Bloodletting on Wall Street
There were two noteworthy episodes last week in the continuing drama surrounding the housing market meltdown. First, the New York Times did the arithmetic and found that the Wall Street banks had already written down debts that amounted to almost half of their profits in their boom years from 2004 through the first half of 2007.
The other big item was that two Bear Stearns hedge fund managers were marched off to jail, charged with fraud and other related offences. According to the public accounts, these managers were extolling the virtues of their funds to customers, while at the same time in private emails to each other they were writing that the funds were about to be wiped out.
My guess is that the bloodletting is far from over. Much of the other half of the Wall Street profits will be gone by the end of the year. Also, many more Wall Street big shots will surely be doing the perp walk before the story reaches its conclusion.
This raises many questions about Wall Street and the economy. First, since so much of bank profits were illusory, the story about profits in the economy is somewhat different than we had thought. There really was no profit boom in this decade. In fact, true profit shares of GDP were almost certainly less in this cycle than in the 1990s. This means that the upward redistribution that prevented most workers from getting much benefit from productivity growth over the last decade went exclusively to high-end workers, not corporate profits.
I will have more to say in future columns about profit shares in the economy; this is a very important issue. But Wall Street's vanishing profit syndrome tells us much about the current state of the relationship between stockholders and top executives.
Remember, the business ideology of the last quarter century was that the shareholder is king. Everything must be done to maximise shareholder value. If this means massive layoffs or shutting factories that had supported a local economy for decades, so be it.
However, we have just seen the top managers of many major Wall Street banks take their shareholders for a huge ride. These are people who got annual compensation packages that always ran into the millions of dollars and often the tens of millions of dollars.
What did these high salaries get the shareholders? If you bought shares of Citigroup back in early 2004, you would have paid close to $50 a share. The stock now sells for less than $20, a loss of more than 60%, before adjusting for inflation. A share of Merrill Lynch stock sold for close to $60 in 2004. It now sells for close to $36, a loss of 40%. And Bear Stearns - we won't talk about Bear Stearns.
The point is that top executives have managed to wrest control of companies away from shareholders so that they can earn huge compensation packages regardless of their performance. This is an economy-wide problem. There are incompetent managers at the top of many companies, all of whom can count on compensation well into the seven figures, even as they run their companies into the ground.
However, the problem is worst on Wall Street. The compensation is higher and the performance is poorer. Furthermore, because of the central role of finance in the economy, the failings of the Wall Street crew are likely to have greater economy-wide ramifications than ineptitude in most other sectors.
There are no easy remedies here. Clearly we need a new regulatory structure to make it more difficult for the bankers to leverage the economy to the edge of disaster. But with the Wall Street crew completely dominating the debate over regulation, we have little reason to hope for serious reform.
In the absence of a major regulator overhaul, there is one simple measure that would at least ensure that the public gets a cut of the action. A modest financial transactions tax could easily raise an amount equal to 1% of GDP, or $150bn a year at present. This is real money - enough to finance a 10% across-the-board reduction in the income tax.
A tax of 0.25% on a stock trade or 0.02% on the purchase of credit default swap will have no measurable impact on productive financial transactions, but will likely put a serious dent in speculative activity. For this reason, it is a win-win-win proposition. It reduces speculation, it takes a big bite out of Wall Street revenue and profits and it raises a bucket of money. If anyone has any better ideas, they are keeping them to themselves.