How can smart bankers be so clueless? Wall Street has been transfixed this week by the antics of former Merrill Lynch CEO John Thain. While the firm was encountering difficulty in early 2008, he spent $1.2 million renovating his office. In September, when it became clear Merrill couldn't survive as an independent entity, he arranged a deal to sell Merrill to Bank of America. Thain agreed to stay on and run the investment-banking operations of the new firm. Merrill's continuing losses threatened to sink Bank of America, which earlier this month received another $20 billion in bailout funds and a commitment by the Federal Reserve to backstop up to $118 billion of other assets. And yet Thain carried on like a Master of the Universe, jetting off to Vail for a couple of weeks, plotting a trip to the World Economic Forum in Davos, and rewarding executives with billions in bonuses—handed out in December, before the merger officially closed, to prevent Bank of America from putting the kibosh on the payments.
There was more outrage Monday when it was reported that Citigroup, which has morphed from the nation's largest private-sector financial institution into a hobbled giant dependent on taxpayer funds, was about to close a deal on a $50 million jet. And the Wall Street Journal reported over the weekend that many recipients of bailout money were spending millions of dollars lobbying the federal government.
As Lehman Bros. showed, there are good reasons to avoid letting failed banks go bankrupt. But as these three episodes show, there are also downsides to conducting bailouts outside of bankruptcy and without a formal change of control. When a company files for Chapter 11 (which is getting so crowded, we might need to rename it Chapter 12), the ownership structure changes: Creditors typically supplant the old stockholders. But the series of deals that former Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke hammered out for the finance industry has mostly diluted existing stockholders without formally wiping them out. As a result, management has continued to act as if it still reports to the representatives of the shareholders (their handpicked board members) rather than to the people who are providing them with the rescue billions they so desperately need (you and me). And so they continue doing the things that executives do: lobby governments, buy jets, and pay bonuses.
These banks and financial institutions aren't quite dead. But without taxpayer support, they wouldn't be alive. Policy types have warned that if we don't act dramatically, we might risk repeating Japan's experience of the 1990s, in which a desire to avoid foreclosing on delinquent companies led to the emergence of "zombie companies"—firms that couldn't really pay their debts, didn't have the wherewithal to invest, and yet opened for business every day. The problem today with Wall Street, and with many banks, is that they don't quite realize their business models are defunct, that they don't have an independent life absent government support.
In The Sixth Sense, Haley Joel Osment's character is terrified because he sees dead people walking the streets, working, going to school, playing, seeing patients, oblivious to the fact that they are no longer alive. I get the same feeling today watching CNBC, reading the newspapers, walking through midtown Manhattan and counting the Town Cars idling outside the headquarters of investment banks. Like John Thain, there are lots of people who continue to act as if they are living, breathing, Wall Street players, oblivious to the fact they've been reduced to nicely dressed corpses.