Political

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

It Isn’t That Easy to Avoid a Crisis

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

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

Goldman’s crisis avoidance stands on the following pillars:

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

Risks We Knew, and Ignored, in the Last Decade

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

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

What are the Current Risks?

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

…the bank appears to be in denial:

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

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

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

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

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

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

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

 

 

 

 

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Management / Political — 0 Comments
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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American Society / Corporate Behavior / Political — 0 Comments
6
Jul 11

Recycling Losers

A curious feature of institutional behavior is the tendency to hire or retain executives who have failed in their jobs.  A prime example of such behavior is the hiring of baseball managers.  Baseball is enthralled with the familiar.  So it seems the best way to get a manager’s job is to be fired from one.   Despite their undistinguished records, managers like Jim Fregosi (win/loss record 1028-1095); Jerry Narron (291-341); Grady Little (385-290); Dallas Green (454-478) and a host of others were fired by one club, and then hired by another.  Many were given veteran clubs with proven stars, and yet they could not win championships.  Anecdotally, baseball was often accused of recycling old white men.  But recent reforms in baseball have demonstrated an equality of mediocrity if you will, as baseball has recycled minority managers with losing records.

The same dysfunctional thinking occurs in American business.   After being fired in the wake of the Bank of America merger, John Thain went from leadership at Merrill Lynch to head the CIT group.  Robert Rubin remained as Chairman of Citicorp after the financial crisis (although he resigned in 2009).  Lloyd Blankfein at Goldman Sachs and Jamie Dimon at J.P. Morgan continue in their positions.

President Obama assembled his financial team and shamelessly recycled flawed people: Ben Bernanke (Federal Reserve Chairman); Timothy Geithner (Secretary of the Treasury); Lawrence Summers (Head of the Council of Economic Advisers); Robert Rubin (economic adviser) and Jeffrey Immelt (President’s Economic Recovery Advisory Board).   Without cataloging their financial sins, clearly each of them contributed in a major way to the near collapse of the American financial system.

Failing Upward

In an aptly named article, Failing Upward, Yves Smith highlights the hiring of Madelyn Antoncic as Treasurer of the World Bank.   Ms. Antoncic’s previous position was Chief Risk Officer of the bankrupt Lehman Brothers:

The World Bank has appointed Madelyn Antoncic as its new vice president and treasurer.

Ms Antoncic served as Lehman Brothers’ chief risk officer from 2002 to 2007 and following the collapse of the bank, stayed on for a year as managing director and senior advisor at the Lehman Estate, helping to maximise value for creditors….

Commenting on the appointment, World Bank Group president Robert B Zoellick, says: “Known for her forthrightness, I am delighted Madelyn is taking up this important role.” See Failing Upward

Ms. Smith concludes that large financial institutions are comfortable hiring familiar people for big jobs, no matter how poorly they have previously performed.

Forthright but Ineffective

Robert Zoellick praises Ms. Antoncic’s forthrightness.  Another analyst comments that she “was likely the only person on Lehman’s executive committee who had any sense.”   See World Bank Taps Ex Risk Officer as Treasurer. But we then learn that senior management knew that the firm was taking on too much risk.   What was Ms. Antoncic’s role in controlling risk; indeed what did she know?  Was not controlling risk essentially her job?

So where was Antoncic to reign in such risk during that time? Well, she was being kicked out of executive meetings where risk was being discussed. Antoncic, with her PhD in economics and a prior 12 year stint at Goldman Sachs, might have know Lehman was taking too much risk but her opinion was blatantly disregarded when she was removed from Lehman’s executive committee in 2007. See World Bank Taps Ex Risk Officer as Treasurer

So Ms. Antoncic, the lonely voice of reason, was kicked off the executive committee. I do not know Ms. Antoncic, but her behavior raises important management questions.  Did she resign from Lehman?  Did she inform the Board of Directors or government regulators that the bank was taking on too much risk and might collapse?  No, she continued to collect her paycheck, a monument to her ineffectiveness and her questionable ethics.  If she was one of my employees, I would have fired her.  Forthright but ineffective just does not cut it.

