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Thursday, March 26, 2009

"Alimony," Not Bailout

Can We Afford Wall Street?

I've got a way to make palatable the $3 trillion (or is it $4 trillion? Or $6 trillion?) injected into Wall Street (so far).

Don't think of it as a bailout, think of it as alimony. Yes, alimony.

As in, what you pay to divorce someone -- or in Wall Street's case, something -- that has become an increasingly expensive and bad match. Indeed, someone who is a parasitic drag on your daily existence and threatens your very well-being (no, I've never been through a messy divorce).

Lost in the uproar over AIG bonuses, second and third (and fourth and fifth) helpings of bailout money, etc., is the fact that modern Wall Street fails the most basic test for economic utility: cost-benefit.

Direct Costs

It's possible that, like a bad dream, "the current unpleasantness" will pass, and the Federal Reserve and Treasury will somehow be made whole on trillions in guaranties, "term facilities," equity "investments," open-ended loans -- and God knows what else taxpayers have spent on Wall Street's salvation. But I wouldn't hold my breath.

Assuming, conservatively, that Wall Street simply doesn't lose any more taxpayer money, the tab already easily exceeds $3 trillion.

Not only is that a staggering sum, it exceeds all the profits Wall Street has ever made, combined.

Warren Buffett famously observed that the airline industry, in almost a century of operation, has cumulatively operated at a net loss. The same is now true of Wall Street.

Indirect Costs

Sadly, all the money spent so far is just for clean up; it omits the long-term costs likely to result from the financial Chernobyl that modern-day Wall Street has become.

Such indirect costs are likely to include: ramped-up regulatory oversight (if you thought Sarbanes-Oxley was expensive and intrusive, just wait); billions in unemployment benefits to recession casualties; increased government transfer payments to destitute citizens whose savings and investments have suddenly been decimated, etc.

However, that's nothing compared to perhaps the biggest -- albeit incalculable -- cost of all: grievous damage to the trust and confidence that are the foundation of a capitalist economy (and fiat currency).

Benefits

On the plus side of the scale is . . . what, exactly?

Wall Street's investment bankers supposedly allocate capital -- wisely and efficiently -- to the most deserving.

Yet their recent track record in that department is abysmal: witness the billions directed to all the neophyte "dot.com's" that promptly crashed and burned, taking investors and the '90's bull market with them (notably spared: all the VIP's -- typically the banks' largest customers, and coveted future customers -- who routinely received allocations of shares at wholesale prices that they quickly flipped).

Commercial banks have hardly performed any better.

Until Glass-Steagall was dismantled a decade ago, they took in deposits, and then used that money to make profitable, socially productive loans to business and consumers.

At least that was the theory.

In practice, while many banks behaved conservatively, the biggest ones OD'd on toxic securities and are now either illiquid, insolvent -- or both. The cost to the FDIC (and ultimately, taxpayers): more hundreds of billions.

Alternatives

In today's high tech, Internet-based world, it's not at all clear what Wall Street's "value-added" is.

Google famously went public with very little help from Wall Street, using the Internet and something called a "Dutch Auction."

Was its IPO well-priced? Perhaps not: the stock quickly trebled, suggesting that it was underpriced.

However, that's one of Wall Street's dirty little secrets: it hardly matters how underwriters price an IPO, because they only set the initial price, and then only for a small percentage of a company's outstanding stock: once the stock begins trading, the market takes over.

But surely Wall Street's role in mergers and acquisitions is indispensable, right?

Actually, no. Warren Buffett, arguably one of the most successful M & A practitioners around, famously eschews Wall Street advice and deals directly with the target company's management.

So how about Wall Street's role helping to seed start-up companies?

Actually, it doesn't do that. Venture capitalists do. Coincidentally or not, their Silicon Valley headquarters is about as far away from Wall Street as you can get (in truth, the location is due to Stanford University, and the hub of entrepreneurs located nearby).

Finally, we've just had a decade-long experiment in letting fee-hungry banks (and Wall Street-created non-banks) decide who gets mortgages. The results haven't been pretty, to say the least. Of course, now that it's raining, as the saying goes, lenders predictably want their umbrellas back.

So what's a better way to decide who should qualify for a mortgage?

The Fair-Isaac Corporation, a for-profit entity, calculates a "FICO" score that already forms the foundation for most underwriting decisions. Take good FICO scores, add a relatively high down payment -- ideally 20% -- and, Voila!, you've got the makings of a credit-worthy borrower. An independent appraisal adds further protection.

Lump-Sum Payment

There's a name for something that doesn't create value, is levied involuntarily, and ultimately serves only to redistribute wealth: it's a called a "tax."

Aside from being manifestly unfair, the "Wall Street Tax" also saddles the U.S. economy with a cost that impairs its ability to compete in a "flat," hyper-competitive world marketplace.

A financial crash is a very high price to pay to learn we have a "legacy" financial system that is devouring our resources, and threatens our very way of life.

However, if the trillions we are now giving Wall Street hasten the arrival of a better, fairer, and more efficient system, the price will arguably be justified.

All that's left is to make sure that Wall Street knows it's received a lump sum payment. (Don't like "alimony"? Call it a severance payment.)

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