PAYBACK

Vowing to recover “every single dime the American people are owed,” President Barack Obama announced that his Administration will collect up to $117 billion from the nation’s largest banks over the next 12 years to cover losses from the government-funded rescue of the financial industry.  The plan Obama unveiled calls for assessing a fee of 15 basis points annually on the liabilities of banks with more than $50 billion in assets – a group that will include approximately 50 institutions – 35 U.S. companies and 15 U.S. subsidiaries of foreign companies. 

The government plans to recover those funds, even though banks have now repaid approximately two-thirds of the money they received from the TARP fund, plus $12.9 billion in fees, representing an 8 percent return on the government’s investment, according to a Treasury report.  But administration officials say the tax represents a “financial responsibility fee,” targeting institutions responsible for creating the financial crisis and the collateral damage it has caused. 

In announcing the plan, Obama said his determination to demand repayment “is only heightened when I see reports of massive profits and obscene bonuses at some of the very firms who owe their continued existence to the American people.”  Anticipating the “hue and cry” from Wall Street firms, complaining that the tax is unfair and will impede the recovery by discouraging lending, Obama said, “If these companies are in good enough shape to afford massive bonuses, they are surely in good enough shape to afford paying back every penny [of the rescue  funds] to taxpayers.”

Banking industry executives, who began attacking the plan before Obama announced it, intensified their assault after it was unveiled.  “The tax will penalize firms who have repaid TARP with interest and those who never accepted it to begin with,” Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, said, warning that the fee “will decrease the availability of loans and limit the economic recovery.” 

“Using tax policy to punish people is a bad idea,” Jamie Dimon, CEO of JP Morgan Chase & Co., told reporters following his testimony before a committee investigating the cause of the financial industry crisis that required the government bail-out.  “All businesses tend to pass their costs on to customers,” Dimon noted. 

In Congress, where members of both parties have been blasting the largest banks for the huge bonuses they are announcing, Democrats quickly supported Obama’s tax plan.  “Taxpayers wrote the check that saved these firms,” Sen. Christopher Dodd (D-CT), chairman of the Senate Banking Committee, said.  “It’s time for Wall Street to return the favor.” 

Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, agreed, saying the President’s plan “complies fully with the taxpayer protection language of the original TARP bill. Although that measure anticiapted a five-year delay before banks began repaying the assistance they received, Frank said, “The decision to do this before 2013 is a good one.”  With banks reporting robust profits and outsized bonuses, he added, “there is no need to wait.” 

A few Republicans fired back, among them, Rep. Tom Price (R-GA), who said the tax was “driven more by revenge than recovery,” and Sen. John Cornyn (R-TX), who derided the tax as “yet another job-killing policy that makes little economic sense.”

But with those relatively are exceptions, Republicans generally were “uncharacteristically silent,” according to a New York Times report, which suggested that “their instinctive opposition to tax increases [is] apparently checked by their fear of defending banks.” 

While critics derided the plan to levy a tax on large banks a political theater, they also acknowledged that the politics are difficult and uncomfortable for Republicans, who must choose between supporting taxes or supporting Wall Street giants, which have become the political equivalent of lepers – hardly anyone wants to be caught standing close to them. 

“The politics on this are really quite easy,” Douglas Elliott, a Brookings Institute fellow, told Bloomberg News.  “The public would be supportive of anything up to shooting and burning the bankers.” 

Legislators who underestimate the extent of that populist anger do so at their peril, according to Lawrence Baxter, a professor at Duke Law School, who sees a “political dynamic” emerging worldwide around the notion that ‘banks should pay in some way for the cost of this disaster.  Throughout Europe and certainly across America,” he told American Banker, “this is politics that plays very well.  And perhaps it should.”

Industry analysts agree that Obama’s bank tax proposal, in some form, has a good chance of winning Congressional approval.  They also agree that it is unlikely to have much impact either on the banking industry’s finances or its behavior.  Karen Shaw Petrou, managing director of Federal Financial Analytics, Inc., likened the bank tax to “charging a nickel sin tax on half-a-gallon of cheap liquor.  It may more moralists feel good, but it’ won’t do much to stop bad behavior.”  The bank tax, she told American banker, “does nothing to address too big to fail or root out the real causes of the financial crisis.”  In fact, she suggested, it is more likely to act as a “distraction” from what should be the primary focus of lawmakers and regulators:  Making sure the financial crisis with which we are struggling today isn’t repeated in the future.  

COMPENSATION RISKS

An ancient prayer, recited by men and detested by women, proclaims:  “Thank God I’m not a woman.”  Credit unions might be inclined to chant a secular version of that prayer – “Thank God I’m not a bank” – as they observe the torrent of anger raining down on the banking industry, which is being blamed for doing much to cause the nation’s financial crisis and not doing enough to combat it. 

