Corporate Behavior

Don’t Let Your Lawyers Grow Up to Be CEOs

“Mamas, Don’t Let Your Babies Grow Up to be Cowboys” – country music song – Ed and Patsy Bruce

As the open range diminished in the United States, the above lyric was excellent advice. Today, songwriters could be penning a similar lyric: mamas, do not let your attorney sons and daughters grow up to be CEOs. The recent resignation of Pfizer CEO Jeffrey Kindler is a cautionary tale about elevating lawyers to CEO status.

A Great Legal Career

Mr. Kindler has a stellar and storied legal career: magna cum laude Harvard Law graduate, clerk for Supreme Court Justice William J. Brennan, attorney for the Federal Communications Commission, partner in the Williams & Connolly law firm, Vice President of Litigation and Legal Policy for GE, Executive Vice President and General Counsel of McDonalds Corporation. From 2000 to 2002 Mr. Kindler spent time in line management with McDonalds’ Partners Brand (Chipotle Grill, Boston Market and Pret a Manger). In January 2002 he returned to his legal career as Senior Vice President and General Counsel of Pfizer. Selected over two long term Pfizer employees, Mr. Kindler became Pfizer CEO in 2006. Source Wikepedia, SEC Filing

The following comments partially describe and analyze Mr. Kindler’s troubled tenure as Pfizer CEO:

…His tenure, though, has been far from smooth. Within months, Kindler was forced to announce that torcetrapib, which was supposed to have been a blockbuster cholesterol drug, had to be scrapped. Then, two highly touted product launches proved to be disappointments – the Exubera inhaled insulin … and the Chantrix anti-smoking pill.

Kindler eventually followed the same game plan as his predecessor – to appease Wall Street, he pursued a huge acquisition, which was the $68 billion purchase of Wyeth last year. This followed and extended a series of huge cuts across the company, including eliminating 14,000 jobs, several facilities and various R&D efforts….. Investors, however, have remained lukewarm, especially since Pfizer has endured several recent setbacks in the lab and as the patent expires next year on the best-selling Lipitor cholesterol pill. Pfizer stock, meanwhile, continues to languish.. See Jeff Kindler Unexpectedly Resigns as Pfizer CEO

To replace Mr. Kindler, Pfizer selected Ian Read, a company employee since 1978. Mr. Read had extensive domestic, international, and financial experience, all within Pfizer.

The Difficulty in Selecting a CEO

As a long term observer of CEO selection, the one clearest truism is the extreme difficulty in finding and selecting a good one. Two things suggest that Mr. Kindler was not the right selection in 2006. First, he had extremely limited knowledge of the pharmaceutical industry generally and Pfizer specifically. No matter how much intellectual horsepower he could muster, it was no substitute for being steeped in the science and culture of the industry and knowledge of the day to day operations of the company. Second, Mr. Kindler was an attorney by trade with only two years of line experience in his career. Let’s look more closely at that second problem.

Attorneys vs. CEOs

We attorneys have some solid career traits. We are educated to analyze a problem, dissect the issues, develop a legal strategy and then communicate that strategy clearly in both oral and written form to a client or ultimately a court. Law is a conservative process; that is, attorneys are charged to look at risk and any financial or criminal downside of an issue. Attorneys are called counselors for a reason. They are not deciders. They present options and courses of action to a client. Ultimately, the client must decide how to proceed: negotiate, litigate, or settle. Attorneys also are trained to be self sufficient. Working in a law firm, an attorney is more a group leader and project manager than a corporate executive. Trained litigators like Mr. Kindler assemble a team of junior attorneys, associates and paralegals for a case and when that case is resolved the team disbands. It is a constant process of personnel and skill recombination on behalf of one’s client, rather than any long term team building process.

By contrast, the best CEOs are ultimately team builders and strategic decision makers. They have both operational (line) and staff (finance, legal, human resources, etc.) responsibilities. They prefer to make decisions rather than just analyze and counsel. In a world requiring both thoughtful and rapid decision making as well as risk taking, an attorney/CEO is operating outside the usual legal comfort zone, experience and training. Moreover, a fine CEO must get highly knowledgeable and strong willed senior management to work together, a far cry from commanding a team of compliant junior partners and associates with the knowledge that the process will be short term.

Boards of Directors

An old corporate saw describing bad corporate governance goes something like this: if the company is having a financial problem, its Board will elevate the chief financial officer to be the CEO. Similarly, if the company has a manufacturing problem, an outstanding operations executive may be tapped for the highest executive position. In the case of Pfizer in particular, and the pharmaceutical industry in general, recent times have been beset with product liability law suits, patent infringement actions and threats of new legislation. The easy choice for Pfizer’s Board in 2006 was to select its general counsel or an outside law firm partner as CEO. That turned out to be a mistake. Clearly, what Pfizer did not do was keep its fine general counsel, Mr. Kindler, who would have continued to assemble and direct a first rate products liability and patent law legal team to tackle the problems. If Pfizer’s Board, at the same time, found a fine CEO to shepherd the company through its immediate problems and its long term issues, perhaps better company performance would have resulted.

Merck Follows Pfizer

In November 2010, in almost the same time frame as Mr. Kindler’s departure, the Merck Board appointed Kenneth Frazier as its CEO. Mr. Frazier is credited with devising the litigation strategy to deal with Merck’s Vioxx products liability suits. Mr. Frazier appears to have followed a parallel career path to Mr. Kindler. Working in various legal roles at Merck from 1992 to 2010, Mr. Frazier was not appointed to an operations role at the company until April 2010. In other words, he had a mere seven months of operational experience.

