Crash Bang Wallop

Steven Long

It’s hard to escape the irony. Two decades ago, the historian Francis Fukuyama proclaimed the end of history with the triumph of American capitalism.

But Socialism, for Wall Street, is alive and well. After the bail-outs AIG, and the mortgage companies Freddie Mac and Fannie Mae, the Bush administration has in effect nationalised key parts of the finance, housing, and insurance markets.

Prof Willem Buiter

Is the reality of the modern, transactions-oriented model of financial capitalism indeed that large private firms make enormous private profits when the going is good and get bailed out and taken into temporary public ownership when the going gets bad, with the tax payer taking the risk and the losses?

If so, then why not keep these activities in permanent public ownership? There is a long-standing argument that there is no real case for private ownership of deposit-taking banking institutions, because these cannot exist safely without a deposit guarantee and/or lender of last resort facilities, that are ultimately underwritten by the taxpayer.

Ah for the good old days when the money was kept under the bed along with the Reds.

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JC
JC
13 years ago

Can we stop using the word socialist/ bailout to describe the Fed’s actions with AIG. It was not a “socialist bailout”- the latest fashionable term that people seem to fond of using. It was what I would call a punishing intervention.

1.AIG senior managers have been fired.

2. The new managers appear to be the Fed’s advisers from Morgan Stanley and Goldman Sachs.

3.The Fed lent the money at 850 basis points over Libor (3.3%) or 10% over fed funds (2%)

4 the Fed has first ranking over the assets of the firm (US$ 1trillion)

5. The Fed was also granted a warrant over 75% of the firms stock struck at what I have seen is a good price.

Unfortunately we live in an interventionist world that causes most of our economic distortions. The sheer size of AIG and its certain failure would have created untold problems in the financial world.

As someone with libertarian instincts I have real problems coming to terms with this deal.

However theres no way the US taxpayer is going to lose a cent from this deal. In fact they will come out with better terms than back alley Brooklyn loansharks and far more security. Its sex all right, but the Fed is using a condom that is friggen 1 inch thick.

Its intervention of a punishing form.

I think on balance the Fed made the right call, fully protected the taxpayer and will make a huge spread on the loan and all the while trying to avoid a disorderly liquidation.

And please dont try the too big to fail excuse either. They arent too big to fail as the Fed has basically put them into liquidation and is only attempting to ensure financial order as the sale of assets goes through.

So before instinctive interventionists try to use the AIG as an example to green light government spending I expect you to come up with similar terms and conditions.

1. Loan spread of at least 10% over the vig.
2. Outside advisers from MS or GS working arms length
3. Throwing out the management
4. Getting a warrant on 75% of the stock for zero cost stuck at the money.

When someone can present a deal like that and demonstrate we can get our money back because we have first charge over the assets then I suggest we tip the entire surplus into it and make the spread.

JC
JC
13 years ago

But Socialism, for Wall Street, is alive and well.

No Rex it isn’t. It’s the final nail in the coffin of that fucking monstrosity of the 30’s intervention that the Clinton Administration got rid of in 1999 but took all this time to finally come to an end. Wall Street is dead as it should have never existed but did only because of the monstrosity Glass Steagull that forcibly separated Investment banking from regular banking. It took the monster 80 odd years to be finally stuffed in the coffin and buried 80- feet deep. It’s still kicking and screaming but it’s in the final throws of life.

Goldman Sachs and Morgan Stanley the only two left standing will be gone within weeks – swallowed up by commercial banks which is where those sorts of operations should have always resided. In fact that what the Fed seems to be agitating for but isn’t openly prepared to admit it.

conrad
conrad
13 years ago

“Can we stop using the word socialist/ bailout”

JC, you tell that to all the companies that didn’t make crazy decisions that shouldn’t now still have AIG as a competitor.

“Its the final nail in the coffin of that fucking monstrosity of the 30s”

What year did all those credit derivative etc. get invented JC?

NPOV
NPOV
13 years ago

JC – the point is that the dollars of *every* taxpayer, regardless of whether they have anything to do with AIG or not, are being used, without their express consent, to ensure that AIG can remain a *profitable* business, that you know as well as I do will continue to make certain people very rich.

