Banking

Banking / Economics / Financial / Political — 0 Comments
28
Jul 11

It Isn’t That Easy to Avoid a Crisis

David Goldman continues to insist that all is under control.  See my previous discussion in Random Observations.  That is, he insists that current debt and especially sovereign debt problems will not cause another crisis like that of 2008:

More drivel has been written about the probability of financial crisis during the past month than at any time during my lifetime. There’s no crisis–not when all of the problems are transparent, on the table, and subject to negotiation. Instead, there is a change in lifestyle underway for Greek railway conductors, Minnesota firemen, New York City teachers, and a great many other people. Folk who only a few years ago expected to retire at sixty and spend their golden years on cruises will work until seventy and be thankful for a roof over their heads. See Not a Crisis, But a Negotiation

Goldman’s crisis avoidance stands on the following pillars:

  • The problems are known.
  • Because the problems are known they can be negotiated away.
  • Since the financial system has reduced its leverage, a crash cannot occur.  Why?   Because leveraging leads to sales of assets at distressed prices in a crisis.
  • If the US suffers a downgrade, the Federal Reserve and Treasury can easily implement financial maneuvers to work around the downgrade.
  • Finally, we have reduced complex, structured investment vehicles.

Risks We Knew, and Ignored, in the Last Decade

We knew about the overheating housing market and reckless subprime lending for several years before the crash of 2008.  We knew about the problem of excess leverage in the system. (In fact, the Federal Reserve relaxed leverage requirements, allowing firms like Lehman, Bear Stearns and Goldman Sachs to leverage 30-1 to 40-1).  Ben Bernanke claimed that the subprime crisis was “well contained” and would not affect the overall residential housing market.

None of these known problems could be “negotiated away.”  The financial system indeed seized up and nearly ended in total system breakdown.

What are the Current Risks?

Do we really know the current problems?  Last week, Bank of America wrote off $19.2b in bad loans.   Besieged by lawsuits and an unrecovered housing market, Bank of America can no longer hide behind “extend and pretend” fictional accounting.

…the bank appears to be in denial:

The crucial question today is whether Bank of America needs fresh capital to strengthen its balance sheet. Moynihan emphatically says it doesn’t, pointing to regulatory-capital measures that would have us believe it’s doing fine. The market is screaming otherwise, judging by the mammoth discount to book value. Then again, for all we know, the equity markets might not be receptive to a massive offering of new shares anyway, even if the bank’s executives were inclined to try for one.

Weil correctly depicts BofA as a systemic risk.  See Is Bank America at Risk of a Death Spiral?

And Bank of America is not the only “too big to fail” American bank:

And let us tell you a dirty secret: while Bank of America, thanks to Countrywide, is patient zero of the housing mess, Wells is next in line. Residential real estate is proportionately even bigger relative to the bank’s earnings and balance sheet, its accounting has been somewhere between aggressive and misleading, and despite its pious claims otherwise, it is no better than any of the other big banks. Stay tuned. See Is Bank America at Risk of a Death Spiral?

Both Wells Fargo and Bank of America are large, publicly held corporations subject to scrupulous reporting requirements. Nevertheless, large, unpleasant surprises appear seemingly out of nowhere.  Goldman misses the point, that future financial crises are in plain sight and we seem incapable of dealing with them.  The interconnectedness of credit default swaps makes these banks even riskier.  How can we gauge the effect on these banks of a crisis in Greek, Italian or other sovereign debt?

Being dismissive of the plight of highly paid Minnesota firemen and New York City teachers incorrectly trivializes their key role in any future financial crisis.   The fireman and teacher are both current and future homeowners.   They are also consumers.   The financial world ultimately comes down to discounted future cash flows.  Cut the income of enough highly paid workers and suddenly future corporate, governmental and individual cash flows do not look so rosy.  Moreover, this scenario keeps the housing market under pressure assuring future damage to bank balance sheets.

We need to stop denying our financially interconnected world.  Goldman’s analysis makes two mistakes: it skips over the effect financial austerity will have on housing, banks and tax revenues, and it believes our government and financial leaders can solve crises, even crises that are well understood and “transparent.”   The quagmire of our current debt level discussions only proves my point.

 

 

 

 

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19
Jul 11

Random Observations

What an exceedingly strange period in our economic and financial history!  Amidst a non-recovery economic recovery we have below par growth and high unemployment.  Coupled with economic weakness we have above trend inflation.  Let us consider some of the odder stories from last week:

Ben Bernanke and QE3

The first two exercises in quantitative easing have had mixed to negative consequences.   While the stock market has almost doubled from its low, the “real economy” has languished.   We can further document the relationship between QE and poor economic performance with a look at price hikes in key commodities such as food and energy.

Yet here is Dr. Ben Bernanke before Congress, once again selling us a product repair that simply does not work. On Wednesday, he made it clear that QE3 was part of his thinking. And even he is not altogether sure. On Wednesday, he backed away from an immediate move to start a third round of Fed money printing and bond buying.  See QE3 Guaranteed to Fail

Is there any reason that Dr. Bernanke still holds his job?  While his supporters point to a rise in stocks, the “real economy” has suffered.  Aren’t there better candidates for his job, who will try some new ideas? Are money printing and market manipulation the only ideas that any of our leaders can come up with? And to further the irritation with our Princeton economic guru, note that stocks used to rise and fall on company earnings and the economic outlook, not on which side of the bed the Fed chairman woke up on.

