You can blame the former ‘masters of the universe’ for the havoc they’ve wrought, but bear in mind they’ve all taken hits of 60-100 per cent of their net worth.
The global financial crisis burst on the scene in August 2007. Things have unravelled dramatically since. The last 13 months have seen $600 billion of net worth written down by financial firms. Bear Stearns has been absorbed by JP Morgan. Northern Rock has been nationalised, following a stunning display of effete ineptitude by the UK authorities. Bank consolidations have occurred in a number of countries. Financial authorities everywhere have been anxious to avoid bankruptcies. Growing fear about the solvency of financial firms could lead to outright panic, triggering economic collapse. Over $1.6 trillion has been added by global central banks in special liquidity facilities to keep credit markets lubricated.
In September, the crisis entered its most dangerous phase. It became abundantly clear that the institution-by-institution, string-and-cellotape approach taken by central banks and treasuries was not working. On September 15, the US Treasury and Federal Reserve let Lehman Brothers go bankrupt (for silly brinksmanship by its head), to show that they were concerned about future moral hazard. That gambit backfired. Merrill Lynch immediately had to be absorbed at a bargain basement price by the Bank of America. AIG had to be “saved” next day with loans of $85 billion and ownership of 79.9 per cent by the US Treasury and Fed. The world is now at the edge of an abyss overlooking the disintegration of the structures of global finance. Investment banking as a discrete business model has got a heart attack and died. Over the weekend of September 27-28, there was a run on a Hong Kong bank, Washington Mutual was taken over by JP Morgan, and Bradford & Bingley was “Northern Rocked”! Then there was Wachovia, Hypo, five Irish banks, Fortis, Dexia and others. How many more to come?
On September 18, the Fed chairman and US Treasury secretary proposed the Troubled Assets Recovery Programme (TARP). [Note: How do you let former rivals at Lehman’s go bankrupt one day, save AIG the next, come up with a bill for $700 billion for TARP to save the system the day after, and keep a straight face, while going down on one knee to Nancy Pelosi begging for help? That kind of “chutzpah” takes Paulson-sized cojones fertilised in a febrile environment like Goldman Sachs!]
But to come back to the point: these toxic assets were seen by the Treasury and Fed as gumming up the credit system, and creating concerns within the financial community about everyone else’s solvency. Each bank now suspects the other is broke, but is intent on hiding that ugly fact. If Citibank is afraid that HSBC and JP Morgan might be insolvent, and vice versa, they are hardly likely to lend to each other, no matter how much central bank-infused liquidity they happen to be hoarding — and they are hoarding plenty at a cost.
Worse still, the global banking industry does not have the wherewithal to sit down collectively, net out the trillions of toxic assets they have issued to one another, reduce the gross size of the problem to its net elements, pass the netted out obligations to TARP and get on with normal life. The crisis is now political as well as financial. What has stymied systemic solutions to stabilise finance are loud academic, journalistic and political calls to: prevent future moral hazard; object rhetorically to taxpayer bailouts; ensure retribution; and exact revenge for this debacle being visited on an “innocent” (really?) public. When a financial crisis is politicised, the victims are reason and common sense.
We need to dispose of all the wrong (but understandably human) questions that obsess us, so as to get on with fixing what is broken. The most bandied about of these pragmatically pointless questions include: (1) Who is to blame? (2) Are they being punished enough? (3) Why should taxpayers bail them out? (4) How much more government oversight and regulation are needed? (5) What must we do to curb the “market” in order to socialise profits and privatise costs (that is, to reverse of what we think has been happening so far)?
Who is to Blame? If you ask the media and the public, it is investment bankers; former “masters of the universe” who have morphed into incontinent infants. Their response to any shock now is to wet their nappies or beds. In the public mind, these poseurs, criminals and thieves, for years bundled mortgages into complex securitised assets that no one could value, overlaid them with complex derivatives that no one could understand, paid credit rating agencies to rate these toxic securities AAA, and sold them to the unwary (other supposedly sophisticated financial institutions such as pension funds, hedge funds and asset managers) for enormous fees from which they paid themselves excessive bonuses. They called this “innovation”.
Are these guilty (bankers?) being punished enough? Public opinion is that the bankers are not being punished enough for what they have perpetrated. They are being bailed out by taxpayers. Governments should now put a lid on executive compensation if we are not to exacerbate future moral hazard. You have to hand it to socialists and democrats. They never miss an opportunistic trick! But let’s look at some facts. Looking at stock price movements over the last year, the shareholders of global banks have taken hits of about 60-100 per cent of their value. The managers involved have taken hits of 60-95 per cent of their net worth. It was disgraceful that Charles Prince of Citigroup and Stan O’Neal of Merrill Lynch got over $50 million for non-performance. But the value of their stock options has gone down by 70 per cent in the case of Mr Prince and 90 per cent in the case of Mr O’Neal. Creative destruction and punishment for stupidity is at work. That is capitalism. The people responsible for this mess have not got off scot free; except perhaps for George Bush and Alan Greenspan. Even poor Hank Paulson has taken a 70 per cent hit in the value of his Goldman Sachs stock.
Bloomberg reported on September 26 that just over $3 billion was paid to their teams of top executives by the five major investment banks (GS, MS, ML, LB and BS) in 2003-07; about 80 per cent of that was in stock options. That $2.4 billion in stock is now worth less than $300 million. The present value of the compensation paid works out to $180 million per year to 25-30 people, or an average of $7 million per executive. That is a ludicrous amount to pay for the delivery of abject failure. But it is a far cry from the annual $100-200 million embedded in the public mind, thanks to media exaggeration.
The top executives have taken a bigger hit. Jimmy Cayne was worth $1.6 billion last year in Bear Stearns stock. JPM bought it for just $61 million. So he took a haircut of $1.54 billion or over 96 per cent of his net worth. The same goes for Dick Fuld of Lehman’s whose $931 million of accumulated compensation in Lehman’s stock at its peak price is now worthless. He sold 3 million of 11 million shares for less than $500,000; the remaining 8 million have no value. How many could take a 95+ per cent hit on net worth and regard that as insufficient punishment? Media reporting of these executives getting off scot-free is therefore grossly misleading. It suggests that these absurd rewards have retained their original values, when they are now worth a mere fraction. But who has any sympathy for someone who has lost over 95 per cent of what he had, yet still has a few million left?
The author chaired the high-powered committee on making Mumbai an international financial centre
