It looks like the Monsters of the Universe are raking in big bucks for their Wall Street firms, and rewarding each other with massive bonuses once again, despite the ongoing recession in the economy. And how are those saints, heroes and geniuses doing this? By making sound loans to U.S. consumers? By making shrewd investments in existing U.S. companies, new firms, new technologies and small businesses? Not based on what you read. My guess, based on history, is that they are merely taking advantage of the ultra-low interest rate policy of the Federal Reserve, and using the money to buy U.S. Treasury Bonds, making money off the spread.
Keeping short-term rates low, at the expense of savers, future inflation, and asset price distortions, to increase that spread is a common way for central bankers to help banks get out of trouble. One only need look back to the early 1990s to see this, with the help of the New York Times archive (no I didn’t pay for it; sorry about the wage cuts and layoffs guys). In late 1992 this source reported that in “a dramatic turnaround for the banking industry from the gloomy forecasts of just 12 months ago, Federal regulators said today that 1992 would be the most profitable year ever for the nation's banks. As a consequence, they said, fewer institutions would fail in 1993 than had been expected, even though new regulations that go into effect next week require officials to seize weak, but solvent, institutions.” A Congressman named Chuck Schumer responded as follows: “the banks' heavy reliance on Treasury instruments reflected the fact that there were few other long-term investments strong enough for investing insured deposits… ‘Any idiot can make money by taking in money at 3 percent and lending it at 7 percent…But anyone who looks at the last four quarters and thinks the banking industry is back on track is making a mistake.’"
If he were speaking today, he would have said “any idiot earning seven figures,” but let’s quote further from that article. “Since banks have been lending more money to the Government than to private enterprises, experts said, the industry's strongest returns have come from its growing investments in longer-term Treasury bonds, which continue to post yields of more than twice that of shorter-term Treasury bills.”
The Fed was responding to the previous real estate disaster, the 1980s bubble in commercial real estate that wiped out the Savings and Loan industry, at great cost to the taxpayer. “Bankers have attributed the banner year to what they call the spread — the difference between the rate they charge lenders and the rate they pay depositors — which has been at its widest point ever as a result of the Federal Reserve Board's moves over the last year cutting interest rates to their lowest levels since the early 1960's.”
By the early 1990s U.S. business ethics were sinking but had yet to utterly collapse. Thus, rather than bonuses, back then the money earned off the backs of ordinary Americans and their future was used for “plowing much of the record earnings back into reserves for bad loans and to capital that can be used as a cushion to absorb losses in worse times.”
Fast forward to today, and I am shocked at what I am hearing about Wall Street bonuses. The sense of entitlement seems unbelievable; you’d almost think it was the New York State legislature and public employee unions seeking earlier retirement you were reading about. The money is not only unearned, it is unsustainable.
For the past decade the Monsters of the Universe sucked money off the top, counted as “profit,” money from so-called investments that were 100 percent certain to blow up later. The profits were phony, in reality, but the bonuses earned on them were never given back once the associated losses emerged. And those bonuses were not widely shared, because all those middle class finance workers who used to do grunt work like due diligence are no longer on the job. (There had been some talk of outsourcing actual banking to India, but they pretty much just dispensed with it all together).
And now, what I presume to be a “borrow short from the Fed and lend long to the Treasury” strategy is creating profits now but bound to lead to bank losses when interest rates rise. But once again, I don’t expect the bonuses now being announced to be returned when those related losses arise.
According to another Times article seven quarters after the first one “a year after interest rates stopped falling, Wall Street still is not sure what caused the party to end. But the hangover endures, in the form of slower economic growth and intense pain for many investors, who have seen the bond market suffer bigger losses than in any previous 12-month period.” From the biggest bank profits, on bonds, to the biggest losses on bond investments. That can’t happen again, can it? And if the banks are playing the spread once again, I’ll bet they are leveraging the game, increasing the “profits” and the bonuses on them now, and the later losses. After all, why not?
Wall Street should be taking this gift, and with great penitence using it all to get out of the hole. The federal government is sticking it to savers, risking a big increase in inflation, and risking the loss of our status as a reserve currency, to save the financial system. The Fed’s situation is like that presented by Gozar the Gozarian in Ghostbusters: “choose the form of the destroyer!” Inflation or another Great Depression? That these idiots, as Chuck Schumer described them, are getting fat bonuses after contributing to us being in this situation is outrageous.