Bank Bonuses and Dividends After the Financial Crisis: On the Power of Banks in European and American Government and Society

Dividends are typically based on how much a bank (or company, moreover) has profited, less whatever capital is needed from the profit. Similarly, bonuses are based, at least theoretically, on how the managers and the nonsupervisory employees alike perform as well as how the bank performs. In their respective ways of shoring up banks amid the financial crisis of 2008, the E.U. and U.S. differed on how easy it would be for banks to pay dividends and bonuses, as well as to have access to governmental funding. These differences reflect both the relative power of the financial sector in the governmental sector and the cultural attitudes toward business. 

“Under proposals outlined by the European Commission president, José Manuel Barroso, banks would be required to temporarily bolster their protection against losses. . . . Extra capital for European banks should be raised first from the private sector, then from [the state] governments, according to the proposal. Only when those avenues have been exhausted should a euro zone bailout fund be tapped, it said. Banks should not be allowed to pay dividends or bonuses until they have raised the additional capital, according to the proposal.”[1] The bankers much raise additional capital before government coffers could be tapped and dividends and bonuses could be paid.

 
As an aside, the nature of the E.U.'s federal system is also relevant, as state funds would be tapped; only when they are exhausted would a federal fund be used. In the case of the U.S., the states were to be shut out of the solution. This reflects the more general shift from federalism to consolidated power at the federal level. The European federal system was at the time more balanced, and thus more viable.

After Lehman Brothers went under in September 2008, the U.S. Government took “swift action to ensure its banks had a strong cushion of capital.”[2] The banks first (rather than last) resort of capital would come from the Federal Reserve Bank (as created money) and TARP funds enacted by Congress. The bankers did not have to raise additional funds, and they could pay dividends and bonuses even though the government bailout was supposed to be used to expand lending, which largely didn't happen. The banks could take the governmental funds with few if any strings attached. Also, the U.S. Treasury allowed banks to pay back the funds earlier than perhaps advisable because the bankers wanted to be free to pay whatever bonuses they saw fit for themselves.

The difference on whether dividends and bonuses should be allowed at troubled banks reflects a rather basic ideological difference between the E.U. and U.S. concerning whether economic liberty ought to be limited even in cases in which the economic entities are culpable. In short, is a bank (or business) whose management has performed very badly, as in recklessly taking on too much debt, justified in paying out dividends and especially bonuses nonetheless? If traders knowingly sell crap to even their best customers, as traders at Goldman Sachs did in the case of the subprime-mortgage-based financial-derivative bonds, should those traders expect to get bonuses anyway? Competence and ethics are thus both relevant. 

Admittedly, the bonus system on Wall Street had made its way into calculations of standard or basic compensation, such that the bankers had come to expect at least some bonus each year, regardless of performance. However, this expecation (and practice) contorts the very meaning of a bonus; it is not to be expected because it is granted for good or excellent performance, or even ethical conduct. U.S. officials tacitly bought into Wall Street's convenient notion of a bonus, whereas E.U. officials held onto the basic fact that a bonus is an extra, not a given, and, moreover, that raising additional capital as a hedge against systemic risk is more important than bonuses (and dividends). 

I suspect that because the E.U., at the time at least, had major parties on a broader political spectrum than that of the U.S., the financial sector did not have as much power over governmental institutions as in the case of the United States. Put another way, the U.S. political landscape was more tilted in favor of the financial system. Goldman Sachs, for instance, gave $1 million to Barak Obama's 2008 presidential campaign. Furthermore, the U.S. Supreme Court ruled in Citizens United (2010) that corporations could give unlimited amounts of money to political campaigns. Meanwhile, the "hard left" was represented only by "liberal Democrats," whose power has been typically diluted in the Democratic Party. Even the liberal wing of the Democratic Party does not reach the Left parties in Europe in terms of Socialism, for example. 

Therefore, I submit that the interests of corporations, including their stockholders and managements, are distended in American politics. Perhaps not by coincidence, the culture itself is amenable to business. For example, business values have gained a greater footing in how education is conceptualized at many universities in the American States. Since 1980, for example, both universities and students have reduced education to vocation in assessing a major's worth in terms of its potential for resulting in a good-paying job. The criteria for higher education are not so limited, or warped. In terms of teaching, corporate power-point presentations, which were ubiquious in business settings, became more common not only in "teaching by bullet-points," but also in what students would study for exams. 

The cultural value of business in American society, combined with the monied/political power of corporations (including banks) in the halls of government can explain why the American response to the incompetent bankers differed so much from the European response. This is a good case study particularly because it is ludicrous that a no-strings governmental response would follow the bankers' pathetic abuse of the subprime derivative bonds. The sector had even lobbied to keep financial derivatives from being regulated! That bonus were granted attests not only to warped judgment, but to the cultural and political situs of the financial sector in America. I suspect that many Europeans, even E.U. officials, were shaking their heads in disbelief. 

