The Great Debate

from Stories I’d like to see:

Crash winners, the litigation world series, and Defense budget boondoggles

1. Crash Winners

Here’s a new entry for the lists of winners and losers that get published this time of year: The ten lawyers, bankers, consultants or accountants who reaped the most from the financial disaster of the last three years.

The poster-boy would likely be Irving Picard, a partner at the Cleveland-based international law firm of Baker & Hostetler. Picard is the court-appointed trustee responsible for recovering money for Bernie Madoff’s victims. From the sketchy clips I’ve seen, it appears that Picard and his firm have already received more than $200 million in fees for their work from the court overseeing the cases. Is that true?

Then there are the lawyers involved in bringing and defending all those multi-hundred million-dollar and billion-dollar claims against the banks that packaged and re-sold troubled mortgages and other securities. Or the accountants, lawyers and bankers sorting out the assets and liabilities in the wake of the Lehman Brothers bankruptcy and and other implosions.

A really good story would check property records and other sources to pinpoint changes in life style enjoyed by these winners. Did someone buy a fabulous New York co-op, or a house in the south of France? Or fund a new charter school? The point isn’t to villainize these masters of disaster; many people – such as whoever invented Lipitor or other statins to help people avoid heart disease, or the trial lawyers responsible for winning recoveries for victims of corporate environmental pillage or other misconduct – deserve what they get for hard, honest, effective work that stems from others’ misfortune. But at a time when income inequality is the topic of the day, the details here would make great reading and raise all the right questions.

2. The Litigators’ World Series

Which reminds me: Every time I read Alison Frankel’s fabulous “On The Case” Reuters blog about pending litigation, I wonder when someone is going to do the ultimate article about the ins and outs and the who’s who of the world series of litigation inaugurated last September with the filing of a suit against 17 – yes, 17 – big banks and other financial institutions (such as GE Capital) by the Federal Housing Finance Agency.

Here’s a new entry for the lists of winners and losers that get published this time of year: The ten lawyers, bankers, consultants or accountants who reaped the most from the financial disaster of the last three years. Join Discussion

How Citi sank itself on the Fed’s watch

By Nicholas Dunbar The opinions expressed are his own.

Much of the financial crisis can be blamed on bankers who created complex products that allowed them to exploit and monetize less sophisticated investors, borrowers and bank shareholders. However, no account of the financial crisis is complete without an account of the inept regulators who permitted these activities to flourish, causing the crisis to become much worse than it might have been. Among these regulators, most surprising is the story of the New York Fed, supposedly the most sophisticated in its approach to risk. As I recount in this excerpt from my book, The Devil’s Derivatives and as staff at the Federal Reserve Board in Washington DC discovered, the New York Fed was in thrall to what in 2007 was the largest US bank – Citigroup – with disastrous results. -Nicholas Dunbar

The Federal Reserve may have been at the top of the U.S. regulatory pecking order, but within the Fed itself, the New York branch was top dog when it came to regulating banks. This was hardly surprising given the dual importance of Wall Street as the engine room of the bond markets and as the base for the largest multinational U.S. banks. It was only natural that industry risk-management innovations like VAR were first identified by staff in the New York Fed’s markets divi- sion, such as Peter Fisher, who transmitted the ideas to the rest of the regulatory community.

Ever since the regulatory blessing of VAR in the mid-1990s, the New York–based multinational banks had been growing rapidly. By 2003, when William McDonough retired as New York Fed president and was replaced by Timothy Geithner, an ambitious former Treasury and International Monetary Fund bureaucrat, bank supervision was equally important to markets.

If any U.S. commercial bank needed to be challenged, it was Citigroup. In 1999, when then-chief executive Sandy Weill had needed an act of Congress in order to fuse the SEC-regulated Salomon Brothers with Fed- and OCC-regulated blue-chip lender Citibank, he had taken care to reassure his new shareholders and supervisors about the importance of governance. A veteran ex-AIG and Chemical Bank executive, Petros Sabatacakis, was appointed chief risk officer of the new conglomerate and ordered to rein in the freewheeling Salomon traders. Sabatacakis was so tough in applying position limits that on the trading floor he was known as “Dr. No.”

