Charles Gasparino has an interesting column in the WSJ in which he details the bailout mania that seems to have gripped the Feds over the past 30 years. He argues that repeated past actions by the Feds since the 1980's have shown that the next time that large financial institutions find themselves in dire straights because of investments gone bad, Father Government will come to the rescue with wallets wide open. That makes managers at such institutions more likely to take on risks they otherwise would not.
Mr. Forstmann knows a thing or two about greedy investment bankers: He's been calling them on the carpet for years, most famously during the 1980s when he fulminated against the excesses of the junk-bond era. He also knows that blaming banking greed alone can't by itself explain the financial tsunami that tore the markets apart last year and left the banking system and the economy in tatters.
The greed merchants needed a co-conspirator, Mr. Forstmann argues, and that co-conspirator is and was the United States government.
"They're always there waiting to hand out free money," he said. "They just throw money at the problem every time Wall Street gets in trouble. It starts out when they have a cold and it builds until the risk-taking leads to cancer."
Mr. Forstmann's point shouldn't be taken lightly. Not by the press, nor by policy makers in Washington. But so far it has been, and the easy money is flowing like never before. Interest rates are close to zero; in effect the Federal Reserve is subsidizing the risk-taking and bond trading that has allowed Goldman Sachs to produce billions in profits and that infamous $16 billion bonus pool (analysts say it could grow to as high as $20 billion). The Treasury has lent banks money, guaranteed Wall Street's debt and declared every firm to be a commercial bank, from Citigroup with close to $1 trillion in U.S. deposits, to Morgan Stanley with close to zero. They are all "too big to fail" and so free to trade as they please—on the taxpayer dime.
I've been critical of the decision by the Obama Administration pay czar, Kenneth Feingberg, to cut the pay of CEO's at some financial institutions that have gotten bailout money. There are believable anecdotes that some of the top talent have already left those institutions lest their pay get cut in the future and I'd like to think that the government would like to have the best people available running financial institutions, particularly those that have received bailouts.
The trade-off is that the threat of pay cuts by the Feds could limit some of the moral hazard that comes with the expectation of government bailouts. The Feds have already shown that over the past 25 years, a time spanning 5 administrations of various political stripes and numerous congresses, that if a financial institution is at a risk of failure, chances are good that government will help prop it up. If I'm a senior executive at a big bank, I'll rationally believe this and I will take risks I otherwise wouldn't.
But now that the government has taken steps to cut the pay of senior managers at those institutions, I will think twice about taking some big risks because I expect that I may bear some of the losses. That's the theory, at least.
The problem is that in such a repeated game with no end, will the government have the guts to cut salaries again? Will they play the pay cut game the next time around if it's not politically feasible to do so, even if it's the right thing to do economically? And what of the unintended consequences that are sure to crop up as executives adjust which, surely, they will? If nothing else, unintended consequences are often met with band-aid remedies that create more unintended consequences which beget even more band-aid remedies. And so on, and so on, and so on.
Before this sort of regulatory behavior becomes believable, investors will have to see it happen more than once. If not, then it becomes a statistical oddity in the history of financial regulation and not a credible threat.