5 minute read
14-3d Government Financing
Peter Morgan/Associated Press/Corbis
In 1987, Black Monday was the largest one-day market decline in stock market history.
Advertisement
export-import (Ex-Im) bank
a U.S. government export finance agency that supports U.S. firms competing against exports of other countries that are government supported
Over the past two decades, financial crises have occurred in many different countries, including the United States, Japan, Mexico, Russia, the United Kingdom, Spain, Iceland, Italy, Ireland, Turkey, Argentina, Greece, and a number of emerging Asian and Eastern European countries. In financial crises, currency values can plummet, market volatility can cause an exodus of global investors, financial institutions can fail, and governments can lose political support. Disruption in financial markets can slow credit flows to firms, especially smaller firms that rely upon banks for financing. Without access to credit, many firms may have to curtail business activities, lay off workers, and suffer profit losses. Government financing can play an important role in providing interim credit to help business firms in a financial crisis. By providing credit, governments can reduce damage to the economy from which it would otherwise require many years to recover.
In 1944 the International Monetary Fund (IMF) and World Bank were established as agencies of the United Nations. Their purposes are to promote international monetary stability and international trade. The IMF provides short-term loans to countries in financial crisis, evaluates exchange rate policies, and gives technical assistance to countries. With more than 180 countries participating as members, the IMF can serve as a “lender of last resort” to reduce currency panics and assist troubled banks. The World Bank focuses upon long-term loans to developing countries seeking financing for economic reform purposes intended to raise the standard of living. Some examples of World Bank mission priorities are health, education, social institutions, environmental disasters, private business formation, economic reforms, and poverty reduction. The IMF and World Bank are the major suppliers of emergency and development assistance to poorer countries.
Government-supported international finance is provided in developed countries by various agencies. In the United States, the Export-Import (Ex-Im) Bank is a government export finance agency. It seeks to level international competition by supporting U.S. firms competing against exports of other countries that are government supported. The firms receiving Ex-Im Bank financing are typically large MNCs competing globally; they are
es V i CT e P al Pers C i eTH
Over the past 50 years, total compensation of executives in financial institutions, including banks, securities firms, and insurance companies, has ballooned. Previously about 30 times the average earnings of employees in the company, now executive compensation can reach over 400 times. Salaries and other compensation, such as stock option payments, appear to be more closely tied to the total assets than the actual performance of the firm. Also, while managers that perform well and make money earn large bonuses, often no penalties are incurred in the event of poor performance. Executives that are fired frequently receive a “golden parachute” worth millions of dollars in severance pay, cash bonuses, stock options, and other benefits. Some experts link high executive compensation to risk taking by financial institutions. If a chief executive officer (CEO) rapidly increased the size of an institution through mergers and acquisitions and expanded into “hot” areas, such as risky subprime mortgage lending, his or her personal wealth could be boosted. Remarkably, during the financial crisis in 2008 and 2009, a number of troubled financial institutions being rescued by the government continued to pay executives high salaries. For example, in 2008 Merrill Lynch paid out over $39 million in bonuses to a manager who had been largely responsible for over $15 billion of trading losses. On the other hand, Citibank agreed to executive compensation restrictions after receiving government support. Nonetheless, widespread unethical behavior prompted a public outcry concerning excessive executive pay in the wake of government borrowing from taxpayers to bail out failing institutions.
These problems explain why the U.S. government in early 2009 issued executive pay guidelines for large financial institutions receiving government money due to the 2008 and 2009 financial crisis. Salaries would be capped at $500,000 for executives, and stock options could not be exercised until all government support is fully repaid. In addition, there is some discussion of “clawing back” compensation paid out to executives who exhibited excessive risk taking that severely damaged their financial institutions.
Executives should be paid for creating value for shareholders, rather than taking risks. Because of this, as directed by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve has proposed compensation-oversight policies that seek to control salaries and excessive risk taking by all financial institutions, not only those receiving government support. These new polices would examine senior managers, traders, loan officers, and other employees who take risks. Promoting compensation packages that are consistent with safe and sound banking and finance practices will be the primary goal.
It is now believed that excessive compensation structures at financial institutions contributed to the recent financial crisis. Some executives sought to maximize their wealth at the expense of shareholders, workers, firms, and the greater economy. Compensation packages fostering long-term stability and growth that builds wealth more broadly across different stakeholders is needed.
Questi O ns:
1) Are financial executive salaries and other compensation tied to performance? If not, give some examples and comment on whether they are ethical.
2) What is the U.S. government doing about ethical abuses by financial executives? Will these changes help prevent future financial crises?
required to have at least 51 percent of U.S. content to be eligible for financing. The U.S. Small Business Administration offers export financing support for smaller firms. Firms that cannot receive bank credit without a government loan guarantee can receive up to 90 percent federal guarantees for lenders on export loans. Co-guarantees from the Ex-Im Bank can be obtained in some cases.
Bank and government loans can be used by exporters to finance working capital (i.e., labor, materials, inventory, and accounts receivable)—called trade finance—and by importers to cover the cost of major purchases—called term financing. Loans can also be obtained to purchase long-term fixed assets (construction, buildings, equipment, etc.).
trade finance
bank and government loans used by exporters to finance working capital (i.e., labor, materials, inventory, and accounts receivables)
term financing
bank and government loans to importers to cover the cost of major purchases