1. Stephen Castle, “Europe Tells Its Banks to Raise New Capital,” The New York Times, October 13, 2011.
2. Ibid.

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.

Decreasing Bank Size by Increasing Capital-Reserve Requirements: Plutocracy in Action?

Although the Dodd-Frank Financial Reform Act was passed in 2010 with some reforms, such as liquidity standards, stress tests, a consumer-protection bureau, and resolution plans, the emphasis on additional capital requirements (i.e., the SIFI surcharges) could be considered as weak because they may not be sufficient should another financial crisis trigger a shutdown in the commercial paperr market (i.e., banks lending to each other). A study by the Federal Reserve Bank of Boston found that even the additional capital requirements in Dodd-Frank would not have been enough for eight of the 26 banks with the largest capital loss during the financial crisis of 2008. As overvalued assets, such as subprime mortgage-backed derivatives, plummet in value, banks can burn through their capital reserves very quickly. A frenzy of short-sellers can quicken the downward cycle even more. This raises the question of whether additional capital resources would quickly be "burnt through" rather than being able to stand for long as a bulwark. The financial crisis showed the cascading effect that can quickly run through a banking sector as fear even between banks widens as one damaged bank impacts another, and another. 
With the $6.2 billion trading loss at JPMorgan Chase in the hindsight, Sen. Sherrod Brown (D-Ohio) and Sen. David Vitter (R-La) in the U.S. Senate proposed a bill that would require banks with more than $400 billion in assets to hold at least 15 percent of those assets in hard capital. The two senators meant this requirement to encourage the multi-trillion-dollar banks to split up into smaller banks. Although it had been argued that gigantic banks are necessary given the size of the loans wanted by the largest corporations, banks had of course been able to form syndicates to finance such mammoth deals. 
The Senate had recently voted 99-0 on a nonbinding resolution to end taxpayer subsidies to too-big-to-fail banks, so the U.S. Senate had Wall Street’s attention. Considering that the U.S. House of Representatives was working on legislation to deregulate derivatives, the chances that the U.S. Government would stand up to Wall Street even to the too-big-to-fail systemic risk were slim to nil. Indeed, the U.S. Department of Justice’s criminal division had been going easy in prosecuting the big banks for fraud out of fear that a conviction would cause a bank collapse (or because President Obama had received very large donations from Wall Street banks including notably Goldman Sachs).
The two senators’ strategy of going about breaking up the biggest banks indirectly by increasing their reserve requirements disproportionately didn't work, at least as of 2019. Advantages of size, including the human desire to empire-build (witness Dick Fuld at Lehman Brothers), could have been expected to outweigh the economic preference for a lower, more proportionate, reserve requirement. With anti-trust laws having been used to break up giants such as Standard Oil and ATT, the thought of breaking up the banks too big to fail even in the wake of the financial crisis was strangely viewed as radical and thus at odds with American incrementalism. The question was simply whether systemic risk should be added to monopoly (i.e., restraint of trade) as an additional rationale for breaking up huge concentrations of private property. This question could have been made explicit, rather than trying to manipulate the big banks to lose some weight.  
The approach of using disproportionately reserves can be critiqued on at least two grounds. First, should one or more of those banks decide to go with the 15% requirement rather than break up into smaller firms, even the additional capital might not be enough to protect a bank during a financial crisis. The study discussed above suggested as much. Second, even if the additional requirements would turn out to be sufficient in a crisis, the approach would obviate a decision by the government on whether systemic risk justifies a cap on how large banks can get. 
I suspect that the U.S. Congress and president backed off in really reforming Wall Street because of its money in campaign finance. In short, the big banks in Wall Street didn't want to shrink. In a system of political economy wherein the economy is regulated by government, rather than vice versa, backing off just because large concentrations of wealth (and thus power--even political) don't like the plans is unacceptable. Moreover, it is a sign of encroaching plutocracy wherein the regulated dictate behind closed doors to the regulators and politicians. Meanwhile, the public, including the economy itself, remains vulnerable. 

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

Sources:

Eric Rosengren, “Bank Capital: Lessons from the U.S. Financial Crisis,” Federal Reserve Bank of Boston, February 25, 2013.
Zach Carter and Ryan Grim, “’Break Up the Banks’ Bill Gains Steam in Senate As Wall Street Lobbyists Cry Foul,” The Huffington Post, April 8, 2013.

