Week of 1.30.09
Transcript: Billions in Bogus Bonuses?BRANCACCIO: On Wall Street, make a profit, get a year-end bonus. You make horrible mistakes on Wall Street, profits evaporate and still, there's the bonus. By one calculation, 18 billion dollars in bonuses were handed out to New York based financial professionals in 2008 and you know how bad things were last year. Let's talk about the great collapse, who's to blame and what to do about it...with Bethany McLean. Back when she was working at fortune McLean had the foresight to question Enron's stock price and its business model. She was ahead of the pack then and is once again, as she investigates the financial mess we're in.
Thanks for doing this.
MCLEAN: Thanks for having me.
BRANCACCIO: So, Bethany, Wall Street, they finally realized that they've lost the Great War. And it's time to do things completely differently.
MCLEAN: I don't think so. I don't think there's been a real come to Jesus moment on the Street yet.
BRANCACCIO: Even with all we've been through? Even with the great collapse of 2008 and 2009?
MCLEAN: I think there's still an attitude in some quarters that it is the fault of American borrowers for borrowing beyond their means. For homeowners from moving into homes that they couldn't afford. And all Wall Street did was package this stuff up, and sell it to investors around the world. But that they are the least of the villains, rather than the greatest of the villains.
BRANCACCIO: Well, see that's the Enron connection, right? The—the sense that seems to persist. That we know best. We can figure this out. Let us just do what we have to do. We'll be able to move forward.
MCLEAN: And that we're smarter than you, so, we're entitled to make a whole lot more money than—than—than the rest of you.
BRANCACCIO: Well, you do see that, right? In this discussion over bonuses. If Merrill Lynch, thrust into a merger with Bank of America. And then the controversy now. The—New York Attorney General looking into bonuses that were apparently—awarded right at the end of the year. Before the merger with B of A happened.
MCLEAN: Absolutely. And it's—it's—it's a really interesting issue. Because there's—there's a huge perception problem with that. But yet, on the part of Merrill employees, there's a sense that these problems at Merrill Lynch, these enormous losses were caused by a handful of employees, not by these people. And you need to keep people. And you need to pay people what they were owed or promised. And so—and yet the rest of us look at this, and say, "How can they be taking taxpayer money, and still be—and still be getting paid—"
BRANCACCIO: Which Bank of America is.
BRANCACCIO: It—has taken the so called TARP money, the bailout money.
MCLEAN: Correct. Correct. And so, there's this real gap between how Wall Street sees it, and how the rest of the country sees it. The rest of the country sees it with just great rage. And just from the big picture perspective, "How can you take our money and still dole out these bonuses?" And Wall Street says, "Well, we promised people this compensation. A lot of people did their jobs. And weren't part of this—this historic collapse. And they need to be paid."
BRANCACCIO: If you drill down on this bonus thing, right, there's two big arguments about bonuses. First of all, we need the bonuses to keep people from jumping ship to other jobs.
BRANCACCIO: Maybe that made sense in 2006, but there's not a lot of jobs open right now, right?
MCLEAN: Exactly. And that—that—it's—it's a great point, because that's always been the argument. That we need to pay people, because otherwise our most talented people will leave. And it's true that probably the very upper echelon, even if there are no jobs for them to leave to, could just leave for the beach for a couple of years. They've made enough money. But for a lot of people, there's—there's no where else to go. They, for the first time, perhaps, need to say, "I'm going to suffer a little bit, and do my duty. I've been paid plenty in the last couple of years."
BRANCACCIO: Well, the other thing about bonuses, right? It's not just people who jump ship if they don't get them. But it—there's also—a profound implication that there is rewards for performance. Also CEO—executive compensation issue as well.
BRANCACCIO: More generally than just bonuses. And do people not see the fact that profits are radically down?
MCLEAN: I think they don't. And I think I'd add a larger picture to that, I—I think people say, "It's not my fault that profits are radically down. Therefore, I'm still owed mine." And if you look at that in the even slightly larger perspective, over the last bunch of years, Wall Street justified the extravagant amounts that people were paid by saying, "Well, look at the profits we're producing." And now, if you look at the write-offs that firms have taken, most of those profits turned out to be completely illusory. Because the profits have been decimated by—by the write-offs. In other words, the profits weren't real in the first place. So, people have already collected millions of dollars that in a—in a strictly speaking economic sense, they weren't really entitled to.