President Barack Obama wants the largest banks to pay more than $90 billion over the next 10 years to cover the cost of the government rescue plan that stabilized the financial system (see related item).  Several legislators want to tax banks’ “windfall profits, their executive bonuses, or both; and the Federal Deposit Insurance Corporation (FDIC) is considering a plan that would link bank compensation structures to the deposit insurance premiums they pay.

Although it hasn’t gotten as much media attention as Obama’s proposal to charge banks for the cost of the government-funded bail-out, the FDIC’s premium insurance plan is causing just as much industry concern.  The agency is seeking comment on a proposal designed to reward banks with compensation plans that discourage excessive risk-taking, while penalizing those with compensation arrangements that reward short-term revenue gains that can increase long-term risks. 

“The FDIC does not seek to limit the amount by which employees are compensated,” the proposal, outlined in the Federal Register explained.  The intent, rather, is “to [adjust] risk-based deposit insurance assessment rates to adequately compensate the [Deposit Insurance Fund] for the risks inherent in the design of certain compensation programs,” and to encourage institutions to adopt compensation programs “that align employees’ interests with the long-term interests of the firm and its shareholders.”    

Although the details are still being formulated, the plan identifies three specific measures the FDIC will reward:  Paying bonuses in stocks that can’t be sold immediately, “claw-back” provisions that allow institutions to recover bonuses paid for short-term gains that   turn into long-term losses; and having compensation decisions made by “independent” board members, with input from “independent compensation professionals.”

FDIC officials said their proposal is intended to complement the guidance issued recently by the Federal Reserve Board, directing financial institutions to shun compensation programs that encourage excessive risk-taking.  The aim, the agency notice explains, is “to encourage institutions to go beyond the minimum risk standards” agency regulators mandate. 

The agency’s board was divided on the plan, with two of the five members – Comptroller of the Currency John Dugan and John Bowman, acting director of the Office of Thrift Supervision, opposing the decision to seek public comment on the plan.   Dugan questioned the evidence of a link between compensation and bank failures (the FDIC proposal notes “a board consensus that some compensation structures misalign incentives and induce risk-taking within financial organizations”).  He also expressed “substantial concerns about trying to address the real problem of risky compensation arrangements through finely calibrated increases in deposit insurance.”  Both Dugan and Bowman argued that the FDIC should allow time to assess the impact of the Fed’s new compensation guidance before adding to those directives r going beyond them.

FDIC Director Sheila Bair responded with obvious annoyance that she couldn’t understand the objection to discussing the idea of including compensation in the assessment of a bank’s risk-based premium level.  “I also cannot understand why we need to keep waiting for this or that, and in the interim, nothing changes,” Bair added in a somewhat heated exchange during the board meeting. 

The FDIC is seeking comment on a number of issues, among them: 

·         Whether the agency should link compensations structures to premium costs; whether it should consider alternatives that weigh “quantifiable” compensation measures against other variables reflecting an institution’s health or performance, and if so, what those premiums should be;

·         Whether the risk-based compensation assessment should be applied to all institutions, only to the largest ones, or only to those engaged in high-risk activities; and

·         Whether the proposal should apply to the compensation programs of holding companies and affiliates as well as to the depository institutions regulated by the FDIC.

The agency will no doubt get an earful from financial institutions when they comment on the plan, which industry executives had begun to criticize before it was unveiled.  “There is no reasonable way to link executive compensation to deposit insurance premiums,” Bert Ely, an industry analyst, told American Banker, in part, he said, because “such a premium assessment would have to be forward looking.”

James Chessen, chief economist for the American Banker Association, also questioned whether the FDIC could establish a clear and supportable link between bank compensation practices and their risk profiles and warned that the FDIC plan would establish a “slippery slope” that would lead to the FDIC’s “micromanaging banks.”

Cameron Fine, president and CEO of the Independent Community Bankers Association (ICBA) sees similar dangers in the proposal, warning that it would open “a Pandora’s Box” of problems for    the banking industry.  The FDIC, he said,  “is headed down the path of dictating to banks what their compensation practices should be,” using premium rates as “a weapon” to mandate salary structures the agency wants to see.

Although the plan does not target community banks, Arthur John, CEO of United Bank in Michigan, told American Banker that the focus could shift in the future. “These policy changes always have a way of filtering down to us over time,” he said.   

MORE BOOTS MADE FOR WALKING

New York Times contributing write Roger Lowenstein attracted the notice of financial industry executives recently, and not in a good way, when he suggested that it might be in the financial interest of some homeowners with under water mortgages to default “strategically” and walk away from their loans, even if they could afford to repay them.  (See In Focus.)  But Lowenstein was by no means the first to highlight the risk that homeowners in large numbers might conclude that the financial logic of shedding a hopeless debt outweighs the moral arguments against doing so. 

Last November, Mark Zandi, chief economist for Moody’s.com, warned that strategic defaults by borrowers who can make their mortgage payments but decide not to, are increasing and are a major factor behind the still rising foreclosure rates. 

