Pearlstein: Wall Street

Steven Pearlstein
Washington Post Columnist
Wednesday, April 8, 2009; 11:00 AM

Washington Post business columnist Steven Pearlstein was online to discuss the leadership of Wall Street executives and Tuesday's speech by Goldman Sachs CEO Lloyd C. Blankfein (pdf) on Wednesday, April 8 at 11 a.m. ET.

Read today's column: Not Quite a Confession, But a Good Start.

Submit a question now or during the discussion.

Pearlstein won a Pulitzer Prize in 2008 and is co-moderater of the On Leadership discussion site.


District of Columbia: What is your outlook on JER after these latest developments?

Steven Pearlstein: I'm not a stock analyst and don't follow most companies very closely. Like a lot of real estate investment trusts, this one has lost a lot of market value, but probably not as much as the market says it has. As you know, I've been predicting a big commercial real estate bust for a number of years now, and its pretty clear we're looking at pullback in pricing of 40 percent to reflect the new realities of more expensive financing and less leverage and much less rosy assumptions about per square foot rent growth. The industry had been in denial on this for several years. Cap rates are already back at 6 to 7 , and I figure they have a way to go still.


New York: Some in the media have just made the discovery that the people Obama hired to fix the economy, are --gasp!-- from Wall Street. My question is, if Obama had wanted to hire from the "outside", who could he have gotten? I mean, aside from Pearlstein and Krugman.

Steven Pearlstein: We'd all be in real trouble if they had to hire newspaper columnists. And you're right, this jihad against anyone who has ever been on Wall Street is silly. It's good that we have a civil servant at the top of Treasury, and we have a strong and active president who doesn't suffer from the Wall Street disease. But when it comes to constucting instruments to solve the financial crisis, its pretty hard to do it without drawing on the experience and knowledgge of people in finance.


Fort Worth, Texas: Steven, how do we transition out of what we're in right now to something long-term and stable? My fear is that, what with all the easy credit, we're falling for all the same old tricks again. Granted, it could help soften the recession, but my sense is that once things are mildly stable and the government tries to pull back on the credit things will fall apart again. Is transition something that people are thinking about, or is it too far off on the horizon at this point?

Steven Pearlstein: When and how to withdraw the government credit will be a big issue some day, I hope not too long in the future. The trick is to do it as gradually as you can without letting the market heat up again. But these things are pretty measurable on an hour to hour basis almost, but looking at rates and spreads and volumes of new issues and loans. The idea, of course, will be for the government to withdraw as private sector capital begins to flow through the old pipes again, at roughly the same rate.


District of Columbia:Steven,

Help me out with something I can't seem to get an answer to!

Last week, in a report about the high number of defaults on mortgages that had been modified, it was noted that nearly 60 percent of mortgage modifications DID NOT result in lower monthly payments.

But aren't lower payments the purpose of mortgage modifications/renegotiations?

If not, then it really should not come as a surprise to anyone with half a brain that people who default again!

Steven Pearlstein: I'm glad you noticed it and brought it up, because it gets to an important issue regarding the "failure" of loan modifications. These 60 percent reflect the industry's preferred solution when somebody calls in and says they are behind in their payments because of one thing or another. And the call centers are trained to say, "Oh, no problem, we'll just take those missed payments and penalties and wrap them into the amount of principal on the loan, so that instead of a $400,000 mortgage it is now a $410,000 mortgage. So naturally the monthly payments are higher. Of course if there is really a problem with affordability of the mortgage, that's not much of a solution. But that's the way the servicers try to deal with these things.


Alexandria, Va.: Dear Mr. Pearlstein,

What other ways do you see (aside from taxation) of stopping and reversing the Wall Street arms race on pay? As far as I can tell, no other method has been effective during the last two decades of relentless abuses of the executive pay system. So the only remaining remedy seems to be progressive taxation, with high rates for high incomes. Wasn't this the tax system of the 1950s and 60s when economic growth was solid and the economy more fair in distributing is productivity?


Steven Pearlstein: I don't think this is something government can or should solve. What it will require is for leading companies like Goldman Sachs to use recessions like this one to unilaterally disarm -- to announce that they are going to a new structure for compensation which, in reality, would also turn out to be a lower level of compensation. The hope would be that everyone else, out of economic necessity, would follow along rather than try to take advantage of Goldman. It is a common leader-follower arrangement that you see in lots of markets. What Goldman could also do to support this is to lower its prices as well, so that competitors would risk losing customers if they don't follow the lead. Can anyone be sure that would work? No. Is it risky? A bit. But if it doesn't work, Goldman can also quietly respond to instances when competitors try to use higher pay to lure away its best performers. But it could also allow some people to be picked off and acknowledge that the skills many of these people have aren't so unique and the people aren't as irreplaceable as they think they are.

What the arms race in pay is about is really herd behavior.