Don’t Worry Be Happy: Just Disregard Europe’s Problems  

David Goldman in Inner Workings points out that the financial crisis in Europe will not be a rerun of Lehman’s 2008 meltdown:

Under the headline “A Fate Worse Than Banking Crisis” my friend John Dizard at the Financial Times points out that any run on Europe’s banks would be instantly countered by swap lines from the Fed and ECB. His point (one I have been making for some time) is that the scope of the European banking problem is well known and that mechanisms have long been in place to deal with the worst-case scenario. Not so with Lehman, where a sort of China syndrome applied: no-one knew the amount of contingent liabilities that might be affected. See Once Again: It’s Not Lehman II

Mr. Goldman continues to calmly assure us that European problems will not create another financial meltdown:

My conclusion: there is no reason to panic over the present kerfluffle, but there is no reason to own any exposure to southern Europe. Ever again.  See Hopeless, But Not Serious: Once Again.

It’s too early to blow the “all clear” whistle on capital markets, but today’s recovery in the major US stock indices reassures me that this is not another financial crisis on the September 2008 scale, just a particularly nasty negotiation after which Italians, Greeks and Spaniards will end up poorer (along with Minnesota teachers, Wisconsin firemen and New Jersey policemen). It was amusing to see the usual suspects among the Street strategists issue dire warnings about increased tail risk just as markets turned around. See Ken Lewis, George Soros and Other Hedgehogs

So Mr. Goldman is assuring us of financial recovery based on one day of a US stock market rally?  His prognostications eerily remind me of 2007 and the assurances from Ben Bernanke, Hank Paulson and other financial luminaries that the subprime crisis was well contained.  Stock markets rallied then too, only to decline disastrously a year later.

Yesterday was a stark reminder of how unsafe Europe really is:

Greece 2 year interest rate on sovereign date: 34.5%
Portugal 2 year:  21.2%
Ireland 2 year : 23.3%
Italy 2 year : 4.65%
Spain 2 year:  4.55%

America is only marginally safer than Europe.   American research firm Egan-Jones recently also downgraded US Treasury debt.  See Europe is *Not* “Safe”

Are We Better Off Now Than In 2008?

We live in a financially interconnected world, and I am not at all reassured by Mr. Goldman.  I doubt that anyone knows what the effect of a bankruptcy in Portugal or Italy would have on world financial markets.   Could anyone have predicted that the 2008 financial crisis would take down AIG and Lehman and send US banks scurrying to the Treasury for TARP funds?  Do we think the world and the major financial institutions can better weather a storm now than in 2008?  While I may not know, I am more fearful that Bernanke, Goldman, Dimon and Blankfein do not know either, and they are out there making predictions and advocating policy.

Europe, China and the US have spent trillions of dollars trying to bolster their economies.  What if we have used all our money-printing ammunition and the next crisis is even worse?

 

 

 

 

 

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7
Jun 11

Unemployment and the Fall of Labor

U.S. Government and private statistics, reported last week, reinforced our dismal unemployment trend:

  • The unemployment rate rose to 9.1%.
  • Only 54,000 jobs were added in May with numbers revised downward for April as well.  This number especially alarms when compared to the projections of 150,000 to 175,000 new hires.
  • Employment in states, counties, and municipalities fell to their lowest levels since 2006, as governments were forced to reduce their workforces to meet budget targets.
  • New unemployment claims continue to average more than 400,000 per week.
  • 13.9 million individuals are unemployed. 8.5 million people work only part time.
  • 4 million individuals have given up looking for a job.
  • 6.2 million have been unemployed for more than six months. See Dismal Payroll Data

Economic experts, an oxymoronic term and group if ever there was one, offer a number of explanations: over regulation, the costs of complying with Obamacare, illegal immigration, free trade, an anti-business administration and other excuses.   Prophet without Profit has consistently argued that structural change has happened in the American work force.  This economy, recession and “recovery” is neither your father’s nor grandfather’s, and we are kidding ourselves to think we can treat it as such.  See, e.g., Why this May be Worse than the Great Depression and The New Reality: Permanent Job Loss.

The Fall of Labor

In Game Over, Mark Lapolla, managing director of Knight Capital Americas rationally explains our high unemployment:

  • We have created a worldwide economic system where we swap American intellectual property for cheap foreign labor from countries like China or Vietnam.
  • Enterprises based on intellectual property need less capital, commodities and most importantly, less labor.
  • The amount of human labor to produce an economic value has become “de minimis.”
  • Productivity for each newly added worker added has soared, approximately $80,000 per worker compared to a national average of $14,000.
  • Technology has supplanted labor in our enterprises.
  • Evidence of the problem is in high unemployment, duration of unemployment, and little or no wage growth.
  • The housing boom was a temporary salve to workers to permit extraction of wealth from homes.  That band aid policy is now over.
  • The few new highly skilled jobs that appear are being filled by over qualified employees.  They earn much less than they earned in their last jobs.  They do not contribute to a healthy level of economic consumption.

