The Raging Capitalist

We need more, not less, government planning

2011-07-10T12:46:00.000-07:00

I listened to John Stossel's latest show today on Fox Business (see link below), in which he cited Austrian-born economist F. A. Hayek's 1944 book, The Road to Serfdom, which warned against the tyranny that Hayek felt inevitably results when government controls national direction via a central planning function. Stossel was supportive of Hayek's view, and seemed to imply that planning and goal-setting by themselves equate to harsh government control and the elimination of personal freedoms. Essentially, he said we should rely on the capitalist system and let our corporations do our planning for us, as if corporations -- which are largely global today and without national allegiances -- can somehow be relied upon to put the American public's interests before their own.

Hmm... With unemployment so high, with government spending and our national debt out of control, with our infrastructure in decay, with our economy repeatedly bouncing from boom to bust, and with over 25% of our national wealth in the hands of less than 1% of our population (up from 9% thirty years ago), does it seem like we're on a a good course and that it's a good idea to continue to not do any long-term planning with the people's interests in mind? Furthermore, ironically, the corporations that Mr. Stossel so admires all have central (i.e., strategic) planning functions. Such functions are considered to be essential in the business world. Given that people like Stossel constantly advocate for government to be run more like business, then why shouldn't such a function exist within government, but with the national interest in mind? As it is now, in the absence of a strong planning function, we aimlessly meander from election to election, never building towards a unified vision of a better society. In the meantime, China, which does have a strong central planning function, is gaining ground on us every day. It's very frustrating.

You can't get where you want to go without a road map, and a road map is a product of planning.

To read about Stossel's show on his blog, click here. The show will be repeated again tonight, Sunday, July 10th, at 6pm on Fox Business (Comcast channel 130 in the Bay Area).

Helpful Behaviors for Building Wealth

2011-01-22T15:46:00.000-08:00

There are some really good points in this article (link below), although the title is a little misleading. It's not so much about becoming super-rich, but rather, it's really about the behaviors that may help someone become more wealthy than they otherwise might, whatever their income level may be.

The author refers to these things as being traits, but they're really skills that can be developed by anyone. Not everyone has the ability or opportunity to become a financial expert or to even go to college, but that doesn't need to condemn them to a life of financial insecurity. It's never too late to develop these skills either, although they're certainly more beneficial if picked up at an early age. I agree that comfort and confidence with basic math is really important, as is developing a methodical approach to problem-solving. The article emphasizes planning skills as well. In my experience, I've found that many people have an aversion to planning simply because they are afraid of the unknown and what they might learn from the planning process. The simple truth, though, is that it's better to be prepared and to learn about potential problems as soon as possible in order to maximize the amount of time available to rectify them. Developing a willingness to encounter uncertainty and a fearlessness about tackling problems, therefore, can by extremely valuable behaviors. If parents could help their kids zero in on these skills, it would go a long way to improving their children's long-term prospects no matter what those kids end up doing in life.

What can someone do to develop these skills or to instill them in their kids? First, you get comfortable with planning simply by doing it. Start small in order to stay within your comfort zone. For example, if you find yourself running out of cash every month, then put together a simple monthly budget. If you're concerned about retirement, then play around with some of the retirement calculators that are available on the Internet. They'll help you determine how much you have to save every month prior to retiring in order to support your lifestyle in retirement. As far as the kids go, there's nothing wrong with getting them involved in household budgeting. Explain to them how much you make, how much comes off the top in taxes, and how you budget the remainder, which hopefully includes some savings. Demonstrate to them that it's important to not spend more than you make. Explain the concept of priorities. Help them understand that maybe spending $100 a month on a cell phone for them isn't a great idea when mom and dad are concerned about their retirement or making tuition payments. If kids don't know what the limitations are, then there will be no limit to their expectations. The main point, though, is you'll be getting them used to the planning process early, which they will hopefully carry forward into their adult lives.

Click here to read "Character Traits and Behaviors that Make You Rich," by Laura Rowley.

Nassim Nicholas Taleb: A Crazier Future

2010-12-19T09:13:00.000-08:00

The author of Fooled by Randomness and The Black Swan speaking at a Long Now Foundation event. Fresh and irreverent as ever.

The runtime is about 90 minutes, but it's a good overview of the key concepts in The Black Swan, if you haven't had time to read the book. The parable of the turkey is particularly humorous, but makes an important point: intentions that we infer from previous events that may tend to confirm a belief, may actually be the opposite of what we believe. As Taleb's story goes, by virtue of the farmer showing up every day and feeding the turkey, the turkey's trust grows more each day that he is loved and cared for, right up until the hatchet falls. Another good takeaway: don't confuse infrequency with randomness. There's nothing random about market crashes, terrorist attacks, great fires, wars, earthquakes, etc., as they are, in effect, planned or conditions-based. The normal distribution (bell curve) doesn't apply to them, yet we insist on assuming that it does, and often to our peril.

Click here to see the video.

As Yogi Berra said, "The future ain't what it used to be."

Fortune's Top 10 Stock Picks for 2011

2010-12-08T19:02:00.000-08:00

Leigh Gallagher, assistant managing editor at Fortune, tells CNBC which stocks will be standouts in 2011. (The Raging Capitalist has no opinion on these stocks.)

You can read more from Fortune here

Was the Stimulus Too Small?

2010-11-07T14:43:00.000-08:00

Given Tuesday’s election results, there has been much reflection and debate in the media and in Washington about what went wrong for Obama and the Democrats. As suggested by Kathleen Parker in a recent op-ed, and I agree with her, "The election was a referendum on policies that are widely viewed as too overreaching and, ultimately, threatening to individual freedom. It's that simple." Others, perhaps most notably Paul Krugman, state that the stimulus was simply too small and was consequently ineffective, thus not reviving employment and turning voters against the Dems. As Krugman says, "Mr. Obama’s problem wasn’t lack of focus; it was lack of audacity. At the start of his administration he settled for an economic plan that was far too weak. He compounded this original sin both by pretending that everything was on track and by adopting the rhetoric of his enemies."

Although it's important to understand the political climate, we must address the real issue when we start talking about the stimulus and our economic recovery. We all want to reduce unemployment, but the first question to ask is, is unemployment the real problem or is it a symptom of something else? To date, the Fed and the Obama administration have approached our economic woes as if we were merely in an ordinary recession. Following the standard cures for such an event, they believe all will be well with a little time, provided we can just keep the public spending. In essence, they're trying to load the citizenry onto an arc so we can ride-out a tsunami safely at sea, and once the waters subside from our island paradise, we'll return to the shore and resume our lives. Well, I would suggest that the shore is not there any longer, and never really was.

I absolutely agree that we need to buffer our citizens from the shocks of this downturn. However, the real problem is that the economy we have known for the past 30 years was a myth. With the inventions of credit cards, second mortgages, and the mortgage securitization markets (the one sponsored by the government and its evil cousin, sponsored by Wall Street), we have been riding a debt-fueled bubble since the Reagan era. Debt-fueled growth was an easy path for the Republicans to take because it kept the economy firing on all cylinders once the growth associated with the post-WWII/baby boom era began to subside. The bubble worked for the Democrats as well, because it supported their social agenda of home ownership, and it enabled growth in the tax base that supported the progressive agenda of big, "the-government-shall-provide" government. The ruse created an unholy alliance between left and right that went unspoken, even when it became very dangerous. In any event, as we have learned twice now in the past 10 years, bubbles are not sustainable, and we experienced the inevitable collapse.

What disturbs me is that our political leaders still don't seem willing to face the reality that we need to create a new economy. When the dot-coms went bust, everyone knew the early-stage dot-coms didn't have viable business plans, so no one advocated that we devise ways to keep their employees in place until the public came to their senses and started finally using Webvan and Pets.com. Instead, we let those businesses go bust, we provided unemployment benefits to the dislocated, and we waited for businesses to get back on their feet and start hiring again. It actually didn't take very long. The current situation is more insidious, though. Because we were riding an inflated economy for so many years, many excesses became baked into our culture that simply cannot be sustained: federal and state agencies that don't provide a return on investment; ridiculous salaries, benefits and retirement schemes for many government workers; plus we had a misallocation of labor, with many civilians working in bubble-related industries, such as mortgage banking and construction. All of these excesses need to be eliminated in order to create a new, sustainable economy, as we are not going to have the money available to pay for governmental waste or to keep people in jobs that provide goods and services that are no longer in demand. Instead, rather than returning to a consumption-based economy, we must create an investment-oriented economy that is supportive of innovation and entrepreneurship. We must build a new economy that is based on viable business models that generate in-demand goods and services.

The current stimulus may, in fact, have been too small, but that's not to say that what has been spent was wisely spent in an effort to bridge us over to a new economy. The spending has been incredibly scattershot (details here), and virtually all of it supported the "arc and tsunami" scenario noted above. So far, we have spent on tax cuts to support consumption, we have kept government workers in their jobs, we have helped states keep their Medicaid programs going, we've provided unemployment benefits, and we've created some temporary jobs at incredible cost, not to mention doled out billions in pork to individual Congressional districts as quid pro quo payoffs to our Congressional reps. All of this spending has been done with no one -- not Obama, or anyone in Congress, or any members of the intelligentsia, like Krugman -- painting a picture of the new world we would emerge into once all the spending was done, nor have they given us a realistic, properly prioritized spending plan or timeline for getting us there. And do you know why that is? It's because they still haven't faced the reality that our world must change, and that's because they've never really searched for the root cause of our problems.

The answer is that we need to spend little AND we need to spend large. In other words, the spending needs to be differentiated and prioritized. Our former economy popped, yet the Fed and our government are spending trillions in doomed fiscal and monetary strategies to try to reinflate the same bubble. It won't work. Rather than clinging to broken systems, we need to accelerate the destruction of the old and the creation of the new. We need to support our brothers and sisters who have been displaced, but we need to steamline our spending so we can marshal the rest of our resources and refocus them on revitalizing the economy. Inconsistent with revitalization is spending on "make-work" temporary employment. Tempting as it may seem, it should be avoided, as there is no lasting value in the jobs, the projects cost too much to plan and supervise, and the work only postpones the inevitable. Moreover, the cost of the labor can oftentimes be exceeded many times by the cost of materials; e.g., there's more to the cost of a bridge to nowhere than the cost of the labor. The people are better off spending their time learning a marketable skill.

There are many things that we can and should be doing, and that's where the big spending comes in. For example, maybe I'm dreaming, but how much would it cost and how huge would the benefits be if we completely revitalized the city of Detroit? Can you imagine the economic and societal benefits of lifting half a million people up a step or two on the economic ladder? Undoubtedly, the cost would be enormous. Doing so might involve paying to relocate half of the population to other parts of the country (voluntarily, of course) and demolishing entire sections of the city, then consolidating the rest in order to make the city a community again. The remaining people would need to be trained and businesses would need to be provided with incentives to move in. This is just one grand-scale project that would cost big, but until we take it on, a city like Detroit will forever be an anchor chained to this country's feet. Of course, there are many smaller initiatives as well that we should take on: provide business start-up loans and grants; provide salary-based tax credits to existing businesses to take the risk out of hiring new employees; provide vocational training; provide businesses with tax credits for relocating and hiring the unemployed from economically depressed regions, and so on.

It's no wonder many people questioned the value of the stimulus. The problem we were trying to address had never been defined, a picture of the end game had never been painted, the objectives of the spending were too unfocused, and the results were not visible enough or were not individually significant enough to demonstrate the kind of success that would win public support. For example, there was no Hoover Dam, Golden Gate Bridge, AlCan Highway, or Tennessee Valley Authority, which were all projects from the Depression era that generated huge economic benefits, past and present. Moreover, as many on the left have criticized, expectations were not properly set. It was a mistake to let the public believe that a real fix could be effected in just a year or two. We are attempting to rebuild from a disaster that was 30 years in the making. That's going to take time, patience, determination, and a real plan.

Restoring Confidence is the First Step

2010-11-06T10:57:00.001-07:00

I just read a good article by David Smick on the role of confidence in restoring and maintaining a robust economy.

To add my own thoughts, confidence comes from predictability and trust. Job #1 for the government is to stop creating uncertainty and to implement systems that ensure fair playing fields for all, whether they be entrepreneurs or ordinary taxpayers.

Job #2 is to eliminate government waste and other spending that isn't absolutely vital to restoring the economy, thereby allowing government funds to be aimed at viable investments and a reduced tax burden (which also helps with Job #1).

Job #3 is for government to make the targeted, huge investments -- that only it can make due to its size and reach -- in education and infrastructure that will enhance industrial productivity and enable new business formation.

Job #4 is to provide incentives for people and companies to invest their new excess capital (from #2's tax savings) here in the U.S. Creating abundant capital and making it easier to achieve returns on that capital will reduce the cost of that capital to those he want to use it. Many investments that have been off the table for a generation now -- like building a blue collar factory -- would become viable again. Despite all the press about everyone needing to be a knowledge worker, we can definitely make use of well-trained people who can work with their hands, as they do in Germany.

It is well within our means to put people back to work and to set the stage for sustained prosperity. Some sacred cows will need to be slayed, "business as usual" (e.g., earmarks) in Washington will need to change, and we'll need to endure some upheaval as government workers are displaced and redeployed in industry, but the effort would be worth it. We just need to get on with it.

