Tuesday, November 24, 2009

Charitable Giving

"Guess what? I have flaws. What are they? Oh I dunno, I sing in the shower? Sometimes I spend too much time volunteering. Occasionally I'll hit somebody with my car. So sue me—no, don't sue me. That is opposite the point I'm trying to make."

"Do I need to be liked? Absolutely not. I like to be liked. I enjoy being liked. I have to be liked. But it's not like this, compulsive, need, to be liked. Like my need to be praised."

— Michael Scott, The Office

In an otherwise less than sympathetic piece on the public relations travails of the Vampire Squid everybody loves to hate, Financial Times journalist Chrystia Freeland credits the investment bank's recently announced 10,000 Small Businesses initiative as "cleverly conceived" and "designed for maximum effect." I have to disagree.

Like many of you, I am sure, I was impressed when I heard Goldman was going to donate $500 million to a myriad of small businesses, which are widely perceived to be the primary engines of job creation in our economy. Oh goody, I thought: half a billion bucks mainlined into the veins of those businesses best able to kick start the economy back into rude health. What a coup.

Then I read the blasted thing. It is not pretty. Sixty percent of the committed funds will be distributed for "lending and philanthropic support," but this will be directed through "Community Development Financial Institutions." Call me a skeptic, but this does not sound like high powered money coursing directly into the working capital accounts of productive enterprises which can use it. Instead, it sounds like a $300 million slush fund for the functional equivalent of community NGOs. The remaining forty percent—200 million clams—will go toward "education."

Oh great, Lloyd, that's just what every small businessman needs: an education. After all, everybody knows what the owner of a chain of dry cleaners or a machine tool factory really needs is "scholarships," greater "educational capacity," and mentoring by some half-assed social worker out of an abandoned storefront. Why stop there, though? Why not endow a hundred spots at Harvard Business School in perpetuity so Hmong immigrants can learn to apply CAPM and discounted cash flow analysis to their corner delicatessens? 1

Either that, or you could pull your head out of your ass and actually lend some money to these guys instead. Heck, set up a small business lender with half a billion in capital, lever it up ten to one, and loan five billion dollars out to struggling small businesses. You might actually spur some real economic growth, rather than employing an army of aspiring bureaucrats to fill out scholarship applications in triplicate. Plus, you might finally earn some respect from a country which suspects you and your peers are constitutionally incapable of taking a crap without consulting the Harvard Business Review or the McKinsey Handbook of Corporate Obfuscation for instructions. 2

This idea scales attractively, too: Put in a billion of equity, and loan out ten billion, and people might even stop whispering disparaging remarks about the size of your junk in the corridors of Capitol Hill. Now there's a return on capital.

* * *

On the other hand, given that you run an investment bank, if you want to raise some serious money for charity, you could always open a Swear Jar. Just make sure it's big enough.

1 Well, okay, that was a cheap shot. You and I both know doing any such thing would destroy the exclusivity and aura of an HBS education, which would be a societal catastrophe too terrible to contemplate. (Not to mention wasting two years out of the lives of otherwise productive elements of the economy.) Just kidding, bro.
2 I mean really, who comes up with this shit? I know you couldn't give a damn about tiny ass businesses which will never grow large enough to become paying customers of your firm, but you are theoretically announcing this program for public effect, no? Why not make it clear, simple, and understandable, instead of a convoluted, bureaucratic mess apparently derived from some EU functionary's wet dream? Bank? Lending? Ring a bell?

© 2009 The Epicurean Dealmaker. All rights reserved.

Tuesday, November 17, 2009

Compassion Fatigue

"No matter how many times you save the world, it always manages to get back in jeopardy again. Sometimes I just want it to stay saved, you know? For a little bit? I feel like the maid: 'I just cleaned up this mess! Can we keep it clean for ... for ten minutes?!'"

— The Incredibles

I don't know about you, Dear and Long-Suffering Readers, but I am beginning to worry about Yves Smith.

