Posts Tagged: TARP

American Society / Banking / Business / Corporate Behavior / Financial / Political / The Federal Reserve — 0 Comments
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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Banking / Corporate Behavior / Executive Compensatio / Justice System / Political / The Federal Reserve — 0 Comments
22
Apr 11

Over Compensating

Executive compensation is a “hot button” issue.  Corporate executives argue the need for a free hand in setting compensation:  we must attract and retain high performing executives.  They further argue that correctly tailored compensation creates appropriate incentives to increase shareholder value.  According to this thinking, this aligns management and shareholder interests.

Shareholder activist groups strenuously disagree.  Management over compensates itself, and awards senior executives hundreds of times the average worker salary.  Equity compensation (options, restricted stock grants) richly rewards management at the expense of diluted shareholders.   Even more egregious are executive compensation increases even when the corporation has a bad year or underperforms its industry peers.  Boards of Directors, who should be guardians of shareholder interests, are often too aligned with ineffective management. True confession: executive compensation issues comprised much of my career.  Generally, I agree with keeping the government out of the executive compensation process.  In my view, management knows its own business and knows the market for top talent. With Board of Directors’ review, advice and consent, let management set compensation and let the chips fall where they may.  Internal safeguards and shareholder activist groups inevitably punish bad or greedy managements.

However, there is one industry where the government needs to take an active role in setting executive compensation.

Is Goldman Sachs Allowed To Fail?

Simon Johnson, former IMF chief economist, asks the question:  if another financial crisis appears would Goldman Sachs be permitted to fail and follow the Lehman Brothers bankruptcy route?  See Could Goldman Sachs Fail? Johnson polled leading experts who unambiguously stated that Goldman would be bailed out again.  Goldman’s balance sheet at $900b would be just too big to permit bankruptcy.  Dodd-Frank legislation which has resolution authority to handle a large bankruptcy would be ineffective because of the international scope of Goldman’s operations.

While Goldman is one case study, Mr. Johnson could ask the same question about JP Morgan, Citibank, Wells Fargo or a number of other large American financial institutions. I believe he would get the same answer: they are too big to fail. Thus, the experts agree that these institutions have a favored position in the market place: they borrow at below market costs, and benefit from the full faith and credit guarantee of the US government.

A Modest Proposal or a Proposal for Modesty

Mr. Johnson posits that the only solution is to “press hard for higher capital requirements for Goldman and all other big banks.”  More capital would permit absorption of more losses in the event of a financial crisis.  Allow me to propose an alternative.

Goldman and other large banks pay out nearly half their revenue in compensation:  amazing that this practice has not received more government scrutiny.   As we know from Untimely News That’s Unfit to Print, the government is afraid to prosecute these banks for their financial misdeeds.  How about severely limiting executive compensation?

I can hear the howls from Wall Street now.  How can we attract the best talent?  This is antithetical to the principles of the free market!  Our work would not be properly valued!

When a bank accepts bailouts from the government (TARP), when it enlists the government to make good on derivative bets (AIG and Goldman), when it is subsidized by American savers through a zero interest policy, and when it receives a full faith and credit guarantee of the US government,  that bank is no longer a free market enterprise.  That bank is a ward of the state.  As such, its compensation should look more like the federal civil service pay scale.

Controlling and changing bank top management pay scales in this way would be hugely beneficial:

  • Banks would be able to retain more earnings, and immediately improve their capital base.
  • Shareholders would benefit as more cash would be available for dividend payments.
  • The productive economy could successfully compete for the best university graduates.
  • Wall Street firms would shrink.
  • Systemic risk of too big to fail institutions would diminish as would rent seeking behavior.
  • The real economy would flourish.

Perhaps we should start a new campaign:  Government Service Levels (GS) for Goldman Sachs (GS). Put more simply:  GS for GS.

 

 

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4
Jan 11

From Under-Reaction to Over-Reaction

DC Beltway insiders, abetted by their friends in academia, are expert at identifying and recommending political curatives for the ills of society. At the most sophisticated and effective level, punditry has a predictable genesis and trajectory.  First, from the chaos of all manner of the environment’s input, whether in universities or “think tanks” academics identify a societal problem that needs correction.  Many times, what follows is often widespread agreement that a problem exists and needs correction.  When that occurs, the process gains momentum, traction, attention and support from different constituencies.  Politicians whip up widespread public support.  Pundits produce inspirational articles and editorials in support of the corrective action.  Myriad examples emerge of the consequences of the unsolved problem.  Some examples may emerge of solutions to the problem, albeit solved on a finite, boutique, scale.  Soon we have groundswell support to “do something.”  We lobby, pass legislation, establish agencies and write regulations.  At the beginning all goes well, but soon problems arise. We experience administrative overreach, which is often worse than the original problem.  So what has begun as a good idea becomes misshapen beyond recognition and becomes its own societal problem. Some examples:

-          The problem: discrimination on the basis of race or sex.  The solution: Passage of the Civil Rights Act of 1964.  Starting with a simple corrective of ending discrimination we have built an administrative Rube Goldberg empire: the Equal Employment Opportunity Commission, the Office of Federal Contract Compliance, state anti-discrimination agencies. Soon class action and affirmative action programs were introduced as mandates.  Further, the Obama Administration now desires to expand the scope of anti-discrimination laws regarding the concept of equal pay for equal work to a new more troubling concept of “comparable worth.”  Employers are now beset with charges of discrimination and class actions. See ‘Comparable Worth’ Rears Ugly Head in Age of Obama

-          The problem: America lacks universal health care coverage.  The solution: The passage of Obamacare.  The law is byzantine beyond explication:

…the health system is complex, yes, but also ornate. The new law creates 68 grant programs, 47 bureaucratic entities, 29 demonstration or pilot programs, six regulatory systems, six compliance standards and two entitlements.

Getting that massive enterprise up and running will be next to impossible. So Democrats streamlined the process by granting Health and Human Services Secretary Kathleen Sebelius the authority to make judgments that can’t be challenged either administratively or through the courts.  See Obamacare Only Looks Worse on Further Review

The law has other consequences: 117 million current health care plan participants may need to change plans in 2013; 16 million new participants may be forced into Medicaid: Medicare benefits will be reduced to pay for the program; a 3.8% additional tax will be imposed on investment income; a 40% excise tax on “Cadillac” health plans and a $2100 increase for families buying private insurance plans.

-          The problem: Public employees need employment workplace protections. The solution: In 1962, President Kennedy extended collective bargaining rights to federal employees.  While federal employees could only bargain over working conditions, not salary and benefits, this precedent set the stage for widespread collective bargaining rights for public unions.  At the state and local level bargaining occurs over all issues.  Politicians have recognized the efficacy of acceding to union demands.

Thus, we have had an explosion in public sector salaries and benefits, especially lucrative pension plans.  As states and municipalities face huge budget deficits and massive pension plan underfunding, these entities are considering benefit cutbacks, bankruptcy and large tax increases.  The public, facing job insecurity or unemployment are revolting against increased taxes.  See Strained States Turning Laws to Curb Unions; Cash-Strapped States Seeks Laws to Curb Labor Union Power

-          The problem: The financial crisis threatens the solvency of US banks. The solution: The government ignores its own advice to the troubled Japanese financial system.  Instead of forcing the banks to write down bad assets, the government undertakes a costly and legally and economically dubious program of buying trouble assets.  It has  forced $700b dollars of funds on troubled banks, and continued to guarantee bankrupt Fannie Mae and Freddie Mac, and maintain a zero interest rate policy for over two years.   The economic consequences have been enormous:  unemployment near 10%; savers and retirees punished;  oil and other commodity prices exploded and the dollar substantially lower.

Taking it to the Limit it Too Many Times

We have lost the ability to identify a societal problem and implement a measured and thoughtful solution.  We have also lost the ability to forebear, take no action and let the problem work itself out.  We move from under-reacting to over-reacting.  Over-reacting imposes enormous costs on society.  Thus, we have backlashes against affirmative action, a move to repeal Obamacare, tax revolts against the privileged financial protections afforded to public employees, and simmering resentment toward Treasury and Federal Reserve policies which favor Wall Street over Main Street.

Perhaps in matters of important policy, more thoughtfulness, realism and humility, rather than brash hubris and impulsiveness, would restore confidence in both our government and our economy.

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26
Apr 10

Let It Be

When I find myself in times of trouble
Mother Mary comes to me
Speaking words of wisdom, let it be

And in my hour of darkness
She is standing right in front of me
Speaking words of wisdom, let it be

“Let it Be” – The Beatles

Over the years, I led or was a member of the inner circle of many high level corporate crisis teams.  A problem or crisis challenges many a senior business leader to immediate action.  Enshrined in books on leaders is the leader who embraces action rather than “thinking more and reacting less.”  The unfortunate corollary ethic is that inaction is weak, unmanly, lazy or worse.  Even more dramatically, many times, a problem creates an adrenalin rush that is antithetical to rumination or reflection.

An entire lexicon fuels this response to problems and crises.  The language itself has military connotations: we are calling general quarters; battle stations;  red alert; the bunker mentality.  We need to deploy our troops, plot a strategy or prepare a measured response.  We applaud bold action and deride thoughtfulness.

