The American banking system needed federal stimulus funding more than any other industry. The Wall Street banks were operating on little capital reserves and had severely exposed themselves to the mortgage crisis. The American government along with the Federal Reserve pushed through a $700 billion stimulus package for the banks and other companies directly involved. The federal money allowed the banks to continue lending, although in significantly smaller increments, to prevent a complete liquidity shock. In return for the funding, some the banks sold the government preferred shares and assets directly related to mortgage securities. In more dire circumstances, such as the situation of Citigroup, the banks also sold the federal government guaranteed assets. The biggest financial institutions in the United States were allocated Troubled Asset Relief Program (TARP) funding, including $25 billion to JPMorgan Chase and $10 billion to Goldman Sachs.
The general public was upset, regarding the Wall Street banks as the cause of the current crisis. Why give money to the apparent source of the greatest economic disaster of the last 70 years? What is easily overlooked is the role that excessive current consumption well beyond the scope of repayment played into the downfall of the economy. It’s easy to blame the banks for the risky trading of derivative securities. The trading practices helped to expose other banks and economies worldwide to the risk of the underlying assets. But the banks cannot be given full responsibility for the duration and the weakness of the recovery. The inherent value of many of the securities themselves was derived from loans given to the general public. These were not all commercial loans but car loans, credit card debt and other personal loans that often used the value of a house as collateral. The greater the increase in prices in the housing market, the more equity taken out of American real estate. In 2005, Americans borrowed $1.4 trillion against the value of their homes. The national savings rate in 2007 was at its lowest level since the Great Depression, just as the housing market began its decline. The massive borrowing would have continued had the housing market not collapsed. US households were consuming far more than they were able to afford given their after-tax income, which left them completely unprepared for any economic shock. This has made it that much more difficult for the economy as a whole to recover during this recessionary period.
The reality is that some of the banks were able to recuperate that much faster than the rest of the economy. US bankruptcies increased by 32% in 2009 while some Wall Street banks had record years. Goldman Sachs reported an annualized ROE of 19.2% for the first nine months of 2009, with net earnings of $3.19 billion in the third quarter alone. The bank’s stock price has increased over 100% in the last year.
Most of the Wall Street banks have now repaid the TARP funds. If the banks, like any other companies, are able to make the money back and repay the federal government, this should be regarded is a good thing. Few other industries are lining up to repay the billions of federal stimulus funding that they received. Of course, the banks are able to do this by using the money received to increase their capital levels and return to making risky trades. But this is what banks do; this is how they make money. Investment banking is about taking calculated risks and profiting from them. The banks that haven’t been as profitable have issued new securities to raise capital to pay back the bailout funds.
The government and general public are upset with the banks yet again. Just after the slap on the wrists given to Wall Street banks for their excessively risky behaviour, their executives are being compensated like it’s 2007. It’s obvious that the quick repayment of TARP funds was pushed through to allow the banks to return to giving out bonuses. The banking industry is driven by the bonus payment system. Goldman Sachs, vilified by the general public (and Rolling Stone writers) but lauded by the industry for its recovery, sets aside approximately 50% of its earnings each year for bonuses. This year the bank rewarded its top employees with “shares at risk”, equity which cannot be sold for five years. Although this is falling in line with the new principles of financial accountability, this is not a direct limitation to the compensation which is something the government was looking for. This system still pushes employees to make riskier trades, which in turn increases the firm’s profits, which is the bottom line.
The Wall Street banks are not the only institutions posting record years. In 2009 the Federal Reserve made approximately $52.1 billion which is its largest profit ever. This came largely from lending money to the Wall Streets banks. Although the profits between Wall Street banks and the Fed are comparable, the compensation for employees varies greatly between the government and private sectors. The chairman of the reserve, Ben Bernanke, will receive no bonus and take home a salary of $199,700. This is in contrast to JPMorgan Chase, where the average compensation for an investment banking employee is $379,000.
Other industries that received bailout money are experiencing the effects of the government restrictions. AIG, which received $182.5 billion as part of the bailout, recently lost Anastasia Kelly, the vice chairperson and general counsel for the insurance company. The executive left AIG after the federal government restricted her compensation. AIG is a great example of a company still operating under the watchful eye of federal regulators, as it has not been able to repay the bailout funds. This may be the beginning of an exodus of executives working at companies still under government control. The American government has little to no control in regulating the bonus allowance once the TARP money is repaid. The Wall Street banks are taking advantage of these lackadaisical restrictions and returning to the old behaviours that are currently under scrutiny.
Bailing out the banks was essential to maintaining order during the initial shock and assisting in the prevention of a complete credit crunch. The liquidity provided the breathing room needed for the financial industry to manoeuvre through the fall in consumer spending and the rise in economic uncertainty. Most importantly it provided the rest of the world with assurance that the United States would not let the banking system fall. What the banks do with their money now is up to them. The onus in on the federal government for the lack of restrictions established regarding the aftermath of the repayment.
Currently, the Financial Crisis Inquiry Commission is underway to examine why the Wall Streets banks were in situations so dire that they required federal funding as a lifeline. The goal of the commission is to undercover the specific events that led to the collapse and to establish a plan to prevent them from occurring again. President Barack Obama is recommending that serious measures be implemented to discourage a return to previous business practices. The president is suggesting a tax which will come out of the bonus pools to fund other federal recovery plans, while political opponents argue that the banks will just pass the tax on to consumers. This inquiry should have happened before the TARP funds were repaid, while the government still had direct control over how the banks distributed their earnings. Trying to force the banks to pay an extra tax on compensation will not sit well with anyone on Wall Street and will now be extremely difficult to implement. The bonuses paid out to employees helps to attract the most talented and driven individuals and will continue to do so now that the TARP money is back in the federal government’s hands. The outrage of the American people should be directed at the government regulators for the lack of foresight not at the banks themselves.