Economy & Trade, Global, Global Geopolitics, Headlines, North America | Analysis

FINANCE: Global Meltdowns and the Perversions of Lucre

Analysis by Abid Aslam

WASHINGTON, Jan 28 2008 (IPS) - No explanation of the financial malaise afflicting the world economy would be complete without mention of Wall Street’s bankrolling of politicians, pay practices, and shifting of risk to investors.

To be sure, there is no shortage of culprits on whom to blame the mess.

Financial institutions have been reckless, ratings agencies feckless, regulators toothless, and monetary authorities hapless.

Mortgage lenders made dodgy loans to unsuspecting borrowers. Financial institutions then created and hawked securities backed by these mortgages, many of which seemed to have been rigged for default. Institutional investors made huge and ill-fated bets on the asset-backed securities.

The credit rating industry blessed the securities with its top marks despite evidence these were fraught with risk.

The credit rating agencies’ apparent credulity amid years of hyperinflation in U.S. housing prices seems incomprehensible: Comparable spikes in asset values preceded the Asian financial crisis of 1997 and the dot-com crash of a few years later.

Contrary to the image of judiciousness cultivated by the financial sector, few players appear to have had much incentive to exercise caution. The earnings of the sectors’ sales force are tied to the volume, not the quality, of business they generate.

The typical New York investment banker with 10-15 years’ experience made 2.1 million dollars in 2007, according to Washington Post commentator Robert Samuelson. Of this, 1.2 million dollars came in cash bonuses for selling stocks and bonds or pushing mergers and acquisitions, he said, citing figures from compensation consultants Johnson Associates.

Nearly two-thirds of the 1.5 million dollars earned by the average bond trader with that much experience came in the form of cash bonuses. Cash rewards accounted for 80 percent of the 1.8 million dollars made by the equivalent hedge fund manager.

Pronounced swings in market fortunes often are attributed to Wall Street’s herding instinct: traders follow each other in buying and dumping given securities. But as Samuelson puts it, “compensation practices skewed so heavily toward bonuses based on annual profits make matters worse.”

Top executives, likewise, are encouraged to maximise profit on a quarterly or annual basis. If a firm beats analysts’ forecasts for sales, income or profit, the company’s stock rises and top bosses are rewarded with bonuses. The bonuses are theirs to keep regardless of subsequent losses.

Financial powerhouse Merrill Lynch showered Stanley O’Neal with 161.5 million dollars – more than three times his pay the previous year – even as it ousted him as chairman and chief executive last October. At that point, Merrill had owned up to some eight billion dollars in losses on securities backed by substandard mortgages.

Merrill’s stockholders are left to bear the losses, thanks to a transformation that has shifted risk onto investors’ shoulders while opening venerable bastions of private privilege to the investing public.

Major Wall Street firms once were private partnerships but now are listed companies. By cashing out, the old owner-operators were able to rid themselves of future risk. Yet their compensation packages would ensure continued income from profits.

“They got to have their cake and eat it too,” said Peter Schiff, president of U.S.-based investment advisors Euro Pacific Capital. “As a result of this transfer of risk, the business models of America’s leading financial institutions shifted, with profits coming from riskier sources such as proprietary trading and structured finance.”

“To line their own pockets, Wall Street’s bankers willingly exposed their shareholders to risk that they would never have assumed with their own capital,” Schiff said in a written commentary Monday.

What of the financial sector’s overseers?

Regulators and the makers of public policy from whom they receive their mandates and resources clearly have failed to match the financial sector’s capacity for chicanery.

Wall Street had been under scrutiny after the dot-com collapse but this attention waned after the terrorist attacks of Sep. 11, 2001. Governance rules were tightened after a tsunami of accounting scandals swept Enron Corp. and much of corporate America in 2002 but the reforms addressed troubles elsewhere in the system, not those at issue in the current crisis.

However, regulators and the politicians to whom they answer also appear to have abetted Wall Street in its excesses.

Take the case of the Banking Act of 1933, also known as the Glass-Steagall Act. This law was aimed at preventing a rerun of the Great Depression by separating banks and securities firms. The stock market crash of 1929 had been blamed on conflicts of interest among these institutions.

The U.S. Congress repealed the law in 1999, rewarding financial companies for more than 300 million dollars worth of lobbying over more than two decades.

Their efforts had gained traction after 1987, when former J.P. Morgan investment bank director Alan Greenspan became chairman of the U.S. Federal Reserve Board, or central bank. Greenspan argued the law had become a relic constraining U.S. banks’ competitiveness.

The big push for repeal came in 1997-98, when the finance, insurance, and real estate industries – FIRE, collectively – ploughed 200 million dollars into lobbying and 150 million dollars into politicians’ electoral war chests. Most beneficiaries were lawmakers with seats on finance committees.

Robert Rubin, then treasury secretary, gave the Bill Clinton administration’s go-ahead for repeal. Days later, the former co-chairman of Wall Street major Goldman Sachs announced he was moving to Citigroup, the world’s largest bank, to work with chief executive Sanford “Sandy” Weill, who had spearheaded the campaign against Glass-Steagall.

Weill later would be elected to represent member banks’ interests as a director of the Federal Reserve Bank of New York.

FIRE has made more than 90 million dollars in political donations for November’s elections, according to the nonpartisan Centre for Responsive Politics. The Washington-based watchdog is to release updated campaign finance figures early next month.