Wednesday, October 28, 2009

Those Crazy Wall Street CEOs

Reuters’ Andrew Marshall yesterday came out with a thought-provoking article on North Korea. The article, under the headline “Why it's sane for Kim Jong-il to be crazy,” explains the political position of North Korea and its leader through the lens of game theory. The basic idea is that Kim Jong-il has to appear highly irrational to get any bargaining leverage with the outside world, and that, in turn, is needed for him to stay in power.

As I was reading that analysis, I couldn’t help thinking that some of the CEOs on Wall Street were playing the same game. To extort money from Congress, Wall Street’s leaders have to be appear to be crazy enough to blow up the national economy. The same thing happens on a smaller scale all over Wall Street on a daily basis. Yet it is all an act, a sort of Halloween costume for Wall Street players. Wall Street CEOs cannot actually be crazy, or they would quickly lose their jobs or bankrupt their companies.

You see how “crazy” Wall Street is in the latest headlines on CIT Group. The near-bankrupt company’s management and its large bondholders are each trying to gain the upper hand by acting more crazy than the other party. Billionaire-investor Carl Icahn is trying to get in the middle by acting even more crazy than either group. So far it’s not working for Icahn because no one quite believes he’s as crazy as all that. CIT management, after all, already has the track record of taking the crazy risks that drove the company into the ground, while the bondholders were crazy enough to lend money to this apparently bankrupt institution. But Icahn keeps gamely trying, raising the stakes in his seemingly irrational offer. Meanwhile, with all this pretending going on, some observers have started to wonder whether CIT really is facing bankruptcy — could it all be an elaborate act?

AIG management has been using a similar strategy to get the multi-billion-dollar bonuses for its employees even as it spirals down into a seemingly inevitable bankruptcy. The company can’t keep its charade up forever, but management will drag it out as long as they can.

The largest banks are facing increasing challenges and some of them will be back to ask for more money from Washington in the coming months, and when that happens, the White House can put an end to this version of the bank-with-a-bomb act. It can call the bank’s bluff by putting the bank into receivership, filing to put its holding company into bankruptcy, and firing all the executives immediately. Wall Street might retaliate by creating a stock market crash, but it no longer has the financial muscle to make its market manipulations stick for more than a few weeks, so the crash would have little lasting consequence for the economy. After that happened just once, you wouldn’t see a second bank going to Washington to say, “I’ve got a bomb and I’m not afraid to blow up the national economy.” Instead, the banks would start to take responsibility for their own problems. And that would be a good thing. It is, for the moment, the best chance we’ve got of getting Wall Street’s problems solved.