It’s very hard to see how we can justify allowing 100% private companies to reach such size and complexity that governments are effectively forced to prevent failure at any cost.

Patrick
Patrick
13 years ago

that you know as well as I do will continue to make certain people very rich.

Out of curiosity, which people are these?

Rex
Rex
13 years ago

JC – It was Steven Long not me that used the S-word. And it’s a term that’s been bandied about a lot with respect to this situation – so the meme is out there whether you like it or not.

Regarding the bailout itself – who knows whether the bailout was the right thing to do or not? Plenty of people have got an opinion. Some say it’s necessary to stop the whole system falling apart. Others say it will lock in the rot – like the bailout of Chysler led to the current malaise in Detroit. I don’t know.

What I do know is that circumstances where profits are privatised and losses socialised is intrinsicaly wrong, and so when the taxpayer is forced to step in to clean up the excesses – the punishments for those who contributed to those excesses should be brutal.

I’m concerned that in many of these circumstances – the corporate boffins who designed the transactions and took their cut of the funds as they went through their hands, and made a killing on options during the upside, may well have gotton away scot free – leaving the pension funds and others to wear the hit on their equity.

So you say that AIG senior execs have gotten the bullet. Yeah So what? They pushed out the previous CEO Martin Sullivan in June – and he was paid $13.9M salary in the previous year for overseeing at least part of the debacle.

Something’s wrong with the way these execs are compensated if they can get away with such a windfall, while everyone else wears the pain.

JC
JC
13 years ago

Well Rex, I presume that if you link to someone’s comment you’re probably agreeing with them unless otherwise states.

Executive payout is a different issue. You may find it’s wrong but it all depends on their contract and the exit clauses.

What I do know is that circumstances where profits are privatised and losses socialised is intrinsicaly wrong, and so when the taxpayer is forced to step in to clean up the excesses – the punishments for those who contributed to those excesses should be brutal.

Please show me where this is happening with the AIG deal. It’s a fucking punishing deal for the AIG shareholders. It’s the other way around if you had bothered to read the terms of the deal. The government is walking away like bandits and there are no losses that are socialized.

Conrad, N.

Please, Find another “Socialist bailout” with the same terms and conditions as I want to see Oz invest in it.

Rex
Rex
13 years ago

JC. I’ve no doubt that the AIG shareholders are being punished – and I bet the retirees who were relying on their AIG shares to fund their last few years are not happy campers.

The question is – Are they the ones who should be being punished – or should there be some comeback built into exec contracts so that walking away unscathed with a tidy $13 Mill is no longer possible?

I think you dismiss the matter of exec payouts too lightly. I think that executive contracts should require that they have significant skin in the game for up to five years after they’ve departed the firm.

Such a tie in would create an incentive for senior execs to look beyond the quarterly profit announcements, reduce the fatal weakness of short-termism in a lot of Western firms, and improve succession planning.

JC
JC
13 years ago

Rex:

JC. Ive no doubt that the AIG shareholders are being punished – and I bet the retirees who were relying on their AIG shares to fund their last few years are not happy campers.

Yea, it’s tragic. It’s an absolute friggen tragedy with what’s gone on. But that’s an entirely different issue for the ” socialist bailout” that every big spending type like Krugman and the unthinking Floyd Norris (NYTimes) keep incorrectly referring to. Krugman especially because he’s trying to use this mis-reference to fry other fish (he almost always poisons the well with everything he touches).

I think you dismiss the matter of exec payouts too lightly. I think that executive contracts should require that they have significant skin in the game for up to five years after theyve departed the firm.

Such a tie in would create an incentive for senior execs to look beyond the quarterly profit announcements, reduce the fatal weakness of short-termism in a lot of Western firms, and improve succession planning.

How exactly does that work though? And how does a firm that’s in trouble like an AIG attract a talented person to try and sort out the mess. It’s the boards and the shareholders that need to make sure they find good managers.

David Rubie
David Rubie
13 years ago

JC,

“Socialist bailout” is entirely appropriate when the Fed is the only entity who will loan money to save AIG. Either the other market participants aren’t interested in undercutting the Fed (and you state above the Fed is getting a helluva deal, so surely someone could do it cheaper) OR the other market participants are flat broke.