Follow-up on Obama and Change Management

2010-10-05T20:46:00.000-07:00

As a follow-up to my last article on the importance of change management, below are a coupled of links to analyses of Obama's success or lack thereof in managing change. Both analyses reference the Harvard/Kotter change management model that I mentioned in my article.

"...Obama seemed to miss the opportunity to re-mobilize and engage the millions of supporters that had been energized by his campaign and to redirect them towards specific initiatives. Instead, he seemed to focus his efforts on traditional political forms of influence, with the unintended consequence of even greater polarization than there was at the beginning of his term."

Analysis from the Harvard Business Review blog: click here.

"President Barack Obama embarked on one of the most challenging change leadership initiatives imaginable -- with no previous large-scale change experience. Some have said that inexperience does not matter if the president surrounds himself with experienced people.

They were wrong."

Analysis from Human Resource Executive Online: click here.

Our Future Depends on Change Management

2010-10-03T12:38:00.000-07:00

‎"We need to stop waiting for Superman and start building a superconsensus to do the superhard stuff we must do now."

This is an essential truth from Tom Friedman's brilliant October 2, 2010 article in the NYT (see article below).

To expand upon the importance of consensus building, in my opinion, we will never move forward as a nation until our political leaders understand the change management process, keys to which are establishing a legitimate sense of urgency about the problem(s), developing a unifying vision for a better post-change state, and building the consensus necessary to proceed into action.

No matter what any president's party affiliation, consensus of Democrats AND Republicans will be necessary to avoid gridlock. Impossible, you say? Well, that's what true leadership is all about. Building consensus is absolutely necessary, no matter how long it takes and no matter how painful the process may be. It will take an enormously patient, open-minded, courageous and determined president, but as we've seen with the divisiveness that results from the traditional approach -- which Obama fell into the trap of following -- attempts to shortcut the change management process simply don't work. I'm not saying Obama hasn't been well-intentioned (although I do disagree with his vision for our nation), but he either didn't know or didn't respect the process, and more harm has been done than good.

Click here to read more about the change management process, according to Harvard's John Kotter, who is arguably the foremost expert on the subject.

Third Party Rising
By THOMAS L. FRIEDMAN

A friend in the U.S. military sent me an e-mail last week with a quote from the historian Lewis Mumford’s book, “The Condition of Man,” about the development of civilization. Mumford was describing Rome’s decline: “Everyone aimed at security: no one accepted responsibility. What was plainly lacking, long before the barbarian invasions had done their work, long before economic dislocations became serious, was an inner go. Rome’s life was now an imitation of life: a mere holding on. Security was the watchword — as if life knew any other stability than through constant change, or any form of security except through a constant willingness to take risks.”

It was one of those history passages that echo so loudly in the present that it sends a shiver down my spine — way, way too close for comfort.

I’ve just spent a week in Silicon Valley, talking with technologists from Apple, Twitter, LinkedIn, Intel, Cisco and SRI and can definitively report that this region has not lost its “inner go.” But in talks here and elsewhere I continue to be astounded by the level of disgust with Washington, D.C., and our two-party system — so much so that I am ready to hazard a prediction: Barring a transformation of the Democratic and Republican Parties, there is going to be a serious third party candidate in 2012, with a serious political movement behind him or her — one definitely big enough to impact the election’s outcome.

There is a revolution brewing in the country, and it is not just on the right wing but in the radical center. I know of at least two serious groups, one on the East Coast and one on the West Coast, developing “third parties” to challenge our stagnating two-party duopoly that has been presiding over our nation’s steady incremental decline.

President Obama has not been a do-nothing failure. He has some real accomplishments. He passed a health care expansion, a financial regulation expansion, stabilized the economy, started a national education reform initiative and has conducted a smart and tough war on Al Qaeda.

But there is another angle on the last two years: a president who won a sweeping political mandate, propelled by an energized youth movement and with control of both the House and the Senate — about as much power as any president could ever hope to muster in peacetime — was only able to pass an expansion of health care that is a suboptimal amalgam of tortured compromises that no one is certain will work or that we can afford (and doesn’t deal with the cost or quality problems), a limited stimulus that has not relieved unemployment or fixed our infrastructure, and a financial regulation bill that still needs to be interpreted by regulators because no one could agree on crucial provisions. Plus, Obama had to abandon an energy-climate bill altogether, and if the G.O.P. takes back the House, we may not have an energy bill until 2013.

Obama probably did the best he could do, and that’s the point. The best our current two parties can produce today — in the wake of the worst existential crisis in our economy and environment in a century — is suboptimal, even when one party had a huge majority. Suboptimal is O.K. for ordinary times, but these are not ordinary times. We need to stop waiting for Superman and start building a superconsensus to do the superhard stuff we must do now. Pretty good is not even close to good enough today.

“We basically have two bankrupt parties bankrupting the country,” said the Stanford University political scientist Larry Diamond. Indeed, our two-party system is ossified; it lacks integrity and creativity and any sense of courage or high-aspiration in confronting our problems. We simply will not be able to do the things we need to do as a country to move forward “with all the vested interests that have accrued around these two parties,” added Diamond. “They cannot think about the overall public good and the longer term anymore because both parties are trapped in short-term, zero-sum calculations,” where each one’s gains are seen as the other’s losses.

We have to rip open this two-party duopoly and have it challenged by a serious third party that will talk about education reform, without worrying about offending unions; financial reform, without worrying about losing donations from Wall Street; corporate tax reductions to stimulate jobs, without worrying about offending the far left; energy and climate reform, without worrying about offending the far right and coal-state Democrats; and proper health care reform, without worrying about offending insurers and drug companies.

“If competition is good for our economy,” asks Diamond, “why isn’t it good for our politics?”

We need a third party on the stage of the next presidential debate to look Americans in the eye and say: “These two parties are lying to you. They can’t tell you the truth because they are each trapped in decades of special interests. I am not going to tell you what you want to hear. I am going to tell you what you need to hear if we want to be the world’s leaders, not the new Romans.”

The Problem with a Poorly Weighted Dow 30

2010-09-17T19:57:00.000-07:00

I’ve always been annoyed by how the constituent members of the Dow 30 are weighted (i.e., based on the price of each company’s shares), but current weightings are really ridiculous in that only a handful of the 30 stocks have any meaningful influence on the value of the index.

Why is this a problem? Because the Dow is considered (although wrongly) to be a barometer of the health of the entire economy. If the Dow is doing poorly, it influences the psychology and behaviors of consumers and business leaders. With a poorly constituted index, as is the case now, false indications can more easily result, which is potentially harmful, as a negative trend in the Dow could trigger behaviors that could cause a recession.

Do we really want the price movement of three or four stocks to influence the psychology of the country, if not the globe? Some of the current heavy hitters in the index, like IBM and McDonalds, are doing fine now, but they had significant business issues within the past 20 years that dramatically deflated their stock values and which had nothing to do with the state of the economy as a whole. That could certainly happen again, and it's nothing trivial. Obviously, I'm dramatizing the risk somewhat to illustrate my point, but why unnecessarily create risks, especially after what we've been through over the past couple of years? The public is tired of having its fortunes dictated by Wall Street.

Given that price per share is simply a function of how many shares are outstanding, which has no relevance to anything, why not base the weighting on something more rational, like market cap, or why not even do an equal weighting?

Here’s a good explanation of what’s going on, in case this subject is new to you.

Click here for a link to the article that the video is from.

It's Time for Public Pension Reform

2010-08-08T12:44:00.000-07:00

The photo above is of CalPERS' list of Top 10 pensioners. Between $200K-$500K a year for life? Good for them, but not for the taxpayer. (Click here for California Pension Reform's searchable database.)

Daniel Borenstein at the Contra Costa Times has been doing a bang-up job of reporting on how out of control our public pensions are in California (see link below). Not only is the system itself outdated and flawed, but the tactics used by some public employees -- with the support of their bosses -- to "spike" their pensions just prior to retirement border on criminal behavior, as far as I'm concerned.

Those of us in the private sector have to rely on our self-funded 401(k) plans for our retirements. Why are we providing full pay (or more) -- for life! -- to retirees who are in their early 50s? The outrageousness of this problem is exacerbated by recent surveys that show that public workers are also better paid and have dramatically better benefits than private sector workers in similar positions. In other words, they should be more capable of providing for their own retirements than the typical private sector employee. To add insult to injury, not only do many public workers have generous pensions, but they also have the equivalent of 401(k) plans (403(b) plans, etc.) with generous employer matching. How much is enough? Especially in light of the outrageous abuses that have been exposed in the Bell, California scandal, one has to wonder why no one is responsible for monitoring the fairness of these compensation schemes. It's time for serious public pension reform.

Click here for a good article by Borenstein.

The Importance of "Systems Thinking"

2010-06-06T10:16:00.000-07:00

I came across a good article last night from the consulting firm, Booz & Company. It discusses what is known as systems thinking. The use of the word “systems” is a reference to a corporation as an organic whole, with many interconnected and interdependent functions. The article dovetails nicely into my own MBA research. I’ve been thinking a lot about this topic recently due to the BP oil spill, which one can very clearly identify as a breakdown in systems thinking, once you know what to look for.

What became very clear to me in my own research was that the bedrock of any successful, enduring corporate system consists of its leaders’ vision and values, which are expressed on a daily basis through the ethics and standards by which the company operates, through the delivery of its value proposition (i.e., the unique value it intends to deliver to its customers), and in how it operates internally in order to deliver that value proposition.

The vision of how a company will operate internally is communicated in the form of what I call an operating psychology, which consists of the organizational structures, methods, standards, processes, technologies, etc., that the organization will use to accomplish its work. The operating psychology needs to ensure that the leaders' values will be maintained through their employees' daily decisions and actions, and that such actions will produce the long-term vision the leaders have for the company.

A very basic issue to address, for example, when developing an operating psychology is to determine the level of quality the company wants to deliver as part of its value proposition, as quality has huge implications on the investments a company will make on plant and equipment, how much it will spend on training, the quality of people it will hire, whether it will use outsourcing, how much supervision it will provide to its staff, etc., etc.

Safety is another important issue. If a company's business activities are inherently risky, then the business needs to incorporate that degree of risk into its operating psychology. A company like BP, for example, would need to make sure that safety is prominently woven into the fabric of the company, and that safety would always take top priority over everything else. It must do so, as the consequences of doing otherwise can jeopardize the very existence of the company. To make safety the highest priority, the company would need to rigorously train its employees on good safety practices, and it would need to reward exhibitions of putting safety first, even when doing so results in short-term costs. Importantly, there can be no negative consequences on an employee who exercises appropriate caution -- no sideways glances, no withheld promotions, etc. Simply put, a commitment to safety must be a core value, and it must be continuously hammered into the psyche of the company.

Long story short, clearly communicating the operating psychology to the employees is every bit as important as disseminating the customer value proposition. This is where companies often fall down. After watching a 60 Minutes segment on the events leading to the BP disaster, it was obvious that there were both managerial failings on the rig and through every level in the company preceding those failings. It’s no coincidence that BP had the worst safety record in the industry even before this disaster. Clearly, a linkage between safety and the long-term sustainability of the corporation has not been firmly ingrained in BP's operating psychology. In other words, there are reasons why you get horribly short-sighted, costly and dangerous decisions from a mid-level manager on a rig in the middle of the Gulf. Those bad decisions result from breakdowns throughout the entire organization, all of which can be traced back to a failure in having a clear, enduring, and well communicated vision of how the company will operate and achieve success over the long haul.

The BP manager on the rig was worried about staying on schedule, as a slip in the schedule may have cost the company a few million dollars. Instead, by not keeping the long-term perspective in mind, he (and BP, through its bad management) created a disaster that may well bring down the entire company, and have costs on the people and ecosystems of this planet for decades to come. These same types of failings have brought down many corporations over the years, including many of the financial houses in the past couple of years. Hence, learning about these issues is really important, which is why I wanted to share these perspectives and the Booz article.

The article can be found here:

"Seeing Your Company as a System," from Booz's Strategy+Business online magazine.

Similarities between the Shuttle Challenger and BP Oil Spill Disasters

2010-05-19T21:03:00.000-07:00

Most of the major accidents we're all familiar with could have been easily prevented. The more I learn about the BP oil spill, the more I see similarities with the Space Shuttle Challenger disaster: 1) speed and schedule were put before safety; 2) vital information provided by engineers in the field was ignored by management; 3) those same engineers allowed themselves to be bullied into continuing their work, rather than escalating the matter or seizing the power necessary to take control and avert disaster; 4) an overconfidence due to prior records of good safety led to complacency; 5) the failure of a relatively cheap and simple component (in both cases, a type of rubber seal) ultimately triggered the catastrophic failure.

If you've never studied the results of the Challenger investigation, I can recommend it as an excellent case study in poor communication and bad management.

60 Minutes ran a great investigative segment on the causes of the BP oil spill. The video can be seen here.

The results of the Challenger investigation can be seen here.

Citigroup on "Plutonomy"

2010-05-01T07:38:00.000-07:00

Plutonomy: where the rich rule with the support of the government. (Obviously, a derivation of the word "plutocracy.") Bill Moyers was just talking about this on his show and referenced a series of reports from Citigroup on the subject. (Ironically, taxpayers now own the majority of Citigroup!) When something becomes so obvious that investment houses start to build investment strategies around it, then you know it's for real, and in this case, we have a problem.

