Tuesday, January 12, 2010

Bankers' Bonuses and the Tilt in the U.S. Economy

There isn't a level playing field in the U.S. economy. The government gives major advantages to banks and other financial companies. Banks are subsidized by the Federal Reserve, which gives them very cheap credit compared to say, Boeing, Ford or Disney. It also buys funky assets (like mortgage-backed securities) from them and stabilizes their counterparties (like AIG) when the latter get into trouble. When the going gets rough in the financial markets, the banks don't have to get tough. The government brings in a stretch limo and drives them to Easy Street.

The government also tilts the playing field in favor of residential real estate. Government alter egos like Fannie Mae, Freddie Mac, Ginnie Mae and the FHA provide financing at interest rates lower than market forces would justify, and tax benefits like the mortgage interest deduction and now buyers' credits. When liquidity for mortgages dries up, the Fed buys a trillion dollars plus worth of mortgage-backed securities with printed money, holding down interest rates and propping up residential real estate while putting wage earners at risk of inflation.

Thus, capital flows into financial services and residential real estate, where the generosity of taxpayers reduces the chances of loss and increases the potential for profit. Other sectors of the economy can only imitate Oliver Twist holding an empty bowl. Since those other sectors, especially medium-sized and small businesses, might otherwise create jobs crucial to economic recovery, putting them on a starvation diet for capital steers the economy toward stagnation.

News media stories report that Wall Street is about to reveal record or near record earnings, and pay record or near record bonuses. Although no one in the government will admit it, this is a problem created by the government. By giving the banks such massive subsidies and benefits, humongous profits were predictable. Indeed, they're exactly what the Fed and Treasury intended, as buffers to stabilize the financial system. But putting huge profits on bank financial statements is like putting mountains of corn and rice in front of ravenous hogs. What do we think will happen? That bankers will retain profits in the banks' capital accounts for the good of the nation?

No doubt, senior officials at Treasury, the Fed and the White House, as well as almost all members of Congress, are preparing their statements of outrage over the soon-to-be announced bank mega-bonuses. They should save those statements and back them up--twice--because they'll be using those statements a lot. Given the way the government has tilted the playing field in the economy, banks will be making headline profits at taxpayer expense, and paying headline bonuses, as far into the future as one can see.

America is more like to prosper long term if there is a level playing field for capital. But undoing a federal subsidy is greater challenge than climbing Mt. Everest blindfolded. Practically no one in the government, in either party, wants to make major changes to these rules of the game. Meanwhile, back at the ranch, unemployed formerly middle-class Americans are hoping for one day a week when they can have franks and beans instead of rice and beans. Small businesses are looking for anyone who can lend them a dime.

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