Merck has had a long and distinguished history of CEOs with scientific backgrounds. I would argue that the transition to CEOs with staff backgrounds, such as finance and law, has contributed to the company’s decline:

The key to understanding Merck’s slide is to compare its CEOs. During the glory days, it was led by scientist P. Roy Vagelos, who is almost universally described as brilliant, charismatic, arrogant, and hard-driving, both by industry experts and by people who worked with him….The son of Greek immigrants, Vagelos grew up cleaning tables in his family’s luncheonette, in the shadow of the Merck labs. As head of Merck’s R&D for nine years, he brought in hundreds of new scientists, modernized the labs, and increased the research budget an average of 17.2% annually. Because he understood the science, old-timers say, Vagelos was able to inspire …creativity and energy….Moreover, Vagelos got personally involved in the everyday workings of the company. He even ate lunch in the cafeteria. See Merck’s Fall from Grace

Perhaps Mr. Frazier will break the pattern of failed attorney CEOs. In hindsight, both Pfizer and Merck’s Boards would have been wiser to avoid selecting attorney CEOs and have their fine science companies led by a long-term company scientist with operations experience. For now, if I were investing in these companies (and I am not, nor am I purporting to provide investment advice), I would place my bet on Pfizer’s Mr. Read: a long term Pfizer employee with a scientific background and in-house financial and operations experience elevated to his company’s highest corporate position. Let’s see how he does.

GD Star Rating
loading...

Reward Points

No, this is not a blog about airline or credit card rewards programs. It is about the incentive systems in our society and how we reward job performance. Incentive systems have enormous implications beyond the organizations that craft them. Most people’s eyes glaze over when thinking about incentives and compensation, but it is worth a further look.

Early Exposure to Incentives

One of my first cases involved a sales compensation dispute before the California Department of Labor. My employer sold large telephone switches. At the time, some of these switches were as large as a small office building. Sales representatives received half their commission when they signed a deal and the balance when the switch was installed and paid for. In my case the sales representative left between these two benchmarks. He received only the first payment, and thereafter brought a complaint for failure to pay wages. My company prevailed, arguing that the sales representative had not fulfilled the second half of his sales responsibility. He had customer service requirements to ensure the switch was installed to the customer’s satisfaction and payment received, and that did not happen on his watch. The reality is that in many cases the sale is never consummated, or the customer does not pay. Thus, the sales representative was only partially rewarded for signing the customer: a partial payment for a partial job.

Misaligning Incentives and Rewards

We are now living through an age of misaligning incentives and rewards. One could argue that this misalignment is the root cause of the current financial crisis. A look at some of the misalignments:

Countrywide and Washington Mutual were poster children for misaligned compensation systems. Regardless of ability to afford payments, mortgage brokers recklessly wrote subprime, 125% loan to value, no documented income, adjustable rate and other questionable mortgage products. Compensation was earned on closing. There was no “claw back” of the compensation provision when the mortgage holder ultimately defaulted.

Wall Street financial engineers created inexplicably complex credit default swaps and other financial derivative products. These products were sold to cities, pension funds and college endowments. Many of these weapons of mass financial destruction caused shocking losses. At AIG these derivatives blew up, sending insurance companies into government receivership. Writing these bad toxic financial products had no adverse consequences for AIG executives. In short, the head of AIG Financial Products collected $300m in compensation for creating fiendish products. See We Were ‘Prudent’: AIG Man at Center of Crisis. Again compensation was paid up front without a “claw back” when these products misfired.

Money center banks and Wall Street firms were given $700b in TARP funds. No restrictions were placed on compensation, and no requirements were imposed to lend to businesses. A zero interest rate policy incented banks to borrow at near zero cost, buy longer dated treasure securities at virtually no risk and earn large profits. All this resulted in near record financial firm bonuses in 2009 and 2010 and almost no lending to small businesses. Even worse, many of these Wall Street bonuses were based on illusory profits. Suspension of “mark to market accounting” overstated profits and the resultant bonuses.

In each of these instances rewards were based on the initial sale rather than outcomes. No one owned the outcome and society suffered.

Other Misaligned Incentives

Outside the financial area we have misaligned incentives:

Politics – The expense of purchasing mass media to run a national campaign or a local campaign in an expensive broadcast market requires endless fundraising. Given the Supreme Court removal of restrictions on corporate campaign contributions it is no surprise that we have a Congress and executive branch held hostage by corporate contributors. The end result is earmarks for special interests, endless increases in defense spending and watered down financial and health care reform shaped by corporate sponsors. Congress is incented to reward special interests at the expense of the broader good.

Executive Compensation – Executive compensation for CEOs is open to endless possibilities for “gaming” the system. If increased earnings per share is the target objective, a skillful CEO can effect share buy backs, delay recognition of expenses or cut the research and development budget. If options are granted, the same techniques can be used to boost share price. Need to meet cash flow targets? Easy! Just cut expenses through layoffs and reduced product development and research. Virtually any financial target can be manipulated in some way to the CEO‘s advantage.

We Have Learned Nothing

The financial crisis should have been a wakeup call that we cannot continue the same path of misaligned incentives. Financial executives have paraded before Congress with the sorry excuse that they really did understand the derivative products that they were selling or the consequences of a worst case economic scenario. This behavior should be unacceptable and is a failure of both senior corporate management and boards of directors. Nevertheless, the banks and Wall Street firms continue to expand their derivative business. See Far More Derivative Exposure Today than Two Years Ago

Recently, the CEO of D.R. Horton, a major home builder was quoted in the Wall Street Journal:

“As I tell our salespeople as I travel around the country, if they are warm and they have a pulse, write them,” he said on an investor call for the company’s fourth-quarter earnings Friday. “Write them, and then we’ll figure out whether or not we can get them qualified.” Heard on the Street – Overheard: Still Dreaming

We are back to business as usual. We continue to incent bad behavior at the peril of our economy. There continues to be no ownership of outcomes. We should not be surprised if the new year includes a rerun of 2008.

GD Star Rating
loading...

Advertising / Corporate Behavior / Economics / Political — 0 Comments
20
Dec 10

The Dignity of Work

Then: Bosses and Workers

During a tour of his new automated plant, a famous exchange took place between auto maker Henry Ford and Walter Reuther, president of the United Auto Workers:

Ford: “Well, Walter, how are you going to get these machines to pay union dues?”

