Wall Street Bonuses – The Scariest Thing About Wall Street Bonuses

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‘Twas the week before Christmas, and all through the house, not a creature was stirring … except me, who was still trying to figure out how the banks paying back TARP can be construed as a positive thing.

The more I look at it, the more this thing stunk to high heaven from the get-go!

There is so much wrong with this at so many different levels that the TARP payback is going to affect everyone negatively, one way or another.

The Government Gets a Clue … Too Late

This all started with the banks being greedy to a stupid level, with no checks and balances to make sure that they did not step too far over the line.

Obviously, they did step too far and, when the bubble burst, they collapsed.

In rushed the government to bail out not only the banks, but the entire U.S. financial system.

The government, meanwhile, quickly tried to cover its rear-end due to the fact that it was negligent in its oversight of these banks dealings and exposures.

The funny thing was that Treasury Secretary Hank Paulson came out stating that it was the lack of disclosure from the banks that took the government by surprise.

Paulson stated that the government did not have the ability to see the exact size of the exposure the banks had. He said that, going forward, the government would need full disclosure from the banks in order to accurately oversee their dealings.

It All Comes Down to Mortgage B.S. (Mortgage-Backed Securities)

The problem here was how the banks calculated their assets, particularly the mortgage-backed securities. Since there is not a big market for these securities, they are very hard to price.

So, instead of pricing these securities based on market price (mark-to-market), they were allowed to price these assets at whatever amount that their proprietary models said those were worth (mark-to-model).

To get a clearer picture of this, think about your house for a moment. Let’s say your house is worth $500,000 and you decide to use it as collateral on a loan that you have taken out to purchase a new business.

The bank that loaned you the money feels pretty comfortable with the loan because, if you default, they have access to your $500,000 house.

But what happens if the house suddenly and quickly loses value and is now only worth $250,000? Now the bank has a problem because the collateral has lost value. This means that, if you default, the bank has a problem now, too!

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Imagine if Your Stocks Traded for 20 Cents on the Dollar

This is kind of what happened with the mortgage-backed securities. These securities, being debt instruments, are considered to be an asset on the books of the bank and, thus, can be used as collateral by the banks.

So, being priced at 80 cents or 90 cents on the dollar, based upon mark-to-model, the banks had 80% to 90% of the face value of the mortgage notes available as collateral to fund other operations.

Once the housing bubble burst and people could no longer afford those new, “exotic” mortgages, the value of the mortgage-backed securities nosedived.

Although priced at 80 cents on the dollar on the banks’ books, these securities started to trade for 20 cents on the dollar and lower!

The collateral was worth four times less than it was only a short time ago, and the banks were in a real dilemma. Suddenly, their balance sheets were very unbalanced.

When the “real” market value numbers came through, the banks had way more debt than they had assets to cover that debt.

As it turns out, these banks were gigantically over-leveraged, some to 40, 50 and even 60 times!

Is Turnabout Fair Play Here?

The government stated that it had no idea that these banks were leveraged to that extent because they had no way of knowing. There were no rules or laws stating that the banks had to fully disclose anything!

This is why Paulson had lobbied for a law requiring full disclosure of the banks dealings AND the market value of the securities the bank was holding.

They say that you should be careful of what you wish for … you might just get it. And that is exactly what happened!

The Financial Accounting Standards Board (FASB) passed Statement No. 157 (FASB 157) to allow the government to force the banks to price these securities at the value for which the securities were trading on the open market.

The only problem with the enforcement of FASB 157 was that, at the very end of 2007 when FASB 157 was enforced, the new mark-to-market valuation showed that just about every bank in the United States was insolvent.

The government got what it wished for, all right … and did it ever!

The Great Bank Bailout

The government was now forced to act, and act quickly. The Federal Open Market Committee (FOMC) dropped interest rates basically to zero in quick fashion, and pumped hundreds of billions into the system itself!

