http://www.nakedcapitalism.com/2008/12/new-york-times-story-pulls-punches-on.htmlNew York Times Pulls Punches On Wall Street Bubble Era PayWhy is no one willing to call things by their proper names, and instead resort to euphemism and double-speak?
A New York Times story today, "On Wall Street, Bonuses, Not Profits, Were Real," makes its most important point in its headline, and managed to get some good data points on how rich investment bank compensation was in the peak years, but otherwise glosses over the fundamental nature of what went on.
It was looting, and it is high time the media starts describing it in those terms.Let us turn the mike over to Nobel Prize winner George Akerlof and Paul Romer. From the abstract of their 1993 Brookings paper:
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.
Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. These arrangements can create a web of companies that operate under soft budget constraints. To enforce discipline and to limit opportunism by shareholders, governments make continued access to the guarantees contingent on meeting specific targets for an accounting measure of net worth. However, because net worth is typically a small fraction of total assets for the insured institutions (this, after all, is why they demand and receive the government guarantees), bankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values...
Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, causing them to produce in a way that helps maximize the looters' current extractions with no regard for future losses...."
Re-read the key phrase:
"pay themselves more than their firms are worth and then default on their debt obligations." This has happened en masse in what formerly were investment banks who have now become wards of the state.
(snip)
But we digress. Dick Fuld reportedly spends much of his days allegedly wondering why he didn't get a bailout. He should instead be thanking his lucky stars he is not in jail. Bankruptcy fraud is criminal, and fraudulent conveyance is subject to clawbacks. How could Lehman possibly have been producing financials that showed it had a positive net worth, yet have an over $100 billion hole in its balance sheet when it went under? No one has yet given an adequate answer on where the shortfalls were.
countries have a much simpler solution. If a company is "trading insolvent," that is, continuing to do business when it is in fact broke, its directors are personally liable.We have said repeatedly that one of the triggers for the crisis was permitting investment banks to go public (prior to 1970, no NYSE member firm could be listed). We had dinner with one of our long-standing colleagues who was responsible for Sumitomo Bank's investment in Goldman Sachs and had (and continues to have) close and frequent dealings with the firm. He said that the change in the firm's behavior after it went public was dramatic. Before, it would deliberate (one might say agonize) important business decisions,. Waiting two years to enter a new field was not unheard of.
But after the partners cashed in and were playing with other people's money, the firm quickly became aggressive in its use of capital in expanding the size and scope of its activities.
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