Too Comfortable

Executives become too comfortable.   Instead of hiring a challenging subordinate who can bring fresh ideas, they are more likely to hire a loyal unchallenging stalwart who can maintain the status quo.  In a more cynical view of things, I would suspect that Mr. Zoellick found the right employee in Ms. Antoncic.  She would be beholden to him, be loyal to a fault and never challenge his decisions. Unfortunately, these are valued traits in corporate America and in government and can be summarized: “go along and get along.”

In my own experience I watched poor performing executives fail and then be promoted to a larger assignment.  I once quipped that you could not be promoted until you made at least a $500m dollar mistake.   That would demonstrate that you were a real player.  Obviously, Ms. Antoncic was a “real player.”  It took a real talent to be part of team which bankrupted a major investment bank and nearly crashed the entire economy.

The financial crisis will remain intractable as long as we continue to recycle the same financial players and government advisers who got us into this mess.  We need smart people with new ideas and different energy who can get us out this quagmire.  It is going to take the truly exceptional Board of Directors, CEO or US President to get rid of the wrong people, locate and hire the right people, and break with the past.    Perhaps it is time to afflict the too comfortable.

 

 

 

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3
Jul 11

All Millionaires are Not Created Equal

In Is Debt Ever Good? we contrasted productive debt and non-productive debt.   There is a duality with millionaires as well.   Some are productive and some are not.

At his Wednesday press conference, President Obama adopted what he figured would be the populist stance, and he vilified millionaires as a group:

Mr. Obama repeatedly mocked tax breaks that he said were for “millionaires and billionaires, oil companies and corporate jet owners,” saying that voters would not look kindly on Republican lawmakers who defended such breaks at the cost of cuts in popular programs like health care, education and food safety….

“If you are a wealthy C.E.O. or hedge fund manager in America right now, your taxes are lower than they have ever been. They are lower than they have been since the 1950s. And they can afford it,” Mr. Obama said. “You can still ride on your corporate jet. You’re just going to have to pay a little more.” See Obama: Republican Leaders Must Bend on Taxes

The financial press immediately declared this as “class warfare.”  See e.g. Obama’s Case Against the Rich Rings Hollow.  I would conjecture that the American public can distinguish between the good millionaire, who creates jobs and real wealth, and the bad millionaire, who becomes wealthy through political maneuvering or illegal activity.

The Productive or “Good” Millionaire

Americans applaud individuals from all backgrounds who have an innovative idea and are able to execute and create real wealth.  Bill Gates (Microsoft); Sergey Brin and Larry Page (Google); Steve Jobs (Apple); Jeff  Bezos (Amazon);  Pierre Omidyar (EBay); Mark Zuckerberg (Facebook) and a host of other entrepreneurs identified a business need, created a new product or service, raised private capital and became wealthy.   Even in the much maligned financial industry there were pioneers such as Charles Schwab who brought discount brokerage and other financial services to the average investor.  These are thriving enterprises, which need no government assistance or special tax breaks to make money and create jobs.

The Non-Productive or “Bad” Millionaire

Unfortunately, we have too many examples of this type of wealthy interloper:

Failed Bankers – Richard Fuld (Lehman), Charles Prince (Citicorp) and Ken Lewis (Bank of America) are examples of bankers who drove their institutions into bankruptcy or made them wards of the state.  Each of these individuals secured great wealth and suffered no compensation “clawbacks” or criminal prosecution.

Failed Corporations – During the financial crisis, companies like General Electric almost went bankrupt.  When they should have diluted shares and jeopardized their own stock-based compensation through equity and debt offerings, crony capitalists such as Jeff Immelt called on their Washington “friends” to extend large, below market rate, irresponsible loans to GE.

Under- performing Corporations – Legions of CEOs collected large compensation packages while their businesses, employees and shareholders suffered.  Instead of amassing their personal largesse at company expense, many an under-performing CEO should have been dismissed.

Criminal Enterprises – Ken Lay and Jeff Skilling of Enron and Scott Sullivan and Bernie Ebbers of Worldcom, among a long and undistinguished list of corporate malefactors, were able to deceive shareholders and bankrupt their businesses.  And worse, each amassed a large personal fortune.

Defense Contractors – A small, tight knit cadre of defense contractors feed at the Defense Department trough.  Many of these contractors have been accused of violating various bidding and other contracting rules, but are never disqualified from bidding on future contracts.  Cost overruns, delays and malfunctioning systems occur far too often.