Then came Enron and the dot-com bust. Sabatacakis may have ensured that the bank (unlike Chase Manhattan) avoided significant losses in the shakeout, but Citigroup’s conflicted role in bond underwriting, derivatives, and investment research left it open to the charge of having facilitated massive fraud at Enron and WorldCom. That led to the New York Fed and the OCC censuring the bank in July 2003, as part of a settlement in which it didn’t have to admit wrongdoing. Weill was forced to quit as chief executive (while remaining chairman).

As I recount in this excerpt from my book, The Devil's Derivatives and as staff at the Federal Reserve Board in Washington DC discovered, the New York Fed was in thrall to what in 2007 was the largest US bank – Citigroup – with disastrous results. Join Discussion

Autocrats rule, democrats flounder

By John Lloyd The opinions expressed are his own.

Vladimir Putin, Prime Minister of Russia, claimed the Presidency, the supreme leadership of his country, once more last week with – at least in public – an assurance which amounted to nonchalance. The man whom he had made current President of Russia, Dmitri Medvedev, proposed to the party he had created, United Russia, that he be its candidate for the next presidential elections, to be held next year.

He told the party congress that, should he be elected, he would appoint Mr. Medvedev as Prime Minister. A straight switch, requiring only the imprimatur of the people – who, grateful for stability, rising prices and an increase in the status of their country – are expected to give it.

For a country which has been turbulent for a quarter of a century, this promises the smoothest of transitions. Mr. Putin was president – succeeding Boris Yeltsin – for two terms, from 2000 to 2008. Mr. Medvedev kept the seat warm for a further four years: and if re-elected, Mr. Putin can expect two more presidential terms, till 2020 (when he will be 68) – a longer tenure of power than any other major elected leader since the war. This, of course, assumes he remains popular: but while both his own and his party’s ratings have fallen, both easily outstrip every other individual or party in the state.

The proposed transition points to a jagged fact: most authoritarian leaders are presently both more successful and (much) more popular than most democratic ones. The rulers of China, secure in the former Imperial pleasure garden compound of Zhongnanhai next to Beijing’s Forbidden City, continue to balance carrots and sticks in their successful quest for relative stability and absolute growth. Fears of a contagion from the Arab spring has translated into a harsher tone to Chinese rule – but  so far, Tienanmen has not been transformed into Tahrir Square. Dissidence and protests there are, aplenty: but the steady expansion of living standards, consumption and (managed) liberties ensure a majority quiescent, or supportive.

In the democratic world? Uneasy lies the head of every elected leader of a major state. Contemporary politics offers  no swifter descent from the stellar to the cellar than that of President Barack Obama, whose main crime in the eyes of both his opponents and his supporters has been to make the (fully democratic) transition from aspirant to occupant. The leader of the world’s biggest  democracy, Manmohan Singh of India, is said by  The Diplomat, the current affairs magazine for the Asia Pacific region,  to be “seen by many as ineffective, insufficiently driven and, worse, just plain uninspiring”.

Angela Merkel of Germany on whose shoulders the Euro crisis mainly falls – and who scored a rare success this week in getting the Bundestag to ratify a large hike in German financial aid to Greece –   has an unruly coalition, opposition parties taking regional bastions of centre-right power by the month and an electorate sullenly grudging of every Euro pledged to lazy, spendthrift southern states. Her partner in the salvation of the European currency, and the European Union, President Nicolas Sarkozy of France, has had a descent in popularity only a little less precipitous than Obama’s, one which his beautiful wife, Carla Bruni, has tended to hasten rather than halt (a late autumn baby may help).

Vladimir Putin, Prime Minister of Russia, claimed the Presidency, the supreme leadership of his country, once more last week with – at least in public – an assurance which amounted to nonchalance. Join Discussion

Washington’s long con

By Maureen Tkacik The opinions expressed are her own.

There’s a scene in Ray Nagin’s Hurricane Katrina memoir from the Monday night after the storm in which twenty or thirty mysterious security guards, toting three guns apiece, suddenly descend upon the bombed out Hyatt city officials are using as a command center and commence measuring perimeters, laying down wires and barking orders. “We’re here to protect the mayor!” their apparent leader proclaims. “Everyone else leave!”

Nagin watches, “hallucination-like”, as his two preposterously outmanned bodyguards give the guards their best “Oh, hell no” glares, then politely asks the guards: “Who are you guys, and who sent you?” He has well-founded suspicions they are Blackwater mercenaries hired by the local business community, but the leader won’t divulge anything, so he and his staffers just keep asking the same questions of every guard they can corner, until the entire team suddenly vanishes en masse, “Ninja-like, as quickly and quietly as they arrived.”

