Saturday, March 28, 2009

Put the glasses on! Put 'em on!

Apparently the head photographer for BusinessWeek was convinced by... perhaps Roddy Piper... to "put on the glasses," and has revealed who's really controlling the nation:

Zombies Rule America

They Live!

Thursday, March 26, 2009

Sacramental... Beer?

It's so hard to keep young people interested in religion these days. Got any ideas?
Legislation allowing underage Jews to drink beer during religious ceremonies has sparked widespread support in the Arkansas Legislature and puzzlement, even laughter, in the Jewish community.
The official explanation:
The bill’s sponsor, Rep. Dan Greenberg, R-Little Rock, says he drafted the bill on behalf of an Orthodox Jewish rabbi so that underage Arkansas Jewish youths would be able to drink at religious dinners and other events during the first nine days of the Jewish month of Av....

The legislation, primarily, would allow underage Jews to drink beer at post-circumcision celebrations on those rare occasions when a baby boy is born before the Ninth of Av, Ciment said.
Next up, hard liquor?
Some rabbis allow the havdalah to be performed with whiskey. Others accept rum.
And some, I'm sure, offer an open bar. Needless to say, there are some spoilsports out there:
“It’s possible to use grape juice. It’s possible to use milk,” said Jonathan D. Sarna, a professor of American Jewish history at Brandeis University near Boston.

“I am familiar with no Jewish law that requires drinking of beer at any time,” he said.
The bill's sponsor responds,
...I do think it’s quite important to make sure that state government never interferes with traditional religious practices.
(Yet for some reason I'm not holding my breath, waiting for his "religious freedom" bill to legalize polygamy and ritual sacrifice.)

Wednesday, March 25, 2009

So Is It "Really" Salary?

With due respect to the defense of oversized financial industry bonuses, unrelated to profit or performance, can industry insiders please make up their minds? Addressing Edward Liddy, disgruntled employee Jake DeSantis, states,
As of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid.
But that was apparently contingent upon these special retention bonuses,
As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised.
The bonuses are thus characterized as "earnings".
On March 16 I received a payment from A.I.G. amounting to $742,006.40, after taxes.
Now, I have no reason to doubt that Mr. DeSantis is a good guy who works really hard, made lots of money for his company, had no direct hand in the collapse of his division, and... well, I can't go so far as assuming that he didn't know "what the right hand was doing", down in the corner office, but let's leave that alone for now.

The editorial suggests that Mr. DeSantis agreed to work for $1/year in salary because he knew he was going to be paid about $3-4 million in bonuses for the year. (I'm guessing, based upon his description of the accelerated bonus schedule and the amount he received in this "balance of the payments".) If the bonus truly is a form of salary, Mr. DeSantis should have no complaint - he agreed to a $1 salary. If the bonus is not a form of salary, and was payable without regard to performance, let's stop pretending it was "earnings". Please - pick one door or the other, but not both. (Yes, it's okay to say something like, "The bonuses were really part of my salary, so I actually agreed to cut my salary by about 10-20% when I accepted the $1 deal." Granted, it doesn't sound as good.)

Don't Blame Joe the Plumber

Blame Joe the Electrician!
Joseph Cassano, Electrician?
None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.
Seriously, though, if the plumber watches the electrician use speaker wire for a 220 volt outlet, and doesn't tell the foreman....

A brief AIGFP playlist:

Is Universality the Key to Affordability

Health insurance companies appear to believe so.
The health insurance industry offered Tuesday for the first time to curb its controversial practice of charging higher premiums to people with a history of medical problems. The offer from America's Health Insurance Plans and the Blue Cross and Blue Shield Association is a potentially significant shift in the debate over reforming the nation's health care system to rein in costs and cover an estimated 48 million uninsured people. It was contained in a letter to key senators.

In the letter, the two insurance industry groups said their members are willing to "phase out the practice of varying premiums based on health status in the individual market" if all Americans are required to get coverage. Although the letter left open some loopholes, it was still seen as a major development.
That implicates the key differences between the Obama plan and the Clinton/Edwards-style plans. Obama sought to dramatically reduce the number of uninsured Americans, while Clinton and Edwards argued for unversality and the elimination of free riders - people who would go uninsured until the moment they became ill. It's safe to say, health insurers are emphatically opposed to being required to insure, and take huge losses on, free riders.

Checks and Balances

Just curious: Will those participating in the Geithner Plan's "markets" to buy up toxic securities be forbidden from holding or investing in the same securities outside of the fund? That is, if a bank holding the securities wants to participate, will it be required to first sell its toxic assets or to include them in the auction no matter what the sale price? Or if a hedge fund participates, will it be forbidden from trying to buy up a security at $30 with the intention of subsequently bidding on it at $50 or $60, then selling its "outside" shares at the newly inflated "market price"?

It seems that serious restrictions need to be in place to prevent opportunism and self-dealing....

Tuesday, March 24, 2009

The Mechanism of the Geithner Plan

I'm obviously missing something big here.

The Geither Plan creates public-private funds that can bid for securities presently held by banks. This pseudo-market will create a new "market price" for the securities, recapitalize banks (replacing the security they hold with cash), and restore private investor confidence in the securities (so that investors not participating in the funds or, like you and me, excluded from the opportunity will also start investing in the securities.)

Let's say a bank holds a security presently trading at $30, and lists the security on its books at $60. Let's say that the Geithner funds bid the price of that security up to $45, or even $50. Why would the bank sell it? The bank would have to take $10 loss on its books, and would end up being less solvent (on paper) than it was going into the scheme.

Paul Krugman estimates the value of the government's subsidy of these plans at 30%. If the "investors" are seeking to fully exploit that subsidy, and don't care too much about profit, they could in essence bid $60 on a security they actually believed to be worth barely more than $46.

Perhaps, then, Geithner's hoping that when objectively evaluated, the securities are worth between 10 and 25% less than their value on the books, so that bids will meet or even exceed book value while still leaving plenty of room for participating investors to profit. But that won't inspire others, not receiving the subsidy, to join in the "market", and as huge as this program is its success depends upon even larger amounts of private money to come into the market for these securities. And if the current market price is fair, the subsidy falls far short of what it will take to get the bids close to the banks' book value.

Also, if the new "market" results in banks being able to sell their securities for more than their book value, won't the magnitude of the subsidy become obvious? If Bill Gross believes that a security is not worth his money at $60, but is giddy to buy it through one of these plans for that amount or more, how does that establish anything but how stupid the plan is in the first place? (Or how clever, at least from Gross's perspective.)

Update: Nouriel Roubini's answer to the question of whether banks will participate even if it means selling securities below book value? Mandate participation, and then deal with the consequence if a bank proves to be insolvent.

Reasonable Minds, Indeed....

First the facts:
Savana Redding still remembers the clothes she had on — black stretch pants with butterfly patches and a pink T-shirt — the day school officials here forced her to strip six years ago. She was 13 and in eighth grade....

The search by two female school employees was methodical and humiliating, Ms. Redding said. After she had stripped to her underwear, “they asked me to pull out my bra and move it from side to side,” she said. “They made me open my legs and pull out my underwear.”
The search produced... nothing. But what would justify such a search? Obviously this was an investigation of a horrific crime, right?
An assistant principal, enforcing the school’s antidrug policies, suspected her of having brought prescription-strength ibuprofen pills to school. One of the pills is as strong as two Advils.
Oh my goodness - you say these pills are big, yellow and different? Well then, let's hear from the "experts":
Richard Arum, who teaches sociology and education at New York University, said he would have handled the incident differently. But Professor Arum said the Supreme Court should proceed cautiously.

“Do we really want to encourage cases,” Professor Arum asked, “where students and parents are seeking monetary damages against educators in such school-specific matters where reasonable people can disagree about what is appropriate under the circumstances?”
Well, no... But the problem is we live in a country so wrapped up in its "war on drugs" and "zero tolerance" rules that people can actually delude themselves into believing that there's any cogent argument that the strip search was reasonable. The school district coughed up this horse manure:
Lawyers for the school district said in a brief that it was “on the front lines of a decades-long struggle against drug abuse among students.” Abuse of prescription and over-the-counter medications is on the rise among 12- and 13-year-olds, the brief said, citing data from the Office of National Drug Control Policy.
Among them, how many cases involve abuse of ibuprofen? That would be zero, you say?

