Tag Archives | financial crisis

L'Apel: Democratic Capitalism at Risk

Recently, ICGN held their annual conference in Paris. From the Twitter feed, it appears I missed a good one. (see ICGN Via Twitter) I’ve already mentioned Jon Lukomnik’s appeal to look again at the idea that shareowners’ interests and executives’ can be aligned through compensation strategies.

I think one origin of our errors was revising the tax code so that executive compensation above $1 million is only a tax deductible expense if performance based. The result has been, as Lukominik observes, that compensation plans have taken on the characteristics of “a slot machine: They pull a lever and three years later out comes a trickle of coins or a fountain of folding money.” This is a topic worthy of much discussion.

Another truthsayer at the conference was Robert A.G. Monks, whose L’Appel can be read as quickly as fast food but provides nutritional value of a much higher order. Bob lays out a number of observations. I’ll just list a few: Continue Reading →

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Labor Day: The Scariest Jobs Chart Ever

What the chart (made by Calculated Risk) shows is the trajectory of job losses and gains during the great recession, compared to previous recessions. So as you can see, the depth of the decline was much worse than any other recession, and what’s more, the pace of the recovery is much weaker than in previous ones. Over a year it was looking as though the recovery might be kind of V-Shaped (a really big, wide V), but now it’s clear that the comeback Continue Reading →

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Parasitic Capitalism

The US can print the same money it borrows in. It doesn’t ever have to default as long as it retains this privilege. But its creditors now know that the US can’t be trusted. This is why America’s trusted friend and car pool partner in space, Vladimir Putin, has said Americans, “Are living like parasites off the global economy and their monopoly of the dollar.”

Them used to be fightin’ words. But now they are just words that confirm that we have come the end of the dollar’s reign as the world’s reserve currency. This is pushing up yields on government bonds. And in the long run, it will push up the price of precious metals too, as a reserve monetary asset (money).

via Parasitic Capitalism, The Daily Reckoning, Australia, 8/2/2001.

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Reframing Corporate Social Responsibility

Reframing Corporate Social Responsibility: Lessons from the Global Financial Crisis, edited by William Sun, Jim Stewart, and David Pollard, is volume 1 in an important new series: Critical Studies on Corporate Responsibility, Governance and Sustainability. Disclosure: I’m on the Editorial Advisory and Review Board of the series at the request of William Sun, who I’ve already identified as an important voice in corporate governance. See my review of his How to Govern Corporations So They Serve the Public Good: A Theory of Corporate Governance Emergence.

This new volume reflects on corporate responsibility (CSR), focusing on what role, if any, it played in the financial crisis and, perhaps more importantly, how such events might be avoided in the future by more fully integrating CSR into mainstream corporate practices. The editors argue that business discourse and values are currently viewed as Continue Reading →

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Wall Street: From Mortgages to Taxes

The Street is tailoring government bonds to fit the winning mortgage market strategy, right down to selling shorts to investors who are gambling right now that governments won’t be able to meet both their budgets and pay their loans off, given the crippling economy that still hasn’t recovered from the subprime mortgage crash. The idea of course is not to repeat the mistakes and scams that plagued that other market.

Investment houses, some of which many people will recognize from the “Too Big to Fail” hearings on Capital Hill: Bank of America Merrill Lynch, Citigroup, Goldman Sachs Group, JP Morgan Chase and Morgan Stanley, are hard at work conforming muni bond contracts in order to trade them in groups called tranches. Sound familiar?

via Wall Street to trade tax dollars like it did your mortgage, Maureen Nevin Duffy, NewJerseyNewsroom.com. Old to some but new to me.

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How to Profit from the Coming Debt Default

As my stocks tumble amidst growing uncertainty over whether or not to raise the debt ceiling, I couldn’t help but wonder, how could I profit from those who seem bent on destroying the US economy?

House Democrats are circulating a resolution accusing House Majority Leader Eric Cantor (R-Va.) of having a conflict of interest in the debt ceiling debate, a move that could provide an awkward C-SPAN moment for one of the lead Republicans in the budget negotiations.

The resolution goes after Cantor’s investment in ProShares Trust Ultrashort 20+ Year Treasury ETF, a fund that “takes a short position in long-dated government bonds.”

The fund is essentially a bet against U.S. government bonds. If the debt ceiling is not raised and the United States defaults on its debts, the value of Cantor’s fund would likely increase. (Eric Cantor Hit By Democrats For Potentially Profiting From U.S. Default, Huffington Post, 7/8/2011)

Although interesting, the article goes on to note that “Cantor owns $3,327 in the ProShares trust. His congressional pension in the Thrift Savings Plan, on the other hand, is invested in the G Fund of government bonds and is valued at over $263,000.”

Republican Senator Lindsey Graham told ABC’s Jonathan Karl… he “bets” the debt ceiling will not be raised August 2nd and that the United States will very likely default on its debt. (Lindsey Graham On Odds Of Raising The Debt Ceiling: ‘If I Were A Betting Man, I’d Bet No’, Mediaite, 7/12/2011)

Gold anyone?

