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02
Mar 10

Goldman and the Winner Take All Society

Finally, Goldman Sachs has gone too far.  In A Reputation as Good as Goldman?  Part I, we discussed Goldman’s selling of mortgage backed securities, and its role in the current Greek budget crisis.  These activities clearly contributed to its self-inflicted reputational damage.

Perhaps the hubris went further.   Does Goldman believe that its status as a favored Federal Reserve “too big to fail” firm will insulate it from government investigation? Last week Ben Bernanke put a dent in Goldman’s Teflon shield:

Ben S. Bernanke, the Federal Reserve chairman, told Congress Thursday that the Fed was ‘looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece.’

Mr. Bernanke said the Securities and Exchange Commission was also concerned about how derivatives — financial instruments that are largely unregulated and do not trade on public exchanges — have contributed to Greece’s problems. ‘Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive,’ he said. See In Greece’s Crisis, Fed Studies Wall St.’s Activities.

In Is Goldman Finally About to Be Leashed and Collared? Yves Smith observes and analyzes Goldman’s corporate culture.  As a former employee, she reports on colleagues’ piggish and overly aggressive behavior. But in an otherwise excellent post, I believe she overlooks the role of current compensation systems.

Pay Practices and Reputation

In previously discussing the banking crisis, we pointed out a fundamental principal: you get what you incent.

Banks were interested in generating upfront fees. Incentives were predicated on “making the deal.”  The best way to make a deal was to ignore the creditworthiness of the borrower.  The banker who made the bad loan suffered no personal financial penalty.  There was no “skin in the game.” Why not write as many loans to poor credits as possible? See Hard Truths from the Banking Crisis.

The Goldman culture incents a “winner take all” mentality.  Since it is a public corporation rather than a partnership everyone is an employee.    A highly mobile employee rather than an owner is far less concerned about the firm’s long term reputation.  That employee wants to maximize current compensation; worrying about future consequences is for suckers.  Drawing on this paradigm, we are not shocked by headlines excoriating the firm for trading against its clients’ interests, shorting the municipal bonds it helped underwrite, skirting EU rules, or tanking the housing market.

Goldman operates in a larger Wall Street and indeed general culture that encourages greed at the expense of overall civic good:

  • Successful hedge funds report individual earnings in the hundreds of million dollars per employee.
  • Loyalty is dead.  Employees change firms. Highly paid athletes change teams without a second thought.
  • The media treats great wealth as reason for great celebrity.
  • Compensation validates individual worth.
  • Government backstops losses and allows gains to remain private.
  • The zeitgeist promotes: “I better grab as much as I can now before the economy implodes.”

Does It Have To Be This Way?

Any alert Board of Directors should be asking some difficult questions.  Why aren’t we concerned about the long-term firm reputation?  What do we want the corporate culture to be? Just because we can legally do a transaction should we be doing it?  How do we blend partnership-based personal accountability with a public corporation structure?   How do we get employees to care about the long-term view?  How do we meet the competitive threat of hedge funds and private equity without damaging corporate reputation? How does our compensation system comport with these concerns?

Yves Smith noted that it was as dangerous for anyone to get in the way of a Goldman employee and a profit making opportunity as it was to get between a predatory animal and its kill.  Goldman has managed to get itself between a very worried Obama Administration and a very angry public.  How ironic if the Goldman predatory lion becomes the Administration sacrificial lamb.

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01
Mar 10

Labor and Employment Laws: The Hidden Job Killer

When we ignore government sleight of hand, the real number of unemployed Americans is a staggering 26.9 million.  In For 15 Million Unemployed any Job is a Good Job; Questions for Pollyannas; Wishes Aren’t Fishes, Michael Shedlock (“Mish”) continues his excellent analysis of the unemployment situation.  Contrary to Bernanke and Obama Administration rosy projections, Mish predicts that official unemployment will remain greater than 9 % through 2015.  In a quote from Allen Sinai, chief global economist for Decision Economics, Mish describes corporate hiring behavior:

American business is about maximizing shareholder value…You basically don’t want workers. You hire less, and you try to find capital equipment to replace them.

Workers are expensive. Federal, state and local employment laws make them more so.

New Deal Labor Legislation

In the late 19th and early 20th century, rapid industrialization resulted in powerful owner/capitalists, virtually powerless workers, and deplorable working conditions.   Upton Sinclair’s The Jungle dramatized the deplorable state of affairs in the meatpacking industry.  In reaction, in 1935, Congress passed the Wagner Act to permit union organizing. Then it enacted the Fair Labor Standards Act to establish minimum pay, limitations on hours and pay for overtime work.  Perhaps labor legislation should have stopped at that point.