They seem to know that's pretty thin, so they're also offering this claim...
In a sworn statement submitted in the case, Safford Unified School District v. Redding, No. 08-479, Mr. Wilson said he had good reason to suspect Ms. Redding. She and other students had been unusually rowdy at a school dance a couple of months before, and members of the school staff thought they had smelled alcohol. A student also accused Ms. Redding of having served alcohol at a party before the dance, Mr. Wilson said.
The relevance of that would be... what? School officials thought, in retrospect, that the kids might have been all hopped up on ibuprofen? That the girl may have been hiding cans of beer inside her ibuprofen tablets?
The school district does not contest that Ms. Redding had no disciplinary record, but says that is irrelevant.
Rumors that don't justify any disciplinary action? Now those are relevant. Leave the danged facts out of this, thank you.
“Her assertion should not be misread to infer that she never broke school rules,” the district said of Ms. Redding in a brief, “only that she was never caught.”
Exactly. Now let's have the school employees involved subjected to strip searches, applying that same reasoning.

Monday, March 23, 2009

Taxing TARP-Funded Bonuses

Josh Marshall offers a reader comment on the proposed 90% tax of bonuses. There's no indication that the Senate will pass a 90% tax - quite the opposite - and Obama's coming pretty close to threatening a veto. But let's take a look at the complaint:
Since his income is mostly in the form of a bonus, he thinks that the confiscation of the bonuses amount to a constitutional taking.
From a constitutional law standpoint, I think that's an argument destined to fail (even though I think the tax bill is bad policy). As for the "my bonus is really salary" argument, I'll repeat my position: if the compensation is intended as salary, it should be negotiated as salary, paid as salary, and taxed as salary (to the employee and the employer). Renegotiate right now, so that your "bonus" becomes the salary you claim it is.

If you won't do that, let's stop pretending your bonus is really salary.

I'm Prepared to be Convinced

One of the puzzling things about Geithner is that, if he truly believes in his policy as the best policy, he's done so little outreach to people who have a public platform, who want a bailout to work, and are sympathetic to the Obama Administration. I understand the need to keep some details under wraps, but it isn't as if the broad outline of the plan is a secret - it's been known to the public since Paulson's first TARP proposal. You can tell by reading the loudest critics of the plan, such as Paul Krugman, that no effort has been made to win them over. Not even a slight effort to persuade them to take another look. Why not?

Part of my skepticism comes from the feeling that Geithner's not being honest about his goals and intentions, or the risks involved. Sure, he wants to fix the economy and get things back on track. But it seems, without inflicting any sort of price on the people who got us into this mess and, in fact, making them richer than ever with the bailout funds. Is it a joke or a sad truth to observe, if this proposal is half as good as Geithner says it is, none of these sweetheart, non-recourse loans are available to the general public. Only billionaires need apply.

Geither's own defense of his plan, at least the one in the Wall Street journal, is drivel. Granted, it was published when he was still trying to keep the details under wraps, but I think it did a lousy job even with the big picture. I also suspect that the leaks were deliberate, so I'm skeptical of the notion that Geither didn't want them out there - I suspect that he just didn't want his name on them until the official announcement.

Yet even now the strongest defenses I see of the Geithner plan are coming from third parties. There's speculation about the difficulty of getting Congress to approve nationalization, the up-front cost, and the potential for disaster - but none of that is coming from Geithner. Instead I get an editorial in which he offers nothing of substance, and talks to me like I'm stupid. No, that didn't leave me in a charitable mood.

With Assumptions Like These....

I've been debating with CWD about whether or not I should have suggested that Geithner could be a "dedicated, hard-working public servant who means well, and who believes in this approach to the problem". (Note, it's possible for him to be all of that and also be wrong.) Geithner appears to be taking CWD's side:
Many banks, still burdened by bad lending decisions, are holding back on providing credit. Market prices for many assets held by financial institutions - so-called legacy assets - are either uncertain or depressed. With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.
That's simply not true. Market prices for many of those securites are established, and it's easy enough to establish market prices for the rest simply by putting them on the market and seeing what people are willing to pay for them. To the extent that there's uncertainty, it's in the banks' book values for the assets, and within that context there's obvious inflation, not deflation, of the values.

The idea that market values are "depressed" is an assumption, not a fact. It is perfectly reasonable to assume that market values are where they are because of the enormous risk involved in the assets. Geithner's entire "shift the risk to taxpayers" plan is built on that premise - his proposal enables investors to "buy" toxic assets for more than market value while funding the purchase primarily with taxpayer money, find out they're completely wrong, then walk away (potentially with a decent profit) while leaving taxpayers with increased exposure due to their overpayment. So when Geither says,
private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.
it's simply not true. For example, we could require banks to sell on the market some percentage of their toxic holdings at arm's length, under an agreement that we would then purchase a greater percentage of those same assets at their market value. Geithner's plan is designed to prevent the market from setting a price and to inflate the value of assets he's already told us he assumes to be depressed. The enormous subsidy and moral hazard is made necessary by Geithner's quest to have the assets purchased at or above the banks' book values, so as not to harm their balance sheets, as otherwise the banks might not sell.

Geithner professes,
We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession.
If the big concern here is "risk", there are plenty of ways the government can reduce risk to investors without running up the cost of these securities or putting taxpayers on the hook for investment losses. But the problem is, they aren't likely to provide the type of price inflation that Geithner hopes to obtain with this plan.

Geithner completely overlooks the nature of the "risk" that got us into this mess. He seems to be claiming that banks were making prudent investments that were a bit too risky, and somehow managed to make so many simultaneous mistaken assessment of risk that we ended up with a multi-trillion dollar bubble. That's not the story of this crisis. This mess was built on the passing of the buck - shifting risk onto somebody else. The broker sells the loan to a mortgage company, that sells the loan to a bank, that sells the loan to a financial institution, that slices and dices its loan portfolio and sells it to investors, and a bunch of institutions buy cheap insurance against losses from AIG, which... can't cover its debt, so it gets billions handed to it by Geithner.1 But up to the point of collapse, everybody was looking at a commission or short-term profit, coupled with shifting the risk on to the next guy.

Geither's plan shifts risk onto the taxpayer - that's not a distinction from the calamitous environment that led to the bubble; it's an extension of that calamitous environment. Once again, institutional investors get to take huge risk for potentially huge profit with other people's money, but with an even greater assurance that somebody else will cover them if the investments go bad. (There's a part of me that wonders if the goal here is to obfuscate - that Geithner doesn't care if the plan succeeds in the sense everybody else is talking about, and that he's more than content to have taxpayers absorb losses on toxic assets at the rate of $100-$200 billion per year.)

Geithner's sprinking of platitudes about how working people are suffering, the need to be responsible with public money, "never again", whatever, aren't even slightly convincing. Geither doesn't walk that walk. Obama must believe in Geithner, and maybe in a year they'll both look like geniuses, but Obama's praise of Geithner may turn out to be a "Heckuva job, Brownie" moment.

1. Yes it's more complicated than that, but the gist remains the same. As long as profits were to be made, nobody cared about risk.

Compensation Limits on a Government Giveaway?

In keeping with its long pattern of unnecessarily granting anonymity, often in violation of its own policies, the New York Times recites,
But some executives at private equity firms and hedge funds, who were briefed on the plan Sunday afternoon, are anxious about the recent uproar over millions of dollars in bonus payments made to executives of the American International Group.

Some of them have told administration officials that they would participate only if the government guaranteed that it would not set compensation limits on the firms, according to people briefed on the conversations. The executives also expressed worries about whether disclosure and governance rules could be added retroactively to the program by Congress, these people said.
The easy reply to that is, "Okay then, don't participate." But let's think for a moment - why would this even be a concern? They're entering the program as investors not employees, right?

Well, sort of.

They're barely investing. The plan is overwhelmingly generous, and we may be looking at an "investment" of only $3 for ever $97 in taxpayer money put on the line. Picture the moral hazard:
  • The "investor", with its comparatively minimal contribution and vast quantities of federal money in the form of non-recourse loans, snaps up a bunch of securities.

  • Based upon its profitable investments, the investor draws out the maximum return allowed under the plan, keeping its stake in the plan to an absolute minimum.

  • Within a year or two, it becomes apparent that they overpaid for most of the securities, and their investment is a long-term disaster.

  • Once they've recouped their investment, perhaps also taking a reasonable return on their actual stake, they walk away and leave taxpayers with the mess.

