Thoughts About Bailouts and Bonuses

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There seems to be a lot of noise about previously struggling financial companies who were begging for bailouts but now are paying out billions of dollars in bonuses to employees.

I’m not trying to be political here at all, just thinking out loud. First, I don’t see why any private company should be allowed to be “too big to fail”. Otherwise, the whole point of bailing out these companies was… to bail them out and have them recover to be successful once again. The question is, why didn’t the government borrow a credit card tactic and charge them a nice 5% “balance transfer fee” and 35% APR since they were a “high-risk” borrower? You know, the same terms they’ve been giving to consumers forever, even forgetting things like payday loans. Then taxpayers would have earned a nice interest rate on their lent money, the public wouldn’t feel so angry about these bonuses, and the banks can repay quickly and move on with a better public image.

From this Forbes article, it appears that many of the TARP recipients got a deal for about 5% interest rate for the first 5 years. Banks like JP Morgan Chase, Goldman Sachs, and Morgan Stanley have already paid back their money.

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  1. From what I understand, their bond holders would not approve such a high interest “first priority” loan.

  2. JoetheBankgeek says

    They got a constitutional right to a bonus. It says in the Bill of Rights that Congress shall make no law respecting the establishment of religion. And you can’t prohib the free exercise thereof. Not to mention all these big companies are the real government in the first place.

  3. Most of the Golman Sachs managers now work in government positions handing out walfare to the banking sector. The best democracy money can buy!

  4. My beef with the bailout is these banks were allowed to borrow massive sums at low rates and then invest the proceeds. Ninety nine percent of Goldman’s profits were from principal trading activity, i.e. personal trades.

    So they keep talking about how they paid back the TARP money, but they essentially created an arbitrage fund. They invested in stocks and commodities and made substantial profits above the measely interest paid to the US taxpayer. If the markets hadn’t appreciated, then the US taxpayer would have taken the loss, not Goldman. It wasn’t their capital at risk. A no lose proposition for the banks.

  5. I have seriously been trying to think of a way to keep companies from getting too big to be allowed to fail. But if a company is providing well-loved goods or services, who are we to say that they have to stop growing and limit their clientele? Can we force them to break up into smaller, independent companies? Would that even work? Maybe I should read up on the break up of AT&T.

  6. The banks may have paid back the TARP money, but let’s not forget that they also got tens of billions of taxpayer dollars in the AIG bailout. I want THAT money back too. Too bad AIG will not be able to pay up…

  7. That what I think, if the interest rates are set properly, then the banks will think hard before asking for money, and will also pay back promptly. I don’t know about all that arbitrage stuff, but if they were being charged 30% interest I doubt they’d do it. If they really needed money, then the bondholders/shareholders would have approved it. Do they want to end up like Lehman Bros bondholders?

    I just don’t think this situation has all been explained to the average taxpayer very well. The low interest rates just don’t make sense to me.

  8. Supposedly, the “too big to fail” problem will be addressed by the new systemic regulation that is going to be done. What I don’t get is why they don’t just model things like the FDIC. That is, those business which are “too big too fail” should be required to pay into an insurance fund, just like banks do to the FDIC.

    And not just “too big to fail” entities. In the recent crisis the government guarenteed money market funds, the commercial paper market, the mortgage market, etc. All of them should now buy insurance. These sectors now all have incentive to take greater risk because the government has shown that it will come to their rescue. When this same state of affairs happened during the Depression with banks the price for this government backing was regulation and insurance.

  9. This entire situation is quite messy. Some of the banks (like Goldman) did not really want the TARP money, but were reportedly forced by the Treasury to take it. It was quite a stink at the time. If the Treasury not only shoved the money down their throats, but also charged 30% interest, the banks would have revolted (and rightfully so). Me, personally — I don’t mind the low interest rate Treasury charged. I’d much rather somehow make those banks return the AIG bailout money. That’d be a lot more then we would’ve gotten from them if we loaned them TARP dollars at 30% interest… Alas, AIG bailout is gone now…

  10. don’t forget the 0% fed funds interest rates, and the change in accounting laws to benefit the banks. talk about corporate welfare, geeez.

    and govsachs changed their classification to a bank just so they could qualify for a loan.

    meanwhile the “to big to fail” are getting even bigger. and the american yen continues its decline against commodities.

