Posts Tagged: Wall Street

Financial / Political / Tax Policy — 0 Comments
28
May 10

Taxing the Crude

The government is running deficits in excess of $1.6 trillion this year and projected to run trillion dollar deficits for much of the decade.  In the midst of it all Wall Street firms still earn outsized profits and bonuses.  Much of these profits can be directly traced to generous government policies, like zero interest rates which allow virtually risk free profits.   Hedge funds receive favorable taxation rates.   Government also provides other benefits to banks, hedge funds and other firms.

Given all this largesse from  Uncle Sam, why not seek tax revenue from these beneficiaries; namely,  a windfall profit tax.

The Precedent

In response to the Arab oil embargo and deregulation of the domestic oil industry, Congress passed the Crude Oil Windfall Profit Tax of 1980.  Unique factors led to this law:

• Congress was concerned that the domestic oil industry would reap enormous revenues and profits as a result of the deregulation of price controls to allow domestic oil to reset to world oil price levels. Congress believed that the projected huge redistribution of income from energy consumers to energy producers would not be fair.

• Congress also felt the industry was not paying its fair share of federal taxes. The oil industry’s low effective income tax rates were due to the availability of two oil industry tax subsidies (incentives): the percentage depletion allowance, and the provision which permits companies to expense (deduct fully in the initial year) the intangible costs of drilling.

• In addition, Congress was looking for additional sources of revenue. Between 1961 and 1979, the federal budget was in deficit in every year but one (there was a small surplus in FY1969). The Congress’s Joint Committee on Taxation projected the tax would generate, from 1980 to 1990, additional gross revenues of approximately $393 billion.

In 1988, the act was repealed. See Windfall Profits Tax

Oil versus Wall Street

We need oil.  But it is exorbitantly expensive and dangerous to extract.  Moreover, we have to transport, refine, and distribute what we extract.  And if we are honest about it, we do not even know what unknown technological or environmental consequences may face us in the future.

Compare this effort to business on Wall Street.  Sitting in climate controlled offices surrounded by lawyers, MBAs, sales representatives and massive government support, these white collar people earn profits in a virtual monopoly.  In fact, four firms had perfect trading records for the first quarter.  See 4 Banks Score Perfect 61-Day Run. The government had no compunction about levying a windfall tax on the far riskier oil industry.  Why not tax the government-coddled Wall Street firms?

We are at a propitious time to impose a windfall profits tax on these Masters of the Universe.   A new rallying cry: don’t tax just crude oil, tax crude financial profiteers.

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American Society / Banking / Executive Compensatio / Financial / Political / Regulation — 0 Comments
2
Mar 10

Goldman and the Winner Take All Society

Finally, Goldman Sachs has gone too far.  In A Reputation as Good as Goldman?  Part I, we discussed Goldman’s selling of mortgage backed securities, and its role in the current Greek budget crisis.  These activities clearly contributed to its self-inflicted reputational damage.

Perhaps the hubris went further.   Does Goldman believe that its status as a favored Federal Reserve “too big to fail” firm will insulate it from government investigation? Last week Ben Bernanke put a dent in Goldman’s Teflon shield:

Ben S. Bernanke, the Federal Reserve chairman, told Congress Thursday that the Fed was ‘looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece.’

Mr. Bernanke said the Securities and Exchange Commission was also concerned about how derivatives — financial instruments that are largely unregulated and do not trade on public exchanges — have contributed to Greece’s problems. ‘Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive,’ he said. See In Greece’s Crisis, Fed Studies Wall St.’s Activities.

In Is Goldman Finally About to Be Leashed and Collared? Yves Smith observes and analyzes Goldman’s corporate culture.  As a former employee, she reports on colleagues’ piggish and overly aggressive behavior. But in an otherwise excellent post, I believe she overlooks the role of current compensation systems.

Pay Practices and Reputation

In previously discussing the banking crisis, we pointed out a fundamental principal: you get what you incent.

