Unintended Consequences of Nationalizing Banks

This is not a post for or against the actions of the Treasury. This is a quick look at what may be on the horizon–so that we can all keep our collective eyes open. I invite you to add your own observations and questions in the comments. I’d like to start you off with a couple.

Now that the US government has decided to force nine of the biggest financial institutions to take funds, what does that really mean?

  • What impact will there be on the internal risk allocation and compensation programs at these institutions?
  • In reference to JP Morgan, Goldman Sachs, and the rest, if the US government is going to limit risk in the short-term as a backstop to the taxpayer’s investment–what risks to they choose to limit and why?
  • Will some of these firms exit proprietary trading as a whole?
  • How will limiting risk affect shareholder expectation of returns?
  • Also, if you limit compensation, I don’t think it will be just CEOs singing the Paulson Prison Blues. What will attract the entry-level talent that looks to high performance bonuses at the upper levels as a goal?

This also means that the game for Wall Street is about to shift to new players. Make no mistake, a “Neo” Wall Street will arise from this action. The Citadels, SACs and others will fill the risk vacuum left unoccupied by the “old” investment banks. Also, key star players and their groups will migrate or go independent to escape financial and operational collars. And given that a lot of their options/equity compensation is underwater, the long-term incentives may be lacking to keep them in their current seats. The game may be changing, but this is not the end to global finance and capitalism.

My friend Roger Ehrenberg wrote down some of his thoughts on this issue, as well. Check out his two most recent posts:

Bailouts, Nationalism and Diplomacy

A Few Quick Thoughts on the Fed Plan