.

In 2007, Bank of America had assets of $1.54 trillion; by 2011 that number had moved to $2.28 trillion. J.P. Morgan Chase had gone from $1.46 trillion to $2.20 trillion, and Wells Fargo went from $539 billion to $1.24 trillion. Citigroup bucks this trend, moving from $2.22 trillion down to $1.95 trillion. Generally speaking, this cluster of banks represents more rather than less systemic risk after the crisis of 2008.  Were one of these banks to founder, a government-arranged orderly liquidation as per the Dodd-Frank law might not be sufficient to keep credit markets from freezing up. The very existence of a bank with more than $1 trillion in assets should be questioned. Ironically, efforts to evade financial catastrophe in the fall of 2008 contributed to the increase in size. That is to say, staving off the crisis may have made another more likely in the future.

So especially after the scare in 2008, it is incumbant on us to question the sheer existence of the banks that have been allowed and in fact encouraged to get bigger. If a bank having more than $1 trillion in assets is deemed necessary for corporate capitalism to function in spite of such a bank's inherent systemic risk, one might ask how the system got along without them before they had grown so big. After all, it is not unheard of for a syndicate of banks to package financing on a mega-LBO (leveraged buy-out); one mega-bank is not necessary. Indeed, mega-LBOs themselves may result in unacceptable systemic risk. Finance itself, and particularly the increasing role of leverage, can also be subjected to question. 

Although distasteful from the vantage-point of the financial interests vested in the status quo, the trillion-dollar-plus club of banks could be treated differently than the banks of around $50 billion. Whereas the latter could be more strictly regulated, the former could be broken up not only in terms of management, but also in ownership (rather than the spin-offs having the same fractional owners, as was the case with Standard Oil after its “break-up”).  Considering that obviating financial collapse in 2008 included the byproduct of even larger banks, a second systemic-risk law delimiting a maximum size could complement existing anti-trust laws. Unfortunately, the Dodd-Frank law does not address this point, and is thus insufficient from the standpoint of obviating the systemic risk of firms being too big to fail.

Sources:

Robin Sidel and Jean Eaglesham, “Vital? Not Us, Say Small Banks,” The Wall Street Journal, May 13, 2011, p. C1.

2007 Bank Assets, ForbesAdvice.com.

Bank of America Board Ignores a Binding Resolution: Fiduciaries Seizing Power from Shareholders

Corporate board directors have a fiduciary duty to act in the shareholders’ financial interest. What if a board’s directors think they know better that the stockholders as to their interest? In such a case, the directors would be acting like elected representatives who vote contrary to the wishes of their constituents for their own good. While valid from the standpoint of representative democracy, I’m not sure the principle has legitimacy in the corporate context, wherein property-rights are being represented. Simply put, an owner gets to decide how his or her wealth is used, within legal parameters of course. The case of Bank of America’s board may suggest that directors essentially work for their managements while being shamelessly dismissive of even binding directives from the stockholders as a group.

“At the bank’s 2009 annual meeting, shareholders passed a bylaw requiring that the board be overseen by an independent “chairman.” The bylaw passed by a whisker, but it was nonetheless binding.” In the fall of 2014, however, “the board abruptly overturned the bylaw” by electing Brian Moynihan, the bank’s CEO, as chairman of the board.[1] In other words, the directors shamelessly dismissed a binding shareholder directive. The directors claimed that the bank’s governance structure—that is, whether to have the same person occupy both the CEO and chair positions or not—should be allowed to vary “depending on the strategy and environment in which [the bank] operates.”[2] I’m not convinced, however, that this is a valid point.

Firstly, the duality of the chair and CEO (i.e., having the two positions held by two people) is not oriented to particular business strategies or environments; rather, the governance device is intended to prevent a CEO, whose supervisor is the board, from dominating it and thus impairing its overseeing role. Such a situation is like an employee coming to dominate his boss. It doesn’t matter what the business is, the structure itself is problematically both ethically and in terms of the performance of the board and its management. That the board brazenly contradicted the stockholders’ binding bylaw in appointing the sitting CEO as chairman of the board may suggest that the CEO already had too much power over the board responsible for holding him accountable.

