Perhaps the only way to 'square the circle' and align the competing and, lately, contradicting interests of shareholders, management, depositors, and especially the depositors' guarantors (the federal govt: FDIC & Fed), is to go "back to the future". Back to the old merchant banking partnership model of the 19th and early 20th century. Think about it: how many scandals have involved Brown Brothers Harriman? None. Precisely. They are what used to be.
The old partnership model gave management unlimited personal liability as each partner was a general partner. (Obviously we'll need meaningful tort reform before this model can work again -- don't hold your breath!) Upon retirement partners "went limited" -- i.e., they became limited partners with limited liability and a limited voice in managing the firm. In some cases, or in addition (I'm unsure on this) their partnership or equity interest converted to subordinated debt, giving them regular, contractual income and making them senior creditors ahead of the managing (general) partners but junior to other creditors and depositors. In the partnership model, as Chuck Colson put it, "If you have them by the balls, their 'hearts & minds' will follow".
The bad news for mgmt was there was bonuses were small(-er) but the good news was they could build real, true wealth over time. But, they could lose it all with one big, stupid move by any partner. Like subprime, for example. It made them attentive. As Mark Twain once said, "Put all your eggs in one basket. Then watch it very, very carefully."
Ten years ago I forecast -- erroneously or maybe only prematurely -- that the private equity ("PE") funds and hedge funds would converge. They did, but in only very limited fashion by poaching eachother's turf and not, as I'd expected, by merging/converging. Private equity is the closest equivalent we have today to the old "merchant banks" of the Rothschilds and Morgans of previous centuries.
The investment banks of the late 20th century were gutted by the bigger balance sheets of the commercial banks on the one hand and the smarter balance sheets of the hedge funds (and PE firms) on the other. Beginning with LTCM and persisting up to & through 2007, there's been a huge "brain drain" from I-banks to hedge funds ("HF"). But if you combine the two models, then you have the old merchant banking model -- e.g., wherein a John Pierpoint Morgan would commit his (he & his partners') capital to a deal, be it M&A or loan or etc. A model that was viable for centuries (Venice, London, New York). PE & HF are today's analogs to investment banking and trading. But Mr. Morgan's depositors didn't need insurance: they had his balls as collateral.
The advantage to combining PE &HF firms is continuity, and the ability of the founders to "go limited" (monetize what they've built) without selling the firm, w/o placing it in strangers' hands. It also creates permanent capital: no more lining up endless rounds of limited partners for the monotonous dogs' breakfast of Roman numeral funds (I, II, III, IV, etc.). It creates a permanent capital structure. Depositors provide the leverage, but it's on-balance sheet and the general & ltd partners stand as surety, to their last penny.
Epilogue: When I started in banking, back in the 1970's, if a bank exceeded it's legal lending limit to a client (10% of capital), then the bank's directors were each personally liable for the full amount of the loan until repaid, not just the excess. Needless to say, no one ever exceeded their legal limit! (Except crooks like Jimmy Carter's buddy and budget director Burt Lance.) "Value at Risk" is a useful exercise and data-point but whose value is at risk is more definitive!
JRB
2/17/09
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