Nothing Succeeds Like Excess

New Deal labor legislation was just a springboard for greater federal control over the workplace.   Since 1964, there has been a flood of labor and employment legislation and Executive Orders.

  • The Civil Rights Act prohibits race, color, religion, sex or national origin and pregnancy discrimination.
  • The Age Discrimination in Employment Act prohibits age discrimination.
  • One Executive Order prohibits all forms of discrimination and requires affirmative action.  This includes training and outreach programs and other positive steps which must be incorporated in written personnel policies and a plan which must be updated annually.
  • The Equal Pay Act requires that men and women in the same workplace be given equal pay for equal work.
  • The Americans with Disabilities Act prohibits disability discrimination. The Rehabilitation Act requires most federal contractors and subcontractors to take extra measures to hire and promote qualified disabled individuals.
  • The Occupational Safety and Health Act requires employers to meet legal health and safety standards.
  • The Employment Retirement and Income Security Act (“ERISA”) sets uniform minimum standards to assure that employee benefit plans are established and maintained in a fair and financially sound manner.
  • The Workers Adjustment and Retraining Notification Act requires that covered employers provide notification sixty days before a plant closing or a mass layoff.
  • The Family and Medical Leave Act provides covered employees with entitlement to up to 12 weeks of job-protected, unpaid leave during any 12 months for the following reasons:

-Birth and care of the employee’s newborn or adoption or foster care of a child

-Care of an immediate family member (spouse, child, parent) who has a serious health condition

- The employee’s own serious health condition

These are the major pieces of federal labor and employment legislation, but there are additional enactments regulating the employment relationship.

Since we live in a federal system, state and even municipalities impose additional employment, benefit and labor obligations.  Moreover, the courts have intervened to create doctrines such as wrongful discharge to limit an employer’s right to dismiss an employee at will.

Real World Consequences

Much of the above legislation is grounded in noble sentiment: workplace fairness and employee protection.  But there are real world consequences: a loose definition of “serious health condition” allows employees to take large unpredictable amounts of time off, harming production schedules.  Affirmative action programs require lots of staff and recordkeeping, extra recruitment and training, and slower hiring.  ERISA imposes fiduciary liability on plan sponsors. With virtually every workplace sector protected, firing an employee is difficult, with the ever present danger of a discrimination or retaliation charge. And so the American workplace is now one of the most regulated areas of our economy.

Laws are often a hidden tax. See Ask Your Congressional Representative to Do Nothing.   Allen Sinai has reached the correct conclusion: why hire expensive workers who have a host of protections and entitlements when you can substitute cheaper capital (automated machinery, robots, computers, etc)?  In a globalized economy where a highly motivated, well-trained Chinese worker makes about $1 per hour, the over protected American worker may have priced himself out.

If the Obama Administration is serious about reducing the unemployment rate, it should be thinking about shelving expensive health care initiatives and the Employee Free Choice Act.  More employer cost will equal less American employment.

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24
Feb 10

The Mirage of a Financialized Economy

We have spent the last 30 years preoccupied by financial things.  Finance was once the handmaiden of productive enterprise.  That is, Wall Street served productive enterprise, raising and allocating capital for worthy endeavors.  Finance existed for helping railroads, utilities, builders and manufacturers to issue stocks and bonds.  Further, finance helped maintain orderly exchanges where stocks and bonds could be traded.

Building a successful business is difficult. Once an entrepreneur raises capital, he must deploy it properly.  He must hire employees, build factories, develop products, plan marketing strategies, manage production, packaging and shipping, and a myriad of other activities.

A recent concept, financialization is defined as:

…a term sometimes used in discussions of financial capitalism which developed over several decades leading up to the 2007-2010 financial crisis, and in which financial leverage tended to override capital (equity) and financial markets tended to dominate over the traditional industrial economy.

[It] describes an economic system or process that attempts to reduce all value that is exchanged (whether tangible, intangible, future or present promises, etc.) either into a financial instrument or a derivative of a financial instrument.  Source Wikipedia.

Financializing the economy promised a short cut to making money.  We are now paying for that false promise.

Living through Financial Engineering

I started my corporate career in 1977.  I worked for a telecommunications and manufacturing conglomerate that served 27 million telephone customers, employed 250,000 people worldwide, manufactured products ranging from the humble incandescent light bulb to sophisticated microchips.  Leaders in the company were operating executives.  Executive compensation was moderate.

In the 1980’s and 1990’s the winds of financializing change swept through corporate America.  The underlying producing businesses were viewed as stodgy and unimaginative.  Paper mills, lighting plants, railroads and telecommunication companies were boring “cash cows.”   “White shoe” business schools preached financial innovation, or to give it a more professional sounding name, financial engineering. The CFO function dominated.  Executive compensation increased exponentially.