I have no problem with people making the most of their available opportunities and becoming rich, evenly astonishingly so. I only care that we have fair playing fields, and a government that is not in the hip pocket of a few. From one of the Citigroup papers:

"Our thesis is that the rich are the dominant drivers of demand in many economies around the world (the US, UK, Canada and Australia). These economies have seen the rich take an increasing share of income and wealth over the last 20 years, to the extent that the rich now dominate income, wealth and spending in these countries. Asset booms, a rising profit share and favorable treatment by market-friendly governments have allowed the rich to prosper and become a greater share of the economy in the plutonomy countries."

Click here to access Citigroup's report on plutonomy.

Bill Black and Barry Ritholtz on the Goldman Sachs Fraud

2010-04-16T21:03:00.000-07:00

Here's a good discussion on the Goldman fraud allegations. Folks, how many examples do we need to see before we realize these guys should be put out of business? When you come across a corrupt culture, there's never just one incidence of fraud. It's like the old "you can't be a little bit pregnant" saying. As Black says, if you're rotten, you're rotten to the core. Given that these types of situations take awhile to unravel, but then they just get uglier and uglier, it's beyond me why GS stock was only down 13% today. This is only the beginning. Take a look at this quote from Fabrice Tourre, the man who orchestrated this deal at Goldman. Of course, incompetence and/or irresponsibility do not necessarily equate to illegality, but I would say that there'd have to be a good chance that other of his "monstrosities" would have been illegal as well (from an Associated Press article):

In an email to the friend, he described himself as "the fabulous Fab standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!"

Elizabeth Warren on the Collapse of the Middle Class

2010-03-27T16:23:00.000-07:00

Elizabeth Warren is a law professor at Harvard and has become a public figure recently due to her leadership role on the TARP Congressional Oversight Panel. She's also an expert on trends concerning the middle class. In this lecture at U.C. Berkeley in 2007, Ms. Warren discussed why the quality of life and financial security of the middle class has diminished year after year for the past 30 years. Not a pleasant subject, but it's an important topic. I hope you find it informative.

Credit Default Swaps Explained

2010-03-27T10:34:00.000-07:00

Finally, someone has done a pretty straightforward video on how credit default swaps work. The punchline, if you will, is the part near the end about how someone can buy this type of insurance without actually owning the asset that's being insured. That was the magic ingredient that multiplied all of the problems in the meltdown and sent everyone into a panic. Also, take note that these swaps only cost about 2% per year of the insured value. So, when our government made good on AIG's contracts, they were providing Goldman Sachs and others with nice little 50:1 payoffs in many cases.

Barney Frank has it all under control

2010-03-27T09:09:00.000-07:00

Good grief. I caught this interview on CNBC on March 24th. It's of Barney Frank and Chris Dodd talking about their financial reform agenda following their meeting with the President.

Frank's comments are particularly shocking. Fairly early in the video, he says that we've "dealt with" all of the problems that led to the collapse of the likes of AIG and Lehman. Oh really? How have we dealt with them, Mr. Frank? If any new regulations or government powers have been implemented, please cite them.

Then, about 80% of the way through the video, he says that we'll only pay down bank debts (in future bailouts) that threaten a "total spiraling downward" (i.e., a systemic meltdown of the financial system). Mr Frank, isn't systemic risk what we need to prevent by implementing too-big-to-fail measures and Mr. Volcker's ideas regarding the segregation of high-risk, non-banking activities? The whole idea is that we need to refocus banking and Wall Street on "boring" customer-focused activities, rather than high-risk proprietary activities, so that we don't create enormous risks in the first place.

I have to say, I feel like absolutely nothing has been learned, and that the American people are in very poor hands.

Video: Dodd, Frank meet with Obama over financial regulation
- Watch more Politics Videos at Vodpod.

Gretchen Morgenson on why no progress on financial reform

2010-03-27T08:18:00.000-07:00

Wonderful interview on Bill Moyers Journal last night with Gretchen Morgenson of the NY Times: "Eighteen months after the economic meltdown, why has Washington been unable rein in Wall Street with serious regulation? Bill Moyers speaks with financial journalist Gretchen Morgenson for a candid look at the obstacles facing substantive reform and what Congress' proposed legislation would — and wouldn't — accomplish."

Click here to watch the video on PBS' site.

Health Care Reform Implementation Timeline

2010-03-23T13:21:00.000-07:00

As everyone knows by now, sweeping health care reforms were approved by the House of Representatives Sunday night. President Obama signed the health care legislation this morning at The White House.

The Senate will now begin considering a package of House changes to the Senate measure in a process known as "reconciliation." The Senate needs a simple majority of 51 votes to approve the changes. Once this process is complete, President Obama will then sign the reconciliation bill and the changes will be incorporated into the measures listed below.

The health care reforms will unfold slowly. Below, I have provided a detailed timeline highlighting the major changes that would take place year-by-year.

Timeline for Implementation:

2010
Sets up a high-risk health insurance pool to provide affordable coverage for uninsured people with medical problems.

Requires all health insurance plans to maintain dependent coverage for children until they turn 26. Prohibits insurers from denying coverage to children because of pre-existing health conditions.

Prohibits insurance companies from imposing lifetime dollar limits on coverage and canceling policies, except in the case of fraud.

Provides tax credits to help small businesses with up to 25 employees obtain and keep coverage.

Begins narrowing the Medicare prescription coverage gap by providing a $250 rebate to seniors in the gap, which starts this year once they have spent $2,830. The gap would be fully closed by 2020.

Reduces projected Medicare payments to hospitals, home health agencies, nursing homes, hospices and other providers.

Bans health plans from dropping people from coverage when they get sick.

Imposes 10% sales tax on indoor tanning.

2011
Creates a voluntary long-term care insurance program to provide a modest cash benefit helping disabled people stay in their homes, or cover nursing home costs. Benefits can begin five years after people start paying a fee for the coverage.

Imposes a $2.3 billion annual fee on drug makers, increasing over time.

Requires employers to report the value of health care benefits on employees' W-2 tax statements.

Provides Medicare recipients in the prescription coverage gap with a 50 percent discount on brand-name drugs; begins phasing in additional drug discounts to close the gap by 2020.

Provides 10% Medicare bonus to primary care doctors and general surgeons practicing in underserved areas, such as inner cities and rural communities.

Freezes payments to Medicare Advantage Plans. The first step in reducing payments to the private insurers who serve about one-fourth of seniors. The reductions would be phased in over three to seven years.

2012
Sets up a program to create nonprofit insurance co-ops that would compete with commercial insurers.

Penalizes hospitals with high rates of preventable readmissions by reducing Medicare payments.

Initiates Medicare payment reforms by encouraging hospitals and doctors to band together in
"accountable care organizations" along the lines of the Mayo Clinic. Sets up a pilot program to test more efficient ways of paying hospitals, doctors, nursing homes and other providers who care for Medicare patients from admission through discharge. Successful experiments would be widely adopted.

2013
Standardizes insurance company paperwork, first in a series of steps to reduce administrative costs.

Limits medical expense contributions to tax-sheltered flexible spending accounts (FSA's) to $2,500 a year, indexed for inflation. Raises threshold for claiming itemized tax deduction for medical expenses from 7.5% of income to 10%. People over 65 can still deduct medical expenses above 7.5% of income through 2016.

Imposes a 2.3% sales tax on medical devices. Eyeglasses, contact lenses, hearing aids and many
everyday items bought at the drug store are exempt.

Increases Medicare payroll tax on couples making more than $250,000 and individuals making more than $200,000. The tax rate on wages above those thresholds would rise to 2.35% from the current 1.45%. Also adds a new tax of 3.8% on income from investments.

2014
Prohibits insurers from denying coverage to people with medical problems or refusing to renew their policy. Health plans cannot limit coverage based on pre-existing conditions or charge higher rates to those in poor health. Premiums can only vary by age, place of residence, family size and tobacco use.

Coverage expansion goes into high gear as states create new health insurance exchanges – supermarkets for individuals and small businesses to buy coverage.
Medicaid expanded to cover low- income people up to 133% of the federal poverty line, about $28,300 for a family of four. Low-income childless adults covered for the first time.

Requires citizens and legal residents to have health insurance, except in cases of financial hardship, or pay a fine to the IRS. Penalty starts at $95 per person in 2014, rising to $695 in 2016. Family penalty capped at $2,250. Penalties indexed for inflation after 2016.

Penalizes employers with more than 50 employees if any of their workers get coverage through the exchange and receive a tax credit. The penalty is $2,000 times the total number of workers employed at the company. However, employers get to deduct the first 30 workers.

Provides income-based tax credits for most consumers in the exchanges, substantially reducing costs for many. Sliding-scale credits phase out completely for households above four times the federal poverty level, about $88,000 for a family of four.

2018
Imposes a tax on employer-sponsored health insurance worth more than $10,200 for individual
coverage, $27,500 for a family plan. The tax is 40% of the value of the plan above the thresholds, indexed for inflation.

2020
Coverage gap in Medicare prescription benefit is phased out. Seniors continue to pay the standard 25 percent of their drug costs until they reach the threshold for Medicare catastrophic coverage, when their co-payments drop to 5 percent.

A History of Medicare and Social Security Tax Increases

2010-03-21T17:33:00.000-07:00

Medicare was legislated in 1965, and a new payroll tax was implemented in 1966 to cover the expense of the new entitlement program. The initial tax was 0.35%, payable by both the employee and employer on the first $6,600 of the employee's wages. The $6,600 upper wage limit rose by about 50% in total over the first 8 years, and then dramatically increased thereafter, until reaching $135,000 in 1993. That represents about an 11.40% annual increase between 1966 and 1993, whereas inflation increased at an annual rate of 5.38% during that time. The upper wage limit was eliminated in 1994, meaning that the tax began to be charged on all wages at that time.

While the Medicare wage limit was being increased, the tax rate was increased continuously as well. It approximately tripled in the first 8 years from 0.35% to 1.0%, and eventually hit the current level of 1.45% in 1986. In dollar terms, the amount collected on the wage limit maximum from both the employee and employer increased from $23.10 in 1966 to $1,957.50 on the $135,000 limit that was in place in 1993. That represents a 17.2% annual increase, whereas, as noted above, inflation increased at 5.38% over that period. Hence, the maximum tax was increased at over 3 times the rate of inflation, and again, there has been no maximum tax since 1994.

Changes in the Social Security tax are equally staggering. The tax was implemented in 1937 at 1.0% of the first $3,000 of wages. It stands today at 6.20% on the first $106,800 of wages. Inflation between 1937 and 2010 was 3.76% annually, whereas the wage limit has risen at 4.95%. Hence, even if the original 1.0% tax had remained constant, the amount collected on the limit would have increased substantially more than the rate of inflation due to the more rapidly increasing wage limit. However, with increases in both the limit and the rate, the tax in dollar terms has increased on the wage limit from $30 to $6,622, a 7.57% annual increase, which is double the rate of inflation between 1937 and 2010.

Under the proposed health care reform act, to pay for the changes, the legislation includes more than $400 billion in higher taxes over a decade, roughly half of it from a new Medicare payroll tax on individuals with incomes over $200,000 ($250,000 for couples). From an article on MSNBC, here's how the tax hike would work:

"Under Obama's plan, individuals with incomes of more than $200,000 — including both wages and investment returns -would pay a 2.9 percent tax on interest, dividends, royalties and other unearned income that exceeds that threshold. Couples with total incomes over $250,000 would face the tax, too.
The proposal would also increase the 1.45 percent Medicare payroll tax on workers' wages to 2.35 percent on earnings that exceed $200,000 for an individual and $250,000 for a couple. The portion of the Medicare payroll tax paid by the employer would remain at 1.45 percent.
Under this plan, a couple that earns $275,000 in salaries and $150,000 from investments would pay the normal 1.45 percent on the first $250,000 of their wages. They would pay 2.35 percent on the last $25,000 of wages. And, because their total income tops $250,000, they would face the 2.9 percent tax on all $150,000 of their investment income.
Right now, that couple would pay $3,987.50 in Medicare taxes each year. Under the proposal, they would pay $4,212 on their wages and $4,350 on their investment income, $8,562, assuming all of that income is taxable. Congressional estimators predict any final policy would include some exemptions, such as the costs of generating investment income."

Note that in addition to the above Medicare tax hike, the House's revisions to the Senate's bill also include a 0.5% Hospital tax on high-income individuals and couples; i.e., those with incomes over $200,000 and $250,000, respectively.

Clearly, the new taxes are intended to shift the burden to the supposed rich. However, after analyzing the government's past record for increasing the Medicare and Social Security taxes, how long can we honestly expect it to be before that $200,000 floor starts to creep down, or the tax rate starts to creep up, or both?

Sources:
Inflation data: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

Historical tax rates: http://www.ssa.gov/history/pdf/t2a3.pdf

MSNBC article on the new tax: http://www.msnbc.msn.com/id/35844649/ns/health-health_care/

Michael Lewis: Inside the Collapse

2010-03-18T19:56:00.000-07:00

Michael Lewis, author of the new book The Big Short (click for Amazon), gave a great interview on 60 Minutes this week. It's a must see for anyone who wants more of the scoop behind the mortgage meltdown, Wall Street's bad behavior, and the U.S. government's sell-out of the taxpayer to buck-up the busted investment banks.