BRANCACCIO: I don't know if you saw this earlier this week: One news story reported two very, very different ways. The Reuter's News Agency takes a look at the data on bonuses for New York State. And says, "They've dropped the most in 30 years." Is essentially the way that story is being cast.
BRANCACCIO: And then you pick up the New York Times, another way to cast the story is, "The sixth largest bonus payout in history." If you take a look at the New York bonuses, at the end of 2008. And it sure was not the sixth best year for profits.
MCLEAN: And maybe that sums up the gap between the Wall Street and the Main Street way of thinking about things. If you were to oversimplify, the Wall Street way of thinking about things is the Reuter's version. The former. Whereas the Main Street way of thinking about things is the latter. And back to your initial question, no I don't think Wall Street understands how much Main Street holds—holds them to blame.
BRANCACCIO: Even after these other financial catastrophes that we have been through. For instance, Enron, which you caught early in your reporting. We—we didn't learn anything from that?
MCLEAN: I don't think so. And even in the wake of Enron, when people would so, "Oh, things have changed now. It's a totally different environment going forward." I'd say, "I don't think so." And all you'd have to do in the wake of Enron, almost immediately afterward started the stock option backdating scandal. About technology executives, mainly, helping themselves to stock options at lower prices. Without telling investors what they were doing. And that, to me, betrays much of the same mindset. Which is, "We as executives are entitled to money that is really yours, the shareholders." And that's the same—it's—it's the same mindset that has pervaded.
BRANCACCIO: So, the big question for the planet earth seems to be, will it be different this time? Can we put in—new safeguards that would stick? President Obama's choice for Treasury Secretary was confirmed just this week, Tim Geithner. He talks a lot in his confirmation testimony about transparency.
MCLEAN: Real transparency would be a great step forward. But I am always a skeptic about the ability of new regulation to really address problems. You look in the wake of Enron Congress passed Sarbanes-Oxley, which was supposed to fix all of the problems in the marketplace. And lo and behold, what happened this time around had absolutely nothing to do with Sarbanes-Oxley. It was irrelevant to the current crisis.
BRANCACCIO: Regulation fights the last war is what you're saying.
MCLEAN: Ex—ex—exactly. It's often sort of a Maginot line that—that while the enemy goes around and wreaks—wreaks destruction from—from another direction. And I also always wonder about the ability of rules alone to dictate behavior, because clever companies and clever people, find a way to follow the letter of the law, while violating the spirit of the law. To me, the central issue in all of this, is incentives.
BRANCACCIO: So, there isn't a regulatory approach to this? There's nothing we can do, as a government, to crack down?
MCLEAN: I think there's no question when we look at what's happened that more, better regulation is needed. What I'm suspicious of is the idea that regulation can fix everything. Because if people are incentivized to get around the rules, then they will find a way to get around the rules.
And to me, the issue running throughout American business over the past decade has been that people are compensated by taking short term—short term bets. And they get paid if the bet works in the short term, and they have absolutely no incentive to make it work in the long term. So, you look at the Wall Street executives, and Wall Street traders, who were paid tens and hundreds of millions of dollars to generate profits that turned out to be illusory just a few short years later. And there's no clawback to them. And until that system changes, then you're going to have people finding ways to game the system, in order to make money.
BRANCACCIO: Well, under this immense pressure of what's going on, you're seeing some banks putting in provisions, that would be, "Okay, you make a bunch of money this year, we're gonna essentially keep an eye on that bonus. And if it all goes bad next year, we're gonna take some of it back."
MCLEAN: Yeah. Which—which makes complete sense. Which makes complete sense. And I think that sort of radical rethinking of compensation is—is what we need. It's just scary how there's always a way in which things seem to get twisted. Because take, for example, the notion of compensating people with stock options. That, in theory, was a great way to align shareholders' interests with management interests. But it turned out that stock options were awarded over such a short period of time that if you could game the numbers for a couple of years, and produce great profits, you could walk away with your fortune, while the shareholders were left to—to carry the bag. And that's—it's not the way it was supposed to work.
BRANCACCIO: So, it's not just fully linking pay with performance, it's over time—
MCLEAN: Over time.
BRANCACCIO: —linking pay with performance.
MCLEAN: It's over time linking pay with performance. And to me, a lot of the problems that have happened in American business from Enron to this latest scandal, have their roots in people being paid based on short term profits.
