In politics, we are often told, we should not let the perfect be the enemy of the good. That’s why so much of what comes out of our policy-making process ends up as politically-driven compromise. In Washington, splitting the baby is often considered better than no baby at all.
But, as the financial crisis brings the worlds of finance and politics into increasingly overlapping orbits, we need to take note that what may be acceptable compromise in politics can be dangerous ambiguity when applied to finance.
Today, many banks are faced with openly ambiguous mandates that border on outright conflict.
On the one hand, these publicly-listed banks are expected to pursue their business models and to respect their fiduciary obligations to maximize return for their shareholders. These days any financial institution worth its salt is assessing how to take advantage of the opportunities presented by the current financial crisis – especially the hyper-generous financing being provided by the US Government.
At the same time, many of these same players have been deemed “systemic” and “too big to fail”. That often means that their businesses are being heavily subsidized, directly or indirectly, by the federal government to the tune of hundreds of billions of dollars.
In return for these subsidies, banks are being poked, pushed and prodded so as to further public policy goals, respond to (understandable) populist pressures to reduce compensation, restart credit markets, “lend like crazy” and, in some cases, to eschew the very opportunities that many talented financial professionals are champing at the bit to pursue. (It doesn’t get much better than 93% US Government financing, folks.) All this, so as to bring order and stability to the financial system as a whole.
This inherent conflict is why, in spite of my general skepticism about the health of the financial sector, semi-secret stress tests and the accounting gimmickry surrounding the banks’ first quarter results, I was pleased to hear that Goldman Sachs intends to pay back its TARP funds as soon as possible and that JP Morgan hopes to do so as well.
I am not a cheerleader for Goldman. But I am glad that they resisted reported pressure from the Government to refrain from taking advantage of a relative sweet spot in the equity markets to raise private capital and pay back TARP funds. Had they failed to do so, they would have been effectively handing the US Government a major seat at their management table, potentially at the expense of their public shareholders. Their decision to remove this ambiguity about who the bank’s management really reports to was the right thing to do.
I would have thought that last year’s implosion of Fannie Mae and Freddie Mac would have raised major red flags that we need to be especially careful to avoid ambiguity when blending the realms of policy and finance.
Fannie Mae is a particularly illuminating case in point. For the first thirty years of its existence, when completely controlled by the US Government, Fannie was enormously successful in using financial tools and market mechanisms to advance public policy goals. It was only when it was privatized for budgetary reasons, that messages became mixed and things got complicated. It was at that point that, with an ambiguous mandate to serve both the interests of its public shareholders and to further the policy directives of its government masters, its sad fate was effectively sealed.
Similarly, as applied to today’s US banking system, various government plans and financing schemes, combined with efforts to resist taking ownership stakes in these entities, have led to the creation of dangerous ambiguities through the financial system. While well-intentioned, and perhaps politically necessary, the current banking landscape appears to be the result of a desire to preserve the status quo of the financial system, to remain true to our free market ideology and to avoid seeking additional funds from Congress to address the underlying weakness in the banks’ balance sheets.
This has led to the creation of programs, like the Public-Private investment Program (“PPIP”), which have the risk of “conflict” written all over them.
Shortly after the PPIP was announced, the press started running stories in which they “uncovered” what I would have thought was obvious – that many of the major institutions currently receiving billions of TARP funds were preparing plans for how to take advantage of the PPIP – and the very generous leverage and terms that it provides. These banks are not only in the business of making money for their shareholders and employees, but are also holders of much of the “private capital” that the PPIP hopes to mobilize to jump start the financial sector itself. So expecting them to refrain from taking advantage of the program, whose goal is to help these very same institutions, would be to fundamentally misunderstand how big banks operate. Sound confusing? That’s because it is. That’s my point.
It remains unclear to me whether the government plan considers these large financial institutions to be sick patients in need of urgent medical help, or conversely, highly experienced medical professionals, whose private capital and expertise are being encouraged (through generous financing packages) to come to the aid of those very same patients. Or both.
Unfortunately, a financial crisis that compels significant government intervention is bound to be handcuffed by political considerations – thereby making ambiguity almost inevitable. One of the reasons that historically these banking crises have ultimately been solved by “nationalization” or good bank/bad bank schemes is that they are clear cut and free of ambiguities.
While politically necessary perhaps in the short run, the longer these ambiguities exist in the financial system, the more confused and at risk the system may ultimately be. Unlike in politics, in finance today, as in King Solomon’s time, most people understand that in the end, you have to make a choice – because a split baby isn’t really much good to anyone after all.
— Douglas Rediker