Why Are Americans Angry?

We are angry at millionaires who game the tax code, misrepresent the financial status of their businesses, and seek government bailouts while continuing to pay themselves outsized compensation packages.  We resent non-performing CEOs who continue to be richly rewarded. We oppose government contractors with cozy Washington relationships.  To the average American, these millionaires win because the game is rigged.

Americans applaud the honest entrepreneur because he or she fills a real societal need. Further, these individuals are the best examples of the American spirit and ethos of creative imagination, perseverance and hard work yielding a valuable result. Americans do not want to destroy these individuals; they want to be these individuals.  Obama is overreaching when he paints all millionaires with the same brush.  What Americans want is an end to the bailouts and special deals that destroy incentives for honest entrepreneurs and both create and protect the undeserving rich.  Americans  want a level playing field so they can compete and become wealthy, too.

 

 

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American Society / Oil / Political — 0 Comments
30
Jun 11

The Law of Opposites

In management settings, the law of opposites applies far more often than many executives would admit.   On its face, the law is counterintuitive.  One concentrates much energy and time on setting and achieving a certain goal and despite best efforts the exact opposite occurs.   This paradoxical construct is closely allied to another behavioral law: that of unintended consequences.   Writing about politics and government, Ron Paul gives us some insight and some examples:

Everyone is aware of the Law of Unintended Consequences. Most members of Congress understand that government actions can have unintended consequences, yet few quit voting for government “solutions” – always hoping there won’t be any particular unintended consequences this time. They keep hoping there will be less harmful complications from the “solution” that they currently support. Economics teaches that for every government action to solve an economic problem, others are created. The same unwanted results occur with foreign policy meddling.

The Law of Opposites is just a variation of the Law of Unintended Consequences. When we attempt to achieve a certain goal – like, “make the world safe for democracy,” a grandiose scheme of World War I – one can be sure the world will become less safe and less democratic regardless of the motivation.  See The Law of Opposites

Opposites and Consequences in the Workplace

In the business world, both laws frequently apply.   Oftentimes employees complain that they are not appreciated or promoted.  Worse, they observe less qualified employees who are.  My advice on promotion to any employee was:  forget about it.  Go back, do an outstanding job, and hope that excellence will be recognized and promotion will follow.   Most of the time, the complaining individuals spent much of their time not doing excellent work because they spent way too much of their time complaining.  These were the schemers, not the doers.  Inevitably, the job performance of these employees suffered.  These employees did not want to hear:  “relax, go back, work hard and do a good job.”  They felt there was some secret formula that I, the supervisor, was hiding from them.   While it is naïve to think that everyone who does a good job gets promoted, it is a sure bet that needless complaining won’t get an employee there.

Similarly, friends and colleagues in conversation would often say how they wanted to be rich.   Rarely does a person become quickly and safely rich.    The fantasy goal in these conversations was usually some high risk, short term investment which would provide that mythical short cut to riches.  Alas, the only short cut to riches isn’t that at all:  it is hard work, thrift, consistency, perseverance, and perhaps a little luck.   My best advice to these friends and colleagues is similar to the directives to my “underappreciated” employees:   relax, save some money, invest wisely and grow rich over time.

Paradoxically, the more one focuses on a goal, the less the chances of success.  It is much like the philosophy of  Inner Tennis: Playing the Game:  the more one focuses on the score and winning the game the less likely one will succeed.  Relax, see the ball, hit the ball, success will follow.

Solving Economic Problems

This personal rumination brings me, once again, to the actions of the current administration.  Somehow bailing out the banks and car companies, setting interest rates at zero, and printing money was going to solve our economic problems?  What did we get by doing this?  A slumping economy (euphemistically called a “soft patch”); falling house prices; 45 million Americans on food stamps, and soaring food and energy prices.   While the goal of the Administration was not to destroy the economy, look at what has occurred.   Speculators in stocks and commodities have thrived at the expense of taxpayers and millions of our citizens.

