Political

Banking / Financial / Political / The Federal Reserve — 0 Comments
30
Dec 11

The Road to Financial Nihilism

Nihilism is defined as “the total rejection of established laws and institutions.”  We are currently living through an age of financial nihilism.  Nihilism is also usually associated with radical elements that reject all authority.   I would submit that business elites and the political establishment are spawning political, legal and financial nihilism.

The Great Financial Crisis in the fall of 2008 led us on this path.  Perhaps it started with the best of intentions to save the financial system, but the unintended consequences of intended financial actions has negated any good from these efforts.  Let’s look at the particular elements of this sad condition:

  • Zero Interest Rates – When a market sets interest rates, important information is conveyed to market participants.   Interest rates in a free market environment measure risk of repayment, a fair rate of return and the potential for inflation.  When the Federal Reserve anchors interest rates at near zero for “an extended period of time,” investors can no longer make long-term rationale investment decisions. Thus, money is likely to be mal-invested in uneconomical projects or speculation increases in economically sensitive commodities such as oil, metals and grain.
  • Suspension of Mark to Market Accounting – At the start of the financial crisis, Congress leaned on the Financial Accounting Standards Board to suspend “mark to market” accounting (that is, the valuing of an asset in the most honest way, that is, taking into account its impairment or loss of value) .  In its most basic form, this is just plain dishonesty.   This dubious practice spread to banks in Europe as well.   Thus, there is no transparency in bank balance sheets; we (and even the banks themselves) simply can no longer believe the numbers on any institutional balance sheets. The result is that European banks are no longer willing to lend to one another.   Why?  These banks are now leveraged as much as 50-1, thus only a 2% drop in asset prices puts them at risk of failure.  We know that sovereign European bonds have dropped much more than 2%.   Thus, it is likely there is little or no real collateral to support a loan. See Art Cashin Exposes the Behind the Scenes Panic in Europe. With housing prices continuing in decline in the United States, I would suspect that many US banks too are hiding losses, and are in more dire straits than they or the Administration admits.
  • Stress Tests – To reassure the public, both the Federal Reserve and the European Banking Authority ran stress tests on large banks.  Dexia (Belgium’s largest company) passed the most recent round of these “stress tests,” and then failed within three months.   Irish banks failed four months after their 2010 round of these tests.  See How Did Europe’s Bank Stress Test Give Dexia a Clean Bill of Health?  Bank of America and Citigroup shares have plummeted in 2011.  The Federal Reserve performed similar stress tests on these and other major American banks.  How credible were our “stress tests?”
  • Eroding the Sanctity of Brokerage Accounts – The collapse of MF Global revealed that a brokerage firm could appropriate segregated customer accounts for its own uses.  It appears that MF Global circumvented US laws on account segregation by pledging customer accounts against a repo agreement in London.  Now, customers may never recover their monies.  See MF Global: The SERIOUS Issue Reaches Mainstream Media.  Karl Denninger points out that the standard brokerage agreement permits hypothecation and re-hypothecation, meaning that your brokerage account can be pledged to support a brokerage company or bank loan.  Since derivatives have preference over depositors, customer’s segregated accounts funds are at risk.
  • Eroding the Sanctity of Real Property – To speed securitization of mortgages, the banks created an alternative mortgage registration system which bypassed centuries-old rules of settled property law.  A recent report documents the disastrous consequences:

… “thanks to the Mortgage Electronic Registry System’s (MERS) failure to accurately complete and/or publically record property conveyances in the frenzy of banks securitizing home loans and ins subsequent foreclosure actions, neighbors of a foreclosed property (with a sequential conveyance) as well as a foreclosed property itself will have unclear boundaries and clouded/unmarketable titles making it difficult, if not impossible, for these homeowners to sell their properties and for subsequent purchasers to obtain title insurance on the property.”