On top of that, many banks received cash directly — and not just a little bit, either.

It turned out that the government not only did not realize the scope of the depreciation of these securities — as most were on the banks’ books for 80 cents on the dollar, and were now actually trading for under 20 cents on the dollar — but the physical amount of the securities that the banks owned!

Beyond the trillions put out by the government both directly to these banks — and indirectly to them by supporting the mortgaged-backed securities market — the government basically insured all of the losses of the banks’ debt portfolios.

Added to this was the fact that, very quietly, the government amended FASB 157 — allowing the banks to go back to mark-to-model and to artificially strengthen the banks’ balance sheets, making the banks look healthy again.

Suddenly, the combination of a healthier-looking balance sheet — along with some rejuvenated earnings brought about by the banks being given billions of 0% money from the government and propped up by ridiculously low estimates courtesy of the Wall Street analysts — the banks’ stock prices started to rise.

In fact, they rose enough to generate investing interest from the private sector.

It seemed as though TARP had worked.

Problem is, TARP only worked to treat the symptoms, not the disease. The problems that led to this situation remain.

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Getting Out From Under the TARP

Once the government stops supporting these markets, they are going right back to their previous, pre-government-intervention prices.

This is where the repayment of TARP could be a big problem. First of all, you must realize that the repayment of the TARP money is simply for one reason … bonuses!

As long as the bank has TARP money, its bonus structure will be controlled (i.e., limited) by the government. This is such a huge problem that Bank of America (BAC) said that it could not find a quality, qualified CEO while under the controlled bonus structure that TARP brings with it.

This forced Bank of America to repay its TARP money by issuing another secondary stock offering, diluting the current shareholders. 

The moment that the money from the secondary stock offering came in, it was immediately sent off to pay back the government, getting Bank of America out from under TARP and back in control of its bonus structure.

Only a couple days later, Bank of America — after having such difficulty in finding a CEO — had their man signed, sealed and delivered.

I know many of you have your doubts about bonuses being the driving concern to the banks in prepaying the TARP money. The paragraphs above should tell you something.

Doesn’t anyone find it particularly convenient in the timing that there was a rush of banks repaying TARP in the last few weeks before Christmas and BONUS time?

For you doubters, think about it for a minute. Why would you (or anyone else) want to give billions of dollars that are loaned to you at a 0% interest rate that you can use to generate tons of income at almost no risk earlier than you have to?

Getting Paid at Any Cost

It does not take a lot of talent to make money with an endless supply of capital at a 0% interest rate! The only possible reason for this is greed. They want to get paid … and to hell with everything and everybody else!

So, Wall Street’s psychological make-up has not changed single bit after this incident. Their greed that almost destroyed the entire financial system of the United States and will wind up costing the taxpayer like you and me real money remains intact.

Thank God! I would hate to have Wall Street develop a conscience!

So, Where Does All That Repaid TARP Money Go?

But that is not what concerns me the most. What really concerns me is that the mortgage-backed securities that started this whole thing are still on the banks’ books!

And now, instead of having the real TARP dollars on their books to support their balance sheets on the asset side, they now have converted it to cash from you … diluting your value as a shareholder.

The government is going to take that repaid TARP money and use it elsewhere.

Let’s hope that, when the government pulls out of supporting the mortgage-backed securities market, the banks are ready to handle it. Because if they don’t and have to go back to the government for money, they may find that there is none for them because it is now being used elsewhere.

I don’t know what the likelihood is for this situation to become a real problem, but an increase in unemployment along with the government decreasing its support of the markets, the economy and the individuals (via extended unemployment compensation) could make this doomsday scenario a reality.

I am not calling for it, but the possibility of it is on my radar and is something that you need to be prepared for. Hedge your positions!  


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Article printed from InvestorPlace Media, https://investorplace.com/2009/12/wall-street-bonuses-the-scariest-thing-about-wall-street-bonuses/.

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