Taxpayers at that point might cry, "Foul!" The investor would have increased our exposure by overbidding for securities, so why should he be allowed to draw out billions of dollars while costing taxpayers many times that amount?

Is "Because otherwise he wouldn't have 'invested'" an adequate response?

Update: Krugman's done the math. I'll defer to his numbers not only because he's, you know, a Nobel Prize-winning economist, but because he's actually done the math. ;-)

Sunday, March 22, 2009

All Talk, No Action....

Fiddling while Rome burns.... [Insert cliché of your choice here.]

The point of calling on Congress to come up with the type of "Chapter 10" bankruptcy that its members know to be needed, or for Summers and Geithner to come up with a plan to wind down "too big or too entangled to fail" financial institutions, is not simply to goad them into taking action for the benefit of future generations. It's because things aren't exactly coming up roses right now, and those solutions could be useful, right now.
A group representing General Motors Corp. (GM) bondholders doubts whether the auto maker's survival plan will be enough to keep the company out of bankruptcy given the sharp decline in U.S. vehicle sales.

In a letter sent Sunday to U.S. Treasury Secretary Timothy Geithner and advisors to President Barack Obama's auto task force, advisors to the group say demands that bondholders swap two-thirds of their debt for equity in a restructured GM pose too much risk given the company's precarious state.
I'm not sure whether their concern is truly about GM's ability to survive; I suspect it's mostly about getting better security for their stake. But one way or another, if a "Chapter 10" existed, we wouldn't be having this discussion - either the parties would agree, or the company would enter into the new bankruptcy proceeding. There could be brinksmanship, but it would be qualitatively different - it would be between whether the negotiated outcome was likely to be better for everybody than a bankruptcy proceeding, not about which interest group gets the greatest benefit of an ad hoc taxpayer bailout.

This is Too Much to Ask?

Brad DeLong provides his summary of how the Geithner plan would work. It still sounds like a phenomenal deal for the private investors who get to go along for the ride - we put up $97 to their $3, then split any profits 5:1 (fortunately in our favor), and almost nothing to lose if they walk away. But despite some melodrama, DeLong offers by far the clearest explanation and most compelling argument in favor of the plan that I've heard to date.

If Geithner (or Summers) were to offer an understandable synopsis, like this, or even just confirm, "Yeah, that's what I'm talking about," we could have a much better conversation about the bailout. Is that really too much to ask?

(I still await an answer to Krugman's concern - what if this isn't just about the banks' balance sheets? Or the question raised by others (possibly inlcuding Krugman), what if the prices offered at auction are below the banks' "book values" for the assets and are rejected? It occurs to me also - will this be like an auction of repossessed autos, you can look at the surface but no test driving permitted, or will investors be allowed to fully scrutinize the securities in advance of the auction?)

Democracy is... Flat?

Tom Friedman shares his insights....
If you want to guarantee that America becomes a mediocre nation, then just keep vilifying every public figure struggling to find a way out of this crisis who stumbles once - like Treasury Secretary Timothy Geithner or A.I.G.’s $1-a-year fill-in C.E.O., Ed Liddy - and you’ll ensure that no capable person enlists in government.
We could call this "meta-condescension". If I don't excuse Liddy for being condescending to me about contract rights and the importance of overcompensating people in the financial industry, I get a condescending lecture from Friedman about how unfair I was to react to the condescension.

Sure, I've had my moments of conscience about talking about the mistakes of both of these men, whose biggest sins appear to be that they are extraordinarily conventional thinkers for their respective industries, further hampered by tin ears. But that doesn't mean I'm not going to respond to a patronizing commentary about the "sanctity of contracts" from the former CEO of Allstate, or dismiss his notion that the people at AIG are doing taxpayers a great favor by unwinding contracts that should have landed the company in bankruptcy court, not made it the beneficiary of the largest taxpayer bailout in history. You know what? If the choice is between sitting silently while Liddy earns his $1, or being able to fully and fairly criticize the decisions of the CEO of AIG, I say pay him a market wage.

Geithner's department is far from fully staffed, and he's taken on a tough job - in normal times, probably only 1% of Americans even know who the Treasury Secretary is, and probably not many more than that know that we have one. As I said yesterday,
I'm still willing to assume that Geithner is a dedicated, hard-working public servant who means well, and who believes in this approach to the problem. But if he can't or won't explain himself, he deserves no deference.
We also shouldn't overlook the fact that public servants, first and foremost, are supposed to serve the public, and the public has the right to question them when their priorities appear to be the advancement of private commercial interests. Frank Rich captures the apparent attitude of the officials who are supposed to be addressing our concerns:
Bob Schieffer of CBS asked [Larry] Summers the simple question that has haunted the American public since the bailouts began last fall: “Do you know, Dr. Summers, what the banks have done with all of this money that has been funneled to them through these bailouts?” What followed was a monologue of evasion that, translated into English, amounted to: Not really, but you little folk needn’t worry about it.
Contrary to Friedman, I'm not content to be treated like a toddler just because Geithner is paid about $200K/year. I want to know what's in the bitter pill I'm being asked to swallow, and why other remedies aren't better.
You will ensure that every bank that has taken public money will try to get rid of it as fast it can, so as not to come under scrutiny, even though that would weaken their balance sheets and make them less able to lend money.
Oh no.... You mean, private banks that don't need government money wouldn't take it, and market forces would dictate their ultimate success or failure? What a horrible possibility! And again, you say, the solution is for us to "shut up and take it"? That seems like the least we can do....
And you will ensure that we’ll never get out of this banking crisis, because the solution depends on getting private money funds to team up with the government to buy up toxic assets - and fund managers are growing terrified of any collaboration with government.
Arguably the solution involves nationalizing the troubled banks, including those of the "big four" that can't make it on their own, cleaning up their balance sheets, and restoring them as quickly as possible to public ownership with new shareholders and new management.

Friedman has apparently embraced Geithner's solution - the government provides the money for private companies to buy up toxic debt, providing enough of a subsidy that they're willing to pay the valuation given to them by the banks that hold them, while "sharing" profit and protecting the private buyers from taking losses. It assumes that the assets at issue aren't grossly overvalued by the banks, or that the real estate bubble will quickly reinflate, or... well, we can't really be sure, because Tim Geithner won't tell us his assumptions. And Friedman implies, "We have no business asking; shut up and take it."

What's funny is, Friedman can't even follow his own advice:
Right now we have an absence of inspirational leadership. From business we hear about institutions too big to fail - no matter how reckless. From bankers we hear about contracts too sacred to break - no matter how inappropriate. And from our immature elected officials we hear about how it was all “the other guy’s fault.” I’ve never talked to more people in one week who told me, “You know, I listen to the news, and I get really depressed.”
The first words, put into the mouths of "business", could as easily be assigned to Geithner (or Ben Bernanke), who plainly believes that certain banks and financial institutions are "too big to fail". The "banker" could easily be AIG CEO Liddy, whose deference to compensation contracts goes way beyond what I can recall ever hearing from an employer, let alone from an insurance executive. And to attack public officials as immature and self-serving? As someone, oh yes, Thomas Friedman put it, "If you want to guarantee that America becomes a mediocre nation, then just keep vilifying every public figure struggling to find a way out of this crisis who stumbles once".

Yesterday, addressing bankers, Ben Bernanke commented,
Many of you likely are frustrated, and rightfully so, by the impact that the financial crisis and economic downturn has had on your banks, as well as on the reputation of bankers more generally. You may well have built your reputations and institutions through responsible lending and community-focused operations, but nonetheless, you now find yourselves facing higher deposit insurance assessments and increasing public skepticism about the behavior of bankers - outcomes that you perceive were largely caused by the actions of larger financial institutions. Many of you managed your businesses prudently and shunned more exotic instruments and activities. And many of your customers--households and businesses - avoided excesses and are able to meet their financial commitments on a timely basis.

No doubt this frustration has been heightened by the problems caused by financial firms that are too big or too interconnected to fail. Indeed, the too-big-to-fail issue has emerged as an enormous problem, both for policymakers and for financial institutions generally. Creditors of a firm perceived as too big to fail have less incentive to monitor and restrict the firm's risk-taking through adjustments to the price at which they lend money to the firm. If left unaddressed, this weakening of market discipline creates an unlevel playing field for smaller institutions, which may not be able to raise funds as cheaply, even if their individual risk profiles are better, or at least no worse, than those of their larger competitors. The erosion in market discipline distorts market behavior and can give firms an incentive to grow - either internally or through acquisitions - in order to be perceived as too big to fail.