The Banks’ Consultants: Guarding the Hen House

Leaving it to consultants hired by mortgage servicers to right the wrongs that the services inflicted on foreclosed homeowners was the unhappy consequence of bank regulators giving ambiguous guidance and failing to install viable oversight mechanisms. According to the Government Accounting Office, “regulators risked not achieving the intended goals of identifying as many harmed borrowers as possible.” Even if the reviews had been completed, there was on guarantee that wronged mortgage borrowers would have received any compensation. On the other side of the ledger, the banks had received billions from the U.S. Treasury with no strings attached. Whether intentional or not, the banking regulators put too much stock in the consultants, who, after all, had been hired by the mortgage servicers."
The report confirms that the Independent Foreclosure Review process was poorly designed and executed," Rep. Maxine Waters (D-Calif.) said. The "report confirms what I had long suspected -– that the OCC’s oversight of the supposedly independent consultants hired by the servicers was severely deficient. The report should serve as a wake-up call.” By referring to the consultants as supposedly independent, Rep. Waters implies in her statement that the flawed review process put the consultants in the position of being able to exploit a conflict of interest.
On the one hand, the flawed oversight means that the consultants were the ones to protect the public interest. The public had to rely on them to correct the wrongs in the interest of the foreclosed. We can label this the consultants’ “public interest” role. The consultants’ other role  was in working for the servicers. As Benjamin Lawsky, the superintendent of New York's Financial Services Department, pointed out, "The monitors are hired by the banks, they're embedded physically at the banks, they are paid by the banks and they depend on the banks for future business." This is the consultants' other role, which can compromise the first role. 
In a conflict of interest, one role can circumvent another, more legitimate role. Even if the conflict is not exploited with the more legitimate role taking the hit, a person or institution in such a position can be reckoned as unethical, according to some scholars. Other scholars argue that only the actual exploitation of the more legitimate role by the other is unethical.
In my view, if exploitation can be seen as a possibility in the relation between two roles, the relation itself is unethical. Put another way, it is unethical to put a person or organization in such a position, even if actual exploitation does not occur. In my view, to create or perpetuate the condition wherein a person or organization can exploit a conflict of interest is unethical.
It follows that the government has a moral responsibility to eliminate the conflicting roles even if they are not being exploited. Furthermore, the person or organization having two such conflicting roles  as can be counted as a conflict of interest is also ethically obliged to pick one role or the other. Often this is not convenient from a short-term financial standpoint, so business practitioners tend to look the other way, rationalized that since no actual exploitation of the conflict of interest has occurred, there are no ethical issues. They are wrong. The mortgage servicers should never have hired consultants to monitor the servicers. This circle itself is problematic, ethically speaking.
The regulators rather than the consultants should have been the key enforcers, and thus protectors of the public interest. The regulators can be faulted not only for their lack of competence, but also ethically in having allowed the conflict of interest to exist.  A business should not be allowed by the regulators to guard the hen house. To permit this to happen is unethical even if no hens are eaten.  


For more on institutional conflicts of interest, see my book, Institutional Conflicts of Interest: Business & Public Policy, available at Amazon.

Sources:

Ben Hallman and Eleazar Melendez, “GAO Foreclosure Report Finds Bank Regulators Failed to Provide ‘Key Oversight’,” The Huffington Post, April 3, 2013.

 Dan Fitzpatrick, "'A Dose of Healthy Competition' For Banking Regulators," The Wall Street Journal, April 18, 2013.

Were Raises at Bailed-Out U.S. Companies Approved by Treasury?

In early 2013, the Special Inspector General for Troubled Asset Relief Program reported that the U.S. Treasury Department disregarded its own guidelines in order to allow large pay increases for executives at three major companies that had received bailouts during the financial crisis. In particular, eighteen raises for executives at American International Group (AIG), General Motors, and Ally Financial were approved. Fourteen were for $100,000 or more. A raise for the CEO of a division of AIG was $1 million. Treasury approved these raises even though they exceeded the pay limits set in Treasury’s own guidelines.

Was Treasury Secretary Tim Geithner smirking because his friends were happy?     NYT

In assessing Treasury’s approval of the raises, one must weigh the argument that they were needed to retain expertise needed to restore the companies to financial health (and thus be able to pay back the bailouts) against the argument that bailouts should come with strings such that the funds are not used opportunistically. At the very least, executives associated with the companies’ failures should not be rewarded. However, what about new-hires brought in to restore the companies?  If the restoration is successful, shouldn’t those managers be compensated?  Even if the raises were not necessary to retaining talent, managers who had not been part of the problem should be compensated for effective work. At the same time, it is proper and fitting that companies being bailed out be subject to strings, and thus neither the companies nor their employees should be able to benefit inordinately.
That Treasury disregarded its own guidelines can be read as an indication that the officials were concerned that vital talent would be lost had the guidelines been followed. The bailouts in the E.U. contained limits on executive compensation without any apparent hindrance to the viability of the banks. In other words, the argument that the raises were necessary to retain talent could have been a ruse. An alternative interpretation consistent with this scenario is that the business sector had too much influence over Treasury officials. In addition to lobbying influence and connections between Treasury officials and former colleagues on Wall Street, it is possible that pro-business officials had adopted the business line that government should not interfere with business—even companies being bailed out.
Put another way, contrasting the lack (or ignoring) of strings at Treasury with the salience of strings in the case of the E.U.’s bailouts may illustrate a cultural difference between Americans and Europeans generally with respect to pro-business ideology. Had executives at the three bailed out companies above enjoyed inordinate influence within Treasury, the conflict of interest for the government officials could have been enabled by a shared ideology: namely, what is good for GM is good for America.

