Financial System: Where Saving is Punished and Risky Behaviour is Rewarded

Posted On Sunday, Jan 01, 1950


If there is a god of justice, he must be living in Wall Street.

Or employed by governments to write policies that ensure finance companies continue to rule the world.

After being saved by trillions of dollars of implicit and explicit guarantees from tax payer money over the past one year, some of the financial firms have paid back their loans to the government.
Free of the government's control, they are now ready to pay bonuses to their employees.

According to a news story on November 9th on Bloomberg, "Goldman Sachs, Morgan Stanley and JP Morgan's investment bank, survivors of the worst financial crisis since the Great Depression, are set to pay record bonuses this year.

The firms -- the three biggest banks to exit the Troubled Asset Relief Program -- will hand out $29.7 billion in bonuses, according to analysts' estimates. That's up 60 percent from last year and more than the previous high of $26.8 billion in 2007. The money, split among 119,000 employees, equals $250,400 each, almost five times the $50,303 median household income in the U.S. last year, data compiled by Bloomberg show."

Citibank Chairman says big is not good

All this when John Reed, a previous Chairman of Citibank who took Citibank towards "universal banking", apologised for being a backer of the financial lobby that abolished the Glass-Steagall Act in the USA in 1999.

The Act was created by the US government in 1933 to ensure that the financial ruin which preceded and resulted in the Great Depression would never occur.

Basically, the Glass Steagall Act prevented banks from owning businesses in the securities industry (stock brokers, investment banks), insurance companies, and fund managers (and the reverse).
There were also limitations on size and the geographical extent of their activity.

"Too Big To Fail" was not a business strategy that managements of banks could pursue and have implemented by an army of roll-the-dice MBAs.

Because the size of the financial firms was small, the government had no problem allowing them to fail.
And many financial firms and large banks did fail in the 1960's and 1970's.

But in the year 2009 - ten years after John Reed successfully lobbied for the repeal of the Glass Steagall Act - firms like AIG, Citibank, Goldman Sachs, and Morgan Stanley all had large global footprints. They could not be allowed to fail.

The taxpayers bailed them out.

Well, to be more accurate, ex-employees of these financial firms (who happened to be working in governments) used the tax payer's money to bail out their friends.

According to one conspiracy theory doing the rounds on the internet, those financial firms who were not well connected or not liked by "friends" in the government were allowed to fail. Bear Stearns and Lehman Brothers are cited as examples of companies with bad connections.

Those who save are punished - to help the financial firms

Having survived on tax payer money, these large financial firms used the pensioners and savers money to make profits.

Paradoxically, the virtuous have been punished.
People in the western world who saved have seen the annual interest they earn from their bank deposits collapse from 4% to 0.5%.

Saving is a good thing, we are often told, and - yet - the last few years have shown that those who encouraged the creation of debt (again, the same large financial firms) and those who did borrow have been rescued.

The savers got the short end of the stick for not gambling.
The poor pensioners who live off their interest income have taken a beating in their annual incomes.
Those who are young and save diligently for their retirement have also seen the interest rates on their savings decline.

That is because the central banks of the world are keen to ensure that money remains free. This zero-cost money finds its way to the banks which can then lend them for even 1% and make huge profits. Simple mathematics shows that 1% - 0% = 1% and if you are looking to calculate the "rate of return on capital employed" it is the 1% earned divided by the 0% cost of capital. The answer is infinite. Profit for nothing.

So, there have been two subsidies and two bailout packages.

The first was the one-time injection of money to the banks and the financial firms - in the trillions of dollars globally.

And the second was the decision to keep the interest rate so low that the banks have no choice but to make money!

Assuming that the banking system has deposits of USD 10 trillion worldwide from savers and pensioners, every 1% of interest paid less to those who save is a bonus of USD 100 billion every year for those who can shovel money around.
It is this shovelling activity that has resulted in the "recovery" of profits for the banks and financial firms.

Who do the banks lend to?

But there is a risk in lending in economic uncertain times.
As there is risk in borrowing.

Private companies are not really borrowing to build any large factories.
Capacity utilisation in the United States is at less than 70% - and probably equally bad in the developed world.

Government debt, meanwhile, has ballooned in much of the developed world.
The US, UK, and European governments have seen less tax collections (revenues) due to the slowdown of economic activity. Their costs have increased because they need to look after more unemployed people (a 23-year record of 10.2% in the USA) and try to create new employment by funding projects like building roads, bridges, and canals.

But to fund those projects the governments need money.
They borrow this from the banks.
At 1% per annum.
Or 3% for 10 years.

So, in some sense the wonderful profit numbers we are seeing from the banks is this free money being recycled back to the government

One arm of the government that prints the paper currency gives the money to the banks. At 0%.

Another arm of the government that spends the money on job creation borrows it back from the banks and financial firms. At a borrowing cost of 1% to 3%.

Banks are the dalals in-between.

They make hundreds of billions in profits in this process.

And, like all good people who have made profits, they declare themselves a bonus.

By the way, a banker's life is worth more than yours

The Masters of the Universe, well-connected by their college degrees and united in their desire to maximise profit have another problem: they are worried about swine flu.

The flu season has just started in the US and, according to medical experts, the swine flu pandemic could erupt once again.

On November 7, the Agence France-Presse reported that "The New York Department of Health said Citigroup, Goldman Sachs, and Morgan Stanley applied for supplies of the H1N1 vaccine and were eligible because they were large employers with in-house clinics".

Table 1: The other "bonus":

 CitigroupGoldman SachsMorgan StanleyTime WarnerMemorial Sloan-Kettering Cancer Center
What do they do?Financial firmFinancial firmFinancial firmMediaHospital
How many vaccines did they request?2,2005,4001,5002,00027,400
How many did they get?1,200200Zero100200
% of request fulfilled55%4%0%5%1%

Admittedly, people working in the financial firms and the media travel a lot and are exposed to more risk. So they need to have vaccines for their staff which are in the "at-risk" group.

And since they have their own in-house clinics, the medicines can be administered there.

There must be a god out there looking after the financial firms and ensuring that they get the bonus - and the H1N1 vaccine.

For the rest of us: earn a lower rate of interest on your deposits and stand in line at the general hospitals.

Suggested allocation in Quantum Mutual Funds

Quantum Long Term Equity FundQuantum Gold Fund (NSE symbol: QGOLDHALF)Quantum Liquid Fund
Why you should own it:An investment for the future and an opportunity to profit from the long term economic growth in IndiaA hedge against a global financial crisis and an "insurance" for your portfolioA hedge against a global financial crisis and an "insurance" for your portfolioCash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation80 %20%Keep aside money to meet your expenses for 6 months to 2 years

Disclaimer : Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments

Note: This article was first carried on

Above article is authored by Quantum.

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