The indefatigable blogger and soon-to-be-published author is really showing the strain of commenting from the front lines of the global financial crisis, as she has done, admirably, from the very beginning. Today, she lit into Neil Barofsky's SIGTARP post mortem on the New York Fed's disbursement of billions of taxpayer dollars to cancel credit default swaps written by the pathetic boobs at AIG. AIG sold those swaps, you may remember, under the cheerfully naive assumption that, as long as you hold a AAA credit rating and employ a bunch of overpaid financial engineers in a fancy office on Curzon Street, you can write as many naked puts on as much toxic crap as you like with no consequences. Much as I would be delighted to learn otherwise, I believe we may safely consider that presumption to be dead, buried, decayed, mixed into topsoil, and completely absorbed into the Earth's mantle via tectonic subduction by now.

In the meantime, however, the rest of us continue to live with the consequences of AIG's tomfoolery, and Ms Smith remains understandably upset about this state of affairs. So much so, in fact, I think she rather unfairly pans Mr. Baroksky's report as unacceptably timid and mealy-mouthed. I read her to say she would rather have the report blast the Fed's mishandling of the AIG crisis in no uncertain terms, not sugarcoat its misdeeds in the bland and unoffensive coating of bureaucratese.

But this is unfair. From my perspective—known to most of you as distinctly unappreciative of the Fed's spineless and inept handling of this imbroglio—I think Barofsky and pals did a rather bang-up job of blowing holes in both the government's actions and their pathetic ex post rationalizations therefor. You just have to read between the dry, measured lines a little.

* * *

As witness, I offer for your reading pleasure select excerpts from the Conclusions and Lessons Learned section of the report, with a few helpful explanatory titles and glosses of my own design.

Page 28: "Plan B? What Plan B?"

— or —

The New York Fed Conclusively Demonstrates It Cannot Plan Its Way Out of a Paper Bag, Even with a Map and a Blowtorch

When first confronted with the liquidity crisis at AIG, the Federal Reserve Board and FRBNY, who were then contending with the demise of Lehman Brothers, turned to the private sector to arrange and provide funding to stave off AIG’s collapse. Confident that a private sector solution would be forthcoming, FRBNY did not develop a contingency plan; when private financing fell through, FRBNY was left with little time to decide whether to rescue AIG and, if so, on what terms. ... Not preparing an alternative to private financing, however, left FRBNY with little opportunity to fashion appropriate terms for the support, and believing it had no time to do otherwise, it essentially adopted the term sheet that had been the subject of the aborted private financing discussions (an effective interest rate in excess of 11 percent and an approximate 80 percent ownership interest in AIG), albeit in return for $85 billion in FRBNY financing rather than the $75 billion that had been contemplated for the private deal. In other words, the decision to acquire a controlling interest in one of the world’s most complex and most troubled corporations was done with almost no independent consideration of the terms of the transaction or the impact that those terms might have on the future of AIG.

This bang-up example of tactical thinking and mental flexibility, of course, led directly to a threatened downgrade of AIG by the ever-helpful credit rating agencies, which in turn made it absolutely necessary for AIG to get out from under those nasty, collateral-sucking CDSs. This allowed the Fed staffers a stellar opportunity to affirm their collective membership in the phylum Platyhelminthes (spineless flatworms) by halfheartedly negotiating for haircuts on the CDOs underlying AIG's swaps with its recalcitrant counterparties.

Apparently, the sum and substance of these negotiations was remarkably similar to that which my bloggish antagonist Economics of Contempt rather presciently proposed just recently:

AIG: "Would you be willing to accept, say, 70 cents on the dollar?"
Goldman: "No."


I kid you not.

Seven of AIG's largest counterparties—including, for the two which were French, that beacon of unfettered capitalism and bastion against tortious interference in contract law, the Government of Fucking France—told the Fed to go pound sand. The eighth, UBS, showed a deplorable lack of principle by venturing to offer a 2% haircut to its position, as long as everyone else did. Nevertheless, the Fed decided that friends don't let friends make insultingly small unilateral concessions where the US taxpayers' dime is concerned, so they just told them to forget it.