Government rescues to prevent the failure of major financial institutions also have required large amounts of public resources. These actions have involved extremely unpleasant and difficult choices, but given the interconnected nature of our financial system and the potentially devastating effects on confidence, financial markets, and the broader economy that would likely arise from the disorderly failure of a major financial firm in the current environment, I do not think we have had a realistic alternative to preventing such failures.
Yet where Geithner and Bernanke appear content to (possibly) create a solution for these institutions to apply "next time", I think "There's no time like the present". I would be creating a Chapter 10 bankruptcy for companies like Chrysler and GM that are "too big to fail", and putting the weakest of those companies through it as a "test case". I would do the same thing with the "too big to fail" financial institutions. Why not? As Bernanke says,
Finally, an important element of addressing the too-big-to-fail problem is the development of an improved resolution regime in the United States that permits the orderly resolution of a systemically important nonbank financial firm. We have such a regime for insured depository institutions, but it is clear we need something similar for systemically important nonbank financial entities. Improved resolution procedures for these firms would help reduce the too-big-to-fail problem by giving the government the option of safely winding down a systemically important firm rather than keeping it operating.
There's no time like the present.

Saturday, March 21, 2009

The Bad Bank Bailout Plan

Was that an ambiguous title? It works both ways. Seriously, how can I make sense of this? Why do Geithner and Obama believe its okay to keep trucking out the same, tired idea without responding to the critics, explaining why their plan is better than the alternatives, or explaining why we should expect it to work? I have tried to assess the plan sympathetically, but what's to love?
The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks.
So we give money to "investors" who can safely overbid on securities, while the government protects them from taking losses. The most charitable interpretation of this would seem to be that the Obama Administration believes that market prices for toxic securites are significantly below their actual worth, and thus that there's minimal downside in creating a system that inflates their price. A far less charitable interpretation is that this is seen as a quick way to clear banks' balance sheets of garbage assets for something close to book value, with the difference between the inflated purchase price and actual value being absorbed the taxpayer over time... perhaps $100-$200 billion per year, or so.
To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders.
As others have pointed out, taxpayers do the best under this plan when sale prices are low, as we're protecting the investors from taking losses. Auctions don't protect taxpayers - higher purchase prices make eventual losses more likely, and thus increase the risk to taxpayers.
The goal of the plan is to leverage the dwindling resources of the Treasury Department’s bailout program with money from private investors to buy up as many of those toxic assets as possible and free the banks to resume more normal lending.
Call it the "hair of the dog" cure - fix the hangover from excessive leveraging of debt with a bit more leveraging.
Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come.
Why are we betting, when it's... not necessarily easy, but perfectly feasible to check beneath the hood? What about that isn't supposed to make me conclude that the last thing Geithner wants to do is find out what these securities are truly worth. If you don't trust market value, why not look at the underlying assets, the default rate, recoveries after foreclosure, the number of properties that aren't likely to ever recover in value....
Analysts worry whether the prices investors offer will be high enough to induce the banks to sell assets. The hope is that high valuations at the auctions will increase the price of assets that remain on the books of banks, bolstering confidence in the sector.
This part has never made much sense. It's a given that these assets are overvalued by banks, at least compared to current market values. Swapping the bad assets for cash doesn't improve the bank's balance sheet, but perhaps we've injected enough cash into the banks that Geithner no longer regards that as a concern. Yet it's reasonable to assume that banks aren't going to want to worsen their balance sheets.

This notion that "auctions will increase the price of assets that remain on the books"? Where's the basis in reality for that type of optimism?
Many investment executives said they were worried that participating in any bailout program would expose them to political wrath and potentially steep new restrictions on their own pay.
Yeah, so many that you can't even name one. Spare me.

Rather than trotting out the same plan, with a few details changed, time and time again, I would really like it if the Obama team would explain (a) the assumptions they are using, particularly in relation to toxic assets; (b) why they believe toxic assets are undervalued by the markets, using objective data; (c) why they believe banks are either fairly valuing or undervaluing those same assets, even though they're listing them far above recent market prices, using objective data; (d) the precise nature of their plan; (e) why their plan is better than alternatives - in detail; and (f) how much they expect it to cost taxpayers, both if it goes as planned and if it turns out that critics of this plan are correct.

I'll add this; I'm still willing to assume that Geithner is a dedicated, hard-working public servant who means well, and who believes in this approach to the problem. But if he can't or won't explain himself, he deserves no deference.

And Yet The World Didn't End

One of the unexpected aspects of staying in a hotel high in the Andes was the ready availability of a local treatment for altitude sickness (and headaches, and fatigue).
Hotel Coca Leaves
Coca leaves are not generally available in Chile - you have to go to really high altitudes, in areas where they're also considered a sacrament. But just as at sea level, it's the alcohol that gets locked up. The President of Bolivia attempts to explain why western drug policy toward the coca leaf is absurd; but although he's right, I doubt his opinion will have much impact.

(If you want a first-hand description of coca chewing, sorry, I guess I'm too much a product of our 'war on drugs' culture.)

Friday, March 20, 2009

Being a Mouthpiece is One Thing....

But abandoning any shred of dignity in the process? Michael Gerson recites from the latest party memo:
The most famous piece of legislation passed by the 111th Congress may have nothing to do with health care or energy. It could be the Dodd amendment, also known as the Geithner amendment, or perhaps the low-level-anonymous-staffer-everyone-can-safely-blame amendment, reading in part:

"The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009 . . . " AIG executives were foolish to use this loophole to "retain" employees, some of whom nearly destroyed the American financial system. But the company did not act with deception or secrecy.
Yes, that's the part that's widely circulated. And, as party hackery goes, Gerson's use is "correct" - he's using it to suggest that the goal was to "protect" excessive compensation going backwards, as opposed to limiting new compensation agreements going forwards. But it's exceptionally misleading to suggest that the provision was meant to reach the masses of employees at a company such as AIG, as opposed to the executive suite:
(b) Executive Compensation and Corporate Governance-
(1) ESTABLISHMENT OF STANDARDS- During the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, each TARP recipient shall be subject to--
(A) the standards established by the Secretary under this section; and

(B) the provisions of section 162(m)(5) of the Internal Revenue Code of 1986, as applicable.
(2) STANDARDS REQUIRED- The Secretary shall require each TARP recipient to meet appropriate standards for executive compensation and corporate governance.

(3) SPECIFIC REQUIREMENTS- The standards established under paragraph (2) shall include the following:
(A) Limits on compensation that exclude incentives for senior executive officers of the TARP recipient to take unnecessary and excessive risks that threaten the value of such recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding.

(B) A provision for the recovery by such TARP recipient of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of the TARP recipient based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.

(C) A prohibition on such TARP recipient making any golden parachute payment to a senior executive officer or any of the next 5 most highly-compensated employees of the TARP recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding.

(i) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any prohibition developed under this paragraph shall not apply to the payment of long-term restricted stock by such TARP recipient, provided that such long-term restricted stock--
(I) does not fully vest during the period in which any obligation arising from financial assistance provided to that TARP recipient remains outstanding;

(II) has a value in an amount that is not greater than 1/3 of the total amount of annual compensation of the employee receiving the stock; and

(III) is subject to such other terms and conditions as the Secretary may determine is in the public interest.
(ii) The prohibition required under clause (i) shall apply as follows:
(I) For any financial institution that received financial assistance provided under the TARP equal to less than $25,000,000, the prohibition shall apply only to the most highly compensated employee of the financial institution.

(II) For any financial institution that received financial assistance provided under the TARP equal to at least $25,000,000, but less than $250,000,000, the prohibition shall apply to at least the 5 most highly-compensated employees of the financial institution, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

(III) For any financial institution that received financial assistance provided under the TARP equal to at least $250,000,000, but less than $500,000,000, the prohibition shall apply to the senior executive officers and at least the 10 next most highly-compensated employees, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

(IV) For any financial institution that received financial assistance provided under the TARP equal to $500,000,000 or more, the prohibition shall apply to the senior executive officers and at least the 20 next most highly-compensated employees, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.
(E) A prohibition on any compensation plan that would encourage manipulation of the reported earnings of such TARP recipient to enhance the compensation of any of its employees.