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Median CEO Pay Up Again: My Apologies

Do I need to apologize? I’ve been using USPX guidelines to vote down pay packages at large companies over the $9 million 2010 median reported by Equilar earlier this year. Now, they’ve revised their pay figures. Final data show median pay for top executives at 200 big companies last year was $10.8 million, up 23% from 2009. (We Knew They Got Raises. But This?, New York Times, 7/2/2011)

The average US worker earned $725 a week in late 2010, up 0.5% (less than inflation) from the year before. I’ve been voting down almost all pay packages where a named executive officer (NEO) earned more than what I thought was the median last year of $9 million. Now it looks like I’ve been too harsh and should have only been voting against those over $10.8 million. I suppose I could say I’m sorry for my vote at those companies where an NEO got more than $9 million but less than $10.8 million. On the other hand, only 1.5% of the companies in the Equilar study had they pay proposals rejected… so, no harm, no foul.

Do we really need to pay them that much? I think our attempt to link pay to performance has resulted in refocusing the corporation. Instead of serving some reasonable public purpose and paying profits to shareowners, many corporations now are moving off shore to avoid paying taxes and are focused on maximizing profits for named executive officers.

Meanwhile, a study from Capgemini and Bank of America Merrill Lynch estimates that financial wealth control by the high net worth individuals jumped 9.7% over the last year to $42.7  trillion. It is hard to see the economy really recovering while the middle class is being hollowed out… although I suppose we could pin our hopes on exports to the growing middle classes of China, India and Brazil.

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CalSTRS Advance Board Diversity

CalSTRS withdrew all eight of its board diversity shareholder proposals filed during the 2011 proxy season after successfully engaging companies to consider diversity in director searches.

In recent years, the issues of board of director leadership and oversight roles have taken on increased significance to long-term investors, such as CalSTRS. Today’s economic challenges highlight the importance that board diversity plays in enhancing value and providing companies with a full range of fresh talent and experience. According to Anne Sheehan, CalSTRS Director of Corporate Governance:

We’ve advanced the ball in the name of board diversity and are committed in our conviction that corporate boards and their nominating committees consider diversity in the larger context of improving shareholder value. One lesson from the financial crisis was the role corporate board group-think played in fostering management short-term priorities that proved detrimental to sustainable value creation. We think improved board diversity will address that problem.

To assist boards in the enhancement of diversity on corporate boards and of shareholder value, CalSTRS and CalPERS launched the Diverse Director DataSource, known as “3D,” by announcing the selection of corporate governance vendor Governance Metrics International to develop and operate the DataSource. 3D is expected to go live later in July and begin accepting nominations from board candidates. The database will offer shareholders, companies and other organizations a valuable resource for identifying candidates.

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Economics of Good and Evil: The Secret Foundations of a Science

Economics of Good and Evil: The Quest for Economic Meaning from Gilgamesh to Wall Streetby Thomas Sedlacek, explores the path dependency of modern Western economics through mythology, religion and fables. I wish the book had been published and influential forty-five years ago when I was a freshman economics major.

When I was an undergraduate student in economics we started with the moral/political arguments of Adam Smith, Thomas Malthus, Karl Marx, David Ricardo, J.S. Mill, and Alfred Marshall. I was so delighted with my chosen major that after the first semester, I signed up for sophomore year economics classes, which for us meant Samuelson. Continue Reading →

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ETF's: Danger or Positive

The factors that brought about the tech bubble, the collateralized debt obligations crash and the rest are being replicated with ETFs: floods of cash and tidal surges of ingenuity in the markets advancing faster than the regulators’ event horizon.

via Fair exchanges?, Inside Investor Relations, 6/29/2011

‘ETFs, indexes and ‘closet indexers’ among mutual funds already make up about 40 percent of the market, I’m told that if you get up to about 60 percent, there really is no market anymore,’ Bob Monks points out. Others disagree. Additionally, Jon Lukomnik says ‘indexes provide active ownership discipline: where you can’t use exit, you use voice.’

See the FSB five page advisory report entitled Potential financial stability issues arising from recent trends in Exchange-Traded Funds (ETFs) found through Why ETFs give an uneasy sense of déjà vu, ft.com, 5/5/2011.

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Believe it: Sometimes Governance is to Blame More than the Tax Code

The recent discussion in the media about the litigation around the Tribune Company LBO in 2007, is an excellent illustration of the consequences of a governance failure as well as the failure of many commentators to recognize the causal relationship. In the linked article, Holman Jenkins of the WSJ correctly notes that this deal was ill-conceived from the beginning.

To sum up a complicated situation, a bankruptcy judge has now decided that the Tribune’s unsecured creditors can sue everyone involved in the leveraged buyout, including the lending banks, on grounds that the deal was a “fraudulent conveyance”—they knew or should have known they were piling on more debt than the company could survive. Already a special examiner appointed by the bankruptcy judge has found sufficient evidence to support such a claim. 

He pins the blame on our convoluted Internal Revenue Code, specifically its provisions awarding special dispensation to Employee Stock Ownership Plans, one of the vehicles used to bring the deal to fruition.

