Bailout & Bonuses at BoA

Bank of America has posted its third consecutive quarterly loss. Apparently, the double whammy of paying back TARP and defaults on consumer loans has packed quite a punch to the firm's bottom line.

From Bloomberg:

"'Economic conditions remain fragile and we expect high unemployment levels to continue, creating an ongoing drag on consumer spending and growth,' [Bank CEO Brian] Moynihan said in a statement. 'We are encouraged by signs the economy is improving, as we have seen in the stabilization of our credit costs, particularly in the consumer business.'"

Specks of sun are breaking through, perhaps, but clouds of high unemployment and sluggish consumer spending remain heavy and dark everywhere you look.

Given the gloom surrounding the current economic outlook for consumers outside of Wall Street, why would BoA consider taking the hit now to repay TARP? Wasn't TARP designed to help struggling, massive banks recapitalize?

More from Bloomberg:

"The company repaid $45 billion of government rescue funds in December. Getting out of TARP freed the bank from federal pay limits and as much as $2.85 billion a year in dividends to the U.S."

With TARP repaid, BoA can take money they don't seem to have and pay bonuses to people whose business behaviors left the bank on the rocks.

Of course! It's bonus season. BoA can't afford to lose the people whose questionable business decisions landed them in a swamp. Seems a dubious business practice. But one that is SOP in the financial sector - establishing bonuses that will be awarded no matter how terrible the company does.

As long as the feds back them up with the necessary financing, it's a business model that works - if you're in line for those bonuses. Outside of BoA - well, as Moynihan said, the outlook "remains fragile and we expect high unemployment levels to continue, creating an ongoing drag on consumer spending and growth.”

Not an outlook that offers much to bank on.

Am I dreaming?

The man reluctant to cut his vacation short to help Katrina victims is working with Bill Clinton to help Haitian earthquake victims?

Is this a dream or the transformation of George W. Bush into a philanthropist?

From a story in the Washington Post:

"Bush said that his heart, and that of former first lady Laura Bush, 'are broken when we see the scenes of little children struggling without a mom or a dad or the bodies in the streets.'

He pledged to work alongside Clinton to encourage Americans to dig into their pockets. In the near term, he urged people to avoid donating blankets or other items but to just 'give your cash' to aid organizations that can spend it wisely.

(Just had a flashback to those pallets filled with $12 billion in cash that vanished in Iraq in 2003 - 2004. Is Halliburton involved in anyway with the relief effort?)

Strange that a man who failed to mobilize the FEMA forces during the worst natural disaster to hit America has found himself assisting the victims of another terrible natural disaster. Will it be another "heck of a job?"

More from the Washington Post:

'The Haitian people have got a tough journey, Bush said. "But it's amazing how terrible tragedies can bring out the best of the human spirit ... While that earthquake destroyed a lot, it didn't destroy their spirit."

A prediction so bold it landed on the front page of the WSJ!

GM predicts a profitable year in 2010.

Now that IS bold! The company, clawing its way out of bankruptcy. The economy, still shedding jobs by the tens of thousands each month (down from the hundreds of thousands shed in a few months ago - leading many to predict the beginning of the jobless recovery.)

And a prediction unprecedented in optimism.

The Wall Street Journal characterized GM's statement as a "bold and surprising forecast," and noted the company has not seen a profitable year since 2004.

The WSJ also noted that "significant hurdles remain to repairing GM's bottom line, namely winning back tens of thousands of customers and improving the profitability of vehicles sold."

And the newspaper gives us another curious statement:

"When GM started piling up billions of dollars in losses in 2005, Rick Wagoner, its CEO at the time, stopped offering financial guidance."

Does this mean the CEO shut down from stress? Failed to steer the ship back to profit? Threw up his hands in despair as the Titanic sank?

Oh well. He's set for HIS retirement, having received a $10 million package upon his hasty departure a year ago. Nothing like the golden parachute to let those inhabiting the C-suite know that no matter how badly they screw up (they can even "stop offering financial guidance" all together in a time of catastrophe), they STILL get a fat golden parachute when they're shoved out the door.

All this seems a far cry from the Randian paradise GM once inhabited, back when the Beach Boys included GM brands in their catchy, summery songs, the Big 3 ruled the roads, CEOs earned their salary and the thought of a company surviving thanks only to a government bailout was a capitalist's worst nightmare...

Passing on a great post about TR

The Edge of the American West blog has a wonderful post on Teddy Roosevelt.

It's a lovely post with a lovely conclusion:

"It is always easier to explain why Washington, Jefferson, and Lincoln belong on Mount Rushmore. Lincoln is America’s Christ. And Washington plays God the Father to Lincoln’s martyred savior. Which leaves to Jefferson the role of Holy Spirit: just so, as the author of the Declaration of Independence, the deeply flawed Jefferson nevertheless carried enough divine fire to channel into words the nation’s enlivening ideal of equality and natural right.

