Bad banks

The Treasury Dept.'s "stress tests" for banks have been much derided in the press. The consensus is that the stress tests make what are probably unrealistically optimistic assumptions about the economy, and that they go way too easy on the banks. The banks have even been allowed to lobby the government to alter or conceal the results after the tests were completed; hardly confidence-inspiring.

But that doesn't mean that the tests results are useless. They may not give an accurate picture of how much bailing out each bank needs, but they probably give a very good picture of which banks need the most bailing out (in econ-ese we would call this an "ordinal" measure of bank solvency). Thus, in a relative sense, JP Morgan Chase (my bank, woohoo!) and Goldman Sachs are doing pretty well; Morgan Stanley and Citigroup are in moderate trouble; Wells Fargo is in more serious trouble; and Bank of America is totally screwed.

The fact that Bank of America came in dead last - needing almost three times the bailout of the next worst-off bank - is particularly interesting to me. Bank of America just happens to have been involved in a recent scandal regarding bonus payouts to the executives of Merrill Lynch, the investment bank it bought out during the crisis. It has also been involved in an unusual amount of lobbying. This is no coincidence.

Bank of America, like AIG, seems to have based its entire business model on winning this "too big to fail" game. BofA bought up Countrywide, the first big subprime lender to go bust, and Merrill Lynch, one of the worst-off investment banks. Obviously, the idea was to become as big as possible, even if (especially if?) becoming bigger meant becoming less solvent, because BofA's executives wagered that the government would have no choice but to bail them out.

They wagered correctly. Having thus successfully extorted tens of billions from the American taxpayer, the executives of BofA (like those of AIG before them) promptly raised salaries, bonuses, and perks for themselves - because hey, why not? The CEO of a bank with a full government guarantee but no government control has zero accountability. BofA's bosses seem to know that they will never again be the executives of a fully independent, privatized bank; hence they are simply cashing out.

Which is one big reason why we need to nationalize some of these banks and replace their management. Executives of America's big financial firms must know that playing the "too big to fail" game, win or lose, will not pay off for them personally. And the argument for keeping these people on the payrolls - that as "private-sector" businessmen they have magical wealth-creating skill - is completely negated by the fact that these guys' main skill is playing chicken with the U.S government. Neither BofA nor the U.S. taxpayer nor the economy will suffer to see men like that replaced.

Update: Matt Yglesias is thinking along similar lines, saying:

[After BofA is bailed out,] there could just be no really coherent corporate governance at all since such a huge part of [the bank] will be owned by a silent partner government. Then you’d have basically unaccountable managers probably working full time to extract as much wealth out of the enterprise (which will still be a really big and important enterprise) before the party’s over.

Better, I think, [for the government] to act like a “normal” big institutional shareholder and try to appoint some directors.