Sunday, July 19, 2009

Normalcy restored in Wall Street!

A few months back Wall Street was on its knees, literally, out with a bowl pleading for bailouts. After a series of capital and liquidity injections, access to cheapest credit, credit expansions (by lowering collateral scope and standards), blanket deposit guarantees, and plain bailout assistance, the Wall Street landscape is now dominated with a handful behemoth financial conglomerates. The shakeouts, consolidations and mergers, bankruptcies, and bailouts of the past few months have led to an unprecedented concentration of financial power among these remaining giant "too-big-to-fail" institutions. Ironically, this and the precedents set and signals conveyed, over this period may have left the financial system even more amenable to moral hazard and systemically vulnerable to increased instability and risks.

Amidst all the talk of green shoots and glimmers of hope, the recent announcements of unexpectedly good second quarter results by Goldman Sachs, JP Morgan, Bank of America, and Citigroup stand out for its audacity.

All these institutions have taken large slices of direct (both cash and debt guarantee support) and indirect (implicit guarantees like "too-big-to-fail" support) tax-payer financed government assistance and favorable regulatory changes (like permission to investment banks to indulge in depositary activities).

It has therefore, rightfully and very obviously to anyone, been claimed that the American tax payers deserve a large chunk of the profits of these institutions. Further, all these remaining institutions stand to gain spectacularly by capitalizing on the turmoil in financial markets and their rivals’ weakness to pull in billions in trading profits.

Goldman’s profit was lifted by record quarterly revenue of $6.8 billion in its fixed-income, currency and commodities unit, where mortgage and other credit instruments are traded, and a unit where Goldman has embraced bolder risk-taking. Goldman has already returned the $10 bn it received under the TARP as equity injection, in return for preferred shares, with the dividend on them.

Goldman Sachshas been raking in money in large part because government assistance through debt guarantees, money it received from the AIG bailout and access to cheap loans from the Federal Reserve. It was paid 100 cents on the dollar for its $13 billion counterparty exposure to the insurer, and it has $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corporation.

As the Times writes, "Goldman’s trading revenues have been helped by the fact that several of its rivals have gone out of business following the credit crisis, a fact that has added to its market share. It has also been able to increase it fees." Its equity underwriting business also generated record net revenues, worth $736 billion in the second quarter, as it benefited among other things from a rush by other troubled banks to issue shares and raise their capital levels.

These spectacular profits have been accompanied by a return to the flawed short-term profits driven executive compensation regime, marked by the usual massive payments to executives and traders.

The fact that all these firms recevied massive amounts in bailout assistance and other aforementioned support, makes these payouts appear plain indecent. Goldman, which posted the richest quarterly profit in its 140-year history and announced that it had earmarked $11.4 billion so far this year to compensate its workers, is expected to payout on average, roughly $770,000 to its employees this year, almost the same as what they received at the height of the boom.

However, these results may actually be concealing more than what they reveal and may have been boosted by one-time windfalls, inflows of bailout monies, and most importantly the access to cheap credit to leverage for big gains. In fact, the bulk of profits of Citigroup and Bank of America come from one time asset sales - the former from a joint venture with Morgan Stanley for its Smith Barney division, and the latter from the sale of shares in the China Construction Bank. Credit losses, from credit cards to home loans, continue to mount across most of these banks, the toxic assets remain, and the fundamentals remain shaky on most parameters.

In any case, these profits and the massive payouts being made to top executives and traders is only the latest example of the now well established feature of Capitalism 2.0 - privatization of gains and socialization of losses!

Update 1
Even as Goldman is luxuriating in its tax payer sponsored profits, another bank holding company, CIT, is not so fortunate as it battles for survival - bankruptcy or bailout! But CIT's smaller size, $80 bn in liabilities as opposed Goldman's $800 bn, may make CIT "too-small-to-be bailed out". More on this here and here.

Update 2
Times reports that the generous bonuses to employees announced by the big banks for 2009 may be at the expense of shareholders. Roughly 90 cents out of every dollar that these struggling big banks earned in 2009 — and sometimes more — is going toward employee salaries, bonuses and benefits.

Citigroup paid its employees so much in 2009 — $24.9 billion — that the company more than wiped out every penny of profit, and after paying its employees and returning billions of bailout dollars, Citigroup posted a $1.6 billion annual loss.

Citigroup is, in effect, paying its employees $1.45 for every dollar the company took in (payout ratio) last year. Bank of America is spending 88 cents of every dollar it made in 2009 to compensate its workers. At Morgan Stanley, that figure is 94 cents. JPMorgan Chase, which has fared better than those three, paid out 63 cents of every dollar. Though Goldman is paying only 45 cents per dollar made, on average in absolute terms each of its 36,200 employees would take home a record $447,000. Until recently, the ratio for most Wall Street banks hovered around 60 cents of every dollar, in line with other labor- and talent-intensive industries like retailing and health care.

The five largest banks on Wall Street — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley — earned a combined $147.4 billion before paying compensation and taxes in 2009. They plowed back a combined $31.2 billion into their companies and returned a total of $2.1 billion to shareholders in the form of dividends. They paid $114.1 billion to their employees.

Update 3 (2/4/2010)
Hedge fund salaries were back to their ususal highs in 2009, with Daiv Tepper leading the pack by earning $4 bn and whose fund yielded 130% return for investors in his Appaloosa Investment Fund I, according to survey by the AR magazine. Second came George Soros's Quantum Endowment where he earned $3.3 bn and investors 29%. The earnings of the top 25 fund managers tumbled 50% in 2008.

In an indication of how richly compensated top hedge fund managers have remained despite public outrage over the pay packages at big banks and brokerage firms, the top hedge fund managers rode the 2009 stock market rally to record gains, with the highest-paid 25 earning a collective $25.3 billion, beating the old 2007 high by a wide margin. The minimum individual payout on the list was $350 million in 2009. For many of the top 25, the big personal gains in 2009 came after steep losses in 2008. Mr. Tepper's flagship fund, dropped 27% in 2008.

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