Source:

Marcy Gordon, “Treasury Disregarded Own Guidelines, Allowed Executive Raises At Bailed-Out GM, AIG,” The Huffington Post, January 28, 2013.

See also: Skip Worden, Essays on the Financial Crisis.

Can the Federal Reserve Handle Banks Too Big To Fail?

The biggest banks operating in the U.S. reaped an estimated $13 billion of income by taking advantage of the Federal Reserve’s below-market rate of .001% on $7.7 trillion in emergency loans in the wake of the credit freeze in September 2008. Rather than using the additional funds to increase lending, the banks fortified reserves and paid bonuses out to executives. Had member of Congress had been able to anticipate all this, it is possible that they would have prescribed stronger medicine, perhaps even including breaking up the banks with over $1 trillion in assets.
As Shakespeare has Marcellius say in Hamlet in reference to moral and political corruption, “something is rotten in Denmark.” Another line could be added from Macbeth. “Out, out damn spot!” Bloomberg News reported that “the Fed and its secret financing helped America’s biggest banks get bigger and go on to pay employees as much as they did at the height of the housing bubble.”
Total assets held by the six biggest U.S. banks increased 39 percent to $9.5 trillion on Sept. 30, 2011, from $6.8 trillion on the same day in 2006, according to Fed data reported by Bloomberg. Employees at the six biggest banks made twice the average for all U.S. workers in 2010, based on Bureau of Labor Statistics hourly compensation cost data. “The banks spent $146.3 billion on compensation in 2010, or an average of $126,342 per worker. That’s up almost 20 percent from five years earlier compared with less than 15 percent for the average worker. Average pay at the banks in 2010 was about the same as in 2007, before the bailouts.”
When members of Congress were voting on the $700 billion TARP, they were being kept in the dark on the Fed’s loans. The general public was out of the loop as well. Ted Kaufman, a former U.S. senator from Delaware, said that if Congress had been aware of the extent of the Fed rescue, the knowledge “could have changed the whole approach to reform legislation,” He claims he “would have been able to line up more support for breaking up the biggest banks. More than three years after the financial crisis, Sen. Sherrod Brown of Ohio observed, “There are lawmakers in both parties who would change their votes now [i.e., in December, 2011].” Byron L. Dorgan, a former senator from North Dakota, says the knowledge might have helped pass legislation to reinstate the Glass-Steagall Act, which for most of the last century separated customer deposits from the riskier practices of investment banking. Had people known about the hundreds of billions in loans to the biggest financial institutions, they would have demanded Congress take much more courageous actions to stop the practices that caused this near financial collapse.”
The government’s response to the crisis has not significantly reduced systemic risk, even with the higher reserves requirements for the biggest banks. According to Bloomberg, “Kaufman says some banks are so big that their failure could trigger a chain reaction in the financial system.” For so few banks to hold so many assets is “un-American,” says Richard W. Fisher, president of the Federal Reserve Bank of Dallas. “All of these gargantuan institutions are too big to regulate,” he continued. “I’m in favor of breaking them up and slimming them down.” Oliver William, an economist, concluded that the “banks that were too big got even bigger, and the problems that we had to begin with are magnified in the process.” A conflict of interest may be part of the underlying cause.
It could be that the bankers at the Federal Reserve Bank have been overly friendly to the bankers getting the funds. This conflict of interest could expose the Fed to losing lent funds should one or more of the troubled banks become insolvent and with insufficient collateral. Therefore, in an attempt to make the Fed accountable in regard to its emergency lending,  Congress included in its Dodd-Frank legislation (2010) requirements stipulating that the Fed develop and submit guidelines regarding selection criteria to be applied to banks seeking emergency loans and requirements by which bank collateral is to be reckoned as sufficient.
The publication of selection criteria would reduce the risk of moral hazard. The cost of borrowing for so-called too-big-to-fail banks is lower than that of smaller firms because lenders believe the government won’t let them go under. The perceived safety net creates what economists call moral hazard—the belief that bankers will take greater risks because they’ll enjoy any profits while shifting losses to taxpayers.” Jeremy Stein, a Fed governor, has spoken of moral hazard, according to the New York Times, as “the belief that government support can subsidize banks and make them less careful about the dangers inherent in their businesses.” Depending how strict the selection criteria are, “the banks might then realize that the Fed will not be a pushover in times of market stress.” At least as of April 2013, the Fed had not followed through on the mandate in Dodd-Frank that the Fed promulgate rules.
The Fed might have good reason to stave off rules that could restrict the Fed’s flexibility in a crisis. “The Fed might be thinking, ‘We don’t want to make a lot of rules that might hinder us from acting in an emergency situation that we can’t anticipate,’” Michael Bradfield, a former general counsel at the Fed, remarked. “I think the Fed should have reasonably broad discretion to deal with systemic issues,” he continued, “(b)ut then the question is, What’s systemic and what’s really needed, and what conditions ought to accompany that lending?” Demanding too much in collateral, for example, might mean that some very big banks that are hemorrhaging capital might not qualify for an emergency loan and go under as a result. If those banks are too big to fail, the entire financial system could follow suit.
Unfortunately, discretion at the Federal Reserve could enable the “insider” conflict of interest to be exploited. Such exploitation is likely from the banking lobby as well as from the Federal Reserve. Bloomberg reports that “(l)obbying expenditures by the six banks that would have been affected by the legislation rose to $29.4 million in 2010 compared with $22.1 million in 2006, the last full year before credit markets seized up—a gain of 33 percent, according to OpenSecrets.org, a research group that tracks money in U.S. politics. Lobbying by the American Bankers Association, a trade organization, increased at about the same rate.
In a rare glimpse of how the banking lobby operates, there is evidence that the lobbying firm Clark Lytle Geduldig & Cranford sent a memo to the American Bankers Association expressing worry that the Occupy movement and the Tea Party movement might find common ground and become a potentially potent threat by joining forces. Tellingly, the memo’s writers reveal how even potential threats to big business are relegated: “If we can show they have the same cynical motivation as a political opponent it will undermine their credibility in a profound way.” Using the media outlets, the “messengers” of powers vested in the status quo can quickly discredit others, as if from a popular wave of mass opinion. Meanwhile, the matter of the very existence of the banks too big to fail continued to float below the radar—the media dutifully transmitting the transparent issue of tents and evictions in various cities. In other words, even the occupiers—the anarchists outside the system!—allowed themselves to be played. Perhaps we are all being played.

