Welcome To Our Imperfect World

Source: Decline of the Empire

I was struck by an exchange between the Business Insider’s Henry Blodget and fund manager Mark Dow of Pharo Management (video below). Dow is a former staff economist at the IMF. I transcribed the exchange. The interesting part begins at the 2:27 mark.

Mark Dow — … the point is that [interest on excess reserves] an instrument of monetary policy. The Fed is not giving away money to the banks because they want to help their buddies. The banks would much rather be lending this money out, but there’s no one to lend it to. And the Fed has said we need to control the Fed Funds rate more than anything else, it’s a Public Good, if you want to look at it that way, just like bailing out the banks, as immoral as it was, it was necessary so the collateral damage was minimized, so the dry cleaner in Cedar Rapids could make payroll because he happened to deposit at a bank that was on-lend to Citigroup, or whatever. Right? Unfortunately, that’s the perverse incentives that ripple through the system…

Henry Blodget — Every time I talk to you, you make such a persuasive case that there was just no choice, we had to bail out Wall Street and so forth, and yet you step back from this, Wall Street coined money for 20 years leading right up to the crisis. Everything fell apart, all the banks were bailed out, some of the senior managements are still in place, all the equity is now recovered, we protected bondholders 100 cents on the dollar,

I just, I don’t understand why it is that it has to be that the laws of capitalism that affect the rest of the country and world, simply do not apply to Wall Street, because what you’re saying, we just can’t or we would croak.

Mark Dow — In this particular case, for sure we would have gone down. Unfortunately, in a perfect world the bondholders would have taken a haircut. In a perfect world, well, equity didn’t go to zero in the case of most of these banks, but most of these guys, they might have gotten bailed out, but they lost a lot of money, they lost less than they should have. They should have lost everything. But had they lost everything, the collateral damage would have been massive. The little guy who didn’t do anything wrong is still upset because he thinks that bankers made money somehow.

Henry Blodget — They did!

Mark Dow: No, they didn’t. If you look at any of these guys, their net worth got crushed. They owned a lot of stock in their companies, right? Now, the bondholders, they got made whole, but the people running these companies were not bondholders, right? They were equity holders. They got hit and they got hit seriously. Now, they should have been wiped out, right? No arguments there. But unfortunately, that couldn’t be done without wiping out the average guy, who didn’t do anything wrong.

Henry Blodget — Fair enough.

This is a remarkable exchange, but unfortunately we don’t hear many like it anymore. Everyone seems to have moved on, and that’s the problem. 

When Paulson (and Geithner, etc.) were extorting Congress for bail out money to keep Wall Street breathing, I was dead set against it. My attitude could have been summed up in two words: Screw ‘em! At the time, in the fall of 2008, I was not aware of the “perverse incentives” that rippled through the system, I was not aware that the dry cleaner in Cedar Rapids might not be able to make payroll because his deposits were on loan to Citigroup.

If I had known, I would have supported a temporary bailout to stabilize the financial system, to be followed by serious measures to wipe out those who crashed it. And the problem is this: that never happened. When I read that Bank of America is in trouble, I just laugh. When I hear that Warren Buffoon has put five billion dollars into Bank of America, and will make lots of money from that investment, I just laugh. Has nobody gotten the news? Bank of America is too big to fail.

More than some other large banks, Bank of America’s fate is also heavily intertwined with that of consumers. It services one in five home loans, and with 5,700 branches assembled through decades of mergers, it counts 58 million customers…

Bank of America’s capital position is much stronger than it was going into the financial crisis — it held $218 billion at the end of the second quarter by one key measure, but was still behind peers like JPMorgan Chase and Wells Fargo.

Buffoon’s investment is as safe as houses used to be. The Sage of Omaha loves this country! What a deal, invest 5 billion dollars and get a 100% guaranteed return your money. He made one billion the first day. It’s not as if BofA stock is going to fall to zero and the bank is going to go belly-up. It’s not as if BofA operates under the standard rules of capitalism.

It was the lack of a follow-up to the financial crisis that demonstrated the utter corruption of governance in the United States. Justice was not served, no bankers went to jail or got wiped out after the fact. The system was not purged of perverse incentives. Wall Street’s ability to disrupt the life of the “little guy” was not removed. As Henry notes, bondholders were payed 100 cents on the dollar, bank management teams are in many cases still in place, and are still earning those outrageous bonuses.

The “little guy” may not have had a clear understanding of his little-guy-ness until after this crisis. Now it is crystal clear who the little guys are, and who the Big Guys are. Mark Dow refers to what might have happened in a perfect world. He refers to the necessity of bailing out the banks, as immoral as that was.

Welcome to our Imperfect World.

Read more at Decline of the Empire