The number of engineering opportunities was boundless:

  • Terminate pension plans and pocket the surplus assets
  • Create leveraged employee stock ownership plans to make 401k contributions
  • Take out gigantic company owned life insurance plans on large swaths of the workforce
  • Issue huge amounts of debt and buy back the company’s equity
  • Create voluntary employee benefit trusts to pre-fund retiree health benefits for unionized employees.
  • Create leasing and realty divisions within the company for both internal and external needs
  • Take the firm private through a management organized leveraged buyout

These are but a few of the financial techniques employed to inflate company earnings or turn a quick profit. Most of these strategies involved taking on large amounts of debt and exploiting loop holes in the tax code. None of this enhanced the productive capabilities of the underlying business. The “cow” was slowly starving and the bricks and mortar of the enterprise were crumbling.

Enron and WorldCom

The beginning of the new millennium saw two major American corporations, Enron and WorldCom, disintegrate.  Accounting fraud was at the heart of these collapses.  Enron created off shore entities to hide losses and posted yet unrealized revenue as profit.  WorldCom underreported line costs by capitalizing items which should have been expenses.  They also inflated revenues through bogus accounting.  Not only did these entities hurt their shareholders, but also their competitors who had to compete again these fraudulent entities for scarce capital.

Sarbanes-Oxley was passed in 2004 to stop these accounting maneuvers and restore integrity.  The subsequent collapse of Bear Stearns and Lehman tells us that Sarbanes-Oxley failed, and that financial transparency still does not exist.

The Evils of Financialization

Financialization of the economy has become an evil unto itself.  Culprits in the 2008 financial crisis: sub-prime lending, mortgage-backed securities, collateralized debt obligations, off balance sheet structured investment vehicles, hedge funds, private equity,  excessive leverage are all the progeny of the 1980’s schemes and strategies to enhance corporate financial performance.

I have two observations.  First, many of these maneuvers are nothing more than alchemy applied to finance.  Old saws such as “there is no free lunch” and “you can’t get something for nothing” remain true.  Slapping a Nobel Prize or a prestigious business school imprimatur on a strategy does not change these universal truths.

Second, an early rule of investing I learned is: when one sector becomes more than 30% of the value of the S&P 500 index, sell that sector. This was true in the 1980’s when the oil sector passed that benchmark and in 2008 when the financial sector did the same. Too much of society’s resources and human capital are now tied up in one area of the economy. At least in the case of oil there was a real societal good.

The financial industry in 2008 and now has become a financial casino without the glitz or charm of the Mirage. In fact, it has become a mirage and that says a lot.

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19
Feb 10

A Reputation as Good as Goldman Part II

In A Reputation as Good as Goldman Part I, we examined Goldman’s role in exacerbating the housing market collapse, AIG’s demise, and the Greek government debt crisis.  These major stories were the subject of separate front page articles in the New York Times. Mentors had always warned me no to be too clever by half, a lesson Goldman perhaps missed.   Are the Goldman stories symptomatic of behavior for the last ten years on Wall Street?  Was this always the way Wall Street firms and Goldman behaved?

Sydney Weinberg

In 1930, Sydney Weinberg became the head of Goldman Sachs. He ran the firm for the next 39 years.  By 2010 standards, he was an unlikely person for the job. He had left school at 15 (1907) and started at the struggling brokerage firm as a janitor’s assistant.  He then served in the Navy during World War I, returned to the firm and ultimately became co-head of the securities trading group. He is credited with saving Goldman Sachs from bankruptcy during the Depression. See Annals of Business: The Uses of Adversity by Malcolm Gladwell

In 1956, Weinberg managed his greatest corporate coup. Goldman Sachs was selected to handle for the Ford Motor Company the enormously difficult, largest ever until that time, initial public offering.  The effort took two years. The most fascinating part of the transaction was Weinberg’s fee:

When Henry Ford had asked Weinberg at the outset what his fee would be, Weinberg had declined to get specific; he offered to work for a dollar a year until everything was over and then let the family decide what his efforts were really worth.  Far more than the actual fee, Weinberg always said he appreciated an affectionate, handwritten letter he received from Ford which says, along with other flattering things, “Without you, it could not have been accomplished.” Weinberg had the letter framed and hung in his office, where he would proudly direct visitors’ attention to it, saying: “That’s the big payoff as far as I am concerned…” The fee finally paid was estimated at the time to be as high as a million dollars. The actual fee was nowhere near that amount: For two years’ work and a dazzling success, the indispensable man was paid only $250,000. Deeply disappointed, Sidney Weinberg never mentioned the amount.  See The Partnership: The Making of Goldman Sachs by Charles D. Ellis.

