Executive Compensatio

This Dimon Doesn’t Have it Rough Enough

Jamie Dimon, CEO of JP Morgan Chase, is back in the news railing against those who bash the rich:

Dimon was responding Wednesday to a question at an investor conference about the hostile political environment towards banks.

“Acting like everyone who’s been successful is bad and that everyone who is rich is bad — I just don’t get it,” said Dimon at the conference, which was organized by Goldman Sachs Group Inc.

Dimon said he’s worked on Wall Street for much of his life and contributed his fair share.

“Most of us wage earners are paying 39.6 percent in taxes and add in another 12 percent in New York state and city taxes and we’re paying 50 percent of our income in taxes,” Dimon said in defense of his fellow Wall Street bankers. See Jamie Dimon Rails Against “Rich is Bad” Talk

Are We Bashing the Rich or the Well Connected?

America is a land of opportunity. Children of poor immigrants can grow up to be President, entrepreneurs, brilliant scientists or even CEOs of Fortune 500 companies. Thus, Americans venerate a Steve Jobs or a Bill Gates. Not that these individuals are without detractors, but they are admired for starting from scratch, innovating, and filling a market need. Often these individuals single-handedly create the market for their products and services. See All Millionaires are not Created Equal

Let’s examine why Jamie Dimon and other bankers are less admired and often vilified. Note the deft sleight of hand in Mr. Dimon’s answer to the question: the question posed concerned the hostile environment toward banks. Mr. Dimon’s response is that he does not understand why the public thinks that everyone who is successful is bad. He in fact never answered the question of why everyone hates banks.

At the core of the hatred of banks (and perhaps Mr. Dimon himself) is crony capitalism. Mr. Dimon’s “success” is owed largely to the unholy alliance between the Bush and Obama Administrations and the Too Big to Fail Banks. Let’s examine the blessings the government has bestowed on Mr. Dimon:

Bear Stearns – JP Morgan Chase and Mr. Dimon merged with the “failing” Bear Stearns, paying $10 per share for a company that had recently traded at $93 per share. The Federal Reserve then made a $29b non-recourse loan to JP Morgan secured only by the mortgage backed securities of Bear Stearns. Thus, the Federal Reserve could not seize JP Morgan Chase assets, if the Bear Stearns collateral proved insufficient to repay the loan. See Seeking Fast Deal, JP Morgan Quintuples Bear Stearns Bid, Wikipedia

Secret Loans from the Federal Reserve – From 2007-2009, the Federal Reserve made $7.7 trillion of secret loans to 190 financial institutions, resulting in profits of $13b. These loans were at below market rates, virtually free, ensuring profit for the banks. Bloomberg, which made the Freedom of Information Act request, estimated that JP Morgan profited in the amount of almost $458m. Mr. Dimon did not disclose these loans or the banks’ need to his shareholders:

JPMorgan Chase & Co. CEO Jamie Dimon told shareholders in a March 26, 2010, letter that his bank used the Fed’s Term Auction Facility “at the request of the Federal Reserve to help motivate others to use the system.” He didn’t say that the New York-based bank’s total TAF borrowings were almost twice its cash holdings or that its peak borrowing of $48 billion on Feb. 26, 2009, came more than a year after the program’s creation. See Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress

Zero Interest Rates – The zero interest rate policy of the Federal Reserve continues to permit banks to borrow at below market rates, thus enhancing bank profits at the expense of savers.
Compensation – While being rescued by the Federal Reserve, JP Morgan Chase’s board awarded Mr. Dimon a $17m bonus for 2009. In 2010, Mr. Dimon made $20.8m. JP Morgan partisans will argue that this was modest compared to industry peers. Should US taxpayers, those of us who ultimately stand behind these loans, reward executives with large compensation packages? Unlike the situations of most of the rest of us, JP Morgan Chase makes available to its top executives tax advantageous programs such as the permitting tax deferral of compensation, 401k plans, a defined benefit pension plan and use of the company plane. If terminated without cause, Mr. Dimon would receive cash and stock awards valued at $16.7m. See Are CEOs Paid too Much: Not All of Them; JP Morgan Chase CEO Gets $17 Million N0-Cash Bonus; Elements of Executive Compensation (JPM); JP Morgan Chase 2010 proxy

Being Rich Isn’t the Problem

Yes, there is income inequality and we have heard endlessly about the elite 1% profiting at the expense of the 99% of ordinary Americans. But the real hostility goes deeper than just these income disparities. There is a good reason why Mr. Dimon chose not to discuss the hostile environment toward banks. He is well aware of why it exists: the American public has been treated to the spectacle of secret loans to banks; CEOs have been permitted to keep their jobs after nearly destroying their own banks and the US economy; too generous executive compensation practices and perquisites continue which ignore the fact that taxpayers needed to bail out these institutions (and will probably have to do so again); banks still fail to undertake serious loan modification programs for underwater homeowners; they hoard excess reserves at the Federal Reserve rather than make loans to stimulate the real economy; they attempt to impose fees on cash withdrawals from ATMs; and finally and disgracefully, these banks have not been prosecuted.

Mr. Dimon, the focus is on you and other bankers, not necessarily “the rich.” Perhaps we need more hard hitting articles like the Bloomberg piece on secret loans to banks, to focus the attention on the true issues, not bogus articles of class warfare. Unfortunately, neither the press nor the Administration has been rough enough on Mr. Dimon.

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5
Sep 11

Insanity

“Insanity: doing the same thing over and over again and expecting different results.”
Albert Einstein

When we examine the headlines, this oft-quoted phrase becomes increasingly relevant. We accept public policy errors with barely a whimper. We are either too comfortable with the status quo or paralyzed by fear of the unknown. Worse, perhaps we have lost our ability to question critically. Maybe all the aforementioned are true at once. Let’s examine some of the current insanity.

Living on Flood Plains

Our family was raised near the Passaic River in New Jersey. In high school in 1970, my brother did an in-depth study of flooding in the Passaic River Valley. Even then, after relatively modest storms, flooding of the towns of Lincoln Park and Wayne, NJ, was all too common. My brother interviewed then State Senator (later Governor) Thomas Kean. Kean was well aware of the problem and had worked with the Army Corps of Engineers to devise a plan to stop the flooding. A new dam was needed, but the project withered from political opposition. Now, more than forty years later, the area routinely floods in these and other Passaic River towns. No dam has been built. Worse, overbuilding since the seventies has intensified, leaving more families in harm’s way. Now, with full media drama, we are treated to heroic emergency rescues, and heart rending scenes of home evacuations and lost possessions.

My guess is that many of these homeowners will receive sizeable checks from federal flood insurance programs. We the taxpayers are subsidizing the choices of individuals to build homes on flood plains. Although I believe there is a role for a federal emergency response, Ron Paul was right to question the need for a federal response to Hurricane Irene. Even the liberal Huffington Post recognized the insanity in some of these programs.

Federal disaster relief programs have their faults. The National Flood Insurance Program, originally designed to force homeowners to take financial responsibility for living in flood plains, has encouraged development in unsafe areas. So too have federal levee and flood control programs. See A Natural Disasters History Lesson for Ron Paul

Insanity is to encourage overbuilding in flood plains, watch hurricanes and lesser storms destroy houses, and then having taxpayers reward reckless builders and homeowners with monies from the Treasury. We need to at least begin the process of requiring our citizens to acknowledge the risks they take in their choices. Financial responsibility should reside with the homeowner not the taxpayer.

Boards and CEOs

Much hoopla surrounds the naming of a new CEO for a major American company. Too often, we find out later that the Board of Directors never fully investigated the candidate to explore the “soft issues” such as management style. And then comes the consequences for the company and its shareholders. We have two recent cases of high profile executive terminations: Jeffrey Kindler at Pfizer and Robert Kelly at Bank of New York Mellon.

In both instances the Board discovered after the CEO was ensconced that his abrasive management style was alienating other key senior managers. The result was dysfunctional management decision making.

This woeful tale occurs quite often. The Board becomes enamored of a brilliant, seemingly charismatic executive. But if the Board did its homework, it would discover that sometimes an executive is a brilliant individual contributor, but a mediocre or too often a terrible manager. Given the hierarchical nature of corporations and the fear of losing one’s job, subordinates do not speak out about their bosses. Or if the rare employee has the courage to speak out, the Board rationalizes complaints: such employees are disaffected complainers, or sore losers in the climb to the top.

When corporate performance inevitably founders, the mass exodus of senior talent or the disclosure of a scandal catapults the Board into action. Horrors! All those complainers may have been correct. Secret sessions occur, the Board develops some backbone and fires the executive, but tells the world that the executive is retiring or resigning to spend more time with their family. Worse, Boards do not deal harshly enough with a mistake in hiring: they reward the offending executive with a large severance package and a proclamation of gratitude for taking the company to a new, higher level. The end result: a cynical group of employees and shareholders.

See Inside Pfizer’s Palace Coup, Robert Kelly: Bank Fired Him Because of His ‘Abrasive’ Management Style Lowered Morale

QE3

Wall Street continues to beat the drums for a third round of quantitative easing from the Federal Reserve. Peter Tchir of TF Market Advisors debunks the effectiveness of QE2. The stock market may have gone higher but that may have been related to the problems in Europe that lowered the value of the dollar or the lower stock price levels then (1050 S&P 500) versus now (1215 S&P 500). The “wealth effect” related to rising stock prices did little to improve the lot of the average American. Unemployment remained high, house prices did not recover and wages stagnated. Finally, there were dramatic increases in commodity prices raising the cost of key items such as food and energy. Yet, the Federal Reserve continues to hint at QE3 and major investment banks view it as a given. See QE3, What’s not to Like?

Repeating Insanity

What has happened to critical questioning of key institutions: Congress, the Executive Branch, the Federal Reserve and even corporate boards of directors? Policy initiatives are floated every day in the press, one crazier than the next, and few pundits ask why? As crises seem to occur without respite, my guess is that this obtuseness will not serve us well.

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5
Aug 11

The Meal Was Great…Part II

Dinner with friends included lots of discussion points that resonated and reminded us of our corporate working lives. While these points were clear to us as working persons, our perspectives from the outside render these points just as important. The revealing fact that hits home so closely is: Americans are being impacted by flawed policies and assumptions whether employed or not, or impoverished or not.

Financial Sector Dominance – Government policy encouraged the growth of the financial sector at the expense of the “real economy.” Glass Stegall, which separated banking operations from trading operations, was repealed by Graham-Dodd. Devilishly complex financial instruments became Wall Street fee generating devices at the expense of traditional lending. These firms became employers of choice for talented university graduates.
The Short Cut Society – Instead of saving for a house, a vacation or a new appliance we were happy to use credit cards or second mortgage lines for instant gratification. Instead of a boring career in manufacturing, better a Wall Street trader or hedge fund manager. CEOs expected huge compensation packages regardless of performance quality.
Spin vs. Truth – Shading of the truth became a national obsession. Instead of honest reporting of inflation statistics, hedonic adjustments lowered the consumer price index, depriving social security recipients and federal pensioners of earned cost of living adjustments. CEOs spun disappointing earnings results taking write offs, obfuscating the accounting or lowering earnings guidance so that when earnings were finally announced “they beat expectations.” Congress is no better, promising “smoke and mirrors” debt reduction plans with little, if any, real deficit reduction.
Lack of Political Leadership – The debt reduction exercise is one more example of the lack of leadership at the Chief Executive and Congressional levels. Politicians are more concerned about preening before cameras than serious statesmanship. Bipartisanship seems like a quaint relic of a bygone era.
Congress for Sale – Given the enormous cost of congressional races, representatives are in a constant search for dollars from corporations and other large contributors. Thus, we have Congress captured by special interests. Congress has long forgotten the middle class voter. The appearance is that Congress is totally beholden to the corporate sector and that corporations appear entitled to special relief any time they are in need.
Complexity – Complexity pervades every part of our political and economic system. Complexity is used to muddy rather than clarify. The tax code, Obamacare and financial reform are the latest examples of overly complex legislation and accompanying regulation. Only an army of lawyers can navigate through these legal minefields. Conveniently, citizens are kept in the dark and small businesses cannot afford to compete with larger enterprises.
Rise of the Nanny State – We recently had New York’s ridiculous attempt to regulate kickball, dodge ball, waffle ball and Red Rover as dangerous activities needing state oversight and a permit. See Classic Kid Games Like Kickball Deemed Unsafe by State to Increase Summer Camp Regulation. This is emblematic of a society which demands a legislative or regulatory solution to every problem. Businesses must be protected against failing (GM, Chrysler, Citicorp, AIG), employees must be permitted leaves for such mundane diseases as chronic sinus infections (Family and Medical Leave Act), and the public must be protected against carcinogens such as the sun and salt. Every aggrieved person must have a day in court. Spill hot coffee on oneself, bring a lawsuit against McDonalds. Play football and suffer an injury, sue the helmet manufacturer. Somebody is always to blame and our legislative bodies are all too willing to protect us against life’s vicissitudes.
Free Trade– Say it fast and free trade sounds like a great idea. Cheap foreign goods enrich our lives. Thus, Ross Perot was ridiculed for saying that NAFTA’s giant sucking sound was American jobs heading for Mexico. Mr. Perot sold American ingenuity short: American jobs are heading for China, India, Vietnam and a host of other low wage countries. These countries have few, if any, labor, anti- discrimination, family and medical leave, unemployment, child labor, environmental or safety laws. American workers are being asked to compete against workers who are paid subsistence wages and afforded no protections. Our politicians are only too willing to serve corporate interests at the expense of the American worker.
Immigration – Immigration is probably the purest example of selective enforcement of our laws. It is difficult for American workers to compete against Chinese or Indian workers. The problem is even greater as regards undocumented residents in our country. Further, the cost of medical, education and municipal services is underwritten by the American taxpayer. In places like Texas, Arizona and California this puts enormous strains on state and local budgets when education and medical services must be extended to undocumented residents.
Structural Unemployment – Technology and job outsourcing has added to shockingly high unemployment rates. It is not clear whether any of these jobs will ever return. As we pointed out, zero interest rates lead to use of more labor saving capital equipment at the expense of hiring workers. See The New York Times Finally Discovers Structural Unemployment. Hence, our employment problems may not be temporary but a permanent feature of the economic landscape.

All of the factors are intertwined. In fact, they are negatively synergistic. For example, a Congress that supports failed banks condemns savers and pensioners to miniscule return on savings, further compromising any incipient economic recovery. A below trend economic recovery only encourages the exile of more jobs overseas so that corporations can retain profitability.

Believe it or not, dinner was pleasant and more. But our conversational substance and concern for what is happening with our country and what is wrong with America indeed cast a cloud over all our thinking. Along with other “ways that we were,” optimistic was also one of them, and that is much diminished.

After all this postulating about what is wrong, clearly what should come next are some hypotheses about solutions that can work. A discussion for another blog.

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3
Aug 11

The Meal Was Great; Our Outlook, Not As Good

I had dinner the other day with two close friends, both former colleagues. We are, in parlance, “men of a certain age:” baby boomers, children of the sixties, sons of World War II veterans. We all began our work lives in our twenties, worked for giant corporations, and turned jobs into long-term careers. When first hired by our companies, we planned to stay just a couple of years and then move on to another company. With the benefit of hindsight now, and the need for false humility ended, we can each gratefully admit that we enjoyed significant professional success, although none of us thought we would rise to the senior executive levels that we did.

We now occasionally get together for dinner and discuss our families, our current pursuits, how our former employer is doing and the general state of things. Last time, we discussed what went wrong with America generally, why our children will not have long careers with large companies, and why they likely will not be as financially successful as we were.

We spoke about our fathers and the norms of their generation. They fought in the War, returned and worked hard, and had few expectations about success or wealth. They kept their noses to the grindstone and rarely complained.

We discussed the landscape of the corporations we went to work for. When I was hired as a junior attorney, the General Counsel barely made five times my salary. Bonuses were stingy and a modest number of stock options (in the hundreds of shares) were offered to a handful of our most senior executives. Interestingly, it was generally a harmonious and engaging work environment. In contrast, by the time I retired, the Chairman and CEO made more than 400 times what an average employee made. Employees were not nearly as engaged or happy.

The immediate catalyst for our wondering what has gone wrong with America was the current debate over the US debt ceiling. I started to think back to the blogs I had written and tried to put together some hypotheses. I caution the reader this is not a rigorous, but rather an impressionistic view of sociological, political and economic trends which shape the current state of affairs. If it is insightful, I give tribute to good dinner conversation and fine friendship:

Loss of Shared Sacrifice – Perhaps it was the “Me Generation” of the 1960’s, but America has lost its sense of shared sacrifice; that is, the notion that we are all in this together and we rise or fall as one nation. Instead we have an ethic of greed: I want what I want and I want it now, everyone else be damned.
Out of Control Military Spending – Too much of America’s resources are spent in our defense budget. Compounding this problem is a series of seemingly endless wars. While we deploy hundreds of thousands of troops to Iraq and Afghanistan, our allies deploy hundreds. Note that the German, Canadian, and Australian economies boomed, while ours stagnated.
The Volunteer Army – A volunteer army allows wars to be fought by other people’s children. Thus, the popular outcry against wars or military spending is diminished because our own (privileged) sons and daughters are less likely to be involved.
Too Many Laws – The Wall Street Journal highlighted the growth in federal criminal law. We over-criminalize too many areas of society. One commentator archly noted that someone violates some law each day, often unaware of his lawbreaking conduct. See As Criminal Laws Proliferate, More are Ensnared
Unequal Enforcement of the Law – Perhaps since the OJ Simpson trial, our citizens cynically believe that if one hires a good enough lawyer, one literally can get away with murder. This carries over to the belief if a corporation is big enough, especially a “too big to fail” financial institution, it will never be prosecuted.
Socialism for the Rich, Capitalism for the Poor – When the “too big to fail” institutions became insolvent, the Bush Administration, Congress and the Federal Reserve rushed in with a comprehensive program of TARP and zero interest rate lending. The Obama Administration has continued these policies from the beginning. Insolvent homeowners have been evicted from their homes, and many unemployed workers have exhausted their unemployment benefits.
Reckless Lending and Borrowing – The Federal Reserve was a major culprit in the growth of both public and private credit. Instead of accepting the economic consequences of the internet bubble crash, Alan Greenspan reduced interest rates to below market levels to encourage real estate lending. Subprime lending further inflated the housing bubble. Based on an inflated residential and commercial real estate market the economy boomed. Assuming that this was permanent prosperity, debt was taken on at all levels: states and municipalities, corporations, homeowners and the federal government. Now we cannot repay that debt.

While my dinner with friends continued all in one evening, Part Two will continue this discussion.

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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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22
Dec 10

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.

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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.

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16
May 10

Surfing the Financial Crisis

I’ve been watching the financial crisis since it began in 2007. Every so often it is good to step back and consider some of the anomalies. Thus, some disconnected thoughts:

- The time between crises gets shorter. It was seven years from the dot.com to the sub-prime crash. It has taken us only one year from TARP and other alphabet soup US-based federal bailout programs to the European Commission trillion dollar bailout. With the Euro plunging after the bailout, how long will it be to the next crisis?

- If everything is really improving why have short-term US interest rates not risen? I am amazed that for over 2-years of regular Treasury auctions, 3 month bill rates have ranged between .1 – .2%. Why does the Federal Reserve keep stating in its guidance that it intends to keep rates at zero for an extended period of time?

- Why would anyone invest in the US equity markets? The most active stocks each day are severely troubled, probably insolvent companies: Citicorp, Fannie Mae, AIG, and Bank of America. More than sixty percent of every day’s volume is non-human, computerized, automated trading. And what is worse, computers doing this trading are shaving cents off each transaction to the detriment of institutions and retail investors. No one believes in long term investment value any more. Respected analysts believe the market is severely overvalued and should probably trade at the 850 S&P level.

