Econbrowser‘s James Hamilton is advocating executive compensation laws:
Lehman Brothers: $27 million for CEO Richard Fuld. The financial freeze that followed the collapse of Lehman is seen by many as the key event that turned the recession of 2007-08 into the frightening freefall currently under way
…
What caused that principle to go so badly awry in the present instance? I believe there was an unfortunate interaction between financial innovations and lack of regulatory oversight, which allowed the construction of new financial instruments with essentially any risk-reward profile desired and the ability to leverage one’s way into an arbitrarily large position in such an instrument. The underlying instrument of choice was a security with a high probability of doing slightly better than the market and a small probability of a big loss. For example, a subprime loan extended in 2005 would earn the lender a higher yield in the event that house prices continued to rise, but perform quite badly when the housing market turned down. By taking a leveraged position in such assets, the slightly higher yield became an enormously higher yield, and while the game was on, the short-term performance looked wonderful. If the agent is compensated on the basis of current performance alone, and the principal lacks good information on the exact nature of the risks, the result is a tragically toxic incentive structure.
…
My interest in this issue is not so much to exact revenge on those who created our current problems, but instead to ask, how can we change the incentives so that this kind of problem is not repeated again? And that in turn leads me to wonder, why limit the proposals above only to a handful of companies?
Despite Prof. Hamilton’s protestations, I consider this a classic example of American vindictiveness.
In the first place, it was not Fuld’s compensation that caused the credit freeze of 4Q08: it was the sudden withdrawal of $400-billion from money market funds that accomplished that little trick. No individual, no company and not even any industry is able – or willing – to withstand the cumulative effect of uninformed decisions by millions of retail customers.
To ascribe blame for the Credit Crunch on Wall Street policies is as superficial as blaming the Tech Boom and subsequent wreck on IPO specialists and Tech Funds. Retail was coming to them, insisting on get-rich-quick internet investments – and got them. End of story.
Our reaction to the Credit Crunch should be informed by our reaction to, say, a horrific and avoidable traffic accident. We can throw the book at the driver, if it makes us feel better. It won’t stop future accidents. We can improve the regulation of that particular intersection, with improved sightlines and signage; it might cut accidents at that corner, but won’t do a thing for the next block down the street. If we’re really serious about banning accidents, we have to ban cars; we will probably find that the cure is worse than the disease.
There are definitely some aspects of regulation that can be improved – removing the right of directors and shareholders to hire whoever they like at whatever it costs is not one of them – but to try and tame the business cycle with regulation is a fool’s game. As with the Great Moderation, as with the Soviet Union, that’s the sort of thing that works very, very well … until one day, quite suddenly, it doesn’t.
I will also note Dealbreaker‘s estimate of $1-trillion in fees paid in the course of the mortgage boom … so, in defense of the executives:
- if they’d turned down that kind of money, investors would have hired a pig more aggressive in getting to the trough
- what killed the investment banks was not so much their horrific losses, but risk-aversion by their lenders
Am I giving Wall Street a free pass? No. I pointed out in the post SEC & BSC that Wall Street covered its need to tick the “risk management” box by hiring people who didn’t know what they were doing and then ignoring what they said. But the way to get ahead in any large organization – whether it’s an investment bank, a regulator, government, or Honest Bob’s Financial Planning Boutique – is to figure out what your boss (and your clients) want to hear and telling it to them. No amount of well-intentioned regulation will ever change that.
On a related topic, US & International financials got cremated today:
Banks fell after the U.K.’s second bank-bailout plan in three months raised concern the financial crisis is deepening. The government of Prime Minister Gordon Brown said it will spend an extra 100 billion pounds ($142 billion) to support banks and increase its stake in Royal Bank of Scotland Group Plc (RBS:LN).
Royal Bank of Scotland American depositary receipts (RBS:US) plunged 69 percent to $3.33. ADRs of Lloyds Banking Group Plc (LYG:US), the U.K.’s biggest mortgage lender, tumbled 58 percent to $2.61.
JPMorgan Chase & Co. (JPM:US) retreated 21 percent to $18.09. Citigroup Inc. (C:US) lost 20 percent to $2.80. Wells Fargo & Co. (WFC:US), which Friedman Billings Ramsey Group Inc. said will probably cut its dividend during the first half of this year, sank 24 percent to $14.23.
…
Bank of America Corp. (BAC:US) dropped the most in the Dow Jones Industrial Average, slumping 29 percent to $5.10. The biggest U.S. lender by assets needs at least $80 billion to restore capital to minimum levels required by regulators, according to Friedman, Billings, Ramsey Group Inc. analyst Paul Miller.