Mr. Barofsky picks up the narrative from here:

Page 29: "Integrity Is Our Watchword"

— or —

For Some Unexplained Reason, Perhaps Having to Do with Sunspots or the Phase of the Moon, the Institution Which Presided Over the Botched Fire Sale of Bear Stearns and the Clusterfuck Incineration of Lehman Brothers Magically and Unexpectedly Decides to Grow a Pair of Testicles Adopt a Set of Principles

In pursuing these negotiations, FRBNY made several policy decisions that severely limited its ability to obtain concessions from the counterparties: it determined that it would not treat the counterparties differently, and, in particular, would not treat domestic banks differently from foreign banks — a decision with particular import in light of the reaction of the French bank regulator which refused to allow two French bank counterparties to make concessions; it refused to use its considerable leverage as the regulator of several of these institutions to compel haircuts because FRBNY was acting on behalf of AIG (as opposed to in its role as a regulator); it was uncomfortable interfering with the sanctity of the counterparties’ contractual rights with AIG, which entitled them to full par value; it felt ethically restrained from threatening an AIG bankruptcy because it had no actual plans to carry out such a threat; and it was concerned about the reaction of the credit rating agencies should imposed haircuts be viewed as FRBNY backing away from fully supporting AIG. Although these were certainly valid concerns, these policy decisions came with a cost — they led directly to a negotiating strategy with the counterparties that even then-FRBNY President Geithner acknowledged had little likelihood of success.

The first, of course, is my personal favorite, for there is absolutely no tactic more effective at gutting whatever leverage and flexibility you might have in a negotiation—other than shoving a fragmentation grenade up your ass and pulling the pin—than refusing to treat different counterparties differently. I remember hearing hints of this preposterous limitation in earlier accounts of the AIG fiasco, but the Fed always seemed to imply it was a legal restriction inherent in its charter. Now, perhaps, we learn differently:

FRBNY’s decision to treat all counterparties equally (which FRBNY officials described as a “core value” of their organization), for example, gave each of the major counterparties (including the French banks) effective veto power over the possibility of a concession from any other party. This approach left FRBNY with few options, even after one of the counterparties indicated a willingness to negotiate concessions. It also arguably did not account for significant differences among the counterparties, including that some of them had received very substantial benefits from FRBNY and other Government agencies through various other bailout programs (including billions of dollars of taxpayer funds through TARP), a benefit not available to some of the other counterparties (including the French banks). It further did not account for the benefits the counterparties received from FRBNY’s initial bailout of AIG, without which they would have likely suffered far reduced payments as well as the indirect consequences of a potential systemic collapse.

Oh, yeah, that was a real winner.

Also in the winner column was the Fed's newly discovered squeamishness about playing hardball. Where the fuck did that come from? Mr. Barofsky needs no gloss on this topic (pp. 29–30):

Similarly, the refusal of FRBNY and the Federal Reserve to use their considerable leverage as the primary regulators for several of the counterparties, including the emphasis that their participation in the negotiations was purely “voluntary,” made the possibility of obtaining concessions from those counterparties extremely remote. While there can be no doubt that a regulators’ inherent leverage over a regulated entity must be used appropriately, and could in certain circumstances be abused, in other instances in this financial crisis regulators (including the Federal Reserve) have used overtly coercive language to convince financial institutions to take or forego certain actions. As SIGTARP reported in its audit of the initial Capital Purchase Program investments, for example, Treasury and the Federal Reserve were fully prepared to use their leverage as regulators to compel the nine largest financial institutions (including some of AIG’s counterparties) to accept $125 billion of TARP funding and to pressure Bank of America to conclude its merger with Merrill Lynch. Similarly, it has been widely reported that the Government, while arguably acting on behalf of General Motors and Chrysler, took an active role in negotiating substantial concessions from the creditors of those companies.

Gee, that sounds familiar.

* * *

Of course, then there is the whole "backdoor bailout" question, which arguably lies at the core of the persistent conspiracy theories percolating through our troubled polity.

