Government Bungling
By Daniel at 21 January, 2009, 1:11 am
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When people of little influence make mistakes, the negative consequences of their mistakes are small and usually mostly affect those who made them and the people close to them. When people of great influence make mistakes, the negative consequences of their errors ripple out in a wide arc, affecting many people, most of whom are not even known to the errant culprits. An example of this is the financial debacle the world is witnessing today. Greedy bankers and their associates both in the private and public sectors have created the current financial disaster. When governments make mistakes, everyone is in for a long and horrible time. These days, I fear we are witnessing major government blunders in its misguided attempts to resolve the current financial turmoil.
If the news media’s account of the “shotgun” marriage between Bank of America (BofA) and Merrill Lynch (Mer) is accurate, I would like to use this as an example of what I mean. According to the news media, BofA had second thoughts of going forward with the merger sometime in December of 2008. However, the US Treasury and the Fed overruled this sentiment and forced the merger to continue. Here we see BofA management exercising a level of prudence when they started questioning the merits of a merger with a severely distressed Mer. At the insistence of both the Treasury and the Fed, BofA consummated the merger. The net result, BofA in now enfeebled after the merger whereas it was relatively stable before the merger.
Who has been the most severely punished by this misguided merger? Immediately, the shareholders of BofA who saw their stock drop like a rock. Shareholders are people with excess money to invest in stocks and these are the very people the government relies on to maintain confidence in the equities market. After destroying the confidence of the investing public, the government has proposed a solution to shore up the enfeebled BofA without relying on the investing public. The government decided to print another $20 Billion and lend this to BofA at 8% plus another $100 Billion in guarantees to cover toxic assets it acquired from Mer.
If enfeebling BofA was a “boondogle” then this supposed assistance of equity infusion at 8% represents that many more nails on BofA’s coffin. 8% is punitive when compared to the 0-0.25% Fed Funds rate. The supposed “logic” was to encourage BofA to return the money ASAP. The logic of enfeebling BofA and then punishing it with exorbitant rates is simply mindboggling.
Forcing the merger has some logic. In essence, the government believes and trusts BofA’s management more than Mer’s and would like BofA to help them resolve the Mer problem. The process however, unfairly punishes BofA shareholders and is not beneficial to BofA as a going concern. Saddled with toxic assets and a usurious rate, problems at BofA will only mount, ultimately depositors and borrowers of BofA will be penalized.
Rather than continue to harp on a bad decision, I would like to propose an alternative solution. Let the merger stand. On the $20 Billion capital infusion, I recommend that the interest on this loan be dropped to the Fed Funds rate. In essence, this money is borrowed from the biggest bank in the land, the Fed, so it should be priced as such. At this price, the banks are really getting assistance instead of being kicked hard repeatedly when they are already down.
I propose that all government assistance to banks be priced similarly. Please do not punish the institution because doing so punishes the investing public who is not at fault and whose confidence the government is trying to win. When punished institutions suffer this in turn will negative impact the general public. Rather, both the Treasury and the Fed should put to task all the different managements of the banks they helped. Bank management should be given 2 years to resolve their respective toxic assets and return their banks to profitability. Bank management should submit a 2 year plan of action. These plans should be reviewed quarterly by the regulators (Treasury, Fed, FDIC, and State) and updated yearly. If after two years the bank continues to make little or no headway, or should the bank deviate from the plan in a significantly negative way even before the 2 years is up, management should be replaced immediately.
It is very likely that the rehabilitation process will take more than 2 years. If so, allow the process to continue if significant progress is being made. Compensation to management should be halved across the board, maybe even cut down to a third. The half or 2/3 that was removed should be treated as deferred compensation payable only when the banks in their care are again financially stable. Put the feet of bank management to the fire while still offering them potentially great rewards when they are in fact successful. We have many talented people in the banking industry, let them prove their worth or get rid of them. I am sure there are many talented though less well known people who would jump at the chance to demonstrate their abilities and make a name for themselves in the process.
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