Arlington, Va.: When Hank Paulson left Goldman Sachs to become Treasury Secretary for George Bush he was allowed to sell his highly concentrated portfolio of Goldman shares tax-free because of so-called ethics rules.

He avoided tens of millions of dollars in taxes and was also able to diversify out of Goldman shares.

Is there public information on where he invested his profits?

Steven Pearlstein: No.


New York, N. Y.: Aside from "leaders of the big Wall Street firms," another group remaining silent are the numerous regional banks that had the foresight to avoid the sub-prime mess in the first place. Investors Savings (N.J.) greets depositors with a banner featuring its CEO stating as much. Under the circumstances, what, if any, enhanced role could such banks be assigned in the recovery efforts? It's a shame to waste such acumen.

Steven Pearlstein: They don't have to have the government "assign" them any role, because the marketplace should be doing that on its own, assigning them larger market share as the big, overleveraged banks that made unwise investments and loans are forced to shrink and raise expensive capital.


Princeton, N.J.: You say, "The answer to that problem isn't for Congress to use the tax code to effectively legislate pay caps for Wall Street."

I am not sure exactly what you mean. For years I have advocated a return to the high marginal rates we had in 1946 to 1973. We need much high marginal tax rates so executives do not have the ability to accumulate wealth that would embarrass an oriental potentate. They make short term decisions that are bad for the US, the world and even their own institutions, but are good for their own balance sheet.

During the period 1946 to 1973 taxes were much higher. Marginal rates averaged 70 percent; they were 93 percent under Eisenhower. The economy was better than what we now have. For example, median wages went up 3 times as fast as since 1973. Also I recently saw a graph of the national debt as a percentage of the GDP from 1946 to the present. It started high, went straight down until 1973, and then flatten out and in 1980 made a sharp turn and went straight up except for a wiggle during the Clinton administration. CEO's earned 50 times what their workers earned; it is 500 times today. Staring in 1973, the percent of wealth and income taken by the richest 10 percent, one percent, and 0.1 percent has gone up at an ever increasing rate. This is a recipe for disaster.

Steven Pearlstein: Marginal rates above 50 percent start to have pretty negative effects on tax compliance, on the willingness to take risks and work hard, and on international competitiveness. The data show that. It's not a straight line. If you combine a 10 percent state tax rate and a 40 percent federal rate, you get 50 percent. That should be enough to finance the worthwhile activities of government, allowing for substantially lower rates for lower income brackets. People in the middle class have to get the message that they will probably have to pay higher taxes in the future if they want the quantity and quality of government services they indicate they do.


Chicago, Ill.: Steve, Can you explain how we didn't double or triple pay Goldman? First, we gave AIG money to cover their clients losses on MBS, they then paid $12 billion to Goldman among many others. Second, we gave Goldman money to re-capitalize them because of their losses. Third, we are creating a program to buy these MBS off Goldman at a minimal loss. So when in all of that did they have to eat any of their losses. It looks like the exact opposite. Goldman Sachs is just one example. Thanks

Steven Pearlstein: In general, it is true that a company like Goldman can benefit in a variety of ways from a variety of initiatives, and in the process strengthen a faltering financial system that we concluded months ago was necessary to be strengthened so that the rest of us could avoid a depression. It's for us, not them.

Second, we didn't give them anything. We invested money by taking shares which now pay 5 percent dividends and have so many strings attached that Goldman wants to pay the money back early.

Third, I'm not sure we're going to buy toxic assets from them under the Geithner program, nor are they likely to sell. They are already marking to market and don't have that much toxic stuff on their books at this point since they started selling the bad mortgage stuff years ago. That's why they are in relatively good shape.

Look, don't get me wrong, government money of various sorts is being used to prop up banks. You can't prop up the banking system without doing that. The government is trying to do this in the most cost effective manner within the context of a complex market system, with the hope that in the end it doesn't cost the taxpayer too much. But the fact that AIG money made its way to Goldman, a counterparty in credit default swaps, shouldn't be a surprise. The reason we took over AIG was precisely to avoid a situation in which those swaps became worthless and the impact rippled through the rest of the financial system.


Don't leave out the Wall Street customers: I know there's not enough space to flog all the guilty parties in every column, but who falls for the "peddling of bad merger and acquisition ideas?" CEOs and Boards who aren't looking out for shareholders. How can we change this?

Steven Pearlstein: "We" can't.


Tampa, Fa.: In your column today you wrote that "-t]he most important is culture -- in the case of Wall Street, a culture that not only tolerates but almost celebrates taking advantage of customers."

I don't see how this can change. Wall Street has always been about making money at the expense of customers. They make a simple calculation of risk vs. reward: What's the risk of being caught vs. the reward of making a profit off of your customers?

