New op-ed from Simon Johnson
Jamie Dimon's Biggest Disaster Is Straight Ahead
Who are the government sponsored enterprises today? Which entities are too big to fail, in the eyes of lawmakers and regulators, and therefore are receiving implicit, no-cost government guarantees?
The answer is our largest bank holding companies such as JPMorgan, the second-biggest U.S. bank in terms of assets behind Bank of America Corp. This point is made in the latest quarterly report from Neil Barofsky, the special inspector-general for the Troubled Asset Relief Program.
Who has an incentive to increase debt relative to equity in really big ways? Again, it’s the largest banks. The executives in these companies are paid based on their return on equity -- and the easiest way to increase that is to add leverage. Of course, this increases returns only when times are good. It also increases the potential losses when markets tumble. In other words, greater leverage increases risk.
But the global executives who congregated at Davos, Switzerland, a few weeks ago were uniformly optimistic, and further encouraged by cheerleading from Dimon and his financial industry colleagues.
The government’s best intentions notwithstanding, there is no way bank executives will ever be compensated on a properly risk-adjusted basis. In fact, research by economists Sanjai Bhagat and Brian Bolton shows that top private-sector bankers know when to cash out: before all the suckers get crushed. And it is cash that bank CEOs get -- the chief executives of the 14 largest U.S. financial companies received cash inflow worth $2.6 billion between 2000 and 2008.
If shareholders are protected from being wiped out by the implicit too-big-to-fail guarantee, they should welcome the arrival of additional leverage as the economy improves. In fact, as the latest quarterly earnings results appear, the financial press has started to ask Goldman Sachs Group Inc. and other banks why they don’t increase their leverage even more.
Top bankers are also pressing hard for the right to increase dividend payments. That’s effectively a transfer from creditors and taxpayers tomorrow (because of the guarantee) to shareholders today.
Continue reading at Bloomberg...