Rarely does a leader publicly pause, reflect, and ask:  “What if I do nothing…what if I let it be?

Reaction to the Financial Crisis

Both the Bush and Obama administrations overreacted to the financial crisis.  In short order, they created TARP and an alphabet soup of borrowing programs. The government then impulsively guaranteed close to $23 trillion of debt. Compounding the folly, the government became a partner in GM, Chrysler, AIG and Citicorp.  Stimulus programs barreled through Congress bringing us first time home buyer credits, “cash for clunkers,” and interest rates at or near zero.

What If?

What if the government had done nothing when the crisis exploded into the public’s conscientiousness?  We purport to be a capitalist economy whose basic tenet is simple and understandable:  reward risk that succeeds, punish risk that fails.  The necessary adjunct to this tenet makes perfect sense:  punishing failure encourages the capitalist to be careful with his assets, thus limiting misallocation of funds. Unfortunately, what has happened in the US economy is not capitalism: successful enterprises are forced to compete with failed, government propped up ones. And new capital will not be available for new enterprises.

If we did nothing it would be painful for a short period of time.  Yes, there would be hardship, unemployment and business failures. However, the self correcting nature of capitalism would mitigate the length of the hardship, as capital would rapidly re-deploy to successful and new enterprises: an economic version of “no pain, no gain.”  Instead we have persistently high unemployment, “zombie banks” afraid to lend and, compared to prior recoveries, sub optimal economic performance.

Legislative Reform

In response to problems in health care the current Administration rammed through a complex, little understood health care proposal.  We know taxes will rise dramatically.  We have no idea how costly, efficient or effective the new health care system will be.  Given typically heavy handed government involvement, I am not optimistic.   Nancy Pelosi’s comment that we need to pass the bill so we can find out what is inside is not exactly a confidence builder.

Similarly, the Administration is trying to pass another gargantuan and little understood financial reform bill.  I have been critical in other essays about the financial institutions that got us into the financial crisis, but there are laws on the books right now that would go a long way to curbing some of the excesses.  We simply have to enforce them.  Another simple fix: reinstate Glass Steagall, which separates commercial banking from the securities business.

Stop the Committees Who Saved the World

In 1999, Time Magazine featured Robert Rubin, Alan Greenspan and Lawrence Summers as the Committee who Save the World from a global financial meltdown. What if there had been no Committee to Save the World?  A smaller failure in 1999 might have led to a more chastened financial sector.  Perhaps sub-prime lending, overbuilding in residential housing and commercial real estate,  the 2008 stock market meltdown and now the potential for sovereign debt defaults in Greece, Spain, Dubai and other countries would not have taken place.

Our current “Committee to Save the World” (Geithner, Bernanke and Summers) is certainly falling short of the mark. Perhaps our bold men of action should be a lot less bold, a lot more thoughtful, reflective and yes, inactive.  Might we all be better off?  In the immortal words of the Liverpool Philosophy Society (AKA the Beatles) could we not just “Let It Be?”

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10
Mar 10

Are We a Socialist Country?

Europeans and Russians are socialists.  Americans are staunch capitalists.  Maybe all it took was a financial crisis to reveal the slide toward socialism in America.  During the Cold War, faced with a military threat from the Soviet Union, Americans would rather have died than become socialists:  better dead than red.  Unwittingly, we now invite socialism into our lives.  Ironically Wall Street firms and large industrial corporations, the purported bastions of capitalism, have paved the way to socialism.  A left-leaning Administration has been only too happy to oblige.

The Slippery Slope

The road to hell is paved with good intentions.  I do not think any of the pillars of our economy intended that the country become socialistic.   Each entity was merely maximizing its own position, seeking to enhance shareholder value.   When financial crisis hit, our formerly capitalistic businesses could not rush to Washington fast enough to seek support, bailouts and guarantees from the government.   The government was only too happy to oblige with the passage of TARP and then an alphabet soup of government support and guarantee programs.  In one short crisis period from summer 2008 to spring 2009, the government ignored 200 years of American economic and constitutional history to save a group of greedy and profligate bankers and industrial corporations.   The end result: we privatized profit and socialized losses.