Reuther: “But Henry, how are you going to get them to buy cars?” Quotes

One of my college jobs was working for my university’s Labor Education Center. Many of the faculty members were ex-UAW officials. These men had witnessed the bloody organizing campaigns at Ford and other manufacturers. After law school and clerkship my first associate’s job was with a small law firm representing unions. I confess to a bit of a soft spot for the old time labor unions that looked out for the welfare of the working man. Unfortunately, in their current incarnation unions deliver less protection to workers, and arrogate more power unto themselves.

The director and senior professor of the Labor Education Center began as a factory worker, became a union organizer and earned a doctorate. He was dedicated to the education of workers and union leaders. A valuable lesson he taught was the simple dignity of work, regardless of status, pay or title. A working person possessed a quiet and mostly unsung nobility: producing a decent day’s labor, supporting a family, being a role model for his or her children, contributing to community.

I remember once being in the hallway of the Labor Education Center chatting with another student intern. A janitor was cleaning the hallway. The director, by this time my valued mentor, walked up to me and said, “if you cannot help this hardworking janitor, at least get out of his way.”

Now: The Reality of Unemployment

The most recent new claim number for unemployment is 427,000. Despite the media spin of an improving job market, this still connotes a troubling and recessionary employment level. Missing from the media coverage is that 893,000 workers moved into the extended unemployment coverage category. In Who’s Lying, James Quinn deconstructs the government’s employment statistics:

The number of Americans employed over the last few years is as follows: 2007 – 146.0 million, 2008 – 145.5 million, 2009 – 139.9 million, 2010 – 138.9 million.

It seems there are 7.1 million less employed people than there were three years ago. Contrary to the spin from the White House, there are 1 million less people employed today than during the horrific 2009 year. Luckily, another 6 million people left the work force, or we’d really have a problem. The truth is that if the government actually counted everyone in the country who wants a job, the unemployment rate is not 9.8%, but 23% and it continues to rise. Who’s Lying, See also Shadow Government Statistics.

Losing Our Way

In the employment arena America has lost its way. We have focused on short term profits to the detriment of the long term welfare of our society. Outsourcing and layoffs have been the means to achieve short term performance.

Corporate human resource departments once protected and educated their employees. In the modern world human resource departments view employees as adversaries: costly, demanding and ungrateful. Few employees today believe corporate sloganeering that employees make the key competitive difference in the marketplace.

Government policy is less than supportive of hiring. The morass of workplace rules, tax policy that favors off shoring and outsourcing, and expensive health care mandates are all disincentives to hiring.

An effective 23% unemployment rate denotes a troubled and unfair society.

We have forgotten the simple dignity of work. Even worse, we have forgotten how to respect the simple and mostly unsung work of others. The Reuther-Ford conversation resonates today: if we keep laying everyone off, who will buy our cars?

GD Star Rating
loading...

American Society / Corporate Behavior / Education / Management / Political / The Federal Reserve — 0 Comments
5
Dec 10

Mission Creep

A common subversive phenomenon of corporate behavior is “mission creep.” The behavior is subtle and almost undetectable to all but the most expert students of organizational behavior. Let’s examine some concrete examples.

Human Resources is fertile ground for mission creep. HR generally is a staff function hierarchically below the CEO, Business Heads, the Chief Financial Officer, the General Counsel and other corporate functionaries. What better way for an ambitious human resources executive to rise in that hierarchy to achieve importance and responsibility than by unilaterally expanding his mission into functions beyond his expertise. So the formally humble human resources executive “volunteers,” “takes on” tasks beyond the traditional (and boring) hiring, compensation and labor relations functions, and thereby finds new more important missions.

Several employers ago, the head human resources executive evolved from the mundane, to run internal communications (and implicitly controlling external public communications), a portion of real estate and strategic planning, corporate surveys and an information technology complex. He also sat on the executive committee of the company. So from humble beginnings our enterprising human resources executive created a veritable empire – mission creep, mission accomplished.

Education is another enterprise ripe for mission creep. Enterprising administrators can expand their empires so that more than 50% of a public school district is comprised of highly paid administrators rather than direct classroom teachers. See Mission Creep: How Large School Districts Lose Sight of the Objective – Student Learning

Creep is not limited to corporations and school systems.

Pharmacy Creep

As we get older we also encounter pharmacy creep. We may start with a multivitamin in young adulthood. But by the time we reach our 50’s we may have acquired prescriptions for a statin, a blood pressure drug, niacin, an anti anxiety drug, and for males perhaps some Cialis or Viagra. Each specialist we visit is more than happy to prescribe even more drugs to add to the medical arsenal. In addition to greater cost, eventually, the drugs start to interact with each other in unforeseen ways, usually with unpleasant, unintended consequences.

Modern Governments

Federal government mission creep makes the above examples look harmless. It is easy to blame the Obama Administration for the current mess we are in. But the seeds for governmental mission creep were planted eight decades ago during the New Deal. However, mission creep thrives under both Republican and Democratic administrations. We should highlight some areas where government has directly usurped the private sector:

- The auto business through GM and Chrysler

- Lending and insurance through AIG, Ally(GMAC) and Citicorp

- Security through TSA

- The mortgage market through Fannie Mae, FHA, GNMA and Freddie Mac

- Interest rates, fiscal policy and even the stock market through Federal Reserve intervention

Indirectly, the government is well on its way to controlling (1) the workplace through detailed labor and employment legislation and regulation, (2) healthcare through Obamacare, and (3) the financial industry through recent legislation. The defense complex with massive purchases and 750 overseas bases is almost an industry unto itself.

Every time a private enterprise or a state or municipality goes hat in hand to Washington for “assistance” or a bailout, we invite the government to expand its mission.

