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Those Wall Street Bonuses Come at a High Price

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The word is out. Wall Street is back. Houses in the Hamptons. High end cars. Manhattan condos. After two years of nervousness, excess may once again trump discretion, or shame.

Soon we will see Goldman CEO and former gold trader Lloyd Blankfein walking the halls of Congress once again, defending his industry's largesse and lucre--though perhaps this time he will have the good grace to forego his prior suggestion that they are doing "God's work."

Wall Street's revival comes even as Citibank CEO Vikram Pandit took time out of the G-20 meetings in Korea to complain about how chilly the climate was for bankers in the U.S., in contrast to the warmth he felt ensconced among his global finance brethren.

Chilly indeed.

Could America conceivably be more accommodating to its major financial institutions, as they prepare to pay out record levels of bonus compensation in the coming weeks?

The myth continues that Wall Street was bailed out with the $700 billion of TARP money. Pushed through a recalcitrant Congress in the wanting months of the Bush administration by Hank Paulson and Ben Bernanke and disbursed over the months that ensued, TARP has become the iconic whipping boy of left, right and center alike.

Ironically, little of the TARP money was actually used to purchase bank "toxic assets," as originally intended, as most banks refused to sell--fearing the losses that they would be forced to recognize. Instead, TARP funds were provided as equity infusions and asset guarantees that nursed the banks back from the brink of collapse.

Today, the details of the whole episode are receding into memory. Even as films and books have chronicled wide-ranging stupidity, fraud and incompetence, as a matter of public policy bad conduct was occasionally noted, but never pursued. We have moved on.

The boards of the banks remain intact. The CEOs that oversaw the debacle fly off to G-20 meetings in Geneva or Korea to bemoan their fate. To hear them talk, one would think that the banks were incidental to the financial crisis. And in their revision of history, the TARP money was forced upon them. They were doing just fine on their own.

Few recall Hank Paulson and Ben Bernanke viewing the American economy on the verge of collapse. Fewer still give credit to any of the participants--Bush, Paulson, Bernanke, Obama, Geithner--for having stabilized the financial system. That is now deep in the past.

The total cost of the orgy of greed that that surrounded the packaging and trading of complex derivatives and collateralized securities has yet to be fully tallied. Last year, the IMF projected total bank losses at over $4 trillion, with $2.7 trillion of those losses at U.S. banks. Federal Reserve Bank data shows household balance sheet losses from the market collapse reached $15 trillion in 2009--almost 24% of the total net worth of American families--before ebbing to $10 trillion as the equity markets rebounded.

What is lost in the fury over TARP is that it represents only a portion of the federal intervention to support the country's leading banks, as well as the two largest investment banks, Goldman and Morgan Stanley, which converted into bank holding companies in order to gain access to Federal Reserve support.

The most far-reaching area of federal intervention has been the sustained injection of massive amounts of liquidity (i.e. money) into the banking system by leaving the critical Fed Funds Rate--the interest rate charged on interbank loans among members of the Fed system--at or close to zero.

The effects of a 0% Fed Funds Rate are profound. In a normal time, and in a normal, cyclical recession, lowering the Fed Funds Rate ripples through the economy as a lower cost of capital on prime business loans and other loans. In the current economy, however, little new business lending is taking place.

While Fed data indicates that little commercial banking (lending) is going on, banks are taking full advantage of the availability of zero interest loans, and have borrowed trillions from the Fed. Literally trillions. Goldman: $600 billion. Morgan Stanley: $2 trillion. Citi: $1.8 trillion. Bear Stearns (now J.P. Morgan): $1 trillion. Merrill Lynch (now Bank of America) $1.5 trillion.

The term trillion makes all of this somewhat hard to grasp. But what is easy to grasp is the notion that if someone lends you money at 0%--OK, 25 basis points if you want to be picky--reinvesting it at a positive spread is not hard to imagine. Most Americans would relish the thought of replenishing their depleted retirement savings with zero interest loans, and would find any number of ways to take advantage of the opportunity. Put the money in a bank. Buy treasuries. Buy bonds. Buy commodities. Buy gold. Buy almost anything.

For the banks, free money translates into huge trading profits with no trading risk if they stick to investing in treasuries, and more if the go farther afield. And that is the point. The Fed strategy of keeping the Fed Funds Rate at or near zero provides a back door way of recapitalizing the banks, of rebuilding the balance sheets of financial institutions that lost an estimated $3 trillion and were insolvent. $700 billion of TARP funds was nowhere near enough, and the banks bridled at the constraints on compensation that came as part of the deal.

In contrast, the Fed strategy was clean, and for the most part invisible. It required no vote of Congress, no authorization or appropriation of federal funds. There was no public humiliation on Capitol Hill. The only downside--for the public at least--is that before those banking profits reach the bank balance sheets, 40% or so of the trading profits will be paid out as bonuses.

But the Fed strategy has come at a high price. While the zero Fed Funds Rate is great for the banks, it has been a killer for those living off of their savings and for the nation's pension systems. Senior citizens whose income is derived from rolling over certificates of deposit have seen their interest income decline by as much as 95% as CD yields declined from the 3% to 5% range prior to the economic collapse to recent levels of ¼ to ½ of 1%, according to Fed data.

If much of this seems incomprehensible, the message is simple: The Federal Reserve policy of keeping its target rate near zero is intended to allow banks to recapitalize, but has the effect of taking money from the elderly and others living off their savings, and transferring that money to the banks.

Over the coming weeks, Wall Street banks will pay out an estimated $30 billion in bonuses. These bonuses come on the heels of the second year in a row of record trading profits. Those record profits are not a product of great market insight, but reflect what is possible when money is free.

So when you see Lloyd Blankfein walking the corridors of power on Capitol Hill, defending the trading profits of his industry and proclaiming once again that they are doing God's work, give your mom a call, or your great aunt or your elderly neighbor living on a fixed income. Give them a hug, and thank them for their sacrifice for God and country. Apparently, their sacrifice is necessary to rebuild our banking system and our nation.

After all, someone has to pay the price, and God knows its not going to be the people who created the mess to begin with.