Bonus busters

Anybody still braying with populist fervor over the retention bonuses at AIG should have a look at this letter of resignation from Jack DeSantis, recipient of one of the million dollar contracts that created all the stir. It certainly resolves the questions I was left with last week when I advanced my "sneaky secretary" hypothesis (which turns out to be invalid, by the way.) A few interesting points, widely overlooked:

• In the case of DeSantis, at least, the retention bonus was to be his entire compensation for the year. Like Liddy, his salary for the year was one dollar.
• A relatively small number of employees of AIG's Financial Division were involved in the credit default swap mess, and almost all of those are gone from AIG.
• Confronted by frothy-mouthed Congressmen, Liddy just quaked and quivered, failing to explain the justification for offering the bonuses -- justification that actually makes some sense if you're not choking on your own bile.
  

By the way, this is not to say that I think anybody is worth more than a million dollars a year. If you can't manage to have a really nice life on one million plus benefits, you're not smart enough to be earning that much. Even DeSantis says, "Some might argue that members of my profession have been overpaid, and I wouldn’t disagree."

(I'm also one of those who believes that the highest paid employee of a company should not be earning more than twenty times what the lowest paid employee earns. If the CEO is paid a million, the clerk doing data entry should be paid fifty grand -- but since this entry is not entitled "utopian schemes," I'll say no more about that idea.)

Anyway, if a Congressional Committee ever manages an opportunity to question, say, Dick Cheney or Donald Rumsfeld, I hope it can manage to be a lot more focused and thoughtful than Financial Services was when it grilled Ed Liddy. Anybody who needs bloviation and outrage can listen to Rush Limbaugh. From our elected representatives, I think we deserve something more.

Detoxification of the banking industry

I've had a chance to look at the new bank detoxification plan. On the surface, it has some positive features, foremost among them the opportunity to get a better idea of what the frozen assets are worth. If hedge funds or private investors are willing to risk any of their own money, one would assume they think there is a reasonable chance of turning a profit -- especially in the current, risk-averse environment. If "Hedgehog Investments", say, will bid fifty cents on the dollar for a batch of Citi's CDOs -- even with 93% government leverage -- one could finally establish at least a nominal value for those CDOs -- half of face value.

True, without the government leverage Hedgehog would not have bought them at all, but by buying a diverse assortment of derivatives the Hedgehog traders might assume that some of those would turn out to have real value. (This is the classic definition of a "hedge.") On the winners, Hedgehog takes 50% of the profits. On the losers, the taxpayers take 93% of the losses. Do the math. If a substantial majority of the paper is pure crap, Hedgehog still comes out ahead -- but unless the opposite is true, and most of the paper turns out to be worth more than the price paid, the taxpayer loses, big time.

Great deal, huh?

Let's look a little harder. Under Treasury's plan, the banks get to decide which assets go up for sale. The most senior tranche of a security -- the shareholders entitled to be paid first when the asset pool is distributed -- is fairly safe even if the security as a whole is not performing well. Banks traditionally hold on to those senior shares. The problem for megabanks like Citi and BofA was that they were unable to unload the more junior tranches, and are stuck holding them on their books. Only those junior tranches will go to the auction block, and I think it is safe to assume that, by this late date, the banks have a pretty clear idea of which are likely to yield a profit and which are completely worthless.

Trying to get rid of the ones that are totally worthless may be tempting, but hedge fund managers rarely are total idiots, so nobody will want to buy the most junior tranches. Nobody buys a turd, no matter how deeply discounted it may be -- so the bank that made the offering would be forced to mark down the unsold turds on its books, perhaps all the way to zero. Uh oh! Here comes formal insolvency! Better to keep the turds on the books, and pretend they're still worth thirty or forty cents on the dollar.

So all trading necessarily will be in the middle tranches, but even with their heavy government subsidies, private investors still may be unwilling to pay as much as the banks need to regain real solvency. It's quite possible that hedge funds will make large profits, taxpayers will suffer enormous losses, and the big banks still will fail.

Here is one last scenario -- and I certainly hope somebody at Treasury has thought of it and is making sure it can't happen:

Citi bids 100 cents on the dollar for $300 billion worth of B of A's most toxic "assets." Under the government program, Citi puts in $21 billion of its own money, and the rest comes from the government. In the meanwhile, B of A bids 100 cents on the dollar for $300 billion worth of Citi's most toxic assets, similarly investing $21 bilion of its own money. Then, both Citi and BofA "discover" that the assets they bought are worthless, so each writes down $21 billion in losses. Each bank ends up $279 billion ahead of when it started, and the government is on the hook for $558 billion. Brilliant!