Sources:

Bob Ivry, Bradley Keoun, and Phil Kuntz, “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress,” Bloomberg Markets Magazine, November 27, 2011.

Peter Eavis, “Fed Still Owes Congress a Blueprint on Its Emergency Lending,” The New York Times, April 23, 2013.

Skip Worden, Essays on the Financial Crisis, available at Amazon.

The U.S. Federal Reserve as a Regulator of Banks: An Institutional Conflict of Interest

According to the Wall Street Journal, the Federal Reserve “has operated almost entirely behind closed doors as it rewrites the rule book governing the U.S. financial system.” The paper notes that this has been in sharp contrast to the trend at the Fed toward greater transparency in its interest-rate policies and emergency-lending programs. The complaint of a dearth of public meetings misses, however, not only the scripted nature of such displays, but also the more fundamental question of whether a central bank buffered from political pressure should play such a salient role as regulator. At the very least, the democratic deficit and a lack of accountability may be exacerbated by the Fed’s greater role as a regulator of banks—particularly after the major investment banks become commercial banks, and thus subject to the Fed’s regulations.

“While many Americans may not realize it,” the Journal continues, “the Fed has taken on a much larger regulatory role than at any time in history. Since the Dodd-Frank financial overhaul became law in July 2010, the Fed has held 47 separate votes on financial regulations.” This was as of February 22, 2012. In the process, the Fed was “reshaping the U.S. financial industry by directing banks on how much capital they must hold, what kind of trading they can engage in and what kind of fees they can charge retailers on debit-card transactions.” Unlike other regulatory agencies, not even the Fed governor’s votes were made public. Considering the contact that Fed officials had with their regulated banks on these issues and the Fed’s ties to banking itself, the lack of public meetings (only two on the 47 votes) suggests an opportunity for a conflict of interest to operate below the radar in the interest of the banks while the public holds the risk.

On the Volker Rule, which was to be the part of the Dodd-Frank law that prohibits banks from proprietary trading using their own funds because doing so is too risky for a bank too big to fail, Fed officials met with bankers at JP Morgan Chase sixteen times, Bank of America ten times, Goldman Sachs nine, and Barclays and Morgan Stanley seven each. On the Dodd-Frank provision on regulating derivatives—something a dissenting Fed governor claimed has exemptions that are too wide—Fed officials met with JP Morgan Chase fourteen times, Deutsche Bank and Goldman Sachs twelve each, and Bank of America, Barclays, Morgan Stanley and Wells Fargo eleven each. Even just in relying on these banks for information and feedback, the Fed risks getting biased input on which to make judgments.

Morgan Stanley may have insisted that the regulation of commodity derivatives would put farmers who rely on the futures market at risk. Moreover, the bankers could have insisted that an exemption would not be abused, or they could coordinate their own pressure with a farming lobby and U.S. senators from farm states. The bankers’ intent was obviously to minimize the cost to them in the regulations that are put in place. The public interest, or risk to the public, was beside the point.

The banks played a similar role in the late 1990s as they lobbied the White House and Sen. Phil Gramm to keep derivatives unregulated. That unseen monster winded up biting us in the ass in 2008. Therefore, putting the public interest at risk is not just part of some theory; giving the regulated too much influence in the writing of regulations involves a conflict of interest that can literally result in the collapse of the global financial system. A public-level perspective, rather than that of a firm or industry, must be primary among regulators or the system itself is put at risk.