While there is little doubt that IRC incentives played some role in the debacle, the fact remains that the deal was quite aggressive in all events. This was the case even with the most favorable tax consequences and economic assumptions, and prompted significant concern at the time by those asked to pass on the company’s solvency ex post. In other words, the deal resulted from bad decisions by both purchasers and sellers. There was simply insufficient vetting of the deal by anyone.

As we know, the corporate governance field exists in large part to cause companies to avoid such bad decisions. Caused in large part by terrible decisions in the financial sector (as well as households entering into the overly aggressive mortgages), the Great Recession attests to the fact that governance law has not worked in the intended manner and that substantive changes are required to have it work properly.

While there is no question that our IRC is sorely in need of overhaul for many reasons, it is important that its deficiencies not be used as a scapegoat for governance failures. It is important that public dialogue about what needs to be done to avoid the sorts of bad decisions that led to the Great Recession be properly focused and prominently note the role of governance and the need to change its framework so as to bring about fewer bad decisions.

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Video Friday: Joseph Stiglitz Discusses Elite 1% & U.S. Free-Fall

Of the 1%, by the 1%, for the 1%, Joseph E. Stiglitz in May Vanity Fair, discusses the fact that the top 1% now control 40% of our wealth.

The corporate executives who helped bring on the recession of the past three years—whose contribution to our society, and to their own companies, has been massively negative—went on to receive large bonuses. In some cases, companies were so embarrassed about calling such rewards “performance bonuses” that they felt compelled to change the name to “retention bonuses” (even if the only thing being retained was bad performance)…

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Enthusiasm for Free Market Drops

When GlobeScan began tracking views in 2002, four in five Americans (80%) saw the free market as the best economic system for the future–the highest level of support among tracking countries. Support started to fall away in the following years and recovered slightly after the financial crisis in 2007/8, but has plummeted since 2009, falling 15 points in a year so that fewer than three in five (59%) now see free market capitalism as the best system for the future.

GlobeScan Chairman Doug Miller commented: “America is the last place we would have expected to see such a sharp drop in trust in the free enterprise system. This is not good news for business.”

The results mean that a number of the world’s major emerging economies have now matched or overtaken the USA in their enthusiasm for the free market. The Chinese and Brazilians, 67 percent of whom regard the free market system as the best on offer, are now more positive about capitalism than Americans, while enthusiasm in India now equals that in the USA, with 59 percent rating the free market as the best system for the future.

Among the 20 countries polled in both 2009 and 2010, an average of 54 percent today rate the free market economy as the best economic system, unchanged from 2009.

Americans with incomes below $20,000 were particularly likely to have lost faith in the free market over the past year, with their support dropping from 76 percent to 44 percent between 2009 and 2010. American women have also become much less positive, with 52 percent backing the free market in 2010, down from 73 percent in 2009.

via Sharp Drop in American Enthusiasm for Free Market, Poll Shows – World Public Opinion, 4/6/2011.

My guess is that these numbers could easily be reversed with higher taxes on the rich, a more equal distribution of the wealth and of productivity gains, as well as more democratic corporate governance. A free market that allows the vast majority of its population to fail or stagnate, while the wealth of the top 1% soars, is not going to win any popularity contests. What are we waiting for?

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Video Friday: Financial Crisis & CEO Input Into Board Selection

In response to growing concerns on the spread of the financial crisis, the Yale School of Management, in partnership with the Wall Street Journal and CNBC, organized a roundtable discussion in New York on September 23, 2010 that brought together business leaders and scholars from Yale, Wharton, NYU, and the Columbia and Harvard business schools to discuss the unfolding situation in the markets and the economy more broadly, as well as the proposed federal bailout plan. Click Here. Hat tip to Simoleon Sense; I didn’t realize it had been posted.

For a completely different take on the financial crisis, Arthur Benjamin asks, what if we put probability and statistics at the top of the pyramid instead of calculus?

On This Week in the Boardroom (TWIB), co-hosts TK Kerstetter, President, Corporate Board Member, and Scott Cutler, Executive Vice President, NYSE Euronext review what nominating/governance committees should know about including the CEO in the board recruitment process. Additionally, hear why Hewlett Packard’s new CEO and nominating committee are under fire by proxy advisory firms. For our take on these issues, see The Appearance of Legitimacy: Board Elections and HP Nomination Committee Under Fire.

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Deregulation of Derivatives Caused the Crisis

Lynn A. Stout argues the credit crisis was not due primarily to changes in the markets, it was due to changes in the law, specifically the Commodities Futures Modernization Act (CFMA) of 2000’s sudden and wholesale removal of centuries-old legal constraints on speculative trading in over-the-counter (OTC) derivatives.

Derivative contracts are probabilistic bets on future events. They can be used to hedge, which reduces risk, but they also provide attractive vehicles for disagreement-based speculation that increases risk. Thus the social welfare consequences of derivatives trading depend as an empirical matter on whether the market is dominated by hedging or speculative transactions. The common law recognized the differing welfare consequences of hedging and speculation through a doctrine called “the rule against difference contracts” that treated derivative contracts that did not serve a hedging purpose as unenforceable wagers. Speculators responded by shifting their derivatives trading onto organized exchanges that provided private enforcement through clearinghouses in which exchange members guaranteed contract performance. The clearinghouses effectively cabined and limited the social cost of derivatives risk.