The report goes on to point out that courts have criticized the MERS model as flawed and have ruled against MERS’ stance to foreclosure. MERS is described as being “wholly inaccurate and not allowing homeowners to fight foreclosures because it [MERS] shields the true owner of a mortgage in public records.” See Study Claims that MERS Destroyed the Chain of Title and Consequently, the Housing Market

And worse yet, in sorting through the avalanche of subsequent foreclosures, mortgage servicers have filed fraudulent affidavits and false documentation. See e.g., Nevada Files First Criminal Charges in Robo-Signing Case

  • Greek Credit Default Swaps – In good faith, buyers purchased credit default swaps on Greek bonds to hedge against a potential default.   The European authorities strong-armed banks and other investors to accept “voluntary” 50% haircuts on Greek bonds.  Because of this “voluntary” characterization the credit default swaps were not triggered.  With Spain, Ireland, Italy, Portugal and other countries suffering huge losses on their bonds, is it likely that investors will invest in these bonds when the hedge of a credit default swap can be negated through European financial authority fiat?   See Credit Default Swaps Useless as Hedge Against Default
  • Federal Reserve Intervention in Markets – So far, when stock markets have faltered, the Federal Reserve has come to the rescue through quantitative easing (QE1& 2) or Operation Twist.  Thus, investors cannot know the true value of any stock since the Federal Reserve will not allow it to fall to a market-determined price.   Similarly, with zero interest rates and purchase of mortgage- backed securities, the Federal Reserve will not allow house values to fall to market clearing prices.
  • Failure to Prosecute – Outside of a handful of insider trader prosecutions there has been no attempt to prosecute the malefactors of Wall Street. Excuses range from opining that the practices were legal, to the difficulty in building a case.  In the Savings and Loan crisis of the early 1990s the same difficulties existed, yet 1100 prosecutions were brought with 800 banks executives sent to jail.  See In Financial Crisis, No Prosecutions of Top Figures

Real World Consequences

We have eliminated price discovery from our markets.  We have neither permitted stocks to fall nor interest rates to rise.  Instead of prosecuting the banks that caused this problem, we shower them with interest free loans from the Federal Reserve so they can speculate or earn risk free profits by re-depositing funds with the Federal Reserve.  Thus, capital is being diverted from sound investments and used for speculative purposes or worse.

European financial authorities have destroyed the efficacy of hedging sovereign bonds in their handling of the Greek bond haircuts.  And thus another important market is being destroyed.

More ominously, Karl Denninger reports that in the wake of the MF Global failure, farmers are eschewing the hedging of crops through commodity futures and instead selling directly to food companies.  Thus, price stability will be diminished and consumers will ultimately pay higher prices.

The failure to “mark to market” and run honest stress tests has resulted in a freezing of interbank loans (a classic credit squeeze) and resulted in a silent run on banks, as UBS reports (bold face type in original text):

European banks are making great use of the ECB’s overnight deposit facility. Last night they parked $590 billion at the ECB breaking the record they had set the night before. They are clearly unwilling to lend to other European banks, highlighting the distrust and fear in the interbank marketplace.

The distrust on the streets is said to be growing also. Barroom gossip says that safe-deposit boxes are in a demand that borders on frenzy. They allow you to take your Euros and covert them into something of value (gold, Swiss Francs, etc.) and sock it away in a safe place.

 Others are said to be buying property in London and elsewhere lest you awake one day and discover that your Euros have reverted to drachmas or lira.

 Savvy bankers are said to be setting up personal and communal trusts domiciled in places like the Bahamas, the Caymans or the Isle of Jersey. Some banks are offering depository accounts denominated (and repayable) in alternate currencies like the dollar or the yen.

 We think a Lehman-like event would most likely be triggered by a run on a bank or a series of banks. The scramble for currency (value) protection among the public could turn into that bank run in the same way that a crowd can instantly turn into a mob. Watch the money flows out of Greece and Italy very carefully. The pot continues to bubble. See Art Cashin Exposes the Behind the Scenes Panic in Europe

If the Administration, The Federal Reserve and the European Authorities had set out to destroy capitalism, free markets and the current financial system, they could not have done a better job.   Free markets and a free people are intertwined.  The road to financial nihilism is ultimately a very dangerous path.

 

 

 

 

 

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9
Dec 11

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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25
Nov 11

Cheating

An ongoing cheating scandal in the affluent suburbs of New York City now stains our headlines.   Students in several outstanding academic high schools paid test takers to take their college entrance exams.  Six students were arrested in September, and earlier this week an additional 19 students either surrendered to the police or were arrested.  Students paid these test takers $500 to $3500.  See More Arrests in SAT Cheating Investigation.

It is too easy to blame this behavior on the decline in morality evinced by Wall Street scandals and the behavior of our political class.  A deeper point needs to be addressed.  We have become a society of numbers and meaningless symbols.   How much do you make per year?  What school did you attend?  How much is your house worth?