We have to accept this and impose a regulatory regime that assumes this is the case and addresses it. This requires aggressive enforcement, even it means Congress will have to bite the bullet and adequately fund the regulators. It will also require severe penalties. Only the combination of aggressive enforcement and severe penalties will change the result of Wall Street's daily calculation of risk vs. reward. When this calculation yields a sufficiently high probability of being caught and suffering a serious penalty, Wall Street will change.

So instead of trying to change the culture, accept it and act on it.

As for funding, why not take a page from drug enforcement? Police get to keep assets seized under drug laws. It is an important source of funding for them. Let the SEC keep the fines and penalties it imposes. If it's good enough for the drug police, it's good enough for the capital markets police. (OK, you can stop laughing; Congress would never allow it!)

Steven Pearlstein: Better enforcement is certainly part of the solution.


WSJ forum was actually pretty good: What did you think of the March 30th WSJ special section on a "Future of Finance" forum they held among the poobahs, academic and otherwise?

I thought Peter Fisher (former Republican Treasury under-secretary, Blackrock) had especially cogent, specific thoughts on what reforms could work and what had gone wrong.

Steven Pearlstein: Have to say I missed it. But I'll look it up.


On Furthering a Good Start: I appreciate your article which appears to confirm that Wall Street geniuses can't self-regulate things where bonuses are concerned. After all, it's other peoples' money. One solution is regulations or laws prohibiting bonus pay in stockholder or bailout companies unless real profits are achieved (not phantom profits which appear in periods for which bonuses are due but don't hold up later). Bonuses paid on phantom profits should be considered company theft. In addition, require independent auditors to calculate or certify profits for SEC and shareholder/public reports rather than relying on internal staff calculations. Finally, impose criminal sanctions on individuals who approve and/or receive unwarranted compensation from bailout or public companies. Certainly entrepreneurial innovation or real growth potential shouldn't be stymied, but what these execs did with bonuses on phantom profits must be stopped.

Steven Pearlstein: Instinct is right but its often more complicated than that, as I've said here many times. Giving bonuses to people in money-making divisions of companies that, overall, lose money, is not necessarily a bad thing. In fact, it may be a necessary thing. That doesn't mean that the bonus pool for a money-making unit should be unaffected by the financial health of the overall company. But you have to acknowledge the reality that these units compete in their own marketplaces not only for customers but employees and not having pricing and compensation schemes that reflect that market reality can leave you at a competitive disadvantage.

Having said that, during a recession, the risk of "losing" employees obviously goes down, But to say that nobody ever should get bonus pay when a company is losing money is about like saying that salesmen should never get commissions when a company is losing money. That's a recipe for losing even more money.


South Riding, Va.: For the past few years, it seemed like the overall goal on Wall Street was to maximize the current stock price. Companies were looking for ways to boost their stock and not always looking at the long term value/impact of their actions. They were likely neglecting to make investments in the organization as that would have been an expense that reduced the profit. Now that the stock values are at rock bottom, and money to invest in the company is hard to come by, they will struggle even more. Can the market recover? Will it ever really reach the prices we saw a few years ago? What can the small investor (with a little bit in savings or a 401K plan) do?

Steven Pearlstein: The market will recover -- it always does. Can't say when but I wouldn't rush in just yet.


District of Columbia: Have you heard about any credit card companies -- whether they're taking the government assistance or not -- lowering interest rates in a thoughtful, coordinated way? I'm of a mind to call them up, demand a lower rate, and if told no, say, "This is why I can't pay them off! Congress is going to come after you!" I'm mostly joking. I know the debt's my own fault. But still. Twenty-eight percent interest?

Steven Pearlstein: Suddenly the music stopped and you are left without a chair. You'll just have to wait, I'm afraid, until new credit card money (or home refinancing) is available at a lower rate and you can refinance with somebody else. The current card company is squeezing you because they know you don't have options.


Evanston, Ill.: At what point will anti-trust start to enter the debate? Shouldn't too big to fail mean you are too big to exist? Geithner and Obama seem content to preserve the existing mega-banks and add some extra regulations. Doesn't that put the taxpayers squarely on the hook for the next bailout in 10/20 years?

Steven Pearlstein: The regulators should never have allowed some of these mergers to go through, primarily because these companies became too big to manage. I also think there is less price competition than in a healthy market.


Clifton, Va.: Sorry Geitner is part of the problem not the solution. Being a Fed gov is not being a civilian govt employee. Fed has a better pay scale bubba at all levels. Geitner is just as much part of Wall Street as a trader on the floor.

A real Fed!

Steven Pearlstein: Please!


District of Columbia: A lot of people folks have noted the apparent double standard in Obama's treatment of the financial industry vs. the auto industry. One justification I've heard is that we "need" the banks in a way we don't need GM.

Isn't it also possible that Obama (and Geithner and Summers) believe that the banks can succeed in a way that they don't believe GM can?