Finding a Proper Role for Government

What is missing from public discourse is a little humility. Perhaps we cannot have it all, and asking the government to get it or do it for us is the road to diminished freedom. We have discussed re-engineering government before. See Why not Reengineer Government? Re-engineering is a sophisticated way of saying that we need to rethink the role of government. We need to focus on core functions of government such as physical protection of our population, and privatize what we can. The powers that be need a little more humility, and recognize that government cannot and should not accomplish everything.

Our current economic quagmire is a message that mission creep is costly and in the long-term unsustainable. Mission creep diminishes private sector creativity and wealth creation.

The current huge deficits and economic misery are symptoms of a government mission that has gone way off course and cannot be accomplished.

GD Star Rating
loading...

American Society / Banking / Corporate Behavior / Justice System / law / Political — 0 Comments
25
Oct 10

The Rule of Law: Inefficient is Good

A critical advantage of our legal system is its inherent inefficiency. Domestic and international investors happily invest in the United States securities markets because of our financial transparency and adherence to laws. At the core of it all is a maxim: no one is immune to the law. Importantly, within this definition is the corollary that individuals have procedural safeguards and substantive legal rights.

The Rule of Law, however, has a price: expense, time consumption and inefficiency. In civil law, a complaint must be drafted, filed and served. A defendant is afforded time to research, draft, file and serve an answer to a complaint. Both parties appear before a judge who sets a discovery schedule so that each party may learn pertinent facts. Discovery may consist of written interrogatories, requests for production of documents and depositions. A judge then sets a briefing schedule for motions to limit introduction of evidence and for dispositive motions to summarily dismiss or resolve the matter in court. Barring resolution of the case on motion a trial is set. A trial is held with or without a jury, a verdict reached and a time set aside for post trial motions. After a final verdict the litigants may appeal to a higher court. Time from filing a complaint to trial can take as much as two years. An appeal can take several more years.

The yield from this system is immeasurable: fairness to all parties and an honest result.

Dynamic Tension: Foreclosures and the Rule of Law

Banks and their supporters have woven a public relations campaign to limit the damage from the mortgage foreclosure crisis. The current spin is that dead beat homeowners are seizing on minor paperwork problems and legal technicalities depriving banks of their right to speedily foreclose on homes. In her Naked Capitalism blog, Yves Smith exposes the Wall Street Journal’s attempt to disparage the consumer attorneys representing the homeowners:

The lead article in the Journal tonight, “Niche Lawyers Spawned Housing Fracas” telegraphs its bias in its headline: the foreclosure crisis is merely the creation of two bit lawyers who by implication don’t know what they are doing, and are pumping trivial issues up for their own enrichment, with the housing market as collateral damage.

Funny that anyone can think this spin is remotely true. The fact that solo practitioner lawyers could have such an impact on the system is not proof that they are miscreants, as the Journal implies. It is that the foundation of mortgage securitzations is rotten as a result of widespread abuses, first on the origination end, later in the foreclosure process. These small firm players are using the legal equivalent of toothpicks; the fact that their efforts have destablized the foundation of the residential mortgage backed securities market is tangible proof that they were imperiled to begin with. See The Wall Street Journal Runs Inaccurate Piece on Antiforeclosure Lawyers

Ms. Smith goes on to point out that mortgage servicers (GMAC in the article) imposed hidden charges on homeowners, refused to process payments that would have made the homeowner current and other abuses. The homeowner’s attorney merely did what good attorneys should do, i.e., look carefully at the facts and the law and find abusive practices. Further, the attorney deposed a GMAC official (a “robo” signer) who admitted that they signed an inaccurate affidavit. Somehow the Wall Street Journal felt that depositions were part of the bag of legal tricks from the foreclosure attorneys. The Journal minimized the fact that a false affidavit is a criminal offense. Ms. Smith concludes that banks cannot have it both ways: they cannot proclaim the sanctity of law and contract and then abuse legal processes to speed through foreclosures. Servicers do not get to be judge, jury and executioner.

The Mills of the Gods Grind Slowly, but they Grind Exceedingly Fine

I have seen our lumbering justice system first hand. It is slow, expensive, time consuming, detailed, and frustrating. Sometimes judges can be dismissive, rude and unfair. On the other hand, corporations are all about efficiency. How quickly can we get something done? How little can we spend? I once sat in an industry forum and the chief attorney for a major computer corporation suggested that employers should lobby Congress to federalize all of employment law, which would divest states of any right to regulate the workplace. While an intriguing idea, it would have undone the US Constitution and severely undermined our federal system.

The Wall Street Journal should be embracing these safeguards, inefficient though they may be. Newspaper reporters were once arrested for treason and sedition for publishing anti-government articles. (See the Zenger case and the Alien and Sedition Acts). Would the Journal want to return to a society where politicians and bureaucrats were judge, jury and executioner? I don’t think so.

Years ago, when one of my labor cases ended particularly badly, I ranted about the unfair result and poor decision. My boss pulled me aside in an avuncular manner and reminded me that this is the price we pay to avoid labor anarchy. Due process and adherence to the rule of law is the price we willingly pay to avoid total anarchy.

Before the Obama Administration or Congress makes another run at overriding state real estate law, they should think long and hard about the long term and fundamental damage their actions could cause. Inefficiency in support of the Rule of Law is good.

GD Star Rating
loading...

American Society / Banking / Corporate Behavior / Financial / Regulation — 0 Comments
17
Oct 10

Millions for Design, Not One Cent for Administration

Shortly after the American Revolution, France began seizing Americans ships and demanding payment for their return. CC Pinckney, one of three members of the American delegation to France, memorably replied: “Millions for defense sir, but not one cent for tribute.” XYZ Affair

In the modern world of corporations, let’s modify this quote to: “millions for design, but not one cent for administration.”

Brilliant Wall Street “masters of the universe” have designed elegant and sophisticated mortgage backed securities. Exactly what are these financial instruments? The designers instructed that a mortgage be underwritten, conveyed to a trust (REMBIC), and then placed in a mortgage backed security to be sold to investors. Even more appealing to investors is that they could select various tranches (levels of risk) of the final product to invest with higher or lower expected default rates.