These traditional legal restraints on OTC speculation were systematically dismantled during the 1980s and 1990s, culminating in the 2000 enactment of the CFMA. That legislation set the stage for the 2008 crises by legalizing, for the first time in U.S. history, speculative OTC trading in derivatives. The result was an exponential increase in the size of the OTC market, culminating in 2008 with the spectacular failures of several systematically important financial institutions (and the near-failures of several others) due to speculative derivatives losses. In the wake of the crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Title VII of the Act is devoted to turning back the regulatory clock by restoring legal limits on speculative derivatives trading outside a clearinghouse. However, Title VII is subject to a number of possible exemptions that may limit its effectiveness, leading to continuing concern over whether we will see more derivatives-fueled institutional collapses in the future.

Stout concludes, “the hypotheses that legalizing OTC derivatives trading reduced systemic risk, or provided significant liquidity benefits, should be rejected as at best wishful thinking.” Stout, Lynn A., The Legal Origin of the 2008 Credit Crisis (February 25, 2011). UCLA School of Law, Law-Econ Research Paper No. 11-05.

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Governance After the Financial Crisis

Corporate Governance in the Wake of the Financial Crisis: Selected International Views is a publication of the United Nations Conference on Trade and Development (UNCTAD). It contains commentary and analysis by leading experts from around the world, including the OECD, World Bank, ICGN, IOSCO, The Corporate Library, PRI and others with a forward by Mervyn King. The intent is to inform ongoing reform efforts and document the work of major organizations.

Frankly, I haven’t read it yet but it looks great and you can download all seven chapters from the UNCTAD site. Thanks to Jackie Cook of FundVotes.com for giving me a heads-up through the Social Investment Forum… otherwise I may have missed it.

Highlights are touted as follows:

  • Multilateral and national financial reform efforts have identified specific areas of corporate governance requiring reform at financial institutions. In particular, reform efforts should focus on:
    1. strengthening board oversight of management;
    2. positioning risk management as a key board responsibility, and; Continue Reading →
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Star Power Economy May Lead U.S. to Ruin

You want to win elections, you bang on the jailable class. You build prisons and fill them with people for selling dime bags and stealing CD players. But for stealing a billion dollars? For fraud that puts a million people into foreclosure? Pass…  make them pay a fine instead. But don’t make them pay it out of their own pockets, and don’t ask them to give back the money they stole. In fact, let them profit from their collective crimes, to the tune of a record $135 billion in pay and benefits last year. What’s next? Taxpayer-funded massages for every Wall Street executive guilty of fraud?

The mental stumbling block, for most Americans, is that financial crimes don’t feel real; you don’t see the culprits waving guns in liquor stores or dragging coeds into bushes. But these frauds are worse than common robberies. They’re crimes of intellectual choice, made by people who are already rich and who have every conceivable social advantage, acting on a simple, cynical calculation: Let’s steal whatever we can, then dare the victims to find the juice to reclaim their money through a captive bureaucracy. They’re attacking the very definition of property — which, after all, depends in part on a legal system that defends everyone’s claims of ownership equally…  — this whole American Dream thing recedes even further from reality.

(Why Isn’t Wall Street in Jail? | Rolling Stone Politics, Mat Taibbi, 2/16/2011) Between 2007 and 2009, Wall Street profits were up 720%, unemployment was up 102% and the value of home equity in American went down by 35%. According to the Congressional Budget Office, average household income for the top1% has risen from about $500,000 to almost $2 million. For most of us, it has been relatively flat.

According to Jacob Hacker and Paul Pierson, politicians don’t respond to the concerns of voters, they respond to the relative power of the organizations that represent them. Labor has been on the decline, while the power of the Business Roundtable and the Chamber of Commerce has surged.

An article published by The Economist titled The psychology of power: Absolutely looked at a series of experiments that confirm Lord Acton’s dictum that “Power tends to corrupt, and absolute power corrupts absolutely.” “The powerful do indeed behave hypocritically, condemning the transgressions of others more than they condemn their own… It is not just that they abuse the system; they also seem to feel entitled to abuse it.”

Researchers conclude that “people with power that they think is justified break rules not only because they can get away with it, but also because they feel at some intuitive level that they are entitled to take what they want.”

Alan Downs 1997 book describing corporate narcissism (Beyond the Looking Glass: Overcoming the Seductive Culture of Corporate Narcissism) found that high-profile corporate leaders such as “Chainsaw” Al Dunlap literally have only one thing on their minds: profits. According to Downs, such narrow focus may bring short-term benefits, but it ultimately drags down employees and companies… as well as entire countries, at least that would be my take.

Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs by Rakesh Khurana pointed to another thread in the same cloth of American capitalism, charisma and reputation have begun replacing management experience and industry expertise as the primary qualities we search for in a CEO. Succession planning at many corporations is weak. Boards often only take any real action after deterioration has begun to set in. When the the recruiting process begins, they are pressured to take decisive action, seeking an outside savior.

