As IF Times

link Prince, Rubin Say They Didn’t Recognize Citi’s CDO Risk in Time – Bloomberg.com.

One of the cornerstones of capitalism is that you are rewarded for your efforts.  There is no absolute measure of this of course, but generally speaking, if one takes on great risks and makes good decisions, any commensurate benefit to a corporation should be reflected by compensation to the guys in charge.

Conversely, if the enterprise fails, well then logically, the leaders take the hit along with everyone else, if not more so.  Over the past decade, the compensation levels of bank executives have reached heights not imaginable by their counterparts only a decade before.  When John Gutfreund, the then CEO of Salomon Brothers was accorded 3 million dollars a year in compensation in the ’80’s, it was a pretty eye popping amount.  As Michael Lewis says in his recent book, The Big Short, how quaint is that number today.   You now hear of compensation levels for routine bank ‘traders’ to be tens of millions of dollars and in the case of Robert Rubin, in one of his better years, he brought in over $100 million dollars in blended salary, bonus and stocks.

Guys who get paid that kind of dough think that lottery wins are rounding errors. All of the people who get to such postions of wealth are no doubt highly educated and certainly well connected.  How can it be then that no one thought to consider that their paychecks may be a function of some unusual aberration rather than by virtue of their own skill and talent?

The people being questioned by Congress now regarding their roles during the banking collapse of a few years ago can only plead one of two things: ignorance or complicity.  At the moment, the plea is the ” I had no idea” defence.  According to Chuck Prince of Citigroup,

“…Nobody could have predicted that the bank’s highest-rated collateralized debt obligations — created by repackaging mortgage bonds into new securities — would lose so much money, Prince said. The chief risk officer didn’t understand the risks, nor did Citigroup’s senior traders and bankers, he said…”

Obviously, that’s not entirely true as a  handful of smart hedge fund guys took the opposite side of the mortgage derivative trades and profited enormously when the house  of cards crumbled.  If these guys knew, why wouldn’t the banks considering  the access to resources that they have?  If they are that clueless, maybe the salaries paid were inappropriate.  As a matter of fact, why do these  employees even have jobs  today?  Can you imagine  a hospital where all the patients inconveniently died but the same staff is still  taking on new patients?  As I have pointed out in the past, banking is on the surface, a very dull business.  At it’s simplest, it is lending money at x and paying depositors x minus an amount, the difference is profit.

How quaint is that notion, because banking is so much more complex today since they are in the business of creating investment derivatives with the related harvesting of fees, making markets in products they create, etc etc.  However, these products carry asymetric risk profiles for the CEO’s.  They can only benefit.  No one walks the plank if things blow up. The business and capital of banks is so complex, auditors have a hard time figuring out where all the pieces are.   If you’re being paid, 10, 20, 40 or 100 million dollars a year to look after these enterprises, it would only make sense to have a good grasp of just how you’re getting paid and at least  know how the sausages were being made.

It looks like the guys at the top of they pyramid were just lucky enough to be there as the gate receipts kept flooding in, because according to their own testimony, they had no idea what was going on.  Nice gig.

link JPMorgan Assails U.K. Bonus Tax, Sparks Doubt on Canary Wharf – Bloomberg.com

The expected knee jerk fall out continues from the massive banking boo boo that cratered some big time institutions last year. Mr. Dimon, chair of JP Morgan complains that his firm did not take any money from the UK government and therefore should not be subject to a 50% tax on any bonuses that may be paid to their staff. In a very thinly veiled threat to the UK authorities, he hinted that the location of new headquarters in London could be in jeopardy since other European financial centers are more receptive to financial firms.

This is like watching two biker gangs going at it, there is no good guy and you hope they both lose.

Firstly, any time that governments slap a usurious tax on legitimate businesses is just plain misguided at best, socialistic at worst. It’s either pandering to the people or pandering to a philosophy.

However for Mr. Dimon to claim that JP Morgan did not receive money from the UK is totally disingenuous. At the time of the great banking meltdown last year, large and venerable institutions deemed too big to fail were given funds by governments in the U.S. and the U.K. in order to stay afloat and maintain liquidity. In our modern times, the fabric of the financial world consists of threads from players from all over the globe. One of the greatest risks is not an obvious one and that is, counterparty risk. If bank A has instruments guaranteed implicitly by assets or promises by bank B, any upset in the value of Bank B’s assets will negatively influence the assets of bank A. Put another way, if your house is insured by Allstate and Allstate collapses, your house is no longer insured.

This of course is where the governments came in, for while it was not known exactly the extent of the cross liabilities of all financial firms at the time, it was accepted that most every bank and financial firm in the world would be affected if liquidity and financial guarantees were not made. Purists would say, “let ’em fail”, but the fact is we really do not know the final consequence of such inaction. Regardless, that’s for another discussion.

The point is, JP Morgan quite possibly owes it’s relative health today to the survival of other large banks that still exist only because of funds doled out to them during the crash. In addition, because banks have been allowed to grow and take over most every aspect of our lives from simple banking, to mortgages, insurance, trading etc etc, the collapse of such behemoths can truly wreak havoc upon any economy as last year’s hiccup showed. In this light, governments are pressured, actually forced to guarantee the banks’ businesses. In effect, the government backstops all these ‘too big to fail’ institutions. If you’re too big to fail, there’s little risk in any of your business decisions.

Imagine if you controlled the spigots to the water supply in a region and you decided to spend lots of money to make jalapeno flavored water for export because apparently there was money to be made in it. It’s not going to matter if it fails or not, because people will always need water and will support your company regardless. You can’t lose.

The largest banks are in the same position. Banking is not that interesting. Only by taking chances on products or services can you create outsize returns for your shareholders, as it should be for any business. Right now, the risk reward curve is skewed so that in crummy years, even if they lose the house money, the executives still get paid handsomely whereas if the outsize bets pay off in any given year, they get paid like robber barons. What a gig! So for Mr. Dimon to complain that a 50% tax on bonuses is unfair speaks to how out of touch people are in the financial world.

Finally, we assume that a decision to locate offices in London confers some benefit to the shareholders of JP Morgan. If this were not the case, presumably they would have chosen to locate elsewhere in the first place. So we assume that the complaining is just bluffing. Of course, it’s easy to bluff when playing with the house money.