Strategic defaults currently represent about 4 percent of all underwater loans, but that number could grow, according to Zandi, who told USA Today,  “People are going to determine that it doesn’t make financial sense  to hold on to their homes.  That’s going to be a significant problem” going forward, he said, “and it will keep foreclosures high for a long time.”

Foreclosure filings increased by 14 percent in December compared with November – rising for the first time since July of last year -- and analysts blamed an increase in strategic defaults partly for that trend.  Approximately one-third of all first mortgages are currently under water according to the Mortgage Bankers Association, but Deutschebank estimates that the percentage will reach almost 50 percent by the time home prices stabilize.  A Citigroup executive quoted in the USA Today article said nearly 20 percent of the defaults he’s seeing are strategic.  “It’s a very large number, and it’s a very, very significant risk to the housing recovery,” this executive said.   

Falling home prices, exacerbated by rising foreclosure rates and a weak housing market, have pushed an increasing number of homeowners under water.  But what is driving the strategic default trend, analysts say, is a change in attitudes:  An increasing number of people who would have rejected strategic defaults as immoral are now more inclined to view “walking away” as a reasonable financial management strategy. 

In a recent study, researchers at the University of Chicago, Northwestern and the European University institute found that  while 81 percent  or those surveyed agreed it would be “morally wrong” to default on loans they could afford to repay, those who knew someone who had defaulted strategically were more likely to feel comfortable doing so themselves. This suggests a “contagion effect” that, the authors said, could drive the strategic default numbers up.

“The most disturbing aspect of this is that it is becoming acceptable to do,” Joel Naroff, an economist with Naroff Economic Advisors, told USA Today.  “What does it mean down the road for housing and the economy,” he asked, “if people are happy to walk away [from their mortgages] and destroy their credit?”  �

A WIDENING GAP

Few have escaped the impact of the worst economic downturn since the Depression, but low- and middle-income households have been hit hardest, falling further behind more affluent households on the income ladder.  Although incomes have fallen across the spectrum,   the wealthiest Americans, earning $138,000 or more, earned 11.4 times the average $12,000 of those nearest the bottom. The current income gap compares with a differential of 11.2 percent in 2007 and 11.22 percent – the previous high -- in 2003, according to new Census data released recently by the Commerce Department. That report also indicates that the number of households living below the poverty line has surged in the past two rising to 13.2 percent – an 11-year high. 

These statistics, reported in the Current Population Survey and the American Community Survey, may seriously understate the poverty rate, according to some analysts, who note that the Census formula does not reflect medical costs or geographical differences in the cost of living.  The National Academy of Science, which has been urging a revision in the formula, estimates that a more accurate tally would reflect a steep increase in the poverty rate for older Americans, putting it at 18.6 percent rather than 9.7 percent in the current calculation.

“It’s a hidden problem,” Robin Talbert, president of the AARP Foundation, told USA Today.  “There are still many millions of older people on the edge, who don’t have what they need to get by,” she added.

Revising the poverty formula to include transportation, child care and non-cash assistance would increase the overall poverty rate from 12.5 percent to 15. 3 percent, according to Census Department estimates.  The change would affect the distribution of federal funding for benefits programs directed at cities, states and individuals.  � 

SLIMMING DOWN

Statistics documenting a continuing increase in obesity rates suggest that Americans aren’t slimming down, despite a barrage of messages urging them to do so.  But the houses in which we live appear to be getting smaller, even if we aren’t. The size of new homes built in 2008 declined by 7 percent, reversing an upward trend unbroken since 1994 and leading a CNNMoney article to suggest that “the Romance between Americans and morbidly obese McMansions has finally cooled.” 

Analysts differ on whether the scaling back represents a permanent adjustment or a temporary reaction to market conditions that will change again when the economy improves.  Income pressures and tight credit are clearly among the factors driving a preference for smaller, less costly homes, analysts agree; down-sizing baby boomers may also be influencing the trend.  But it is also possible that buyers are beginning to reconsider not just what they can afford but what they need. 

F. David Durham, senior vice president with John Wieland Homes and Neighborhoods, an upscale builder in Atlanta, GA, is among those who think the current trends reflect “a fundamental change in the way people are going to want to live.  We’re not waiting for things to return to the way they were,” Durham told the Wall Street Journal.  The Journal article noted several major builders that have introduced floor plans for homes with 2,000 to 3,000 sq. ft. to replace the 3,500 to 4,500 sq. ft. models that were standard, and near the low end of the size range, before the market collapsed.  Spiral staircases, sprawling entry-ways, “entertainment suites,” and built-in wine bars that were also standard are now extras in the new designs.  But builders are wary of going too far along the down-scale path – four bedrooms, granite countertops in the kitchen and two-car garages (but not four-car models) remain on the “must have” list.