Investors may have contributed to the problem. By insisting on “independent” outside directors (I prefer my directors “dependent” on shareowners through nomination and election), we now have boards with little knowledge specific to the business itself. Recruiting has changed from getting a real fit between the companies needs and the CEO’s talents to one of attracting a high class celebrity with charisma, generally one with plenty of bargaining power to match.

Yet, we know corporate saviors are few in number. Steady progress, building from the inside without all the glamor is much more likely to pay off and is the more prudent model, as documented in Good to Great by Jim Collins. Companies that far outperformed their competitors were generally those where CEOs weren’t charismatic and were recruited from within based on their known capabilities.

We seem to be betting the farm on charismatic bankers and CEOs who offer the promise of easy money. What happened to hard work and middle class values? They’re disappearing, along with the middle class itself.

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UK Revolt Against Wealthy Tax Cheats

Imagine a parallel universe where the Great Crash of 2008 was followed by a Tea Party of a very different kind. Enraged citizens gather in every city, week after week—to demand the government finally regulate the behavior of corporations and the superrich, and force them to start paying taxes. The protesters shut down the shops and offices of the companies that have most aggressively ripped off the country. The swelling movement is made up of everyone from teenagers to pensioners. They surround branches of the banks that caused this crash and force them to close, with banners saying, You Caused This Crisis. Now YOU Pay.

According to this report, it is happening in the UK. The UK Uncut message was simple: if you want to sell in our country, you pay our taxes. Just about the only attack against the movement has been Rupert Murdoch. According to Johann Hari, of The Nation, his company, “News International, is one of the world’s most egregious tax dodgers, contributing almost nothing to the US or UK treasuries.” Will Americans establish a progressive Tea Party?  Vision: Everyday Brits Are in Revolt Against Wealthy Tax Cheats — Can We Do That Here? | AlterNet, 2/5/2011.

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Wall Street Pay Breaks Record, Thanks to Taxpayers

Goldman Sachs, JPMorgan, Bank of America, Citigroup and Morgan Stanley benefited from hundreds of billions from TAARP. Higher revenues amplified Wall Street’s bottom lines.

Combined pay at financial firms hit an all-time high last year and the percentage of revenue that went into employees’ pockets climbed from 31.1% in 2009 to 32.5% last year.

As William Alden of The Huffington Post notes, the Federal Reserve $600 billion asset-purchase program, intended to stimulate the economy, has “also been a direct and indirect boon for the banks. As it buys U.S. government debt, the Fed announces its purchases ahead of time, giving certain banks an opportunity to profit on the trades.” (Wall Street Pay Broke Record Last Year., 2/11/2011)

“On a per-employee basis, the average pay and benefits added up to about $141,000, up from $136,000 in 2009 and the previous high-water mark of $138,000 in 2007. High-earning traders and managing directors earn many multiples of the average.” (U.S. Seeks to Defer Portion of Bonuses, WSJ, 2/5/2011)

Yes, it is important to bring the economy back from the brink but why do we reward those responsible for bringing the system down?

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The Financial Panic & Financial Regulatory Reform

The Financial Panic of 2008 and Financial Regulatory Reform — The Harvard Law School Forum on Corporate Governance and Financial Regulation, Posted by Randall D. Guynn, Davis Polk & Wardwell LLP, on Saturday November 20, 2010, provides a good overview of the crisis and response.

The US and the rest of the world experienced a genuine financial panic in September and October of 2008. The US responded by taking a series of emergency actions to stabilise the financial system. The financial panic of 2008, and these emergency measures, created the ‘perfect storm’ for new financial regulation. The Dodd-Frank Act is the most extensive revision of US financial regulation since the 1930s, although it has left some important issues unresolved.

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The Constitution in the Financial Crisis

The Stanford Constitutional Law Center’s fall conference addressed The Constitution in the Financial Crisis. The government response to the financial crisis raises a number of “constitutional” questions in a broad sense—basic questions about how the government is structured, what its role is, and how its decisionmaking power is allocated between branches and distributed over time. Unfortunately, I missed the first day but was able to attend and take these rough notes on November 12, 2010.

9:30 The Federal Reserve in Our Constitutional System

Larry Kramer

Moderator: Larry Kramer, Richard E. Lang Professor of Law and Dean, Stanford Law School. Panelists: John Steele Gordon (author); Allan Meltzer (Carnegie Mellon); John Taylor (Stanford); and Michael W. McConnell (Stanford).

In the government’s response to the financial crisis, a central role has been played by the Federal Reserve. Is the Fed performing a new function? Should we distinguish between its banking functions, its regulatory functions, and its effective spending power? What is the relation between the structure of the Fed—and especially its seeming independence of political actors—and its approach to policy? Is the Fed genuinely independent? If so, who determines its policies and priorities, and to what interests is it responsive? What are the lessons to learn from the history and antecedents of the Fed, such as the First and Second Banks of the United States? Does the Fed embody, or subvert, the Madisonian project? And is there any necessary relation between the structure of political and governmental institutions and the task of a central banker?

