“Judgment Day for Wall Street?”

Sydney M. Williams

Thought of the Day

“Judgment Day for Wall Street?”

March 16, 2012

For three and a half years Wall Street has earned the enmity of Main Street. Of course, a politically polarized Washington has made sure that this issue of mistrust stays front and center with the electorate.

Mandated government loan programs and the unfortunate repeal of Glass-Steagall certainly played a role in the near collapse of the financial system, but there is no question that management and boards of some of the nation’s largest banks bore equal, or greater, responsibility. Decisions were knowingly made that elevated risk to shareholders, counter-parties and their own capital base. A focus on the short term prevented a full vetting of the consequences. Greed became dominant. The prospect of instant riches via complex derivative-based trading strategies overwhelmed any sense of a communal moral good. In many cases, officers and directors failed in their fiduciary responsibilities. Regardless, there was no question that, in the autumn of 2008, the system had to be saved. And the largest banks were saved… by taxpayers’ money, via TARP and similar programs.

To let our financial system collapse would have been cataclysmic. As I have written on many occasions, to that end we owe a great debt of gratitude to those who were in charge at the time – especially Henry Paulson, Ben Bernanke and Timothy Geithner. Those men had to make decisions in a few hours, some of which, from the perspective of a few years were obviously wrong. But, they did what they did and the system survived. Depositors were able to access their funds and the dollar still functions (though weakly) as a medium of exchange.

But what many of the banks did with some of the TARP money was reprehensible – using taxpayer funds to pay bonuses, in too many cases, to those responsible for the destruction. What has been at fault in these firms is a culture, built on the concept of speculating with other people’s money for the purpose of lining their pockets – heads I win, tails I don’t lose. That attitude was given expression in a letter by mid-level Goldman executive Greg Smith in Wednesday’s New York Times. Nobody likes a whistleblower and we may find ulterior motives for Mr. Smith’s unusual letter of resignation, but his allegations rang true at a time when Wall Street is increasingly under the microscope.
All companies have four constituencies: Owners; Employees; Customers, and Community. In private businesses, owners and employees are often one and the same, but in most public companies they are distinct. The board of directors is responsible for hiring the chief executive and should theoretically represent shareholders; in large public companies that often means millions of small shareholders across the country, generally through their ownership of mutual funds and retirement plans. In Wall Street, public firms – the last major partnership, Goldman Sachs went public in 1999 – using shareholder funds have been far more reckless than in the days of partnerships. Not surprisingly, people are more prudent with their own money than with someone else’s. Goldman is no exception. When they went public thirteen years ago, the public owned 18% of the company; today the public owns about 70%. With diminished ownership by insiders came increased recklessness.

Among other allegations, Wall Street has been accused of looking after its own interests, at the expense of its customers. While such accusations in many cases are accurate, the truth is that even Wall Street trading firms, like Goldman Sachs, need customers, for their money, their flow, fees and as counter-parties. They know that a too-cavalier attitude toward clients eventually will return and bite them in the butt. Ultimately, it will destroy their franchise and their ability to make a profit.

However, there are those who deliberately have violated rules about segregating customer funds. The most notable recent example is the MF Global scandal, which embodies the height of arrogance and disdain for the customer. The scandal is breathtaking in its bold disregard for law and convention, not only in the fact that at least $1.6 billion of customer assets are still missing almost five months after the bankruptcy filing, but in that it appears that the perpetrators may not be brought to justice. Any violation of the Commodities Exchange Act is a crime, but appropriating funds from segregated customer accounts is supposed to be the most inviolate of rules. Yet, according to reports in the New York Times the prosecutors were having trouble putting together a criminal case. They have to find a “smoking gun” according to their reports, as detailed by Joe Nocera on Monday in the Times, and it appears such a weapon is missing. And now there is a debate as to whether to pay bonuses to those executives who stayed on at MF Global aiding in the sorting through the mess. But from what pool of money would the bonuses come? From customer funds still being held? From taxpayers? There is no clear answer. Money, as my mother always said, doesn’t grow on trees. It must be earned.

The cynic in me wonders if the Justice Department is not giving cover to the politically connected Jon Corzine. Whatever is happening, it stinks. If white collar crime, such as this, goes unpunished, the message that sends to our youth is clear – crime pays, as long as you steal enough and have friends in high places. And it certainly does not suggest a Judgment Day is imminent.

But the constituent who keeps getting the short stick, and receives little or no defense from the press or Washington, is the hapless shareholder, whether he invests directly as an individual or through mutual funds and retirement plans. While the stock prices of JP Morgan Chase and Wells Fargo are finally back near where they were in the spring of 2008, the same cannot be said for other banks, like Goldman Sachs (28% lower), Morgan Stanley (71% lower) and Citigroup (82% lower). Shareholders, who were innocent as to the machinations of management and the blind eye of directors, have suffered grievously. Raising the dividend and authorizing share-repurchases is at least a means of returning some money to these long suffering shareholders. And, contrary to what the popular press would have their viewers and readers believe, most of the stock in these banks is owned by mutual funds, representing millions of individuals on Main Streets scattered across the United States. It is in equity ownership, as Charles Merrill explained so presciently sixty-five years ago, where Wall and Main intersect.

Sadly, it does not appear to this writer, though, that Judgment Day is coming to Wall Street – at least not yet. Rather we are experiencing a devilish twist to those lines from Hosea: ‘For They Have Sown the Wind, but Taxpayers are Still Reaping the Whirlwind.’ (But since less than 50% of the people pay federal income taxes, the “Government Party” may not really care!) Lovers of freedom, in which camp I place myself, must remember that crony capitalism knows no party – it is practiced by the Left every bit as much by the Right. It is damaging to our basic liberties. We don’t need or want witch hunts, but a failure to prosecute obvious criminals, especially when they are well connected, harms us all, and ensures that corruption will be here to stay.