Weinberg understood the value of a continuing relationship with Ford Motor Company and was soon appointed to their board.  Moreover, for nearly a half century, Goldman became the chief investment bank for Ford which vaulted the firm into the top tier of Wall Street firms.  To Sydney Weinberg reputation was everything.

Tradition and the Making of a Culture

John Weinberg followed his father Sidney as head of the firm.  The younger Weinberg preserved his father’s ethic and corporate culture.

Once upon a time, Goldman Sachs shunned publicity.  During the period from 1930 to 1969, Sydney Weinberg ran Goldman Sachs where he developed a staunch corporate cultural aversion to publicity.  During the 1970s, a tandem of John Weinberg and John Whitehead assumed the reigns of leadership at Goldman Sachs.  Whitehead left the company in 1984 to enter public life.  John Weinberg carried on in the same vein as his father Sydney – shunning publicity – to the point where he hired a man to keep his name and his firm’s out of the press.  He kept him off the full-time payroll (though he sat full-time at a desk in head office) so that if, improbably, a comment did slip out, it could be honestly dismissed as not coming from a Goldman Sachs employee.  John Weinberg served as sole senior partner and chairman until 1990.  His mantra was to put the client’s interests first and he wouldn’t allow Goldman to be involved in (sic) hostile takeovers. See All Roads Lead to Goldman Sachs.

As a young law student, Ben Stein interviewed with John Weinberg.  He was impressed with Weinberg as a “smart guy,” but also surmised that he inherited the position from his father, Sydney Weinberg:

But what I did not know about John Weinberg was that even though he was rich and well connected, as a young man he joined the Marines to fight the Japanese in the Pacific, then fought again in Korea. That was America’s ruling class then. The scions of the rich went off to fight. See Looking for the Will Beyond the Battlefield

Clearly, John Weinberg believed that honor and service to one’s country mattered.  But in the current Goldman and Wall Street culture, going off to serve one’s country is for the common folk: why do that and miss out on so many deals and great bonuses?

What Changed?

The end of the Weinbergs’ era can be traced to several factors.  First, Goldman Sachs, Morgan Stanley and other large investment firms were partnerships.  This means the partners were investing their personal fortunes.  Moreover, retained capital was extremely important to the future success of the business.  Thus, there was a limit on executive compensation based on capital and personal preservation.  Second, as firms went public, it was easier to convince a less involved board of directors (rather than partners) to pay large bonuses to executives. Third, those same executives became increasingly greedy, and probed and trampled ethical boundaries. Short-term thinking reigned on Wall Street.  Fourth, compliant government officials endorsed and enabled these behaviors instead of regulating them.

Finally, we need to look at the important intersection of law and ethics.  Just because something is legal does not mean one should do it.  A legal thing is not always an ethical thing.  Would the Weinbergs’ have permitted Goldman to take positions against their own clients?   Would they have forced AIG into insolvency? Would they have designed scams to fool the EU? I doubt it.

It will be a long time before Goldman restores its reputation.  And President Obama is not catalyzing any restoration of ethics or reputation by calling the current Goldman CEO a savvy businessman.   By its actions, I doubt if Goldman Sachs cares.

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18
Feb 10

A Reputation as Good as Goldman? Part I

Part I of II in a series. Part II here.

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Arguably the greatest living investor, Warren Buffet, clearly valued a person’s or an organization’s reputation.   In 2008 Buffet was the “white knight” investor for a struggling Goldman Sachs, investing $5b in the firm.  A mentor of mine had wise complementary counsel to Buffet’s:  when providing legal advice, be sure that you would be comfortable if that advice were to appear in a New York Times, Washington Post or Wall Street Journal front page article.

We live in  an age of greed, and indeed supreme irony.   Perhaps Mr. Buffet never shared his wise advice with the senior management of Goldman Sachs.  Worse, maybe he did and they ignored him.  In any event, how has Goldman’s reputation fared?  Let’s examine three separate front page New York Times articles.

Banks Bundled Bad Debt, Bet Against It And Won (NY Times, December 24, 2009)

Goldman Sachs sold mortgage-backed debt securities to pension funds and insurance companies. To hedge their position and to profit from a decline in the housing market, Goldman created a synthetic derivative security called Abacus. This second security was a direct bet against the position of their institutional clients. The mortgage-backed debt securities sold to the institutional clients performed poorly, with losses in the billions. Some of the original securities were of such poor quality that losses occurred within months of issue. Goldman created these synthetic securities well in excess of any hedging needs, permitting it to profit handsomely at the expense of its institutional clients.  The obvious ethical problem was succinctly stated:

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

The SEC and other governmental agencies are investigating Goldman and other firms to determine whether or not they violated “fair dealing” rules.