  11. Privatize gains. Socialize losses.

    I don’t understand why Goldman Sachs got 100% repayment of the $12.9 billion that was owed to them by AIG.

    Is California next?

  12. @Debbie M: The best suggestion I’ve seen for solving the “too big to fail” dilemma is progressive taxation. If the tax structure makes it less attractive for a bank to grow bigger and bigger, then the natural response is to take a huge mega-bank and spin off divisions as smaller independent and (because of the tax structure) more efficient smaller banks.

  13. no, the best solution to “to big to fail” is just let them fail.

  14. Unfortunately, just letting them fail will not work. By the time companies are that big, they have powerful constituencies both inside and outside of government, and the repercussions of their failure would damage the entire economy. Just letting them fail at that point is cutting of one’s nose to spite one’s face, especially for the people in power but also for all of us who depend on the economy to survive, and who doesn’t? At the very least, rescuing these companies should involve breaking them up, since they have demonstrated that their size is no longer an asset to themselves or the country.

  15. joe is correct, let them fail!

  16. These firms need desperately to re-capitalize. The best way to make lots of money quickly are short-term, very risky enterprises. The only difference between what they’re doing now and what they were doing 2.5 years ago is that bets they’re making are implicitly guaranteed by the federal government.

    Bonus incentives haven’t been regulated, so while these short-term gambles pay off, everybody makes lots and lots of money. But the second they turn bad, the Treasury’s going to be on the hook for it all.

    Say it over and over: private the profits, socialize the losses.

  17. Jon says

    I really don’t see what people are upset about. Who cares that these companies made lots of money. The Treasury made lots of money as well, and as taxpayers that’s what you should care about. Unlike most government programs that are blackholes of money sucking, these ones actually made the taxpayer money back! And we’re complaining? Really?

  18. This has been explained pretty well on the public media waves and on blogs like:

    No matter how you’d like this to be non-political it is. The banks became big and got away with bailout because of their enormous influence on capitol hill and persistent removal of any market regulatory force.
    Letting them fail means making the whole financial system fail and that could be even more expensive than bailing them out. It may be a better decision in the long run indeed, but who makes long-term decisions these days, right?

    So the only way to get rid of this parasitic beast is to be political and encourage everyone on this blog to consider that.

  19. The government did charge a “balance transfer fee.” in the form of warrants that were charged along with the TARP money given to the banks.

    Goldman Sachs paid $1.1 billion to buy those warrants back.

    So annualized, the government got over 20% on their money there. Which isn’t bad. It remains to be seen how the rest of the government’s TARP money will perform, but I think if the economy continues to stabilize, I think they’ll do just fine. I’m not saying the system is great, but your description is flat-out inaccurate.

  20. The funny thing is, is that most of the aforementioned banks (those who have already paid back the bailout funds) never asked for it… they were told by .gov to take the money, hence their ability to pay the money back prior to the 5 years. On the contrary BofA and AIG really needed the money.

  21. this country has survived world wars, a civil war, and a depression, it will survive some banks failing as well.

    this bandaid approach is just prolonging the problems, as in the great depression, and setting the table for a bigger collapse. the federal reserve is a failure. this economy now goes from from one bubble to the next.

  22. liberty minded politics says

    preach it joe.
    end the fed.

  23. Failure is the only counter balance to risky ventures with high returns. Take the risk away and it encourages poor behavior.

    Q: Is the Fed a government agency?

    A: No. Look it up.


  24. Probably one of the best arguments for active management as of late… Didn’t Buffett by a big chunk of Goldman when it was depressed? I wish my index fund had done that. : )

  25. yes, warren bought bank stocks, then used his influence to get congress to give the banks a bailout. what a bottom feeder.

    crony capitalism at it worst.