Implications

The implications are quite stark.   A society built on consumption must become a society of savers.  Unemployment will remain high for much longer than may be politically palatable.  Good jobs in the work force are going to require a high level of scientific, computer and mathematical skills.   Finance, retailing and other service jobs will be in a long decline.  Similarly, high unemployment will equal slow growth.  The housing market will continue to stagnate.

In the same vein Charles Hugh Smith recognizes these structural labor force problems.  America has focused too long on the quick fix of creating instant wealth through financial schemes or social media like Facebook and Twitter. We are now paying for our long term neglect of manufacturing job creation, and our failure to pursue a rationale industrial policy:

The U.S. has a distinct industrial policy: benign neglect, ignorance, favoritism towards real estate development and financialization, and a fanatic devotion to short-term profits and cost-cutting. Productive vs. Unproductive: Manufacturing vs. Financialization

To bring America back we are going to need to de-emphasize getting an MBA, and to focus on technical skills:

The U.S. culture denigrates skilled labor and glorifies the C.E.O. and innovator as god-like heroes. Other nations, notably Germany, maintain a value and education system which recognizes and nurtures technical skills. In the U.S., we fawn over social media companies that generate billions in new wealth for Wall Street and a handful of founders and venture capitalists, and drill into every student’s head the value not of tradecraft skills but of a four-year business degree. Productive vs. Unproductive: Manufacturing vs. Financialization

Smith concludes that in the winner take all, extraction economy, we get a small number of wealthy winners and the remaining 90% are relegated to living in a corporate-colonial economy ruled by financial oligarchs.

Our Next Steps

The first step is to recognize that our industrial and employment policies are deeply and structurally flawed.  We are applying outmoded policies to a vastly changed economic situation.  The second step is to stop wasteful and ultimately fruitless government efforts like boosting the stock market or housing market through quantitative easing or zero interest rates.   The third step is to reorient economic policy to encourage a return to manufacturing, to re-train the labor force in technical areas, and to create incentives to save and invest.  Otherwise, last week’s headlines will become even scarier.

 

 

 

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4
Jun 11

“Justice” for the Poor and a Pass for the Rich?

An embarrassing feature of the financial crisis has been the lack of criminal prosecutions.  Despite the extraordinary level of talent in the Justice Department, the Attorney General cannot muster a serious case.  Promises of investigations and action have proven hollow.

Hitting Bottom?

This week we reached a new low in this dearth of prosecutions.  A Wall Street analyst temporarily cheered the financial markets in his analysis of Goldman’s Sachs’ legal predicament:

Goldman Sachs Group Inc. (GS) won’t face criminal prosecution related to sales of mortgage-linked securities because such a move could threaten the U.S. financial system, according to Brad Hintz, an analyst at Sanford C. Bernstein & Co.

The U.S. Department of Justice, which is reviewing a Senate subcommittee report that alleged Goldman Sachs misled clients before the financial crisis, will avoid jeopardizing the fifth- largest U.S. bank by assets because it’s viewed as “too big to fail,” Hintz wrote in a note to clients today.

“If an alleged violation is identified during a Goldman investigation, we expect a reasoned response from the Justice Department,” Hintz wrote. “In a worst case environment, we would expect a ‘too big to fail’ bank such as Goldman to be offered a deferred-prosecution agreement, pay a significant fine and submit to a federal monitor in lieu of a criminal charge.” Goldman ‘Too Big’ to Face Prosecution Over Mortgage Securities, Hintz Says

Institutionalized Cynicism

Mr. Hintz’s analysis oozes Wall Street smugness.  Too big to fail institutions can break the law with impunity with little threat of meaningful retribution?  I would insist that “meaningful retribution” does not mean large fines; it means jail time for convicted executives and sanctions for criminal enterprises.

Let’s examine Mr. Hintz’ moral bankruptcy:

  • We are three years into this financial crisis.  Even though it is patently absurd, Bernanke and Geithner have proclaimed themselves system saviors. To the contrary, we have spent $5.1 trillion dollars in deficit spending.  We have rewarded reckless bank investments, and kept interest rates at zero.  And yet an analyst has the temerity to assert that the indictment and conviction of Goldman Sachs would jeopardize the financial system?  If this is true, then Geithner and Bernanke should be indicted as well.
  • Goldman Sachs has already entered into a $550m civil settlement with the SEC for misleading investors in mortgage-backed securities.  It also agreed to reform its business practices.  Clearly, Goldman does not fear the worst retribution, as it has misled or committed perjury in testifying before Sen. Levin’s subcommittee. Truthful testimony before a Congressional committee is fundamental to our democracy.  Panels investigating Watergate, Washington corruption and organized crime elicited truthful testimony under the threat of perjury and jail time. How is the public served in letting a Wall Street firm and its executives expect but a wrist slap?
  • Equal justice under the law is fundamental to our democracy, and it is being undermined. Anger and cynicism is on the rise.  Why not rob a bank if the worst penalty is that you will have to pay back only a fraction of the proceeds?   Why continue to voluntarily pay your taxes? Underpay or refuse to pay and then negotiate.  We cannot incarcerate enough juveniles from the ghetto nor throw enough drug dealers in prison.  While these individuals may have committed reprehensible crimes, fraud and perjury are equally reprehensible.