As we now learn, mortgage notes may never have been actually conveyed to the trusts. Further, the banks are having difficulty locating the original mortgage notes. To muddy the water further, we have allegations of fraud, faked documents, mass notarizations, and false affidavits. See This Magic Moment

How did we get to this current state of affairs?

After the Big Launch

It is intriguing to imagine being the star chef, the center ring performer, the creator of something special. Far less interesting is the job of cleaning the kitchen, sweeping out that center ring, or making the complicated creation actually work. Somehow the follow up has less, or little, dignity.

Corporations operate the same way, and corporate behavior reflects all human behavior. When a company launches a new financial product, service or program, the accolades go to the designers: the star lawyer, finance official, actuary or business executive who originates and sells the idea to high level management. The designers get big bonuses, exposure to the CEO or board, and promotions to the inner sanctum. They give scant thought to how a new financial product or service will be administered. And corporations allocate few budget resources to administration.

The Tragic Stepchild: Administration

How do corporations or banks repetitively get to this state of affairs? Some probable reasons:

Greed – Rewards flow to the designers, not the administrators.

Elitism – The designers tend to be from elite schools and hold fancy sounding titles in the corporation. Administrators, on the contrary, hold high school diplomas and maybe some college courses from somewhere.

Lack of Funding – Once the thrill of design has worn off, management wants to control costs so the administration function, a/k/a overhead, gets short shrift.

Program or Product Complexity – Many programs are devilishly complex, yet need to be flexible. The combination is expensive and requires well trained personnel. And complexity is an excellent way to hide cost and pricing.

Poor Training – Closely allied with lack of funding and complexity is poor training. Designers may prepare rote scripts for administrators, but they are inadequately trained to exercise judgment or handle non-standard questions or errors.

Fear – Job insecurity and low corporate status make program administrators reluctant to report problems or errors to their superiors. They are even more fearful of being “whistleblowers” and reporting actual malfeasance.

Neglect – Corporate headquarters are in or near tonier places like New York, Los Angeles or Chicago. Administrative operations are either in rural areas or overseas. Other than brief flyovers, headquarters management has little time or interest in being where the administrators and their problems are.

Clean Hands and Dirty Programs

Previously, I have written about the reluctance of our elite college graduates to seek jobs in manufacturing. See Clean Hands and a Weak Economy. Administration is a close analog. It is populated by non-elite individuals, in remote locations with little promise of promotion for a job well done.

We are now seeing the fallout from this corporate disdain and distaste for administration. Reports are now legion of hairdressers and Wal-Mart employees with little or no training being pressed into service working for foreclosure mills. They have no idea what a mortgage note or affidavit is, much less what to do with it. See Meet the Foreclosure Experts

America 2010: millions for design, not one cent for administration. Where were the regulators? We should never have been in this mess.

GD Star Rating
loading...

American Society / Banking / Corporate Behavior / Justice System / law / Political — 0 Comments
13
Oct 10

Postscript to Foreclosuregate

The last blog outlined features of the impending mortgage foreclosure crisis. Some additional thoughts:

No easy fixes: banks fervently hope for a cure all, omnibus federal law that results in a quick resumption of foreclosures. Why this won’t happen:

- Federalism – We are a federal republic with distinct areas of sovereign rights divided between the federal and state governments. Most people do not give this principle a lot of thought, but it is critical. Real estate is the province of state and local government. Recording of deeds and liens on real property, filing fees, notarization of documents, certifications and state transfer fees are all state processes. Sweeping away several hundred years of real property law through federal override legislation will create enormous constitutional issues.

- State Investigations – The forty state joint attorney general investigations have already asserted state primacy in resolving this matter. Note – As of this afternoon, all fifty state attorney generals have joined the investigation. Attorneys General Launch Mortgage Probe

- The Plaintiffs’ Bar – Plaintiffs’ trial lawyers form their own constituency on this issue. The pro-plaintiff American Association for Justice (formerly the American Trial Lawyers Association) is a formidable lobbying force and a major contributor to the Democratic Party. Numerous class actions have been launched against the banks and title companies and we should expect more. These suits will not disappear without a fight.

- Other Constitutional Issues –

o Retroactive legislation raises its own constitutional issues, especially trying to divest a party of a long- held, established right.

o The impact on due process rights – Substantive due process, a little used Supreme Court doctrine, prevents the federal government in the economic realm from trampling on individual property rights.

Politics and Greed

- TARP – Banks have been saved through TARP, the AIG bailout and numerous federal guarantee programs.

- Bonuses – Wall Street just announced $144b of employee bonuses this year, a record number.

- HR 3808 – To remedy problematic notarizations (only part of the problem), bank lobbyists tried to force passage of the seemingly innocuous HR 3808, “The Interstate Recognition of Notarizations Act of 2010.” This measure passed both chambers by unanimous voice votes. A firestorm of protest arose, and the President took the extraordinary step of a “pocket veto” and, to leave no doubt, a formal veto. Imagine the reaction to a more comprehensive piece of legislation to save the banks. See HR3808 Now ACTUALLY Vetoed

- Federalism – I have lobbied on broad pieces of industry-favorable legislation. Congress has real sensitivity to preempting states rights, making sweeping corrective legislation very unlikely.

Other aggrieved parties will not be silent:

- Mortgage Investors – If the securitization problem was fraudulent, investors in mortgage backed securities have rights under the securities laws to seek redress. Since these mortgages were sliced, diced and sold internationally this becomes a global issue.

- Pension Funds – Many of the mortgage investors were pension funds. There is a fiduciary question whether these were appropriate investments. Is there a corollary pension fund obligation to seek redress?

- Fannie Mae and Freddie Mac – These two government agencies may have been defrauded into purchasing mortgages from the Wall Street banks. These agencies have started subpoenaing files from the banks in order to “put back” the mortgages to the banks. Since the taxpayer is the ultimate guarantor of these two entities, there will be political pressure to force the losses on the banks.