Pointing to the lack of public meetings in the Fed’s approach as a regulator, Sheila Bair, former chair of the FDIC, stated, “People have a right to know and hear the discussion and hear the presentations and the reasoning for these rules. All of the other agencies which are governed by boards or commissions propose and approve these rules in public meetings.” Fed officials point out that open meetings tend to be scripted and even perfunctory. As if to state good intentions are sufficient, Fed chair Bernanke said in a 2010 speech, “As an agent of the government, a central bank must be accountable in the pursuit of its mandated goals, responsive to the public and its elected representatives and transparent in its policies.” However, a central bank is closer to its banks in many ways that it is to the public or its elected representatives. In fact, a central banks is supposed to be buffered from political influence. While this makes sense in terms of monetary policy, regulating is a separate function and a democratic deficit there is problematic.

I think the public meeting issue is a red herring. The real problem lies in a central bank going beyond monetary policy and acting as a bank for the banks to also be a regulatory agency. That the Fed’s regulatory process differs from those of the “real” agencies suggests that the Fed officials do not even seen the Fed as such an agency. As Bernanke said, “a central bank is . . .” This is the Fed’s identity. It is distinct from a regulatory agency. Accordingly, Congress should establish a separate regulatory agency to cover the banks, leaving the Fed officials to concentrate on their core functions in operating a central bank. It is not as if Bernanke “got it right” leading up to September 2008. Even in 2007, he did not think the declining housing market would cause much of a problem. He had no idea that the swap and derivative markets were about to implode. This is not a good basis on which take on additional responsibilities, particularly writing new banking regulations. In other words, it is not like much would be lost were banking regulation written and enforced by a regulatory agency rather than the Fed. In addition, such an agency would not be so closely tied to the banks as the Fed is, as hinted at by its myriad of meetings with them. Such an agency would not be explicitly distanced from political pressure as the Fed is.

There is nothing wrong with elected lawmakers and executive branch officials making sure that the laws they have passed and are enforcing, respectively, are being operationalized and enforced by regulators who keep the public interest foremost in mind. As a central bank, the Fed is neither under the U.S. President in the executive branch nor under Congress. Meanwhile, Fed officials are very close to the banks they regulate. The problem of accountability that is in the Fed’s independence from the two branches added to the conflict of interest of the Fed being so close to the banks it regulates sets the public up for the sort of thing we saw in September 2008. That crisis did not come out of nowhere, and the reasons for it go beyond the housing market. At the very least, relying so much on an “agency” (and chair!) that failed to anticipate September 2008 and then geared a bailout to the banks rather than to the millions of foreclosed borrowers (hint: conflict of interest!) to write and enforce additional banking regulations on an industry that does not want them is beyond stupid; it is suicide. Meanwhile, the issue was presented as one of public meetings, which were scripted anyway and did not prevent the Fed from meeting with its bankers.

Source:

Victoria McGrane and Jon Hilsenrath, “Fed Writes Sweeping Rules From Behind Closed Doors,” The Wall Street Journal, February 22, 2012.

Related books: 

Essays on the Financial Crisis

Institutional Conflicts of Interest

The Federal Reserve Expanded Its Turf in Spite of Having Come Up Short

Testifying before the US Senate Finance Committee on his re-appointment, Ben Bernanke volunteered that the Fed had been “slow” in protecting consumers from high-risk mortgages during the housing bubble and that it should have forced banks to hold more capital for all the risks they were taking on.  “In the area where we had responsibility, the bank holding companies, we should have done more.” he told lawmakers.  The hearing provided new evidence of doubt among lawmakers about the Federal Reserve’s  role as the nation’s guardian of the financial system. “In the face of rising home prices and risky mortgage underwriting, the Fed failed to act,” said Senator Richard Shelby of Alabama, the senior Republican on the banking committee. “Many of the Fed’s responses, in my view, greatly amplified the problem of moral hazard stemming from ‘too big to fail’ treatment of large financial institutions and activities.”  Accordingly, Senator Dodd proposed that the Fed’s powers as a bank regulator ought to be transferred to a new consolidated agency. Even though Bernanke admitted that the Fed made mistakes as a regulator of the bank holding companies, he and other top Fed officials adamantly opposed Dodd's proposal, arguing that the Fed has unique expertise nonetheless and that the Fed's ability to preserve financial stability depends on having the detailed information that only a regulator has about the inner workings of major institutions.