Part 1:

Part 2:

Short "extras" (about a minute each)

More from Michael Lewis on the bailouts:

Michael Lewis on Wall Street pay:

Michael Lewis on how Wall Street is subsidized by the Fed:

More from Michael Burry on being a misfit:

Michael Burry on the size of his bet against mortgages:

Tips from Dr. Doom, and Understanding His Doomsday Scenario

2010-03-13T08:44:00.000-08:00

This is a pretty gloomy, yet surprisingly lighthearted interview with Marc Faber, otherwise known as Dr. Doom. I'm glad he can keep his spirits up in light of how he feels about our future!

Faber (and the other fellow in this interview) is obviously as contrarian as one can get. However, in the ten years I've been following him, unfortunately, his opinions have been on the mark. I give him a lot of credit for being able to look at things objectively and for being willing to go on record with unpopular opinions. From my perspective, I like to gather all points of view. Blinders off, so to speak. I then try to form my own ideas based on all of the inputs.

In this video, Faber shares a few ideas on how people can protect themselves financially in the face of what he believes is a coming high-inflation environment. Faber is an advocate of buying "hard assets" that benefit from inflation, such as gold, farm land, and other real estate. This then raises the question of why he believes we'll have high inflation.

The situation is that we will about double our national debt in the next decade. Obama has been very up-front about this. Since this will be during a time when America is doing everything it can just to get back on its feet, there is no expectation that Americans will somehow become wealthier in that time frame, and therefore more capable of paying down that debt. Hence, the likely scenario is that the government will simply print money to do what's known as "infalting away" the debt. In other words, if $200 billion in bonds that China is holding come due, we would simply print the money to retire the bonds. Naturally, that would devalue our currency, which would then make everything we buy from other countries more expensive; i.e., inflation. In addition, it would make issuing additional debt in the future more expensive, as our international lenders got burned last time by getting a devalued currency in return for their bonds. After all, who wants to lend a dollar and get the equivalent of, say, 80 cents in return?

With everything then being more expensive, people would have to cut back on spending, which would create a recession and increase unemployment. With higher unemployment, the government would have to increase entitlements and deficit spending, thus exacerbating the debt problem by having to borrow more at ever-increasing interest rates. This perpetuates the cycle and accelerates our trek towards ruin, which is the doomsday scenario these guys are talking about.

Essentially, people, companies, and countries reach a tipping point when they take on too much debt, and it inevitably takes them down. This is the problem many Latin American countries ran into in past decades, and this is where the so-called "PIIGS" countries (Portugal, Ireland, Italy, Greece, and Spain) are headed today. These two gents are saying we're probably looking at the same fate in about 10 years. Frankly, I'm looking for reasons to refute what they're saying, and I'm having a hard time finding any. Fun, huh?

The Greek Debt Debacle: Likely Winners and Losers

2010-02-28T09:49:00.001-08:00

I think this matter of banks having facilitated Greece's hiding of the magnitude of its debt is going to get a lot more interesting before its all over. Here's an update on the story from the NY Times: "Banks Bet Greece Defaults on Debt They Helped Hide." Here's the short story:

A number of European banks and America's own Goldman Sachs engineered a number of complex currency swap transactions that allowed Greece to understate its debt.
Since these banks had inside knowledge that Greece's financial position was much less secure than it appeared, being good opportunists, the went out and bought credit default swaps (insurance against default) on Greece's debt. So, they made big fees setting up the scheme, and they stand to benefit if the scheme falls apart.
Who did they buy the credit default swaps from; i.e., who was the unwitting sucker to take the bet? Probably multiple issuers, but it looks like the brain trusts at AIG were among them, which means that the American taxpayer would be on the hook in the case of Greece's default, given that the U.S. now owns 80% of AIG.
So, if Greece gets closer to default, this means that the U.S. either bails out Greece to avoid losses at AIG, or it just steps up and bails out AIG yet again. Once again, the financial industry wins, and the taxpayers lose.

From a translation of an investigative piece from the German newspaper Frankfurter Allgemeine Zeitung:

London investment bankers name AIG as a further CDS-seller. That company had to be nationalized during the financial crisis due to its having written insolvency insurance on American mortgages. This debt-load would have led to the collapse of the world’s biggest insurer. Prior to the financial crisis AIG is said to have widely held State credit-risk. If yet-larger insurance positions on Greece exist, then the American government would have a strong interest in preventing that country’s insolvency.

The Flawed Compensation System in Investment Banking

2010-02-28T09:11:00.000-08:00

Here's a good article from the prolific Edward Harrison that explains the differences between conventional corporations (including commercial banks) and the big Wall Street firms relative to how people are compensated and who's really calling the shots on risky decisions. In the Wall Street firms (Goldman Sachs, and the now-departed Lehman and Bear Stearns), the top execs are often clueless about the risks their firms are taking (which is a major problem, of course), and you have much lower level people pulling off hugely risky deals. If they win, their payouts are huge. If they fail, they get fired, but just move down the street to another firm. This is why we can't give the same protections to Wall Street that we give to commercial banks. They should be allowed to take risks, but not with government backing. That's what the proposed Volcker rules are all about.

From Mr. Harrison's article:

Corporate hierarchies
In a normal corporate environment, there is a strict hierarchy in which those at the top earn more than those at the bottom. In order to rise to the top (and earn the salary and huge bonus – I might add), one needs to be considered successful. And that means putting in years of effort for which one receives performance reviews.
If you do well on these reviews, you might even receive accolades, awards and so on – the point being you are a rising star with talent. So you get promoted. “The way you’re going, you might even rise to CEO one day!” That’s the kind of praise you might hear. So the whole hierarchical apparatus is designed to align high achievement with other external signs of success: good evaluations, promotions, more money, more responsibility, more underlings, larger budgets, awards, and accolades and so on. All you need to do is look at an org chart and you get a pretty good sense of who’s supposed to be the stars. And by the way, this is how it works in commercial banking as well.
Investment banking hierarchies
But, that’s not how it works in investment banking at all. When one deal or a series of trades can mean billions in profit, even a relatively junior person can have influence on the bottom line far beyond what her title suggests. This is certainly true in the advisory business, but it is even more true in trading – especially proprietary trading, a major reason that proprietary trading is inherently risky and would be restricted under the Volcker Rule. By the way, this is also a major reason that investment banks that are public companies and not partnerships are risky companies with notoriously poor managers.
A slovenly 32-year old junior trader with terrible social skills, zero management ability and no one reporting to him can make millions of dollars a year. He’s the guy you read about in the newspaper making three times the CEO’s salary. He’s the guy that all the other firms are trying to poach. And he’s the guy that used to be referred to admiringly as a “big swinging dick.” You don’t see that at Acme Incorporated. That’s what I mean when I say it’s all about the money. You learn very quickly in investment banking that status is not all about the titles, it’s more about the money.
Read any account from investment banking like Predator’s Ball or Liar’s Poker you will quickly notice that even the higher level guys are driven to earn a lot of money, not only for the money itself but for what that money says about their status and value relative to their peers.

You can read his full article on Seeking Alpha here.

Conservatives targeting their fringe

2010-02-28T08:47:00.000-08:00

On the heels of the Scott Brown victory in Massachusetts, it looks like Republicans are finally learning that they don't need to kowtow to the far right. I wrote about the need for this back in October.

From the Politico article:

After months of struggling to harness the energy of newly engaged tea party activists, the conservative establishment — with critical midterm congressional elections on the horizon — is taking aim for the first time at the movement’s extremist elements.

The move has been cast by some conservatives as a modern version of the marginalization of the far-right, anti-communist John Birch Society during the reorganization of the conservative movement spearheaded by William F. Buckley Jr. in the 1960s and 1970s.

“A similar effort will be required today of conservative political and intellectual leaders,” former Bush speechwriter Michael Gerson wrote in his column in The Washington Post. “It will not be easy. Sometimes it takes courage to stand before a large crowd and proclaim that two plus two equals four.”

Read the full article on Politico here.

Capitalism, The System of

2010-01-30T14:52:00.000-08:00

Given that I call myself The Raging Capitalist, I can't miss an opportunity to provide a good example of what the capitalist spirit is really all about. Such is provided in the linked article by David Brooks, particularly in his discussion of Lincoln and Hamilton. Brooks writes:

They rejected the zero-sum mentality that is at the heart of populism, the belief that economics is a struggle over finite spoils. Instead, they believed in a united national economy — one interlocking system of labor, trade and investment.

In their view, government’s role was not to side with one faction or to wage class war. It was to rouse the energy and industry of people at all levels. It was to enhance competition and make it fair — to make sure that no group, high or low, is able to erect barriers that would deprive Americans of an open field and a fair chance. Theirs was a philosophy that celebrated development, mobility and work, wherever those things might be generated.

Brooks' concern is that populist rage over abuse of the financial system will ultimately lead to the suppression of the capitalist ideals that have been so fundamental to our prosperity as a nation. His concern is valid, and the public's rage needs to be properly addressed, and without focusing that rage on a condemnation of capitalism itself.

Capitalists in no way want to turn a blind eye to those who have corrupted and co-opted our financial system. True capitalists aren't about gaming the system, or buying political influence, or hoodwinking the masses. They believe in the rule of law, creating open and fair playing fields, and allowing funds to easily flow between investors and entrepreneurs. Therefore, it would be high on the typical capitalist's agenda to want to dispense justice to those who have abused the financial system. However, those efforts need to be intelligently targeted and the penalties should be in proportion to the crimes (see my post on Obama's financial crisis fee). Similarly, we must enhance regulation, but we must take care to not strangle the system. We must ensure that risks taken with capital are in-line with investors' intentions, but capital must be allowed to flow freely. We must give the public free and fair access to the resources of the financial system, but we must not do it in such a way that checks and balances are ignored and unintended consequences result.

Importantly, we must remember that capitalism is a system. It has no political or social agenda. It doesn't think, or feel, or have opinions -- no different from the plumbing in your house. Attempts to weave the social agenda into capitalism (e.g., to make housing "affordable") have always failed, as they interfere with the "laws of nature" that apply to capitalism, such as having to live with the risks that you create. It is implicit in the capitalist system that its "users" -- the public -- can decide for themselves how hard they want to work, and how much risk they want to take. Some will succeed, and some will fail. Like Mother Nature herself, capitalism turns a blind eye to personal tragedy and hardship. Some will go out on a limb and run their own businesses, and others will choose to become human resources in those businesses. Capitalism makes no value judgments. Businesses generate profits, and their owners evolve into investors who bankroll the next generation of entrepreneurs. That's the cycle. That's how the system works. For all its harsh realities, capitalism is simple, self-correcting (when not interfered with), elegantly pure, and time-tested. We need to protect it with everything we've got.

Obama's Financial Crisis Fee -- sounds SO good, but oh, SO wrong

2010-01-14T17:57:00.000-08:00

President Obama announced plans today to levy a “Financial Crisis Responsibility Fee” on the nation’s largest banks — those with more than $50 billion in assets. Basically, it will be computed as .15% (i.e., 15/100ths of 1%) of the banks’ liabilities, excluding deposits covered by FDIC insurance (because a separate fee is assessed on them).

To a revenge-starved public, this may sound SO right and be SO overdue, but it is SO wrong. Once again, Obama has proposed a solution — as he did with health care reform — that is so lacking in nuance that it is clear that he doesn’t truly understand the problem. Either that, or it’s simply more evidence that he’s in Goldman Sachs’ hip pocket.

So, what’s wrong with this solution? Answer: it penalizes conservative, well run institutions, and once again, lets those who are the real troublemakers off the hook. The troublemakers that are left alive, that is. Keep in mind that most of the institutions that caused the crisis are now out of business or were merged into more responsible firms and are now under new management. By far, the biggest culprit still standing — and thriving, as no financial reforms have yet been implemented — is Goldman Sachs.

Although Obama and the media refer to “banks” as a homogeneous group, it is important to separate routine commercial and consumer lenders from super-large “money center banks” (e.g., Citibank, BofA, Wells Fargo, and JP Morgan Chase) and Wall Street “investment banks,” the latter of which (e.g., Goldman Sachs) were not actually banks at all until the financial bailout. Although they’re called investment banks, they never had bank charters, weren’t regulated as banks, and didn’t have FDIC-insured deposits until Treasury Secretary Hank Paulson allowed them to convert into chartered banks in order for them to qualify for TARP bailout funds. It was a slight of hand to do a solid for his friends on Wall Street, plain and simple. The investment banks are the firms that engage in the most risky trading and derivatives activities, and such activities constitute a huge percentage of their overall businesses. Money center banks also engage in risky investment banking activities — “thanks” (I say facetiously) to the Clinton administration’s successful efforts to repeal the Glass-Steagall Act — but because they are so large and diversified in their activities, such risky activities are a much smaller percentage of their overall businesses. Even among the money center banks, however, some were much less careful than others in managing their risks: Citibank was perhaps the worst, and JP Morgan Chase seems to have been the best. Indeed, despite having a diversified portfolio of low-risk businesses, Citibank was nonetheless almost brought down by its relatively few higher risk businesses. (You remember the old saying about one bad apple, right?) Long story short, banks are very different from one another, and they need to be penalized based on the risks they take, not how big they are.