Faulty Transmission Mechanisms

This has become quite a mess and there is no easy way out. One of my savvy financial friends argues that the banks are the transmission mechanism for the economy and must be saved at all costs. The mortgage crisis demonstrates we have a very faulty transmission mechanism.

I would argue that the recently enacted Dodd-Frank financial reform bill has a mechanism for dealing with these failed behemoths. It will not be fast or pretty, but our system of laws requires it. Shortstopping the legal processes and again bailing out the banks will have immeasurably worse political consequences.

Unfortunately, this is not a broken transmission mechanism that you can take for a quick fix to your local AAMCO dealer – “The World’s Leading Transmission Expert.”

GD Star Rating
loading...

Banking / Corporate Behavior / Justice System / law / Uncategorized — 0 Comments
12
Oct 10

This Magic Moment

This magic moment, so different and so new,
Was like any other, until I met you.
And then it happened, it took me by surprise…
I knew that you felt it too, I could see by the look in your eyes…
This Magic Moment – Lou Reed

Wise investing is difficult. Constant spin and deception in the mainstream media only make it harder. A sudden event that changes everything is, in parlance, a magic moment. Previously, I discussed how one bank, HSBC, took a $10b write off in 2007. This was our initial warning, the “magic moment,” that predicted a major financial crisis. See Watershed Event in the Financial Crisis. In that case, the smoke-and-mirror financial atmosphere at the time prevented most of us from seeing what was happening.

To make things more frustrating, an old saying on Wall Street goes: “no one rings a bell at the top.” That means, no one is ever going to alert us to the market’s magic moments. We have to be smart enough to peer through the smoke, push aside the mirrors, and see clearly what may be right in front of us. And we can never count on the same set of circumstances to happen twice. The lack of that bell leads us to an epiphany: things are never going to be the same again.

We are again approaching a magic moment – “Foreclosuregate”. JP Morgan, Ally and Bank of America are imposing moratoriums on foreclosures and 40 state attorneys general are on the verge of announcing a joint investigation into the practices of the mortgage servicing industry. 40 States Expected to Investigate Foreclosures. Two major title companies, Old Republic and Stewart, have ordered their agents to stop writing title policies on foreclosed homes. Stewart Title Clamps Down on Foreclosure Sales. The Wall Street Journal and the New York Times have tried to downplay the issue; they so far dismiss the problem as one of technical defects and paperwork errors. Why does this remind us of Ben Bernanke”s 2007 assertions that the subprime crisis was “well contained?” Fed’s Bernanke: Subprime Mortgage Problems Contained

Elements of “Foreclosuregate”

First, a disclaimer: although I am an attorney, I worked on only two real estate closings in 35 years of law practice. I did learn, however, that real estate transactions are document intensive, detailed and precise. Disclosures must be crystal clear. All legal formalities must be observed, such as notarizations, fees, stamps, seals, etc. Documents must be promptly and correctly recorded to protect the buyer and the mortgage holder. Any shortcuts could harm one’s client, law license and malpractice premium.

Apparently, in the frenzy of mortgage backed securities, banks and lenders took many such shortcuts. It is beyond the scope of this blog to detail every bit of malfeasance and poor legal practice during the Roaring 2000’s in the housing market. But here are some of the pitiful truths fueling the developing crisis:

Poor underwriting standards – Individuals who clearly did not qualify received loans. Stories are legion of low wage workers taking out loans of several hundred thousand dollars. Interest only and teaser rate loans were used to generate fees for the mortgage broker. The broker was hoping that the borrower would return in a couple of years, refinance the home based on an inflating house price and generate more fees.
Poor Documentation – Mortgages consist of the mortgage itself and an accompanying promissory note. These documents are usually promptly filed at the county level to perfect a lien on the property. It appears that this step may have been handled incorrectly or bypassed (See MERS).
MERS (Mortgage Electronic Registration System) – MERS is a bank creation to enable financial firms to securitize (create mortgage backed bonds – MBOs) quickly and to avoid county filing procedures and attendant filing fees. Let’s take a quick look at how and why the banks did this:

In the mid-1990s mortgage bankers decided they did not want to pay recording fees for assigning mortgages anymore. This decision was driven by securitization—a process of pooling many mortgages into a trust and selling income from the trust to investors on Wall Street. Securitization, also sometimes called structured finance, usually required several successive mortgage assignments to different companies. To avoid paying county recording fees, mortgage bankers formed a plan to create one shell company that would pretend to own all the mortgages in the country—that way, the mortgage bankers would never have to record assignments since the same company would always “own” all the mortgages.

They incorporated the shell company in Delaware and called it Mortgage Electronic Registration Systems, Inc.

Even though not a single state legislature or appellate court had authorized this change in the real property recording, investors interested in subprime and exotic mortgage backed securities were still willing to buy mortgages recorded through this new proxy system. The MERS Edifice Quavers

Poor Foreclosure Processes – To foreclose on a property, one needs proof of ownership of the note, supporting affidavits and notarizations. An affidavit requires personal knowledge of the bank official seeking to foreclose, who then swears that he has reviewed all documents and that they are true. MERS has thousands of assistant secretaries, who are not employees of the firm, but employees of the bank, seeking to foreclose on their behalf. Some courts have ruled that MERS has no legal standing to foreclose. Moreover, many of these assistant secretaries sign thousands of these foreclosure documents each month, and have no personal knowledge of the documents or file. These individuals have been called “robo signers” and are arguably acting in violation of court rules. In addition, it appears that original documents do not exist and have been recreated, raising the issue of forged documents.

