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Pearlstein: Outrage Over Wall St. Bonuses

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Steven Pearlstein
Washington Post Columnist
Friday, October 31, 2008; 11:00 AM

Washington Post columnist Steven Pearlstein was online Friday, Oct. 31 at 11:00 a.m. ET to discuss the "outrage" over the bonuses at Wall Street firms that agreed to accept a government investment.

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Read today's column: Hank Paulson's $125 Billion Mistake.

A transcript follows.

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

Pearlstein was honored with the Pulitzer Prize for commentary for his columns about mounting problems in the financial markets. His award was one of six Pulitzer Prizes won by The Washington Post this year.

Read Pearlstein's latest columns.

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DC: Dude, I thought you were WAY on Paulson's team. How does such a smart guy like Paulson make such an obvious error? What's the deal?

Steven Pearlstein: I'm on YOUR team, dude. Anyone who's been around this town understands that I'm a very unreliable ally. I call 'em the way I see 'em.

It's real easy to make a mistake in these circumstances. This isn't tiddly winks. There's no textbook. There's a big gap between theory and practice. We're dealing with emotion and psychology of literally millions of investors and financiers around the world. There are big political stakes and big political pressures that have to be accommodated. So Paulson got sidetracked at my opinion by listening to a lot of very smart and knowledgeable people. He wanted to join in in a joint effort by all the G-7 governments that did a capital infusion into the banks. And there is this "consensus" among the crisis managers at the Fed and the Treasury that any rescue program has to be structured so that it doesn't stigmatize the users. They get this from the Fed's experience of banks not wanting to use the discount window because everyone knows you're in trouble. Well, in normal times that may be so. But these are not normal times and the very existence and viability of institutions are at stake. In this context, I don't think chief executives are going to fool around and dally if they see money that could save their institutions that they can't raise elsewhere or on more generous terms.

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North Carolina: A little off topic, but from what I've read, it sounds like smaller banks are in much better shape than larger banks because they mostly stayed out of this risky lending business. Do you think we might see an uptick in mergers among these smaller banks and the emergence of new regional banks?

Steven Pearlstein: Possibly, but mostly because all bank stocks are relatively cheap now and its a good time to buy if you're a strong bank and have stronger stock or cash to play with.

As to the smaller banks being in good shape, let's wait on that. Their vulnerability is builder and developer loans, and some of that has yet to hit the fan.

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Reston, Va.: Steven, I read an article in Investor News that stated that high-ranking Democrats are considering eliminating pre-tax contributions to 401(k) plans. They are also considering mandating all workers contribute 5% of their pay into an account managed by the Social Security Administration which would be invested in US Bonds that return 3%. Have you heard anything about this? Do you think it will have any legs when Congress returns to session with their likely super-majority?

Steven Pearlstein: No I haven't heard that. Democrats are probably toying with having negative checkoff for contributions to private 401 K plans, so more people participate. But I don't think, given the political history on this, Democrats want to get into putting a voluntary add-on component to Social Security. That's supposed to be the universal safety net for all Americans, and they like the program pretty much as it is. They will have to tweak it a bit by raising the income limit on SS taxation, and pushing back the retirement age and limiting the cost of living increases a bit for those at the upper end -- progressive indexing its called. But those three things should be enough to put the program back on solid actuarial footing.

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Great Falls, Va.: Ok, I waited through your interminable vacation to ask my question. In, I think, your last chat, you noted that not many Americans had shown real leadership through this crisis, with the exception of Warren Buffett.

How exactly has he shown any leadership in making sweetheart deals that the common investor could never make? Both the GE and the Goldman deals included preferred shares, which would still get paid in bankruptcy. Yes, the common investor can make that deal, but it doesn't exactly show faith in the companies. More tellingly, the deals included warrants with absurdly low strike prices. That part of the deal, Goldman Sachs was not about to offer you or me.

I don't mean to criticize Mr. Buffett, exactly; he makes those deals because it's his job, and he's very good at it. But as far as real leadership goes: I'll give Mr. Buffett some credit when he starts buying big chunks of common stock. He won't do that until he's really convinced that we're near the bottom. His public statements, his recent purchases -- those are just akin to "selling your book."