To illustrate the problem, I downloaded the September 30, 2009 financial statements for Goldman Sachs and a pretty “plain vanilla” large bank, U.S. Bancorp, from the Federal Reserve’s website. The financial statements show how much of the banks’ revenues come from routine banking activities versus high-risk trading operations, which are the “casino” activities that got us into so much trouble. Goldman’s assets as of September 30 were about 3.3 times greater than U.S. Bancorp’s, so I'll need to make some adjustments in my math for that. For the first 9 months of 2009, Goldman generated $28.3 billion of trading revenues and interest on trading assets. Essentially, rolling the dice, albeit, in a casino that they seem to have pretty much rigged most of the time, except for when things go terribly wrong. In comparison, U.S. Bancorp generated a paltry $125 million from trading. This is a staggering differential. Adjusting for the difference in the sizes of the two firms, for every dollar of assets deployed in their businesses, Goldman was conducting about 68 TIMES more casino activity. This helps put the difference in the nature of these two banks into some perspective. Relatively speaking, one is like a plodding old electric utility, whereas the other is a powder keg waiting to explode if any of its risk assumptions prove to be faulty, which is exactly what happened in 2008.

Recall, however, that Obama’s proposed fee will be based on liabilities exclusive of FDIC deposits. Granted, that helps equalize things just a bit, in that such deposits make up a much larger percentage of U.S. Bancorp’s liabilities. In other words, it will get a much larger exclusion from the fee than Goldman precisely because it is a more conservative institution, which is exactly what we want. Even so, however, when looking at casino activities for every dollar of liabilities to be taxed, Goldman is still conducting 25 TIMES more casino activity than U.S. Bancorp. Yet, they will both pay exactly the same fee on each dollar of assessed liability. Not exactly fair, is it? Relative to what it makes on high-risk activities, the fee/tax Goldman will pay will be insignificant.

Granted, I’m a financial professional, but it took me all of about 15 minutes to do this work. Importantly, though, I took the time to validate what I suspected intuitively. As I said in my second paragraph, solutions can sometimes seem so obvious and so clear, and yet be entirely wrong. This is an obvious trap to anyone who has ever done any serious analytical work, so trained professionals are always on the lookout for the biggest booby trap of all: things you think you know, but really don’t. That’s why solutions should be based on real analysis, conducted by bona fide professionals who know how to maintain their objectivity. As I have stated in previous articles, important decisions should not be based on hearsay, anecdotal evidence, or preconceived notions. Popular, but erroneous, decisions may sound good, but they don’t solve anything, they’re often unfair, and they often encourage the exact opposite behaviors of those we really want.

I know I sound like a broken record, but we simply need to demand a higher quality of work from our government.

Big surprise: Geithner lines Wall Street's pockets again

2009-11-02T20:00:00.000-08:00

Well, speak of the devil (in reference to my previous post), Tim Geithner comes through again... for Wall Street, not the American people.

Once again, Bill Black provides a cogent narrative of the latest shenanigans. Is Geithner just the most incompetent boob to ever hold an office, or is he the devil incarnate? I'd love to say that time will tell, but somehow I think this guy will always be two steps ahead of the law. No one in Washington seems to be interested in holding him accountable.

Frontline's "The Warning" explains the roots of the financial crisis

2009-10-24T11:18:00.001-07:00

PBS's brilliant Frontline really needs to be commended for its work in exposing the causes of the financial crisis. In a time when we can question the motivations of many in the news media, Frontline is not pulling any punches and is clearly party-neutral with respect to identifying the culprits in this calamity.

This week's program, "The Warning," chronicles the efforts of Brooksley Born, then the new head of the Commodity Futures Trading Commission (CFTC), to gain approval in the late 1990s to regulate credit default swaps and other types of complex derivatives that were largely responsible for the recent financial system meltdown. Her efforts were thwarted, however, due to heavy opposition from Clinton's triad of senior financial advisors: Secretary of the Treasury, Robert Rubin, his Deputy Secretary, Larry Summers, and Fed Chairman, Alan Greenspan.

Thanks to documentaries such this, it becomes painfully clearer all the time that we simply don't learn from our mistakes. Even though Ms. Born's concerns were proven to be valid during the very time that Congress was holding hearings on her powers -- thanks to the trillion-dollar meltdown of Long-Term Capital Management, the then-darling of the hedge fund industry -- the CFTC's regulatory authority was never expanded, and now we all know the consequences. Making matters worse, Obama has put virtually the same team that opposed Ms. Born into powerful positions in his own administration. Is there any wonder why more than a year has passed since the meltdown and no financial reforms have been implemented?

Here's a little additional background to keep in mind as you watch the episode:

Prior to becoming Sec'y of the Treasury, Robert Rubin was the CEO of Goldman Sachs. Hank Paulson, Bush's last Treasury Secretary, was also the former CEO of Goldman Sachs. Goldman's power and influence in Washington are extensive! Predictably, Goldman Sachs was the largest contributor to the Obama campaign, and continues to be the most blatantly opportunistic firm on Wall Street with respect to taking advantage of the absence of regulatory reform.
Two of Rubin's disciples, Tim Geithner and Gary Gensler (also ex-Goldman), are now, respectively, Secretary of the Treasury and head of the CFTC, which, again, is the agency that should be regulating derivatives, but isn't.
Rubin moved on from the Treasury to Citigroup, which was one of the sickest of the sick in the meltdown, with the result being the U.S. government supplying $100 billion in emergency aid and taking a 34% equity stake.
Following Clinton's final term, Summers moved on to the presidency of Harvard, where he was embroiled in one controversy after another. He was ultimately ousted by the faculty through a vote of no confidence. Too bad they didn't act sooner, though, as Summers' recommendations regarding investments in derivatives cost the Harvard endowment over $1 billion.
Summers made over $5 million last year from Wall Street connections, supposedly for doing speaking engagements and consulting approximately one day a week. He is now Obama's senior financial advisor, and frequent mouthpiece on financial policy. (Follow my "Larry Summers" link on the right to read some of my additional thoughts about Summers).
Greenspan ultimately retired, with his reputation now in tatters. He admitted this year before Congress that many of his most fundamental beliefs concerning regulation and the self-correcting powers of the markets, upon which his key decisions as Fed chief were based, were simply wrong.

Watch "The Warning" and draw your own conclusions. I'm sure you can probably guess, however, how I feel about our current president surrounding himself with a cast of characters who were so toxic to our way of life, and who seem to be in no particular hurry to put fixes in place.

Also outstanding is this video timelime of the events that set the stage for the financial crisis. Again, big kudos to Frontline.

Click here for Frontline's timeline.

It's About Principles: What the Republican Party Must Do

2009-10-18T14:50:00.000-07:00

The following are the stated principles of the Republican Party:

The Republican Party, like our nation's founders, believes that government must be limited so that it never becomes powerful enough to infringe on the rights of individuals.
The Republican Party supports low taxes because individuals know best how to make their own economic and charitable choices.
The Republican Party is supportive of logical business regulations that encourage entrepreneurs to start more businesses so more individuals can enjoy the satisfaction and fruits of self-made success.
The Republican Party is committed to preserving our national strength while working to extend peace, freedom and human rights throughout the world.

I believe strongly in all of these principles, and yet, I have never voted for a Republican presidential candidate. (I haven’t always voted for the Democrat either, instead choosing to let my abstention speak for itself.) One would think that I would be easy game for the GOP, so why haven’t they been able to win me over? It’s not because their core principles are not brilliantly clear, sensible and powerful. Rather, it’s because Republicans never actually make their core principles the foundation of their platform, nor are they ever even able to achieve a unified vision of their platform across the various factions within their party.

The trouble with Republicans is not their passion for their core principles. It’s that they are usually even more passionate as individuals about something else, and they don’t know where to draw the line between beliefs about governance and beliefs about deeply personal life choices. What is especially unsavory to independent moderates about the conflation of these beliefs is that the personal beliefs that are most loudly proclaimed are often based on some form of intolerance, and they reek of hypocrisy in that they typically conflict with the core principles’ themes of individual responsibility, personal freedom, and limited government. Intolerance and hypocrisy also set you up to be a bad joke, as depicted in this video:

Rather than painting a clear picture of how legislation based on their core principles would create a better America, Republicans allow themselves to become fractured over issues concerning, for example, religion, abortion, gay rights, and in the case of Mitt Romney’s candidacy, whether they could accept a Mormon president, as if Mr. Romney’s faith mattered in the least to his potential job performance. Simply put, the Party has been a mess for a very long time, and it can only win the Oval Office when the Democrats hand it to them on a silver platter, as LBJ did with his aimless mishandling of Vietnam, as Carter did with his mishandling of the economy and our national defenses, and as Clinton did with his indiscretions, which elevated “moral values” to the #1 reason why people voted for George Bush in 2000. Winning by unifying against another’s weaknesses simply isn’t a sustainable long-term plan, because you have no strategy once the other guy is gone and you’re in control. You need a vision of your own, which is where core principles come into play. No principles, no identity. It’s that simple.

It took millions of independent moderates to put President Obama into office. I was among them. We all had our reasons for voting for him, but the lack of a good alternative was probably foremost. That, by no means, makes for a strong support base. Indeed, recent polls are showing that millions of independent moderates have withdrawn their support. Again, I am among them. This is going to open a door for Hillary in 2012 and for the GOP.

I believe that a healthy two-party system is critical, and that moderates need a voice within that system. Moderates are the swing vote, yet they are without a home. That needs to change, which is why I would like to see the Republican Party reform. If the GOP is going to become a viable alternative for moderates, it needs to have courage in its convictions and build a fortress around its core principles. Party members need to agree among themselves to shelve the social issues that ultimately divide the party and create an unacceptable environment for moderates. Accordingly, they need to develop a platform that focuses exclusively on matters concerning the prosperity, defense and welfare of the people. The GOP will never win if it is known as the anti-abortion, or anti-gay, or pro-prayer-in-school party. Certain right-wing factions within the Party would love such monikers, but they would be the kiss of death for the GOP. Party leadership needs to take control, purge intolerance from the agenda, and put the focus of the platform on the sound administration of the country. They need to go back to basics and stick to business. If they do, they might have a chance, and we might have an alternative for moderates.

Has the "Obama Bubble" Reached its Peak?

2009-10-09T21:14:00.001-07:00

Having endured dot-com mania and the housing/credit crisis, we’re all starting to get pretty good at recognizing the signs of a bubble: lots of hype, no sense of proportion, free-flowing accolades and unearned reverence, irrational behavior, and endless exhibitions of wretched excess. Certainly, some of these bubblelicious signs apply to our president.

I really don’t think President Obama has anguished over how to inflate his image and get himself placed on a pedestal, but that’s precisely where many people, especially those overseas, have placed him. His charisma and promise of hope have bought him a very low bar. I'm sure, upon honest reflection, most people would admit that there has been little objective evaluation of his work thus far. However, we reached a tipping point today. The gap between his image and his qualifications and actual results became too wide and clear to be denied. With his premature “winning” (as if he actually wanted it) of the Nobel Peace Prize today, I think the pitfalls of this leader-as-pop-icon situation that the public has created have finally hit home, even with many of his most devoted supporters. Especially coming on the heels of the IOC "malfunction" in Copenhagen, one can’t help but wonder if today may have been the top for Obama – just like NASDAQ at 5132.52 on March 10th, 2000 – and that it may be all downhill from here. Of course, the Right expressed plenty of outrage today about the win being undeserved. However, I think this eerie feeling that the Obama bubble has been pricked is what’s giving so many others more of a feeling of loss today, rather than outrage. Truly, it’s sad when bubbles finally burst.

I think the obvious-to-all absurdity of today’s award was a wake-up call. It reminds us that we need to be realistic in our expectations and rigorous in our evaluations. Moreover, it reminds us that people in lofty places (e.g., the Nobel judges) can make foolish decisions or ones that are motivated to serve their own political aims, and that the rest of us need to stay awake at the switch in order to detect when they do. President Obama and the rest of our politicians are only human. They have strengths and weaknesses like the rest of us, and as our public servants, we should treat them with respect and realize that they’ll never do everything perfectly. Importantly, however, as we do with employees in the workplace, we must also diligently monitor and evaluate their work, and hold them accountable for their actions. Questioning is not a sign of being unsupportive. It’s helpful, as we learn from it, and it’s essential if we want to be our very best.

With the bloom off the rose a bit now, maybe we can take some of the emotion, dogma, and tribal warfare out of this presidency and get down to the objective administration of this great republic. Today may have actually been an important turning point for the better.

The Whole Foods Health Care Flap

2009-08-22T14:41:00.000-07:00

So, this is the article from Whole Foods' CEO that created the big flap. Three main themes: government frugality, individual responsibility, and personal choice. How controversial! In order to consider these ideas some kind of betrayal of Whole Foods' customers' values, it seems to me that those who have their undies in a twist are making some very thin connections: healthy eating = progressiveness = liberalism = blind agreement with Obama's agenda. None of those connections are 1:1 (exclusive). Obviously, Mackey's experience leads him to have a different opinion about how to create a healthier America. Why not respect that, and use it as an input when evaluating our options? At least his experience is based on real-world interactions with real people who have experience using both socialized and free market health care systems. I wish we could say that Obama and Congress have experience grounded in reality, but we know that simply isn't true.

Click here for Wall St. Journal article.

Goldman CEO Warns Employees to Keep a Low Profile

2009-08-04T20:55:00.000-07:00

From the New York Post:

Goldman Sachs CEO Lloyd Blankfein has warned his employess to avoid making big-ticket, high-profile purchases as the gold-plated Wall Street firm hunkers down amid a firestorm of public and political anger over outsize bonus payments.

According to sources at the bank, Blankfein has told Goldman staff that spending should be toned down in light of the billions in bailout money that banks, including Goldman, have gotten from Uncle Sam.