It’s the second one by my reckoning.

Not, it’s not an excuse the nationalise the whole finance industry, but the US Govt. couldn’t afford to do it anyway, at any price. They’re bankrupt themselves and will be printing worthless paper to finance these deals. Hello stagflation.

Funniest part of the whole mess (not that burning ordinary folks hard earned is at all funny) but suddenly all those free market CEO’s don’t have any confidence in the market mechanism itself: Morgan Stanley CEO for example griping about short selling when the same market practice payed for his last yacht. I’d be laughing even harder if I hadn’t taken a rather sobering glance at my last superannuation statement. We’ve all got skin in this game.

Francis Xavier Holden
13 years ago

aah. The Vig.

All else is fleeting.

JC
JC
13 years ago

Dave

Why assume that CEO’s are free market types? They just greedy pigs like the rest of us.

Morgan Stanley CEO for example griping about short selling when the same market practice payed for his last yacht. Id be laughing even harder if I hadnt taken a rather sobering glance at my last superannuation statement. Weve all got skin in this game.

John Mack is a good guy. He was my boss… er well a few rungs down. but yes, if he said that he is being a little hypocritical. However I would excuse that to emotional turbulence. The firm reported a quarterly profit of 1.5 billion the other night and the stock gets knocked down 40% +. Anyone would be a little shitty and not thinking straight if that happened to them. He’s a great manager by the way.

Weve all got skin in this game.

Yea, tell me about it. I went to cash a while ago and still nervous :-). I was talking to a buddy yesterday and he asked if I thought the bank I was with was safe.

David Rubie
David Rubie
13 years ago

JC wrote:

I was talking to a buddy yesterday and he asked if I thought the bank I was with was safe.

That’s the trouble isn’t it – nobody knows for sure. You have to admire the chutzpah of Standard and Poors re-rating outfits like MBL when their own stupidity in rating all that junk mortgage debt in the past caused the problem in the first place. If there was any justice, it’d be S&P walking the plank, not Morgan Stanley and the like.

I want to see what happens in the next week or so after the brokers are through making all those margin calls to people who borrowed money against their over-inflated houses to invest in shares, who suddenly discover their lines of credit have gone. Actually, on second thought, I don’t want to see that.

JC
JC
13 years ago

Dave:

Wood away from the trees, it’s one huge de-leveraging process going on. That’s what it is. I reckon the market is cleaning up the shit right back to the Tech crash. It’s Greenspan’s fault by the way. He ought to be the one thrown under a train for keeping rates low for too long and allowing people to think they were some sort of financial gods.

David Rubie
David Rubie
13 years ago

JC wrote:

I reckon the market is cleaning up the shit right back to the Tech crash. Its Greenspans fault by the way.

Maybe. He’s certainly a convenient scapegoat. That whole “narrowly avoided recession” should probably have happened, but perhaps there’s just a little crony capitalism to be blamed as well – while the party was on, it was glorious indeed and the participants just couldn’t be persuaded to go home, but they could lean on their generous host for another round of drinks. I’d characterise Greenspan as an “enabler” rather than sheeting the whole thing home to those interest rate decisions.

One more interesting quasi-conspiracy starting to circulate is that the fed is only bailing out institutions with large foreign investment – although I can’t tell whether Lehmans was allowed to fail just because it didn’t have enough Chinese/Saudi shareholders (something AIG has in spades).

NPOV
NPOV
13 years ago

Patrick, come back to me in a year’s time and tell me how much the CEO of AIG has taken home in the previous 12 months. But actually the real winners will be the traders who take a risk on the current discount share price and will do very nicely out of it once AIG is back on its feat. And do you think one of them will thank the U.S. taxpayers for making it possible?

As for the idea that bail-out is somehow “punishing” shareholders, are you seriously arguing that letting the company go bankrupt would be better for them?

JC
JC
13 years ago

One more interesting quasi-conspiracy starting to circulate is that the fed is only bailing out institutions with large foreign investment – although I cant tell whether Lehmans was allowed to fail just because it didnt have enough Chinese/Saudi shareholders (something AIG has in spades).