A Glimmer of Hope?

Today the tide appears to be turning:

Goldman Sachs has received a subpoena from the office of the Manhattan District Attorney, which is investigating the investment bank’s role in the financial crisis, according to people with knowledge of the matter. Goldman Said to Get Subpoena Over Its Role in Crisis

The good news is that Cyrus Vance Jr. stepped into the prosecutorial vacuum and issued subpoenas.  The bad news is the thunderous silence from the Justice Department and the New York state attorney general.

I attended a recent talk by Rabbi Adin Steinsaltz, a renowned biblical scholar.  He noted that the genius of the Torah as a legal instrument is that judges were admonished to favor neither the rich nor the poor.  America outside of Wall Street and Washington believes that the rich, “too big to fail” banks have been given a permanent get out of jail card.  We could restore belief in equal justice under the law if we vigorously prosecuted and convicted rich wrongdoers the way we currently pursue poor ones.

 

 

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30
May 11

Wildfires and the Economy

Sometimes very wise things are also very simple: like a story for children.  I am a mentor volunteer for local disadvantaged fourth graders. This week’s reading assignment was to read and discuss Wildfires, a short children’s book written by Seymour Simon.

The author’s theme seemed contradictory:  wildfires are not always harmful.  Rather, they are part of the natural cycle of forest life.   They occurred well before man populated North America.  Extended droughts provided the necessary environment so that when lightning storms arose, wildfires ensued.   No firefighters or park rangers impeded the natural order of things.   Eventually, enough rain fell to extinguish a fire, or a fire would run out of fuel.

In elegant language understandable to fourth graders, Mr. Simon advocates a controversial and grown up point. The US Forest Service actually did a disservice to the long term health of our forests.   Our ecosystem needs fires to allow light to reach the forest floor, to remove kindling which could cause even larger conflagrations, to permit certain animal species to reproduce, and to allow tree seeds to travel and reproduce.  New and natural growth cannot occur without the cleansing effect of a wildfire.   We now understand that aggressive firefighting was poor governmental policy that actually damaged the environment.

An Economy Managed Like a Wildfire?

The economic analogy is obvious.  When the 2008 great financial crisis occurred the Treasury and the government overreacted.   Treasury pleaded with Congress to create bailouts: TARP, TALF and an alphabet soup of other programs.  The Federal Reserve aggressively lowered interest rates to zero and made bank purchases of distressed mortgage-backed securities and other poorly-rated assets.   Finally, the Administration went on a policy and public relations campaign to save GM, Chrysler, GE, AIG and other large private companies.   Government chose to aggressively fight the financial wildfire.

Policy makers forgot that, like a healthy forest, capitalism requires “creative destruction.”   Coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942), this term denotes a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”

In a properly functioning capitalist economy, old or dysfunctional businesses must be discarded and  replaced by more dynamic enterprises.    If not, we would still be powering computers with vacuum tubes instead of advanced generations of semiconductors.

Killing the Business Cycle

On Friday, David Goldman’s blog Inner Workings pointed out the fallacy of aggressive governmental steps to arrest the financial crisis.  His prediction:  we will be mired in a little or no growth mode for years.

I’ve been on Larry Kudlow’s CNBC show arguing that the US will have 2% growth indefinitely–no real recovery, no double dip, no banking crisis, but no bank stock rally. Today’s depressing numbers are in line with my depressing expectations. We’ve got a creative-destruction economy, without the creation: the startups, the venture capital, the entrepreneurship. MySpace and LinkedIn don’t count: they are a faddish extension of old technology, a means by which Americans who bowl alone can pretend to have lots of friends.  The People’s Republic of America Reports 1.8% GDP Growth (or: Why this is NOT a Business Cycle)

Lending to create new businesses has evaporated.  In fact, credit creation is moribund.  Banks are happy to borrow at low interest rates and reinvest at higher interest rate government securities without undertaking the riskier business of lending.  New business formation is harmed.  Multinational corporations are satisfied with earning profits outside the United States, which means we have anemic job growth.  We are mired in a non-recovery recovery.

Let the Light In

In our wildfire analogy, the largest trees are the ones that most need to be eliminated.  These are the ones that block growth on the forest floor.   Government may have temporarily arrested financial decline, but at what cost?   I grant you that it will be painful to permit the creative destruction of our “tallest trees”: poor performing banks and industrial companies.   The pain would be sharp but not prolonged.  Using another analogy, we needed to rip the economic band aid off quickly to minimize prolonged pain.http://www.prophetwithoutprofit.com/wp-admin/post-new.php

Mr. Simon in Wildfires pointed out another flaw in aggressive fire fighting:  putting out smaller fires too early.  Dangerous residual undergrowth became tinder for more destructive, larger, out of control wildfires.   Similarly, our government did not fix the financial problems of 2008; they only postponed our date with a larger financial conflagration.