A source within the bank said Blankfein first began calling for an end to the conspicuous consumption late last year, but has stepped up his campaign in recent weeks as the White House has sought to rein in compensation and as the firm has gotten dinged by a pair of high-profile magazine articles.

"This is a sensitive time for us, and [Blankfein] wants to make sure that we're not being seen living high on the hog," said one Goldman exec.

Indeed, the exec said that senior managers were ordered to tell their staffs that just because Goldman made a record second-quarter profit of $2.3 billion, they shouldn't bank on getting a fat bonus just yet. Blankfein was quoted as reminding staff that bonuses are based on full-year results, and that the year is far from over.

Blankfein's admonishing of workers about profligate spending comes as the firm has been hit with a barrage of negative press lately over its uncanny ability to make money not only in the best of times -- but also the worst.

A Rolling Stone article referred to the firm as "a great vampire squid wrapped around the face of humanity," while a recent New York magazine piece floated the idea that Goldman benefited from the rescue of troubled insurance giant American International Group.

A spokeswoman declined to comment.

Goldman's speedy recovery in the wake of the global recession and the demise of many of its rivals has drawn more outrage than awe.

Observers question everything from the bank's massive pay to its uncanny ability to serve as a incubator for Washington policymakers. Goldman alumni include former Treasury Secretaries Henry Paulson and Robert Rubin, and Jon Corzine, the current New Jersey governor and former US senator.

Goldman accepted $10 billion in rescue funds from Uncle Sam to help it stay afloat last year amid a crisis of confidence on Wall Street but quickly repaid the money thanks to record revenues.

The Goldman exec said that while Blankfein was cajoling workers to cut back on their spending to avoid negative publicity, he was also playing cheerleader.

In a company-wide voice mail left last week, the CEO assured employees that management is "focused on addressing the negative news and that [Goldman] remains committed to integrity and excellence."

"I know you're all working hard," he added.

If this seems familiar, perhaps you're recalling the scene from Goodfellas in which Robert De Niro admonishes his crew members for going on spending sprees following their big Lufthansa heist. For your enjoyment:

Finally! Congress is Waking Up to Wall St. Market Manipulation

2009-08-04T08:21:00.000-07:00

Everyone knows that Wall Street firms are using high frequency trading platforms to frontrun their own clients, yet no one is speaking out against it...until now. Thank you, Senator Schumer.

Click here for related article.

Daniel Hannan speaks about U.K. Health Care System

2009-08-02T12:20:00.000-07:00

I love this guy. He's one of the most articulate and clearest-thinking politicians I know of. I wish he were American.

His cautionary tale about how Canada's "public option" morphed into a government-only program is very much in line with what I believe will happen here.

"No New Taxes"... Yep, We've Heard that One Before

2009-08-02T11:09:00.000-07:00

Oh, I don't know, maybe they should have thought about deficits (like the rest of us did) before they lined Goldman Sachs' pockets with billions and queued up billions in pork barrel spending disguised as stimulus. I know I sound like a broken record about the government's need to think things all the way through, but it's just so obvious.

George Stephanopoulos re Tim Geithner interview:

To get the economy back on track, will President Barack Obama have to break his pledge not to raise taxes on 95 percent of Americans? In a “This Week” exclusive, Treasury Secretary Tim Geithner told me, "We’re going to have to do what’s necessary.”

Click here for related article.

Larry Summers: A Master of Double-Speak

2009-08-02T09:34:00.000-07:00

This guy is so over-rated it makes my stomach churn. Obama's economics team refuses to admit that because they got it wrong on the severity of the recession, that the stimulus plan was not front-loaded enough and that the spending needs to be more sharply focused and shifted forward. Instead, they shout down tough questions and continue to try to BS the American public into believing that they've got it all under control and that the wasteful, massive deficit spending yet to come on pork and social agenda items will be good for us.

Listen in this clip to how Summers flip-flops between whether the stimulus plan was intended to have a short- or long-term impact. Listen also to the double-speak about job creation. "We don't know what the baseline is, or how many jobs will actually be saved or created, but we know it will be more than what otherwise would have happened." Huh? I wish I never had to substantiate any of my ideas or actions. It's insulting to anyone with half a brain. This guy is a thug, a crook, and a moron.

Visit msnbc.com for Breaking News, World News, and News about the Economy

Health Care Reform: Rise up, Mr. Obama. This is your Man-on-the-Moon Moment.

2009-08-01T14:12:00.000-07:00

Many reforms in health care are needed, but the proposed legislation doesn’t address them. For example, the argument that the so-called public option will increase competition is totally false. Employers are justifiably tired of paying ever-increasing insurance premiums for their employees. When the public option becomes available, many firms will simply decide to give their employees a raise to cover the cost of the public option, and then they’ll cancel their company-sponsored plans. That way, they can convert their medical benefits expense to salaries expense, which is much easier to control (i.e., salaries increase at about the rate of inflation, whereas medical premiums have been rising at two to three times that). Once that happens, you’ll then have most Americans on a bare-bones Medicare-type program, with no options and no industry competition. The insurance carriers currently battle it out against each other every day. They do what they can to keep costs down, but they can only do so much to control the medical and pharmaceutical industries. With whom do government agencies like the Social Security Administration, the IRS, and Veterans’ Affairs compete? No one, and they don’t exactly set any standards for efficiency and customer service, do they? It will be the same with whatever new agency ends up running health care.

The health care industry represents 16% of our economy. It employs millions, and it touches every one of us. There is no simple, quick fix for this problem. Bringing health care costs under control is going to take a tremendous amount of collaborative work by the insurance, medical, pharmaceutical, and technology industries. This undertaking is far bigger than the Apollo project, for example, and that project could have never been accomplished without industry doing most of the work. As it did with Apollo, government (NASA, in that case) should play a facilitation role in health care reform, but it should not attempt to become the industry itself. It doesn’t have the technical or managerial skill, nor could it ever put the incentives in place to ensure that the system would be able to actually improve service while also driving costs down, which should be the ultimate goal. The current dialogue in Washington never makes mention of that, which is frightening and disappointing in its lack of ambition. Our politicians are content with the notion of serving more people, but serving them poorly in order to do it (all but themselves, that is). Well, I’m not.

Mr. Obama should use his estimable leadership skills to unify the efforts of these various industries, rather than trying to put them out of business or under some type of Soviet-like control. A sharp bureaucrat can always muscle some kind of ineffective legislation into place (e.g., the stimulus bill), but a real leader inspires the public to raise its ambitions and strive to take on new challenges. President Kennedy inspired the nation to put a man on the moon within 10 years. I’d like to see President Obama do something similar with health care reform. He has the vision and the charisma. He just needs to do it. That's what voters really wanted from him anyway, not bureaucratic quick fixes.

Mr. Obama, don’t deny Americans the opportunity to be Americans. Tackling problems head-on and developing world-class solutions is what we do. Yes we can, remember?

Beware of the "Global Warming Industrial Complex"

2009-07-19T12:18:00.000-07:00

How's that for a new term?! I just heard it yesterday. (For younger readers, that's a takeoff on Eisenhower's term, the military industrial complex.)

Is global warming a problem? Probably. Has it been overblown? Probably. One thing is for sure, though, it has now become very big business -- a new expense for some businesses and a huge money-making opportunity for others -- and once something becomes big business, there simply becomes too much temptation to manipulate the facts.

Members of the global warming industrial complex (e.g., Goldman Sachs, GE, alternative energy producers) have been lobbying hard for cap-and-trade, and it has been easy for our politicians to fall in line in support of it. After all, the public has been worked into a panic about it, and what politician wants to appear to be politically incorrect, especially when climate change is so popular with the hip and influential?

I'm not saying that we shouldn't do anything about climate change. Rather, I'm asking, are we sure we've really done enough homework to ensure that an elaborate scheme of trading carbon credits -- in which polluters get to keep polluting as long as they have enough money to do so -- is the real answer to the problem? Besides, if the answer is a system in which Goldman Sachs is allowed to shave a profit off of every transaction, I'm going to be suspicious from the get-go anyway. It just smells fishy.

In recent times, we've seen one poorly structured scheme after another that has backfired on the public, whether it was Enron being allowed to dominate the energy markets, or the attempts to create an "ownership society" by lowering standards at Fannie Mae and flooding them with too much money, or the lack of regulation over securitized home mortgages and derivatives, or poor regulation of the IPO-ing of internet companies, or no regulation of hedge funds (that manipulate the markets), etc., etc. The simple truth is that our government doesn't have the discipline and objectivity to think scenarios all the way through; i.e., to contemplate possible negative outcomes as well as positive ones. They don't model the unintended consequences, which is an essential skill that any good businessperson tries to learn. Furthermore, they don't have the integrity to say, "Let's stop and rethink this" when they discover that they're wrong. Instead, they simply work the numbers so they can justify the case they're trying to make, and then they ram their legislation into place as quickly as possible. (...and we've come to learn that few bills are even read before voted on!) They can get away with making expensive mistakes because they have the taxpayer and deficit spending to fall back on. If a businessperson makes the same mistake, he's bankrupt (unless, of course, his business is too big to fail). The bottom line: I fear that we are rushing head-long into another poorly structured scheme that will not address the problem, that will burden the public with yet more expense that it cannot afford, and that will line the pockets of the well-connected and corrupt.

The military industrial complex panicked us into an over-blown fear of the communist threat in the '50s and '60s. The result was massive, wasteful defense spending and a war in Vietnam that cost over 50,000 U.S. lives, and well over a million lives of our supposed enemy. Now, the global warming industrial complex, with the full buy-in of our eager-to-be-loved president, is pushing us towards a "solution" that will line their pockets, add an enormous expense to every family in the country, do nothing regarding other countries' responsibilities re climate change standards, and supposedly reduce temperatures by only .2 degrees by the year 2100. I've spent my entire career being a problem solver, and it just seems to me, based on the outcomes in this deal, that people haven't spent enough time working on the potential solutions. Ditto for healthcare reform, but that's another story.

Simply put, we need to demand more rigorous work and a higher level of professional integrity from our politicians. Furthermore, we need to maintain a healthy skepticism about everything our government proposes. Don't we have enough evidence that we need to?

Goldman Sachs Goes Green... In More Ways than One

2009-07-18T14:10:00.000-07:00

Hmm... Are we seeing a pattern yet?

1) Goldman Sachs conspires with our government officials to create a panic over a real or imagined problem.

2) Current or former senior officers of Goldman are put in charge of the problem.

3) It is determined that only Goldman Sachs is qualified to handle whatever the fix is for the problem, and it is given a preferential role in all related money-making opportunities.

Related article:

Goldman Sachs to be carbon regulator?

July 8, 2009

Sens. Dianne Feinstein (D-CA) and Olympia Snow (RINO-ME) have introduced a bill to make the Commodity Futures Trading Commission the sole regulator of the carbon market created by cap-and-trade legislation.

So does this mean that freebooting Goldman Sachs could be the de facto regulator of the carbon market?

Consider that:

The current chairman of the CFTC is Gary Gensler, formerly of Goldman Sachs.
Goldman Sachs is a part owner of the exchanges where carbon allowances would be traded.
Goldman Sachs has spent millions of dollars lobbying for cap-and-trade legislation in anticipation of making billions of dollars at the expense taxpayers and consumers.
Goldman has a special exemption from the CFTC to exceed the trading limits normally placed on commodity speculators. Not only was this exemption secret for 17 years, the CFTC recently had to ask Goldman for permission to release the letter to Congress!
Goldman Sachs employees are heavy contributors to the Democratic Party giving it over $4.4. million in the last election. Barack Obama received more than $997,000, Feinstein received $24,250, and Snowe received $17,000 from Goldman. All-in-all, this could result in a pretty decent return-on-investment for Goldman.

As the global warming bubble inflates and then bursts, will Goldman Sachs self-regulate all the way to the bank… making record profits at the expense and misery of taxpayers and consumers?

Can you tell the difference between the CFTC and Goldman Sachs?

Gary Gensler, CFTC Chairman

Lloyd Blankfein, Goldman Sachs Chairman

Rolling Stone's Matt Taibbi Speaks About Goldman Bonuses

2009-07-18T13:24:00.000-07:00

More on the corruption surrounding Goldman Sachs. Matt Taibbi of Rolling Stone has been doing a good job following all of this. Here's a link to the article referenced in the video.

Is Obama on Goldman's Payroll?

2009-07-18T12:42:00.000-07:00

I've spent most of my career working in the financial services industry, and I have never seen the kind of corrupt shenanigans that are going on today. Washington is absolutely in Wall Street's hip pocket. Yes, today, on the heels of a near collapse in the economy. The gentleman in this video provides a very lucid analysis of what's going on.

Goldman Sachs' Tentacles Reaching into Government

2009-07-18T12:40:00.000-07:00

Here's a very clear presentation on how Goldman Sachs has woven its way into the fabric of our government. Is it any surprise that they are able to virtually print money?

Inside the Great American Bubble Machine

2009-07-07T08:42:00.000-07:00

This is a must-read article about Goldman Sachs' abuses from Matt Taibbi at Rolling Stone.

Click here for related article.

Executive Pay Caps are a Sham

2009-06-10T22:06:00.000-07:00

The government’s theory is that compensation plans at the big banks were responsible for the banks’ excessive risk taking. To curb the risky behavior, the government wants to limit pay to $500K per year. I guess the idea is that the bankers will engage in risky behavior until they’ve made their $500K, then they’ll pack up their beach chairs and go on vacation until January.

