This bonus season, with encouragement from the White House, Wall Street firms have been paying their employees less in cash and more in stock. The idea is that vast cash bonuses encourage reckless, short-term decisions—while stock awards incentivize long-term planning that creates lasting value.

On January 21, in an abrupt change of policy, President Obama announced his intention to take on the big bankers who have brought us so much trouble. “If these folks want a fight, it’s a fight I’m ready to have,” he said with a clenched jaw at a press conference.

Sunday, February 7, 3:28 p.m. Among the convention’s several last-minute saves—opening the conference to media, replacing one speaker who fell ill and another who dropped last minute—was bringing on Andrew Breitbart.

The White House background briefing is that their proposals would freeze biggest bank size “as is”--this makes no sense at all.

On the first day of the Financial Crisis Inquiry Commission, Phil Angelides demonstrated a gift for powerful and memorable metaphor: accusing Goldman Sachs of essentially selling defective cars and then taking out insurance on the buyers. Lloyd Blankfein and the other CEOs looked mildly uncomfortable, and this image reinforces the case for a tax on big banks--details to be provided by the president later today.

Sources say that Goldman Sachs’s bonuses will be announced on Monday, January 18, and actually paid sometime between February 4 and February 7. In previous years, the bonuses were paid in early January--but the financial year shifted when Goldman became a bank holding company.

For critics of the company and its fellow travelers, the timing could not be better.

Anxiety levels about the financial sector are on the increase, even on Capitol Hill. The tension between high profits in banking and stress in the rest of the economy becomes increasingly a topic of discussion across the nation.

And you are hard pressed to find any government official who has not by now woken up--in private--to the dangerous hubris of big banks. To add insult to injury (and many other insults), the Bank for International Settlements is holding a meeting to discuss excessive risk-taking in the financial sector; according to CNBC Thursday morning, Lloyd Blankfein of Goldman and Jamie Dimon of JPMorgan Chase were invited but did not show up (they really are very busy).

The smart strategy for Goldman in this context would be to pay no bonus for 2009 (in cash, stock or any other form), but this is not possible for three reasons.

I'm sure Morgan Stanley is reconsidering the way it compensates executives, as described in today's Wall Street Journal, mostly because of the general outcry over executive pay.

Fannie Mae and Freddie Mac, the couple which together has needed $111 billion to stay afloat and are very far from doing so, did their filings with the Securities and Exchange Commission on Thursday afternoon, just before Christmas eve. I suppose this was to make sure the news contained in them would get the maximum possible attention. This was reported by the Associated Press. But see if it gets printed in your morning newspaper.

Last week I noted the evolving thinking on unemployment and the recovery--in particular, the growing number of analysts who think the job numbers might increase pretty quickly over the next several months. The most compelling argument I'd read came courtesy of a Deutsche Bank report arguing that companies overshot with their layoffs during the recession, so they'd have to hire more than the increase in GDP would normally justify during the recovery.

Alas, a few days later, the ultra-sharp economics team at Goldman Sachs came out with a report (not online) explicitly rebutting this view.

Deutsche Bank's optimism derived from an empirical regularity known as "Okun's law," which suggests that, for every one-point change in GDP (relative to potential), the unemployment rate changes by half a percentage point. The DB economists noted that unemployment had risen significantly faster than would normally be associated with the drop in GDP that we observed during the recession, so it should fall significantly faster as GDP increases.

The Goldman economists made three arguments in response:

1.) If you look at the Okun's Law relationship over the last 25 years, rather than all the way back to World War II (as most analyses do), the last two years (i.e., the recession) look pretty similar to the previous 23. So it's possible that the world simply changed a bit in the 1980s. 

2.) If you look at the Okun relationship in terms of payrolls (i.e., number of people employed) rather than the unemployment rate (which can fluctuate for arbitrary reasons), the relationship look like it's been pretty stable during the recession--i.e., that there was no overshooting on the way down.

3.) Most compellingly to my eyes, to the extent the unemployment rate did overshoot a bit during the recession relative to the post-war experience, it actually overshot on the upside a bit for a couple years beforehand, so we may just be seeing an evening out of sorts. As the Goldman team puts it:

Of all the different industry groups scrambling to shape climate policy in Washington--from electric utilities to Detroit automakers--one stands out as a bit unexpected: Wall Street. Financial giants like Goldman Sachs and JP Morgan have enlisted, all told, more than 100 lobbyists to roam the Capitol and influence the debate over how to curb greenhouse gases. There’s a reason for that: Any cap-and-trade bill that puts a limit on emissions and allows polluters to buy and sell permits will create a vast carbon market.

Increasingly, leading bankers repeat versions of the argument made recently by E. Gerald Corrigan in his Dolan Lecture at Fairfield University. Corrigan, former President of the New York Fed and a senior executive at Goldman Sachs for more than a decade, makes three main points.

(1) “Large Integrated Financial Groups”--at or around their current size--offer unique functions that cannot otherwise be provided. The economy needs these groups.

(2) Breaking up such groups would be extremely complex and almost certainly very disruptive.

(3) An “Enhanced Resolution Authority” can mitigate the problems that are likely to occur in the future, when one or more group fails.

These assertions are all completely wrong.

Gerry Corrigan’s first claim (p.4), that Large Groups are indispensable, is completely at odds with the data. The current size of our biggest financial firms is a recent phenomenon. In 1998, when Corrigan already worked there, Goldman Sachs was roughly ¼ of its current size and was regarded a top international investment bank. 