Hiring by the Numbers

For much of my career, a significant part of my responsibility was the hiring and supervision of attorneys in a large legal department.   At best, hiring is a crap shoot.  Despite a glossy resume, one can never tell why someone is in the job market at any given time, or how that person will actually meet the standards and fit the profile of the job for which they are interviewing.  Usually complicating the decision making process is  the legal department’s need to hire  experienced attorneys with a minimum ten years experience. In this environment a new hire was expected to perform at an extremely competent level with little or no training or supervision, the proverbial “hit the ground running” paradigm.

One of my peers hired strictly by the numbers.  A candidate had to be a graduate of one of the top 41 law schools, and had to have more than a 700 LSAT.  My colleague preferred a candidate to have a background as a prosecutor with US Attorneys’ Office or the Judge Advocate General.

After a while, I broke the code on my colleague’s idiosyncratic requirements.  I discovered that he used the Gourman Report of Graduate Programs.  Dr. Gourman does not reveal his exact methodology or statistics.  Generally, the Gourman Report methodology asks university graduate departments to rate each other, and assess which they think are best in their field.   By definition then, this questionable methodology yields a self-reinforcing cycle of the top programs continuing to nominate each other in a reciprocal and mutual admiration society.  See Caveat Emptor: The Gourman Report for a critique of the report’s methodology.   The same large prestigious universities continue to populate these lists.  Page 1 of the Gourman Report list of law schools had exactly 41 names; my colleague’s law school alma mater happened to be number 41.  Thus, I deciphered my colleague’s “scientific” method of hiring and the inherent folly of using numbers to find good people.  (Soon thereafter, for amusement I confronted him and pointed out that to be really scientific he would have to find the Gourman report related to the year that the candidate graduated law school to really ascertain whether he was hiring a true “top 41” candidate.)

In another example of this folly, we later merged with a company which would only hire candidates who had combined SATs over 1500, LSATs over 700, a top 15 law school degree (thank goodness for Gourman) and experience in a prestigious law firm or prosecutor’s office.

I am still amazed that I was ever hired, promoted or retained after we completed several major mergers.  I fit none of these criteria nor did many of the best attorneys in our legal department.

The Hard Work of Hiring; the Harder Work of Assessing Job Performance

The SATs are primarily predictors of how well one will perform on tests like the SAT’s.  Since they were instituted as a method of evaluation, they have been repeatedly called into question as predictors of college success. Further, how well one performs in college and law school is not a total predictor of how well one performs in that first law job.  At each step, real life intrudes, essential character and temperament inserts itself into the process, and a lawyer has either learned to practice law competently or not.

No short cuts or quantitative formulas exist in making hiring decisions.  Generally, every candidate I interviewed had a good academic and work record.   Intelligence, analytical prowess and certainly test numbers were merely table stakes to get in the door.  Other more important factors determined whether or not an attorney would be successful in a corporate environment.  In evaluating candidates, I tried to ferret out the following:

  • Can they work under pressure, or under attack?
  • Can they take on a project with minimal supervision?
  • Are they willing to put in long hours, including nights and weekends, to accomplish the job?
  • Are they patient and persistent; can they see a project to its conclusion?
  • Are they creative; have they ever displayed ingenuity? Can they work with and lead a team of lawyers and business people?
  • Do they communicate clearly in speech and writing?
  • Can they accept criticism?
  • Do they respect subordinates as well as superiors?
  • Do they display emotional intelligence; can they intuit the atmosphere as well as the facts of a situation?
  • Is integrity clearly a part of their makeup?  Has it ever been tested?

The Education Testing Service and testing results cannot measure any of the above-listed factors.  And in my 32-year corporate career I firmly believe that one cannot be successful on a long-term basis without meeting the above criteria.

Despite conducting rigorous interviews and extensive background checks, an honest hiring supervisor will admit that it is difficult to judge these non-numerical factors.  Further, if a hiring supervisor is correct 50% of the time, he or she has beaten the odds.  I was lucky and was able to hire many attorneys who rose through the corporate ranks and became senior corporate leaders.  Some went to the “best” law schools, some did not. I was also required to ask some of my hires to leave.  While difficult each time, that too is the nature of hiring and corporate management.