(F) A requirement for the establishment of a Board Compensation Committee that meets the requirements of subsection (c).
(4) CERTIFICATION OF COMPLIANCE- The chief executive officer and chief financial officer (or the equivalents thereof) of each TARP recipient shall provide a written certification of compliance by the TARP recipient with the requirements of this section--
(A) in the case of a TARP recipient, the securities of which are publicly traded, to the Securities and Exchange Commission, together with annual filings required under the securities laws; and

(B) in the case of a TARP recipient that is not a publicly traded company, to the Secretary.
Is it conceivable that the Secretary would have been asked to review the bonuses under this legislation, to determine if it should be applied to employees outside the 25 highest paid individuals as contemplated by the legislation? Sure. Is it likely that the Secretary would have found it consistent with prevailing wages in the industry, the intent of the legislation, or the treatment of employees in other bailed-out organizations who had already received similar bonuses, so as to merit extending the prohibition to everybody at AIG? Not at all.

Gerson carries on,
Concerns on the broader compensation issue were serious enough to ensure unanimous Senate passage of an amendment to the stimulus bill sponsored by Sens. Olympia Snowe and Ron Wyden that penalized bailout bonuses in excess of $100,000.

But the Snowe-Wyden amendment disappeared into the misty bog of a House-Senate conference committee, only to be trumped by language that grandfathered in AIG's retention bonuses.
I've quoted enough legislation for the moment, and the Snowe-Wyden language is somewhat opaque - let's let Wyden put it into simple terms:
In an interview with the Huffington Post, the Oregon Democrat noted that during the crafting of the stimulus package, he and his Republican colleague from Maine introduced a provision that would have forced bailout recipients to cap their bonuses at $100,000. Any amount paid above that would have been taxed at 35 percent. The language made it through the Senate, but during conference committee with the House, it was inexplicably removed.
Note, the 35% tax would be payable by the company, not by the employee. And nothing in the Snowe-Wyden language would have prohibited or voided the bonus. Yes, under this proposal, a bonus contract negotiated after January 1, 2008 would have been covered. But if AIG is correct, as seems to be the case, that it was contractually bound to pay the bonuses, it would have had no meaningful impact on the present conflagration. The bonuses would have been paid, and AIG would owe an additional $60 million or so in taxes, all of which would still have effectively come out of taxpayer contributions to AIG. Would that have made you feel better about it?

Gerson carries on,
President Obama vowed to "pursue every legal avenue to block these bonuses," when the proper "legal" avenue was to write a responsible law - a process his own administration apparently undermined.
If you actually look at the legislation back when it contained the Snowe-Wyden language, it didn't just cap bonuses - it retroactively capped pay to an amount not "in excess of the amount of compensation paid to the President of the United States". It did not prohibit or invalidate bonuses - it instead imposed a corporate tax on bonus payments in excess of $100,000. You shouldn't have to be a very strong thinker to recognize why that would trouble the Treasury Secretary who is trying to bring sanity back to the financial industry, as there's every reason to believe that arbitrary salary caps of this sort would have been destabilizing. (Having made the "conservative" case for wage controls, what's up next? Price controls?)

Gerson next imagines a hedge fund manager having to justify a huge return on a purchase of toxic securities.
"Perhaps the witness can explain to us how he justifies such windfall profits with the people's money? Have you no shame? Give us the names, addresses and phone numbers of every millionaire you enriched at public expense so we can leak them to the press."
If Gerson took the time to find out what he's talking about, rather than doing stenography from the party memo, he might have seen the following in the Snowe-Wyden language:
(C) BONUS PAYMENT- The term `bonus payment' means any payment which--
(i) is a discretionary payment to a covered individual by a financial institution (or any member of a controlled group described in subparagraph (D)) for services rendered,

(ii) is in addition to any amount payable to such individual for services performed by such individual at a regular hourly, daily, weekly, monthly, or similar periodic rate, and

(iii) is paid or payable in cash or other property other than--
(I) stock in such institution or member, or

(II) an interest in a troubled asset (within the meaning of the Emergency Economic Stabilization Act of 2008) held directly or indirectly by such institution or member.
Such term does not include payments to an employee as commissions, welfare and fringe benefits, or expense reimbursements.
If he imagines a popular uproar over a subsidized giveaway of troubled assets to hedge fund managers, why does he think there would be no such uproar over the giveaway of the same assets at fire sale values as bonuses to the leaders of bailed-out companies, as would have occurred under the Snowe-Wyden language he endorses?

Gerson concludes,
What sane money manager would want to partner with a government that blames others for its mistakes, urges the violation of inconvenient contracts and threatens to tax benefits retroactively?
No doubt, the lack of effective regulation and oversight of the financial industry, most crucially under G.W. Bush,1 constitutes a government mistake - but is that what Gerson means? Even if so, it hardly exculpates the financial industry. Also, you don't need to look past the auto industry to recognize that, if it means walking away with billions in your pocket, people are willing to eat a lot of crow (both deserved and undeserved) in front of Congress.

But Gerson's suggesting that it's Obama who "urges the violation of inconvenient contracts"? No, that would be Gerson himself. Although some pretend otherwise, as previously noted, not even the Snowe-Wyden legislation would have abrogated the AIG bonus contracts. The final legislation didn't retroactively modify or abrogate contracts, and instead applied only to new contracts - and that's the very part Gerson finds objectionable.

As for threatening to tax benefits retroactively? I think the new tax on bonuses is bad policy, and I've said so, but give me a break. The entire mechanism by which the Snowe-Wyden amendment sought to reign in "excessive bonuses" was through a tax, retroactive to January 1, 2008.

1. I have sympathy for the argument that most of the policies preceded Bush, but none for the argument that this somehow excuses the Bush Administration from its responsibility for perpetuating those policies, or failing to notice the walls crumbling all around them.

I'll Agree With... Half of That

Josh Marshall comments on what we both think is ill-advised tax policy, in the "90% clawback tax" on bonuses to employees of TARP recipients that have received more than $5 billion in federal money. It's a politically easy response to public anger, taking the place of more sober policy that should have been put in place from day one. And let's not forget that Congress is once again "the gang who couldn't shoot straight" - both parties were complicit in the "hold no one accountable" approach to the bailout. Perhaps some of their new found rage should be directed inward.

Marshall writes,
First, what's to stop the companies from just folding the 'bonuses' into straight salary income? In which, the whole thing goes out the window?
Actually, I think that would be a good thing, given how often we hear the argument that due to the pervasive nature of oversized bonuses in the financial industry, and how they routinely equal or exceed the recipient's annual salary, they really should be thought of as part of the recipient's salary. If this forces industry-wide salary renegotiation, I doubt that the new salaries will in fact be as inflated as that theory suggests. And our legislators will no longer have the excuse that we have to let the absurd salaries and bonuses slide for fear that financial industry employees will quit en masse. To the extent that these companies pay what should be salary in the form of bonuses to gain a tax advantage, all the better that the bonuses become salary.
Second, this cuts a pretty broad swathe. You don't want CEOs who drove their companies into the ground pulling down multi-million dollar bonuses from companies that wouldn't even exist any more without big taxpayer handouts. And the folks at AIGFP who played a big party in driving the whole economy into the ditch with their reckless and possibly criminal behavior shouldn't big reaping big rewards of taxpayer money for their behavior.

But it's not clear to me why a couple, both of whom work in the financial services industry, and make $150,000 each should essentially have their entire bonuses taken back in taxes.
Well, color me weird, but if you have a $300,000.00 household income from a company that would be out of business but for a huge taxpayer bailout, I don't have enormous sympathy for the notion that you should get a six or seven figure bonus simply for showing up at work. That ties into my earlier argument - if in fact those salaries are inadequate or aren't competitive, renegotiation is a good thing.

If I understand his point, though, it's less about that couple's specific circumstances and more about "why them?" That's fair - we're vesting the sins of the employer (and the sins of our political leaders) on employees who may simply be hard-working, honest, diligent bankers. (Yes, and there are also lawyers who fit that description. Go figure.) They may have nothing to do with their employer's situation, or may be the people who have kept it from being a lot worse, and we're singling them out for a reactionary, confiscatory tax. It seems like the worst form of hypocrisy for any modern Republican to vote for a 90% income tax on anybody, even without the angry declaration that the money being taxed is an undeserved windfall.

