Edward Kane is a prestigious finance professor with Boston College. His notable and influential career has included two books before and during the 1980s S&L crisis warning of what was blooming. Some of Kane’s greatest contributions have arisen in examining the ethics of government management of the “safety net” for the financial sector. Kane was one of the co-founders of an influential group called the Shadow Financial Regulatory Committee.
In recent years, Kane has generated new ideas for accounting and legal reforms that more truthfully align the relative positions of managers, shareholders, and taxpayers with stakes in large “too-big-to-fail” financial firms.
Kane’s concerns are for the positions of taxpayers amidst the risk-taking incentives for large financial firms that enjoy privileged access to taxpayer-funded safety nets absorbing losses in the financial sector. Kane has described taxpayer positions as “badly-designed equity stakes.”
In finance, common stockholders are commonly recognized as holding a “residual claim” to the assets and cash flow of a firm. They get what’s left over, for example, in a liquidation, when assets are sold, creditors are paid off, and shareholders get the leavings. They also get the residual income, on the income statement, after expenses are paid, including the interest paid to bondholders and other creditors that stand ahead of them.
Does that mean equity stakes are necessarily bad things? No. But it does mean that they tend to be risky things. Because they are relatively risky, they tend to be priced to offer higher expected returns. This doesn’t mean they always produce higher returns than bonds, because they are risky.
In Kane’s view, taxpayers hold a shareholder-like position in "zombie" banks (he coined the term "zombie bank"), but a shareholder that only gets the downside. And unlike regular shareholders, taxpayers cannot sell off their position, and they don’t have the same “limited liability” on the downside. He has proposed that taxpayer equity be recognized in “Too-Big-To-Fail Banks,” and for the corporate laws for fiduciary duty to be reformed to include taxpayers along with shareholders in the fiduciary duties for senior bank managers.
In recent months, Kane has examined financial results and market developments for large European banks. He believes credit spreads and other developments indicate that the markets are anticipating significant support from the Federal Reserve and/or the United States Treasury in the event of possible systemic consequences arising from European bank failures.
The fascinating reasonable outcome, considering these developments in light of Kane’s arguments for taxpayer equity, is that we have to consider whether US taxpayers deserve equity stakes in the likes of Deutsche Bank, in addition to large US banks.
Here’s an introduction to some of Ed’s ideas in this area.