This is obviously a very indirect and gutless way to deal with a major problem, and for starters, it won’t work. The best managers and technicians in these risky endeavors are simply going to move on to banks that aren’t covered by the provisions of the law, or they’ll start up their own firms. Let's face it, if you make $5 million a year, you’ll move to London if you have to. Some sacrifice! The trouble is, the banks they leave will keep running their risky businesses, but they’ll just run them with less talented people; i.e., those who are willing to work for less than $500K a year. How’s that for an unintended consequence? We might as well let teenagers manage our nuclear arsenal as well.

The fact of the matter is that we don’t want our banks engaging in risky activities AT ALL, other than normal lending activities, which have historically been challenging enough for our bankers to manage. We need to restore banking to what used to be called the 3-6-3 principle: borrow at 3%, lend at 6%, and be on the golf course by 3 o’clock. As holders of the public trust, we want our banks to engage in simple, transparent activities. The days of banks using depositor money to speculatively trade in exotic derivatives and foreign currencies for their own accounts need to come to an end, as do the days of banks making loans and then selling them off with no further exposure to risk. If you make a loan, you need to be prepared to stand by the risk of that loan. You’ll then be more careful making the loan in the first place.

We’ve already seen plenty of evidence that Obama and his team are as corrupt as any group of politicians we’ve had in the White House. The payoffs to labor unions, special interest groups, and corporate bigwigs started as soon as Obama took office. So, it’s no surprise that his administration is pussyfooting around with implementing much needed reforms. It’s no surprise, but it’s inexcusable. (Full disclosure: I voted for Obama, but suffice it to say, I’d like my vote back.)

We don’t need indirect, half-hearted approaches to solving major problems. We need to identify root causes, and aggressively rebuild the systems that will serve the public’s interests and restore trust in our financial system. That’s what was done following the Great Depression, and the regulations that came out of that era served us well for many years until our politicians succumbed to lobbyists’ payola or to their own ill-conceived notions of how to create a "great society" that were completely oblivious to unintended consequences. We must return to basics. Restoring the Glass-Steagall Act would be a great place to start.

Geithner's PPIP: The Greatest Boondoggle in History

2009-05-10T16:24:00.000-07:00

Treasury Secretary Tim Geithner's Public-Private Investment Program (PPIP) is the "greatest boondoggle in the history of the world," says William Black, a former bank regulator, who was counsel to the Federal Home Loan Bank Board during the S&L crisis. Says Black, an Associate Professor of Economics and Law at the University of Missouri - Kansas City, as occurred during the S&L era, the PPIP will allow banks to exchange "trash for cash" and turn "real losses into faulty gains." If the goal of Tim Geithner and other regulators was "to rip off the American taxpayer for the benefit of the least-deserving wealthiest people you can imagine, well - mission accomplished," Black says.

Black's interview on Yahoo! can be seen here:

Good Morning America Explains the Financial Crisis

2009-05-08T22:28:00.000-07:00

This is really cute. So simple an 8th grader or a member of Congress can understand it.

Click here to watch video.

Bill Moyers: Discussion on Financial Crisis

2009-04-24T23:51:00.000-07:00

Bill Moyers had another great show on the financial crisis tonight. The show unified many of the concepts I have written about in recent months. The discussion raises many important questions, perhaps none more important than whether the Obama administration will have the courage to support the newly-proposed Congressional panel that will investigate the crisis and propose reforms. Please watch.

Bill Moyers speaks with economist Simon Johnson and Ferdinand Pecora biographer and legal scholar Michael Perino. Johnson is a former chief economist of the International Monetary Fund (IMF) and a professor at MIT Sloan School of Management, and Perino is a professor of law at St. John's University and has been an advisor to the Securities and Exchange Commission.

Click here to watch video.

Goldman Sachs' Trading Profits: the more things change, the more they remain the same.

2009-04-19T22:17:00.000-07:00

That's Lloyd Blankfein, CEO of Goldman Sachs. You'd be smiling too if you'd just gotten away with one of the biggest heists of all time. Here's why he's so happy:

In 2008, Goldman loses billions trading in mortgage-backed securities and related derivatives.
To qualify for bailout funds, Goldman's application to convert to a bank holding company is expedited, even though it doesn't engage in any common banking activities. (Have you ever seen a Goldman Sachs ATM, credit card, or TV commercial?)
Their former CEO, then-Treasury Secretary Hank Paulson, gives them $10 billion of TARP money...well, they are a bank now, after all.
News surfaces that Goldman had been hedging its exposure to losses in mortgage securities by buying credit default swaps from AIG. (Oh, so you mean they have insurance to cover their losses? Why didn't they tell us that before we gave them the TARP money?)
The Fed and Treasury think a calamity will ensue if AIG fails and its counterparties, like Goldman, are not paid off. So, an additional $80 billion of taxpayer money is given to AIG, who promptly pays off its counterparties, including several foreign banks. Goldman Sachs gets $13.9 billion. (But wait! Didn't we already cover Goldman's losses with TARP money?)
Goldman loves the volatility in the markets--it makes for great trading--and racks up $5.7 billion in trading revenues in the first three months of this year. In short, they're right back to doing the same things that got them into trouble in the first place.
Goldman says it doesn't like that the TARP funds came with strings attached, so they want to pay the money back early. Things are going pretty well for them these days, so they sell $5 billion in stock to raise additional money to pay back the TARP funds.

Happy days are here again!

I would like for Obama to ask his people how the public was supposed to be helped by providing Goldman with the risk capital to run its trading desk. TARP money was intended to fund loans to businesses and consumers, not high-risk trading operations.

Good grief.

Here's more on the whole debacle from Time:

Click here for Time article.

Bill Black Speaks Out on the Stress Tests

2009-04-19T21:54:00.000-07:00

Bill Black, a former senior bank regulator and S&L prosecutor, is one of the few people with both the guts and knowledge to speak the truth about how the banking crisis is being mishandled, and principally by the people who caused it in the first place. When all we get is spin from Larry Summers and Tim Geithner, it's reassuring that at least one strong, reasoned voice is willing to speak the truth.

From the article that accompanied the video:

The bank stress tests currently underway are “a complete sham,” says William
Black, a former senior bank regulator and S&L prosecutor, and currently an
Associate Professor of Economics and Law at the University of Missouri - Kansas
City. “It’s a Potemkin model. Built to fool people.” Like many others, Black
believes the “worst case scenario” used in the stress test don’t go far enough.

He detailed these and related concerns in a recent interview with Naked
Capitalism. But Black, who was counsel to the Federal Home Loan Bank Board
during the S&L Crisis, says the program's failings go way beyond such
technical issues. “There is no real purpose [of the stress test] other than to
fool us. To make us chumps,” Black says. Noting policymakers have long stated
the problem is a lack of confidence, Black says Treasury Secretary Tim Geithner
is now essentially saying: “’If we lie and they believe us, all will be well.’
It’s Orwellian."

The former regulator is extremely critical of Geithner,
calling him a “failed regulator” now “adding to failed policy” by not allowing
“banks that really need desperately to be closed” to fail. (On Saturday,
Geithner said on Face the Nation, if banks need "exceptional assistance" in the
future "then we'll make sure that assistance comes with conditions," including
potentially changing management and the board, but did not say they'd be shut
down.)

Black says the stress test must also be viewed in the context of
Geithner’s toxic debt plan, which he calls “an enormous taxpayer subsidy for
people who caused the problem.” The fact bank stocks have been rising since
Geithner unveiled his plan is “bad news for taxpayers,” he says. “It’s the
subsidy of all history."

Larry Summers and "Brain Bubbles"

2009-04-19T20:15:00.000-07:00

I love this! From the article's author on Larry Summers and "brain bubbles":

"This is the process wherein the intelligence of an inarguably intelligent person is inflated and valued beyond all reason, creating a dangerous accumulation of unhedged risk. Brain Bubbles need to be popped; Larry Summers needs to be stopped!"

Right on!

Click here for related article.

We need to say goodbye to Goldman Sachs

2009-04-13T23:12:00.000-07:00

I have a real bee in my bonnet these days about Goldman Sachs. Yes, they are good at what they do, and technically speaking, I can’t say that I’m aware of them having done anything illegal during the buildup to our current crisis. However, in my book, they are the poster child for all that should be purged from the financial markets. Having Goldman running amok in our financial system is like having wild pigs in your back yard. No one really dislikes wild pigs, but there's absolutely no upside to having them in your back yard. Even worse, they can do a fair amount of damage. Ditto for having Goldman in our financial system.

Goldman’s bread and butter is trading and investment banking, the latter of which is on hiatus for who knows how long. So, its shareholders essentially just own an interest in a big trading desk. Goldman takes shareholder capital and speculatively trades in stocks, options, bonds, foreign currencies, interest rates, credit default swaps, etc. Name a derivative, and they probably trade it. As I said, it’s all speculative. They do nothing to create value. They just trade. However, what they do is different from just going to Vegas and rolling the dice. How so? Because their very act of placing a bet can actually have an influence on the outcome of that bet; for example, when they choose to short a stock. They can relentlessly drive a stock into the ground, and those on the losing side of the trade are the public, who were lulled into believing that buy-and-hold is a viable investment strategy, and that the SEC is ready and able to protect their interests.

I’d like someone in government who is allowing this to happen to explain why it’s in the public’s interest to let Goldman ride roughshod over the financial markets. How do we benefit? Clearly, we don’t, and that’s precisely why the realm in which Goldman plays—what some people call the shadow market—needs to be regulated into oblivion. Simply put, we need to purge the financial system of the casino activities that have done so much harm in recent years, and we need to make an example of Goldman, precisely because it is the much-envied “gold standard” among firms that engage in these activities. The financial markets need to be returned to long-term investors, and made safe with rules that are clear and enforced.

It is a tragedy that the public has been denied the right to participate in the capitalist system without it being corrupted and manipulated. Investors with good intentions have been completely thwarted by the likes of Goldman and countless other hedge funds and institutional trading desks for too many years now. Enough is enough. The stock market wasn’t created with the intention of using the public as pawns in trading schemes that only benefit the rich. Goldman and other market manipulators must be shown the door if we are to ever restore trust in the financial markets.

Leverage: The Meltdown Amplifier

2009-04-11T23:47:00.001-07:00

Someone on another blog, SeekingAlpha, wrote an article in which he asked, "Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage?"

The answer is actually quite simple: leverage. Leverage creates losses that are multiples of the original amount of capital that was put at risk. In short, people borrow to buy assets that end up losing tremendous value, and then those people are left with the debt and no assets to sell to cover it. For example, low margin requirements amplified the losses associated with the 1929 crash, making the fallout much more severe than the typical market correction. Investors were required to put up only 10% of the cost of the stock when they purchased it. When the stocks lost most of their value, the investors still owed a remaining 90% of the original cost. Where was that money going to come from? Certainly not from selling the stock. So, the stock investors of 1929 defaulted on their margin debt and left the banks holding the bag. This is the same situation today, except that we're talking about inflated home values and defaulted mortgage debt.

Complicating the mortgage default problem is the destruction caused by the casino-like activities in the unregulated credit default swaps market. The likes of Goldman Sachs put up pennies on the dollar to buy swaps (again, the use of leverage), most notoriously from AIG, and left AIG with losses of 30-50 times of what Goldman paid. Because our brainiacs in Washington decided to bail AIG out, the public will now be paying for those losses for decades, thus putting a stranglehold on the economy for years.

Most economic crises have not involved substantial leverage. The dot-com crisis is a good example. Trillions were lost in that crisis on dot-com stocks, but those stocks had not been purchased with leverage. Money was transferred from one party to another, but there was no change in the amount of money in circulation within the economy. In other words, although the dot-com stocks took a beating, the economy as a whole was net neutral. Hence, the recovery was fairly swift, given the magnitude of the disaster.

Today, in contrast, we borrowed to create inflated asset values. Indeed, the credit amplified the inflation, as buyers who weren't required to put cash on the table became desensitized to the prices they were paying. Those assets have now declined in value by half, but the debt remains. Hence, the economy as a whole is in a net loss position (technically speaking, insolvent), whereas it wasn't following dot-com mania. It is much more difficult to recover from such losses.

Our government is borrowing money to pay off the debts that are left over from the housing bubble, thus socializing the losses from the housing market and Wall Street's excesses. However, replacing one debt with another debt does nothing to get the economy out of its net loss position. Only the generation of profits and the systematic and disciplined repayment of debt from those profits can do that.

Remember the dot-com meltdown? What if the government had bailed out Webvan, Pets.com, and Kozmo.com?

2009-04-04T20:11:00.000-07:00

Some of my friends have asked me how the current crisis differs from the dot-com meltdown and the recession that followed it. They asked, with a hopeful inflection, "Weren’t trillions of dollars lost in that whole debacle, and even though that recession was really bad, didn’t we get over it pretty quickly?"

Yes, it was an obscene, huge disaster. Trillions were lost, and like today’s crisis, it was the result of a massive, irresponsible bubble. Of further similarity, the damage was initially confined to one economic sector (tech then, and home lending this time), but the fallout subsequently spread over the next year or two to the rest of the economy, resulting in a widespread and deep recession. Importantly, we did recover from that recession fairly quickly, especially when you consider that the recession was exacerbated by an event, namely 9/11, that obviously had no connection whatsoever to the dot-com meltdown. That said, to be fair, it is also important to remember that the recovery from that earlier recession was made possible at least in part by the credit-fueled bubble that we’re currently suffering from.