Steven Pearlstein: Actually, I don't think I singled out Buffett as the only leader. The reason I say that is not because I have perfect memory of the last chat before the LONG vacation -- its because I have a rule as far as Buffett is concerned, which is not to criticize him or praise him too fulsomely. That's because he's a director of the Washington Post Co. and no matter what I say or write regarding him, it's only going to get me in trouble one way or the other. Either I annoy the corporate management here, or I come off looking like I'm shilling for a Post investor and director. The only exception I can recall making to this rule was when he bought Diary Queen and I called every Dairy Queen in Omaha until I found the one he goes to and found out what his favorite treat was. I recall it was some sort of mix-in.

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Washington, DC: What's the deal with the favored status afforded to bank dividends? I remember the Bush administration succeeded in getting legislation passed that exempted dividends from taxes. Now dividends are being sourced directly from the Fed's bank bailout.

Steven Pearlstein: Let's get this straight: dividends are not being sourced from the federal bailout money, in the way I think you mean that. Obviously money is fungible. If the Treasury invests in a bank in exchange for preferred shares paying 5 percent interest, the money goes into the pot from which the bank does what it does, which includes making loans, paying dividends, paying employees, contributing to the local little league, paying the light bill, even paying federal taxes. So you could also ask why federal taxpayers should be supporting local little league teams or even paying themselves back in taxes. And by the same logic, you can say the money is being used to pay dividends, including dividends to the Treasury by the way.

The reality is that if a bank has profits and positive cash flow, and it has adequate capital reserves, then it makes sense to continue paying the same dividends it has been paying. That will make it easier to raise additional private capital if necessary down the road. It will keep shareholders happy so they don't fire the managers, particularly at a time when the stock prices is probably declining. And, in fact, it is probably better for the economy that the profits are returned to shareholders to be invested elsewhere in the economy than if the bank holds on to all of it and then feels compelled to make riskier loans, at the margin, that it would have if it paid the dividend.

In other words, its not that simple.

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Lefty from Princeton: Hello, You say, "Nor does it square with recent evidence that investors are quite capable of sniffing out weak financial institutions long before managements come clean." Where is this evidence? It seems to me that the current situation is such a complicated mess that investors are flying blind. What we have seen is that in the recent past, investors will make horrendous decisions. They will buy securities backed by crappy mortgages. They will invest in derivatives which magnify the risk. We are talking about the same people who did these things. Why should we trust their judgment now?

You say, "Paying the bonuses to successful employees is not only fair but is also necessary to attract and retain top talent." First of all, if we pay huge bonuses, we encourage executives to make decisions that lead to short term gain or what they perceive as short term gain and not decisions which in the long term will be good for their institutions, for the country and for the world. Secondly, there has to be some limit. It is hard to justify income in the billions. Look at the example of Joseph Welch. He took GE from a profitable company that made things like TV's, generators, jet engines, refrigerators, etc. and turned it into a even more profitable financial company. He was rewarded in a manner that would have embarrassed an oriental potentate. Now, of course, GE is less profitable and we are all moaning about the transfer of our manufacturing to foreign countries. Again, these people you are paying these enormous bonuses are the same people who got us into this mess, the GM managers that spent millions advertising SUV's, the guys in London who brought AIG to ruin with credit default swaps, the hedge fund managers who even when successful have distorted the market beyond recognition, the energy speculators who perpetrated Enron and are now working to wreck the oil market. These are the same people. Einstein said," The definition of insanity is doing the same thing over and over again and expecting different results."

Steven Pearlstein: Great quote.

Well, the evidence is that investors were able to spot the weakness of Bear, Lehman and AIG long before their managements 'fessed up to their weak balance sheet. Ditto the mortgage insurers.

That's Jack Welch, by the way, not Joseph, who's name comes from the McCarthy era.

You and I have written a lot about executive compensation and how it has gone way out of control and how its set by a labor market for executive talent that is essentially rigged. We have no disagreement there.