Dunno. Don’t think so as everyone seems to fessing up to having Lehman exposure…. even local councils like Manly (I think). How the hell Manly gets to hold Lehman’s exposure is one for the gods to debate.

I think AIG was sacary because they held all that credit defualt swaps and if they had gone under it would have damaged the credit ratings of the banking system around the world.

———

I read somewhere that the marks to market in some of Lehman’s books were made in heaven as they were valued at bull market levels. If that’s true there should be jail time for a few of the naughty kids.

Taking a clinical view of things… This has to be the most interesting market I have ever seen and will likely ever see. There’s some dark humor in this when you have Morgan Stanley report a quarterly profit of US$1.5billion and the stock tanks 40%. I guess the stock would have rallied 50% if they had shown a massive loss :-)

I think the millionaire factory is in a spot of bother. It may be easier to simply set up a centreLink subsidiary their office as they could get busy. Hey maybe they could privatize CentreLink…. set up a satellite pump it up with debt , pay out all the money to retrenched executives from the loans… and then float it at a premium. Oh shit they tried variations of that already and that model doesn’t seem to work……:-)

JC
JC
13 years ago

And do you think one of them will thank the U.S. taxpayers for making it possible?

N, there no hope the stock holders will make much out of it as the Fed now has an at-the-money warrant on about 75% of the stock. The existing shareholders are dead. Why thank a them when they could have got better term from the local loan shark in Brooklyn? The Fed is making out like bandits on this. Seriously, Swan should call the Fed and ask if we could put our entire surplus in the deal and split the profits.

As for the idea that bail-out is somehow punishing shareholders, are you seriously arguing that letting the company go bankrupt would be better for them?

There’s no upside for them any longer. Their money is gone. Do you understand how the warrant will work? I figured it out. The warrant gives the Fed all the upside on the stock in case they make money and the price goes up. I also think they kept it listed to show the firm is still operational and ” liquid” otherwise it could have impinged on the credit ratings of other firms.

It’s a masterful deal, by the way. It’s an investment bankers deal made in heaven :-) .. A client with a pocket full of cash and the target that has little say on the terms. Only a NY investment banker could have thought of such terms and take delight at seeing the pain :-)

David Rubie
David Rubie
13 years ago

JC wrote:

I read somewhere that the marks to market in some of Lehmans books were made in heaven as they were valued at bull market levels. If thats true there should be jail time for a few of the naughty kids.

Not going to happen, plausible deniability for starters (just shrug and say that’s what every was doing, blame the reval software and/or quants for screwing up the models, point finger at historical market and say “once in a lifetime” or “act of god”), or just click your heels together and say “there’s no place like home”. I would assume that every one of the investment houses knew exactly what would happen if a debt default occurred after what happened with LTCM – it wasn’t that long ago.

It’s going to be very hard to find concrete evidence of misleading market statements, since it’s been common knowledge for an entire year that the market was basically a huge staring contest. Lehmans just happened to blink first.

JC
JC
13 years ago

Dave:

This is America we’re talking about so let’s get this straight:-) After every major collapse they always the round up a few of the usual suspects and make them do the perp walk from the cop car to the steps of the court house in chains and handcuffs. Always happens and always will. I reckon the betting houses ought to run a book on who’s it going to be this time. I’d put money on Dick Fuld after this pic.

Rex
Rex
13 years ago

JC.

How exactly does that work though? And how does a firm thats in trouble like an AIG attract a talented person to try and sort out the mess.

I think the US government – now being the owner – won’t have a problem appointing a white knight to sort out AIG.

In principle my thoughts on “how the execs get long term skin in the game” is this:

1 The fixed cash component of renumeration must be reduced. Say no more than 40% of the total renumeration
2. Another 20% can be based on hitting short term bonus targets
3. The remaining 40% of renumeration is delivered as a serious of options that are a granted annually at a reasonble strike price, and mature at 3 and 5 year intervals after being granted. That means that the exec only gets his final payout five years after he’s departed the scene – and its based on the share price of the company long after he’s departed. – He’d be incentivised to make sure that there was a long term and effective strategy in place – Not just some short term get rich quick play.