Steven Pearlstein: This is mixing apples and oranges, this thing about treating GM different than the financial sector. The financial sector was rescued because it is more central to the oepration of the economy. But the reason GM is getting loans and thousands of struggling small businesses aren't is because GM is central to the health of the economy at this critical moment (at some other time, we would have simply let it go into bankruptcy). None of it is fair, its just doing what we need to do to prevent a collapse of the economy. Reading in all sorts of conspiracies is really quite silly.


Princeton, N.J.: On Credit Default Swaps, I thought that most (80 percent) of these were "insurance" on instruments that the policy holder did not have a strong material interest in. It's like me taking a fire insurance policy out on your house. If this is the case, if AIG defaulted on the policy, it would not strongly affect me. It is hard to see why taxpayers dollars should be used to indemnify me. I took two gambles. Your house would burn down, and AIG would pay. If your house did burn down, you should get paid, but as for me, I just lost one of my gamble (on AIG), and I deserve nothing. Furthermore, since I am not really suffering any loss, I do not see why this would be so bad for the economy.

Steven Pearlstein: Its not a question of "deserve." It's preventing a set of dominoes from knocking each other down and bringing down the financial system. Moreoever, you don't know that CDS weren't used as an indirect hedge. Its complicated.


Concord, N.H.: Hey Steven, why do Geithner and Bernanke keep saying the banks are solvent? If they were solvent they would not need a trillion plus dollars to repair them. Why are they refusing to do their regulatory duty and wind Citi and the like down? Now they are delaying the results of the stress tests. Shouldn't we stop the charade and get about the business of rebuilding?

Steven Pearlstein: False premise. They are trying to recapitalize the banks BEFORE they become insolvent, or to reduce the chance that that will be insolvent.


Clifton, Va: Tell the Prof at Princeton that a 70 or 90 percent rate will just encourage companies to find other ways to reward top execs like cars, boats, planes etc. We will then be more like the UK in 70's when you could tell how well off your neighbor was by the car he drove. Sorry professor we don't need any more socialism here in the US. We need to cut taxes at all levels! I don't care what a CEO makes and if I worked at AIG I would have kept the bonus and sued the NY AG if he revealed my name or broke his legs!

Steven Pearlstein: Thanks.


"Stress Tests": Steve, I'm a little concerned that Treasury is delaying the release of the bank stress tests until fatter first quarter company reports are in. Also, they may just release a summary instead of per institution results. I'm thinking the results of the stress tests are quite abysmal. You?

Steven Pearlstein: Have no idea. Don't think they'll be releasing them, in any case.


Orlando, Fla.: Why not require that a percentage of fees for financial deals be paid in the equities, bonds or other securities that are in the deal and require the firm to hold the securities for 5 years? This would cut down on the high risk deals that firms recommend.

Steven Pearlstein: Why not just reduce the fees. They are ridiculously high. One reason is because you only collect fees on deals that are consummated, even though lots of work is done on deals that are never consumated and no fee is paid. So the done deals have to subsidize the undone deals. Why not simply charge by the hour, so that the investment bank advisers have no incentive to do bad deals.


Laurel, Md.: Tangential, but potentially important...

Could the federal government require that bailout banks move their credit card operations out of Delaware? That state's non-existent usury laws are what allowed the high-fee and automatic reset practices of the last decade that kept the most at-risk borrowers in perpetual debt trouble.

Steven Pearlstein: Might be easier to buy the state legislature and change the law.


I don't think this is something government can or should solve.: But higher, more progressive taxes would solve other problems as well. Look at what happened to the national debt (as a percent of GDP) 1946 - 73 when we had higher marginal rates. Also it would stop what I believe to be the greatest long-term economic problem, namely the increasing concentration of wealth at the top.

Steven Pearlstein: You're stretching it now.


pretty negative effects on tax compliance, on the willingness to take risks and work hard, and on international competitiveness. : Compliance among the rich is terrible at all rates. People didn't work hard in 1946 - 73? Have you looked at the marginal rates or total tax rates of other industrialized countries?

Steven Pearlstein: they didn't start companies in as great a number during that period -- very corporate type of economy based around big corporations.


Middle, America: I believe in evidence based management, not "complex derivatives" which should be placed in the fiction section. You say that we still need bonuses and huge compensation on Wall Street. I say that 24 million people are looking for work, 23,000 Wall Streeters at the minimum, and that everyone in the executive suites in Wall Street and Greenwich should be looking over their shoulder. When will corporate boards start looking out for the workers, the product, and the long-term future of their company and their corporations?

Steven Pearlstein: They think they have been doing that all along, and that the rest of us just don't understand how smart and thorough they are, and well-meaning and how this was just a perfect storm that hit them and it ain't their fault. I know this because I've asked that question of many of them and that is what they say.

That's it for today folks. "See" you next week.


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