Confidence game?

The unfolding news of Merrill Lynch just about boggles the mind.  From “Merrill paid employee bonuses before sale to Bank of America” on

Despite Merrill reporting a massive loss of $21.5 billion in the fourth quarter of 2008, the report noted that the company had “set aside $15 billion for 2008 compensation, a sum that was only 6% lower than the total in 2007, when the investment bank’s losses were smaller”.

“The bulk of 15 billion dollars compensation was paid out as salary and benefits throughout the course of the year,” the report said. Further, attributing to a person familiar with the matter, the report said that an estimated $3 to $4 billion dollars was paid out in bonuses in December.

Merrill and the Bank of America shareholders had approved the takeover on 5 December. “Three days later, Merrill’s compensation committee approved the bonuses, which were paid on 29 December,” it added.

It’s one thing for a profitable company to pay out big bonuses.  It’s another thing altogether for a company that is losing money to do it, then add the fact that the company is in the middle of being sold to a company that is being propped up with taxpayer funds.  This is the kind of thing that makes people very cynical.  Sooner or later it may even make them mad…

Here’s a take from a fellow I knew in college who writes a financial blog called Mean Street for the Wall Street Journal, Evan Newmark, in a recent post “Rise, Taxpayer, Rise”:

…it is amazing that Washington is still considering sending more tax money Chrysler’s way.Not that Chrysler isn’t pulling out all the stops to get it. This week, it announced a “global strategic alliance” with Fiat, another marginal, cash-starved automaker.

This “alliance” is not a plan for Chrysler’s viability. It’s a plan to wring another $3 billion in funding out of Congress to go along with the $5.5 billion of taxpayer money that’s already been put in.

Is Fiat putting any money in? No. Is Cerberus, Chrysler’s principal shareholder, putting any more money in? No. Will any investors put any money in? No.

It’s all up to you, the taxpayer. And with a trillion dollars in government stimulus in the making, that’s not going to change anytime soon.

But after another outrageous week like this last one, you may soon come to the conclusion that enough is enough.

Bob Reich’s calling it ‘Lemon Socialism’.

Put it all together and at this rate, the government — that is, taxpayers — will own much of the housing, auto, and financial sectors of the economy, those sectors that are failing fastest.

What’s left? Most of high-tech, entertainment, hospitality, retail, and commodities. So far, at least, we taxpayers are not propping them up. And when the economy turns up — perhaps as soon as next year, most likely later — these sectors have a good chance of rebounding.

But the others — the ones the government is coming to own or manage — are less likely to rebound as quickly, if ever. If anyone has a good argument for why the shareholders of these losers should not be cleaned out first, and their creditors and executives and directors second — before taxpayers get stuck with the astonishingly-large bill — I would like to hear it.

It’s called Lemon Socialism. Taxpayers support the lemons. Capitalism is reserved for the winners.

Folks who made bad decisions need to pay the price; if you want to profit from the upside, then you have suffer on the downside.  Enough with the giveaways that prop up undeserving losers (who don’t seem at all embarassed to be paying themselves off with the funds).

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  • Jim  On January 27, 2009 at 10:45 am

    Hate to say it, but I believe this is where government involvement in the economy leads us. These executives know there is a safety net beneath them (government). Profit no longer controls their actions due to government involvement (unattractive loans for social good). When it all tumbles down they will take care of themselves, as you or I would.

    Problem is, now that we know where it leads, how do we stop the government from interfering?

    This profit thing is a great controller. The biggest problem this country has – and we haven’t even seen it yet – is public sector UNIONS, which should not exist, as the only offset against union power is profit, and the public sector does not have profits – only taxes. Wait until this problem drops on us, particularly with the current administration having such a debt to the teachers and government unions!

  • Curt  On January 27, 2009 at 2:07 pm

    It’s true that there is definitely a moral hazard issue with any type of insurance or bailout.

    What gets me about the Merrill situation, however, is that not only do the taxpayers get a raw deal, but probably getting shafted even worse are the shareholders of BofA. It seems to me that there is a disconnect of management incentives to shareholder value. Merrill was very used to handing out big bonuses, presumably to hold on to talent (although how much you need to pay to hold the average talent is a good question), and even when things started going south I think they could not stop themselves from just handing out more money. I suspect the same thing would have happened even if BofA wasn’t getting big bailout money.

  • Jim  On January 28, 2009 at 3:16 pm

    “It seems to me that there is a disconnect of management incentives to shareholder value.”

    I could not agree more, but I do not know how to fix this disconnect. I watched executives in the Semiconductor Industry “steal” from the shareholders for many years with stock options, which is about the same as cash bonuses, just more time involved. It may just be a cost of capitalism, just as owners in the past century were able do as they wished with the income.

    Shareholders could stop it if they would truly participate in the Board of Directors activities and

  • Curt  On January 28, 2009 at 4:15 pm

    Yes, it’s not a new problem, and there’s been a lot of tinkering with various compensation and incentive plans to try to address it. Stock options themselves were seen as a way to align staff to shareholder value, but they can be abused as well.

    It’s one thing when you’re Warren Buffet, and can buy a big share of a company and have a say in what’s done. But shareholding is so diffuse now, with many holdings through various mutual funds and 401ks, it’s hard to see what most shareholders can effectively do in these cases…

  • Jim  On January 29, 2009 at 12:18 pm

    I am going to make a comment which I do not want to pursue in this thread (due to the time and effort it would take, not that it doesn’t interest me!) and that is that you know I believe we live in an “age of selfishness” due to the loss of a moral base by our society and I see this as the root cause. That is, in 2009 corporate executives will do things that were not even thought of in 1929.

    I suggest the following – a way to get a “balance of power” in a corporation and easily accomplished in our age of instant communication:

    Let’s make Corporate Compensation Committee a set of people at all levels, rather than a subset of the Board of Directors. Perhaps a committee of 10: 3 from hourly employees, 2 from supervisory employees, 2 from management employees and 3 from the BOD. A super majority (6) would be required to pass compensation packages.

    I’m not sure how you would solve the potential of intimidation from above, but this would certainly help the communication to the employees of remuneration policies and amounts and would perhaps put some pressure on the top dogs!

  • Curt  On January 29, 2009 at 12:45 pm

    Interesting idea! It does seem like some kind of counterbalance to the “grab all you can get away with” mentality is needed.

    One of these days we’ll dig into this “moral base” question.

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