The latest Administration skirmish with the law of opposites was tinkering with the strategic petroleum reserve (SPR).  On June 23, the International Energy Agency (IEA), with full support of the Obama Administration, released 60 million barrels of oil from its reserves.  Fully half of these reserves came from the US.  Republicans and others claim that this effort was done for political reasons to lower pump prices for beleaguered consumers before the 2012 election.   See Global Oil Reserves Tapped in Effort to Cut Cost at Pump.  The Huffington Post applauded this maneuver.  While conceding 60 million barrels represents only 16 hours of worldwide oil consumption, prices dropped 6% and speculators were chastened.  See Strategic Petroleum Reserve Release under Fire – For Being Effective.

But the strategy was transitory, ephemeral, and ineffective.  By Tuesday, June 28th, both crude and gasoline prices surged past the price they had been at immediately before the June 23rd IEA release, a reprieve from higher oil prices of just five days.

Kevin Kerr, of Money and Markets predicts that the release will completely back fire, and will result in a dramatic spike in prices:

It’s another foolish rob-Peter-to-pay-Paul action by the imploding U.S. government.

The careless action taken by the IEA and President Obama, has now underscored how worried they actually are about global economic growth and tight supplies. So in essence this move could actually stoke the fire to drive prices much higher, much more quickly.

In a recent Bloomberg report, Caroline Bain, of the Economist Intelligence Unit, was quoted as saying:

“Although the immediate impact of the IEA’s reserve release will be to depress prices, in the more medium term, it could actually be bullish for prices. Reserves are finite and cannot be released forever.”

Unlike Uncle Ben’s printing press that never seems to run out of ink, oil supplies are not something the U.S. government can simply print more of.

To put the gravity of the situation in perspective, this is only the third time in the past 50 years that IEA has released strategic reserves. And in order to tap the SPR, President Obama had to authorize it.

Frighteningly, the prior two times resulted in super-spikes. And I think we can expect that record to hit 3-0 very shortly.  See Why Obama’s Desperate Move Could Send Oil Prices Soaring

Once again, the Administration undertook a policy shortcut for political reasons  and it backfired.  Further, we have renewed speculation in a key commodity.   Wouldn’t a more functional way to deal with high oil prices be to encourage supply increases through responsible exploration, and reduce demand through conservation?

Gimmickry

Unfortunately we live in the age of gimmicks.   If we could only find the right interest rate, the most robust stimulus package, the most flexible accounting rules, a way to get the stock market to boom, or the right oil price our economy would be healed and we would again be prosperous.   The law of opposites mandates that the longer we focus on the problem and tinker, the more those nasty, unintended, negative consequences will occur and move us further away from our goal.   Only hard work, thrift and political integrity solve these intractable problems, yet the Administration and the Federal Reserve keep searching for the quick fix.   As long as that is the case, we are doomed to more unintended consequences, shaky financial markets and a weak economy.

 

 

 

 

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21
Jun 11

Corporations: The Good and the Bad

In Are Corporations Really the Devil? we examined the concept of corporate profit maximization.  Corporations are essentially amoral in nature, pursuing economic efficiency for the benefit of shareholders. In this pursuit they exhibit both good and bad behaviors.  Since Charles Hugh Smith conflates corporations with the “work of the devil,” let’s begin with his thesis of the evil corporation.

The Bad

Having worked for thirty-plus years within the bellies of these beasts I can indeed report lots of bad stuff:

Greed – Executive compensation often dominates the corporate agenda.  It is a costly diversion, consuming the efforts of attorneys, consultants, accountants and senior management.  Management is often diverted from the more important job of running the business.  In the end neither shareholders nor the executives are satisfied.  The result of the process is that there are too many overpaid executives.  Few if any executives demonstrate the management acumen justifying such overly generous compensation packages.

Lack of Foresight – I could excuse large pay packages, if a senior executive had true foresight and talent in matters relating to the business of the corporation itself.  The record of too many CEOs?   They stayed in businesses which should have been sold, missed investing in and deploying new technologies, made horrendous hiring decisions, laid off employees when they should have been hiring, and were late in removing poorly performing executives.   A corollary truth to this realization:  many executives can competently perform their jobs, but few are visionary.  Few executives can follow hockey great Wayne Gretzky’s advice: “…skate to where the puck is going to be, not to where it has been.”