Poor Securitization Processes - Real Estate Mortgage Investment Conduits (REMIC) are investment vehicles designed to hold commercial and residential mortgages in trust and issue mortgage backed securities representing an undivided interest in the mortgages. Under IRS regulations and NY Trust law, the mortgages must be contributed on the startup day. A problem arises if MERS claims to have title to the mortgage:

… all rights to a mortgage loan must be deposited into the trust for it to achieve tax exempt status under federal REMIC law—which does not contemplate the use of a proxy mortgagee. Yet, despite claiming sole ownership of mortgages sold to investors, in documents regularly recorded with county officials these same institutions maintain that MERS is the sole owner of the mortgage. The chain of financial institutions linking originators to securitization depositors collectively want to have their lien and sell it too. The MERS Edifice Quavers

These are just some of the myriad problems arising from the mortgage mess.

Implications

This is not a problem that is going to be resolved quickly. Banks are vulnerable on a number of fronts:

- At best, the banks will have a delayed right of foreclosure thereby reducing the value of the mortgage note.

- Banks could be charged with fraud or required to take back the mortgages from MBS purchasers who were misled as to the value of mortgages and the shoddy securitization practices now imperiling their investment.

- The banks could owe tax penalties for failing to have the mortgages and notes conveyed to the REMICs on startup date.

- Plaintiffs’ lawyers have already brought a number of class actions against the banks seeking damages and a stay of foreclosures.

- State attorneys general will be seeking recording fees, foreclosure stays and other penalties for these practices.

- Title companies will be forced to pay out policies and seek redress from the banks. .

- Courts may impose sanctions against the banks and their attorneys and may delay or dismiss foreclosure proceedings.

Mistakenly, the press has focused only on the issue of residential foreclosures. There are two more issues to be concerned about: securitized commercial mortgages and MERS procedures were used in that part of the market as well. Second, failure to follow procedures may affect homeowners not in foreclosure. When an owner has paid off his mortgage and the mortgage and note has been resold and assigned numerous times, how does he know he has a legally binding accord and satisfaction of his mortgage? The chain of title may have been compromised on a national level. In fact recently a website encouraging homeowners to demand proof that one’s servicer is holding one’s mortgage note has gone online , Where’s the Note?

The market continues to rally much as it did after the HSBC subprime confession and write down in 2007. Another financial aphorism goes: economic facts don’t matter, until they matter. See It Doesn’t Matter Until It Matters. Disturbing facts are just entering the public consciousness. In this volatile, thinly traded market dominated by computer traders, I would rather exit two months early and sell my bank stocks, rather than be five minutes late and thousands of dollars poorer.

Disclaimer: The Prophet does not have a position in any banks, title insurance companies or other financial institutions and this is not a recommendation to buy or sell any security. Consult your own financial advisor.

GD Star Rating
loading...

Advertising / American Society / Business / Corporate Behavior / Media — 0 Comments
16
Sep 10

Chivas and Chivalry

Even before Mad Men became so popular, advertising was always fascinating. Embedded in a glossy print ad or an imaginative television or radio ad is a commentary about us, our hidden aspirations and how we see ourselves.

One such ad has caught my attention. Chivas Regal has a new worldwide campaign to promote its scotch whiskies. The ad is aptly called “The Movement, Living with Chivalry.” It is beautifully filmed and supported by haunting, inspirational music from The Cinematic Orchestra: “How to Build a Home.”

Ads cannot convey the aroma, taste or quality of an alcoholic beverage, so Chivas had to create an image. The viewer must believe that the beverage is part of an exclusive lifestyle. Chivas brands its new campaign a “movement,” a return to chivalry. Part of the genius is the play on the words “Chivas” and “chivalry.”

Chivalry is defined as the medieval institution of knighthood which emphasizes individual training to hone skills and give service to others. Chivalrous virtues are honor, loyalty and courtly love. Let’s look at Chivas’ idea of modern chivalry from its Live with Chivalry website:

Here’s to doing things the right way.
To giving a damn about others.
Here’s to giving your word… and keeping it.
Here’s to honour,
And it’s simple extension… the handshake.
Here’s to style, exuberance and charisma.
Here’s to gallantry… long may it live.
To the man rich… in experience.
Here’s to chasing wealth… in all its forms,
And here’s to sharing it.
Here’s to straight talking or, as it used to be known… honesty.
Here’s to having some front… and watching someone’s back.
Here’s to knowing that life’s real luxuries are time and friendships.
Here’s to optimism and leaps of faith.
And while we’re at it… here’s to freedom.
And having the audacity to go out and get it.
Here’s to knowing that you are not alone.
That together we’re better, stronger, smarter.
Here’s to the brave and the enlightened.
To a shared way of behaving that sets certain men apart from all others.
Here’s to those who Live with Chivalry… here’s to us!

“The Movement” video-mercial starts with a well dressed young man in a tailored conservative business suit walking in a financial district of a large un-named city amidst a crowd of faceless business people. Passersby jostle the actor; he looks dejected. Then a voiceover: “Millions of people…everyone out for themselves. Can this be the only way? No.”

The background music intensifies. “Here’s to honor and gallantry, long may it live…” highlights scenes of men in formal wear with their hands together in the center of a circle and an attractive formally dressed young man carrying a pretty young woman (damsel in distress?) on his back across a rain soaked field. “Here’s to doing the right thing and those who give a damn” shows us men in formal wear in unison pushing a friend’s stuck Mercedes (what? No Honda in this ad?) out of the mud. “Here’s to the straight talkers who give their word and mean it” accompanies scenes of older, gray haired elders in suits looking like they just sealed a deal. “Here’s to freedom and the true meaning of wealth and men who keep their word” shows men about to sky dive and signaling each other, followed by other young men on horseback riding along the seashore. “Here’s to the brave among us” accompanies sooty fire fighters near an extinguished blaze. “Here’s to a code of behavior that sets certain men apart from others” (what else?) lauds a triumphant sports team clasping a trophy and celebrating by jumping into the water. Finally, “here’s to us” shows us another formally attired young knight entering a ballroom with his similarly attired friends and handsome proud parents. And Bingo! They all raise a crystal tumbler and enjoy a Chivas.

What is the Ad Saying?