Banks were interested in generating upfront fees. Incentives were predicated on “making the deal.”  The best way to make a deal was to ignore the creditworthiness of the borrower.  The banker who made the bad loan suffered no personal financial penalty.  There was no “skin in the game.” Why not write as many loans to poor credits as possible? See Hard Truths from the Banking Crisis.

The Goldman culture incents a “winner take all” mentality.  Since it is a public corporation rather than a partnership everyone is an employee.    A highly mobile employee rather than an owner is far less concerned about the firm’s long term reputation.  That employee wants to maximize current compensation; worrying about future consequences is for suckers.  Drawing on this paradigm, we are not shocked by headlines excoriating the firm for trading against its clients’ interests, shorting the municipal bonds it helped underwrite, skirting EU rules, or tanking the housing market.

Goldman operates in a larger Wall Street and indeed general culture that encourages greed at the expense of overall civic good:

  • Successful hedge funds report individual earnings in the hundreds of million dollars per employee.
  • Loyalty is dead.  Employees change firms. Highly paid athletes change teams without a second thought.
  • The media treats great wealth as reason for great celebrity.
  • Compensation validates individual worth.
  • Government backstops losses and allows gains to remain private.
  • The zeitgeist promotes: “I better grab as much as I can now before the economy implodes.”

Does It Have To Be This Way?

Any alert Board of Directors should be asking some difficult questions.  Why aren’t we concerned about the long-term firm reputation?  What do we want the corporate culture to be? Just because we can legally do a transaction should we be doing it?  How do we blend partnership-based personal accountability with a public corporation structure?   How do we get employees to care about the long-term view?  How do we meet the competitive threat of hedge funds and private equity without damaging corporate reputation? How does our compensation system comport with these concerns?

Yves Smith noted that it was as dangerous for anyone to get in the way of a Goldman employee and a profit making opportunity as it was to get between a predatory animal and its kill.  Goldman has managed to get itself between a very worried Obama Administration and a very angry public.  How ironic if the Goldman predatory lion becomes the Administration sacrificial lamb.

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18
Feb 10

A Reputation as Good as Goldman? Part I

Part I of II in a series. Part II here.

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Arguably the greatest living investor, Warren Buffet, clearly valued a person’s or an organization’s reputation.   In 2008 Buffet was the “white knight” investor for a struggling Goldman Sachs, investing $5b in the firm.  A mentor of mine had wise complementary counsel to Buffet’s:  when providing legal advice, be sure that you would be comfortable if that advice were to appear in a New York Times, Washington Post or Wall Street Journal front page article.

We live in  an age of greed, and indeed supreme irony.   Perhaps Mr. Buffet never shared his wise advice with the senior management of Goldman Sachs.  Worse, maybe he did and they ignored him.  In any event, how has Goldman’s reputation fared?  Let’s examine three separate front page New York Times articles.

Banks Bundled Bad Debt, Bet Against It And Won (NY Times, December 24, 2009)

Goldman Sachs sold mortgage-backed debt securities to pension funds and insurance companies. To hedge their position and to profit from a decline in the housing market, Goldman created a synthetic derivative security called Abacus. This second security was a direct bet against the position of their institutional clients. The mortgage-backed debt securities sold to the institutional clients performed poorly, with losses in the billions. Some of the original securities were of such poor quality that losses occurred within months of issue. Goldman created these synthetic securities well in excess of any hedging needs, permitting it to profit handsomely at the expense of its institutional clients.  The obvious ethical problem was succinctly stated:

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

The SEC and other governmental agencies are investigating Goldman and other firms to determine whether or not they violated “fair dealing” rules.

Testy Conflict with Goldman Helped Push A.I.G. to Edge (NY Times, February 7, 2010)

AIG insured some of Goldman’s complex mortgage securities.  When the housing crisis deepened, AIG paid Goldman $2b to cover potential losses. AIG later asserted that Goldman had inflated the potential losses and sought monies back. Goldman countered that it was due even more money.  The SEC is now looking into whether or not Goldman’s demands for loss coverage depressed the mortgage market and hastened AIG’s demise.

In another supreme irony, after the government took over AIG, Goldman received an additional $12.9b from taxpayers, one hundred percent of expected losses.