…
MGIC Investment Corp. (MTG:US) slid 24 percent, the most since Dec. 1, to $2.13. The largest U.S. mortgage insurer posted a sixth straight loss and predicted an unprofitable 2009 as the deepening U.S. recession will cause more homeowner defaults. The company’s fourth-quarter operating loss of $2.06 a share was worse than the expected deficit of $1.14, according to the average estimate of six analysts surveyed by Bloomberg.
…
Regions Financial Corp. (RF:US) lost 24 percent to $4.60, the steepest decline since Sept. 29. The Alabama bank that expanded in Florida a year before the mortgage market collapsed posted a fourth-quarter loss of 35 cents a share, excluding a goodwill charge. Nineteen analysts surveyed by Bloomberg estimated Regions would post a 9-cent loss for the quarter.Other regional banks also slipped. PNC Financial Services Group Inc. (PNC:US) sank 41 percent to $22. Sovereign Bancorp Inc. (SOV:US) fell 18 percent to $2.
…
State Street Corp. (STT:US) had the biggest drop in the Standard & Poor’s 500 Index, sliding 59 percent to $14.89. The world’s largest money manager for institutions said 2009 operating profit will be little changed from last year after fourth quarter earnings fell 71 percent.Other asset-management firms also declined. Bank of New York Mellon Corp. (BK:US) fell 17 percent to $19. Northern Trust Corp. (NTRS:US) slid 14 percent to $43.93. Legg Mason Inc. (LM:US) fell 18 percent to $17.34. American Capital Ltd. (ACAS:US) dropped 20 percent to $3.66. Calamos Asset Management Inc. (CLMS:US) slid 16 percent to $5.29.
Not a bad day, altogether. SplitShares got whacked, not surprisingly given their dependence on financial common stock. But if the decline in PerpetualDiscounts was credit-related, then why were Fixed-Resets up? Volume continues to be quite good. BNS.PR.T closes tomorrow … and then there will be no more new issues announced but not closed!
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 6.88 % | 7.45 % | 39,695 | 13.62 | 2 | -0.3459 % | 868.3 |
| FixedFloater | 7.32 % | 6.93 % | 159,135 | 13.76 | 8 | -1.1259 % | 1,399.1 |
| Floater | 6.02 % | 5.60 % | 33,854 | 14.51 | 4 | -0.5615 % | 1,014.3 |
| OpRet | 5.31 % | 4.78 % | 147,879 | 4.06 | 15 | 0.5441 % | 2,020.7 |
| SplitShare | 6.21 % | 9.97 % | 86,174 | 4.14 | 15 | -2.8635 % | 1,791.2 |
| Interest-Bearing | 7.19 % | 8.77 % | 38,622 | 0.90 | 2 | -1.0453 % | 1,967.8 |
| Perpetual-Premium | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.3602 % | 1,560.1 |
| Perpetual-Discount | 6.86 % | 6.84 % | 233,027 | 12.75 | 71 | -0.3602 % | 1,436.8 |
| FixedReset | 5.90 % | 4.79 % | 846,152 | 15.32 | 21 | 0.1879 % | 1,833.0 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| WFS.PR.A | SplitShare | -7.32 % | Asset coverage of 1.2+:1 as of January 8 according to Mulvihill. Hardly surprising that something with a name like “World Financial Services” got hammered today! YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2011-06-30 Maturity Price : 10.00 Evaluated at bid price : 8.86 Bid-YTW : 10.91 % |
| FFN.PR.A | SplitShare | -5.69 % | Asset coverage of 1.1+:1 as of January 15, according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2014-12-01 Maturity Price : 10.00 Evaluated at bid price : 7.46 Bid-YTW : 11.48 % |
| FTN.PR.A | SplitShare | -5.21 % | Asset coverage of 1.3+:1 as of January 15, according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2015-12-01 Maturity Price : 10.00 Evaluated at bid price : 8.01 Bid-YTW : 9.38 % |
| LBS.PR.A | SplitShare | -5.17 % | Asset coverage of 1.4-:1 as of January 15 according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2013-11-29 Maturity Price : 10.00 Evaluated at bid price : 8.25 Bid-YTW : 9.97 % |
| DFN.PR.A | SplitShare | -4.13 % | Asset coverage of 1.7-:1 as of January 15 according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2014-12-01 Maturity Price : 10.00 Evaluated at bid price : 8.81 Bid-YTW : 7.95 % |
| PWF.PR.K | Perpetual-Discount | -3.92 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 17.42 Evaluated at bid price : 17.42 Bid-YTW : 7.15 % |
| ALB.PR.A | SplitShare | -3.20 % | Asset coverage of 1.2-:1 as of January 15, according to Scotia. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2011-02-28 Maturity Price : 25.00 Evaluated at bid price : 19.65 Bid-YTW : 17.22 % |
| BCE.PR.Z | FixedFloater | -3.08 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.00 Evaluated at bid price : 15.11 Bid-YTW : 7.51 % |
| FIG.PR.A | Interest-Bearing | -3.07 % | Asset coverage of 1.1-:1 as of January 19, based on Capital Units NAV of 1.70 and 0.53 Capital Units per preferred. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2014-12-31 Maturity Price : 10.00 Evaluated at bid price : 7.27 Bid-YTW : 13.21 % |
