Posts Tagged: crony capitalism

American Society / Corporate Behavior / Financial / Political / Tax Policy — 0 Comments
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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Banking / Economics / Financial / The Federal Reserve — 0 Comments
6
Oct 10

Why is Charles Schwab the Only One Concerned About Zero Interest Rates?

Charles Schwab, father of discount brokerage, again raised the insanity of a zero interest rate policy.  Writing in the Weekend Edition of the Wall Street Journal, Enough with the Low Interest Rates, Mr. Schwab succinctly states his views:  the Federal Reserve’s experiment with near-zero interest rates,  begun after the credit crisis of 2008, has now become counterproductive.

As a temporary fix it served its purpose. It was an emergency antibiotic appropriate for the illness. But continuing with the experiment is disfiguring the economy and fueling doubt. Healthy economies find their own equilibrium based on market forces of supply and demand. When people don’t think market forces are driving the economy and believe instead that it is being driven by excessive government intervention, they don’t take the risks an economy requires.

It’s time to stop the experiment and return to monetary normalcy.

Interestingly, Mr. Schwab wrote an op-ed piece six months ago for the Journal on low interest rates; Low Interest Rates are Squeezing Seniors.  His argument: “[t]oday’s historically low interest rates may be feeding banks’ profitability, but they are financially starving our seniors.” Despite his first article, the interest rate on the benchmark 10-year Treasury bond has declined from just under 4% to just under 2.5%.  Source Yahoo Finance.  Perhaps in order to achieve a better result, Mr. Schwab should write on weekdays when Mr. Bernanke can read the Journal at his Federal Reserve office.

In the most recent op-ed, Mr. Schwab makes the following points:

  • Near zero interest rates weigh on both business and consumer confidence.
  • Banks are able to make money through the carry trade (borrowing short term money at low interest rates and buying higher yielding, longer dated treasury securities).
  • The carry trade impedes making loans in the real economy and slows the velocity of money.
  • Savers, especially retirees are hurt, with diminished spending power.
  • Society is driven to seek out riskier investments to try to improve yield.
  • Job growth, consumer spending, business investments are not improving.
  • Small business is unable to borrow since banks merely “sit on” excessive reserves.
  • Banks are afraid to lend for 30-year mortgages since they are fearful of a future increase in interest rates once this “temporary” zero interest rate regime ends.

Mr. Schwab believes that the economy is ready to heal, if institutions just let interest rates find their market-based level.

It Is More Than Confidence

Mr. Schwab identifies that low interest rates are a problem.  He views the problem as one of confidence.   That is, the Federal Reserve, by keeping interest rates artificially low, signals to the markets that the economy is weak and in need of the perpetual stimulus of low interest rates.  In contrast, I believe that we have a different problem, constant government tinkering and meddling in the economy.  The economy could heal if the Administration and the Federal Reserve would stop picking the economic winners and losers, and let market forces perform their historical function of allocating capital and punishing the profligate.  Instead, the Federal Reserve has chosen the following path:

  • Favoring banks over savers
  • Preventing creditors from suffering any losses, not permitting the bankrupt to go bankrupt
  • Artificially propping up the housing market
  • Artificially propping up the stock market
  • Depressing the yield on virtually all debt instruments

This is not just supposition; it is confirmed in an October 4 speech by Brian Sack, Executive VP of the Markets Group at the NY Federal Reserve Bank.  Through manipulating interest rates, Mr. Sack believes that he has found the magic cure for the economy: “[t]hese effects on Treasury yields appear to have been transmitted into lower rates on private credit instruments and higher asset prices more broadly.”   Managing the Federal Reserve’s Balance Sheet. The Federal Reserve believes that it can levitate stock market and housing prices with no consequence.

Hubris

“Whom the gods would destroy, they would first make mad.” Medea by Euripides

On Monday October 4, Mr. Bernanke made two speeches and Mr. Sack made one.   It is not a matter of confidence impeding the economy as postulated by Mr. Schwab.  First, it is the hubris of the Federal Reserve that it can control a $14 trillion economy and $50 trillion dollars of US assets through zero interest rates or asset purchase programs.  They may have better luck trying to control the tides.  Second, it is crony capitalism, where politically connected financial institutions, public sector unions and unionized industries such as auto manufacturing are favored to the detriment of savers and Main Street.   Finally, it is the refusal to allow debt to be written off, homeowners default, banks and companies fail, or the stock market to fall to cleanse the system.