It is no accident that the commercial starts out in the financial district of London or New York. The pushy, faceless automatons bumping into our hero are not random. The scene symbolizes all that is wrong with our financial era, with faceless, greedy, well dressed, smooth talking bankers dehumanized by the mercantile process. A sense of honor and acting for the common good are absent in the canyons of finance.

Chivas has imagined an alternative world: the medieval code of knighthood brought into the bright light of good looking youthful privilege and adventure. Alexander Dumas in literature and Hollywood in movies gave us the chivalry of the Musketeers: one for all and all for one; this ad simply updates the context. Knights are gallant, rescuing damsels in distress. Young men have a code of honor; their word can be trusted and they confront real danger, not the faux combat of an electronic trading floor. Plus, these modern knights are not afraid to get their hands dirty while doing the right thing. They clean up well, put their tuxedos back on, and get the girl. Bottom line: they earn their Chivas.

The Knights of Today and Tomorrow?

Thank goodness there are still people of honor who walk the earth. Given the behavior of our politicians, business and financial leaders, we can only hope there is a cadre of good men and women somewhere who can lead us forward.

It is ironic and disturbing that a whisky company needs to clarify these values for us. As in the ad, I wish we could rely on people’s personal honor and need only a handshake to seal a deal. In addition, I wish that we could say not only “drink responsibly” but also “lend or govern responsibly.”

I would be the first to raise my crystal tumbler to these honorable lads and their exploits. However, as I mentioned in previous blogs, I would be toasting with Lagavulin.

GD Star Rating
loading...

American Society / Banking / Business / Corporate Behavior / Economics / Executive Compensatio / Financial / investing / law / Management / Media / Political — 0 Comments
13
Sep 10

One Year of Blogging

After one year of blogging on economic, corporate, social and political issues, I thought I would try to make sense out of trends:

The rule of law has taken a major hit in the United States. Some examples of this phenomenon are the unlimited guarantees to Fannie Mae and Freddie Mac, guarantees to banks and favored companies, and Federal Reserve purchases of mortgage backed securities. See Shredding the Social Fabric
We have exposed monetarist and Keynesian economic solutions as intellectually bankrupt. Amazingly, the decision makers who believe in these theories have not been fired. More amazingly, with all the evidence that we are still mired in a deep recession, we keep trying the same tired strategies.
Obama’s economic acumen and performance has been disappointing. His monomaniacal focus on a health care bill that the country cannot afford hampers new hiring. Worse, it enriches the insurers and big pharmaceutical companies. And worst, he has wasted important political capital. Further, with his tepid financial reform bill he missed a real opportunity to address citizens’ concerns about the excessive power of Wall Street.
Congress should be tried for malpractice. Members of Congress did not read the financial reform or the health care bill. Nancy Pelosi had the temerity to implore Congress to pass these bills so she and the public could find out what is inside.
The Executive Branch and Congress appear to be for sale to the highest corporate bidder. Industry lobbyists essentially control Congress and the executive branch.
Where has leadership gone? Congress used to produce real leaders: Everett Dirksen, Hubert Humphrey, Robert Taft, William Fulbright, Sam Nunn, Henry Jackson and others. We may not have agreed with their views, but they were serious, well-respected, independent minded individuals. We never doubted that these leaders put the country’s interests first. The Executive Branch also produced great leaders. Compare past Secretaries of the Treasury– Andrew Mellon, Douglas Dillon and Lloyd Bentsen– to the flawed and unworthy Timothy Geithner.
Political clout, not reason and merit, determine current policy. GM, GE, the banks, municipalities and others were saved from extinction because of campaign contributions and union ties. Picking winners and losers based on political considerations generates cynicism and undermines the guarantee of equal protection under our laws.
Zero interest rate policies encapsulate everything that is wrong with our current system. We have impoverished the thrifty and the prudent and rewarded the profligate and the incompetent. On the backs of savers, we have bailed out the banks. This is particularly heinous because the victims of this policy are the retired and elderly who have watched their savings dwindle and their retirement lifestyles vanish. An economic policy which encourages savers to speculate in the stock market or buy junk bonds is unconscionable.
Promises of better corporate behavior after passage of Sarbanes-Oxley have been false. Congressional pressure on the Financial Accounting Standards Board to suspend mark to market accounting has created the “extend and pretend” economy. We no longer properly recognize losses; banks know this and refuse to lend knowing they can obfuscate the true state of their balance sheets. More damaging, the true financial condition of the banks leads investors to purchase equities essentially under false pretenses. Many of the bank stocks have declined significantly from their peaks.
Culturally, extend and pretend has permeated beyond our financial culture. BP and the government hid many facts about the Gulf oil spill. Even now we probably do not know the full extent of the damage and independent researchers have been denied access to information.
Corporate Boards of Directors are still not paying attention. In the case of Mark Hurd the violation of corporate financial policies was rewarded with a generous severance package. (Trust in a corporation is predicated on the integrity of their financial policies.) His unemployment did not last very long, as Oracle recently named him co-president. Did character matter to Oracle or its Board? Does anyone have any shame anymore? Was the HP Board afraid to fire Hurd for cause?
We are becoming a divided country. The government protects the rich and the poor. The middle class is being economically squeezed by inflation in basic goods, unemployment or the threat of it, rising health care and education costs and diminished retirement savings. All these things plant the seeds of political upheaval.
Finally, blogging serves an important purpose in presenting an alternative viewpoint to mainstream media. Blogging is the antidote to endless economic cheerleading by paid media and government officials. Blogging has become the new millennium’s populist forum. For example, bloggers steadfastly maintained that we have not emerged from the recession/depression and there were never any “green shoots” of recovery. The mainstream media now feigns surprise at reports of economic weakness and prognostications of a double dip recession.

Watching the passing parade of economic and political folly is both depressing and exhilarating. Depressing because we believed there would be a change in business-as-usual Washington. Exhilarating because the public is awakening to the fact that they have been misled. And that augers a change in the status quo and perhaps a better tomorrow.

GD Star Rating
loading...

Prophet Without ProfitThinking Non-Linear