- How do Goldman Sachs and JP Morgan have perfect trading performance, that is, making money every day of the first quarter? Karl Denninger has calculated the odds of achieving this feat at one in many trillions. Have the SEC and other government regulators taken an extended holiday during the financial crisis? It sure seems that way.

- The 1987 version of the SEC portrayed in the movie Wall Street was able to detect illegal activity in the fictional Blue Star Airlines and arrest the hapless Bud Fox. Mary Schapiro and the current SEC staff can’t seem to find water with two hands if they fell out of a rowboat in the middle of the Atlantic.

- Why do things keep getting more complicated and less clear? Yes, we live in a complex world. But I have a deep suspicion that complexity is being used as a subterfuge to mask true intent. Why do we need multi-thousand page financial and health reform legislation, customized credit default swap instruments and impenetrable corporate proxy statements? The answer: complexity is designed to disguise the essence of each issue.

- Why is the Federal Reserve afraid of a full-fledged audit? As taxpayers, we are the ultimate financiers for the various government bailout programs. What happened to sunshine as the best disinfectant in public matters? This is an economic, not a national security matter. Or in the minds of the government, has everything become a national security matter, even the Fed’s purchase of the Red Roof Inn?

- Why is Senator Chris Dodd, himself compromised with a Countrywide below market loan, allowed to lead financial reform?

- With a Justice Department of 100,000 employees, why haven’t we indicted a major financial institution?

We live in dangerous times. Perhaps some of our leaders should be thinking about some of these questions and issues.

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29
Apr 10

Some Random Thoughts on Goldman

Tuesday’s Senate hearings on Goldman raised as many issues as they answered. Today’s thoughts on the status of Goldman Sachs’ current folly and the US financial industry:

- Goldman executives have no idea how angry the average American is at Wall Street in general and Goldman in particular.

- Nobody likes Ivy-league trained, arrogant, wise-cracking executives, least of all those who wear great suits and have great haircuts.

- In a work-related email, lack of discretion and caution can really return to haunt the writer. Thus, characterizing a deal as “shitty,” calling the securities “monstrosities,” doubting the sale of your product to “widows and orphans,” and not understanding the complexities of these products guarantees later problems to both writer and firm.

- When pressed on the use of the word “shitty” in the email, the correct response is not that it was an unfortunate use of words. Rather, explain whether or not it was a good or bad deal for the investors.

- To the average American, trying to justify a $9 million cash compensation package as “modest” will never work.

- If indeed the customer comes first at Goldman, it is impossible to duck questions on fiduciary duty to your customer.

- “I did nothing legally wrong” will only antagonize the SEC and other prosecutors. The court will decide what is lawful.

- As a corollary point, isn’t Goldman smart enough to stop its ongoing public relations releases attacking the SEC and proclaiming innocence? Nobody believes them.

I have made much of Wall Street’s casino atmosphere. The Senate should now focus on the following:

Why are these types of securities even legal?
What societal or economic good do they promote?
How did Goldman and other firms prosper through the short-selling of their competitors’ securities (e.g. AIG, Bear Stearns, Lehman)
Even if a security is marginally legal, is it ethical to sell it to customers without detailed and comprehensive disclosures?
Since Goldman does not write mortgages, commercial loans or engage in other aspects of retail banking, why should it have a national bank charter?
Since it is really a disguised hedge fund, why should it be able to borrow at the Federal Reserve’s discount window at zero percent interest?
What is Goldman’s current level of leverage compared to leverage employed just prior to the financial crisis?
How could overuse of leverage cause a second more serious financial crisis?
Does Goldman (or any other firm) expect to be bailed out again if the crisis reappears?
What has Goldman done or approved to assure the public of no more tainted securities and no second bailout? Personnel changes, managements controls, ethical standards, external oversight?

The press has given much coverage to these hearings. It is now time for some thoughtful reflection on Wall Street’s behavior: Is there excessive leverage? Favoring of certain financial institutions? Are we investing or gambling? Have we learned any lessons? Where are the regulators?