Page 30: "No, No, No. I Didn't Give You That Dollar, I Gave You This Dollar"

— or —

The Fed Attempts to Gauge Exactly How Stupid 310 Million Americans Really Are by Denying the Fungibility of US Currency

Questions have been raised as to whether the Federal Reserve intentionally structured the AIG counterparty payments to benefit AIG’s counterparties — in other words that the AIG assistance was in effect a “backdoor bailout” of AIG’s counterparties. Then-FRBNY President Geithner and FRBNY’s general counsel deny that this was a relevant consideration for the AIG transactions. Irrespective of their stated intent, however, there is no question that the effect of FRBNY’s decisions — indeed, the very design of the federal assistance to AIG — was that tens of billions of dollars of Government money was funneled inexorably and directly to AIG’s counterparties. Although the primary intent of the initial $85 billion loan to AIG may well have been to prevent the adverse systemic consequences of an AIG failure on the financial system and the economy as a whole, in carrying out that intent, it was fully contemplated that such funding would be used by AIG to make tens of billions of dollars of collateral payments to the AIG counterparties. The intent in creating Maiden Lane III may similarly have been the improvement of AIG’s liquidity position to avoid further rating agency downgrades, but the direct effect was further payments of nearly $30 billion to AIG counterparties, albeit in return for assets of the same market value. Stated another way, by providing AIG with the capital to make these payments, Federal Reserve officials provided AIG’s counterparties with tens of billions of dollars they likely would have not otherwise received had AIG gone into bankruptcy.

And, lastly, the SIGTARP report blasts the Fed's continued ridiculous insistence on complete confidentiality for its actions, even in retrospect. Given the revelations we have been privileged with, I can only assume the Fed's diffidence has far more to do with covering up its massive, multidimensional incompetence in dealing with AIG than with any other purpose.

Page 31: "Transparency? We Don't Need No Fucking Transparency!"

— or —

Sunlight Is the Best Disinfectant, But Only for Those Other Guys

Second, the now familiar argument from Government officials about the dire consequences of basic transparency, as advocated by the Federal Reserve in connection with Maiden Lane III, once again simply does not withstand scrutiny. Federal Reserve officials initially refused to disclose the identities of the counterparties or the details of the payments, warning that disclosure of the names would undermine AIG’s stability, the privacy and business interests of the counterparties, and the stability of the markets. After public and Congressional pressure, AIG disclosed the identities. Notwithstanding the Federal Reserve’s warnings, the sky did not fall; there is no indication that AIG’s disclosure undermined the stability of AIG or the market or damaged legitimate interests of the counterparties. The lesson that should be learned — one that has been made apparent time after time in the Government’s response to the financial crisis — is that the default position, whenever Government funds are deployed in a crisis to support markets or institutions, should be that the public is entitled to know what is being done with Government funds. While SIGTARP acknowledges that there might be circumstances in which the public’s right to know what its Government is doing should be circumscribed, those instances should be very few and very far between.

* * *

In fact, reading through this report, I find very little evidence that Barofsky et al. were even remotely swayed by the transparent nonsense the Fed used to justify its idiocy. Sure, they included it in their report, as they were no doubt required to do, but their conclusions seem remarkably impervious to the Fed's perspective.

And, weasel words aside, I read the SIGTARP report and find complete confirmation of two important points. First, the New York Fed, led by our current Secretary of the Treasury, botched the rescue of AIG so completely and so pathetically that it does border, as Yves says, on criminal incompetence. Second, the Fed had enough negotiating leverage in the entire affair to have substantially lessened the amount of taxpayer funds it ending up paying to AIG's counterparties, to the tune of billions and billions of dollars. A competent and motivated negotiator could have extracted billions of dollars in concessions with little else. But the Fed squandered that leverage, and it explicitly renounced several situational and structural advantages it possessed that contributed to that leverage, in the service of ... what, exactly? Certainly not in the service of its fiduciary duty to the American people, which cannot and should not be limited simply to the ad hoc preservation of a bunch of systemically important financial institutions.

Sadly, the horse has left the barn, the barn has burned down, and the farmer's wife has run off with the village idiot. I fear there is little upside in further speculation on what might have been. Suffice it to say, however, that I think Michael Moore should add a coda to his recent movie, Capitalism: A Love Story. In my vision, the chubby provocateur will pull his rented armored truck up to the steps of the Federal Reserve Bank and start chanting into his bullhorn:

"I am here to make a citizen's arrest of the Board of Governors of the Federal Reserve. We want our money back!"

I would pay $12.50 to see that.

© 2009 The Epicurean Dealmaker. All rights reserved.