John Steele Gordon

John Steele Gordon: Thinks once the Fed has purchased other securities, it will be easier for them to do so in the future. Precedent has been set.  See also, Empire of Wealth: The Epic History of American Economic Power (P.S.) and Hamilton’s Blessing: The Extraordinary Life and Times of Our National Debt: Revised Edition.

Michael McConnell

Michael W. McConnell: The Federal Reserve Bank is independent of both Executive and Congress. Budgets are generally under the control of Congress and the Government Accountability Office (GOA) can audit. Not true of Fed. (However, I see section XI of Dodd-Frank gives the GAO authority to conduct a one-time audit of the Federal Reserves emergency lending during the credit crisis.) A few years ago, the Fed held $850-900 billion in reserves. When the latest announced round of quantitative easing has been realized, they will hold $1.7 trillion. Agreed with Taylor for the need for audit of Fed purchases of securities other than Continue Reading →

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Capital Offense

Forty years ago, when I was a banker, we made our money by paying depositors enough interest to keep them slightly ahead of inflation and by making loans to credit-worthy customers for mortgages and automobiles. The spread was just a few points and most of the work was done by hand, so the process was more expensive but our fees were lower. Since we kept the paper, instead of bundling it into tranches, we were careful. Specialized banks put together IPOs, helping finance start-ups and private firms going public. At that time, the finance sector was very small portion of the economy and my fellow bankers were a boring lot, even the investment bankers. But we were honest, straight arrow types.

Now, the finance sector reaps 42% of all profits, even small banks sell their paper, the dividing line between investment banks and others is gone, and the big banks make their money developing and selling derivatives, complex financial instruments, and placing bets. In my day, physicists and mathematicians worked for NASA or the newly developing Silicon Valley. Today, they develop models and financial instruments that make it possible to leverage excessively and next to impossible to evaluate risk.

Between December 2007 and 2008, household wealth fell 17%, more than five times the decline in 1929. Over the three decades ending in 2007, the top 1%’s share of the nation’s total after-tax household income more than doubled, from 7.5% to 17.1%. The share of the middle 60% of Americans dropped from 51.1% to 43.5%.  The Great Recession, which began in the Fall of 2007, temporarily halted the stratospheric advance of the rich but they, and they alone, have now largely recovered. The record level of income inequality in America is growing once again. Wall Street year-end bonuses for US hedge fund employees will rise by 5% this year – after increasing 15% last year.  Portfolio managers at larger funds will average $4.85 million. (FT, Hedge fund bonuses signal rosier times, 11/5/2010)

During the Depression, the financial sector was totally revamped. So far, during the Great Recession, Dodd-Frank makes only relatively minor revisions: higher capital requirements for banks, more derivative trades on standardized exchanges, walling off some swaps, etc. When I’ve gone to conferences, of such ICGN, there is a strong sense that although institutional investors have gotten religion about the need to better assess the risk of their own portfolios, little has changed in our financial markets. Few were marched off to jail. Wall Street remains the master of Main Street.

In his book, Capital Offense: How Washington’s Wise Men Turned America’s Future Over to Wall Street, Newsweek reporter Michael Hirsh writes a compelling tale that reads more like a novel than a well-researched history. Hirsh looks back at how the free-market zeitgeist hit what he thinks may have been its peak in the Fall of 2007, but I think maybe not. One could argue the results of the recent election signal a return to the policies of free-market advocates like Milton Friedman, Alan Greenspan, and Robert Rubin.

Hirsh traces the intellectual threads and individual personalities that lead to the financial crisis. When it hit, even Greenspan admitted the folly of his hands-off policies and called for a breakup of the biggest banks.

“If they’re to big to fail, they’re too big,” Greenspan said. “In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

We didn’t. How did it happen? Hirsh does a good job of laying the whole thing out. Much of it involves spinning gold from lead through mechanisms that hid risk used by those who manipulated a sacred belief in free markets, herding instincts, and a game of musical chairs based on so-called tail risks that seemed unlikely to occur, since they would result in catastrophic system failure.

Hirsh cites Martin Wolf of the Financial Times: “Just as Keynes’s ideas were tested to destruction in the 1950s, 1960s, and 1970s, Milton Friedman’s ideas might suffer the same fate in the 1980s, 1990s, and 2000s.” “Call me naive,” Paul Krugman wrote, “but I actually hoped that the failure of Reaganism in practice would kill it. It turns out, however, to be a zombie doctrine. Even though it should be dead, it keeps on coming.”

Too many have too much invested in the current system. Politicians and regulators who go along with the herd are rewarded. The business model remains intact with the same people or their disciples in charge. “By the end of 2009, over-the-counter derivatives trading had climbed back up to more than $600 trillion. Of that amount some $230 trillion was controlled by four banks: Goldman Sachs, JP MorganChase, Morgan Stanley, and Bank of America.”

Daniel Sparks, the former head of Goldman’s mortgage department, freely admitted in Senate testimony that their obligation was to act in their own best interest, not those of their clients. We now see the market was rigged, full of scams, much of it justified by aiding liquidity. However, even as reforms are contemplated we must recognize that Wall Street is global, government is not.