Testy Conflict with Goldman Helped Push A.I.G. to Edge (NY Times, February 7, 2010)

AIG insured some of Goldman’s complex mortgage securities.  When the housing crisis deepened, AIG paid Goldman $2b to cover potential losses. AIG later asserted that Goldman had inflated the potential losses and sought monies back. Goldman countered that it was due even more money.  The SEC is now looking into whether or not Goldman’s demands for loss coverage depressed the mortgage market and hastened AIG’s demise.

In another supreme irony, after the government took over AIG, Goldman received an additional $12.9b from taxpayers, one hundred percent of expected losses.

Wall St. Helped to Mask Debt Fueling Europe’s Crisis (NY Times, February 14, 2010)

Goldman’s questionable financial maneuvers were not confined to the United States.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting.

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

European authorities are looking into the role of Goldman and others in skirting EU rules.

Is There Another Way?

Has the American public been lulled into believing that this is an acceptable way of doing business, or do we require the people involved to be publicly excoriated, tried, convicted and jailed before we acknowledge their tactics were shabby?  Is Goldman Sachs an institution now synonymous with crafty machinations and greedy outcomes? Are its tactics symptomatic of a Wall Street “disease?”  Is there an alternative way of doing things?  Does reputation matter?  Part II will examine these issues and possibilities.

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16
Feb 10

Where Are We Now?

“Where Are We Now?” is my fiftieth blog post.  The purpose of a political and economic blog is to “connect the dots” looking for coherent patterns.  This post will attempt to do just that, warning you that the emerging pattern is disturbing.

Slow Motion Depressions

Policy makers in Washington and other western capitals are recently smug. They proclaim that, through coordinated monetary and fiscal response, we have averted the Second Great Depression.  More bluntly, all we have done is throw a lot of money at the problem through unprecedented monetary easing and a fiscal policy of bailouts and stimulus bills.  The core financial issue remains:  western countries and the US in particular have too much debt and insufficient income to service that debt.  Depressions have their own timetable. In my opinion, government intervention has only slowed the timetable, but definitely has not averted the event.

The Magic Act

Politicians and central bankers are a bit like magicians.  While an observer is firmly focused on the right hand we miss the left hand’s activities, which are hiding in plain sight.   Just look at current economic and financial trends:

  • Increasing Risk of Sovereign Debt Default – In late 2009 a problem arose with the financial solvency of Dubai.  Much like the subprime crisis in the US, financial pundits assured the public that the Dubai default was minor and self contained.  Yesterday, credit protection for Dubai rose to a record high exceeding the November peak. See Dubai CDS Hits 652, Ploughs Through November Highs As Gold Jumps.   Greece too is on the verge of sovereign debt default and is seeking a European Union bailout.  Portugal, Ireland, Italy and Spain are reportedly in dire financial trouble as well.  The United States, Japan and United Kingdom are not immune from talk of default.
  • Crisis at the State Level – The Center for Budget and Politics has projected 48 of 50 states will have budget deficits.  Cumulatively, the Center estimates an $180b shortfall for this fiscal year.  All states with the exception of Vermont have a balanced budget requirement.  Some assistance to the states has been proffered through the American Recovery and Reinvestment Act, but it is questionable whether this aid can continue. See Recession Continues to Batter State Budgets; State Responses Could Slow Recovery. It is more likely that states will follow the lead of newly elected Republican Governor Chris Christie.  Recognizing that the state is on the edge of bankruptcy, Christie has declared a fiscal “state of emergency” and intends to slash $2.2b from the budget. See Chris Christie Declares Fiscal ‘State of Emergency,’ Paving Way for NJ Spending Cuts. The crisis in municipal finance portends trouble in the municipal bond markets.  The unsuspecting public has purchased municipals in search of yield and instead may receive an unpleasant surprise.
  • National Fiscal Irresponsibility – President Obama signed into law a $1.9t increase in the debt ceiling, raising it to $14.2t. As the administration has predicted deficits out to 2020, this ceiling will rise each and every year. Also, it does not include the Christmas Eve bailout of Fannie Mae and Freddie Mac which provided “unlimited financial assistance” to these two entities. We will likely exceed our previous limit of $400b on financial assistance under emergency bailout provisions.  See US Promises Unlimited Financial Assistance to Fannie Mae and Freddie Mac.  Moreover, how can we continue to finance these deficits without an increase in interest rates?  However, such an increase in interest rates could put the US in a “doom loop,” as interest payments become the dominant budget line item crowding out other federal spending programs.
  • China – Recently China has made a number of financial moves that do not bode well for the US and world economy. First, China has ordered its currency managers to withdraw from any US dollar denominated risk assets, such as corporate bonds, equities and only invest in US guaranteed assets.  Second, it has raised its reserve requirements on its own banks to dampen an over-inflated domestic real estate market.   Speculation in Chinese real estate has reached the point that Jim Chanos, a respected investor, predicts an economic collapse.  See Jim Chanos: China Bubble Ready to Burst. Given the size of our deficits, the US desperately needs China to continue purchasing US government securities. The world needs China as a growth engine to continue world trade and prevent a second leg of the recession.

