1-02-2010

Lynch Mobs Don’t Deal Well with Babies or Bathwater

Last week, I was in a very small group of people who prognosticated severe re-regulation of banks in Investment Banking Comeuppance Interrupted. I explained that populist politics would force a severe re-regulation of the banks and concluded with, “When it hits, it won’t be fair and it won’t be pretty, but it will be effective in handing bankers their comeuppance.”

Today, I’m just one of the crowd opining on what has been proposed.  But, I do believe that (to severely mix metaphors) the lynch mob outlining re-regulation is throwing out the baby with the bathwater. 

I have absolutely no problem with limiting the proprietary trading done in big banks. I was appalled in July of 2008 when Goldman hedge fund clients lost billions in sub-prime mortgage investments, and then in August, Goldman proprietary made billions on the other side of that trade. The concept that we are now in an environment where large banks can borrow at zero and deploy trades to make profits for employees is inherently unfair.

However, when you extrapolate this concept to include that it is unfair for banks to make a lot of money in the current interest rate environment, the Fed’s main policy point has been lost. Austin Goolsbe, one of the most influential White House economists, is quoted this morning in the WSJ: “The key issue is that the institutions that are getting a backstop from the taxpayer shouldn’t be able to make a profit off their own investing,” NO, THIS IS NOT THE KEY ISSUE.

The key issues are:

1. The Fed wants banks to repair their balance sheets and that’s why Fed Funds are at zero,

and

2. The employees of these banks should not receive any largesse from this environment through compensation. 

The shareholders of the banks are largely institutions that represent individuals’ holdings and pension holdings, and allowing them some recoup is not a problem. The problem is that investment bankers paid themselves too much when it was good and too much now that it’s bad.   Crushing bank profitability will play well on Main Street, but in the end, it won’t benefit Main Street. Credit will remain hard to get. Attacking compensation practices head-on should have been done coincident with the extension of TARP funds, but we know that things were moving fast and solutions had to be found. It’s never too late to do the right thing. The right thing now would be to take on compensation directly. There is still plenty of profitability without large banks doing proprietary trading. However, broadly going after bank profitability is not the answer.  

Fred S. Fraenkel
Vice Chairman and
Chairman of Investment Policy
Beacon Trust Company

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