 

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5
May 11

Truth and the Government

Truth is the currency of effective government.  Deception, lies, and misstatements debase that currency.  The public expects its government to tell it the truth.   Governmental institutions are fragile.  Exposure of a government that lies to the people de-legitimizes its leaders and ultimately its institutions.  Thus, government should be extremely careful to maintain credibility in its public pronouncements.

Recent events raise questions about the priority of truth in the Obama administration.

Why the Truth?

As a young attorney, I was taught never to lose the confidence or trust of the judge, jury or arbitrator trying my case.  The fastest way to lose the confidence or trust of a fact finder is to misstate, mislead or outright lie about a fact in a case.   As one of my mentors would say, a lie or misstated fact is like the proverbial loose thread on a sweater.   When you pull on that thread the sweater (and one’s case) will unravel quickly.  Misstate a fact, or lie, and the case is effectively lost.

That brings us to two recent high profile media events:  President Obama’s birth certificate and the killing of Osama bin Laden.

Osama bin Laden

Let’s start with the good news.  Osama bin Laden is dead.  Capturing him was a monumental achievement.   The United States demonstrated Executive branch political leadership, and the CIA and the armed forces worked effectively together on an operation that required secrecy, sophistication and courage.  A ten-year long, national open wound was finally dressed and addressed.

The bad news is the handling of the subsequent public pronouncements.  Discrepancies appeared immediately.   An administration counter-terrorism expert, John Brennan, initially reported that Osama bin Laden was living in a one million dollar plus compound, using women as human shields.  We were told that bin Laden’s wife was shot and killed, and that he was armed when shot by the Navy Seal team.

Within 24 hours the story changed.  Now we were told a different woman in the compound was shot but not killed, bin Laden was not armed, and the house was but an ordinary home worth no more than $250,000. See White House Revises Account of Bin Laden’s Final Moments

CIA Director,  Leon Panetta,  assured the media that pictures of a dead bin Laden would be released.  The next day the White House indicated that these pictures would not be released. President Obama will not Release Bin Laden Photos

This operation took months to plan.  We have seen pictures showing the President and military and security officials watching the operation as it transpired.  Our best and brightest officials had more than enough time to craft a plan for release of information and photos upon completion of the mission.  Given the gravity and sensitivity of this issue, why would not authorities have withheld all information about the operation until the facts were secure and beyond doubt?  Why the confusion of top Administration officials?

The Presidential Birth Certificate

Responding to Donald Trump’s challenge, in a White House briefing on April 27, President Obama dramatically released his birth certificate.  See With Document Obama Seeks to End ‘Birther’ Issue.  This should have brought an end to the controversy.  But since the release, one website has catalogued 12 factual and 11 “typesetting problems” in the document.   Obama’s Birth Certificate – discrepancy or forgery? Further, the official White House version of the certificate and the AP version are different!  Most of the “typesetting problems” relate to the layered presentation of the certificate in the PDF Acrobat file.   The certificate was obviously altered.    See You’ve GOT to be Kidding Me (Birth Certificate)

We are beyond the point of wondering whether or not President Obama was born in the United States.  We are dealing with White House credibility and staff competency.  The White House has unlimited resources to produce a copy of any document it wishes.  Instead, the President produces a questionable, possibly altered, document that simply provides more ammunition for “birthers” to endlessly debate the authenticity of his birth certificate.

Part of my corporate attorney work was the review of numerous company press releases.  No document would go out until every statement therein was double and triple checked.  One error could lead to a lawsuit from shareholders, unwelcome scrutiny from Wall Street analysts, or even worse, an internal employee loss of trust.

Why Does This Matter?

Should we be concerned about the ineptness of the White House staff?  In a word, the answer is yes!   Forty years ago today, America learned through release of the Pentagon Papers that our elected officials deliberately deceived the public in the prosecution of the Vietnam War.   Fast forward to more recent history. We are prosecuting a war in Iraq based on an assertion of illegal weapons of mass destruction which never existed.   Closer to home, we were told that the banking system would collapse without the TARP bailout.   And now, Ben Bernanke minimizes the threat of inflation while Americans watch the cost of gasoline and food rise to unacceptable levels.

It is dangerous to play fast, loose and sloppy with the truth.  Eventually, there will be a crisis where telling the truth actually matters.  Will the American public believe it?

 

 

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22
Apr 11

Over Compensating

Executive compensation is a “hot button” issue.  Corporate executives argue the need for a free hand in setting compensation:  we must attract and retain high performing executives.  They further argue that correctly tailored compensation creates appropriate incentives to increase shareholder value.  According to this thinking, this aligns management and shareholder interests.

Shareholder activist groups strenuously disagree.  Management over compensates itself, and awards senior executives hundreds of times the average worker salary.  Equity compensation (options, restricted stock grants) richly rewards management at the expense of diluted shareholders.   Even more egregious are executive compensation increases even when the corporation has a bad year or underperforms its industry peers.  Boards of Directors, who should be guardians of shareholder interests, are often too aligned with ineffective management. True confession: executive compensation issues comprised much of my career.  Generally, I agree with keeping the government out of the executive compensation process.  In my view, management knows its own business and knows the market for top talent. With Board of Directors’ review, advice and consent, let management set compensation and let the chips fall where they may.  Internal safeguards and shareholder activist groups inevitably punish bad or greedy managements.