For a public with a short attention span and a Senate looking for quick financial reform, it is handy to target Goldman. Unfortunately, flogging their executives is merely peeling back one layer of the very large, smelly onion that Wall Street has become.

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20
Apr 10

The People v. Wall Street

Writing this blog is an educational exercise. At its beginning, I had less focused ideas about the excesses of Wall Street, a timid government and an abused middle class. Now, as I investigate and analyze people, institutions and events shaping our situation, I am synthesizing a philosophy of what is really going on in 2010 America.

Once Upon a Time in America

We are all captive to and shaped by our experiences. Corporate America in the 1970’s, the time and place where my career began, was a different era. CEO compensation was modest. A junior attorney in a very large corporation and the general counsel (a “proxy 5 officer”) were paid in a 1:4 ratio. When I retired in 2009 the general counsel made more than 90 times the compensation of the most junior attorney. The first CEO for whom I worked agonized over layoffs, and a layoff itself was a rare event. Layoffs were temporary, with employee recall rights. Endless internal discussions preceded consolidation of facilities or plant closings.

Enter the Age of Financialization

Sometime in the 1980’s someone flipped a switch and we entered the age of financialization. Perhaps this mythical paradigm shape shifter realized that Fortune 50 corporations could not exceed the 3-4% annual US GDP growth rate without engaging in financial game playing.

Employees became a fungible expense. The focus was not on increasing sales or growing the business, but rather on cost control. The reigning logic was that eliminating an expense saved 100 cents on the dollar, but revenue return yielded at most 10 cents on the dollar. Thus growing the business was sacrificed on the altar of cost savings. Add in the threat of corporate raiders, takeover artists, merger partners and others, and ruthless financial efficiency trumped growing the business. Loyalty to customers, employees and communities became secondary bogus public relations. Mass layoffs, subcontracting to domestic vendors and outsourcing to foreign countries, plant closings, divestitures, and joint ventures became talismans to support shareholder value. Cutting expenses was easy, therefore good; growing the business was hard, therefore bad.

It was not a great leap to start thinking of businesses as cash cows to financially manipulate and enhance results. Newly minted MBAs were only too happy to implement leveraged employee stock ownership plans, hybrid debt/equity securities, share buybacks, pension plan freezes and terminations, company owned life insurance schemes and debt/equity swaps – all in the name of heightening shareholder value. Such “sophisticated” corporate stewardship also required enhancing executive compensation with stock options, mega grants, long and short term bonus awards to align the executive with shareholder interests.

Too Much of a Good Thing Always Ends Badly

The experience of industrial corporations relying on financial maneuvering in the 1980s and 1990s was prologue to the financial excesses of the past decade. Financialization took hold of the entire economy. We rationalized that services, especially financial services, would make up for declining manufacturing. The financial oligarchs moved to center stage. Until the current financial crisis neither the regulators nor the media were willing to monitor, analyze, criticize or curtail the shoddy practices and political dominance of Wall Street.

Perhaps the SEC suit against Goldman Sachs is a watershed event. Obama’s decision to bail out the banks in hopes of more lending has proved a false hope to small business and the middle class. These duped constituencies may not understand the fine points of collateralized debt obligations or mortgage-backed securities, but they do get it. The media regularly regales the electorate with outsized bonuses award to the barons of Wall Street while unemployment and under employment remain at near all time highs. Even more galling is that these same financial institutions were on bended knee in 2008, asking for TARP funds, loan guarantees and cheap money for their very survival.

The Jury is Out

We are at a defining moment. Are the banks going to control the government? Does the Obama Administration have the courage to break from the financialized economy? Will he fire Bernanke, Summers, Rubin and Geithner and regain control of the government? Is the SEC action against Goldman a one-time publicity stunt or a sea change in enforcement?

Right now the middle class is seething with limited job prospects, declining home values, a diminished retirement portfolio and increasing taxes. We feel cheated by Wall Street and the actions of our largest financial institutions.

Financialization taken to the extreme has led us to where we are. We need wise and firm political leadership to lead us out. Given the weak response of the last two administrations, I have my doubts.

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Prophet Without ProfitThinking Non-Linear