Michaeel Kalecki
Michaeel Kalecki
13 years ago

Ah just when people were warning us about the dangers of Trade Unions Investment Bankers show they are far more dangerous.

Who will determine the ownership of this firm IF it recovers?

The Government. Government ownership = ?

in this case it had to happen because it was far too big to fail.

This had all to do with Bush ad the lack of proper regulation and nothing to do with Clinton.

JC
JC
13 years ago

Always rely on you Homer to ruin a perfectly reasonable conversation. Homer is Michael by the way, wearing an upside down mustache and black rimmed glasses thinking we won’t recognize the hound.

lets Fisk “Michae”, shall we:

Ah just when people were warning us about the dangers of Trade Unions Investment Bankers show they are far more dangerous.

Yes Homer, people have also been warning about the dangers of plane crashes yet lots of people die in car accidents. What’s your point? Investment bankers are advisers homer, they had nothing to do with sub-prime as their specialty is mergers and acquisitions. I think you’re after the origination desks. These dudes are your culprits.

W

ho will determine the ownership of this firm IF it recovers?

The Fed owns 75% of the stock, Michael. They call the shots.

The Government. Government ownership = ?

Is this another one of your trick questions, homes. Let me see is the answer is…

A duck?

in this case it had to happen because it was far too big to fail.

What had to happen? It has failed economically, the Fed didn’t let it legally fail.

This had all to do with Bush ad the lack of proper regulation and nothing to do with Clinton.

ummm why? And why bring Clinton into it anyway. He did a good thing getting rid of Glass Steagull. As usual you were asleep at the back of the class. Please keep up, Homer.

JC
JC
13 years ago

Rex:

You think that should be legislated or the Boards make that decision?

JC
JC
13 years ago
Rex
Rex
13 years ago

JC – I think it should be strongly encouraged by regulators and ratings agencies as an indicator of a well managed company. Companies without an incentive plan that encourages long-termism are views as potentially reckless and a bad risk.

Michaeel Kalecki
Michaeel Kalecki
13 years ago

JC ,

you brought up Clinton and it was very silly.
you are the one trying tortuously to explain why the government doesn’t control this monolith insurance company.

Please note the difference between the regulatory standards between the USA and Australia.

the subprime debacle would have never got off the ground in Australia.

JC
JC
13 years ago

Yea, that’s probably a good point Rex. The issue as i see it is that it may become really hard to move people from one firm to another if they aren’t offered an attractive enough deal, so that it then retards competition..

I used to find it really hardly to move traders from one firm to another if they weren’t guaranteed for a couple of years even if they had a bad year. People don’t move without an inducement and those that are available may not be much good at their job.

Maybe you’re right tough, maybe the regulators can push the envelope in terms of forcing firms to set up longer terms incentives. They are there by the way. The trouble on wall street is that no one trusts one another from quarter to quarter. if management thinks someone isn’t performing they’ll fire people in a heart beat. The other side is that people become very mercenary which is understandable too.

JC
JC
13 years ago

JC ,

you brought up Clinton and it was very silly.

You really are annoying, homer, which is why to receive a great deal of abuse from most people at every blog. I brought Clinton in passing in that he did the right thing and removed Glass Steagull. It was a observation by the way and I was being complementary, which I’m sure you never understood it as such. You thought i was rebuking him, right?

you are the one trying tortuously to explain why the government doesnt control this monolith insurance company.

Homer, the Fed/ government does control it. Christ you’re incoherent at times. Of course the government controls it.

Please note the difference between the regulatory standards between the USA and Australia.

Oh yea. Okay. There’s about 70,000 pages of regulations that impact on financial firms and individuals in the US. Please contrast and compare with ours and tell us what you find. Off you go.

the subprime debacle would have never got off the ground in Australia.

And you know why? Tell us Homer.

Michaeel Kalecki
Michaeel Kalecki
13 years ago

JC,

you tortuous logic has the Government controlling the company but not owning it!

learn what sub-prime loans are and then try to understand why they really do not exist in Australia.

Even getting a no doc loans involves putting up property as collateral.

