Years ago, when I was a Wall Street banker, there was a ton of pressure to make money TODAY. If you made money today (the calendar year) you got a big bonus, you got a raise and promotion and more capital allocated to what you were doing so that in the next year one could make even more money. These were powerful incentives, More money in one’s pocket was great, the promotions looked good but the increase in capital was what made one a star. The more capital you had available, the bigger the dick was the thinking. And if you had a lot of bank capital at your disposal to make deals you were a “Big Swinging Dick”. There were also powerful disincentives – if you didn’t make money TODAY, you got canned at the end of the year.
So every day I went to work thinking about how I could make some bucks on that day. I was doing FX swaps at the time, but think about making a simple loan. Say you had a client who wanted to borrow some money and was willing to pay LIBOR +3. If you wanted to turn that loan into a TODAY event you dropped the LIBOR spread and charged a big upfront fee. The 3% interest spread was “Drip” income as it accrued on an annual basis. The upfront fee was a “Rake” that increased the TODAY income and achieved the desired dick growth.
Which deal was better? 1) A five-year loan at LIBOR +3, or 2) a five-year loan at LIBOR +1 and a fee of 3% at closing? Option #1 had better all-in economics, but no dick factor, so I (and everyone else) chased after #2. The bonus pool was filled with 10% of the fee income (Rake) but none of the interest income (Drip).
The incentives for TODAY income caused a pollution of future income; that was fine with the Brass as they were also looking to boost current income as they had stockholders to worry about, and they wanted to have very big dicks.
I left the Big Casino before 2000, but I know that the mentality that existed back then continued all the way through 2008 when the SHTF. The demand for TODAY income only got worse, and as a result some horrible deals got done. Capital was mis-allocated, bonus’s were paid on shitty deals that generated fees, but later resulted in huge losses. The thinking was “Worry about TODAY”, if tomorrow it rains, you can get another job. As much as any other factor the Drip versus Rake and the Big Dick mentality was the cause of the bubble that burst so loudly.
I was reminded of this history (I don’t think things are any different in 2014) as a result of a report from the CBO (Link) on how the government evaluates its many lending activities. The Federal Government has outdone what Wall Street has been trying to do for years. The numbers are huge, the consequences will be be high.
According to the CBO the three big D.C. providers of credit are all playing the Rake versus Drip game. Between The FHA (mortgages), EXIM Bank (AKA Boeing and GE) and the many student loan programs the D.C. crowd is front ending billions of ‘rake’ income that should be accounted as future ‘drip’ income. The CBO concludes:
The life-time costs of federal credit programs are recorded upfront on an accrual basis (that is, they are recognized in the year in which the loan is made). The lifetime cost of a federal loan or loan guarantee—called its subsidy cost—is measured by discounting all of the expected future cash flows associated with the loan or loan guarantee to a present value at the date the loan is disbursed.
At first glance this looks okay. D.C. recognizes its ‘costs’ up front. But when you look at the actual numbers you see that the year one ‘Subsidy Costs’ are all negative (meaning a profit). If the same lending activity were measured on a ‘fair value method’ the upfront profit would turn to a loss. The CBO report concludes that the difference between what is fair value and the way Washington treats debt would result in at $332 billion difference over the next ten-years:
The CBO report is screaming, “This is F-ed up! Fix this now, or pay a price later!” Of course, nothing will come of this. D.C. will continue to be a mega lender, and part of the reason is that it books all the drip income as rake, and this makes a couple of people in Washington Big Swinging Dicks. Like Wall Street, the Big Dicks are only concerned with today, if things blow up, they just move on to another job. CBO sums it up pretty well:
When the government extends credit, the associated market risk of those obligations is effectively passed along to taxpayers, who, as investors, would view that risk as having a cost. Therefore, the fair-value approach offers a more comprehensive estimate of federal costs.
Some of the bigger Dicks in D.C.: