Journalism in the Public Interest

Why the Shareholder Rescue Never Comes

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Shareholders can't be counted on.

That's the message from the dispiriting shareholder vote on whether to leave Jamie Dimon as both the chief executive and the chairman of JPMorgan Chase, or to split the roles. Even more shareholders backed him in his dual role this year than did last year.

For some time, reformers have hoped that shareholders might ride to the rescue to solve the problem of Bank Gigantism, otherwise known as Too Big to Fail.

Big-bank critics, like the freethinking analyst Mike Mayo, analysts at Wells Fargo, and Sheila Bair, the former head of the Federal Deposit Insurance Corporation — and others, including me — have raised the possibility that shareholders might revolt over banks' depressed stock valuations and seek breakups. Broken-up banks would be smaller and safer.

No, it's not going to happen. Shareholders are part of the problem, not the solution.

No group has skated free of severe (and deserved) criticism in the wake of the financial crisis: financial firms, regulators, credit rating agencies, borrowers and the news media. That is, except one, which happens to be among the most culpable: institutional investors. Yet today, the structure of institutional investing is the same. And so is shareholders' view of their responsibilities.

When applied to banks, corporate governance campaigns are wasted efforts.

"We need to recognize that corporate governance is not going to fix the financial sector," said Lynn A. Stout, a Cornell law professor, who is a critic of the notion that companies should be run primarily to maximize shareholder value. "We have to have effective government regulation."

By keeping Dimon in his two roles, shareholders indicated their belief that only a supposed superhuman executive could run such a banking monstrosity.

But he either failed to rein in his bank's reckless trading, or he failed to understand it. And he has failed in the most basic responsibility of any steward, to plan for his succession.

These transgressions may not have been worth ousting Dimon. But hardly anyone called for that. Instead, shareholders had an opportunity to reorganize the company to diffuse a little power and increase oversight.

They punted. So what explains this shareholder fecklessness?

In some sense this was an act of reflexive class fealty. In rejecting a split of the chief executive and chairman roles, institutional shareholders seemed to prefer spiting pension funds (for their perceived union bias) to rebuking a CEO whose actions last year actually put them at risk.

That's not the only reason shareholders are immobilized. Giant bank financial disclosures are too incomprehensible for even the most sophisticated and dedicated professional investors.

Shareholders suspect that management wouldn't break up the banks in a risk-reducing way. They would be separating whole businesses, not shrinking the size of any one division. Therefore spinoffs would mean that the unknowable supernova risks, like that of derivatives businesses, would be concentrated in smaller entities.

But the most important reason is that shareholders benefit from the big banks' structures. Stout points out that shareholders want companies to take high-risk, high-return bets. They capture the unlimited upside and their losses are capped.

This is true across sectors, which is what helps drive so much short-term corporate thinking. But with banks, things are even worse. Big banks benefit from government subsidies, both implicit and explicit. As the Federal Reserve moves interest rates down and engages in huge asset purchases, the holdings on bank balance sheets rise in value. Shareholders are the chief beneficiaries.

The economy? Not so much. Not when unemployment is at 7.5 percent and so many Americans have "jobs" that can't support anything close to a middle-class life.

Shareholders, a group that includes executives who were larded up with options, helped push banks into the financial crisis. And then, in one of the most damaging and least remembered episodes of the debacle, learned some valuable lessons about what a protected class they were.

When JPMorgan saved Bear Stearns in early 2008, Treasury Secretary Henry M. Paulson Jr. initially pushed for a symbolically low price for the stock — $2 a share. Such a low price would have sent a punitive message. Bear Stearns was going down; shareholders would have gotten absolutely nothing if JPMorgan hadn't saved them.

Yet instead of being grateful, they revolted. They threw tantrums and bluffed. And it worked. JPMorgan raised its offer to $10 a share.

Of course, shareholders did get wiped out in the Lehman Brothers bankruptcy.

But what was the lesson the government drew from that? To rush in to save every institution it can.

Today, the government says that it has ended Too Big to Fail. By the provisions in Dodd-Frank, the government plans to seize holding companies of failing financial companies, wiping out shareholders and even some debtholders. The government might be able to carry this through if just one giant bank fails on its own for an isolated reason, like the storied British bank Barings did in 1995.

But most of the time, if one giant bank is going down, they will all go down together. Inevitably, the Federal Reserve spigot will open and the Treasury and Congress will find a way to intervene, as the economist Simon Johnson recently pointed out.

If shareholders really believed that bailouts were a thing of the past, they would be acting responsibly. From the JPMorgan vote, we can see that they aren't.

John V. Lesko

May 29, 2013, 2:20 p.m.

The issue is not whether or not companies should be run to maximize shareholder value, nor is it the actions of individuals.

  Instead, the core issue is structural - that which makes individual elected officials, between election cycles, “shape and shift” their positions and legislation discretely so as to appeal to the lobby money.  This shaping and shifting results in minimal and wrong legislation and no action on breaking up the banks as economists Alan Greenspan, George Shultz, Larry Summers, Paul Krugman and many others have called for! 

The need for public funding of elections, done both at the legislative and constitutional levels, has been well-researched and reported in Lawrence Lessigs important book, Republic, Lost and condensed in his TED talk.  Indeed Lessig’s book may be the most important book of our time because it explains why the good sense in the last chapter of Simon Johnson book , 13 Bankers, will never come to pass and why there is a thing called “Regulatory Capture” creating the mess called Dodd/Frank and sinking the good parts of it already!

Russell Miller

May 29, 2013, 2:37 p.m.

Interesting that the Fed’s “spigot” opened to investment banks one day after Lehman Bros went down.  My guess is that Goldman got rid of someone they competed with.  Paulson after all is ex-Goldman.

Like everything else the political reality precludes any logical fix, but how we can still be insuring deposits of these bank who pursue whale strategys is an indictment of our whole political and financial system.

david Layzell

May 29, 2013, 3:06 p.m.

I have long believed that a corporation sought to maximize the long term interests of the shareholder then mostly good would come about

It is becoming clearer that there is no such thing as a long term shareholder when the majority of shares are owned by institutions.

I am not sure what the solution is but it is time to keep shouting that it is a real problem

Alexandra Manfull

May 29, 2013, 3:14 p.m.

Dear Readers (and Mr. Eisinger),

I emailed Mr. Eisinger last week in the hopes that he would consider featuring a post on the topic of my senior thesis at Princeton—the impact of public ownership in the financial sector. I am grateful to Mr. Eisinger for devoting his blog to what I believe is a very important topic.

Since the end of 1970, the number of public banks has increased four-fold, from 139 banks to 558, and every major bulge bracket firm is now public. Yet, few have explored the potential consequences of this trend. I argue that shareholders played a major role in the most recent crisis by pressuring banks to sideline clients and take on excessive risk, destabilizing the financial sector and by extension, the entire economy in four major ways (see pages 83 - 85):

•  “First, shareholder demands for short-term value creation skew incentives to encourage dangerous risk-taking… As compared to other industries, the financial sector has unparalleled opportunities to outsize risk on a grand scale, at least within the limited span of a pay period…”

•  “Second, even with advanced risk management models, public ownership adds a new, terminal level of uncertainty to assessing a firm’s financial health. Once public, a bank’s equity supply depends on the opinions of thousands of investors that can be irrational and at best, subject to the emotion of fear. If a bank is under duress, it is likely shareholders will sell the stock and starve the bank for capital, just when the firm needs it most.”

•  “Third, public ownership has rendered banks more interconnected, facilitating the transmission of one banks’ crisis to all others. Stocks within the same sub-sector often move together; if one public firm announces a poor quarterly result, the market will likely punish other financial stocks as well. This phenomenon creates the opportunity for a type of modern-day bank run, in which a bank can suffer a liquidity crisis caused by a rapid decline in share price, rather than a sudden withdrawal of deposits.”

•  “Fourth, the 2008 financial crisis demonstrated how public ownership has created the opportunity for a ‘too big to fail’ scenario, in which firms are too large—and therefore, too structurally important to the economy—to fail, at least not without disastrous consequences to broader society… But, on the systemic level, massive public firms are exposed to similarly massive failure. Moreover, if a government bails out these banks, as occurred in 2008, they face limited consequences for the excessive risk-taking that necessitated the rescue and they are incentivized further to value shareholders’ short-term interests.”

My thesis begins with the historical origins of public banks, but I believe my discussion of the present era is crucial to understanding and reforming the financial sector as it exists today. In conclusion, I advocate a simple policy change to realign incentives in the proper direction (see page 86):

“I would propose legislation requiring public banks to have two separate Boards of Directors, one exclusively devoted to representing shareholder interests and the other to client interests. In theory, boards today are meant to consider the interests of the entire corporation, which includes shareholders, management, employees, and clients. There is no enforceable law that requires directors to uphold shareholder primacy.  However, shareholders alone elect the Board of Directors and in any case, the pervasiveness of the shareholder value psychology in the U.S. prevents boards from reliably protecting the welfare of clients. Under the proposed sort of schematic, clients would vote for their own representatives. Important company decisions, particularly those tied to compensation, would require majority approval from both boards.”

Too many of the recent policy proposals coming out of Washington seek to exhaustively outlaw every practice that proved problematic during the crisis. In my opinion, these efforts are narrow-minded and unduly oppressive to financial innovation. My alternative proposal has won support from both academics and senior members of banks, including an individual in Goldman’s proprietary trading group.

If you are interested in reading more, feel free to shoot me an email at .(JavaScript must be enabled to view this email address).


Alexandra Manfull

Another piece of the puzzle that is the economy. There are many opinions available, and depending on your intellectual investment you can form varying theories to construct a whole from the parts. A politically-centric point of view will be different from a money-centric one. I personally believe, and find much evidence to support, that there is a lot of froth and blather going on about the economy which does not really address the state of crisis. Yes, crisis. The underlying situation we all find ourselves in is the problem of unsustainability, I believe. There are big changes ahead, and they will not be pretty. Governments have chosen their place with big money and influence, and there are further crashes coming… not planned by anyone, but the signs can be seen. And big money is not afraid of that, they feel they will get bailed out again. They are likely correct.

Government and banking are both parts of the same oligarchial rule over government and commerce i.e. wealth and the economic means to perpertuate wealth. Obama is the perfect example of the ominipotence of oligarchs. A supposed man of the people is nothing more than a enuch for wealth perpetuation. The oligarchial status quo is preserved as Obama is used to keep the masses enturbulated with desire for fairness manifested through watered down laws affecting race, class, gender, religion, and citizenship. Dodd Frank is a boom for consultants and attorneys eating the crumbs fallen from the tables of the wealthy. Jamie Dimon is another captain of industry manning the worm eaten ship of the capitalism whose mainsails will always be oligarchial control over the levers of our economy found at the intersection of government and commerce.

Ernest J. Smith

May 29, 2013, 5:11 p.m.

The system might be rational if the Chairman/CEO is the founder and
principal stockholder in the corporation.

Otherwise, we should all remember that the CEO is the principal
EMPLOYEE charged with the day to day management of the corporation.

The Chairman of the Board is the principal REPRESENTATIVE of the
owners of the corporation and is charged along with his fellow directors with the overall supervision of the CEO and his management team.

Combing the two positions makes as much sense as a common thief being his own policeman!

Ernest J. Smith

May 29, 2013, 5:14 p.m.

Sorry!, sticky fingers. “Combing was meant to be Combining.

Alexandra: I completely agree with you that short-sighted goals (buy/sell reactions to expectations via projected quarterly earnings) to satisfy stockholders have played a huge role in banks taking increased risk which resulted in the subsequent financial meltdown. Not to mention other downsides of short-sighted reactionary practices in businesses, especially preserving the status quo rather than investing in our shared future health.

Your fix: The additional layer in creating a board of directors serving consumer interests sounds good on paper but would require alert investors to make sure it doesn’t suffer from “mission creep” (serving interests which are the polar opposite of the original intent). Investors are about as “alert” as the majority of our voters. Almost all investors including institutional investors are focused only on investing where the greatest return can be realized. They are not concerned with the financial well-being of those who consume the product being invested in. Electing a board depends upon the goals of those who cast the votes.

Example: Our government “oversight” committees (house ethics committee, et al) were set up for the purpose of watching out for “our” interests (protecting us from our own elected officials). They’ve instead become politicized if there’s a quorum for a witch hunt - otherwise remain toothless. So we have “bought-off watchdogs” watching “bought off watchdogs”. And these are committees which have a great deal more transparency than meetings held in lofty corporate boardrooms. Transparency is nice if anyone happens to be paying attention.

The “fix” is simply for voters to become educated, aware, and concerned enough to vote for representatives who will work for the benefit of their constituents. Then we can pass measures which will re-enact/update the reforms which were “deregulated” (especially glass/steagall), and reduce size enough to make no business “too big to fail”. Breaking up monopolies, Anti-trust laws, bringing white collar criminals to justice - all appear to be tools relegated to our past. Since we are the voters, we really DO deserve what we get.

The writer seems to ignore the issue of relative performance by a particular company.  Compared to his peers, Dimon has managed to avoid most of the catastrophes which has plagued major banks around the world.

If shareholder value is maximized - and that is the purpose of the Board of Directors - then there seems little reason to impose a standard on one outstanding company, when so many companies (of whatever industry) have been performing badly.

If Dimon were the only Chair/CEO, or even one of a few, then calls for splitting the Chair and CEO roles of JP Morgan Chase would seem to make sense.  But, as you all know, that is not the case.

If you want that kind of universal reform of such roles in publicly-owned companies, then start with the problem companies, and work your way up the line.

Such a a strategy would then make sense for Jamie Dimon, but until you get close to that standard among publicly-owned companies, it is foolish to beat your head against the wall when it comes to one of the best-managed companies in the US.

Were there mistakes within JP Morgan Chase?  Sure, but how many companies are free of mistakes?

Compared to his predecessor, Bill Harrison, Jamie Dimon is prescient and prudent, even if a bit obnoxious.

The Declaration of Independence signs off with these poignant words:

“And for the support of this Declaration, with a firm reliance on the protection of divine Providence, we mutually pledge to each other our Lives, our Fortunes and our sacred Honor.”

Looking and listening to our leaders over the course of recent history, one sometimes wonders whether our ethos has morphed from “sacred honor” to “sacred fortune.” See this:

Raj Balasubramanian

May 30, 2013, 12:57 a.m.


Big business is behaving very badly: it does not pay its fair share in taxes; it does not create enough good jobs for Americans; and it does not use best practices to prevent unethical, unsafe, and even illegal actions.

Big business has instead enriched itself—especially those at its top—and bribed our politicians into obedience, all at a severe cost to We The People.

To correct the corporations, we must do 5 things.

a.  RAISE THE CORPORATE TAX RATE TO 50%, to remind big business that We The People and our government have greatly helped them make ‘their’ wealth.

b.  TAX THE U.S. PARENT COMPANY IN TOTO for all domestic, offshore, and subsidiary revenues as well as assets, to stop big business from abusing offshore / subsidiary options.

c.  Allow NO ACCESS TO U.S. MARKETS NOR GOVERNMENT CONTRACTS FOR FUGITIVE COMPANIES and their offspring that try to flee abroad to escape correction.

