Bailouts, bonuses and Madoff. Are we getting tired yet of the endless litany of related headlines such as the Wall Street Journal’s recent “Bank Bonus Tab: $33 Billion; Nine Lenders That Got U.S. Aid Paid at Least $1 Million Each to 5,000 Employees”?
The rock star of these “fab” financial “leaders” is Andrew Hall who makes a bundle for himself trading energy contracts for Citigroup's energy-trading unit Phibro LLC, with compensation approaching $100 million for 2008. It is interesting to read Sunday’s New York Time’s front page article on his activities and compensation. No doubt he is a talented individual and I suppose if Citigroup didn’t want his operation’s expertise in “taking advantage of unusual spreads between the spot price of oil and the price of an oil futures contract,” other firms would be lining up to pay his price. That is the American way. We know how to lavish money on our superstars, whether from the media or sports, or in this case, dice-rolling trading moguls.
The Times refers to his compensation as “his cut of profits from a characteristically aggressive year of bets in the oil market.” It also says “the company, for example, often wagers that the price of oil will rise so fast during a particular period, say six months, that it can make money by storing oil in supertankers and floating it until the price goes up. “ Finally, “right before the first Gulf War, Phibro placed an elaborate bet that the price of oil would spike and then go down faster than others were anticipating. The company earned more than $300 million from the gamble.” I emphasize bets, wagers, and gamble, as these words cut to the heart of the matter. Arbitrage and hedging can be a means of controlling risk or it can magnify risk to the point of endangering the entire financial system. Is this what our banks should be doing: betting, gambling and waging? Heads they win, tails the taxpayer loses? I have to wonder what the consequences would have been if Mr. Hall’s trades had gone disastrously against Citigroup. Would he have been personally at risk for the same $100 million he “earned” being on the right side? Do we want our banks, the bedrock of our financial system engaging in such activities – aren’t these the domain of the individual entrepreneur and private capital? To what extent does such “trading” create spikes such as $147 for a barrel of crude oil while there is a glut of the commodity?
Then there is the continuing rhetoric about having to reward the financial superstars that got us into this mess in the first place, or they will “walk.” I like Warren Buffet’s homey comments on this topic so I quote from his 2006 letter to his Berkshire Hathaway shareholders. Although this is aimed at CEO pay in general, which is also absurdly high in many (but not all) corporations, it applies to our banks and other financial service firms as well:
“CEO perks at one company are quickly copied elsewhere. ‘All the other kids have one’ may seem a thought too juvenile to use as a rationale in the boardroom. But consultants employ precisely this argument, phrased more elegantly of course, when they make recommendations to comp committees. Irrational and excessive comp practices will not be materially changed by disclosure or by ‘independent’ comp committee members….Compensation reform will only occur if the largest institutional shareholders – it would only take a few – demand a fresh look at the whole system. The consultants’ present drill of deftly selecting ‘peer’ companies to compare with their clients will only perpetuate present excesses.”
Another mind-boggling headline “Picowers Rebut Suit Tied to Madoff Fraud” is from Saturday’s Wall Street Journal. and The New York Times version of the same “Big Investor Counters Charges in Madoff Case.” According to the Madoff bankruptcy trustee, Irving Picard, Picower’s accounts posted gains of more than 100 percent a dozen times between 1996 and 2007, with one gaining 950 percent, but this counter suit contends the latter was “only” 37.6 percent and none of his accounts earned more than 100 percent “in any single year.” But the $5.1 billion Picower withdrew over the years may have represented a return greatly exceeding any reasonable return during the same period. How a knowledgeable investor (presumably Picower qualifies) could believe that Madoff can “guarantee” steady returns of 10 to 12 percent a year and be satisfied by the statements received from Madoff to bear out those returns is beyond me. I still think the “idea” of creating a new reality TV show, something we seem to be better at than regulating financial Ponzi schemes (either private or government sponsored) might be just the ticket to fund the innocent victims of Madoff.
On the eve of President Obama’s inauguration, I had written the following: “The winners in this economy were not only the capitalists, the real creators of jobs due to hard work and innovation, but the even bigger winners: the financial masters of the universe who learned to leverage financial instruments with the blessings of a government that nurtured the thievery of the public good through deregulation, ineptitude, and political amorality. This gave rise to a whole generation of pseudo capitalists, people who “cashed in” on the system, bankers and brokers and “financial engineers” who dreamt up lethal structures based on leverage and then selling those instruments to an unsuspecting public, a public that entrusted the government to be vigilant so the likes of a Bernie Madoff could not prosper for untold years. Until we revere the real innovators of capitalism, the entrepreneurs who actually create things, ideas, jobs, and our financial system will continue to seize up. That is the challenge for the Obama administration – a new economic morality.”
I haven’t changed my view and I fear that while we bail out banks, insurance companies and their like, leaving present compensation practices in place, we just continue to perpetuate financial risk taking, swinging for the fences, making “bets and wagers” that will just dig us into a deeper future hole. As the headlines attest, the “challenge” remains. A true recovery requires jobs, jobs, jobs – and how are they going to be created – by banks trading energy futures? What happened to the commitment to the infrastructure? Our roads, utilities, and public transportation are falling apart. Alternative energy seems DOA. Aren’t these the areas our financial recourses should be focused on, ones that will create jobs, in construction, technology, and finance, and can lead a true economic recovery we can pass on with pride to future generations?