So, will the recovery from this recession also be quick? If not, what’s different this time?

My feeling is that the current government-sponsored stimuli will lead to the appearance of recovery for a time, but it won’t be sustainable. Why? Because all true recoveries are born from the failure of the weak, and the redeployment of sidelined assets (including human assets) in the creation of new goods and services that consumers really need and want by viable businesses with the know-how to cost-effectively leverage those assets. In other words, financial capital (whether it comes from investors or taxpayers) must be deployed in ways that will generate true demand in order for economic activities to be sustainable. Government-sponsored spending initiatives don’t do that. Why? If they were viable, sensible investment opportunities, investment capital would have already found its way to them.

In the dot-com meltdown, the likes of Webvan, Pets.com, and Kozmo.com were allowed to fail. Shareholders and bondholders lost billions, but there were no bailouts. Their business models were flawed from the get-go, and there simply was not enough demand for their services to make them viable long term. Death was a fitting and proper solution, and the hordes of tech workers who had been wasting their time creating animations of gerbils jumping through flaming hoops were provided an opportunity to move on to the likes of Apple, Cisco, Google, Salesforce.com, and countless other enterprises old and new to create new products and services. Had the government propped up Webvan with billions of dollars to build additional unneeded warehouses, where would we be today? Of course, there was that painful couple of years in which businesses and consumers hunkered down, cut costs, rebuilt their financial strength, and regrouped strategically. That was no fun, but the healthy emerged from that period stronger, leaner, and more focused on providing true value to the consumer.

Today, unfortunately, we refuse to take the pain and we are propping up the weak, afraid to face reality. Insidiously, those who have been in bed with Wall Street for years have been put in charge of cleaning it up, so no real progress will be made until all personal favors are repaid and the players move on to their vacation homes on Long Island. So, rather than promoting failure and a healthy redeployment of assets to capable stewards of those assets, we are left with zombie corporations that will need, in Treasury Secretary Geithner’s judgment, $2 trillion of additional funding to survive. (Geithner is one of the bad guys, by the way.) In the meantime, while we’re trying to resuscitate those zombies, we plan to spend trillions more on bridges to nowhere (i.e., “shovel ready projects”) and other social programs that are destined to become anchors around taxpayers’ necks, as our politicians will surely find ways to turn temporary stimuli into permanent entitlement programs. When all is said and done, we’ll be no better off. Our economic engines will not be refueled, the corrupt and incapable will still be in charge, the casino mentality responsible for this mess will be allowed to return (if not facilitated outright), and we’ll be saddled with $10 trillion more in national debt, with no obvious benefits from its expenditure. Hence, these are the reasons why the recovery will not be sustainable.

Capital is precious, and it must be used in ways that will provide returns. Life support for zombie corporations, bridges to nowhere, and high speed trains to Las Vegas don’t provide a return on investment. Like information, ideas, and humanity itself, capital needs to be free to find its proper place. It needs a home where it can prosper and multiply. Ineffectively deployed capital needs to be allowed to move to a new home, as it did following dot-com mania, the S&L crisis, the “Asian Contagion” currency and credit crisis of the ‘90s, the oil patch meltdown of the early ‘80s, the foreign lending crisis of the late ‘80s that almost took BofA down, and the LBO junk bond boom-bust of the ‘80s. (See, there’s really nothing unusual about crises. We have them all the time!) All of those crises were considered devastating at the time, but they ultimately had no long term ill effects. On the other hand, the current blueprint for recovery was tried in the U.S. in the ‘30s and in Japan in the ‘80s-‘90s, and the outcomes then, respectively, were the Great Depression and the “Lost Decade.” I wouldn’t call that a blueprint for success.

I thought "contracts were made to be broken"

2009-03-22T21:26:00.000-07:00

Riddle me this: why is it that for years and years businesspeople used to say that "contracts were made to be broken," but as soon as the government steps in to financially back a company, they're all of a sudden saying that we have to "protect the sanctity of contracts?" I guess we can all afford to take the high road when we don't have to pay the bill.

When companies don't have unlimited funds at their disposal, it's amazing how creative and cooperative they can be with each other in renegotiating their obligations. If AIG had told its counterparties that they could either have their insurance premiums back or get nothing in a bankruptcy, wouldn't those counterparties have been willing to work something out? Instead, the government raced in with billions of dollars and made good on 40-to-one bets. Goodbye $170 billion of taxpayer money. How smart was that?

Businesses restructure deals and renegotiate contracts with employees, vendors, customers, and business partners all the time. The likes of Goldman Sachs are probably laughing their asses off at how naïve the government was for making good on their bets. If the government can't learn how to do business the way businesses do, then maybe it shouldn't be rushing into the corporate sector with billions of dollars in taxpayer money.

Understanding credit default swaps and why the AIG bailout was wrong

2009-03-21T11:37:00.000-07:00

Was the AIG bailout really necessary? Maybe, but probably not. Let me explain.

Credit default swaps (CDS) can be used in two ways: 1) to insure actual mortgages or other forms of debt against non-payment, or 2) as speculative instruments, like stock options, to place bets on the condition of a specific debt obligation or the debt markets in general. Of the CDS related to the mortgage crisis, estimates are that about 10% of the CDS were used to insure actual debts, while 90% were used in speculation, where the buyer did not actually own any debt to be insured. I'll address each of these "pools" of CDS separately.

Re the 10% non-speculative pool, if you assume that all of the sub-prime mortgages originated in the past few years, $6-$7 trillion worth, had been insured with CDS (which they weren't), and that AIG had been the only insurer (which it wasn't), and that the mortgages are now worth 50%-60% of their original values, then AIG would be sitting on about $3 trillion in CDS losses. This would have aggregated all of the mortgage losses under one roof. In other words, the total CDS losses would be equal to, and could not exceed, the amount of the mortgage losses. So, on the scoreboard: mortgage losses $0; CDS losses $3 trillion. If this had been the scenario, there would have been two options. One, AIG could have been taken into bankruptcy and the holders of the mortgage obligations would have been forced to eat the losses they thought they had insured. Alternatively, the government could have decided to, and did, bail out AIG and pay off the CDS. To get the payoffs, however, the holders of the CDS are supposed to sign over their mortgage assets to AIG. If the mortgages ever increase in value, then AIG would at some later date be able to recover some of its CDS losses. So, under this scenario, all financial institutions other than AIG would remain healthy, and AIG (and the government as owner of AIG) would be sitting on a stack of mortgages, hoping and waiting for a bounce-back in housing values.

Re the 90% speculative pool, these were just bets between financial firms (i.e., Wall Street firms, insurers like AIG, hedge funds, etc.). These firms can place all the bets they want with each other, but ultimately, no money related to the bets ever leaves the financial system. This is why all the talk about an AIG collapse leading to a meltdown of the financial system doesn't make sense. Think of it this way: imagine all of these firms walking into a room with $100 each. You lock the door behind them, and allow them to feverishly place bets with each other on anything they want for 24 hours. At the end of 24 hours, you unlock the door and count the money. How much money would be in the room? An average of $100 per firm. One firm could theoretically have all the money, but on the whole, the financial system would be whole. Now, if the government were to walk into that room and say, "You know, this was fun, but we're going to reverse all of the bets you guys placed in the last 24 hours, and you all get to leave the room with what you came in with.", what would be the downside? None, as none of them actually needed the insurance to cover losses they had incurred in the mortgage market. All the betting was just a bunch of nonsense that didn't need to take place, and it can be reversed without any consequences.

The AIG crisis was greatly overblown due to a fundamental lack of understanding by our government officials about the speculative uses of CDS. When AIG melted down, cool heads needed to prevail, and all CDS activities should have been suspended. Speculative CDS trades should have been reversed and the premiums paid for the CDS should have been returned to the buyers. In other words, these speculative CDS trades could have been unwound, with a net loss of zero to the financial system.

To the extent AIG’s CDS were covering legitimate mortgage losses, the government could have made an assessment of whether AIG could make good on those claims, assuming they'd be able to take custody of the underlying mortgages that were insured, and that those would be sold for, say, 50 cents on the dollar. Including the proceeds from those mortgage sales, if AIG wouldn't have had enough capital to cover those legitimate claims, then it should have been put into bankruptcy and the claimants could have been paid some pro rata share of the amount they were due. This would have put the remaining portion of the mortgage losses back onto the books of the banks that were holding the mortgages. The government would then have to deal with those banks' solvency one-by-one.

In reality, the government has allowed AIG to make good on all claims, regardless of whether they were bona fide or speculative. Speculative traders in CDS have walked off with $100 billion in taxpayer money. Goldman Sachs, for example, walked off with almost $13 billion. Worst of all, when AIG paid off these amounts, they didn't force the counterparties (like Goldman) to hand over any mortgages to offset the losses. (Remember, in the insurance business, when an insurance carrier pays a claim, they have a right to take title to the impaired asset.) AIG and the government could have cut the losses in half simply by forcing the counterparties to go into the mortgage market, buy the mortgages covered by the CDS, and turn them over to AIG when AIG paid off the CDS. Why they didn't is just one more example of either incompetence or panic-induced haste at work.

Clearly, this CDS mess is the biggest financial disaster in history. Due to gross incompetence, or even worse--perhaps a conspiracy against the public in favor of Wall Street--we are witnessing the greatest transfer of wealth from the general public to the rich in the history of mankind. What can we do about it? We can still insist on a massive accounting of the speculative CDS positions. Remember, that money has not left the financial system. It's still rattling around the halls of Goldman Sachs and elsewhere. To the extent it went to overseas banks, we probably won't be able to get it back, but to the extent it's within our borders, we have a right to it. It's our money.

Barney Frank is a Wimp, Part 2

2009-02-01T14:55:00.000-08:00

Congressman Barney Frank continued to provide more obvious evidence that he is wimping out in performing his duty as Chair of the Financial Services Committee today on ABC’s “This Week.” He continued his campaign of setting expectations at a low level with his metaphorical discussion of “collateral benefit;” i.e., how we’re all going to have to get accustomed to the notion of some people becoming unjustly enriched by the policies that Washington will put in place to the solve the financial crisis. Furthermore, he ranted about how he wants to protect the jobs of public servants in his own district, and how he wants to cure society’s ills (e.g., the unfair distribution of income) with the economic stimulus plan.

Barney Frank is quite simply an irresponsible buffoon, and his attitudes and positions are inexcusable. When you accept a committee chair position, as he has done, that position should be your primary area of focus, especially when that area is in crisis. Instead of furthering his social agenda, he needs to worry about fixing the banking crisis and restoring credit.

Banking is the foundation upon which our economy is built. Trying to build a “great new society” on top of the shambles of our current economy would be like trying to build a skyscraper on top of Jello. Problems must be prioritized and addressed in their proper order. We need to reliquefy the banks by auctioning off their toxic assets AND by providing them with some new form of debt relief that would eliminate their many billions of dollars in exposure to derivatives losses. Without doing both of these things, the banking crisis cannot be solved, nor the broader economic crisis. There’s no point entertaining the notion of curing society's ills (as the Democrats seem compelled to want to do) without a healthy economy. We need to prioritize.

Frank’s “performance” on "This Week" can be seen here:
Click here to watch video in a new window

Barney Frank is a Wimp

2009-01-29T20:57:00.000-08:00

In an interview tonight (January 29, 2009) on Nightly Business Report, Congressman Barney Frank, Chairman of the Financial Services Committee, compared solving the credit crisis to fighting a war. He said that in a war, you have the concept of collateral damage: innocent people being inadvertently harmed in the crossfire. On the other hand, he warned that to solve the financial crisis, the public is going to have to get used to the concept of collateral benefit: undeserving people being unjustly enriched by the policies implemented to solve the crisis.

Maybe Barney Frank wants to roll over and concede defeat, but I certainly don’t. Going back to the war metaphor, can you imagine if FDR had said, “Gee, that Hitler guy is one bad ass dude. Fighting him is going to be really hard. I guess we’re going to have to get used to the idea of Europe being under his domination.” Are you kidding me?! Are we really so afraid to tackle a problem head-on and to deal with it appropriately, and in a way that is fair and just to the public?

We have to find the root causes of the crisis and solve them with minimal damage to the public. Credit derivatives are one big part of the problem. If the banks were so poorly managed that they let business unit heads and rogue derivatives traders expose them to countless billions of dollars in losses to hedge funds, why shouldn’t the public have the right to nullify those transactions and send the hedge funds packing? There is a concept under the law called “unjust enrichment,” whereby transactions that are blatantly unfair can be overturned. That’s clearly the case here, and we’ve got to use that concept to nullify these derivatives transactions.

Merrill Lynch reported a $15 billion loss in Q4, mostly related to derivatives losses, and their new parent company, BofA, promptly went to the government for a handout and got one. We have got to be out of our minds for letting that happen, and for letting someone like Barney Frank, who is clearly absent a spine and any measure of ingenuity, represent us.

Executive Leadership for Sustainable Growth in Mature Firms

2009-01-05T19:35:00.000-08:00

Below is a link to the report from my team's management research project at MIT. It was in fulfillment of the requirements for an MBA in the Sloan Fellows program at MIT's Sloan School of Management. It was a really interesting and gratifying research project.

Click here to get the document. It's a big document, so it can take 30 seconds or so to load on older machines.