I do take issue with the conflation of the bizarre pseudo-retention bonuses (a retention bonus you may get even if you've quit) at AIG, as compared to a long-term retention bonus (e.g., a loan that is forgiven over six to ten years, issued selectively to people who you truly do want to retain) that can help keep key employees in place, or performance bonuses. (I'll grant, what passed for performance in the financial industry over the past decade included conduct that, in retrospect, would not warrant bonus pay.) I also think this is a bad way to make public policy.

Update: Marshall partially explains the difference in our perspectives:
I know a number of people who work or in a few cases worked at the big investment banks here in the New York. And while the size of the bonuses would float to some degree with how well the bank did in a given year, and presumably how well they performed, to a great degree it was locked in income. And the great bulk of these people's incomes came from their bonuses.
That's all well and good, but to me if the bonuses are in fact salary they should be negotiated and paid (and as Marshall notes, taxed) as salary. Marshall shares a reader comment that is also instructive:
Most Wall Street firms began as partnerships, not as publicly-owned corporations. Partnerships apportion their profits at the end of their fiscal year; that practice has remained the norm, even though shareholders (or, in the case of AIG, taxpayers) now own these corporations.

And that's really the nub of the problem. Most Wall Street firms have gone public; at the same time, many public banks have entered the Wall Street game. But corporate governance, compensation, and accountability haven't kept pace. In essence, these firms offloaded most of their risk to shareholders, but continued to be run in an insular fashion, and to divert the great bulk of their surplus revenues to their workers and executives. In the bubble years, enough cash rolled in that the complaints were muted - executives and traders took it home in wheelbarrows, and the share prices still went up.
He argues that the Wall Street compensation system reflects the desire for "the rewards of ownership with the security of employment". I agree with the comment's conclusion, that the compensation model is unsustainable, but that a special "feel good" tax isn't a solution.
The real solution lies in ensuring that corporations are run in the long-term interests of their owners, not to line the pockets of their executives.
The need for that solution reaches far beyond the financial industry....

Okay, So What Do We Do?

Pat Buchanan shares his thoughts on the financial crisis:
Who is to blame for the disaster that has befallen us?

Their name is legion.

There are the politicians who bullied banks into making loans the banks knew were bad to begin with and would never have made without threats or the promise of political favors.

There is that den of thieves at Fannie and Freddie who massaged the politicians with campaign contributions and walked away from the wreckage with tens of millions in salaries and bonuses.

There are the idiot bankers who bought up securities backed by sub-prime mortgages and were too indolent to inspect the rotten paper on their books. There are the ratings agencies, like Moody’s and Standard & Poor’s, who gazed at the paper and declared it to be Grade A prime.

In short, this generation of political and financial elites has proven itself unfit to govern a great nation. What we have is a system failure that is rooted in a societal failure. Behind our disaster lie the greed, stupidity and incompetence of the leadership of a generation.

Does Dr. Obama have the cure for the sickness that ails the Republic?

He is going to borrow and spend trillions more to bring back the good old days, though it was the good old days that brought us to the edge of the abyss into which we have fallen. Then he is going to spend new trillions to give us benefits we do not now have, though the national debt is surging to 100 percent of the Gross National Product, and may reach there by 2011.
A simplified narrative followed by a simplistic judgment. It's a bit like, well, blogging. (Yes, obviously myself included.) Monday morning quarterbacking. Buchanan speaks as if he saw this coming. But of course, he didn't.

It's one of the strange things about this crisis - we're dealing with a scope and scale that defies imagination. What's a trillion dollars? (Is this what you pictured?) It was easy enough for people to look at housing prices as compared to incomes, or housing prices compared to rental prices, and say "This can't continue." But few people had the perspective on the situation to see this as a potentially huge problem - and fewer were willing to speak out about it. And as prescient as those few voices were, I don't recall any that even hinted at the magnitude of the coming collapse. A recession and some housing deflation, sure. But a global financial meltdown?

Buchanan's piece also highlights the other side of the problem - nobody knows what to do, or what will work. The strategy carried over from the Bush Administration is as Buchanan describes - put the same Humpty Dumpty financial system back together, whatever the cost, and hope it stays up on the wall this time. And there are genuine reasons to say, "That might not work," or "These other approaches might be better," but nobody really knows. Hence the conservative approach - return to the status quo ante.

Buchanan doesn't even offer that much - he has criticism, but he doesn't pretend to have a solution. Instead, he imagines a world where credit is harder to obtain (news flash: we're already in that world):
Is Obama willing to speak hard truths?

Is he willing to say that home ownership is for those with sound credit and solid jobs? Is he willing to say that credit, whether for auto loans, or student loans, or consumer purchases, should be restricted to those who have shown the maturity to manage debt — and no others need apply?
Right... we're going to deny student loans to students, because they're young and don't have good job histories. Next solution, please? I'm not sure what to make of Buchanan, period, let alone when he says stuff like this; by his own measure, we created more than enough trouble by having the government meddle in the credit business, so perhaps we shouldn't be moving into an era where the President dictates tighter credit terms. I'm fine with saying that we can't restore the system that led us into this crisis, but what's Buchanan calling for? More regulation? Nationalization?

Perhaps the government should be stepping out of the business of deciding who should have credit, and perhaps that's especially true in relation to any express or implied notion that it will step in and bail out financial firms (including those like FNMA and FDMC) if they screw up. If lenders (and shareholders, and bondholders) know that the risk of loss is truly and entirely theirs, I don't think the President would need to play a role in deciding which citizens are sufficiently responsible to "deserve" a mortgage, car loan or credit card.

Thursday, March 19, 2009

But From The Employee's Standpoint....

Let's say your boss negotiates a bonus plan for your division that ensures you considerable wealth - bonuses significantly in excess of your entire annual salary - for each of the next two years. If you're not in the financial industry (where this seems pretty common) you might think, "This is nuts," but are you going to say "no"? You may recognize that your boss is primarily doing this for his own benefit, but what a deal.

Now let's assume your company is cratering, and is bailed out by taxpayers. But you're not responsible for the catastrophe, you're working as hard as - and perhaps harder than - ever, and you kept your side of the deal. You didn't put out your résumé and change jobs to an employer where your pay and bonuses would not be scrutinized. Are you ready to give up your bonus?

Don't get me wrong - I understand why people aren't happy about taxpayer money being used to pay these bonuses. I'm not happy about it, or the de facto perpetuation of a financial industry compensation bubble with taxpayer funds. But there's a difference between saying that and vilifying individual recipients without regard to their relative culpability.

The issue of financial industry overcompensation is hardly a secret. Efforts to reign in compensation to date have been ineffective not as a result of bad design, but as a product of deliberate policy. The politicians who are presently grandstanding are exploiting public anger, but it's more than fair to ask why they are being reactive instead of proactive - why did they happily go along with the status quo until this point? Do they truly believe these bonuses are the biggest outrage to date?

It was a colossal mistake for the Bush Administration to insist that tens... hundreds of billions in taxpayer money had to be distributed with essentially no strings attached, and for the Obama Administration to continue that approach. The compensation issues provide an easily understood metaphor for the problem, but it appears that taxpayers are already unnecessarily out billions of dollars as a direct result of the Paulson/Geithner giveaways.

AIG's Long History of Responsible Conduct

In 1987, AIG made a huge mistake in launching a credit-default-swaps portfolio, the source of the company's eventual collapse. Don't take my word for that - hear it from current CEO, Edward Liddy:
Mistakes were made at AIG, and on a scale that few could have imagined possible. The most egregious of those began in 1987, when the company strayed from its core insurance competencies to launch a credit-default-swaps portfolio, which eventually became subject to massive collateral calls that created a liquidity crisis for AIG. Its missteps have exacted a high price, not only for the company and its employees but for the American taxpayer, the federal government's finances and the global economy. These missteps brought AIG to the brink of collapse and to the government for help.
So, how that that happen? As a former CEO is quick to tell you, as long as you make profits on paper nothing should be deemed a mistake:
From 1987 to 2004, the company's financial products unit contributed more than $5 billion to AIG's pretax income.
As you might imagine, in former CEO Greenberg's eyes, there was no cause for concern until after he left the company:
In spring 2005, after I left the company, AIG's credit rating was downgraded. It would have been logical for AIG's new management to end or reduce its business of writing credit default swaps because of the risk it faced of having to post billions of dollars in additional collateral in connection with certain credit default protection. Yet AIG ramped up its credit default swaps business; significantly, the quality of the securities AIG wrote credit protection for deteriorated, and the company plunged into subprime mortgages. The results were disastrous.
There's no reason to doubt Greenberg's word that everything was peachy until the day he left.... except for the fact that he was ousted from AIG over dubious accounting practices, and the financial products division was his baby:
But in 2005, amid an investigation by then New York Attorney General Eliot Spitzer, Greenberg was forced out by AIG's board. He had refused to cooperate with the company's own probe.