BRANCACCIO: There's this horrible example in the center of it. That nice gentleman, Bernard Madoff, who's accused of the $50 billion Ponzi scheme. He was working in an area that was heavily regulated.
MCLEAN: Right. Well, you can take that analogy one step further, too. A couple of years ago, if people were to point at who was going to bring down the system, they would have chosen hedge funds. Lightly regulated vehicles. Who knows how they're operating. They're going to be the cause of the next—next financial collapse. Lo and behold, hedge funds, for whatever problems they have, have actually not been in the center of this. They're one of the few groups that is not in Washington asking for a bailout. Citigroup, one of the world's most heavily regulated institutions is. So, that to me, is the perfect example of why regulation is not—not a cure-all.
BRANCACCIO: But part of it, though, is there's regulation that works, and regulation that doesn't work. I mean, it may not have been the issue of, "Well, Bernie Madoff was regulated, and he was still allowed to do this." It was that the S.E.C. clearly was incompetent in regulating. It's a competence issue.
MCLEAN: It is a competence issue. And it's a motivational issue. And it's—pay issue. It's all sorts of things. It's political pressure upon regulators in Washington, not to crack down during a boom. Can you imagine if you had told homeowners in 2005-2006, that the government was going to crack down on the availability of mortgaged finance, because they saw a bubble coming? People would have revolted. They would have said, "That's not the government's place to do that." And yet, now here we are, a couple years later, all looking back and saying, "The government should have cracked down on this." So, there's a little bit of hypocrisy going on—on—on the pre—on the part of Main Street, as well.
BRANCACCIO: Still, the Federal Reserve could have said, "This is getting really frothy, we are really scared. I know you want your house, but the fact is—western civilization is at stake." And in fact, what the Fed said was the opposite.
MCLEAN: Exactly. And I think it's very easy to look back and fault the Fed, and I think the Fed deserves a great share of—of the blame. The only thing I'm trying to point out is that in the wake of a collapse it is always far more palatable to regulate, than it is in the middle of a boom. And you have to be realistic about that. And you have to somehow build that into the system. That nobody is going to want to see regulation in the middle of a boom. And that—that includes the people who are being protected by the regulation.
BRANCACCIO: Now, I thought after all we have seen with this great collapse, that it would not be possible for me to read another headline that takes my breath away. But sure enough, late this week, "The Banks Need More Taxpayer Money."
BRANCACCIO: They need a trillion or maybe two trillion dollars more than we've already given them. You think we need to give them some more money?
MCLEAN: Well, one of the central problems in this has been an inability to own up to what the banks really need. For a long time there's been this pretense that if we just give the banks money, taxpayers will somehow be made whole. Because these assets are just being mispriced by the market. The truth of the matter is nobody knows what these assets—these troubled assets on banks' balance sheets are worth. But if banks were willing to find out, they—they could sell them now, to private capital. It's just that banks aren't willing to sell at a low enough price.
BRANCACCIO: They're afraid that the price they'll get will just be awful. And that locks in the fact that these—
MCLEAN: That these losses are real.
MCLEAN: Which tells you that somebody has to bear the brunt of these losses. Is it taxpayers? Is it equity holders? Is it bond holders? And there needs to be a frank discussion about who should bear the risk of this, and how that—how that affects the entire system. There's no question that what's happened with banks—the banking system isn't fair. But I think there—the discussion would be greatly helped if there was honesty and transparency about what the losses were, and who was going to have to swallow them.
BRANCACCIO: Well, there's one way for you and I, the taxpayer, the government, to know exactly what's going on in some of these banks. Go the whole hog and nationalize these banks. I know it seems like something that Americans don't do. The Brits are pretty much nationalizing Royal Bank of Scotland. Why not just own these things? Since we have so much money in the game?
MCLEAN: Well, if you're going to own them, first of all, you still have to address the question of who bears the loss. If you're going to nationalize them, are you wiping out shareholders? Are you leaving a stub of equity for shareholders? What's happening to bondholders?
BRANCACCIO: To explain, that's typically what would happen. If you nationalized the bank, often the common stockholders completely lose out.
MCLEAN: Exactly. Then do the bondholders lose out as well? After all, there's not supposed to be a guarantee for a bondholder that you get paid back. So, you still—if you're going to nationalize the banks, that doesn't get around this discussion of who's going to—who's going to bear the loss. You—you still have to do that.