Of the unnervingly frequent Bush Administration flashbacks I suffered reading Ron Suskind’s Confidence Men: Wall Street, Washington and the Education of a President, Nagin’s staredown of the elite hired guns is the one Obama never manages to repeat.

Instead the whole saga plays out like a more articulate slow-motion rehash of a memorable passage from an earlier Suskind book, in which an earlier inexperienced president in the afterglow of a crisis-fueled electoral victory listens to his economic advisers plot the next six months of tax breaks and “incentive package” announcements and finally asks, “What are we doing on compassion?”

(Silence.)

But Bush was a quicker study than his successor. By the end of Bush’s 2002 meeting with his economic advisers he has mastered the narrative they are concocting: the “spin” that the economy is bad is not “credible” enough to warrant compassion, but it is saddled with uncertainty—a malaise he identifies on his very own without cue as resulting from the twin ills of “SEC overreach” and the threat of Saddam Hussein’s continued rule in Iraq. By contrast, it takes 355 pages for Obama to complete a parallel metamorphosis, from compassion-infused campaigner to unprompted producer of his own brand of Beltway antilogic, by which he informs his advisers in the fall of 2009 he has learned to stop worrying about unemployment rate, since its historical magnitude is merely a rosy indicator of “productivity gains in the economy.”

Suskind’s character studies in "Confidence Men" end up corroborating your best gut-level impressions, of all the innumerable well-intentioned individuals who understood in September ‘08 what so many like them understood in September ‘01, that this was their chance to do their part to restore a bit of civility to a civilization that seemed otherwise hellbent on setting a world record in rot. Join Discussion

from James Saft:

Icelandic mulishness wins the day

Iceland's remarkable return to growth shows once again that in this crisis the best policy is often the one that will make international partners most angry.

Having been reviled and chastised when it refused to make good the outsize debts of its banks, Iceland this week capped a striking turnaround when it announced that its economy expanded by 1.2 percent in real terms in the most recent quarter, its first such rise in two years.

This is in stark contrast to Ireland, whose pliability and inability as a member of the euro zone to act unilaterally leaves it with a still crashing economy which must service ever more debt by making ever deeper cuts to public spending.

Iceland, which sailed into the crisis in 2008 as essentially a small fishing fleet with a massive hedge fund attached, looked its predicament square in the eye and followed a set of policies seemingly designed to tick off both its friends and enemies, doing its small but mighty best to beggar its neighbors by letting its currency crash, imposing capital controls and, crucially,  refusing to make whole the global creditors of its three failed international banks.

While an International Monetary Fund and multilateral package was eventually agreed, and a deal with Britain and the Netherlands over debts from Icesave Bank are currently being hammered out, Iceland's leaders, at least the current ones, seem convinced that making bank creditors share its pain was the right course.

"The difference is that in Iceland we allowed the banks to fail. These were private banks and we didn't pump money into them in order to keep them going; the state should not shoulder the responsibility," Iceland's president, Olafur Grimsson, said last month, tweaking the nose of EU officials who are insisting that Ireland make good all senior creditor calls on its own distended banking system.

"Bondholders should not rely on the government stepping in and bailing them out," Iceland Central Bank governor Mar Gudmundsson said last week. "They should do their due diligence."

Iceland's remarkable return to growth shows once again that in this crisis the best policy is often the one that will make international partners most angry. Join Discussion

from Entrepreneurial:

Why America’s small businesses are becoming like banks

By Terra Terwilliger The opinions expressed are the author's own.

Over two years after the start of the Great Credit Crisis, banks are still not lending money. But big businesses know exactly where to go for a quick, interest-free loan … the little guy. Even as corporate profits recover, big companies continue to squeeze their small vendors, stretching out payment terms and writing late checks. Unfortunately, this blatant exploitation is damaging the small business economic engine that drives half of US GDP.

A friend who owns a small consulting company recently received notice from a Fortune 500 client that henceforth their payment terms would be extended from 90 to 120 days. No discussion, no recourse, just a fancy legalese version of “we’re going to start paying you later because it’s better for us, so get used to it.”

That’s as if your employer casually one day sent you a letter saying that they were going to start paying you 30 days late. Unfortunately, you wouldn’t be able to tell your landlord, the gas company and the supermarket the same thing. Your bills still have to be paid on time.