In that scenario, the taxpayers have purchased a truckload of worthless crap for 93 cents on the dollar -- probably a substantially higher price than even Henry Paulson would have been willing to pay. Could the banks get away with it? Not in the form I just presented it, but with appropriate use of proxies and the usual lack of transparency, perhaps. With complicity from key players in government, well...

Doesn't it make a lot more sense to nationalize all the big banks that can't make it on their own -- now? Fire the thieving buffoons who ran their banks into the sewer, and replace them with technocrats on the government payroll. Let those specialists take as many years as necessary to break up the megabanks and and sell off their assets, getting the best price possible for the taxpayers. In the meanwhile, Congress must enact legislation to make certain that no bank ever again becomes too big to fail. (Glass-Steagal comes to mind, for starters!)

A bank that is too big to fail is too big to exist. If Obama and company would just grow some balls and stop cringing when Republicans call them naughty naughty socialists, they will discover a great deal of popular support. Americans will accept nationalization, provided the "evil, greedy bankers" who "did it to us" are punished.

AIG again, again

About fifty years ago, I remember my mother telling me how a secretary could provide herself with job insurance. The trick was to reorganize the boss's filing system -- so that she was the only one who ever could find anything. I don't know if my mother ever really employed that system, but when I heard about how the jerkwads at AIG who wrote all those toxic credit default swaps had to be paid retention bonuses because they were the only ones who could figure out the mess they'd created, I wondered if their mothers, too, had worked as secretaries.

Most of America is outraged by the bonuses, but I'm bothered a lot more by the payouts to the banks that bought the CDSs. Yes, I wonder why American taxpayers are bailing out foreign banks, but even more important to me is the question of why the securities insured by AIG were purchased at book value. Who made that decision? Could it possibly have been the very same jerkwads who orchestrated the CDS debacle in the first place, and who now will collect bonuses for "unwinding" the mess they made?

One thing is certain: Geithner, Summers, Bernanke and, yes, Obama all have been entirely too deferential to Wall Street to this point. Unless the President shows some genuine guts and leadership soon, those high approval ratings he's enjoyed so far will plummet like the Dow.

Again, again, again (later)

And so it seems, according to NPR, that Edward N. Liddy, Obama appointed CEO of AIG who testified before Congress today, says the executives who designed and sold the credit default swaps all have been fired -- the guys collecting (or voluntarily giving up part or all of their) "retention" bonus payments in the CDS division are not, perhaps, the same guys who screwed the company and the American taxpayers and the world.

That would appear to sink my "secretary's new filing system" hypothesis -- but it also would appear to sink the "We have to keep them because they're the only ones who understand it" hypothesis. Me, I figure the bullshit still is flying fast and thick. We can't have any names of executives, it seems, because if their names became public they might be strangled with piano wire. (No kidding! That's exactly the justification for secrecy Liddy offered Congress.)

So we must wait, and see, and put our faith in Barney Frank, I guess.

The N word...

It's pretty bad when things are changing so fast you have to print your own bumper stickers -- or, perhaps, when liberals are so confused they can't figure out what they, collectively, want.

Okay -- not every liberal wants collectivization, but hell, sometimes it's just time.

There are two ways to break up companies said to be "too big to fail." One is to withhold bailout funds so as to force them into bankruptcy, the "let the free market sort things out" method. The other way is for government to wade in and do it. How?

Let's look at the government's options. One possibility, I suppose, is to bring anti-trust suits against the largest of the financial companies. Anti-trust suits, though, take years. We don't have years. Another possibility is for Congress to repeal the loathesome Gramm-Leach-Bliley Act and bring back something resembling Glass-Steagall. Then, presumably, megabanks like Citigroup would be obliged to break themselves up. Given the powerful obligations of members of Congress in both parties to the finance sector, that's not about to happen any time soon.