JC
JC
13 years ago

Okay Homer, the government “owns” it. Sheesh i didn’t realize the space between “own” and “control” would get you so angry. Here’s an idea, instead of using the word “own” or “control” why don’t we just use the word “rectangle” so we meet in between.

So the government rectangles it now whereas previously the shareholders rectangled the firm.

(is that better, homes)

learn what sub-prime loans are and then try to understand why they really do not exist in Australia.

Umm well actually we did have no doc loans but we’ll leave that as an aside.

Even getting a no doc loans involves putting up property as collateral.

Yes, we all know Homes.

Michaeel Kalecki
Michaeel Kalecki
13 years ago

if you read the half yearly stability review you would see the no docs loans are on the periphery.
Moreover given we have recourse if people walk away from their loans they still have to pay it.

They are a couple of reasons why we a light years away from the USA.

niall
13 years ago

since when is a loan with punative conditions the same as a ‘socialist bailout’?

NPOV
NPOV
13 years ago

niall, I’m sure Friedman would’ve called it socialism.

What I can’t work out is whether those who are calling the bail-out socialism are meaning to imply that socialism is a bad thing.

Patrick
Patrick
13 years ago

This had all to do with Bush ad the lack of proper regulation and nothing to do with Clinton.

This much is simply bollocks. What regulations did Bush not promulgate that you would have liked? Or are you blaming SOX? (Not such a bad idea, it certainly hasn’t helped).

Tel
Tel
13 years ago

Even getting a no doc loans involves putting up property as collateral.

Centro also had property as collateral.

Tel
Tel
13 years ago

Executive payout is a different issue. You may find its wrong but it all depends on their contract and the exit clauses.

You can have any contract you like, but when the company has no money, they can’t pay. The CEO can have fun waving his piece of paper in bankruptcy court whilst standing in queue with all the other creditors waving invoices, time sheets, tax forms, promissory notes, and what have you. A statutory ruling that all senior executives come LAST in the pecking order when the company goes belly up would be an excellent idea.

The government is walking away like bandits and there are no losses that are socialized.

Arrrhghgh! Bandits ye say? Forced em at the point of me cutlass, prepare to be boarded so all hands can bail ye out. Avast! When two parties accept a transaction of their own free will, that thar be a deal, and ye be makin’ merchants of us pirates. Arrhgh! I’ve known a man to take an offer, and the offer was none too pretty either, but let me just say that the other offers on the table were worse and that be as fair a trade as any.

The remaining 40% of renumeration is delivered as a serious of options that are a granted annually at a reasonble strike price, and mature at 3 and 5 year intervals after being granted. That means that the exec only gets his final payout five years after hes departed the scene – and its based on the share price of the company long after hes departed. – Hed be incentivised to make sure that there was a long term and effective strategy in place – Not just some short term get rich quick play.

That makes sense to me, how exactly to pick the strike price?

Really, some sort of shareholder auction seems the only way that is reasonable. Suppose we let each key executive pick both the strike price of the options and a per-option sweetener cash price that they are willing to offer out of their own pocket (which might be zero), but we let shareholders decide how many options they are willing to sell at that price (selling “call” options against their own shares). If the exec picks a nasty low price, then they lose because shareholders will not take it up. If the exec picks a juicy high price, then shareholders know that they can sell the options at low risk to themselves (and they get enthusiastic because the exec would be seen to be bullish about the company future). Sounds like a fair system.

Note that, from a shareholder’s perspective, they might be happy to sell call options to the CEO at a better deal than what they would sell such options to sale on the open market — especially if they think this CEO is doing good things for the company. Indeed, the relative popularity of the top few execs could be seen by how generous shareholders were in each case.

Naturally, the final price and number of options offered to each executive should be a matter of public record.

JC
JC
13 years ago

I think the US market may have turned around with the rescue package and the shockingly illiberal restriction of not allowing shorts in 800 financial stocks. What a lousy thing to do. Anyway the US government has possibly decided to socialize the losses amounting to about $500 billion (is my guess). Pretty awful, socialistic thing to do. I guess it avoids having to spend a few trillion if they waited.

I would bet the poor suffering shareholders at AIG would have loved to have seen the package a week earlier though as it would have got them out of a hole instead of the nationalization. There must be a lawsuit in there somewhere:-)