Big Bad Banker Bonuses: Part Two

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Corruption does exist, but it is important to distinguish corruption from misunderstandings. Anger directed at financiers has existed for ages. There are even roots of this feeling in the Bible and Quran. There is the biblical story of money lenders in the temple in the Bible, and some interpreters of the Quran claim usury is forbidden ( ‘Shariah’ Indexes do exist). So the anger in 2011 and ‘Occupy Wall Street’ movements are far from new. However, the investments industry has changed a lot. The tools and breadth of the industry is larger than ever before with regulations at an all-time low, or at least unable to keep up with the development of new and complex tools. A famous investment banker, Otto Hermann Kahn, wrote a short book called High Finance in 1916 about the state of finance and considered the reasons people might think so poorly of his profession. I did not choose this book because it is famous, but more so because it is not famous. I also wanted to compare the current industry to the one that existed a century ago.

He begins by wondering why there is a widespread “attitude of suspicion” and “hostility” towards financial activity. His piece becomes someone strange as he begins discussing how people need to forgive past financial failures since the European war will soon be over and America must help finance the effort (America hadn’t entered it yet, he wrote this in 1916). Otto confesses that finance has strayed in the past, but that this was during the “mighty and blinding rush of that whirlwind of enterprise and achievement.”

He quotes one instance that is relevant: “Campaign contributions by corporations were a recognized and almost universal practice. The acceptance of such contributions did not shock the most tender political conscience. Now they are rightly forbidden…and is now made and considered a crime.” This is no longer true. Campaign contributions are now once again a universal practice, especially after the ‘passing’ of the Citizens United case. Now financial giants can campaign to have kickbacks and less regulation. This is no longer the difference between left and right. The dichotomy is never as simple as no-regulation and some-regulation. The issue here is that, whether or not regulations exist, they can be influenced (and bought) to the advantage of massive banks.

I would also like to give one brief example of corruption in the 2008 financial crisis. For all the previous defenses I have made for those who receive bonuses I should also highlight a clear case of illegal compensation. The Majority and Minority Staff report from the permanent subcommittee on investigations in the US Senate have files from their investigation on Wall Street And The Financial Crisis: Anatomy of a Financial Collapse. In it they investigate Washington Mutual (WaMu) executive compensation. While often all ‘big banks’ are lumped together in this period, as mentioned earlier, some banks such as Goldman Sachs were relatively not as bad. WaMu was not one of these banks. They had perhaps the most absurd policies of issuing mortgages without any investigation on the person borrowing the money, wrapping up the mortgages, and selling them as ‘secure assets,’ all as part of the executive strategy of turning WaMu into a ‘big player.’ In a document from an email sent to all Dublin Loan Fulfillment Center (LFC) employees a manager wrote: “Less than 1 week and we have a long way to go to hit our 440m! Including today, we have 4 days of funding to end the quarter with a bank!… so don’t hold back.” He then lists the employees who underwrote the most loans. Loan volume increased and the quality lowered. Quality control spent ’15 minutes on each file’ and if they tried to deny it management would approve them anyway.

The more loans approved at the bottom level, the more that were securitized and sold, and the bigger bonuses the executives received. From 2003 to 2007 the CEO, Mr. Killinger, was paid between $11 million and $20 million each year in cash, stock, and stock options. In 2008 when he was asked to leave the bank he was paid $40 million dollars. He received nearly $100 million in total. He ran the company into the ground with fraudulent loan practices. When people meet with loan officers and apply for a loan they generally assume the adviser is a professional. While it is unfortunate more people aren’t educated in personal finance, they were misled by WaMu ‘professionals’ who told them they could afford a house that they in fact could not afford, and that were marked sub-prime from the beginning. And when the system crashed, their houses were foreclosed on, but it’s not entirely fair to say they were ‘living beyond their means.’ WaMu was not helping their clients understand the level of their gamble. On March 17th, 2011 charges were brought against Mr. Killinger by the FDIC for $900 million in damages. Mr. Killinger and two other executives settled for $63 million. CEOs often make horrible mistakes and sometimes drive their companies into the ground. In this situation, however, the financial fall-out from the firm’s loan practice was so great that it required the FDIC to take the entire firm into receivership once the bank failed (after 9% of all deposits were withdrawn in 10 days) and subsequently sell the bank to J.P.Morgan for dirt cheap. Most industries and firms don’t possess this power to bring down an economy.

This mess of WaMu’s failure highlights one of the darker shades of gray in Wall Street executive corruption. And even in this case the CEOs settled, because despite populist anger it is difficult to prove he acted illegally. A bad strategy is not illegal. With the entire industry obsessed with ‘irrational exuberance’ it is likely Mr. Killinger was ignorant about the riskiness of his strategy and was only seeing dollar signs, not acting with malicious intent to destroy the bank. The official investigation concluded that WaMu was selling residential mortgage backed securities (RMBS) and claiming that they met requirements that they actually did not. This was not enough to convict.

This is all what runs through my mind when I’m asked if I support Occupy Wall Street and why I say that am undecided. And even before that movement when I was asked if I was comfortable going into the “evil” world of finance. Most of those who argue against corruption in the industry have arguments that frustrate me; bonuses aren’t inherently evil, they are part of a complex pay structure. But yes, corruption does exist, I realize it, and in some respects it has become unprecedented. Not because financiers and corporations have become more evil. I think it is a safe assumption that ‘financier evil’ has remained constant over the past couple centuries. It is because the Supreme Court and legislators aren’t doing their jobs and lobbyists with infinitely deep pockets can continue to enact corporatist policies. While I strongly believe the bailout was necessary for the banks that were too big too fail, it would be foolish of me to pretend it didn’t help create the already dangerously large moral hazard that our banking system enjoys.

If you have comments please post them here as well as Facebook. I am also open to all suggestions you might have on how to do a better job or what you think of my project so far. Tomorrow the post will be on Malthus. The posts will continue daily for roughly one full week. After the initial launch period they will become more spaced out.

-Simon

My Resources:

High Finance by Otto Hermann Kahn: 
U.S. Senate Subcommittee Investigation: 

3 thoughts on “Big Bad Banker Bonuses: Part Two

  1. I, too, have been pretty frustrated with how other people view the financial industry in general. It seems to me that it’s a complexity problem. For medical doctors, people don’t really know what they do or how well they do it (I guarantee that there are more than a few unethical doctors, just like financiers) but being a doctor means that the person helps other people with physical ailments, and since everyone gets sick at some point most people can empathize and relate with the fact that doctors are simply people who make illness go away. This line becomes a little more vague with psychiatrists because what they do cannot be readily seen by a 3rd party so when people hear that word it seems that they think, “okay, they help people, but I’m not exactly sure what they help with because I cannot see it.” So people are a little more skeptical and defensive than they should be, just because they don’t entirely understand mental conditions. Then we get to finance, and all people know is that they do things with money, and money is hard to come by yet people in finance work with it all day. Money is the financier’s tool just like a carpenter works with saws, drills and hammers. Most people don’t know anything about signing a loan for a car (or house) so they surely will never understand the point behind liquidity or credit risk or insurance on securities (let alone basic stock). When I tell people that I’m in grad school they get all bubbly and excited and ask, “oh wow, what do you study?” When I tell them I’m in finance they seem to not know what to say next and they look like they made a mistake to ask in the first place. High level finance really is as far out of peoples’ minds as particle physics or other highly abstract, conceptual sciences.

    I don’t doubt that people will have a grudge towards finance as long as our world is based on a capitalistic model and we continue to ignore practical finance and economics in most primary education systems. It’s all just a big misunderstanding.

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