Friday, March 27, 2009

Democracy breaks out, Beltway Village is stunned

Some day, we'll look back at this period of time and talk about stages in Obama's Presidency and what various turning points were and so forth. Right now we're just having to wade through what we know as it comes at us day by day.

Digby has a good take on the popular anger over the AIG bonuses that in the media narrative burst forth last week. It was more like it took until last week for the Beltway Village to notice it to the extent they did. And then they hyped it all week while wringing their hands over the terribly disturbing anger at respectable Wall Street investment bankers. Digby's piece is called, Blind to the Zeitgeist 03/24/09:

The AIG bonus scandal was a watershed moment in this crisis. The White House did not handle it well (and should have known it was poison before they put it back in the stimulus in the dead of night in the first place.) The minute it hit, people all over the country viscerally understood what was happening and formed a new definition of the crisis, thus narrowing the options for the president. But the options weren't narrowed the way these insiders think they were. This new populist environment made the plan they already had in the works less politically viable, not more. Doing a giveaway to these hold-up artists now is going to make it much, much harder for them to come back for another bite down the road.

I don't believe the congress is the problem. And let's just say that if it is, if the majorities the Democrats have, the amount of popular outrage and the magnitude of the crisis we face aren't enough to push through real reform of the financial sector in the face of Wall Street screeching, then let's kiss health care and everything else goodbye. If the political will isn't there for something this vital, it's not there for anything and we are simply screwed. [my emphasis]
Good Republicans like Bobo Brooks were puzzled at how a couple of hundred million or so in bonuses could become such an issue even though it's a small part of the ballout bill. Not being a TV Big Pundit, Digby was able to talk about why. It's because financial institutions are being supported by the taxpayers dollars after their management ruined the companies; in AIG's case, the public effectively owns the company though I believe 20% of the stock is still privately owned.

You don't need to be a hot-shot compensation specialist to see that there's something screwy about the kind of incentives involved. Though our pundits memories are re-written almost as quickly as the operatives on Dollhouse, most people with normally functioning minds can remember that just a few weeks ago, the Republican blowhards were in high hissy-fit mode over the need to cut the wages of autoworkers whose companies might need federal assistance. But then investment bankers, apparently including some at AIG in the very division that sank the company, are getting mega-bonuses and they and their executives are downright huffy over the fact that anyone would question that arrangement.

We don't use the word "class" in most respectable political discussion these days, unless we're talking about the latest bogus conservative claims about the alleged failure of public schools. But in this case, the class-based reaction is painfully obvious, in which the workers are expected to take lower wages and layoffs because their bosses ruined their company while wealthy investment bankers feel entitled to take huge rewards from their ruined companies.

In addition, it's not just a matter of fairness or social equity, though it certainly is that, too. The compensation structure at large banks is a real management problem and creates perverse incentives for executives and "star" players to enrich themselves at the expense of the long-term health of their firms. If the corporate ownership system worked in the way that "free market" textbook theory says it should, the stockholders would have restricted these practices long ago. But it doesn't work that way. Now that the public is the majority stockholder in AIG, it's just plain good business to object to this dysfunctional compensation system.

Here's a simplified version of my own understanding of how the Geithner plan would work. Banks like all other businesses have balance sheets based on the accounting equation Assets = Liabilities + Equity [Capital]. Although it may seem counter-intuitive at first, for banks, loans are assets and deposits are liabilities. The problem for what economists are calling "zombie banks" is that some significant part of the assets of big banks like Citigroup and Bank of America are in problem loans directly or in holdings of "derivatives" made up of loans that were bundled together and sold as a security. They are called "derivatives" because the value is not directly in the security being sold, but in some other asset which the security represents, in many cases in this situation, high-risk home mortgages in many of the most toxic assets.

Under the accounting equation, to take sample values for an example, 100 (assets) = 75 (liabilities) + 25 (equity). But if those "toxic assets" held by big banks were valued at what they are really worth, that asset number could go down to, say, 70. But the liabilities don't go down with the new asset valuation. So the equation becomes 70 (assets) = 75 (liabilities) minus 5 (equity). A company with negative equity is bankrupt.

And in our current situation, an accurate market evaluation of bank assets based on looking at the underlying loan tapes could show that some big players like Citigroup and Bank of America are actually bankrupt. That would mean the FDIC would have to put them into receivership, i.e., take them over and reorganize them to later sell off the reorganized pieces. What economists like Paul Krugman and Jamie Galbraith and other want is for such a revaluation to happen so that the underlying problems of the banks can be fixed. And they are worried that the Geitner plan won't do it.