Thursday, November 12, 2009

Notes from a Presidential Address I Would Like to Hear

As delivered from the bully pulpit long ago, in another time and place, which looks a lot like this time and place:
Probably the greatest harm done by vast wealth is the harm that we of moderate means do ourselves when we let the vices of envy and hatred enter deep into our own natures. But there is another harm; and it is evident that we should try to do away with that. The great corporations which we have grown to speak of rather loosely as trusts are the creatures of the State, and the State not only has the right to control them, but it is duty bound to control them wherever the need of such control is shown.

— Speech at Providence, Rhode Island (August 1902)

Every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.

— The New Nationalism (August 1910)

Our aim is not to do away with corporations; on the contrary, these big aggregations are an inevitable development of modern industrialism, and the effort to destroy them would be futile unless accomplished in ways that would work the utmost mischief to the entire body politic. We can do nothing of good in the way of regulating and supervising these corporations until we fix clearly in our minds that we are not attacking the corporations, but endeavoring to do away with any evil in them. We are not hostile to them; we are merely determined that they shall be so handled as to subserve the public good. We draw the line against misconduct, not against wealth.

— State of the Union address (December 1902)

* * *

There is more:

We stand equally against government by a plutocracy and government by a mob. There is something to be said for government by a great aristocracy which has furnished leaders to the nation in peace and war for generations; even a democrat like myself must admit this. But there is absolutely nothing to be said for government by a plutocracy, for government by men very powerful in certain lines and gifted with "the money touch," but with ideals which in their essence are merely those of so many glorified pawnbrokers.

— Letter to Sir Edward Grey (September 1913)

Political parties exist to secure responsible government and to execute the will of the people. From these great tasks both of the old parties have turned aside. Instead of instruments to promote the general welfare they have become the tools of corrupt interests, which use them impartially to serve their selfish purposes. Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people. To destroy this invisible government, to dissolve the unholy alliance between corrupt business and corrupt politics, is the first task of the statesmanship of the day.

— "The Progressive Covenant With The People" speech (August 1912)

* * *

Where oh where is the Bull Moose for our time and place?

© 2009 The Epicurean Dealmaker. All rights reserved.

Wednesday, November 11, 2009

Veterans' Day

November 11, 2009:
What passing-bells for these who die as cattle?
—Only the monstrous anger of the guns.
Only the stuttering rifles' rapid rattle
Can patter out their hasty orisons.
No mockeries now for them; no prayers nor bells,
Nor any voice of mourning save the choirs,—
The shrill, demented choirs of wailing shells;
And bugles calling for them from sad shires.

What candles may be held to speed them all?
Not in the hands of boys, but in their eyes
Shall shine the holy glimmers of goodbyes.
The pallor of girls' brows shall be their pall;
Their flowers the tenderness of patient minds,
And each slow dusk a drawing-down of blinds.

— Wilfred Owen, Anthem for Doomed Youth

Let us not forget those who have truly paid the price for our folly and our hate.

Nostra culpa, nostra culpa, nostra maxima culpa.

Photo credit: Great War Primary Document Archive: Photos of the Great War.

© 2009 The Epicurean Dealmaker. All rights reserved.

Monday, November 2, 2009

Character Study

Alfred Pennyworth: "A long time ago, I was in Burma. My friends and I were working for the local government. They were trying to buy the loyalty of tribal leaders by bribing them with precious stones. But their caravans were being raided in a forest north of Rangoon by a bandit. So we went looking for the stones. But in six months, we never found anyone who traded with him. One day I saw a child playing with a ruby the size of a tangerine. The bandit had been throwing them away."
Bruce Wayne: "Then why steal them?"
Alfred Pennyworth: "Because he thought it was good sport. Because some men aren't looking for anything logical, like money. They can't be bought, bullied, reasoned or negotiated with. Some men just want to watch the world burn."

— The Dark Knight

I have argued elsewhere at length that the bulk of commentators and regulators confronting the Panic of 2008 and its aftermath put far too much emphasis on the supposed causal effect misaligned compensation incentives had on these events. While these no doubt added to the problem in some instances, for the most part the focus on banker pay is poorly judged. Some of this error can be laid at the foot of natural envy, but some of it can be attributed to a fundamental misreading and simplification of the investment banker's character.