As we have discussed before, all irrational structures fail.  See Why Do all Irrational Structures Fail? Unfortunately in capitalism there is no free lunch; artificially bolstering the markets will fail too.   Hardships occur. But the self correctives of lower prices for housing, stocks and bonds and higher interest rates are the only way to re-start the economy.  More than financial chicanery, a return to the basics will restore the confidence that Mr. Schwab seeks.  Mr. Schwab should not be the only one criticizing Federal Reserve policy.

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American Society / Banking / Business / Financial / Political — 0 Comments
28
Dec 09

Trust Once Lost

My college history professor had an astute observation: “trust once lost cannot be easily regained.”  Naked Capitalism has two excellent posts today: “Is Blaming AAA Investors Wall Street Serving PR?” and “Has Obama Been a Success despite Suspicions of Crony Capitalism?” A common theme that both articles fail to fully articulate is– trust.  Trust is a commodity everyone now sells short.

Wall Street’s Treatment of Investors

In “Is Blaming AAA Investors Serving Wall Street PR?” Thomas Adams argues that Goldman Sachs and other clever bankers are pinning the blame on institutional investors who bought AAA-rated, collateralized debt obligations. Many of these securities turned out to be worthless. The investment banking community argues “caveat emptor,” but Adams convincingly rebuts:

The argument that the CDO market blew up because it was so complex and speculative is fundamentally flawed. Believe it or not, the bonds that caused the damage to AIG, the bond insurers, and banks were not highly speculative, high risk bonds. They were AAA securities and were supposed to be virtually free of credit risk. In many cases, they were “super senior” bonds – meaning they had another layer of protection above the AAA level to make them even safer than regular AAA bonds.

AAA securities were meant to be easily understood by any investor.  These products should not have required sophisticated analyses as Goldman and others now argue.

Adams cuts to the heart of the investment banker’s sin:

The problem with the CDO market, and a good chunk of the financial crisis, is that the participants took complex, highly volatile, highly risky and highly leveraged assets and passed a magic wand over them to turn them into AAA. Unfortunately, this process did nothing to remove the volatility, risk, complexity or leverage (in fact, the CDO made all of these worse). From the very start, the market for AAA CDO bonds backed by ABS collateral was a fraud….

Most telling is that the same investment banks selling these investments as AAA securities were simultaneously shorting the same securities to profit from their eventual default. See Banks that Bundled Bad Debt Also Bet Against It.

This is the new age of investment banking.  Would Sidney Weinberg the legendary head of Goldman Sachs bet against his own clients? I suspect not. Mr. Weinberg understood the basic value of trust.

What Price Success?

The Obama administration is extremely proud of stabilizing the economy.  In “Has Obama Been a Success Despite Suspicions of Crony Capitalism?” Edward Harrison addresses the large gap between the President’s words and deeds. Harrison bypasses Obama labels — liberal, a closet republican, technocrat — and instead examines the evidence:

The evidence, therefore, tends to demonstrate that we have witnessed an orchestrated campaign by the Bush and Obama Administrations to recapitalize too big to fail institutions by hook or by crook, bypassing Congressional approval if necessary. And when it comes to healthcare, both Congress and the White House have bent over backwards to keep the lobbyists onside. As I see it, our government has favored special interests in the past year of Obama’s tenure to our detriment.

Thus, banks or pseudo-banks are guaranteed survival (e.g. American Express, GE, Goldman Sachs and others) while Main Street (small businesses and community banks) is pushed to the back of the economic assistance line.

And consider other erosions of public trust by the Obama Administration:  an alphabet soup of federal guarantee programs, sham bank stress tests, suspended accounting rules, and favoritism toward health insurance companies and big pharmaceuticals in the current health care debate.

The Age of Cynicism

We live in an age of flawed short term thinking.  How do we make our numbers for the next quarter? How do we get through this financial crisis? How do we get a health care bill passed so we can claim victory? How do we win the 2010 elections?  Each “success” comes at a very high price.  America is a carefully woven social contract with trust as its bedrock.  But increasingly, cracks now appear in this bedrock of trust just when it is most needed.  Will public trust be completely gone when the inevitable next crisis occurs?

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