He is still fighting civil charges being pursued by New York state, as well as a string of other lawsuits outstanding between him and AIG.

But detractors say he could face a tough time saving face given the latest loss revelations since the former chieftain was sole architect of AIG Financial Products - the business that poured itself into the CDS market, and ultimately cost AIG so much.
Under Greenberg and Joe Cassano, the former Michael Milken associate who headed the financial products group, there was trouble. In 2001 the financial products division engaged in illegal conduct, resulting in a $80 million fine and its return of close to $40 million in fees, back in 2004:
To make the transactions look legitimate, Financial Products had set up a company to "invest" in the entities, while receiving an equivalent amount in fees, investigators said. The structure of the deal violated securities laws, FBI agent Randy Tice asserted in an affidavit filed in federal court as part of the simultaneous settlement of a criminal case and an SEC civil complaint.

AIG and two Financial Products subsidiaries agreed to pay an $80-million fine and give back $39.8 million in fees it had earned, plus $6.5 million in interest. PNC paid a $115-million fine.

The settlement also required AIG "to implement a series of reforms addressing the integrity of client and third-party transactions." A group of senior AIG executives would review complex transactions from the previous few years, working with an independent monitor chosen by the Justice Department, the SEC and the company.
Unsurprisingly, the company's auditors wanted to take a close look at its operations - and was apparently told that they had to take "no" for an answer:
Both PricewaterhouseCoopers, the company’s auditor, and an independent accountant complained of a lack of access to the London unit and its leader, Joseph Cassano. The accountant, Joseph St. Denis, said in a statement to the committee that he had been deliberately blocked from questioning Mr. Cassano because he might ”pollute the process.” Mr. St. Denis later resigned in protest.
(There were a lot of red flags.) When things reached the breaking point, Cassano was allowed to retire with a sweetheart consulting deal, until negative publicity brought it to an early end.
He was forcibly retired in March of 2008, but kept on a $1 million per month retainer and allowed to keep living in the AIG-paid for apartment in London. It was only in September 2008 that Rep. Henry Waxman flipped out when he heard that the guy who blew up AIG and put taxpayers on the line for tens or hundreds of billions of dollars was still getting a $1 million a month retainer. That's when they killed the retainer too.
As things crumbled around them, those within the financial products division "negotiated" an incredibly one-sided "bonus" package based upon their division's illusory 2007 profits.
These bonuses are payable regardless of performance and are calculated at 100 percent of 2007 compensation for all employees except senior management, who receive 75 percent of 2007 compensation. The amount is payable unless they are fired with good cause, resign without good reason or fail to meet performance standards. For those hoping that these employees could now be fired, “good cause” is defined in the agreement as a very high standard.
Although the recent payments are supposedly necessary to keep on board the people needed to unravel AIG's mess, as it turns out the hardest work in wrapping up the mess was completed months ago.
The work of defusing the most dangerous bets placed by American International Group was largely concluded by December, according to documents and interviews, long before the company gave bonuses to employees it said it needed to retain to avoid a financial meltdown.
The remaining people at the financial products division could be replaced - unless they all quit at once.
But what about the argument made by top AIG officials that the people receiving retention bonuses have unique skills and knowledge that make them indispensable?

"They are replaceable," Pasciucco acknowledges. "If we were running a long-term business, we could probably replace them over time, not all at the same time."
So the sole remaining justification for the bonuses is that a bunch of replaceable employees might walk off the job at the same time, into the loving arms of the current financial industry job market, rather than "settling for" their salaries or a renegotiated bonus package based upon such absurd measures as their job performance.

Update: Here's a more comprehensive summary of AIGFP's history. It provides a bit more context to some of the bad decisions made along the way.

Keeping the Rats on the Sinking Ship

Steven Davidoff takes a look at the AIG bonus contract, and finds a few surprises. Well, not really surprises if you're as cynical as I am, and inferred that these extraordinary bonus contracts were negotiated in anticipation of a government bailout.
These bonuses are payable regardless of performance and are calculated at 100 percent of 2007 compensation for all employees except senior management, who receive 75 percent of 2007 compensation. The amount is payable unless they are fired with good cause, resign without good reason or fail to meet performance standards. For those hoping that these employees could now be fired, “good cause” is defined in the agreement as a very high standard.
Payable without relation to performance. Payable based upon 2007 compensation. In other words, negotiated with full awareness that the Financial Products division was going down the tubes.
This was not a boilerplate contract. Rather, it was highly negotiated. And it was highly negotiated to pay retention fees at high levels without regard to performance. This is obviously shocking. But it makes me wonder: perhaps one area of direction here should be actually looking at who negotiated this and why?
That was a question I had hoped somebody would get around to asking Liddy during yesterday's Congressional hearing, rather than grandstanding. Dare I say, the hearing met my expectations, which means it fell far short of meeting my hopes?

Davidoff harrumphs that people focusing on the bonus scandal are missing the forest for the trees:
Yet, as I said in my post on Tuesday, “Seven Sad Truths About A.I.G.,” the real concern over the insurance giant should be about the $170 billion in government bailout money it received and and A.I.G.’s subsequent payments of tens of billions to a myriad of banks.

* * *

But of course, this is all merely a diversion for what should be the main focus: Where did the $170 billion go that taxpayers spent on A.I.G and why, and what we are going to do with A.I.G. going forward.
As should be obvious, the bonuses are an easily understood metaphor for everything that's wrong with this bailout. Most of the people in this country have suffered financially as a result of the financial crisis. It's absurd for taxpayer money to insulate those responsible for the crisis from feeling any pain - and even more absurd that it happens time, and time, and time again.

Pundits pontificate about bubbles, and the government's role in creating and sustaining bubbles, without giving heed to the fact that there's a huge bubble waiting to burst - a bubble that's sustained only through direct taxpayer subsidy: The financial sector's compensation bubble. If we would stop listening to people like Ruth Marcus and Andrew Ross Sorkin yammer about how seven figure bonuses - bonuses entirely divorced from profit and performance - are necessary to prevent people from fleeing the companies they've ruined for "better paying jobs" at some other financial institution, we might start seeing financial sector salaries come down to earth. One way or another, it's absurd for companies that are bankrupt but for multi-billion dollar infusions of taxpayer cash to be paying gargantuan bonuses completely divorced from anything that would justify their payment.

A lot of what's happened, including the payments Davidoff deems outrageous, has happened with straight-faced politicians assuring us that it's completely necessary, for the greater good, and will help keep things from getting worse. Sure, if you take the time to look under the hood, figure out what "counterparties" are, and really think about such atrocities as the manner in which AIG, with the full knowledge and participation of the likes of Geithner, Bernanke and Paulson, has tossed around taxpayer money rather than trying to cut deals that could help "save us" money, you have every right to be appalled.

If you hear somebody like Edward Liddy suggest that these bonuses help AIG "save" taxpayers money as it unravels the hideous mess it's Financial Products division made, you have every right to be outraged - AIG should be put through bankruptcy, but we're told that the magnitude of the harm that would cause necessitates our bailing it out, but its obscene to suggest that taxpayers had a choice here, or that they're being "saved" money when they shouldn't have been asked to contribute so much as a penny in the first place.

To say people shouldn't be angry about the AIG bonuses, or that they're overreacting, is a bit like asking, "That guy's been kicking you in the shin, hard, every day for the past six months, and the most you've done is grumble. Why did you get so angry today?" Does it really need to be explained?

Wednesday, March 18, 2009

How to Make Your Banker Laugh

When you're told that the new account you've opened is a "high yield savings account", ask, with a completely straight face, "High yield - does that mean I'm getting .01% interest, or .02% interest?"

Edward Liddy Was CEO of Allstate?

That's rich. The former CEO of Allstate lecturing people on contract rights as inviolable?
Allstate ranks as the worst insurer for consumers, according to a comprehensive investigation of thousands of legal documents and financial filings.

The rankings show a distinct pattern of insurance industry greed amongst 10 companies that refuse to pay just claims, employ hardball tactics against policyholders, reward executives with extravagant salaries, and raise premiums while hoarding excessive profits.