Harbingers of the Economic Unraveling

Before the next phase of an economic crisis there are often clues to impending problems. Some harbingers to consider:

  • Junk Bonds – The Greek crisis has spurred investors to sell junk bonds, highly risky assets, at the fastest rate since 2005.  As a result credit spreads are widening between treasury and higher risk corporate bonds. See Junk Bond Spreads Widening: A Canary in the Coal Mine.
  • Problems in a Treasury Auction – Last week’s US 30-year Treasury bond auction was considered a failure.  Indirect bids, that is, foreign buyers, dried up and the government had to offer a yield of 4.72% compared to an expected yield of 4.687%.  See Dismal $16b 30 Year Auction
  • Credit Card Problems – Capital One, a major credit card issuer, reports that in January delinquencies rose and that expected unrecoverable loans have risen to 10.41% from 10.14% in December. See Capital One: Credit -Card Delinquencies Rose in January.
  • State and Municipal Finance –In its upcoming July 1 fiscal year budget, California expects a $20b shortfall.  Illinois has a $61b pension shortfall, and is borrowing to make contributions.   Harrisburg, Pennsylvania, is contemplating a March 1 bankruptcy filing.  These stories are the proverbial tip of the municipal finance debt iceberg. See Illinois Pension Fund $61b Underwater; State Borrows Money for 2010 Contribution; California $20b in the Hole Again.

Reality

Till now the policy direction of the Obama administration and other western leaders has been to “extend and pretend:”  we will ignore economic realities by permitting banks to suspend “mark to market accounting” and we will send various administration spokesmen to spread the fairy dust of “green shoots” to pacify an anxious public.  Essentially, we have an economic policy of faith and hope that willfully ignores reality.  Economics does respond to the laws of mathematics.  Like a termite that silently eats away the wooden supports of a house, excessive debt has eaten away the structure of the world economy.  There will be more troubled countries like Dubai and states like California before this Depression has run its course.

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11
Feb 10

Populism and the Modern Cross of Gold

United States history in high school is taught as a series of disconnected facts and snippets.  Students memorize Shay’s Rebellion (1786-87), The Whiskey Rebellion  (1794) and Populist Party presidential candidate William Jennings Bryan “Cross of Gold” speech (1896).

However, if we connect the dots of these disconnected facts we find an underlying strain of populism:

‘Populism” is a political ideology the central tenet of which is the conviction that governments ought to concern themselves with providing the conditions for the greatest good for the greatest number.  Populists typically are opposed to both oligarchy or government by the few, and plutocracy, or governments by the wealthy

Shay’s Rebellion, the Whiskey Rebellion and the formation of the Populist Party had in common legitimate economic grievances.  In each instance farmers and working men were protesting policies of the eastern elites.  For example, Shay’s Rebellion was in response to a wave of western Massachusetts farm foreclosures, high state taxes, governmental salaries and court costs, and an inflexible monetary system that favored eastern Massachusetts banking and commercial interests.  Similarly, the Whiskey Rebellion and the formation of the Populist Party were in response to economic policies that penalized farmers and the working man.  Once again, the rebellion targeted eastern elites, the federal government and national banks.

Modern Day Populism

One modern example of populism is the Tea Party Movement.  This movement has focused on deficit spending, wasteful stimulus spending (“pork”), health care reform, high taxes and threats of increased taxation.  But is this a true grass roots movement?  Some view it as a Republican or conservative public relations initiative designed to pressure and embarrass the Obama administration.

Irrespective of the Tea Party Movement, I believe an authentic strain of populism is alive and well in the United States.  Fuel for populism includes:

  • Dissatisfaction with both major parties:  they are viewed as irresponsible handmaidens of special interests.
  • Taxpayer funds used to bailout banks and other financial and industrial enterprises (American Express, GE, AIG, etc)
  • Favoritism toward the unions in the GM and Chrysler bailouts
  • Record deficit spending
  • A zero interest rate policy that punishes savers and retards economic recovery
  • Bonuses to executives of nearly failed enterprises
  • Health care reform proposals that favor insurers, drug companies and trial lawyers
  • Failure to focus on creating good paying, private sector jobs as real unemployment (U-6) hovers at 17%

Flawed and elitist process has added to populist fervor.  Bank bailouts, stimulus and health care bills were negotiated in secret, favored special interests, disregarded public opinion, and may have bypassed constitutional and legal safeguards.

