Two years before the financial crisis hit, Merrill Lynch confronted a serious problem. No one, not even the bank's own traders, wanted to buy the supposedly safe portions of the mortgage-backed securities Merrill was creating.
Bank executives came up with a fix that had short-term benefits and long-term consequences. They formed a new group within Merrill, which took on the bank's money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.
Moral hazard for the win, folks. Merrill turned their mortgage cole slaw factory into snake oil salesmen, paying them huge bonuses to buy stuff their own traders wouldn't touch. The traders racked up millions. The company went under and was bought out by Bank of America.
Within Merrill Lynch, some traders called it a "million for a billion" -- meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as "the subsidy." One former executive called it bribery. The group was being compensated for how much it took, not whether it made money.
The group, created in 2006, accepted tens of billions of dollars of Merrill's Triple A-rated mortgage-backed assets, with disastrous results. The value of the securities fell to pennies on the dollar and helped to sink the iconic firm. Merrill was sold to Bank of America, which was in turn bailed out by taxpayers.
What became of the bankers who created this arrangement and the traders who took the now-toxic assets? They walked away with millions. Some still hold senior positions at prominent financial firms.
And they're busy setting up the same Big Casino games again, because they know they can play all they want to and that the government will bail them out ten times out of ten. Same games, different firm, same results. These guys get the cash, we get the bill. And the Wall Street reform passed will only address a tiny fraction of this mess.
The next crash crisis is coming. My guess is that it'll be sooner rather than later, and this time it will be blamed on the taxpayer for daring to have Social Security when everyone knows our economy has to go towards paying off the moral hazard tables at the Big Casino. Hell, as it is Republicans are going to de-fund the Consumer Financial Protection Agency, so that small fraction will go to zero.
And the next time the banks go busted, we'll get the check and told we have to take the cuts. Felix Salmon sums it up:
Merrill’s antics are the reductio ad absurdum of bonus culture, and show why it’s so silly for investment banks to pay multi-million-dollar bonuses and reckon that they’re protecting their long-term franchise at the same time. Not everybody was as egregious as this. But the differences between Merrill and other investment banks were only of degree, not of kind.
And a degree of being caught, too.
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