Fed's Lending Facilities Subsidize Egregious Wall Street Executive Compensation

Thomas Montag just received $40 million to start work today as Merrill Lynch's new head of sales.  Mr. Montag is clearly a brilliant salesman, having negotiated such a rich deal from Merrill.  Not only has Merrill been forced to raise billions to replenish its capital as it has lost an insane amount of money in the past year, but the investment bank didn't even need to steal Mr. Montag away from a competitor.  Mr. Montag left Goldman in December and was presumably collecting unemployment checks from the government when Merrill's John Thain drove up in a Wells Fargo armored car filled with bars of gold and handed Mr. Montag the keys.

It seems that despite enormous losses, layoffs, incensed shareholders, government handouts, and the Fed's extreme generosity, Wall Street hasn't changed its tune.  Although bonuses are supposedly discretionary, banking executives continue to claim that it is necessary to compensate "talent" with millions of dollars in bonuses or risk losing them to competitors.  Frankly, shareholders should know this fact and anyone who views Wall Street compensation practices to be distasteful shouldn't own the stocks.  My beef is therefore not with the banks themselves, or with shareholders.  It is with the Fed.

Since the credit crisis began, the Federal Reserve has jumped through fire-rimmed hoops to concoct new lending facilities to keep the banking community afloat.  Without these lending facilities, it is my belief that several banks, in addition to Bear Stearns, would've collapsed under the weight of illiquid mortgage securities due to severe restrictions in the money markets.  Until the credit crisis began, the Fed never accepted mortgages (with the exception of agency pass-throughs) as collateral against its repo loans during open market operations with Wall Street.  The Fed couldn't accurately price mortgages and didn't want to be faced with the prospect of selling illiquid securities in the event of a default by a counterparty.  The beauty of a repo is that if the couterparty defaults on your loan, you can immediately turn around and sell the securities and be made whole.  When there is no market for the securities you are holding as collateral against the loan, you cannot recoup your money.  That is the precise reason why money markets froze last summer and have failed to recover.  Previously liquid securities have become less liquid and it is hard to determine where securities would be liquidated in the event of a default.  The Fed is now assuming that liquidation risk as it enters into repos using questionable collateral.  Furthermore, the Fed has lowered interest rates a number of times in the face of rising inflationary pressures, also in an attempt to bail out the banking sector, and is offering loans to Wall Street on illiquid collateral at roughly 2%.  Initially these lending facilities were supposed to be temporary until credit markets thawed.  But the Fed just extended them through January 2009.  In my opinion, as Wall Street's new regulator, the Fed had (and probably still has) a unique opportunity to make a bold statement.  In return for access to the discount window, the TAF and the TSLF, Wall Street should not be allowed to pay out cash bonuses until the "temporary" lending facilities cease to exist and the Fed is no longer exposed to potential losses from its illiquid holdings.  If shareholders want to continue to throw money at these institutions that have continually misled them about the risks on their balance sheets, that is fine with me.  But being on the hook as a taxpayer for a bank failure that could cause the Fed to take losses immediately after Wall Street paid out record bonuses in 2007 really pisses me off.  If Mr. Bernanke wants to avoid looking like a shill for Wall Street, he needs to step up his game.  If we're going to socialize the losses, we should get some protection.  It is incredibly hard for me to believe that banks are even considering paying out bonuses in the face of enormous losses.  But a $40 million guarantee to a new hire that has yet to make a penny for a bank that just posted $10 billion worth of losses in the past two weeks is evidence that the culture hasn't changed.

It has been a year since Jim Cramer went off his meds and ranted on CNBC about the Fed needing to open the discount window.  Bear Stearns proceeded to pay out $3.4 billion in compensation for 2007, a 21% decline from the prior year, despite a 94% decline in net income from the prior year and then went bust a few months later.  Some believe that had Bernanke opened the discount window earlier, Bear would still be around.  I believe that had the bank preserved some cash by not paying out bonuses, it might still be around.  I'll let my readers draw their own conclusions.  For nostalgia's sake, I'm including the Crazy Cramer video.  Enjoy...