Careerism and Promotions – Many executives put their own career advancement over the good of their employees, fellow executives and the corporation.   And worse, business ethics and simple interpersonal courtesy and manners were routinely and very sadly lacking.   Bad corporate behavior includes:  withholding of critical information, undercutting colleagues’ efforts, and wasteful projects for self aggrandizement.  Many times bad behavior leads to ethical lapses and legal shortcuts that subject the company to expensive liability.

Many times the wrong person is promoted into a higher level job for all the wrong reasons.  The tireless self-promotion and undercutting of colleagues that some executives made their modus operandi sent terrible messages to good performing employees when these behaviors were rewarded with inappropriate promotion and aggrandizement.

Abnegation of Responsibility - When something in a corporation goes wrong, executives who accept blame and responsibility are few and far between.   It is the rare executive who accepts blame for a decision gone awry and takes responsibility for the cleanup.

Job Insecurity – When I began my professional life in 1977, there was excellent job security in corporate America.  Starting in 1981 and each and every year thereafter until I retired in 2009, my corporate employers and many others had work force reductions either through early retirement or layoffs.  It was a fact of life.  Accepting this fact, my belief is that one is paid up to date, and the corporation does not owe the employee lifetime employment.

Bureaucracy – A corporate hierarchy by definition is a bureaucracy. Myriad layers of corporate approval always slow innovation.  In the wrong environment, bureaucracy is a sure condition for good ideas to go nowhere.

The Good

Wealth Accumulation – Given the current state of our tax laws, corporations provide the average employee with a means for wealth accumulation.   Many companies have 401k savings plans, often with generous matching contributions, health spending accounts, defined benefit pension plans, employee stock purchase plans, and medical, dental, vision and life insurance plans.  In my experience a frugal secretary who took advantage of stock purchase and savings plans would be able to accumulate substantial wealth, often times in excess of a million dollars.

Freedom from Discrimination – With our wide range of equal employment and anti discrimination laws, employees of big corporations are largely free of discrimination.   Although much maligned, the human resources department does ensure that employees are treated in accordance with the law and that the workplace is essentially fair.

Training and Promotions – Corporations provide their employees valuable formal and informal training.  Further, many large employers pay for college and advanced courses, thus enhancing resumes and promotional opportunities, notably promotion from within, which increases seniority while maintaining job stability for an employee.    I worked with many secretaries and paralegals who completed college and master’s programs, and then were promoted into management.

Ethical Conduct – Corporations promulgate codes of conduct.  Corporations are serious about enforcing these codes of conduct, as ethical infractions could lead to criminal penalties and fines.  While everyone can point to Enron and WorldCom as counter examples, by and large corporations are ethical bastions with numerous controls in place (internal and external auditors, compliance and legal departments) to deal harshly with violators.

Balancing It All Out

Regulators – Mr. Smith believes that large corporations can bend compliant regulators to their will.   And yes, corporations are profit maximizers in any way they can be.  They are going to try everything within the law to shape the regulatory environment in their favor.   Mr. Smith fails to realize that this is not a one-handed game.  Industry competitors, consumer groups and other activists are also lobbying regulators to bend the rules in their favor.  One corporation cannot entirely shape a regulatory agenda.

Taxes – Commentators lambasted GE for investing in a huge tax department to avoid paying any US income tax.  In law school one of the strongest mantras is:  no taxpayer has an obligation to pay one cent more than is due.  If one does not like GE’s tax avoidance, change the tax laws.

Technology – Much has been made of layoffs, outsourcing and the dispensable employee.  Little thought has been given to the role of technology which has eliminated the need for many jobs. High speed communication innovations and faster, larger modes of transportation have made outsourcing of manufacturing and other jobs feasible.  Are corporations supposed to retain employees when the job no longer exists or is uneconomical to perform in the US?

Man versus Machine

Corporations are a legal construct.  They are created by humans and are flawed like humans.  On balance, they probably do more good than bad.  To particularize the current state of affairs, we live in a highly competitive, financially short sighted world. And knowing that means that the days of guaranteed employment, lush compensation and benefit packages, and benevolent corporations will not be returning in our lifetimes.  In the end I guess no one likes to contemplate the thought that we are all dispensable.