Joseph Stiglitz appears to be Hirsh’s hero in the wings. Stiglitz argues the rich have more money than they can possibly spend, while the poor — who would spend all they have — have little to nothing. Economic growth driven by demand has cratered, especially in developed countries like the US where the gap between rich and poor is rising. Stiglitz argues we need to reorder incentives to move financial engineers to more productive pursuits, like real engineering. Wall Street objects; that would deprive them of top talent but Stiglitz argues that is exactly the point. (read Freefall: America, Free Markets, and the Sinking of the World Economy)

Real reforms during the Depression didn’t really take shape until after Pecora delivered his report. The Financial Crisis Inquiry Commission, headed by Phil Angelides, has a report due in December 2010 but Hirsh doesn’t hold out much hope. He calls Angelides “well-meaning” but “out of his depth.”  Hirsh notes that Angelides used his first hearing to call in the biggest Wall Street CEOs. That made good press but, as one observer noted, it was like “making Richard Nixon the first witness in the Watergate hearings.” Better to start with those on the front line.

Hirsh ends on a bleak note. The U.S. has lost ground in our ability to achieve military victories in asymmetric warfare, in manufacturing, technological innovation, and now in our moral authority tied to a free-market fantasy. “The age of certainty is over” but Wall Street continues to dominate the U.S. economy. I’ve heard the same bleak assessment time and again, although not so coherently argued, at many money manager and director’s conferences during the last two years.

At a 1953 hearing before the Senate Armed Services Committee, GM president and Secretary of Defense nominee Charles Erwin Wilson was asked if he could make decisions adverse to the interests of General Motors. Wilson answered affirmatively but added that he could not conceive of such a situation “because for years I thought what was good for the country was good for General Motors and vice versa.” We now seem to be under the delusion that what’s good for Wall Street is good for the country, even though we’ve seen it ain’t necessarily so.

Also of interest:

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The Future of Financial Regulation: Dodd-Frank and Beyond

Frank-Dodd Panel

On November 1, 2010, I attended an event sponsored by the Rock Center for Corporate Governance at Paul Brest Hall, Stanford University. I’ve noted a few times that students don’t seem to be taking advantage of Rock Center events. This time the hall was comfortably crowded.

Background: Enacted in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) reshapes the regulatory framework for the US financial system. Its goal is to “create a sound economic foundation to grow jobs, protect consumers, rein in wall street and big bonuses, end bailouts and too big to fail, and prevent another financial crisis.” Continue Reading →

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Financial Sustainability: Restoring Market Stability, Corporate Value & Public Trust (ICGN Mid-Year 2010)

Disclaimer: Given Dodd-Frank, proxy plumbing and all those comments I want to provide the SEC, the report below doesn’t do the ICGN Mid-Year Conference justice.  I wrote this up more than a week later with poor notes and memory. Comments, corrections and substitute photos are solicited.

Sharing Perspectives Across the Atlantic. Phil Angelides, Lord McFall and moderated by David Pitt-Watson.

The Financial Crisis Inquiry Commission will report in December to give an unbiased historical accounting of the causes of financial crisis. It will be out in book form but will also be available through download.

Phil Angelides

$11 trillion in wealth was wiped away. The market took until 1954 to get back to the levels of 1929. Let’s hope this one doesn’t take as long but, more importantly will we learn the lessons necessary to prevent or minimizes future bubbles?

It was a failure of accounting and deregulation. Too many were rewarded based on volume not on performance and their was no continuity in risk (they thought) after all the slicing, dicing and creative complexity.

Lord McFall

Rewards can’t be asymmetric and function properly. This was not a natural storm; the clouds were seeded. Signs were there, such as a 2004 warning from the FBI about a housing fraud epidemic, but they were glossed over. Now, our remaining investment banks are largely trading banks, not focused on generating capital but on gaming the markets. The betting market is much larger than the real economy… with more than 85% of transactions being synthetic.

Dodd-Frank requires the investment banks to hold 5% of the securities they sell but I’m not sure what good that does since that portion of their business is now minor. We need to rethink the role of finance in our economy. Continue Reading →

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Video Friday: SRI Rockies Interviews & Simon Johnson on "Too Big to Save"

Joe Sibilia, CEO of CSRwire interviews several influential speakers at the 2010 SRI in the Rockies. The series is produced by First Affirmative Financial Network in partnership with CSRwire. Plan to join investors and investment professionals from the U.S. and around the world November 18-21, 2010 at the 21st annual SRI in the Rockies Conference at the JW Marriott Hill Country Resort & Spa in San Antonio, Texas.

Also of interest, Simon Johnson, a former chief economist for the International Monetary Fund and author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, says the recently passed Dodd-Frank Financial Reform Act does little to prevent the biggest financial risk of our time — banks that are becoming “too big to save,” either because potential losses could overwhelm government resources, or the public will refuse to sanction another large bailout. Either way, the world economy could crash. But preceding any crash, watch for a worldwide “meta-boom.”

Nobody in my mind can be taken seriously if they wish to discuss bringing the U.S. debt under control unless and until they’re willing to deal with these financial sector issues that again threaten to completely destabilize both our economy and the fiscal soundness of the government.

