Magic!

Magic!

From the NYT:

“The rest of the nation may be getting back to basics, but on Wall Street, paychecks still come with a golden promise.

Workers at the largest financial institutions are on track to earn as much money this year as they did before the financial crisis began, because of the strong start of the year for bank profits.

Even as the industry’s compensation has been put in the spotlight for being so high at a time when many banks have received taxpayer help, six of the biggest banks set aside over $36 billion in the first quarter to pay their employees, according to a review of financial statements.”

The fact that the very banks who just caused the world’s economy to collapse are helping themselves to the same pay they made when they were earning record profits has occasioned a certain amount of snark from the class warriors of the hard left. But I think they’re wrong. The banks’ profits in the first quarter absolutely justify enormous paychecks, since they had to be made to appear where the uninitiated might see no profits at all.

Consider Citi: it made a profit of $1.6 billion, of which $2.7 billion was gains booked because — get this — its creditworthiness went down. To those of us outside the financial services industry, this might sound fishy: how can the fact that people think you’re getting more likely to default mean that you are doing better? Here’s the answer:

“When the debt declines in value, the banks have to assume at the end of the quarter that they bought the debt back and retired it. The banks would “buy it back” at a lower price, so they get to make a profit. Here’s an example: Imagine that a bank has a bond that was once worth 100 cents on the dollar and is now trading at 60 cents on the dollar. At the end of the quarter, the bank has to assume it would buy that debt back at 60 cents — which is essentially a profit of 40 cents.

That’s what happened to Citigroup in the first quarter. Citigroup had a rough quarter in which investors showed little faith in the bank’s future by widening the spreads on the bank’s credit-default swaps. As those spreads widened, they sent the message that investors believed Citigroup would be less profitable. In a nice twist, the widening spreads also triggered an accounting rule that allowed Citigroup to record a profit.”

Citi would have booked over a billion in losses without this — and that’s without getting into the other fascinating ways in which they made their earnings look more impressive than they otherwise have seemed. Bank of America did the same thing. Wells Fargo also deserves credit for using other accounting rules to make profits appear where none had been before.

But all of these feats of accounting pale before the astonishing achievement of Goldman Sachs, which is on track to pay employees almost as much, on average, as it did in 2007. That might seem excessive — until you realize that in order to book a profit, Goldman Sachs had (among other things) to make an entire month disappear — a month with a pretax loss of $1.3 billion. That’s not easy to do — but the intrepid Goldman employees made it happen. I’d say that deserves a raise.

If it weren’t for the magicians on Wall Street, Goldman Sachs might have had to make do with twelve months like everyone else. Citi and Bank of America would not have been able to transform their deteriorating credit into big profits. Their actual loans disintegrate before our eyes, along with the rest of the economy; there seems to be no relief in sight; and lo! they make profits appear out of thin air. If Penn and Teller deserve their millions, why not Wall Street?

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