  26. Jon @Capitalistmaven

    They talk about all the Billions they made in profit from the banks that paid back the TARP money. However, in NO WAY is the Treasury actually making money on the whole deal also. Yes, they made money on some individual transactions and made sure the press publicized each one but if they make $2 Billion profit from Goldman but most likely will lose most of the over $100 Billion they gave to AIG or the 10’s of Billions they gave to Citi (not even including the $300 Billion in assets backed by the government at Citi) then are they really making out on the whole deal? I don’t think so. And they are still on the hook for plenty of government backed money Goldman is still using if the market turns down.

  27. “The question is, why didn’t the government borrow a credit card tactic and charge them a nice 5% “balance transfer fee” and 35% APR since they were a “high-risk” borrower?”

    “From this Forbes article, it appears that many of the TARP recipients got a deal for about 5% interest rate for the first 5 years”

    How about you get your facts straight before you post? The information has been available on yahoo finance, cnbc forever; the original TARP document was available too. Is it too much to expect a financial blog writer to actually follow business news?

    1. the original TARP program was not intended as a bailout for weak banks. It was intended to provide capital to relatively strong banks so that they would increase lending and unfreeze the credit markets. This was a public knowledge as soon as first TARP came out.

    2. Paulson didn’t want stigma assigned to the funds so he wanted all top banks to take it – whether they wanted to or not. He got CEOs of top 9 banks together and told them that they all have to take the money. Some CEOs – like Goldman Sachs, for example, as well as Wells Fargo have objected very vocally to it, but had to consent.

    3. After first 9 banks took the money, that put other banks at a disadvantage. So a number of other banks followed suit – though USB, for example, told that he was also pressured to take the money. At the time the TARP wasn’t described as a bailout, so there was no reason for some of these banks not to take it whether they needed it or not.

    4. The conditions for repayment is 5% for the first 5 years and 9% thereafter. However, in addition to this, the government got stock warrants. Anon above has already mentioned that repaying these stock warrants cost banks an equivalent of annuallized 20%. Now, if you are lending money to somebody and forcing the bank to take the money and charging them 20%, you hardly in a position to set conditions on how they run their business, do you?

    5. A couple of large banks that really needed the money were Bank of America and Citigroup. Now, Citigroup really messed up. But most problems of Bank of America came from its purchase of Meryl Lynch. Since that time a lot of documents came to light, including congressional testimonies that show that the government actually forced Bank of America to proceed with the purchase of Meryl Lynch when BofA wanted to back out. So if the government was the primary cause of BofA problems; if BofA actually did its “patriotic duty” in buying Meryl, why shouldn’t it get a bailout?

    6. Because of people like you – who shout without checking their facts – the congress introduced new conditions and restrictions AFTER THE FACT. As a result, a lot of best run banks repaid this money as soon as possible instead of paying years and years worth of interest. If you check out treasury rates – the government cost of borrowing – you’d see that the government is getting a nice profit on these funds. Talking about cutting one’s nose to spite one’s face.

    But really, this has been brought up a number of times even on this blog. It’s a bit surprising that you don’t bother checking out your facts.

  28. OK let’s talk about the basics.

    The banks problems were triggered by capital shortfalls. Lending them money at 30% interest rate does not improve their capital position, which is asset minus liabilities. Rather it would consume their capital faster because banks assets don’t earn 30% return. That’s why the “bail-outs” are not structured as loans, but as preferred stocks which is capital. The yield on the preferred stock must be low enough otherwise it would again consume capital too fast and kill the banks.

    Yeah, it is “bail-out”, not “kill-out”

  29. The federal banking system is a good system if you look at what it fixed compared to its hiccups.

    There was a time in America when banks charged 18-30% interest for a farm loan and inflation was negative or stagnant. People were begging for inflation. One bank wouldn’t recognize another bank’s notes. That’s unregulated banking. It was the tipping point.

  30. 2 stock market crashes in one decade, a real estate bubble, and the banks needing a trillion dollar bailout is a hiccup? lol.

    a dollar in 1922 is worth about 6 cents in relative valve.

    lets see how much longer the fed can continue to print money out of thin air, before another crisis is created.

    the fed lowering interest rates to 0% is basically a tax on societies savers to subsidize those who live beyond there means, and corrupt bankers.

    end the fed!

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