Watch the  interview with [email protected] The Coming Meta-Boom and Meta-Bust — One Economist’s View (10/13/2010)

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Video Friday

Meredith Whitney, CEO of Meredith Whitney Advisory Group LLC. In 2007, she was the first financial analyst to predict major losses for Citigroup, one of the nation’s largest financial services companies. Program from Sunday, September 5, 2010. Q&A CSpan. Hat-tip to The Big Picture.

The United States of Inequality: Introducing the Great Divergence by Timothy Noah, Slate, Sept. 3, 2010.

This Week in the Boardroom: 9/9/10, Board Preparation for Proxy Access with TK Kerstetter, President, Corporate Board Member and Scott Cutler, Executive Vice President, NYSE Euronext.

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You Have to Be Asleep to Believe It

The crisis of middle-class America (FT, 7/30/10) offers a couple of stirring portraits in chronicling the decline of the American dream. Most Americans have been treading water for more than a generation. Over the same period the incomes of the top 1% have tripled.

In the last expansion, which started in January 2002 and ended in December 2007, the median US household income dropped by $2,000 – the first ever instance where most Americans were worse off at the end of a cycle than at the start… Nowadays in America, you have a smaller chance of swapping your lower income bracket for a higher one than in almost any other developed economy – even Britain.

If incomes were declining during the last expansion, think of where they’re headed now. The accompanying anger seems to be driving the Tea Party, but in what direction?

It’s called the American Dream because you have to be asleep to believe it.

— George Carlin

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New Resources: Sustainability Quotes, Crisis Timeline, Cal Corp Law & Proxy Access Avoidance

Quotes – The Business Case for Sustainability & CSR Reporting: Selected Quotes from the Business Community July 2010. Tim Smith of Walden Asset Management, offered up  a helpful resource providing a selected set of quotes from CEO’s and company CSR reports on the business case for Sustainability and CSR reporting highlighting how they contribute to shareowner value.   Business leaders explain in their own words why their companies are stepping up on Sustainability issues and how they contribute to the business and its bottom line. The research was done by Carly Greenberg, a Summer Associate at Walden and a student at Brandeis University. You can download it from the Socially Responsible Business/Investments section of our Links page.

Sullivan & Worcester recently announced a free resource for law and corporate librarians, researchers and reporters. The Financial Crisis Timeline is a full chronological directory of the Federal Government’s actions relating to the financial crisis since March 2008. Links take the user to government press releases or government web pages.  You can also find on our Links page in the History section, for future reference. (Hat tip to Dan Boxer, University of Maine School of Law)

Keith Bishop, a partner in Allen Matkins, recently started a blog devoted to California corporate and securities law issues. For future reference, you can find it on our Links page in the Law section. As I recall, Bishop first came to my attention after 1991, when the Rules Committee of the California Senate appointed him the Senate Commission on Corporate Governance Shareholder Rights and Securities Transactions.

For companies seeking to aviod proxy access, J.W Verret (Truth on the Market) posted the second of two strategies. Proxy Access Defense #1 involved adopting poison pills.

In Selectica, summarized by Pileggi here, the Court held valid a poison pill with a 4.99% trigger.  At first glance this seems to be a great twist for those of us who remain skeptical of the federal government’s intrusion into this foundational issue of state law.  Boards could just lower the pill trigger to 4.99%.  Then even to the extent shareholders could afford to obtain a 5% interest in a company, those who did not already own a 5% interest at the time of the pill’s adoption would not be able to obtain an interest sufficient to nominate onto the corporate proxy.

Even after enactment of Dodd-Frank, Verret speculates this tactic might work at most companies, since the threshold being considered by the SEC for small companies is 5%. The latest strategy offered up by Verret in Proxy Access Defense #2 is even more insidious:

The Delaware General Corporation Law gives the board and the shareholders the co-extensive authority to adopt bylaws setting the qualification requirements necessary to become a director.  There is very little case law interpreting this provision, other than the general rule from Schnell v. Chris-Craft that powers granted to the corporation may not be used in an inequitable manner.  Qualification requirements based on experience, education, and other background-like variables would likely survive scrutiny, particularly where they are adopted well in advance of a threatened proxy fight.

The key element in such a bylaw would be that the Board would serve as the ultimate interpreter of the provisions.  For example, a qualification provision could require directors to have 20 years of experience at a comparable company in the same line of business.  The Board, then, would determine whether that requirement has been met, and only after the proxy contest has actually happened.  Under the holding in Bebchuk v. CA, a shareholder challenge to such a facially neutral bylaw would likely not even be justiciable until a shareholder nominee actually won the contest.  And yet, the prospect that the Board will invalidate the director may discourage nominees in the first instance.

I wonder if Professor Verret also offers advice on how to circumvent tax codes, the Occupational Safety and Health Act, or the Americans With Disabilities Act. Harvard must be pleased to have such a distinguished scholar. Hopefully, most companies will seek to work with their shareowners but I suppose there will always be companies like Apache that may find Verret’s strategies appealing. No, I’m not adding these posts to our Links page. Hopefully, they will fall under the category of fantasy.

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