With such an established trinity, what need for a fourth figure? If we can see elements of the godly in each of Washington, Jefferson, and Lincoln, what can we do with the rather thoroughly earthly Roosevelt? But perhaps that is the point. Alongside gods humanity also has a place, and a man who did so much to make daily life in America a little better, and to create the expectation that daily life in America must be better, belongs there."

It's worth a read...

Unlocking the code to financial innovation!

I will be the first to admit that I am a CDO ignoramus. After a year of research, I still can't figure out how collateralized debt obligations work or why we need them. What I find mystifying is the opacity of the offering. And from what I understand, we have not only CDOs that we can buy, but synthetic CDOs, which, as far as I can tell, function as a sellable mirage of the original CDO, which is itself a bunch of debt lumped into various tranches of different risk classes.

But apparently we need this kind of innovation - regulations for the financial sector would squash this kind of innovation, so we're told, and then the market for Ferraris would drop significantly.

(JUST KIDDING about those Ferraris!)

In my search for knowledge, I find myself exploring all sorts of econ blogs - enjoying the journey while remaining mystified by the CDO conundrum. So I read with interest the latest post on the Economics of Contempt blog - "On Goldman and synthetic CDOs."

EoC seems a pretty smart guy - he knows far more about the intricacies of finance than I do. He's not shy about expressing his opinion, which makes his blog enjoyable to read.

This post of his is a rebuttal to a post on Yves Smith's Naked Capitalism blog that denounced Goldman's synthetic CDO practices.

You'll have to read both Yves' and EoC's posts to understand the full gist of their debate. Here's what I found so interesting in EoC's post:

"More importantly, what you have to realize — and where I think Yves goes wrong — is that Goldman wasn't necessarily placing an independent bet against the synthetic CDO market; rather, it was using synthetic CDOs to bet against the housing market."

And what, exactly, does it mean when Goldman bets against the US housing market? EoC gives us the formula:

"The mechanism was this: declining housing prices → higher default rates → reduced cash flows to mortgage-backed securities → lower RMBS/CDO prices → higher value of CDS protection on RMBS/CDOs → ca-ching!"

Ferraris for everyone (at Goldman Sachs) when those foolish home owners default on the loans the banks never should have approved.

Now those are some really smart peeps over there at Goldman Sachs. They saw the tsunami coming and made sure they'd ride the wave in a highly profitable manner and not get swamped like Lehman Brothers and Bear Stearns.

(And when they sent Henry Paulson, their CEO, to head up the Treasury Department back in 2006, I guess he didn't much know about this, or he would have done more to prevent the economy from falling off the cliff, rather than wait for it to crash before taking any action.)

EoC knows there is nothing nefarious in Goldman's actions - this is the world of Wall Street - it is inevitable that profit for some means loss for others. Here's EoC's take on this:

"If Goldman's plan all along was for the synthetic CDO market to collapse, then why were they consistently the biggest liquidity provider (by far) in structured products and structured finance CDS (i.e., ABX tranches)? The point is that Goldman didn't need to artificially drive down the synthetic CDO market. They set themselves up to profit from the decline in synthetic CDOs that would follow naturally from weakening fundamentals in the housing market. By the same token, Goldman didn't need to manipulate the structure of the synthetic CDOs they arranged; any run-of-the-mill synthetic CDO referencing subprime-backed cash CDOs (to the extent there was such a thing) would've suffered steep price declines once housing prices started plummeting."

EoC points out that Goldman was public in feeling bearish on housing - and we see now, it was bearish with good reason.

But for me, that code for success (declining housing prices → higher default rates → reduced cash flows to mortgage-backed securities → lower RMBS/CDO prices → higher value of CDS protection on RMBS/CDOs → ca-ching!) is innovation we don't much need today. Betting against the US housing market seems like a terrible way to make a buck. Phenomenally successful for Goldman, but catastrophic for the economy at large.

And so I find myself still mystified at the innovation known as the CDO. Seems like innovation in finance leads us to meander down a rocky trail that takes us from the approval of terrible mortgages to the creation of mortgage-backed securities chock full of those really bad mortgages to higher default rates on those same mortgages to "ca-ching" for Goldman Sachs.

Goldman Sachs saw the collapse of the housing market coming, and its brilliant staff was able to sell synthetic CDOs to customers as they bet those same instruments would lose value.

Those who found themselves with mortgages they couldn't afford and those who bought the innovative financial instruments from firms like Goldman Sachs discovered they owned "the big oops" - products with all loss and no gain.