My friend is not alone. Last August, The Wall Street Journal published an article titled “Big Firms are Quick to Collect, Slow to Pay,” which revealed how companies with more than $5b in annual sales were systematically slowing payments to suppliers, while speeding up their own collections. The analysis showed that companies with revenues over $5 billion took an average of 55.8 days to pay suppliers, compared to 53.2 days a year earlier … and compared to the 40.1 days in which businesses with revenues under $500 million pay up.

The situation is not getting better. “We just updated our payables analysis for 2010,” says a spokesperson for REL Consultancy, the company that did the original WSJ research. “We see the same trends in 2010. Large companies continue to pay slowly, and they are still using their muscle to make their suppliers accept longer payment terms.”

Big companies not only force vendors to accept painful terms, they also don’t reliably pay up. According to the Experian Business Benchmark Report of July 2010, the average days beyond terms (days a company is late on paying according to its own billing standards) for companies with over 1,000 employees increased by 5.6% over the past six months, with 17% of all monies owed delinquent. Some of these delays are doubtless due to billing errors or legitimate disputes about payment. Some are bids to wring a few more days of cash flow out of already stretched vendors.

Over two years after the start of the Great Credit Crisis, banks are still not lending money. But big businesses know exactly where to go for a quick, interest-free loan … the little guy. Unfortunately, this blatant exploitation is damaging the small business economic engine that drives half of US GDP. Join Discussion

from The Great Debate UK:

A history lesson for lenders

-Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.-

Anyone looking for a broader perspective on the events of the last three years could hardly do better than choose for bedtime reading “This Time is Different” by Carmen Reinhart and Kenneth Rogoff.

It is nothing less than a history of financial crises through the ages, starting in late medieval England and continuing via 15th and 16th century Spain and its New World colonies on to the teething problems of Britain’s banks in the industrial revolution and the upheavals of the 20th century, ending in 2008 with the bankruptcy of Lehman Brothers.

The emphasis throughout is on sovereign default. For many politicians, bankers and economists, it ought to read not just as a lesson, but as a severe rebuke, because its basic message is that there is nothing new under the sun and that financial history reads like a long catalogue of facts we have chosen to forget.

So, as the authors show, no country’s history is free of bank collapses, sovereign defaults and currency debasement in one form or another.

Many countries have been serial defaulters, and – surprise, surprise! – the recidivists include some of today’s shakiest sovereigns, notably Greece (which went bust several times in the first decade or two after it gained its independence in 1821, and has never in its history merited a good credit rating) and Spain, which after many defaults in the pre-industrial era seemed until relatively recently to have reformed.

Anyone looking for a broader perspective on the events of the last three years could hardly do better than choose for bedtime reading “This Time is Different” by Carmen Reinhart and Kenneth Rogoff. Join Discussion

from The Great Debate UK:

Greenspan and the curse of counterfactual

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

Suppose that, instead of appeasing Nazi dictator Adolf Hitler at Munich in 1938, Neville Chamberlain had taken Britain to war, what would today’s history books say about the episode?

It is of course impossible to know. Perhaps something along the lines: “the British prime minister’s stubborn refusal to compromise resulted in a war which dragged on for 6 months at a cost of over 300,000 lives.....” Make up your own scenario.

We can never know. But we can be 100 percent certain the history books would NOT now say anything like: “by refusing to appease the dictators, Neville Chamberlain saved more than 30 million lives, prevented the division of Europe and saved the world from 40 years of Cold War”.

In the same way, we can be absolutely sure that, if former Federal Reserve Chairman Alan Greenspan had raised interest rates and tightened credit in 2005 or 2006, putting a stop to the lending boom before it could become a risk to the banking system as a whole, he would not today be feted as the man who saved the world from the worst financial crisis in 60 years.

More likely, opinion would be divided over whether the ensuing recession, with the loss of maybe 1 percent of GDP and 100,000 jobs, was at all necessary.

Critics would have called for Greenspan’s head and possibly even for the Fed to lose its independence, while the defence would have been left lamely quoting the famous dictum of a previous chairman that it is the job of the Fed to take away the punchbowl just as the party gets going.

Since banks paid millions in salaries before the financial crisis for their supposedly high-calibre management teams, experience suggests that what we really need now is to pay lower salaries in order to recruit lower-calibre managers. Join Discussion

from The Great Debate UK:

Bankers’ bonuses: the fish stinks from the head

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

The awful thing about lynch mobs is they so often hang an innocent man, leaving the guilty totally untouched.  In the case of the banks, the danger is acute.  As I have already argued, hedge funds and private equity are being unfairly targeted, especially in Europe. But there is another, even less popular class which is likely to end up in the firing line, for no good reason and with consequences which could be damaging for all of us.

