Should we be allowed to by stocks in banks?

Because no individual ever designed Capitalism, most people do not understand it. In a recent article on the investor website Seeking Alpha, the Pragmatic Capitalist wrote a story on whether banks should be publicly owned. Disclaimer: when reading this you must know the his terms are public being owned by stockholders and private being not owned by stockholders. Now in the news public means taxpayer/government owned. Here is what he has to say:

“Being public means you must maximize profits for your shareholders. If you don’t, your shareholders will eventually kick you out on your behind (unless your name is Rick Wagoner). In their search to maximize profits the banks took on more risk than they were accustomed to. After all, the competition was steadily increasing EPS and the CEO across the street was making $10MM more than you were so you clearly needed to inject a little nitrous into your business model. In banking, that means taking on more risk and boosting EPS at any cost. So what did they do? They made big bets on a few sectors of the market – primarily housing. This plan worked great for almost a decade. Bank’s earnings soared. They were no longer just borrowing from the fed at 3 and lending at 6. They were creating all sorts of products that ensured no one would call them “economic girly men”. And the earnings and CEO pay proved it.

But a funny thing happened while Wall Street fell asleep at the risk management wheel: The wheels came off. The car veered. The car crashed. And then it exploded. And then it exploded again. And I’m pretty sure it’s getting ready to explode again (as I write this, not to pick on Citi, but the stock is down 20% to an astounding $5.35 per share). There was an inherent conflict of interest in being a public company here. The idea of maximizing profits and keeping up with the Goldmans meant taking on more risk or perishing. It meant that banks were using cash for buybacks at record high stock prices in attempts to increase EPS. It meant that banks were buying up smaller banks to streamline their operations and give the appearance of organic growth. Would these vital institutions have been so imprudent if the public scoreboard over at the NYSE had not driven them to be so greedy?”

The reason why banks got greedy is because people are greedy and people run banks. This however was no different than 5 years ago, 10 years ago, and 100 years before that. People are always going to be greedy.  Whether they are owned by a group of people who are on the board, an individual, or stockholders will not make a difference on degrees of greediness.

The reason why banks have a problem is because they are only allow to invest into mortgages, thus not allowing themselves to be diversified. When you invest in the stock market, the first rule is buy low, sell high and the second is diversify. We do this all the time, even when making daily decisions. Why do we constrain banks in the same way? I believe it is because we have an attitude that banks are dangerous, they should always give us a return, and houses will always be safe. People always say land is the safest investment and they aren’t making anymore of it. This is a common misnomer. Land is no different than any other commodity and it can be artificially made (see the Kansai Airport in Japan). People need to treat banks like what they are. investments not safes.

The rest of the post from the Pragmatic Capitalist is here.


Published in: on January 26, 2009 at 12:25 pm  Leave a Comment  
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