However, there is one industry where the government needs to take an active role in setting executive compensation.

Is Goldman Sachs Allowed To Fail?

Simon Johnson, former IMF chief economist, asks the question:  if another financial crisis appears would Goldman Sachs be permitted to fail and follow the Lehman Brothers bankruptcy route?  See Could Goldman Sachs Fail? Johnson polled leading experts who unambiguously stated that Goldman would be bailed out again.  Goldman’s balance sheet at $900b would be just too big to permit bankruptcy.  Dodd-Frank legislation which has resolution authority to handle a large bankruptcy would be ineffective because of the international scope of Goldman’s operations.

While Goldman is one case study, Mr. Johnson could ask the same question about JP Morgan, Citibank, Wells Fargo or a number of other large American financial institutions. I believe he would get the same answer: they are too big to fail. Thus, the experts agree that these institutions have a favored position in the market place: they borrow at below market costs, and benefit from the full faith and credit guarantee of the US government.

A Modest Proposal or a Proposal for Modesty

Mr. Johnson posits that the only solution is to “press hard for higher capital requirements for Goldman and all other big banks.”  More capital would permit absorption of more losses in the event of a financial crisis.  Allow me to propose an alternative.

Goldman and other large banks pay out nearly half their revenue in compensation:  amazing that this practice has not received more government scrutiny.   As we know from Untimely News That’s Unfit to Print, the government is afraid to prosecute these banks for their financial misdeeds.  How about severely limiting executive compensation?

I can hear the howls from Wall Street now.  How can we attract the best talent?  This is antithetical to the principles of the free market!  Our work would not be properly valued!

When a bank accepts bailouts from the government (TARP), when it enlists the government to make good on derivative bets (AIG and Goldman), when it is subsidized by American savers through a zero interest policy, and when it receives a full faith and credit guarantee of the US government,  that bank is no longer a free market enterprise.  That bank is a ward of the state.  As such, its compensation should look more like the federal civil service pay scale.

Controlling and changing bank top management pay scales in this way would be hugely beneficial:

  • Banks would be able to retain more earnings, and immediately improve their capital base.
  • Shareholders would benefit as more cash would be available for dividend payments.
  • The productive economy could successfully compete for the best university graduates.
  • Wall Street firms would shrink.
  • Systemic risk of too big to fail institutions would diminish as would rent seeking behavior.
  • The real economy would flourish.

Perhaps we should start a new campaign:  Government Service Levels (GS) for Goldman Sachs (GS). Put more simply:  GS for GS.

 

 

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15
Apr 11

Untimely News That’s Unfit to Print

In the The Very Late News, we examined the media’s late and lazy reporting on important stories related to the 2008 financial crisis.  Today the New York Times does it again with Financial Crisis, No Prosecutions of Top Figures. The lead reporter, Gretchen Morgenson, has a weekly column in the Times.  She is no neophyte on issues of financial fraud.  Why has it taken the New York Times three years from the onset of the crisis to report the lack of prosecution of Wall Street criminal conduct?

A Lame Apology

Morgenson asks the hot question:  why has there been no prosecution of high profile executives?  But instead of hitting hard, she opines on the “complexities of pursuing legal cases in times of panic.”   In a meeting between the Fed’s Tim Geithner and Andrew Cuomo, Geithner never suggested “any lack of diligence or a slowdown” in ongoing investigations.  He did not have to.  He was the perfect third base coach.  All he needed to do was run through the signs: “bunt, take, hit – Do Not Prosecute.” Mr. Cuomo did not miss the “don’t prosecute” sign.

The remainder of the Times article explains why federal prosecutors chose not to bring an action.  I recommend it in its entirety for a treatise on federal and state prosecutorial delay, obfuscation and denial.  The article begins and ends with Andrew Cuomo, but where were the other government prosecutors?

Coincidence

Also today, the Times reports on the 650 page Senate Permanent Subcommittee report: “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse.”  From Senator Carl Levin, head of the subcommittee:

“The report pulls back the curtain on shoddy, risky, deceptive practices on the part of a lot of major financial institutions” …“The overwhelming evidence is that those institutions deceived their clients and deceived the public, and they were aided and abetted by deferential regulators and credit ratings agencies who had conflicts of interest.” See Naming Culprits in the Financial Crisis

Will we be prosecuting these offensive deceptive practices?

Banks and Bonds

Ironically, today’s Times also reports that Barry Bonds was convicted of one count of obstruction of justice.  The investigation of steroid use in baseball started in 2002.  After nine years of investigation, huge prosecutorial resources  and 25 government witnesses, the government could not prove that Mr. Bonds used steroids.

Too bad Mr. Bonds is a baseball player rather than a Wall Street bank.  Perhaps if his name were Ernie Banks instead of Barry Bonds, he could have confused the prosecutors, who might have overlooked the offense.  We don’t want to rattle or hurt the Banks.