Broadly speaking, the banks pay 6- and 7-figure bonuses to two quite different sorts of people. First, there is a layer of what we might call technocrats: the striped-shirted traders of legend, with their loud voices and even louder dress codes, along with the managers who try to control them, the quants who invent complex trading strategies and price exotic new instruments, and a variety of others with specialised skills. Since they are rewarded in proportion to the profit they generate for their employer, which can usually be measured with considerable accuracy, their bonuses are often very large indeed. The question is: should we treat these professionals who trade on their expertise and who heavily outnumber senior management in the same way as their bosses? Not as far as I can see.

However unpopular these market professionals might be, I can see no reason whatever for intervening to limit the rewards their expertise earns for them. Arguments about “justice”, “fairness” and “ethics” are irrelevant, especially when they rely on judgements about lifestyles.

Fairness is no criterion for determining pay scales, unless we are also willing to limit the earnings of rock stars, footballers, best-selling novelists.....that is the way to the madhouse (and the collective farm).  The market sets a high price on rare skills, and in a competitive world, any attempt by a single country to restrict that price will result in it losing those skills and the business that goes with them.

No, anger about bank pay levels ought to be directed exclusively at senior management, where the key decisions which brought down the banking system were taken. Merging high street banks with investment banks, securitising mortgages so as to expand balance sheets by borrowing in wholesale markets instead of relying on deposits for funding, leveraging up to and a long way beyond the prudential limit, relentless empire-building that turned Citibank, RBS, HBOS into monsters with balance sheets on the scale of middle-ranking UN member countries – all these catastrophic decisions emanated from the boardroom, not the trading floor. The guilty men were handsomely rewarded for running their banks on to the rocks and, just to add insult to injury, are in most cases now extracting large rewards for salvaging the wreckage! This is the problem, and in my view the only problem, with bank bonuses.

Even before the crisis, it was hard to justify the rewards they earned. Their marketable skills are not always apparent, since they are not always professional bankers themselves –some have spent most of their careers in other industries. It is extremely difficult to measure their contribution to profit, which is precisely why their remuneration packages often involved options with payoff patterns based on highly controversial computations of how well the bank’s shares perform. If their remuneration packages looked over-generous before the crisis, they must be totally indefensible now "après le deluge".  Can anybody seriously believe that paying more modest salaries would have resulted in even worse mismanagement?

The awful thing about lynch mobs is they so often hang an innocent man, leaving the guilty totally untouched. In the case of the banks, the danger is acute. Join Discussion

Did Asperger’s help cause the crisis?

Did the financial system blow up because it was built and largely operated by people with many of the characteristics of a mild form of autism called Asperger’s syndrome?

As explanations for the crisis go, it’s on the extreme side but forms an interesting counterpoint to the “blame the looting bankers” story line.

People with Asperger’s, a mild form of autism, are characterized by, among other things, a deficit of “theory of mind,” essentially the ability to understand that other people have different beliefs or knowledge than themselves. Nicholas Nassim Taleb, author of The Black Swan, has written that a lack of theory of mind left many in positions of responsibility without the ability to conceive of and guard against black swans, which are rare, high-impact and hard to predict events.

There were, after all, a remarkable number of people blaming “hundred-year storms” for the crisis, which was at least in substantial part caused by an over-reliance on risk management controls and models that proved to be far too narrow.

There was a love of data and a refusal to conceive of the data being not wrong, but incomplete, which led many to cling to their models of how the world was working even as it fell around them. Remember all of those reassurances that problems in subprime were “contained”?

“Note that the very same people who attack me, on grounds of political correctness, for discussing Asperger as a condition not compatible with risk-bearing, and its dangers to society, would be opposed to using a person with highly impaired eyesight as the driver of a school bus,” Taleb writes in his typically provocative style.

“All I am saying is that just as I read Milton, Homer, Taha Husain, and Borges (who were blind) but would prefer to not have them drive me on the A-4 motorway, I elect to use tools made by engineers but prefer to have society’s risks managed by someone who is not affected with risk-blindness.”

Did the financial system blow up because it was built and largely operated by people with many of the characteristics of a mild form of autism called Asperger's syndrome? Join Discussion