BRANCACCIO: And if we're having this conversation, we have to remind ourselves, you know, who are shareholders of these banks? It's the possibility that it's—
BRANCACCIO: —our pension funds. Our 401(k)s.
BRANCACCIO: A lot of Americans. Not just the fat cats.
MCLEAN: Exactly. And that's an important thing to remember. That not only are a lot of the shareholders and the banks, but a lot of us are dependent on the system being fixed. So, as much as we may rant and rave about how awful it is that banks are getting bailed out. Well, you know what? We might be the ones who bear the brunt of the agony if banks aren't bailed out, as well. As I said, it's—it's—it's unfair. But I would raise one other caveat about nationalization. The federal government has not shown itself to be great at—at running things. And so, that—that is—that is a very real fear and issue to—to confront.
BRANCACCIO: Well, we could talk about it in a practical matter. Let's say Uncle Sam owns Citibank, God forbid. Who is the human being who gets to run that? Who will work for a government salary? Who has the expertise?
MCLEAN: Well, that might actually be a silver lining in all of this. That with all the Wall Streeters out of work, you may actually find quite a few who are willing to go work for a government salary. Somebody said to me the other day that the new real—the new dream job is a salary, health care, and lunch. And so, you may—you may actually find talented people who are—who are willing to do that.
BRANCACCIO: Another concern, often raised about nationalization, in fact, Robert Rubin himself, the former Treasury Secretary, the Goldman Sachs star, the until recently, senior advisor to Citigroup saying that he's very concerned about even the notion of nationalization. Because if the government owns the bank, the government will be under political pressure to, for instance—not kick people out of their homes that they're no longer paying for.
BRANCACCIO: Is that such a bad thing? If the government were responsive to political pressure?
MCLEAN: I—it's—it's—it's a tricky question—because I—I think more should have been done, and could be done to help homeowners in—in—in this—in this collapse. But—but there—but there is a line that has to be drawn somewhere. And it's not bad to have that conflict in the system, between public good, and—and—and private ownership. And I would look at the nationalization of Fannie and Freddie as—as a great example.
The decision was made to nationalize them, and the decision was made for them not to raise fees in certain aspects of their business. And to be very lenient on foreclosures. All of which is good for—for homeowners, but all of which is also going to raise Fannie and Freddie's losses. And therefore raise the ultimate cost to the taxpayer. So, there is—there is a tradeoff here. And once again, I think it's a question of transparency and honesty in the process. And not pretending that we can have our cake and eat it too.
If we artificially sustain home prices—or support home prices—in the short term, but don't allow home prices to reach an equilibrium where they actually make sense again, we're in a sense doing what Alan Greenspan did in 2002, and slashing interest rates in order to create—create a new bubble.
That doesn't really address the problem. And so all people are clamoring for foreclosure relief. If you restructure somebody's mortgage, and keep them in a home that they still can't really afford, you're not doing them any favors either.
BRANCACCIO: Well, the word—the word from the Obama administration is "Don't say the word out loud, nationalization." But what is being considered, among other things, is this idea of the so called bad bank. It's like a partial nationalization, only the taxpayer gets really the worst part of those assets. Is that a good idea?
MCLEAN: Well, whether it's a good idea or a bad idea, it doesn't allow us to duck the question of who's going to bear the losses. Because the bad bank has to purchase those assets at some price. If the bad bank purchases those assets at a price at which taxpayers might actually make money, then you're going to cause a severe hole in the balance sheets of financial institutions that's probably going to require them to need more capital.
If the bad bank buys those assets at a price that keeps financial institutions whole, and their balance sheets looking sound, than taxpayers are going to have to bear the losses on those assets. So the bad bank is not a way to duck this ultimate question of who's going to bear the brunt of the losses.
BRANCACCIO: One of the issues that has come to the fore, when it comes to print, is the SEC doing its regulation? Is—a lot of people there hope to have lucrative careers after they get out of government. So they circulate to the SEC, and the argument is, they're less inclined to be strict when they're working for the SEC. There's built-in tension.
MCLEAN: I'm actually not sure how much credence I give that. I think that people at both the SEC and in the Justice Department make their names by—by prosecuting high profile—high—high profile targets. And I give that less credence than I do human nature, which is inclined toward belief rather than skepticism. And people's unwillingness to look at a Bernie Madoff and say, "Maybe he's actually a fraud."