| BCE.PR.R | FixedFloater | -3.03 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.00 Evaluated at bid price : 16.00 Bid-YTW : 7.03 % |
| BAM.PR.B | Floater | -2.96 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 8.51 Evaluated at bid price : 8.51 Bid-YTW : 7.29 % |
| FBS.PR.B | SplitShare | -2.91 % | Asset coverage of 1.1-:1 as of January 15, according to TD Securities. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2011-12-15 Maturity Price : 10.00 Evaluated at bid price : 8.01 Bid-YTW : 13.56 % |
| BNA.PR.A | SplitShare | -2.74 % | Asset coverage of 1.8+:1 as of December 31 according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2010-09-30 Maturity Price : 25.00 Evaluated at bid price : 23.10 Bid-YTW : 11.94 % |
| BCE.PR.C | FixedFloater | -2.44 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.00 Evaluated at bid price : 16.00 Bid-YTW : 7.18 % |
| POW.PR.D | Perpetual-Discount | -2.37 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 18.12 Evaluated at bid price : 18.12 Bid-YTW : 6.97 % |
| IAG.PR.A | Perpetual-Discount | -1.93 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 16.77 Evaluated at bid price : 16.77 Bid-YTW : 6.95 % |
| DF.PR.A | SplitShare | -1.80 % | Asset coverage of 1.4-:1 as of January 15, according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2014-12-01 Maturity Price : 10.00 Evaluated at bid price : 8.75 Bid-YTW : 8.09 % |
| SBN.PR.A | SplitShare | -1.73 % | Asset coverage of 1.7+:1 as of January 8 according to Mulvihill. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2014-12-01 Maturity Price : 10.00 Evaluated at bid price : 9.11 Bid-YTW : 7.18 % |
| RY.PR.C | Perpetual-Discount | -1.66 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 17.80 Evaluated at bid price : 17.80 Bid-YTW : 6.59 % |
| TD.PR.C | FixedReset | -1.65 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 24.35 Evaluated at bid price : 24.40 Bid-YTW : 4.79 % |
| GWO.PR.I | Perpetual-Discount | -1.62 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 15.79 Evaluated at bid price : 15.79 Bid-YTW : 7.22 % |
| BNS.PR.M | Perpetual-Discount | -1.60 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 17.20 Evaluated at bid price : 17.20 Bid-YTW : 6.58 % |
| BAM.PR.N | Perpetual-Discount | -1.58 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 11.87 Evaluated at bid price : 11.87 Bid-YTW : 10.19 % |
| PPL.PR.A | SplitShare | -1.54 % | Asset coverage of 1.4+:1 as of January 15 according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2012-12-01 Maturity Price : 10.00 Evaluated at bid price : 8.93 Bid-YTW : 8.36 % |
| CM.PR.K | FixedReset | -1.48 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 22.41 Evaluated at bid price : 23.30 Bid-YTW : 4.49 % |
| BAM.PR.K | Floater | -1.48 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 8.01 Evaluated at bid price : 8.01 Bid-YTW : 7.75 % |
| NA.PR.L | Perpetual-Discount | -1.45 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 17.02 Evaluated at bid price : 17.02 Bid-YTW : 7.15 % |
| RY.PR.G | Perpetual-Discount | -1.34 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 17.68 Evaluated at bid price : 17.68 Bid-YTW : 6.49 % |
| CM.PR.E | Perpetual-Discount | -1.26 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 19.53 Evaluated at bid price : 19.53 Bid-YTW : 7.22 % |
| GWO.PR.G | Perpetual-Discount | -1.23 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 18.50 Evaluated at bid price : 18.50 Bid-YTW : 7.12 % |
| SLF.PR.D | Perpetual-Discount | -1.22 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 15.43 Evaluated at bid price : 15.43 Bid-YTW : 7.31 % |
| SLF.PR.B | Perpetual-Discount | -1.14 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 16.50 Evaluated at bid price : 16.50 Bid-YTW : 7.37 % |
| TD.PR.R | Perpetual-Discount | -1.08 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 21.02 Evaluated at bid price : 21.02 Bid-YTW : 6.70 % |
| BCE.PR.I | FixedFloater | 1.06 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.00 Evaluated at bid price : 16.21 Bid-YTW : 6.92 % |
| TD.PR.A | FixedReset | 1.09 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 23.21 Evaluated at bid price : 23.25 Bid-YTW : 4.21 % |
| TD.PR.Y | FixedReset | 1.12 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 22.57 Evaluated at bid price : 22.61 Bid-YTW : 4.10 % |
| BNA.PR.B | SplitShare | 1.14 % | Asset coverage of 1.8+:1 as of December 31 according to the company. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2016-03-25 Maturity Price : 25.00 Evaluated at bid price : 21.25 Bid-YTW : 7.89 % |
| PWF.PR.A | Floater | 1.15 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 13.16 Evaluated at bid price : 13.16 Bid-YTW : 4.72 % |