Cross of Gold Redux

If they dare to come out in the open field and defend the gold standard as a good thing, we shall fight them to the uttermost, having behind us the producing masses of the nation and the world. Having behind us the commercial interests and the laboring interests and all the toiling masses, we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.

–William Jennings Bryan

Bryan was inveighing against Eastern Banker interests who would not relax the gold standard and allow the currency to inflate to help farmers.  Ironically, we have been off the gold standard since 1971, but the same societal problems of elites prospering at the expense of the remainder of the economy exist.  Despite its liberal trappings the Obama administration is blatantly favoring bankers and Wall Street, who represent the core of the Eastern Ivy League elite, at the expense of the rest of the economy.

Anger is growing.  The Republican and Democratic Party duopoly may face a serious challenge.  A recent voter telephone survey revealed that 35% of respondents favor creation of a new political party because the Republicans and Democrats are too alike.

Seventy-five percent (75%) of voters are at least somewhat angry at the government’s policies, up four points from late November and up nine points since September. The overall figures include 45% who are Very Angry, also a nine-point increase since September. Sixty percent (60%) of voters that neither Republican political leaders nor Democratic political leaders have a good understanding of what is needed today.  Source – Rasmussen Reports.

Modern day elites who dismiss the rising tide of voter discontent do so at their peril.  While I am skeptical about the Tea Party Movement, it may portend an authentic response to a  current broad and deep popular anger.

Now all we need is a credible incarnation of Mr. Bryan to focus the anger on the elites who are crucifying the public on a cross of zero interest rates and endless bailouts.


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American Society / Political / Regulation / law — 0 Comments
09
Feb 10

Ask Your Congressional Representative to Do Nothing

Every 12-step program has an initial confession, a moment of recognition.  Here’s one: I am a lawyer and I do not know the law.  I have practiced law for more than 35 years, fulfilled continuing legal education requirements and kept up with the daily reporters.  Yet I do not know the law and would venture there is no lawyer who completely knows the law.  Shocking!

Why No One Knows the Law

The law has made itself unknowable.  How did we get to such a place?  There are 50 titles in the United States Code, the official compilation of federal law.  Each title has coordinate regulations compiled in the Code of Federal Regulations.  The tax laws are in Title 26:

If you go to the US Government Printing Office (www.gpo.gov ), you can order a complete set of Title 26 of the US Code of Federal Regulations (that’s the part written by the IRS), all twenty volumes of it, at the bargain price of $974, shipping included.

According to the US Government Printing Office, it’s 13,458 pages in total. The full text of Title 26 of the United States Code (the part written by Congress–available for an additional $179) is a mere 3,387 printed pages, bringing the adjusted gross page count to 16,845. [Statistics as of 2006].

Remember this is one title among 49 others.

An attorney can master small sections or even subsections of the law, but never all the law. Since we live in a federal system, such an aspiring attorney would have to master not only federal law, but also state statutes and regulations.

From day one of law school, a basic principle is hammered home: ignorance of the law is not a defense to a criminal offense.  Thus, we live with the ultimate paradox:  the least schooled of our citizens are charged with complete knowledge of the law, a task that is unattainable even by the most skilled legal practitioners.

Where Laws Come From

Laws emanate from the talented quills of our elected representatives.  Taft and Hartley (labor laws), Sarbanes and Oxley (corporate governance), Glass and Steagall (banking), Smoot and Hawley (tariffs) were all elected representatives.  Congressional representatives demonstrate their worth by identifying a societal wrong that cries for redress. Then they form a coalition to pass legislation.  Often campaign contributions from interested parties find their way to the sponsoring legislator. Immortality awaits these legislators.

Once a law is passed, administrative agencies create regulations to interpret.   Regulations can run many times the length of the law.  Moreover, they have the force of law and in some instances carry criminal penalties for an infraction.

Laws Have a Cost

A law is a hidden tax.  When passed, the simplest of laws require legal analysis, interpretive regulations and a compliance program.  These functions are performed by highly paid professionals. Following the momentary drama and satisfaction of bill passage, these long term costs begin.  Newly passed laws may conflict with existing laws, leading to uncertainty and then an inevitable clarifying court challenge.  Ultimately, these costs are passed along to the consuming citizenry.

What to Do

A modest proposal: we should elect Congressional representatives who promise NOT to pass laws.  Even better would be elected representatives who promise to repeal the most harmful ones.

More seriously, we need   to overhaul and simplify our legal codes.  Society needs basic safeguards, but we have far exceeded that standard. Every problem in society does not require the passage of a law.  Perhaps what we really need is greater trust and a renewed sense of shared responsibility and sacrifice.   Then we would need fewer laws.