But it is another question as to what the government should do about that, or sky high salaries for baseball players and Hollywood movie stars, or anything else that involve a private contract between consenting adults. The answer to this mostly has to do with norms of behavior -- of the corporate sector regaining some sense of balance and propriety and stewardship when it comes to executive comp. That requires leadership, not legislation or regulation, for the most part.

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Laurel, Md.: Steve, in the last two days I've read stories that in Nevada (which was a subprime hotbed) 20% of mortgages are under water, and they have the highest vacancy rate in the country.

So... how to get all the people who can't afford homes in Washington, San Francisco, Boston, New York, etc., to move to Nevada where the housing is?

Steven Pearlstein: That's actually not a joke question. One of the great strengths of the US economy is that markets do clear in that way because people aren't so tied to where they live, unlike many European countries. People move to where the jobs are, and companies move to where the unemployed (read cheap) people are, which is the way markets clear. And we do that better than almost any economy.

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Raleigh, N.C.: Greetings, comrade. (We're all socialists now.) What do you think of Greenspan's "insight" that flesh and blood humans run financial corporations, and that sometimes those humans will act in their own interests rather than the corporations'? I felt like I'd jumped aboard the silly train!! Hey, Alan, Ayn Rand wrote fiction, not history!!

Steven Pearlstein: Actually, Greenspan's surprise was that the people who ran these big corporations weren't clever enough to act in their own interests and see that they were taking too many risks. He assumed that the prospect of hitting the wall, as they now have, would have disciplined their risk taking, which is what a classic economic model would assume. He forgot to factor in the psychology, the herd mentality, the instinct to self-deception in the midst of a mania. I suspect in his heart-of-hearts, Greenspan believes that markets are pretty good and do correct for their own excesses eventually, as they are doing right now. And he's happy to let that process work without government intervention. But the thing is that most other people don't like the volatility and insecurity, and are willing to give up something on the up side to prevent the risk of crash. They are more averse to negative events than they are anxious for the positive events -- that's one of the teachings of behavioral economics. And because of this asymmetric preference, they prefer a somewhat regulated economy that provides a safety net underneath them, even if it means that the economy may be a bit less efficient in allocating capital, might have slightly lower GDP, etc. Economic security is a externality, a good, they are willing to pay for. And this is something that Greenspan has never really acknowledged in all his cheerleading about the brave new world of financial engineering.

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Orlando, Fla.: We are witnessing a huge consolidation of the financial industry that is very risky (too big to fail). Should the government require these institutions split up/spin off after the economy stabilizes?

Steven Pearlstein: Probably not. That genie is out of the bottle, and if you were to make sure that every financial institution was smaller than Bear Stearns, I think you'd be giving up a lot of efficiency and competitiveness.

But there is a question as to whether these institutions are "too big to manage." That certainly seems to be the case as far as AIG is concerned, and Citigroup. But that isn't the story of Lehman or Bear Stearns.

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Stanley, DC: Hi Steven - I enjoy your writing. I heard that the banks just received the $125B this Wednesday. So isn't the criticism somewhat premature? They just got the funds this week.

Steven Pearlstein: There's a lot about the carping that is nonsensical.

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Leesburg, Va.: What is your response to Glenn Greenwald's critique?

Steven Pearlstein: Who?

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Washington, DC: In your column today, you criticize Treasury's decision to invest $125 billion in the nine largest banks. But why do you think that buying "troubled assets" is superior to taking an equity position? As the policymakers more or less admitted, the plan is to buy these assets at above current market ("fire sale") prices. This would serve to increase banks' capital and might even help other banks in an accounting (if not real) sense, since they could argue that the value of their troubled assets had increased to the Treasury purchase price. But the taxpayer has made a lousy bet -- buying an asset at an above market price with the hope that it will eventually go higher. Also, just as in the equity purchase program, there is no assurance that banks as a result would take actions more to our liking than they have pursuant to the equity injection program. Maybe doing something is better than nothing, and any way you do it will have problems.