That takes a level of cynicism and skepticism that a lot of people simply—simp—simply don't have.
BRANCACCIO: Clearly, though, you and I need to go downtown over here in New York and hand out some skepticism pills. Because a little extra skepticism would have gone a long way.
MCLEAN: You know, it would. But it's a really interesting question, because if we were all skeptics and cynics, we really would be through. I mean, to a certain extent, our market base is based on trust and capitalism, and is—is—is based on trust. And one of the problems we're facing today is that there's been a complete breakdown in trust. For—for—for good reasons, but at the same time that everybody is clamoring, "We need more cynicism. We need more skepticism." People are saying, "We need more faith. We need to trust again."
BRANCACCIO: And the other horrible conundrum, if not paradox, is that our system is based on taking risk. And now we're entering this very risk-averse period. I mean, what used to be investment banks, like Goldman-Sachs and so forth, they've all busted themselves down to regular plain old commercial banks with all this regulation. But they will, going forward, be very risk-averse.
MCLEAN: Exactly. But I think they will be risk-averse for a period. Everything is a cycle. And there will be another cycle. It may be ten, 15, 20 years out, but there will be boom—another boom. And there will be—the days of easy credit will come back again, and people will get themselves in trouble all over again. And we'll all look back at this period and say, "How didn't we learn our lessons?" It's a little bit akin to—to our Enron experience earlier this decade, where everybody clamored about corporate governance, and new standards of transparency. And just a few short years later, it was all forgotten.
BRANCACCIO: So Tim Geithner, the new Treasury Secretary is on record just this week saying he wants to put in further safeguards, to be sure that taxpayer money when it goes into bailing out the banks, isn't used to pay dividends to shareholders. Doesn't go to bonuses. But some voices are calling for tougher action. Nassim Nicholas Taleb, who's a NYU professor and has been warning early and often about—Wall Street not seeing the potential that this will explode in their faces, that's his big thing. He says problem number one is that folks in the financial industry are not willing to pay the price for failure. You know, in—in Enron's case, Jeff Skilling, CEO, went to jail. Where's the punishment now?
MCLEAN: I think that's a really tricky question, and I would agree with Taleb in that I think people who are defenders of the free market are generally fairly hypocritical about it. They like to cite the free market as a reason for enormous paychecks. But then, when things go against them, they don't say, "It's—it's—it's the market. Now I have to bear the brunt of that." They say, "Taxpayers bail us out. I didn't do anything wrong."
And in a way—Bernie Madoff is almost reassuring, because he is—it's a fraud. Somebody's gonna pay the price. He's probably gonna go to jail. We're gonna be able to figure out what happened. And that's—that's kinda clear cut and reassuring.
Whereas in the case of this sub prime mortgage—this entire credit fiasco—there are so many villains. So many people had their hand on the steering wheel as the financial system went over a cliff, that holding up any one person and saying, "You're the one who caused it," becomes a really difficult proposition. So sure, Wall Street CEOs and Wall Street executives played a role in what went on. Sure, some homeowners who took out mortgages they couldn't afford played a role in what went wrong. The companies around the country who—who—who—who—who created these sub prime mortgages played a role in what went wrong. So what do you do? Do you haul everybody to prison? Do you—do you hold up one person and say, "We're gonna make you the scapegoat for everything's gone wrong."
And even if that one person did, arguably, do things that were very unethical, is doing something unethical the same thing as doing something that's criminal? Not necessarily. So, I think—I suspect—the resolution of this is going to be very unsatisfying to people who are crying for blood.
BRANCACCIO: Well, Bethany McClean, contributing editor to Vanity Fair magazine, is also working on a book with Joe Nocera about what caused this great financial collapse. It's due out middle of next year, perhaps around the time that we see the first green shoots of recovery, you think, Bethany?
MCLEAN: I think that may be optimistic, but we'll hope so.
BRANCACCIO: All right, Bethany, thank you.
MCLEAN: Thank you.
BRANCACCIO: You too, can follow the money, like financial reporter Bethany McLean. We've made it easy to find out where the bailout billions went. Get the latest facts on our website. pbs.org is the place to start.
And that's it for NOW. From New York, I'm David Brancaccio. We'll see you next week.
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