Wall St. Helped to Mask Debt Fueling Europe’s Crisis (NY Times, February 14, 2010)

Goldman’s questionable financial maneuvers were not confined to the United States.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting.

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

European authorities are looking into the role of Goldman and others in skirting EU rules.

Is There Another Way?

Has the American public been lulled into believing that this is an acceptable way of doing business, or do we require the people involved to be publicly excoriated, tried, convicted and jailed before we acknowledge their tactics were shabby?  Is Goldman Sachs an institution now synonymous with crafty machinations and greedy outcomes? Are its tactics symptomatic of a Wall Street “disease?”  Is there an alternative way of doing things?  Does reputation matter?  Part II will examine these issues and possibilities.

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8
Dec 09

War on Prudence

Dear Prudence, won’t you come out to play
Dear Prudence, greet the brand new day

“Dear Prudence” – The Beatles

Lately, “prudence” is a virtue which has been in short supply.  Prudence is defined as “care, caution, and good judgment, as well as wisdom in looking ahead….”  This virtue has fallen into such disrepute that the American political and financial establishment have undertaken a war on prudence.  Closely allied to prudence are the virtues of thrift and savings.  Alas, these two handmaidens have also fallen on hard times.

Ignoring this virtue will only prolong the recession and economic malaise.

How We Got Into the Current Mess

Economic policy makers have exceptionally short memories.  We are in financial crisis because Americans took on too much debt and over consumed housing, autos, plasma televisions and stocks.  Americans also failed to save. Wall Street behavior made the crisis worse though reckless lending, highly leveraged trading and esoteric derivatives.

In short, we spent and borrowed too much and did not have the incomes to support the residual debt load.  We entered into what the late economist Hyman Minsky referred to as Stage 3 Ponzi finance.  That is, lenders knew that the debt could not be repaid based on the borrower’s income, yet they speculated on being repaid from presumed, ever increasing asset appreciation. For a longer discussion see Hoisington Investment Management, Quarterly Review and Outlook, 3rd Quarter 2009

Have the past two years ended the Ponzi finance system?

Back Doing Business at the Same Old Stand

The Obama and Bush administrations faced clear policy choices. Government could have encouraged savings, debt repayment and reductions in consumption.  Un-payable debts would have defaulted and yielded whatever the market would bear in negotiated settlements or bankrupt proceedings.  The choice would have been painful.  But markets and the economy would have reset.  Prudence on a personal and national level would have been restored.

Government’s alternate choice is now clear: reflate the bubble economy so we can party again as if it were 2005.  Mark to market accounting was suspended.  The Fed bought mortgage backed securities and other dubious debts at or near full value.  The large banks, credit card companies, GMAC, AIG and others were bailed out.  Where was Prudence?  Nowhere to be found!

Keeping interest rates at near zero punished the thrifty and encouraged an ill-equipped public to return to an overvalued stock market and speculate in commodities or high yield debt instruments.  On the consumption side the government encouraged home purchases through tax credits for new homes and cash for clunkers.

Prudence in Hiding on Wall Street

Prudence remains in hiding on Wall Street.  After accepting (and we now learn needing) government funds and guarantees, Wall Street is back to high risk, highly leveraged trading.  Goldman Sachs lost money on only one day in the last quarter.  Instead of thanking taxpayers by demonstrating proportionality and humility in compensation practices, Wall Street will pay itself record bonuses this year.  Perhaps the prudent course would be for these firms to reduce compensation levels and retain some of these record profits before the next storm.   In addition, why not force executives to have some personal risk through mandatory deferrals of compensation to incent more prudent long term behaviors.

Sometimes it is Characterological

Prudence is one of those old-fashioned values that have fallen out of favor.  Prudence requires delayed gratification, the acceptance of occasional loss and the accumulation of wealth slowly based on hard work and careful consumption.  But our current government policy is a reflection of us:  wanting a “quick fix” and a “do over” for the imprudent who lent and invested recklessly.  In sparing Wall Street pain, we have managed to inflict pain on the entire American economy: barely any growth in GDP, unemployment still at 10% and ever growing deficits which will tax future generations.