All that remains, as far as I can see, is nationalization -- government takes over the overbloated banks, wipes out the shareholders, slices, dices, and sells off the healthy assets for a fair price. The taxpayers still are stuck with the toxic assets, but at least it's not a total loss. Writing in the Times, though, former Fed governor Alan Blinder offers what he says is an alternative -- the "good bank, bad bank" solution, in which "the basic idea is to break each sick institution into two. The 'good bank' gets the good assets..." and "the 'bad bank' inherits the bad assets."

Huh? How does government break up the bank without first nationalizing it? And while it's clear that the taxpayers are stuck with the "bad bank," who gets the assets of the "good bank?" Surely not the shareholders -- that would be moral hazard of the worst kind.

AIG again

How about a real stress test?

So here come another $30 billion for AIG -- but when you take a good, hard look, it's not for AIG. Who is it for? Nobody at AIG, nor in the Obama administration, is being especially transparent about that.

AIG lost $62 billion last quarter, and without another bailout would have had to default on its "obligations" to banks all over the world. Without the bailout, that is, all the idiotic credit default swaps AIG issued would be worthless, and banks all over the world would have to write down a load of bad paper. To wit, the Treasury continues to animate zombies -- not just in the United States, but everywhere else as well.

Naturally, this can't be the last bailout. As AIG continues to pay out claims on credit default swaps, it will continue to hemorrhage money, and Treasury will continue to cough up the vast sums needed to keep it alive -- but, do American taxpayers really want to bail out banks in the UK and Switzerland? How about the France and Germany? How about China?

At the risk of boring anybody who actually reads this blog on a regular basis, I will lay out my AIG prescription yet again. Split the company into it's four component divisions, and take the finance division into bankruptcy -- that is, default on all those credit default swaps. That will leave the "insured" derivatives worth whatever they really are worth. That's a real stress test.

Bailing out our own mismanaged banks is bad enough. We really can't afford to bail out the world.

Dereaganizing America

Can they do it? Can Obama & Co. actually manage to undo close to three decades of damage? Can they they, at long last, end the Age of Reagan?

Needless to say, I'm hoping the answer is "yes." I have especially high hopes for tax restructuring, bringing back some of the progressivity lost over the years. If it were my call, the restructuring would be considerably more aggressive, with a top marginal rate somewhere around 45%, but just getting back to Clinton era taxation is a step in the right direction.

Frankly, however, I think the middle class cuts may be a mistake. It's always a lot easier to cut taxes than to raise them, and one of the main reasons we have the deficit problems we do today is because every politician is a Keynesian in rough times, happy to slice taxes and increase spending. The real problem comes in periods of rapid growth, when Keynes would have us increase taxes and cut government spending. There's no real incentive to do it, because tax collections are going up with increased incomes and business activity. Government is flush with cash -- so why would a politician even consider raising taxes or bringing home a bit less pork?

As a matter of fact, in good times politicians are inclined to cut taxes even more than in bad times -- because government seems to be able to afford it -- but that's always a really bad idea. The Keynesian model is to build a surplus in the good times, to offset the deficits incurred when growth is off and stimulus is needed. Putting on the brakes when growth is accelerating also reduces the likelihood of bubbles -- and we've all come to know what those can do.

As for aspects of tax policy other than income tax, where all Obama really has to do is wait for the Bush tax cuts to expire, some real effort will be required. The problem is not the Republicans, who are so closely identified as lackeys of the rich that they have virtually no legitimacy at this time. The problem will be Democrats with obligations to various special interests. If direct payments to agribusiness are substantially reduced, I'll be pleasantly surprised. There's a better chance, I think, of eliminating the subsidies for insurance companies providing Medicare Advantage, but it's certainly not a done deal.

The "experts" are finally coming around to the point of view that most Americans have held all along -- that the economy is in worse shape than government and business leaders have been willing to admit. I find it very hard to believe that the unemployment rate will stay below 10% for the remainder of this year, and I wouldn't be at all surprised if it went higher still. Consider that employment levels are very slow to recover even when the economy starts expanding again, and you have to admit that America's problems are likely to be around longer than the Obama administration might like -- and possibly longer than the Obama administration.

I'm trying to look for the silver lining. The egalitarian economic opportunities of the 1950s and 1960s, a generation of real advances for average workers, were made possible by the vicissitudes or the Great Depression. If it takes hard times to re-establish social and economic justice, than hard times are just what we need.

Human memory is short, of course, and history (as my former students insisted) is "boring," so eventually the locusts will descend again. In the meanwhile, though, we should be spreading as much economic insecticide as possible.