Dual Standard of Justice

Bonds stole no money, yet the full force of Congress and federal prosecutors pursued him for years.  Banks that stole billions and nearly destroyed the economy were deemed too fragile to prosecute.  These “fragile” banks were back in business with near record bonuses in 2009 and 2010.  We have a dual standard of justice that weakens all  respect for law.

 

 

 

 

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11
Apr 11

The Very Late News

“Forgive me, I must start by pointing out that three years after our horrific financial crisis caused by massive fraud, not a single financial executive has gone to jail, and that’s wrong.” Charles Ferguson 2011 Academy Award Acceptance Speech for Inside Job

I am very disturbed at how the media reports financial trends and crises.

First, they cheered speculative trends.  Remember 2004-2007 and how laudatory the reports of the housing boom and soaring stock market were?  The signs of disaster were all there, but nary a warning about the crisis to come.

Second, when the crisis was an undeniable reality, reporters seemed to lose the ability to think critically.  There was simplistic and naïve acceptance of government assurances, and belief that the crisis was well-contained and limited to only subprime mortgages.  Only when the situation became so blatant and ubiquitous did the media admit as much.

Third, by the time any coverage contained a measure of accuracy or alarm, events had deteriorated so much as to render the coverage irrelevant and useless to shape financial reform.

Fourth, this late and useless coverage still failed to “connect the dots” and reveal the obvious unethical and/or criminal behavior behind the crisis:  bank collusion on mortgages, no prosecutions, conversion of private debt to public tax obligation, zero interest rates, punishment of savers, dollar devaluation, and food and energy cost inflation.

Better Never than Late?

As we discussed in Rates are Low, Morals are Lower, even the revered Wall Street Journal is late reporting key financial trends.  Since December 2008, the Federal Reserve has maintained a zero interest rate policy, punishing savers in general and the elderly in particular.  Why has it take the Journal almost 2 1/2 years to report the plight of the elderly?  Moreover, the Journal does a mediocre job of explaining the interconnection between and among misdeeds of the banks, loose monetary policy, poverty among the elderly, high unemployment, inflation, and transferring obligations to taxpayers. See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

And unfortunately, the Journal’s late discussion is one among many instances of late and irrelevant reporting.  Let’s examine two more stories:

Last Sunday CBS’s Sixty Minutes focused on the mortgage foreclosure crisis.  In The Next Housing Shock, reporter Scott Pelley boils the housing crisis down to poor paperwork, major banks hiring irresponsible mortgage service companies hiring low skilled employees paid minimum wage to prepare and verify mortgage foreclosure papers.

Missing from this analysis is the entire cycle (2002-2008) of mortgage fraud perpetrated by banks and Wall Street investment firms on the entire US and world economies.  Mr. Pelley avoids the more troubling issues of writing mortgages for people who could not afford the mortgage payments, the packaging of these mortgages into mortgage-backed securities, marketing these securities to fiduciaries such as pension funds and American and foreign investors.  Rating agencies such as S&P and Moody’s placed their AAA imprimatur to reassure investors.  Does Mr. Pelley even mention how long this has been going on?  Now we find that many of these mortgage-backed securities may not have complied with NY trust law or IRS regulations.  See 60 Minutes on Mortgage Securitization Document Lapses and Foreclosure Fraud

Is Overseas Journalism Better?

In yet another dismal example of journalistic laziness, we can cite yet another major international financial newspaper, the Guardian.

During a 22-month investigation by agents from the US Drug Enforcement Administration, the Internal Revenue Service and others, it emerged that the cocaine smugglers had bought the plane with money they had laundered through one of the biggest banks in the United States….

The authorities uncovered billions of dollars in wire transfers, traveller’s cheques and cash shipments through Mexican exchanges into Wachovia accounts. Wachovia was put under immediate investigation for failing to maintain an effective anti-money laundering programme….

Criminal proceedings were brought against Wachovia, though not against any individual, but the case never came to court. In March 2010, Wachovia settled the biggest action brought under the US bank secrecy act, through the US district court in Miami. Now that the year’s “deferred prosecution” has expired, the bank is in effect in the clear. It paid federal authorities $110m in forfeiture, for allowing transactions later proved to be connected to drug smuggling, and incurred a $50m fine for failing to monitor cash used to ship 22 tons of cocaine. More shocking, and more important, the bank was sanctioned for failing to apply the proper anti-laundering strictures to the transfer of $378.4b – a sum equivalent to one-third of Mexico’s gross national product….

See How a Big US Bank Laundered Billions from Murderous Mexico’s Gangs

How reprehensible that the Guardian did not report the matter until April 3, 2011, days after the deferred prosecution agreement expired.  Karl Denninger in his Market Ticker blog reported on this matter almost nine months ago, in June of 2010. See How to Run Drug Money: Be a (Large) US Bank

What is Really Happening Here?