Maybe when the current course of action totally fails, we can get Dear Prudence to come out and play.

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Business / Political — 0 Comments
29
Sep 09

Why not Reengineer Government?

I have been accused by some of my readership of being unduly negative, offering problems but no solutions.  In service of a remedy, a proposal: faced with huge deficits and proposed federal and state tax increases, why not reengineer government?

What is Reengineering?

Reengineering is the fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical, contemporary measures of performance, such as cost, quality, service and speed.  Back in the 80’s I met the man who coined the term, Dr. Michael Hammer.  At the time, American companies created elaborately overstaffed and redundant bureaucracies. One department of a corporation had no idea what another department was doing.  Many times they were both doing the same thing.  It was also the dawn of leveraged buyouts and corporate takeovers.  Either companies became “lean or mean” or they were takeover targets.

The need for reengineering was encapsulated in Gordon Gekko’s speech (Wall Street-1987) at the Teldar Paper shareholder meeting:

Teldar Paper has 33 different vice presidents each earning over 200 thousand dollars a year. Now, I have spent the last two months analyzing what all these guys do, and I still can’t figure it out. One thing I do know is that our paper company lost 110 million dollars last year, and I’ll bet that half of that was spent in all the paperwork going back and forth between all these vice presidents. The new law of evolution in corporate America seems to be survival of the unfittest.

Applying a good measure of common sense Dr. Hammer and his team examined business processes and determined where overlapping functions could be eliminated and consolidated.  His focus was to eliminate unnecessary work and make the core functions operate more efficiently.  The result often was better service, fewer but more focused employees and ultimately happier customers.

A Stroll by the Department of Commerce

Around the same time, during my work on a case in Washington, DC, I went on a stroll past the US Department of Commerce. In an ugly, New Deal building overlooking the Mall, there were thousands of offices, some with window planters. These folks looked like they had settled into their careers for the next 30 or 40 years.  What did these people do? More importantly now, what do we need them to do?

Between 2004 and 2008 employment in the US Department of Commerce increased 10%, from 30,000 to over 33,000 employees.  The mission of the Department is stated as:

a. Participating with other Government agencies in the creation of national policy, through the President’s Cabinet and its subdivisions.
b. Promoting and assisting international trade.
c. Strengthening the international economic position of the United States.
d. Promoting progressive domestic business policies and growth.
e.Improving comprehension and uses of the physical environment and its oceanic life.
f. Ensuring effective use and growth of the Nation’s scientific and technical resources.
g. Acquiring, analyzing, and disseminating information regarding the Nation and the economy to help achieve increased social and economic benefit.
h. Assisting states, communities, and individuals with economic progress.

I am using Commerce for illustrative purposes, as they oversee many valuable functions such as the census count, the national weather service and the patent and trademark office.  But do we need a federal bureaucracy to promote economic programs, coordinate faith based community programs, advance scientific technology?  It also raises the question of overlapping functions with other federal agencies such as State, Treasury, Defense, and Labor.

The Golden State – California Dreaming

California is mired in a deep budget crisis threatening to bankrupt the state. Nonetheless, the legislature has chosen the path of budget cuts rather than reengineered state agencies. A could be the question of why governmental regulation is even needed in all these areas. One enterprising blogger has catalogued 489 separate California state agencies.  There are commissions, bureaus and agencies on seemingly everything from funerals and cemeteries to cultural resources to the status of women. At one time each agency, commission, council or bureau served a purpose.  But each now has its own political constituency fighting for its preservation.

The Reengineering Solution

Unfortunately, Michael Hammer passed away last year. However, many carry on his work.  One does not have to be an expert to see that applying the principles of reengineering would improve governmental efficiency and public service. Most importantly, it would ameliorate the need for increased taxes.  Government is quick to criticize business for its excesses. It is time for business and concerned citizens to make government also earn its way.  Perhaps, Michel Douglas could be enticed to make a new movie: Sacramento: the Sorrow and the Pity or Nightmare on Capitol Hill.

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