That's an interesting innovation - creating products that provide an inevitable loss for someone. Hard for me to wrap my head around innovation designed to create massive profit for the innovator when the mortgage default rate goes up as the entire US housing market tanks.

Which leaves me to wonder if modern American financial innovation is designed solely to enrich the sellers of the innovation, with enormous losses in store for consumers of the products.

Here's what Joseph Stiglitz, an Economics Nobel laureate, had to say on financial innovation in a story he wrote for China Daily (an interesting media outlet for Stiglitz's story.)

"Indeed, financial engineering did not create products that would help ordinary citizens manage the simple risk of home ownership - with the consequence that millions have lost their homes, and millions more are likely to do so. Instead, innovation was directed at perfecting the exploitation of those who are less educated, and at circumventing the regulations and accounting standards that were designed to make markets more efficient and stable. As a result, financial markets, which are supposed to manage risk and allocate capital efficiently, created risk and misallocated wildly."

And in the end, the major players in the financial sector, including Goldman Sachs, found themselves on the receiving end of one of the most expansive government entitlement programs ever created. And thus, thanks to innovation that led to a crash that led to a bailout, 2009 was a very, very, very good year for Goldman Sachs.

Analyzing a half century of American income tax

Mark Thoma shares an article written by David Cay Johnston of Tax Analysts that compares 1961 income taxes with what we have now. Johnston's goal is to analyze if our tax system is helping us create wealth.

What do you think the data shows?

That the vast majority of Americans have seen only a modest rise in income in the last 45 years. In a span of years that stretches longer than a traditional career, the average income of the bottom 90% of wage earners has risen almost $9300, from an average of $22,366 in 1961 to $31,642 in 2006.

In the last 45 years, GDP has grown - up 227 percent.

Average income for the top 400 taxpayers has also grown from $13.7 million to $263.3 million. That's nearly 20 percent growth in 45 years.

If you've felt a financial squeeze over the years, there's a big reason why. David Cay Johnston explains:

But wages and fringe benefits did not grow with the economy. For most workers, they fell. Wages peaked way back in 1972-1973, were on a mostly flat trajectory for more than two decades, rose briefly in the late 1990s, and then fell sharply in the new century. ... Millions are out of work, and the jobs they once held are ... not coming back. And even if the Great Recession is coming to an end, we face years of jobs growing more slowly than the working-age population, which could radically transform America’s culture, work ethic, and sense of progress.

In 2006 families worked on average about 900 more hours than families did in the 1960s and early 1970s. That is a roughly 45 percent increase in hours worked... For many, the reality is that two jobs produce the same or a smaller after-tax income than just one job did three and four decades ago. ...

During the 45 years starting in 1961, payroll taxes have gone from a minor levy to almost a sixth of wages for the bottom 90 percent of American households. This $760 in income tax savings that the average taxpayer enjoyed in 2006 was taken back, and more, by the increased tax rates for Social Security and Medicare. Those rates rose from 3 percent withheld from pay in 1961 to 7.65 percent in 2006. Not all income is from wages, of course, but those higher payroll taxes wiped out the seeming reduction in the income tax and more. ...

The wealthy have benefited enormously from the income tax code. Again, Johnston explains:

"Without a doubt, the much lower tax rates at the top encouraged people to realize more income in the tax system. And if the only measure is that some people made more, then this would be a good. But let’s ask the question that the classical economists would have asked back when they were known as moral philosophers and their leaders spoke of policies that benefited the majority. Let’s go back to a time before Vilfredo Pareto’s observations began what is the overwhelmingly dominant orthodoxy today, neoclassical economics with its focus on gain.

What is the social utility of creating a society whose rules generate a doubling of output per person but provide those at the top with 37 times the gain of the vast majority? ...

Is a ratio of gain of 37 to 1 from the top to the vast majority beneficial? Is it optimal? Does it provide the development, support, and initiative to maximize the nation’s gain? Are we to think that the gains of the top 398 or 400 taxpayers are proportionate to their economic contributions? Does anyone really think that heavily leveraged, offshore hedge fund investments are creating wealth, rather than just exploiting rules to concentrate wealth, while shifting risks to everyone else?"

In the early 1980s, Ronald Reagan promised that wealth would "trickle down" and benefit all Americans. Johnston's data shows the promise didn't pan out as planned:

"Is our tax system helping us create wealth and build a stable society? Or is it breeding deep problems by redistributing benefits to the top while maintaining burdens for the rest of Americans?

Think about that in terms of this stunning fact teased from the latest Federal Reserve data by Barry Bosworth and Rosanna Smart for the Brookings Institution: The average net worth of middle-income families with children whose head is age 50 or younger, is smaller today than it was in 1983."