d.  REQUIRE AN 87% AMERICAN WORKFORCE in every company to make big business create jobs in the US for our citizens / permanent residents, not for guest workers, foreign students, or undocumented immigrants.  This would be to remind them that their first and foremost priority is us—We The People—since our Constitution was created in 17… 87.  While US-based companies reconstruct themselves to meet this requirement, levy a 13% corporate trade-off tax for every year until they reach the 87% mark.  And these companies should be required to uphold American or higher standards for work conditions and safety for the 13% employed outside the US.

e.  ESTABLISH CITIZEN’S SHARES AND PEOPLE’S SHAREHOLDERS.  To curb unethical, unlawful, and unsafe actions by big business—as well as offset profiteering price raising that unfairly passes on exaggerated costs to consumers—require all publicly-traded companies to issue free nontaxable, nontradeable citizens’ shares (1 or more per adult US citizen, at a total quantity always equal to 49% of all company shares, to be represented en masse by an elected People’s Shareholder, with an annual dividend payment).  Each People’s Shareholder will be up for re-election every 2 years nationwide.

The premise, here, may be somewhat flawed.  As Quartz reported about a week ago…

...big companies have more than a few gimmicks to pretty much avoid any shareholder control.  Then, like with the financial game they play where they keep profits while socializing deficits, everything good was their initiative, everything bad, blame the shareholders.

So did the investors really support Dimon’s continued authority?

“…Someone has to break through the fraud. The biggest fraud is that when you refinanced, the prior loan, and prior trust that held the loan, were NOT paid off. All that occurred were a transfer of servicing rights. Which means, you never had a mortgage/deed of trust. That is the huge fraud that I tried to get across on LL…”

(AFTER GSE “false default” at start of subprime)—

“…it was not a “mortgage loan”. The subject of the “investor” investment was DEFAULT SERVICING RIGHTS.
That is, loans that were never accounted for as “mortgages” on the financial institution accounting books, by which, the financial institution passed on cash flows, and cash flows alone, to investors in the REMIC.
The REMICS (falsely) stated that the securities were valid mortgage backed securities — which is false.

So many miss the boat that the loans were not residential mortgages — even though they were presented to borrowers as such.
These loans were non-qualifying for mortgages, AND for derived mortgage backed securities.

This is why the whole market collapsed.

The investors simply invested in debt collection rights — BEFORE homeowner even defaulted.”

(Which obviously means all those foreclosures are/were illegal.)

I suppose I’m missing a few pieces of this puzzle. Too big to fail means that when an institution is tottering, taxpayers have no choice but to come to the rescue. That sureness of rescue encourages more risk. Heads I win tails I break even.

So taxpayers, who do not volunteer for this adventure, are put at risk. Shareholders have a higher return on investment and a guaranteed return OF investment.

Why do we expect shareholders to rebel against this very sweet deal?

What am I not getting here?

As for missing pieces of the puzzle, please don’t forget that JP Morgan Chase was one of the few major banks that did not run into major problems in 2007, or in the years since.

They have needed no “rescue” and indeed they were pressured into accepting Federal loans to banks, with the reason being that if JPM Chase refused then it would be clear which banks were teetering on bankruptcy (Citi and BofA chief among them), and which banks were not.

So, please don’t conflate the decision that JPM Chase shareholders made, allowing Jamie Dimon to continue to hold the dual roles of Chairman and CEO, with the rescue-dependent banks and any decisions made by the shareholders of those much weaker institutions.

Thank you, Jerry H, for the clarification. Sadly, I’m not quite there yet.

Too big to fail institutions took wild risks. Some risks failed and some succeeded. That’s the nature of risk.

Those that failed were bailed out by taxpayers. Those that succeeded made investors money. Both were part of an unintentionally rigged game.

To my mind, it isn’t just the failures that ripped off taxpayers. It is the situation of too big to fail.

I don’t see why anyone thought that shareholders would object to taking whatever benefits accrue and shifting any losses to taxpayers.

I don’t see why taxpayers would do anything but object.

Jesse Eisinger

About The Trade

In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)