A Factual Progression

Here are the events that have taken us on the path to socialism:

  • The Federal Reserve’s active role in the forced sale of Bear Stearns to JP Morgan
  • The Government seizure of Fannie Mae and Freddie Mac
  • TARP:  Government purchase of troubled assets from private financial institutions
  • Goldman Sachs and Morgan Stanley become banks by expedited process  to obtain government guarantees
  • Government seizure of AIG and complete payback to private institutions for credit derivative losses
  • Federal Reserve intervention in broker mergers, with guarantees against losses (Washington Mutual with JP Morgan, Wachovia with Wells Fargo)
  • Federal Reserve intervention with $1.3 trillion in loans to companies outside the financial sector (GE).
  • Government removal of management at GM and Chrysler
  • Restrictions on executive pay for banks receiving bailout funds
  • Government restrictions on foreclosures unless there has been a Home Affordable Modification Program review.
  • Administration desperation to pass comprehensive health insurance program.   See Timeline:Global  Economy in Crisis

How Did We Get Here?

We invited the devil in the door.  Banks claimed that they could not withstand loan and derivative losses.  Unemployed Americans wanted extensions in unemployment benefits and stimulus programs.  Nobody wanted to see the stock market crash and their portfolios and retirement plans decimated.  Big business wanted the profit opportunity in universal health care coverage.  Insurance companies did not want to hurt their policy holders.  Auto workers wanted to maintain their rich union contracts.  The litany goes on.

Once we were a brave, independent and self-reliant nation.  Now when adversity strikes our first inclination is to blame others and call Washington for a bailout or a handout.  I do believe in the concept of welfare.  Welfare was meant for the truly dire circumstance, the impoverished citizen. Welfare was not meant for auto workers to maintain above market wages and job guarantees, banks to get paid in full for risky derivative bets, GE or GM, homeowners who falsified their income disclosures to remain in McMansions or every insurance policy to be paid in full.

Capitalism is about freedom, risk and failure.  Without failure there can be no progress.  The slide toward socialism is an escape from freedom and ultimately an end to progress.

My European immigrant grandfather lived through the Depression, World War Two, and into the 1980’s.  He once told me he was most proud that he never went on relief (welfare).  We should return to the ways of our forbearers, regain our mettle and become too proud to ask for a handout or bailout.   Our freedom and that of our children depend on it.

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19
Jan 10

Citigroup, Branch Rickey and the Theater of the Absurd

In 1951, Pittsburgh Pirate Ralph Kiner led the National League in home runs, but his team lost 112 games and finished last.  In response to Kiner’s request for more money, legendary general manager Branch Rickey said: “We finished last with you; we can finish last without you.”

Where is Branch Rickey when you need him?

Citigroup 2009 Earnings

This morning Citigroup announced that it lost $7.6b in the fourth quarter of 2009 and $1.6b for the full year. The Wall Street Journal pointed out the positives: better than last year’s fourth quarter; narrowing losses in the consumer credit area; greater efficiencies and financial stabilization.

The main stream media seems determined to make poor performance sound better than it is. I guess we don’t want to ruin the self esteem of executives, who are trying really really hard.

What the media fails to point out is that Citigroup has been given every financial advantage.  The government has given it TARP funds, participates in its capital structure with a 34% ownership stake, and has permitted the bank to mint money with a zero interest rate policy.

Citigroup Bonuses

Citigroup announced a bonus pool of $24b and the media again has obfuscated the real story.   The headline in the Times Online (London) is: “Citigroup Cuts Compensation by 20% as Losses Fall.”  Dig into the story a little further and there is virtually no reduction in compensation.  Because of layoffs the compensation pool of eligible executives has been reduced by 18%.  Thus, the compensation pool is virtually flat year over year.  The company has lost $1.6b this year and $29.2b over two years.

The CNBC corporate apologists attempted to justify the bonuses: there was improvement, Citicorp needs to retain executives to remain competitive, and the bonus will be paid in stock.  One commentator did point out that the stock was immediately vested, and therefore indistinguishable from a cash bonus.

There was a Different Time

I have written about disconnecting effort and reward. See What Went Wrong? Disconnecting Effort and Reward. Citigroup results have made me think that we have also disconnected results and rewards.

In a different time, I worked for a company that one year paid no bonuses.  That year we had poor financial results, but did not lose money.  Based on the poor results, the Chairman and CEO engaged in no handwringing, no excuses, no attenuated intellectual justifications nor elaborate proofs. He merely reached the conclusion that poor performance equaled no bonus – amazing in its simplicity.  As a result, very few executives voluntarily left the company, the world did not end, we all worked harder, and did better the next year.

Maybe Mr. Pandit, Citigroup CEO, should channel his inner Branch Rickey and eliminate all bonuses for 2009.  His reply to whining executives who threaten to quit: “we lost $29.2b with you; we probably could have lost $29.2b without you.”

Branch Rickey applied one other perfect aphorism to a non- producing, disruptive ballplayer:

“It was addition by subtraction.”

Too bad Mr. Rickey is not around to advise Citigroup.

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