Steven Pearlstein: First, your question assumes that the Treasury would buy the assets at more than they are worth? Where did you get that. The Treasury was going to hold an auction at which people who hold distressed assets could compete to sell them to the Treasury. In such a reverse auction, the ones who offer them at the lowest price win. Obviously they'd like to get as high a price as possible, but if they bid too high, they won't get to participate. So this tension, worked through by lots of sellers independently and simultaneously (sealed bids), creates a pretty good approximation of a "market" price. Not perfect, not as good as lots of buyers and sellers at a continuous marketplace -- but that marketplace is now dysfunctional because there are no buyers. So as a second best strategy, Treasury proposed to create a market by having one big buyer, many sellers and a reverse auction process. Then, when the stuff is sold to the Treasury and the prices published, everyone else can figure out the "market" price of what they hold. And, if it works out as planned, that will give everyone more confidence -- confidence to begin buying and selling this stuff again, and investor confidence that what appears on the books of these institutions is a reasonable approximation of what the securities are worth. That gets to the heart of the liquidity problem that they were trying to address.

Now, if, in addition to liquidity problems, there are also solvency problems, then the Treasury has to deal with those as well, and that might well involve some recapitalization of weak banks. But better to concentrate the money on recapitalizing the weak bank than recapitalizing banks that don't need it.

Finally -- and this is a point I meant to make this morning but didn't have space -- in the U.S., the bulk of financial intermediation has shifted from banks to these arcane credit markets. And it is this "shadow" banking system that has frozen up much more than the traditional banking system. So the solution, logically, is to deal with the problems of this "shadow" banking system, which is exactly what the TARP auctions were supposed to do.

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McLean, VA: First of all, that's the best article I've read about this topic. Thanks for that.

It seems to me like this shift from buying Trouble Assets hence the name "TARP" to taking ownership stakes in financial institutions happened quickly, easily, and without much fanfare. It's only after we are beginning to see how the banks are using this gov't assistance that the scrutiny has begun. I feel like public outrage may have been even greater and the bill may have never passed if the Treasury had revealed their true agenda which seems to be a capital purchase program with relatively few strings attached. Where is the oversight committee on this?

Steven Pearlstein: Thanks. There is an oversight board, but it is basically Paulson and Bernanke and other members of the administration, so its not much of a check. The real oversight will come from Congress, but that is after the fact.

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Vienna, Va.: I have read that the government is planning to extend its bailout to insurance companies as well as banks. AIG already is a huge recipient. How much of this is caused by credit default swaps, which are essentially insurance? Ben Stein suggested that the government simply annul CDSs. I have also heard that most of these CDSs are third party bets, rather than real insurance.

Would such a policy work? Should the government limit CDSs?

Steven Pearlstein: Lots of complicated questions there, not all of which I understand well enough to comment on. But I think you raise a good point in asking what is the social and economic utility of allowing people to "insure" bonds or loans that they don't own. That seems to be a big contributor to speculation and volatility and doesn't add a bit of capital to the system used to capitalize real economic activity. Maybe we should just outlaw it.

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Woodbridge, Va.: I thought that was quite a column you had the other day on GM-Chrysler, almost scary. I firmly believe that the demise of manufacturing in this country is sending us on a road to ruin, if we aren't already there.

It's sad, really - if I know my history correctly, the unions were the savior of the working class back in the day, since miners and others were paid a pittance and worked in horrendous conditions, leading up to things like the Triangle Shirtwaist Factory fire in NY.

Now the unions are bad-mouthed from every direction for being short-sighted and narrow minded. However, they are not solely responsible for Detroit's problems.

Steven Pearlstein: No, the unions are not the only ones responsible. Bad management is equally to blame. But 40 percent, say, of the responsibility is still significant.

As to whether the US is losing its edge in manufacturing, I think that is only partly true. Actually, manufacturing output as a share of GDP is only slightly below where it was, and we remain one of the biggest manufacturing economies in the world. We are gaining grounds as a manufacturing exporter. And in the case of autos, we have a thriving domestic industry -- it just isn't centered in Detroit and with the Big Three any longer. The strength and growth is with the foreign transplants.

