Wall St to get away with it again, world waits for next meltdown, Yi spooges

[Admiral Yi]

Gee whiz, Yi, you really think the typical corporate debtholder is a middle class house wife cutting the coupon out every quarter?  How 1950s of you.
Most financial institution debt is held by other financial institutions.  And the motivation isn't just the steady income, it can be making leveraged debts on interest rate outcomes, credit risk, or just taking on the paper as a loss leader to establish a relationship.

My understanding is the principle holders of corporate bonds are insurance companies and pension funds.  What does that have to do with anything?

And of course there are interest rate derivatives.  AFAIK you're not required to own a bank bond to purchase interest derivatives.

[The Minsky Moment]

My understanding is the principle holders of corporate bonds are insurance companies and pension funds.  What does that have to do with anything?

It has to do with incentives which was HVC's point.
Wiping out the equity doesn't really impact incentives because the shareholders don't run the banks.  Management does.*  And management has incentives to take risks that will boost their comp in the short run, even at the risk of the equity being wiped out year later (and quite possibly after they are long gone).

Bondholders are actually more potentially significant for incentives because they are concentrated in a smaller institutional core, because many financial institutions rely on regular capital market debt financing to operate their business, and because of the possibility of using covenants to control risk (albeit crudely).  So to the extent bondholders conclude from the last crisis that they are effectively government guaranteed, there is real potential moral hazard fallout. 

*In theory under Board supervision.  In practice, management can usually capture/dominate the Board, especially in the US where the dual CEO/Chairmanship is still a norm.

[Admiral Yi]

A good point Joan.  But are managers too big to fail or are institutions?  The CEO of BoA was not too big to fail.

[fhdz]

A good point Joan.  But are managers too big to fail or are institutions?  The CEO of BoA was not too big to fail.

Didn't Moynihan get a $7.5 million pay package last year?

[Admiral Yi]

Didn't Moynihan get a $7.5 million pay package last year?

I don't know who that is.  That's not the name of the BoA CEO I'm thinking of.  The one who bought Merryl and Country Wide.

[fhdz]

Didn't Moynihan get a $7.5 million pay package last year?

I don't know who that is.  That's not the name of the BoA CEO I'm thinking of.  The one who bought Merryl and Country Wide.

My bad, he took over in early 2010.

Anybody know what the other dude's severance package looked like?

[merithyn]

* Tom Montag

If you ever need to negotiate an exit from your current employer and have Tom Montag's number - call him.

First he left Goldman Sachs for Merrill Lynch in May 2008. Merrill Lynch bought out his remaining Goldman compensation package for approximately $10 million.

Then, when Merrill Lynch was acquired by Bank of America in January 2009, BofA bought out all of Montag's Merrill Lynch options, vested and unvested, for a value of $29.9 million.

He stayed at BofA, where he is now co-COO.

A little background on Montag: he was once one of the largest individual taxpayers in Japan and he was the one that called that one deal that totally caused the financial crisis 'shitty.'

*Peter Kraus

Peter and Tom definitely talked this thing over.

Kraus joined Merrill at the same time as Montag, with a similar buyout of his Goldman compensation package.

Kraus, however, did not stay on at Bank of America and collected his $25 million severance package.

It was rumored that his split from BofA was in part related to his 'flashy' behavior, which included brandishing his bright green blackberry in meetings.

He consoled himself by buying at $36.6 million apartment and later becoming CEO of AllianceBernstein.

*Joe Cassano

Technically, the guy who lit the fuse at AIG did decline his severance.

But only after his CEO begged regulators to allow the failed insurer to retain Cassano as a consultant at $1 million per month and public uproar ensued.

The irony of the idea that Cassano was needed for his '20-year knowledge' of credit derivatives after that same knowledge decimated AIG is enough to land him on this list.

*Hank Paulson

Wait, he didn't get a severance package, right? Think again.

When he accepted President George W. Bush's nomination as Treasury Secretary, he was forced to sell his approximately $500 million dollars in Goldman shares.

Nothing wrong with that.

The real severance payment?

Because of a seldom utilized tax loophole, Paulson paid no capital gains taxes on this sale. That's right, not a single cent, saving him an estimated $200 million.

*Martin Sullivan

Not surprisingly, Joseph Cassano's old boss had a bit of an warped view of what constituted acceptable behavior.

When he was fired as CEO of AIG, Sullivan collected $47 million.

Later, he named as one of the 'Worst CEOs Of All Time' by Time Magazine.