Mainstream media is providing late and lazy coverage of critical financial stories.  Why?  Some possibilities:

  • Financially strapped print media and network news organizations can no longer afford the expense of hard hitting investigative journalism.
  • In an era of reduced advertising, main stream media are less willing to offend banks and other financial companies who are major advertisers.
  • Financial journalism is not the glamour assignment. Perhaps less able journalists are assigned to these stories.
  • Financial investigations are long and tedious; not as sexy or dramatic as a war, an earthquake or an election campaign.  (Perhaps a corollary here is the lack, so far, of criminal prosecution: we have yet to see even one major prosecution against a large operating bank.)
  • Since banks are the politically anointed agents of economic recovery (TARP, zero interest rates, etc), perhaps the media are afraid to be accused of demonizing the banks and derailing the economic recovery.
  • Even worse, is the Administration colluding with the media to under report financial chicanery?

The truth may be all or none of the above.  But for sure we, the people, and our political leaders remain uninformed.   Serious financial investigative journalism needs to make a comeback.  Right now, only blogs like Market Ticker and Naked Capitalism continue to challenge the status quo.

CBS, The Wall Street Journal and even The Guardian should be embarrassed.  One of my early mentors used to say, and it applies most pitifully to our current major media:

“You have an excellent grasp of the obvious.”  Even the obvious would be better if it was timely.

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5
Apr 11

Rates Are Low, Morals Are Lower

Monday, the Wall Street Journal awakened to “discover” the plight of the elderly: Fed’s Low Interest Rates Crack Retirees’ Nest Eggs by Mark Whitehouse.  The Journal describes elderly Americans, who worked all their lives and saved what they thought were sufficient funds to live out their remaining years in comfort. With the Federal Reserve’s zero interest rate policy retirees are realizing miniscule returns on their savings. They must therefore resort to spending their principal and cutting back on all expenditures.  Some examples of this new reality:

Forrest Yeager, a 91-year-old resident of this seaside community, had been counting on his retirement savings to last until he died. The odds are moving against him. With short-term bank CDs paying less than 1%, the World War II veteran expects his remaining $45,000 stash to yield just a few hundred dollars this year. So, he’s digging deeper into his principal to supplement his $1,500 monthly income from Social Security and a small pension.

“It hurts,” says Mr. Yeager, who estimates his bank savings will be depleted in about six years at his current rate of withdrawal. “I don’t even want to think about it.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs.

Most recent (2009) Labor Department data  show that annual investment income over the last two years examined for 24.6 million households headed by a person 65 and over has fallen 37 % to a meager $2564.    In 2010, 33% of retirees dipped into savings to pay living expenses.

Hand Wringing

At this time, investing in short-term certificates of deposit, time deposits and money market funds would yield .24% annually, one-tenth the level of late 2007.  Inflation is now running at an annualized rate of 5.6%.   Richard Fisher, President of the Dallas Federal Reserve is quoted in the article:

“Americans who have done everything right, have worked hard, saved their money and stayed out of debt are the ones being punished by low interest rates,” says Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed’s policy-making open market committee. “That state of affairs is not sustainable for a long period of time.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

While recognizing the problem, Mr. Fisher’s comments strike me as surrealistic and disingenuous in the extreme.  Why is he hand wringing when he, more than most others, can effect change?  He is a voting member of the Federal Reserve!  In his position of influence, he can actually change the insane policies of the Fed.

Our Golden Years?

What are senior citizens doing to get by?  Mr. Whitehouse’s article lists a number of changes he is observing in financial behavior:

  • Investing in the stock market, even though much retirement saving has been devastated in the last two bear markets (2000, 2008)
  • Shopping at thrift shops and eating in subsidized community centers
  • Cutting or eliminating all other expenses such as movies or hobbies
  • Invading principal for living expenses

Re-entering the workforce is not an option for most retirees, as jobs are more scarce, or a senior age candidate may have more physical limitations on their employment options.

Unintended Consequences

The Journal recognizes that zero interest rate have been a windfall for the banks at the expense of the elderly.   All savers are hurt by the zero interest rate policy, but that is the obvious consequence.

Low rates don’t just hurt retirees. They also penalize people of any age hoping to build up funds for the future, and discourage rainy-day savings that could make U.S. consumers more resilient to job losses and other financial jolts. Americans’ net contributions to their financial assets, such as bank and 401(k) accounts, amounted to 4% of disposable income in 2010, according to the Fed. That’s the lowest level since it began maintaining records in 1946—except for 2009, when people actually pulled money out. See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

No wonder we have a sluggish economic recovery: we have no new savings to invest in the economy.  Further, if we want housing prices to recover, how does a young couple develop sufficient savings for a house down payment?

Return to Sanity

Zero interest rate policies punish the elderly in two ways: reducing personal income, and driving up basic need cost, such as food and energy.  Expecting the elderly to reenter a workforce that already has too many unemployed and underemployed individuals is absurd.  We are punishing that part of society who played by the rules: they worked hard, lived within their means, paid off their mortgages and saved for retirement.  Unfortunately, the Federal Reserve and the Obama Administration decided to reward the banks who made ridiculous loans, created fraudulent mortgage backed securities, overpaid their executives and nearly crashed the entire financial system.  Where is the morality of favoring the profligate over the thrifty?

Mr. Fisher and his colleagues could end the insanity tomorrow.  Stop the Federal Reserve’s interventions in the financial markets and let the market determine the true rate of interest.  Savers everywhere, elderly or not, will thank you.

 

 

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