The Fed has “unique expertise," and yet, “In the area where we had responsibility, the bank holding companies, we should have done more.”   In other words, the Fed’s Chairman admitted that his agency had not done a satisfactory job of regulating banks during the housing bubble and yet his organization should be given even more power as a regulator anyway.  Were we to trust the Fed to regulate systemic risk, given the agency’s squalid record leading up to the financial crisis of 2008? Regardless of what qualms this question may have raised, the Dodd-Frank legislation charged the Fed with guarding the financial stability of the United States. It gave the central bank the power to oversee the largest financial institutions, even if they are not banks. Finally, it gave the Fed a prominent role on the Financial Stability Oversight Council, a body of regulators that will have the power to seize a systemically important company if it threatens the stability of the economy. Testifying before the Financial Crisis Inquiry Commission on September 2, 2010, Bernanke signaled that the central bank was eager to embrace its strengthened role provided for in the Dodd-Frank law. This role ought to give us pause, given his remarks in 2007 in which he thought the subprime problems were “manageable.” To the Commission in 2010, he said, “What I did not recognize was the extent to which the system had flaws and weaknesses in it that were going to amplify the initial shock from subprime and make it into a much bigger crisis.”

Sources: http://www.nytimes.com/2009/12/04/business/economy/04fed.html?ref=business ; http://www.nytimes.com/2010/09/03/business/03commission.html?_r=1&ref=business

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.

Lehman's Dick Fuld as the Antagonist in the film, "Too Big to Fail"

The reporter-author of Too Big to Fail, Andrew Ross Sorkin, expressed the following fear as his 600-plus-page book was being made into a movie: "I went into the process I think worried – as I imagine most writers would be – that it would be sexed up and hollywoodized in some other way." To be sure, putting the Dick Fuld (CEO of Lehman Brothers) character into any sort of sex scene would have been counterproductive at best.

As it was, the director of the tv-movie based on Sorkin’s book let the drama inherent in the historical events to lead the narrative. The only quibble I may have with the historical veracity has to do with Bart McDade replacing Joe Gregory as President of Lehman. According to Larry McDonald, a former distressed-bonds trader at Lehman, the replacement also relegated Fuld even as he remained as CEO only to quell the markets. Specifically, on June 11, 2008, “Fuld was effectively deposed,” according to McDonald, “by Bart McDade with the support of the executive committee” (McDonald, p. 297). In the movie, however, Fuld was still in charge even in September of that year, with McDade still bowing to him in front of the Koreans.

While it could be that Sorkin and McDonald have different sources of information on whether there was a coup within Lehman, the film’s director and screenwriter could have kept Fuld in charge to maintain the character as the principal antagonist. Even so, McDonald’s description of McDade confronting Fuld in Fuld’s office and the subsequent decision of Gregory in the conference room to take the stunned CFO, Erin Callan, down with him in front of the executive committee would have made excellent scenes in the movie.

The other change I would have made to the screenplay would give the viewers an improved insight into how the sub-prime crisis could have been allowed to get so bad. Specifically, the Fuld character could have had a flashback to Mike Gelband’s warning on June 7, 2005 in defiance of Fuld that Lehman should get out of the housing-related CDO market; the bank was then leveraged twenty-two times its net worth (McDonald, p. 136). Meeting with Gelband and other senior executives on the 31^st floor on that day, Fuld and his allies insinuated that Gelband had some kind of attitude problem that needed to be changed “real fast” (McDonald, p. 138).  As a flashback, this scene would have shown the viewer Fuld’s recklessness in terms of risk (and leverage), and thus how the financial system could have been put in such peril by the “experts”. In fact, in the spring of 2007 Fuld decided to bully and belittle Gelband publically at the bank in order to get him to take on even more risk (McDonald, p. 235). This could have been fused into the “attitude problem” meeting, showing the viewer Fuld’s pathology, which goes beyond a bad temper.

Whether one points to Jim Cayne at Bear Stearns or Dick Fuld at Lehman, the role of pathology in the near-demise of Wall Street could uncover for us how recklessness could have gained such traction. In other words, HBO’s Too Big to Fail could have delved into Fuld’s character beyond having him drop some F-bombs. Speaking on Charlie Rose on the evening of the movie’s premiere, Sorkin marveled that it must be difficult for actors to convey their respective characters in just a few scenes. That is true; however, the director and screenwriter could have brought out Fuld’s pathology (beyond his anger) by a few well-chosen additional scenes. Sometimes what a character says, and to whom, can be more damning than how loud he or she says it. Concerning Fuld, the viewers could have been shaking their heads in utter disbelief rather than simply concluding that the guy is arrogant and has a temper.

See related essay: "Leadership at Lehman: On the Failure of Richard Fuld"

Sources:

Kamelia Angelova, “Andrew Ross Sorkin: I was Worried that ‘Too Big to Fail’ Will Be Sexed Up or Hollywoodized as a Movie,” Business Insider, May 24, 2011.

Lawrence McDonald, Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers (New York: Three River Press, 2009).

Essays on the E.U. Political Economy: Federalism and the Debt Crisis

The collection of essays comprising The E.U. Political Economy looks broadly at the E.U.'s federal system, with particular attention to the states, including the matter of "Brexit," which refers to the secession of Britain from the Union. The text then turns more narrowly to the government-debt and banking crisis that occurred in the wake of the financial crisis of 2008. The backdrop of federalism is meant to convey the point that weaknesses in that political system hampered the E.U.'s handing of its states and banks that were in trouble with debt. Lastly, several essays are presented on some more general aspects of the E.U.'s political economy. Rather than being heavily theory-oriented, the essays draw on contemporaneous news reports to quote from practitioners from business and government.