Looking for the Easy Way Out

This returns us full circle to the Long Island SAT/ACT cheating scandal.  As a society we look for the easy way out in decision making.   Perhaps those Long Island students were thinking: if I can just achieve a high enough test score, I can attend a prestigious university which will guarantee me access to a great job or graduate program, which in turn will assure my success in life.  Success is more complicated than that.

We have deteriorated to a society of numbers and brands.  The ideal political candidate goes to the right schools, has the right tickets punched on his or her resume, gets elected to the right office and now is the right candidate for higher office.  We fail to delve into the more important factors of character, grace under pressure, emotional intelligence and integrity.  The epiphany, long since necessary for all of us, is that we entrusted our money and our government to Wall Street and Washington charlatans who went to all the right schools, held  all the right jobs and had all the right  connections.  And look what happened.

Given all of this, it is no surprise we now have a group of students on Long Island willing to sell their souls for $3500 or less.

 

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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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24
Aug 11

Storytelling, Narratives, and Truth versus Fiction

Early on I heard lectures on trial presentation from Irving Younger and Judge Herbert Stern.  Their approaches and strategies were similar to winning trials.   Present a clear and concise story.  Maintain constant credibility with jury and judge.   Highlight the “bad facts” presented by one’s opponent.  Defuse these bad facts.  In essence then, trial presentation is a form of advanced storytelling, and a coherent narrative is crucial.   Whoever assembles and presents the best and most credible story at trial wins.

I found these techniques equally valuable in speeches to employees or senior management.  Importantly, the speaker must connect with the audience, be credible, coherent and passionate about his subject.

This brings us to the current plight of President Obama, who addresses the country on almost a daily basis.  The public, however, appears to be tuning him out.  His speeches are articulate and fact filled, but he is not connecting with his audience, the citizenry.

One Man’s Theory

Drew Westen, Professor of Psychology at Emory University, analyzes President Obama’s leadership and speechmaking.  In a recent lead article in the Sunday NY Times, he asks, “What Happened to Obama?”

…watching…his inaugural address, I had a feeling of unease. It wasn’t just that the man who could be so eloquent had seemingly chosen not to be on this auspicious occasion… It was that there was a story the American people were waiting to hear — and needed to hear — but he didn’t tell it.  What Happened to Obama?

Stories matter.  They orient and inform us, transmit knowledge and impart values.   The public was primed for a compelling story from President Obama on how we got into the financial crisis and, even more importantly, how he intended to get us out.  Millions had lost their jobs and many more their savings.  Westen continues with the story he wishes Obama had told:

“I know you’re scared and angry. Many of you have lost your jobs, your homes, your hope. This was a disaster, but it was not a natural disaster. It was made by Wall Street gamblers who speculated with your lives and futures. It was made by conservative extremists who told us that if we just eliminated regulations and rewarded greed and recklessness, it would all work out. But it didn’t work out. And it didn’t work out 80 years ago, when the same people sold our grandparents the same bill of goods, with the same results. But we learned something from our grandparents about how to fix it, and we will draw on their wisdom. We will restore business confidence the old-fashioned way: by putting money back in the pockets of working Americans by putting them back to work, and by restoring integrity to our financial markets and demanding it of those who want to run them. I can’t promise that we won’t make mistakes along the way. But I can promise you that they will be honest mistakes, and that your government has your back again.”  What Happened to Obama?

The failure to identify the malefactors who created the crisis and the inability to create policies that correct those errors plagues the Obama Administration:

A story isn’t a policy. But that simple narrative — and the policies that would naturally have flowed from it — would have inoculated against much of what was to come in the intervening two and a half years of failed government, idled factories and idled hands.  What Happened to Obama?

To paraphrase Professor Westen, a psychologist and not a politician, we needed to know that the new President Obama could “fix the mess.”  Here was an untested politician with little leadership experience and no significant accomplishments, also a person of tremendous political charisma. So far, he has chosen to politicize, compromise and negotiate, but not to lead.  Damningly, Professor Westen concludes:

….Barack Obama stared into the eyes of history and chose to avert his gaze. Instead of indicting the people whose recklessness wrecked the economy, he put them in charge of it. He never explained that decision to the public — a failure in storytelling as extraordinary as the failure in judgment behind it. … He would have offered them a counternarrative of how to fix the problem other than the politics of appeasement, one that emphasized creating economic demand and consumer confidence by putting consumers back to work. He would have had to stare down those who had wrecked the economy, and he would have had to tolerate their hatred if not welcome it.  What Happened to Obama?