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14
Jun 11

Financially Malled

An inside page item in last week’s Wall Street Journal caught my attention:  Faded Malls Leave Cities in the Lurch. The article focuses on the recession’s effect on retailers and the decline of sales tax revenues affecting municipal budgets.   What we have is another cautionary tale about overly optimistic spending on urban malls.  Apparently, retailers have been willing to build even in the face of a glut in retail space, and now they are suffering the consequences.

A Litany of Woe

Sales tax receipts account for 23% of all state and local tax collection.  Unfortunately, in 6 of the last 10 years municipalities have witnessed worsening declines in this revenue source, with a decline of 6.6% in 2009 and 5% in 2010.    Much as experts would love to blame this sad state of retail affairs on the bad current economy, the facts of the decline may go much deeper and last longer:

…it is problem that will persist after a recovery, as demand for retail complexes is whittled by online shopping and the waning popularity of the big-box store selling everything from groceries to electronics.

“I am not sure cities can go back to playing the retail game the way they have over the past 25 years,” said William Fulton, mayor of Ventura, Calif., and editor of the California Planning and Development Report newsletter.  See Faded Malls Leave Cities in the Lurch

Neighboring cities have engaged in dysfunctional escalating competitions to build ever bigger malls.  To entice owners, cities have offered sales tax revenue sharing agreements, real estate tax abatements, development bonds with municipal guarantees and infrastructure improvement such as roads, and exit ramps from highways.

This largesse is now catching up with cities faced with worsening budget shortfalls.  In one example, Independence, Missouri, has used public funds to make a $3.5m debt payment for a local mall. It expects to make another $4m payment this year.  Plus, the city was forced to lay off and furlough employees to fund these payments.  In another case, Tracy, California, is paying Macy’s $2.7m to move into a local mall, this to prevent the mall from closing altogether for lack of an anchor store.

Goldilocks and the Wolves

Financial media trumpeted the 2000’s as the decade of the “goldilocks economy”: a virtuous cycle where low interest rates spurred the growth in the housing market, and then, derivatively, gains in other industries as well: mortgage bankers, investment bankers, second mortgage lenders, attorneys, appraisers, appliance dealers, builders etc.  Sales tax revenues increased, municipal budgets expanded, municipal workers hired and generous wage, pension and other benefit increases flowed.   The Federal Reserve not only spurred this cycle with low interest rates but kept them too low for too long.  This party continued unabated until the economy hit the wall in 2008.

The Wall Street Journal article failed to complete the story of the malls and municipal finance.  Not only are malls in trouble, but the homeowners who shop in them are in trouble. The two failing markets are symbiotically intertwined.  Foreclosures and falling prices only cut real estate taxes and collections.  The municipalities who extrapolated out endless prosperity now suffer the aftermath: insufficient revenues to make bond payments, obligations under union contracts for wage increases, and underfunded pensions, and active and retired health care liabilities.  The “virtuous cycle” of the “goldilocks economy” is now pernicious with a downward spiral of increased fees, reduced services and threatened defaults.

Finally, the article begs the question of what should be the proper role for government.  We can argue about whether it is to secure individual freedoms and rights, or to ensure the safety of the citizenry. Philosophy aside,  I would argue that government has no legitimate role in incenting shopping mall construction or wooing mall tenants.  Revenue sharing deals, tax rebates, infrastructure improvements and other incentives seem to transcend the proper role of government. Private entrepreneurship is just that, private.

The Wall Street Journal item is just one microeconomic issue in our post financial crash economy. Unfortunately, there are many more stories to tell like the follies of the mall.

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7
Jun 11

Unemployment and the Fall of Labor

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

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

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

The Fall of Labor

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

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

Implications

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

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

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

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

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

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

Our Next Steps

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

 

 

 

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4
Jun 11

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

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

Hitting Bottom?

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

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

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

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

Institutionalized Cynicism

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

Let’s examine Mr. Hintz’ moral bankruptcy:

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

A Glimmer of Hope?

Today the tide appears to be turning:

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

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

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

 

 

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30
May 11

Wildfires and the Economy

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

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

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

An Economy Managed Like a Wildfire?

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

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

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

Killing the Business Cycle

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

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

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

Let the Light In

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

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

 

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