More generally, in the mid-1990s today’s big six “Large Integrated Financial Groups” added together had assets worth less than 20 percent of GDP--with no bank being larger than 4 percent of GDP (including off-balance sheet liabilities). Today, these six are over 60 percent of GDP combined and still growing.

Something strange and a little disorienting is happening in the fight to reform Wall Street: It looks like the reformers are actually starting to win.

This is not something you could have said as recently as six weeks ago. Back then, House Financial Services Committee Chairman Barney Frank had just released a proposal to regulate derivatives, essentially bets on the movements of other assets (like stocks, bonds, commodities) or interest rates. Derivatives are in some respects the key battle in the broader regulatory campaign. They were at the center of last fall’s financial crisis--Lehman’s balance sheet was stacked with them, and they triggered AIG’s collapse. But because they’re so poorly understood by the general public, the fight has unfolded almost entirely in Congressional backrooms, where the banks and their lobbyists naturally have the upper hand.

Frank’s "discussion draft" seemed to reflect that. The proposal the Obama administration unveiled this summer would have forced banks and hedge funds to trade derivatives on exchanges and “centrally clear” them. Clearing means inserting a well-capitalized middleman between two parties on either side of a trade. When derivatives trades are cleared, the failure of one institution doesn’t threaten everyone else it has traded with, which is what happened with Lehman. The only downside is that clearing requires the trader to post margin--a kind of cash cushion--to the middleman, which they’re generally loath to do. Before long, dozens of companies were flocking to Congress to plead their case.

Pity the pay czar. When Ken Feinberg announced last month that he would slash pay at seven firms that received federal bailout funds and convert large chunks of compensation to stock units that can’t be sold for years, he was met with almost universal opprobrium. Critics of Wall Street protested that simply paying out salaries in stock rather than cash would have little effect on executives at the bailed-out firms, to say nothing of the banking culture at large.

Just when our biggest banks thought they were out of the woods and into the money, the official consensus in their favor begins to crack. The Obama administration’s publicly stated view--from the highest level in the White House--remains that the banks cannot or should not be broken up. Their argument is that the big banks can be regulated into permanently low risk behavior.

In contrast, in an interview reported in the NYT this morning, Paul Volcker argues that attempts to regulate these banks will fail:

“The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company.”

Volcker may not have the ear of the President (as the NYT points out), and Alan Greenspan--also arguing for bank breakup, but along different lines--might also be ignored. But watch Mervyn King closely.

I've weighed in on Paulson's behalf a couple times these last few months, but, like Felix Salmon, I really have no idea what he was thinking here.

Over the past 30 years Wall Street captured the thinking of official Washington, persuading policymakers on both sides of the aisle not to regulate (derivatives), to deregulate (Gramm-Leach-Bliley), to not enforce existing safety and soundness regulations (VaR), and to stand idly by while millions of consumers were misled into life-ruining financial decisions (Alan Greenspan).

This was pervasive cultural capture or, to be blunter, mind control. But when the crisis broke it was not enough. Having powerful people generally on your side is not what you need when all hell breaks loose in financial markets. Official decisions will be made fast, under great pressure, and by a small group of people standing up in the Oval Office. 

If you run a big troubled bank, you need a man on the inside--someone who will take your calls late at night and rely on you for on the ground knowledge. Preferably, this person should have little first-hand experience of the markets (it was hard to deceive JP Morgan and Benjamin Strong when they were deciding whom to save in 1907) and only a limited range of other contacts who could dispute your account of what is really needed.

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point)--hence the brouhaha over Steven Friedman’s shareholdings.

Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People’s Daily; CNBC). U.S. banks or bank holding companies would not generally be allowed to undertake such transactions--in fact, it is annoyed bankers who have asked me to take this up.

Would someone from the NY Fed kindly explain the precise nature of the waiver that has been granted to Goldman so that it can operate in this fashion?

There's a bit of a riddle in today's unemployment release from the Labor Department. The release notes that government payrolls were down 53,000 in September, about one-fifth of the total jobs lost last month (which helped drive the unemployment rate up a tenth of a point to 9.8 percent). Now, as it happens, the cracker jack economists at Goldman Sachs actually anticipated this development yesterday, en route to almost perfectly nailing the overall job-loss figure.

Yes! 

Steve Weisman over at The Peterson Institute posted a nice riff yesterday about James Stewart's recent New Yorker piece reconstructing the week Lehman collapsed. His (and Stewart's) conclusion? Hank Paulson screwed up massively:

Simon Johnson, professor at MIT's Sloan School of Management, senior fellow at the Peterson Institute for International Economics, and co-founder of BaselineScenario.com, breaks down the news that Goldman Sachs has been privileging its biggest clients with exclusive investment tips, and argues that the variety of "innovations" that financial institutions employ to gain a leg up over their competitors have damaged the lives of eve

Here's a great moment in the history of the Pakistan's infamous intelligence service, known for its endless double-dealing with the Taliban and other Islamic radicals. It seems the ISI has

In early February I suggested there was a showdown underway between the US Treasury and the country's largest banks.  Treasury (with the Fed and other regulators) is responsible for the safety and soundness of the financial system, the banks are mostly looking out for their own executives, and the tension between these goals is - by now - quite evident.

Being Treasury secretary is usually not a job that calls for great political skills. But with a banking crisis crippling the economy and threatening to turn a recession into a depression, Tim Geithner has been plunged into the center of politics--as both the person responsible for what the administration should do, and as the main exponent of that policy. But he has faltered in crafting an effective policy and failed miserably in putting it forward.