"While Allstate publicly touts its 'good hands' approach, it has instead privately instructed its agents to employ a 'boxing gloves' strategy against its policyholders," said American Association for Justice CEO Jon Haber. "Allstate ducks, bobs and weaves to avoid paying claims to increase its profits."

Allstate set the standard for insurance company greed and placing profits over policyholders. Allstate contracted with consulting giant McKinsey & Co. in the mid-1990s to systematically force consumers to accept lowball claims or face its "boxing gloves," an aggressive strategy designed to deny claims at any cost. One Allstate employee reported that supervisors told agents to lie and blame fires on arson, and in turn, were rewarded with portable fridges.

Thousands of court documents, materials uncovered from litigation and discovery, testimony, complaints filed with state insurance departments, SEC and FBI records, and news accounts were reviewed to compile the rankings and statistics.
Hey - I know. Liddy wouldn't have approved the portable fridges as bonuses had he known about them beforehand, but a contract's a contract.

Edward Liddy's Tin Ear

I feel a bit sorry for the man, actually. As he points out, "My annual salary is $1. My only stake is my reputation." But without going too deeply into his superficial analysis of why we must pay bonuses that he concedes aren't merited by the employees receiving them, and that he would not have approved had he been CEO at the time, this conclusion is astonishing:
In America, when you owe people money, you pay them.
Sure, but you pay them with your own money.

If I send Liddy my mortgage bill and say, "Dude, pay this for me," at best he'll ignore me and at worst he'll make an alternate suggestion of where I should put the bill. But there's no chance - zero, zilch, nada - that he won't recognize that I'm asking him to pay my bill with his money.

It's not a difficult concept to grasp.

Friedman on the AIG Bonuses

Thomas Friedman gets it pretty much right, explaining why the AIG bonuses have created such a problem for the Obama Administration, why the financial bailout is not yet complete, and how difficult it may now be to get the bailout back on track.

I don't agree with everything he says, I don't think Friedman's call for AIG employees to voluntarily give up their bonuses is going to inspire so much as the return of a dollar, and I don't know that his conception of how the bailout might proceed will be successful - nobody does, and Friedman admits that his conception is premised on hope, not certainty - but in a big picture sense he gets it. (And without the Washington Post's condescension.)

Tuesday, March 17, 2009

If You Don't Like the AIG Bonuses.... You're Part of an Angry Mob!

I may have to stop reading the news for a day or two.

Ruth Marcus believes she has an insight here:
Could we put down the pitchforks for just a moment and have a reasonable discussion about the bonuses at American International Group?

I get the outrage. It's galling to pay $165 million to a bunch of wealthy traders to clean up a mess that they, or at least their company, made.

I get the political fix in which President Obama finds himself. The sums are staggering - if not to Wall Street, then to everyone else who's ever worked for a living. The public is worked up, increasingly convinced that its money is being flung around recklessly, to a gang of extortionists at AIG and at European banks, without any hint that the fundamental problem is being fixed.
Yes, obviously, these bonuses are inspiring rage disproportionate to their amount, which I've already observed is miniscule compared to the bailout. (CWD likes to remind me of the quip, "$10 million here, $10 million there, pretty soon we're talking about real money." If only we were talking in figures that "small".) But Marcus conveniently forgets how much the taxpayer has had to swallow. If this were the first scandal over outrageous bonuses, well, we can roll with it. If it were the second, well, we can't just let the system collapse, right? But at a certain point we, the taxpayers, have every right to say "enough". Contrary to Marcus's suggestion I think, if anything, U.S. taxpayers have been very patient and understanding.

But Marcus continues to chide anybody, even the President, who questions the wisdom of these bonuses. She thinks they're justified:
Well, because in the short run, hammering the AIG employees to give back their bonuses risks costing the government more than honoring the contracts would. The worst malefactors at AIG are gone. The new top management isn't taking bonuses. Those in the bonus pool are making sums that for most of us would be astronomical but that are significantly less than what they used to make. Driving away the very people who understand how to fix this complicated mess may make everyone else feel better, but it isn't particularly cost-effective.
This combines two contentions about the bonuses that I have previously seen presented in isolation, and to my surprise Marcus manages to somehow reconcile them - at least in her own mind:
  • The people who put these deals together are the only ones who can undo them; so we have no choice but to pay them ridiculous amounts of money so that they'll stay and clean up their mess; and

  • All the bad people are gone and have been replaced with good people, who shouldn't be punished for the fact that the people they replaced did bad things.

Obviously, if it was possible to replace all of the bad people in the space of a few months such that only good people remain, and those good people are competent to fix the problems created by the bad people, it can't be that difficult to find new, quality employees who can understand and fix the mess.

Beyond that, her justifications make no sense.
  • These people used to earn more before their peers brought down the economy? Well, cry my a river. So did a lot of people who aren't getting six figure salaries and seven figure bonuses.

  • New top management isn't taking bonuses? Then we're to assume that they're no good and are incompetent to fix the problems, because nobody qualified would take those jobs without huge bonuses?

  • Taking back the bonuses will cost the government more than paying them? Care to explain how?

In the longer term, having the government void existing contracts, directly or indirectly, as with the suggestions of a punitive tax on such bonuses, will make enterprises less likely to enter into arrangements with the government - even when that is in the national interest. This is similarly counterproductive.
No wait, really. You're telling us that AIG wouldn't have agreed to be bailed out if it considered there to be a possibility that the government might try to reign in salaries? Even if we pretend they had a choice, didn't you just get through telling us that the new senior management voluntarily gave up bonuses? You think that was because they had no clue that the government would be concerned about excessive compensation? More to the point, where's your outrage about Ford and G.M. being instructed to shred their union contracts?

Marcus repeats some of the nonsense I've addressed in prior posts - for example, these bonuses were negotiated a year ago, before AIG received government money (but no question, let alone an answer, on whether these bonuses were negotiated, and enshrined in these extraordinarily bulletproof contracts, in anticipation of a government bailout. And that these bonuses have been common knowledge for over a year - she had best remind Geithner of that, because he begs to differ. And of course, this carries on into the "sanctity of contracts" nonsense argued even less persuasively by Sorkin.

Like Sorkin, Marcus also attempts to dance around her hypocrisy on the sanctity of contracts:
But, you ask, what about autoworkers who are being squeezed to renegotiate their contracts? Those renegotiations mostly involve the future terms of employment, though, it is true, they also could affect retiree health benefits. If an autoworker doesn't want to show up on the assembly line under the terms of a new deal, he or she doesn't have to. That's different from telling AIG employees they're not getting the amount on which they agreed for work they've already performed.
Horse puckey. If I negotiate a three year contract at a specific wage, and you tell me half-way through the contract that we're shredding it but "that's okay because it only affects my future wages," do I really need to explain to you that the wage structure of the entire contract was premised upon its three year term? Even if I ignore such things as earned retiree benefits, that Marcus dismisses as a footnote?

Further, this isn't compensation for work performed. That's called a "salary" This is a "bonus" - money paid in addition to salary. Typically, bonuses might be paid for this thing called "performance" - but no performance was required for these bonuses. These bonuses have been described as "retention bonuses" - payment to keep people in their jobs at AIG when they might otherwise quit. Except then, why are millions of dollars being paid to employees who have already left AIG? Marcus would tell us that the wage provisions of the UAW contracts can be renegotiated, but not the bonus provisions in those UAW contracts - aren't those "different", as well? What would it take to make Marcus cry "Shenanigans"?

Marcus continues by distinguishing this from bankruptcy - you know, where companies are in the same situation but taxpayers don't bail them out and pay their employees' salaries and bonuses, and the employees end up on the street:
This is more analogous, but bankruptcy is a legal mechanism designed precisely for the abrogation of contracts. It is intellectually consistent to support expanding the power of bankruptcy courts to rewrite mortgages on primary homes - as they can with vacation property - but balk at reneging on the AIG contracts.
Great. Now we're getting somewhere. Okay, Ms. Marcus, let's hear it - explain your intellectual consistency: Why it's okay for this very type of contract to go unpaid when a company goes bankrupt, but not when the only thing that keeps it out of bankruptcy is a taxpayer bailout, unprecedented in size?

Oh... You say you ran out of space before you could do that? How... unfortunate.
Once the pitchforks are out, it's awfully hard to convince the mob to put them down.
Don't worry, you're a Washington Post columnist and, at least so far, the angry mob hasn't turned on the village idiots.