People continue to be excessively worried about investment bankers who are greedy, grasping, and covetous. Bankers who think of nothing but money. Bankers who are just like Joe and Ethel Sixpack, only richer, more ruthless, and less constrained by conscience.

But these are not the bankers we need to worry about. These bankers—who, make no mistake, do indeed exist—can be bought. If we cannot chase them out of too-big-to-fail banks where they make stupid or greedy decisions that harm our society and economy, we can encourage them to repay our bailouts to get out from under our yoke. These bankers are easy. We understand their greed and motivation, because it is essentially logical, and most of us share the same motivation to some degree, if only in paler, more attenuated form. These bankers are no challenge whatsoever.

But anyone who has spent real time in the trenches of investment banking knows that this description does not come close to exhausting the character of its practitioners. There are people in the industry who, when you get right down to it, have no real interest in money. People who couldn't give a flying fuck in a rolling donut whether they make $3 million, or $10 million, or $100 million a year, as long as they make more than the next guy. People who look at income, and bonuses, and aggregate net worth as a scorecard in the great game of life. People who want to make the most.

Or, those rare birds who do the business because they love it, because it's there, and because they can. People like a mentor I used to have who never should have worked a day in his adult life, according to any normal person's calculus. Someone who married into vast wealth, but who spent thirty years in sweltering Boardrooms, shitty motel rooms, and executive committee meetings which would make a dockside knife fight in Calcutta look like afternoon tea with the Queen of England because he loved the work.

Finally, do not forget the psychopaths.

Do you really think some bureaucrat's compensation limits are going to effectively constrain such people? Do you really think they will care? (I grant you, most of their wives will care. But that is what mistresses and prenups are for.) They will bitch and complain, but at the end of the day they will commiserate with compatriots over a 20-year single malt and a Cuban cigar and say "Fuck it." After all, most of these veterans were happy making 50%, 60%, or even 70% less money doing the same damn thing twenty years ago before Alan Greenspan turned on the liquidity spigot.

At best, Kenneth Feinberg's compensation rules for the seven TARP firms and the Fed's proposed guidelines on pay for the entire industry might chase out the opportunistic rabble who poured into the industry over the last decade to take advantage of its well-advertised pay and growing social prestige. People who, in other times, would and have flocked to law, or medicine, or technology startups and who, like rats off a sinking ship, will swarm onto another platform as soon as Michael Porter, or Seth Godin, or Sergey Brin identifies it for them.

Goddamn sheep. Extraordinarily well paid, well-dressed, and well-coiffed sheep, but sheep nonetheless.

Good riddance to them, I say. Let them go "add value" to some other poor misbegotten segment of society. Just watch your wallet when they show up on your doorstep.

* * *

But once these johhny-come-latelies leave, who will remain? I'll tell you who: people against whom your pitiful, transparent little compensation levers will have no effect whatsoever. People who do the business because they love it, because they are good at it, and because there are only so many slots open in the natural ecosystem for pinnacle predators, and the Great White Sharks and Polar Bears got most of them first.

People who will work with their counterparts in law, accounting, taxation, and Corporate America to extend the edge of the envelope and push the legal and regulatory barriers as far as they can go, because that is what they are paid to do and because they can. Because they are smart enough, and driven enough, and because they love the game. Because they take pride in their work. Just like any goddamn pipefitter.

These people are dangerous because they are smarter than you, because they are smarter than any regulator likely to be sent to control them, and because they hold in their hands the map and the controls to the vast and intricate system of pipes and valves which undergirds the global economy. Give them any reasonable set of legal and regulatory constraints—more stringent than the recent past, by all means, I implore you—and they will happily adapt and innovate around them in the future. Push them, and box them in, and reinstate Glass-Steagall if you must: they will grumble, but they will get over it.

But can you imagine what would happen if you pressed them too far? If you tried to turn the entire financial industry into a bunch of unionized, rule-bound clerks? These are personalities who do not go gentle into that good night. All you would need would be for one or two of them to decide they would rather watch the world burn than crawl into a hole.

And believe you me, you do not have enough water to put out that fire.

Not that I'm making threats, or anything. I am a reasonable man.

© 2009 The Epicurean Dealmaker. All rights reserved.