Leadership vs. Politics

Whether leading the United States or a corporation, sincere and forceful communication is vital.   President Obama’s speeches feel like the lectures of a learned academic: an academic who is eloquent, but has taught the course too many times and has lost his passion and interest.  He is reading his script, but we cannot tell if he believes it.

Americans thirst for a leader who can bridge the gap between government and their personal needs.   Unfortunately, President Obama is more interested in being a smart politician than a good leader.  In the movie The American President, an emotional aide beautifully describes the public’s need for strong leadership: “They want leadership. They’re so thirsty for it they’ll crawl through the desert toward a mirage, and when they discover there’s no water, they’ll drink the sand.”  The fictional President replies, “…we’ve had presidents who were beloved, who couldn’t find a coherent sentence with two hands and a flashlight. People don’t drink the sand because they’re thirsty. They drink the sand because they don’t know the difference.”

A recent Gallup poll measuring Obama’s approval rating has dropped to a new low.  The American public is catching on to the idea that something has gone terribly wrong. We are starting to understand the difference between the water and the sand.  The basic structure of society is at risk. Will we continue to abide platitudes and mediocrity?  I think we are better than that!   We should be creating and defining and sharing our narrative, and then forcing it on a President and government who do not seem to know what is wrong.

 

 

 

 

 

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9
Aug 11

“My Word is My Bond”

A phrase I heard often from adults when I was growing up was: “my word is my bond.”   I return to it often now, as it indicates to me not just a promise in a particular circumstance or business transaction, but rather a belief system. If we heard someone utter that phrase today would we believe it?  Sadly these days, most likely we would believe that we were about to be defrauded or worse.

In my professional life, I have witnessed the steady decline in the bonds of interpersonal trust. The financial crisis of 2008, which has never really ended, demonstrated that trust between people has deeply eroded. It was not only the outright frauds of Madoff and other Ponzi schemers, but more mundane misbehavior as well: borrowers lying about their incomes and assets to obtain loans, and lenders deceiving borrowers, government regulators and their shareholders.

It is time to reflect on some biblical wisdom.

The Bible and Truth

Sir Jonathan Sacks, Chief Rabbi of the United Kingdom, in his weekly blog “Keeping Our Word,” examines the Bible’s attitude toward vows and oaths, and the interconnection of trust with freedom.  As background he first examines adherence to the law.  People obey laws for two reasons:  (1) because of they are fearful of power and punishment or (2) it is to their self-interested advantage to do so.   However, both power and self-interest frequently corrupt those who pursue them. And corrupt power will lead to loss of freedom.  And corrupt self interest will lead to loss of social cohesion.

The Bible offers a third, more positive, reason for obeying the law:

… people obey the law because they have voluntarily undertaken to do so. This is a society based not on power or the pursuit of self-interest but on freely embraced moral obligation. Keeping our Word

We use words, performative utterances, to bind our future behavior, thus creating “an orderly future out of the chaos of human instincts and desires.”  The Bible is telling us that words create:

…because words are holy: that is to say, they bind. When words bind, they generate trust. Trust is to society what predictability is to nature: the basis of order as opposed to chaos.

Social institutions in a free society depend on trust, and trust means that we keep our word. We do what we say we are going to do. If we make a vow, an oath, a promise, a verbal undertaking, then we hold ourselves bound by it. This means that we will actually fulfil our commitment unless we can establish that, due to circumstances unforeseeable at the time, we are simply unable to do so.

If trust breaks down, social relationships break down, and then society depends on law enforcement agencies or some other use of force. When force is widely used, society is no longer free.  Keeping our Word

Stated simply, words, vows, oaths, promises and freedom are all intertwined.  When trust breaks down, freedom is lost.

The Current Crisis in Trust

At the core of our current sad state of affairs is a lack of trust.  We cannot count on our leaders to keep their word.  Government statistics are constantly “massaged” and restated.  When can we remember a business leader or politician telling us the truth?   Truth rarely emerges until we reach the crisis stage.