*Stanley O'Neal

After leaving Merrill Lynch with an $8 billion write down, O'Neal left the firm with a total of $160 million.

While not technically severance pay, when Merrill claimed that the pay was for performance in previous years as CEO, questions were raised.

The assets that lead to his departure and dragged down Merrill's balance sheet to such an extent that Bank of America was called in to acquire the firm were purchased during those years when O'Neal's performance apparently merited such a massive payout.

*Chuck Prince

While Citigroup claimed in regulatory filings that it was not technically severance pay, when Chuck 'We're Still Dancing' Prince received $29.5 million in stock options, grants and perks when he left as CEO in the wake of billions of dollars in asset write downs.

He also received approximately $13 million in cash for his performance during the same year when those write downs occured.


Read more: http://www.businessinsider.com/7-outrageous-severance-packages-2011-12?op=1#ixzz2TUGeU7hH

[fhdz]

Yeah, I wouldn't say any of those guys "failed" at all.

[Admiral Yi]

I wouldn't either.  Are CEOs of large financial institutions the only ones who recieved large severance packages?  I think the answer is no, so it's no longer a discussion of too big to fail.

[The Minsky Moment]

A good point Joan.  But are managers too big to fail or are institutions?  The CEO of BoA was not too big to fail.

I have mixed feelings about the whole TBTF concept.  Anyway its not quite what I am getting at.  TBTF has nothing to do with why depositors don't discipline banks - that's deposit insurance, which every commercial and savings bank has.  And TBTF is tangential to the relunctance to force haircuts on bondholders - the concern is more contagion and contagion can be spread by institutions that in themselves are not that big.  Like Lehman.

The larger point is that equity holders can't be relied upon to control bank excesses and so holding the equity at risk doesn't do much.  That's true BTW *even if* the stockholders have the ability to to exercise meaningful control over management.

Imagine a bank with 95 million in deposits and bond debt, 5 million in equity.
Management can choose 1 of 2 strategies.  Assume at the end of the year, the bank dissolves and pays everyone out according to priority.
Under strategy 1, the bank will make $2 million with certainty.  That's a great result BTW - 2% ROA and 40% ROE with no risk.
Under strategy 2, 50% of the time the bank will make $10 million.  The other 50%, the bank loses $100 million and is totally wiped out.
Clearly strategy 1 is far superior to 2.

Here's the problem - the stockholders will prefer strategy 2.
Under strategy 2, their expected return is $7.5 million - 50% chance of 0 and a 50% chance of recovering their initial $5 million plus the $10 million gain.
Under strategy 1, they only end up with $7 million.
Keep in mind that the debtholders are indifferent.  Even if the bank gets wiped out , Uncle Sam pays them out.

You may object that I have failed to take risk aversion into account.  No problem - it is easy to change the numbers and still make the same point.
But even more importantly - you can make the problem go away by further assuming that instead of 1 bank there are 1000 banks.
Now the risk averse stockholders can earn the strategy 2 return risk free by dividing their investment equally among all 1000 banks.
I.e. just like most real ordinary investors do these days.

The divide between management and ownership afflicts every business.
But in the banking business it is compounded by high debt-equity ratios and government guaranteed debtholders that lack usual incentives to monitor.

[fhdz]

Are CEOs of large financial institutions the only ones who recieved large severance packages?

In the end, who paid for those?

EDIT: Honest question, not trying to be leading about it.

[CountDeMoney]

How much of your own article did you read Seedy?  How much of it did you understand?

"Derivatives."

Worse than "titty sprinkles".

[Admiral Yi]

In the end, who paid for those?

EDIT: Honest question, not trying to be leading about it.

Shareholders.

[Admiral Yi]

Joan: one problem I see right away is who is going to be willing to be the counterparty to your bank's triple or nothing play?  There will always be willing borrowers, but you can't triple your stake by lending at interest.  You can only do that making big one way bets.

[The Minsky Moment]

Joan: one problem I see right away is who is going to be willing to be the counterparty to your bank's triple or nothing play?  There will always be willing borrowers, but you can't triple your stake by lending at interest.  You can only do that making big one way bets.

The counterparty risks 10 to get 100 - no problem finding willing parties to take that trade.
And it's not a triple or nothing play - it's a 10% return on assets play.
It just requires an appetite for leverage and some risky investment. 

Don't get hung up on the specific numbers - they are exaggerated for effect.  The point is that incentives can be perverse when equity calls the shots in a thinly capitalized company.