Question

1.How and when do the full. -service (aka commerciall banks move to maximize shareholder value?
How is this linked with the economic crisis in 2008. at the center of which are the full service banks.

2.In a classic book of the "modern corporation" written well before the 1980's, the question is asked. theoretically:
If profits are to be received only by the security holders, as the traditional logic of property would require, how can they perform both of their traditional economic roles? -urthermore if all profits are earmarked foil the
holder where is the inducement for those in control to manage the enterprise efficiently?
What would be your answer to these questions?

Answer 1

1. “The object of a firm is to maximize shareholder value, that is, to make money for the firm.”

In the ensuing single-minded search for profits, banks started pursuing what are known as “bad profits”. These practices were not illegal, but they were not in the best interests of customers or society, and included price gouging, gaming the system, toll collecting, zero-sum trading and excessive compensation.

At first, these “bad profits” were achieved through practices that were shady but not strictly illegal. But in due course, the temptations became too great and the “bad profits” turned into practices that were illegal, including price fixing of LIBOR, abuses in foreclosure, money laundering of drug dealers and terrorists, assisting tax evasion and misleading clients with worthless securities.

Beyond banking, the goal of maximizing shareholder value has also had disastrous economic consequences. It has ended up having the opposite effect of what was intended. Paradoxically, the goal of maximizing shareholder value has resulted in lower shareholder value in the medium term. Returns on assets and invested capital are in steep and steady decline, as Deloitte’s study of 20,000 US firms from 1965 to 2011 shows (the Shift Index).

The bottom line is that the shareholder value theory hasn’t worked, even on its own terms. In banking, shareholder value has not only led the banks into activities of dubious social benefit, of great risk to society, loss of trust and eventually illegality. What is important for today’s discussion is that it also had high opportunity cost for the banks. Pursuing profits has distracted banks from their true social purpose of reducing risk and increasing opportunities for an ever wider circle of citizens and enterprises. Innovation has been taking place in banking, but not in a way that provides sustained benefits for either the banks or society.

The Financial Crisis of 2008

By examining the relationship between the start of 2008 financial crisis and theoffering of specialized Collateralized Debt Obligations (CDOs).17 The debtsbacking these securities can be mortgages (CMO), commercial loans (CLO), creditcard balances, car loans, etc. This process is known as asset securitization. Thenonmonetary institutions expanded total credit (and money) by issuing thesestructured products effectively acting like a fractional reserve multi-bank systemwith no fractional reserve requirement since each successful sale of a CDO issue to investors provided the funds for the next CDO structure sold to investors. Wewitness the effect of this explosive expansion of credit in the M3 money supply plotin. The M1 money supply consists of money: coins, paper money, andcheckable deposits. The M3 moneysupply consists of money and near moneyinstruments that are created through transactions in the flow of funds system. Twoof the roles of money are: (1) medium of exchange to facilitate transactions, and (2)store of value. M3 results from transactions while M1 acts as a store of value. InFigure 4, we see a large run up of transactions in 2006 and 2007 due to the CDOswhile M1 remained stable. After the crisis, cash is king and the M1 balancesincrease drastically as banks and corporations hold cash to stabilize their balancesheets. Transactions, or M3 drops drastically from 2008 through 2010. Even today,we have companies like GE ($90 billion) and Apple ($50 billion) holding large sumsof cash. The banking system is holding $1.5 trillion on their balance sheets as ahedge against loans going bad. This is why the increase in M1 has not resulted ininflation over the past three years.

2. Berle's attitude toward regulation would change even before the stock market crashed. The catalyst was Gardiner Means. Berle's Rockefeller grant required the participation of an economist. This prompted Berle to engage Means, an economics graduate student and childhood friend, as a "statistical and economics research assistant.,, Means contributed The Modern Corporation's empirical studies of corPorate concentration and dispersed share ownership. His empirical results showed that onethird of the national wealth lay in the hands of 200 large corporations. Means projected that, given continuation of the present rate of growth of that relative share, 70% of economic activity would be carried on by 200 corporations by 1950, even as share ownership became more and more dispersed. The upshot was that economic power was concentrating in the hands of a cluster of corporate managers, the same group whose level of responsibility already had come to concern Berle. (These projections of increasing concentration would prove to be fundamentally wrong, but only much later; classical economics was still in its infancy.) At the time, Means' projections sent a loud and clear message: something had to be done about corporate power, something more than Berle had thought previously. Berie changed his views accordingly. What he formerly saw as a governance problem to be treated contractually within the financial community, he now came to see as a case for judicial control in the name of the shareholder interest. Berle stated this position in Corporate Powers as Powers in Trust in the Harvard Law Review in 193 1, an article that previewed legal points in the upcoming The Modern Corporation without a hint as to the political-economic framework in which the book would encase them. More particularly, the article restates what was then considered the problem of corporate power: "Of recent years aggregations of capital have been collected from the public sale ofstock in corporations with paper powers which are broad enough to permit them to rove the world at wi11.,, The article then launches into a discussion of fiduciary duty as a means of addressing the problem, asserting that the arguably archaic and longstanding rule that a corporation was for the benefit ofits owners remained true when ownership and control were separated. Managers were trustees of the shareholders and so might only exercise their wide ranging powers for the benefit of the shareholders. More particularly, "the use of the power is subject to equitable limitation when the power has been exercised to the detriment of [shareholder] interest, however absolute the grant of power may be in terms, and however correct the technical exercise ofit may have been.,, The role ofthe judiciary was to enforce this principle. This was by no means a settled principle of law. Berle accordingly marshaled the cases, pointing to a variety of rules that constrained exercises of managerial authority. For example, the directors' power to issue stock was limited by the requirement that the ratable interest of existing and prospective shareholders be protected. The power of directors to withhold dividends provided a second example: while directors generally had freedom to withhold dividends, courts would force distribution when the reason for the withholding was a non-business purpose. Third, the power to acquire stock in another corporation had to be used for the benefit of the acquiring corporation and not for managerial interests. A final example involved the power to amend the certificate of incorporation. In this setting, the power rested with the majority of shareholders rather than the directors, but the rule remained the same-majority power was subject to equitable limitations. The only distinction between the exercise of shareholder power and that of directors was that the "vote of shareholders would at least tend to create a presumption that action taken benefits all of such shareholders." But the presumption could be rebutted by a showing that the maj ority was a group that had interests adverse to the corporation as a whole.