A memory and observation from my working life:  when I first started practicing law more than 35 years ago, I was routinely involved in corporate acquisitions and divestitures.  A contract to sell a business with several hundred million in sales (a large transaction at the time) would run less than 100 hand-typed, double spaced pages.   By the time I retired, a similar transaction would require massive teams of specialized lawyers: corporate, tax, employment, environmental, and more.  The documents would run into the thousands of pages.  At the end of such a transaction, I might receive several embossed, hard bound books for my library shelf (the size of a small encyclopedia).   Why?  I do not think we became more sophisticated.  I believe we trust each other less.  The same phenomenon occurs in federal regulations, with the Code of Federal Regulations filling an entire library wall.  Do all these laws, regulations and words create more or less trust?

Perhaps if we had a little more trust, we would need fewer words.  And when we uttered or wrote those words we would really mean them.

 

 

 

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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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28
Jul 11

It Isn’t That Easy to Avoid a Crisis

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

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

Goldman’s crisis avoidance stands on the following pillars:

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

Risks We Knew, and Ignored, in the Last Decade

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

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

What are the Current Risks?

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

…the bank appears to be in denial:

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

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

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

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

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

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

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

 

 

 

 

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10
Jul 11

Government’s Proper Role, Ever-Expanding?

We are in a critical time for government budget economists.  Congress and the White House are currently seeking to control budget deficits through spending cuts, tax increases, or a combination of the two.  In Thursday’s Wall Street Journal, Professor Paul C. Light suggests a comprehensive program to save an impressive-sounding one trillion dollars. His plan imports private sector tried and true management techniques:

  • Reduce by one-third senior and midlevel federal management layers and presidential appointees.
  • Freeze hiring of all senior and midlevel managers.
  • “Harvest” all monies owed to the government: eliminate mistaken or fraudulent payments to federal beneficiaries, providers and contractors;  collect  import fees, leases, fines, unpaid loans,  delinquent taxes.
  • Streamline operations: eliminate duplication, overlap, multiple administrative and payroll systems.
  •  Eliminate automatic time-on-the-job increases, pass/fail appraisals and grade inflation; assess and demand 3% per year productivity improvements.
  • Insist on comparative qualitative employee appraisal:  that is, only 10% of employees are most highly rated.
  • Cut the number of contract employees.  See The Easy Way Washington Could Save $1 Trillion

To avoid the political implementation problems, Professor Light would create the Government Reorganization Authority (GRA), a quasi independent authority modeled on the Resolution Trust Corporation (RTC).  The RTC was created during the 1989 savings and loan crisis and given full authority to hire, fire and pay executives at will in service of cleaning up failed savings and loans.  RTC was given a seven year limitation to effect the cleanup.  Creation of a GRA with a seven year sunset  and  broad powers to hire, fire, collect debts, etc. might be the modern equivalent of  the RTC.

A Better Idea than the GRA?

Why do we even need the government functions that Professor Light wants to creatively downsize?  Professor Light assumes that we must continue to perform these governmental functions, but at the same time he proposes to shrink the size of the supporting bureaucracy and make it more efficient.

In contrast, my starting point would be to eliminate these government functions altogether.  We have discussed reengineering government in previous blogs.  See e.g. Reengineer First, Privatize Second, Time to Revisit Public Sector Reengineering and Why Not Reengineer Government?  Instead of deciding to reduce the size of the bureaucracy, we should decide whether it should exist.   Remember the truism of government: bureaucracies will thrive and flourish well beyond their original mission.  Further, they will arrogate power unto themselves in fields unrelated to the original mission.

Do we need Departments of Energy, Agriculture and Education?  All three are creations of now questionable value and overlap with other agencies.   Readers should ask themselves in each case: do we have a comprehensive energy policy? Are we still paying farmers not to grow crops and are food prices higher or lower? Are our students better educated?

Do we still need the Food and Drug Administration?  Could not the free marketplace monitor and assess the quality and value of food and drugs? Could not threats of litigation police manufacturer behavior?

The National Labor Relations Board?   Our court system and the arbitration process can certainly handle workplace infractions; it happens all the time. The same logic applies to the Equal Employment Opportunity Commission.

Each of these departments, boards, agencies and commissions have deeply entrenched spending constituencies which assure their continued existence.  Unfortunately, sacred cows are expensive to feed and maintain.

Start the Conversation Now

Eliminating or combining governmental departments or functions would not be easy, but it would be a more intellectually honest approach to the problem of ever burgeoning government deficits.  Given the current crisis, now is the perfect time to begin the conversation.

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