The man of the hour. Brian Moynihan, Chair and CEO of Bank of America as of 2015. His power exceeded even that of the stockholders, whose concentrated wealth he managed. Lest it be maintained that a CEO with such power optimizes corporate earnings, consider that his predecessor, Ken Lewis, had the bank purchase Countrywide, whose fraudulent mortgages played a vital role in bringing about the financial crisis of 2008. Perhaps CEO/chair duality is of value simply in reducing a corporation's systemic risk. Hence, Congress may legitimately intervene.(Simon Dawson/Getty Images)

Were governance structure to be so malleable as to change according to strategy and environment, corporate governance would be more like a policy than something worthy of a corporate charter. By analogy, the argument that a corporation’s governance structure should depend on strategy and the business environment treats a constitutional clause as if it were a mere statute alterable by a legislature rather than a constitutional amendment. The structure, in other words, is too easily changed, and thus subject to the power-agenda a CEO or chair.

Lest it be objected that corporations are merely economic entities and thus subject only to the criteria of efficiency and effectiveness, I submit that power was alive and well among the directors, the CEO, and even the stockholders as the matter of the binding bylaw came to a head in 2015. “Power is the only issue here, Bob Monks, a governance expert at ValueEdge Advisors, a shareholder-activist firm. The board’s appointment of the CEO as chair “is simply saying power is with the C.E.O. and any structural arrangement that purports to dilute his power will be driven out.”[3] The question is whether the stockholders as a group would have and be able to exercise enough power to hold the board and CEO accountable.

---

[1] Gretchen Morgenson, “At Bank of America, a Vote to Give Shareholders Due Respect,” The New York Times, September 18, 2015.

[2] Ibid.

[3] Ibid.

Foreclosing on Freddie and Fannie

Three years after the financial crisis of 2008, nearly half of the people in Arizona with mortgages owed more than their homes were worth; those people were “underwater.” Only three homeowners had been approved for debt reduction since the debt-reduction program in Arizona began in September 2010. “It is extremely difficult for the principal reduction program to be successful” when Fannie and Freddie opt out, according to Shaun Rieve of the Arizona Department of Housing.[1] Even though Arizona would pay up to half of the principal reduction, up to $50,000 of a $100,000 principal reduction, the two housing entities that were taken over by the U.S. Government have been obstructing taxpayers from re-emerging from “underwater.”

The full essay is at "Essays on the Financial Crisis."

1. Shaila Dewan, “Freddie and Fannie Reject Debt Relief,” The New York Times, October 6, 2011. 

Nietzsche on Bank of America

The positive correlation between incompetence and unethical conduct at companies is striking, for, theoretically at least, a person can be talented or smart and of questionable character. Of course, it could be that cutting corners is a survival strategy of people who are not competent. However, shirking seems to reflect a sordid character, which, like personality, is relatively constant throughout one’s life—though character flaws could manifest more when times are tough (as in when incompetence has eventuated in a dire balance sheet). One might investigate, moreover, whether a firm’s culture can become more tolerant of unethical conduct when the finances are going south—or do unethical cultures tend to be like fixtures in organizations irrespective of financial condition?

The full essay has been incorporated into On the Arrogance of False Entitlement: A Nietzschean Critique of Business Ethics and Management, available at Amazon.

TARP and Foreclosures: A Matter of Misplaced Priorities

Neil Kashkari wrote up the U.S. Treasury department’s Break the Glass Bank Recapitalization Plan in April, 2008—months before the financial crisis—as a “just in case.” It was essentially the TARP program.  Karshkari states in his plan that governmental purchases of toxic mortgage-based assets would do “nothing to help homeowners without [there being] a complimentary program.” He notes that should there be a crisis, “there would be enormous political pressure” for relief going to homeowners in trouble.  Considering the noted downside to his plan, he may have viewed any such pressure from “the masses” as a problem to be ignored rather than even assuaged.  He also admits in his plan that it would provide “no guarantee banks [would] resume lending.”  It is odd that his was made explicit yet not dealt with.  He does gloss an alternative option (C) that would involve refinancing the troubled mortgages, though he assumes a (needlessly cumbersome) case by case basis and that the servicers would determine which loans to put into the program.  The culprits could opt out to insist on the higher payments. In other words, Kashkari was assuming that the government shouldn’t or couldn’t force the banks to take write-downs.  As a former Goldman Sachs man himself (like his boss at the time, Henry Paulson), Kashkari probably didn’t want to propose anything that the bankers wouldn’t view as being in their interest.

The full essay is at "Essays on the Financial Crisis."