| ENB.PR.A | Perpetual-Discount | 1.53 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 23.64 Evaluated at bid price : 23.91 Bid-YTW : 5.84 % |
| TD.PR.N | OpRet | 1.86 % | YTW SCENARIO Maturity Type : Soft Maturity Maturity Date : 2014-01-30 Maturity Price : 25.00 Evaluated at bid price : 25.78 Bid-YTW : 3.90 % |
| PWF.PR.M | FixedReset | 1.88 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.45 Evaluated at bid price : 25.50 Bid-YTW : 5.11 % |
| PWF.PR.F | Perpetual-Discount | 2.07 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 19.20 Evaluated at bid price : 19.20 Bid-YTW : 6.88 % |
| PWF.PR.G | Perpetual-Discount | 2.12 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 21.72 Evaluated at bid price : 21.72 Bid-YTW : 6.83 % |
| BNS.PR.R | FixedReset | 2.32 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 22.47 Evaluated at bid price : 22.51 Bid-YTW : 4.29 % |
| BAM.PR.O | OpRet | 4.11 % | YTW SCENARIO Maturity Type : Option Certainty Maturity Date : 2013-06-30 Maturity Price : 25.00 Evaluated at bid price : 19.00 Bid-YTW : 12.34 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| WFS.PR.A | SplitShare | 198,962 | Asset coverage of 1.2+:1 as of January 8 according to Mulvihill. RBC crossed 171,800 at 9.30. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2011-06-30 Maturity Price : 10.00 Evaluated at bid price : 8.86 Bid-YTW : 10.91 % |
| MFC.PR.C | Perpetual-Discount | 109,090 | Commission Direct (Who?) crossed 105,000 at 17.05. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 16.91 Evaluated at bid price : 16.91 Bid-YTW : 6.76 % |
| TD.PR.E | FixedReset | 104,959 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.25 Evaluated at bid price : 25.30 Bid-YTW : 6.01 % |
| RY.PR.P | FixedReset | 89,874 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.32 Evaluated at bid price : 25.37 Bid-YTW : 5.87 % |
| NA.PR.O | FixedReset | 54,298 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 25.00 Evaluated at bid price : 25.05 Bid-YTW : 6.37 % |
| RY.PR.W | Perpetual-Discount | 52,348 | National crossed 40,000 at 19.22. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2039-01-20 Maturity Price : 19.00 Evaluated at bid price : 19.00 Bid-YTW : 6.58 % |
| There were 37 other index-included issues trading in excess of 10,000 shares. | |||
I am wondering about your idea that the credit crisis was caused by $400B of money market withdrawal after Lehman collapsed. You seem to blame this on retail investors, but I would not be surprised if there was considerable corporate cash management money withdrawn (similar to ABCP in Canada).
As I understand your argument, money market funds invest in short term funding obligations of banks (among other issuers, but primarily banks and short-term Treasuries), so the removal of this substantial cheap source of funding could reduce available credit by 10-20X leverage or $4-8 Trillion.
However, isn’t the Fed buying money market assets to the tune of several hundred $billions? Is this inadequate to cover the withdrawals?
Also, I must say that I am at a loss to understand the most recent swoon in bank equity prices. In contrast to equity, long term corporate bond yields are still easing and (due to rises in long term treasury yields) the spreads are falling. What am I missing?
So, are bank equity holders freaking out about dilution and potential dividend cuts? (Wells Fargo is rumored to be next, having done its “patriotic duty” a la Bank of America by taking over Wachovia).
Are bond holders growing more confident that banks are too big to fail?
Why doesn’t this picture seem to add up?
You seem to blame this on retail investors, but I would not be surprised if there was considerable corporate cash management money withdrawn
For purposes of this argument, I consider these to be equivalent. The basic idea is that withdrawals were disproportionate to the losses and disproportionate to risk.
However, isn’t the Fed buying money market assets to the tune of several hundred $billions?
It is now (see Fed Release H.4.1, but this took a little while to set up – and the idea that Issuer X could count on $Y-million funding through the money market has been dealt a body blow. Outstandings are recovering, but there was a very sharp decline at the time. Even with the liquidity injection, volumes have only just come back to pre-Lehman levels.
are bank equity holders freaking out about dilution and potential dividend cuts? … Are bond holders growing more confident that banks are too big to fail? Why doesn’t this picture seem to add up?
The stock and bond markets often contradict each other, at both the issuer level and (less often) overall. That’s what makes it fun!