- The heart of the scheme will, most likely, be an insurance arrangement, in which the government (part Treasury and mostly Fed) insures a big part of large banks’ portfolio of toxic assets against further loss. The devil is in the pricing of this insurance and how transparent that is – and we will put out more on this shortly – but the clear signal so far is that this will be a veiled major recapitalization of banks at taxpayer expense.
- As announced yesterday, the government will set restrictions on the pay of executives in banks that participate. But note that, under these rules, bonuses are not restricted. Instead, they are just deferred and paid in shares. In other words, if there is cheap recapitalization through government-provided insurance, these executives are getting an incredibly good deal.
Think about it this way. While the macroeconomy goes badly, the government will pay out on the insurance policy and keep the large banks in business. Once the macroeconomy turns around, as of course it will, the banks can pay off the government and pay out massive bonuses.
We are, in effect, insuring incompetents (i.e., the executives who got us into this mess) against both the delayed consequences of previous bungling by themselves and any future missteps they may make.
But even this won’t be enough for the top dogs on Wall Street. We predict that banks will start resetting the strike price of previously deferred bonuses, along the lines of what we have already seen from Google. Watch carefully and track what happens in your comments here.
What we really need is a simple, transparent recapitalization of the banking system. More complicated proposals are opaque and less likely to work. And once people see through the illusions, there will be great disappointment and much resentment.
(This post was written jointly by Peter Boone and Simon Johnson)
Originally published at the Baseline Scenario and reproduced here with the author’s permission.