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Munich, Germany: Blogger Glenn Greenwald has something to tell you.

Mr. Pearlstein, would you like to publish your recent comments on Paulson's bail-out policy one right after the other, without omitting one --- allowing the reader to be amazed about all your blatant contradictions?

Will you have the guts to face the Greenwald challenge?

Steven Pearlstein: This is pretty indicative of the bloggers view of the world. They write about what other people write about. And the mainstream media writes about what's going on in the world.

If you or anyone else wants to compare and contrast and come up with some conclusion about the consistency of my columns, go right ahead. And if you decide I'm not someone you want to read, then don't read it. It's a free country and, at this point, the content is free as well.

As for me, I'm focused on my readers and the economic crisis before us, not getting sucked into the shouting match of the blogosphere.

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Richmond, Va.: Can you tell us where the government is getting all this money to pay for all these financial "rescue" packages? Do we have enough money in our treasury, or do we have to borrow money, sell bonds, etc.? Also, how do you feel about some of the money given to the banks being used to pay shareholder dividends?

Steven Pearlstein: It's all borrowed, every last dollar of it.

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Annapolis, Md.: Steven,

This is not directly related to today's article but I was wondering if you have a theory on why competition on Wall Street doesn't seem to work well.

- Their shareholders shouldn't be happy because employees make obscene salaries taking away value from the shareholders

- Their customers also shouldn't be happy. I have read a few books from Wall Street insiders and the common theme seems to be that the companies only look out for themselves and customers get fleeced wherever possible.

You would think that there would be other competitors coming up doing better work for both shareholders and customers. This has happened in most industries when the leading companies become too fat and greedy.

But it doesn't seem to happen on Wall Street. Do you have an idea why competition doesn't seem to work there?

Steven Pearlstein: You have hit on one of the most important and interesting questions that lies at the heart of this. The evidence is that Wall Street is an oligopoly, with firms competing in some ways (for volume) but not in others (on price). As a result, the firms earn rents --above average returns -- that they pass on to their shareholders and to employees who have the most economic leverage. But why doesn't some firm enter the market and offer better prices for the things Wall Street does. Well, they have in the brokerage area, which is why the major firms don't focus on that any longer. They aren't competitive in mutual funds for the same reason. So they have to keep inventing new products like derivatives and securitizations and CDOs that require highly specialized knowledge and distribution scale and some up front risk capital, which are relatively safe from outside competition. And they rely on their investment banking reputation, which for some reason is important to corporations even though the brand names are now no guarantee of quality or integrity. No board of directors was every criticized for hiring Goldman Sachs, and given the amount of money at stake, they are willing to pay for the "best" rather than go with a cheaper alternative without the reputational cache.

Anyway, breaking up this oligopoly has to be a goal of public policy going forward. But it's not going to be easy.

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Steven Pearlstein: No, the unions are not the only ones responsible. Bad management is equally to blame. But 40 percent, say, of the responsibility is still significant: How do you arrive at that 40% figure? Health care costs are the biggest issue facing US automakers. Not the union boogeyman that the elite choose to blame

Steven Pearlstein: One reason health care costs are skyrocketing is because unions negotiate gold-plated health plans that make their members absolutely oblivious to what health care costs because they pay none of the premium and very little in the pay of copayments and deductibles.

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Who?: I'm sorry, does getting a Pulitzer make you permanently immune to criticism? It must really kill you having to come and dawdle with us unwashed and un-Pulitzer-ed masses. Even those of us without blogs.

Steven Pearlstein: Who says I'm immune to criticism? Apparently this fellow Greenwald has criticized me, so I am, by your own admission, not immune. And I sit here for an hour each week and take your questions and comments and criticisms and publish them for all to see. So where do you get off saying I'm hiding behind a Pulitzer?