Essays on the E.U. Political Economy is available at Amazon.

Bribery at Barclays: Can an Unethical Culture Be Changed?

Amid the financial crisis in 2008, Barclays raised $15 billion from Qatar and other investors. The infusion of capital saved the European bank from needing a government bailout. Unfortunately, the bank may not have disclosed the $390 million paid to the Qatari government for “advisory services” as part of the fund-raising, and the $3 billion loan facility that Barclays made available to that government.[1] The bank, along with three of its executives at the time were charged in 2017 with conspiracy to commit fraud by false representation, and providing unlawful financial assistance—in other words, paying a bribe to avoid needing an E.U. or state-level bailout. According to Amanda Staveley, a European financier, Barclays improperly favored the Qataris in the fund-raising. The relationship between the bank and the Qatari government rings of “mutual back-scratching.” Admittedly, any business deal involves both parties benefiting, and in much of the world bribery is de facto necessary cost of doing business. Nevertheless, Barclays may have had an organizational culture similar to that of Wells Fargo in which anything goes in pursuit of profit.

The full essay is at "Bribery at Barclays."

---

1. Chad Bray, “Former Barclays Executives Appear in Court Over Qatar Deal,” The New York Times, July 3, 2017.

ECB Poised to Approve Italian Bailout of Monte dei Paschi Bank: An Instance of Federal-State Collusion?

Under the E.U.’s banking law enacted after the 2008 financial crisis, the state governments “are not supposed to inject fresh taxpayer money into a bank if it is deemed insolvent. When a bank gets into financial trouble, shareholders and bondholders, assumed to be sophisticated investors aware of the risks, are supposed to take the hit and bear the losses.” Much of the banking reforms were intended, moreover, “to prevent banks from becoming so big and so risky that they could hold the global economy hostage. Politicians and policy makers didn’t want taxpayers to be on the hook for the banks’ mistakes.” What about a mid-sized bank whose financial plight puts a state’s economy and reigning political elite in jeopardy? Should the E.U.’s central bankers look the other way and allow the state’s government to finance a bail-out so stockholders and bondholders need not feel the brunt?

The full essay is at "Essays on the E.U. Political Economy," available at Amazon.

The Strategic Use of Regulation in Government: A Proposal to Split-Up the Big Banks

The strategic use of regulatory reform is no stranger to businesses—especially to the strongest both financially and, relatedly, politically. Such proposals of more regulation are crafted not to benefit the macro economy or even the industry; rather, the point is to enhance a dominant firm’s competitive advantage over rivals. It follows that such proposals are not counter-factual to the thesis that republics are susceptible to the gravitational pull of plutocracy, the rule of wealth. A case in point is the U.S. Trump Administration’s consideration of a legislative proposal to reinstate the main content of the Glass-Steagall Act, which had separated commercial and investment banking such that a bank could not do both.

Gary Cohn, former number two at Goldman Sachs, talking to U.S. senators on behalf of the Trump Administration.

(source: Andrew Kelly, Reuters)

The full essay is at Strategic Use of Regulation.

A Greek Referendum on Creditor Demands: Orchestrated Impediments to Reaching the People

On June 27, 2015, Greek Prime Minister Alexis Tsipras announced a referendum on whether Greece should accept additional austerity in the form of tax increases and pension cuts as demanded by the state’s creditors. Putting the ultimatum from lenders to a popular vote translates into political theory as governmental sovereignty—the portion retained by the E.U. state—voluntarily submitting to the popular sovereign, which is the more fundamental sovereignty in any democracy. “Our responsibility is for the future of our country. This responsibility obliges us to respond to the ultimatum through the sovereign will of the Greek people,” Tsipras said in a televised address.[1] More abstractly, deferring to the people on a major policy question is the responsibility, or duty, of any democratically-elected government. Sadly, few heads of government and legislatures even acknowledge this duty, let alone act on it. In this essay, I address the Greek case as a way of illustrating a few of the drawbacks of appealing to popular sovereignty through a referendum, while still holding that the duty itself is valid. I contend in particular that Tsipras’s Greek opponents, E.U. officials, and the state’s lenders (through government officials in other E.U. states) intentionally sought quite disrespectfully to manipulate Greece’s popular sovereign by distorting the question on the referendum to get a “yes,” or “oxi” result. That is, federal and state officials in the E.U. sought to scare and confuse the popular sovereign of one state—bullying, in effect, the basis of democracy itself for power and money.

 Greece's PM Tsipras looking rather fatigued after meetings on the bailout. (John Thys AFP/Getty)

The full essay is at "Essays on the E.U. Political Economy," available at Amazon.