What the Geithner plan does from the banks' point of view to take some of those bad assets off their books and replace them with cash. That replaces some of the toxic assets with solid assets like cash. And that would turn the equity portion of the accounting equation positive. If that were going to make the zombie banks healthy again, that would arguably be the right course.

But there are two things wrong with this notion on the banking side. One is that the result may very well be less "100 (assets) = 75 (liabilities) + 25 (equity)" than "77 (assets) = 75 (liabilities) + 2 (equity)". The example numbers are purely arbitrary. But the point is that the zombie banks may wind up with such a thin equity margin that they will still be near-zombie banks. The other problem is that the same management teams that ran their companies into zombie bank conditions will still be managing them.

And that's the optimistic view. Although the government is offering investors buying the toxic assets a deal that basically provides them a lot of upside potential but minimizes the downside risk for them. The taxpayers eat the downside. And pumping up the market value of the toxic assets by such arrangements still don't make the underlying mortgage assets on the toxic paper any better. It would artifically boost the book value of toxic assets still held by the banks and thus artifically inflate their equity condition. Krugman thinks this is because of an excessive faith by Obama and his team The Market Mystique (New York Times Online03/27/09):

But it has become increasingly clear over the past few days that top officials in the Obama administration are still in the grip of the market mystique. They still believe in the magic of the financial marketplace and in the prowess of the wizards who perform that magic.
What really needs to happen, even under the Geithner plan, is an honest evaluation of the underlying assets, the loan tapes, as Jamie Galbraith explains in James K. Galbraith Re[s]ponds to Geithner’s Toxic Asset Plan Firedoglake 03/21/09.

I think this piece by Josh Marshall Social Contract Under Strain TPM 03/26/09 does a pretty poor job of analyzing the public criticism of the AIG bonuses. For instance, he writes:

As much as I think some exec paychecks are obscene and point to real imbalances in our economy, I'm really leery of limits on pay levels in private companies. To the extent that executives are paid too much, it seems like a broader issue of poor corporate governance, since shareholders shouldn't be willing to pay executives obscenely more than they're worth. But that's sort of the point: shareholders, in practice, exert little real control over this sort of thing. (And I suspect, though I don't know enough about this stuff to know, that that's the case because in the post-1980 stock market, investors are much less concerned about the functioning of the companies -- in a direct sense -- than their ability to drive stock valuations.)
He seems to be arguing here that because the private corporate governance system doesn't address substantial corporate problems nearly as well as "free market" theory would like us to believe, then it's probably not right for the public to worry about it at the nearly-completely-government-owned AIG.

But that's the point. Those compensation systems are a key problem in corporate governance, whether the big players like pension funds that actually act as stockholder activists are focusing enough on them or not. And it's a problem that creates much broader problems for the economy as a whole. Our democratic government should be acting as responsible stockholders by addressing that problem, however poor a job private stockholders may be doing at it. And the social equity issue is real, however uncomfortable it makes Josh or other reporters to hear people (labor unions, dirty hippie bloggers, etc.) talk about it.

Gene Lyons, on the other hand, gives good marks to Obama's presentation on 60 Minutes this past Sunday in Obama rolls the dice Arkansas Democrat-Gazette 03/26/09 and has a better understanding of why the public objections to the AIG bonuses are significant:

Obama did a decent job explaining why we've got to hold our collective noses and deal with AIG, Citicorp, etc. Basically, it's not possible to invent a new world banking system from scratch without risking a catastrophic depression.

People gripe about, say, Manny Ramirez making $25 million to play left field. But if Manny hits .147, he's out of baseball. These AIG jokers hit a lot worse than that. To put it another way, if a plumber caused a gas leak that burned an AIG aristocrat's Disneyland-sized mansion down, they'd call it criminal negligence.
He also has some harsh words for the shabby attempt by Obama staffers hiding behind anonymity which the New York Times should not be granting for such things to blame Sen. Chris Dodd for the AIG bonuses. Obama's team needs to be building alliances with the fighting Dems in the Congress, not alienating them, because there are plenty of Dems there who would be content to just just serve their favorite corporate lobbyists and not have to worry about all this annoying popular-outrage-by-the-stupid-voters part.


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