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Roswell, Ga.: Far be it from me to defend banks, as I'd like to see some of the worst of the executives tarred and feathered in the public square, but one of the things that is freezing up lending now is all the committed but untapped lines of credit banks have to large corporations. As the commercial paper market seized up and the market for new debt issues contracted, more companies have been tapping their bank lines for loans that banks would rather not be making in the current environment. And banks still have a lot of exposure to companies who in many cases would prefer to issue longer term debt or equity if it wasn't so cost prohibitive (if even possible) right now. Virtually every conference call transcript I've read this quarter includes a liquidity discussion, including how much is available from bank lines of credit.

Wouldn't you think that as the commercial paper and longer term corporate debt markets improve the banks will be in a better position to do more lending? The government's move into the commercial paper market only started this week.

Steven Pearlstein: Yes, which is why those other initiatives taken by the Fed are so important. And the good news is that they are finally working.

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DC: Hello Mr Pearlstein, Please tell me you were joking when you wrote about Buffett: "That's because he's a director of the Washington Post Co. and no matter what I say or write regarding him, it's only going to get me in trouble one way or the other..."

A journalist has to censor what he writes for fear of retribution??

Steven Pearlstein: Not retribution. It's that you jeopardize your reputation and relationship with readers if they begin to think you have an ulterior motive in writing about a subject. I don't write about the Washington Post much either, for that reason.

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Evanston, Ill.: Hey Steven, don't sweat the outcry from the lefty blogosphere fever swamp. They viscously attack anyone they perceive to be supportive of the administration or critical of Obama. A few months ago your esteemed colleague Dana Milbank wrote an article saying Obama was going from the Presumptive nominee to the presumptuous nominee. They attacked him relentlessly for weeks. I don't always agree with you, but I would never suggest you are shilling for power. As evidenced by these chats, you are very transparent in your thinking.

Steven Pearlstein: Thanks.

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Haddonfield, N.J.: Does the Treasury get dividends on the $125 billion investment like a private investor would? If so, the payback would be about 7 to 10 years so what's the big deal? If not, we're getting raked.

Steven Pearlstein: The Treasury gets an annual dividend of 5 percent, plus warrants on common stock that would be worth something if the common stock goes up in a few years. We'll make money on that, but I think the terms should have been more onerous, with either a bigger warrant or a higher dividend rate or both.

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Geneva, Switzerland: Steven, you have created a strawman in your latest column! Because who are the people who were arguing for "modest investments in dozens of banks, whether they needed it or not"? And who wanted the government to have "little say in how the money is used or how the banks are run"?

Can you name the names of any of the economists who were championing this? The idiotic idea of forcing banks to take money they do not need without strings attached is a pure Paulson plan which you yourself admit is NOT what Britain has done and NOT what the critics of the original Paulson bailout was proposing.

Furthermore, Paulson's original plan of taking over toxic debt apparently did not work either. Why would he otherwise have gone for plan B? Since you were a big fan of the toxic waste plan should you not be careful with "I told you so" statements?

Steven Pearlstein: Some fair points.

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Lefty: Look, you and I disagree on a lot, but I respect your opinion and you are sure as heck easier to get to than any other financial writer. You are appreciated and you certainly deserved your Pulitzer.

Steven Pearlstein: Thanks.

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Gaithersburg, Md.: Steven, in Wednesday's Barack Obama special, the Senator said he'd use the tax code to reward companies that create jobs in America and punish those that ship them oversees. I think I've heard some variation on this idea from Democratic presidential candidates all my life. Is this idea both politically feasible and possible to make work the way it should?

Steven Pearlstein: It's a good question. The tax system does tilt toward earning profits overseas for many companies, and the IRS and Congress are working on ending that. But I think we need to get away from talking about "punishing" or "rewarding" when we talk about taxes. We tax income because we think it is a fair way to raise revenue for needed public services, but that doesn't really mean we are "punishing" people who work or invest and earn money. And if we decide that we should allow people to deduct from their income taxes their losses, say, in a business deal, that doesn't mean we are "rewarding" failure. The vocabulary you use to talk about things is important, and in this case the vocabulary in misleading.

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Steven Pearlstein: That's all the time for today folks. "See" you soon, I hope.

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Editor's Note: washingtonpost.com moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.


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