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05
Feb 10

It is All a Derivative of Productive Enterprise

The bulls on CNBC touted the increase in health care employment in the most recent Non-Manufacturing Institute for Supply Management Report on Business. Similarly, Fox Business News trumpeted growth in health care employment, but did point out these jobs paid substantially less than jobs in the manufacturing sector.  What both news outlets missed was that these jobs were derivative.  These positions are substantially funded by the productive sectors of the economy.

Economic Illiteracy

Michael Shedlock this week focused on a major theme plaguing America, economic illiteracy. See Are Teachers to Blame for Economic Illiteracy? Nowhere is this lack of economic literacy more evident than in the service sector in general and health care in particular.  If polled, most Americans would most likely answer that the government or insurance companies provide health care in the United States.  Medicare and the current debate on health care reform only add to this misperception.

Thank Goodness for the Private Sector

Health care money comes from the support of the private sector which directs a portion of a workers’ compensation to paying health insurance premiums for their employees.  Public sector employers also pay health insurance premiums for their employees.  However, in the case of the public sector, that employer is recycling tax receipts, real money, received from private sector activities.  In short, without a productive private sector there would be no health care support.

Restoring Economic Literacy

Americans have come to expect a “free lunch” from the government. Of course, this is fantasy; there is no free lunch.  Health care is paid for by our productive enterprises and manufacturing was the lynchpin.   Further, other service industries such as law, insurance, travel, leisure, entertainment, and others are derivatives of productive manufacturing enterprises.  When the economy turned down law firms were among the first to layoff partners and associates.  Without a vibrant private economy legal activity declined, with fewer contracts real estate transactions, mergers, acquisitions and frivolous lawsuits.  Corporations reduced their legal budgets.  Similarly, other service businesses contracted.

Outsourcing lucrative manufacturing jobs and global wage arbitrage have only worsened the unemployment situation in the United States.  Reliance on a service economy and public sector employment has been false bedrock for our system.  If we want first class health care, we must bolster the private manufacturing sector and reduce the public sector.  Government dominance of our health care system and other service sectors (think banking) only ensures larger deficits, continued recession, higher unemployment and an inadequate, underfunded, cheap, quick and dirty, band aid solutions health care system.

That is not a good prescription for anyone’s health.

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02
Feb 10

Timothy Geithner and Plausible Deniability

Congressional hearings often make wonderful theater.  Last week at the House Oversight and Government Reform Committee, the American public heard testimony from Timothy Geithner, former head of the Federal Reserve Bank of New York and now US Treasury Secretary and Henry Paulson, former US Treasury Secretary.  Both men’s testimony relied on one premise: if we did not bail out AIG and pay its counterparties 100 cents on the dollar, the financial world as we know it would have ended,  i.e., the US would have plunged into a second Great Depression.  By written statement, Fed Reserve chair Ben Bernanke informed the Committee of his full support for this decision.  In person, Henry Paulson agreed.  However, both men said they had nothing to do with the decision.  Further, Mr. Geithner testified that he had relied on his staff or details of the bailout.  And even further than that, he later distanced himself from the decision whether nor not to disclose the details of the bailout. America was treated to the concept of “plausible deniability.”

Plausible Deniability

Working in a corporation one gets a firsthand look at the concept of “plausible deniability.”  Plausible deniability works something like this: a crisis starts; an important decision must be made; a senior executive is charged with making a decision; the senior executive delegates much of the preparatory work to  staff or a trusted lieutenant; the staff or trusted lieutenant ultimately makes a recommendation which later becomes “The Decision. “  If or when something goes wrong in the future, the senior executive denies involvement and places the blame on the staff or the trusted lieutenant.  Almost every time, the superiors of the senior executive accept this scenario.  The senior executive survives.

Let’s Get Real

Harry Truman said “the buck stops here,” meaning that the most senior executive has ultimate responsibility for a decision.  Perhaps with President Clinton or at some time it became fashionable for the senior person to distance himself from the decision so that he would have plausible deniability.  Further, it was expected that subordinates would “throw themselves on their swords” to preserve their boss.

It stretches credulity that the three most senior financial executives in government, The Chairman of the Federal Reserve, the President of the New York Federal Reserve and the Treasury Secretary did not know the intimate details of the AIG bailout.  At stake at the time was $62b of taxpayer money to effect this phase of the bailout.  All three men agree that if the bailout did not take place financial Armageddon would have ensued.

More is expected of our public servants. We appointed these individuals because of their unique skills, judgment and character. Apparently, these individuals were unavailable in the AIG crisis to make critical decisions.  Based on these stated actions, I deplore the confirmation of Ben Bernanke.  Moreover, I would ask for the resignation of Timothy Geithner.

It is time that high level government officials took responsibility and become the watchdog of the public purse. Trying to blame subordinates should elicit the response from the public: “that dog won’t hunt!”

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