Without a shot being fired or a ballot being cast, the United States government has been overtaken by an act of socialism on a scale that is as incomprehensible as it is shocking. Now, in addition to being the world’s largest mortgage backer as a result of its takeover of Fannie Mae and Freddie Mac, the U. S. government is the owner of the world’s largest insurance company following yesterday’s seizure of AIG Insurance. The implications of the $85 billion dollar bailout, which brings the tab (so far) for U.S. government rescues and Fed loan facilties related to the current crisis to be in excess of $900 billion, have not even begun to be considered. This much is clear: Financed by the Federal Reserve, whose head, Ben S. Bernanke, mused last year that the subprime credit crisis would not spread to the larger economy; led by Treasury Secretary Henry M. Paulson, Jr., who proclaimed months ago that “We are closer to the end of this problem than we are to the beginning;” and approved by George W. Bush, the most disconnected and unpopular President in modern U.S. history, the judgment of these players inspires little confidence.
American capitalism has abrupty changed course and headed into waters that may prove far more harrowing than the collapse of even a giant insurance company. Resourceful men and women can always find ways to manage disaster wrought by inattentive executives and directors such as those who drove AIG to the point of disaster. They can rarely survive or prevail when fundamental and guiding principles themselves become the object of disregard and abuse.
*Birthplace of Vladimir llyich Ulyanov (Lenin)
What an American civil war, two world wars and the Great Depression could not do has now been achieved by something called the subprime credit crisis, along with the assistance of an overly deferential corporate governance system that was blind to the risks being faced and a Napoleonesque CEO who could not see the disaster that was looming.
Richard S. Fuld, Jr. has always liked to run Lehman Brothers as though it were a one-man show. The way the company’s fortunes are shrinking, it may come to that. Short of a miracle in the form of a last-minute white knight, as of Monday, Lehman -Wall Street’s fourth-largest, and one of its most storied, investment dealers- will in all likelihood face bankruptcy. Frantic weekend-long meetings at New York Federal Reserve headquarters involving top government officials as well as leading Wall Street bankers, and Mr. Fuld, whose teetering firm prompted the emergency Friday detours from the Hamptons, have failed to produce the solution Lehman needs to stay afloat. There is no buyer and no massive infusion of capital. Bankruptcy lawyers have already been called in.
Lehman’s descent into the horror world of overleveraging and sagging confidence, insufficient capital and mounting losses, like that of Bear Stearns before it, must ultimately be seen as a failure in corporate governance. It is the duty of every board to serve as a check on management and to take care that risks to the survival of the institution are scrupulously avoided. As we noted some time ago, all meaningful positions of corporate power and responsibility have been vested in company CEO Richard Fuld. He heads management as well as chairs the board. He also chairs the executive committee, whose only other member is John D. Macomber, now 81 years old. Mr. Fuld, whom Forbes reports received more than $354 million over the past five years, has been the driving force behind the decisions that have brought the company to its plight. It is a fall that might have been arrested by an active and engaged board of directors, except Lehman does not appear to have one. What it has, instead, is a Dick Fuld fan club.
This is a board where, of the 10 independent directors, three are in their seventies and two are in their eighties. The finance and risk committee, chaired by 80-year-old Henry Kaufman, as first revealed by Finlay ON Governance, met only twice in 2007 and in early 2008 even when risk was becoming the 800-pound gorilla in every Wall Street boardroom. The idea that some of Mr. Fuld’s power should be shared more broadly or that an independent director should head the board is not something these directors have tackled.
After other companies have been faced with multi-billion dollar losses -Merrill Lynch, Citigroup, AIG and UBS jump to mind- the CEO has been replaced. At Lehman, it appears that the board and Mr. Fuld are determined that the fate of the company and its driving force will be inextricably intertwined, perhaps forgetting how that approach ended for Captain E.J. Smith and the ill-starred Titanic. Not even Mr. Fuld’s now famously shortsighted proclamation, made several billion dollars in losses ago, that “the worst of the impact of the financial markets is behind us,” was enough to prompt the ire of his hand-picked directors.
For at least half a year, there have been signs, and rumors, of distress at Lehman. There has also been evidence that management has been in a state of denial, as the conference call remarks last June by its former CFO, Erin Callan, revealed: “We stand extremely well capitalized to take advantage of these new opportunities. From a risk management perspective, we continued to operate in our disciplined manner we’re known for.”
Over the ensuing weeks, losses and write-downs mounted. Lehman’s stock has drifted, and at times plunged, since February. But there is little evidence that the board itself became seized of the issue. No changes in the governance regime were announced. No special committee of independent directors was formed. The obvious need for capital infusion, which the company frequently denied, was never answered adequately. At one point, as recorded here previously, the company was even taking on more shaky investments in the form of Alt A loans.
The market has been giving the board and management its unequivocal and unvarnished reaction for some time. But there was scant evidence that Lehman’s boardroom really grasped the depth of the market’s dissatisfaction, or the untenability of its own financial condition, until last week, when the company’s .share price fell even below the level of Bear Stearns after its collapse and Fed-led rescue. On Friday, the stock closed at $3.65. Only seven months ago, it stood at $65.00.
It is the end of the Lehman era. What an American civil war, two world wars and the Great Depression could not do has now been achieved by something called the subprime credit crisis. It was ably assisted, or perhaps prompted, by a widespread attack of corporate amnesia regarding the dangers of treating risk without the respect it deserves and the failings of boards that slumbered while CEOs saw only the upside of deals and the compensation rewards they would bring and never the other part of the intractable law of gravity.
As far as power and accountability are concerned, there has been really only one man at Lehman Brothers. That’s about the way it will wind up when the lights are turned out, the sign comes down and one of Wall Street’s longest running chapters comes to an end. It is another sad lesson in the dangers of hubris, blindness to the realities of risk and the delusion of invincible status that too long marked the direction and culture of this fabled institution.
Washington’ s takeover of Fannie Mae and Freddie Mac gained the quick support of Wall Street, who never meets a bailout it doesn’t like, and the thanks of Beijing, whose playbook it seems to be borrowing.
Months after U.S. Treasury Secretary Henry M. Paulson, Jr. reassured the world ‘s markets that “We are closer to the end of this problem than we are to the beginning,” the Bush administration this week seized mortgage giants Fannie Mae and Freddie Mac. With that single act, the United States -long-reputed bastion of free enterprise, and led by the first MBA-trained president ever- undertook the largest nationalization of private enterprise in modern history. It was by far the most striking culmination, at least to date, of the folly, hubris and Titanic misjudgment that has seen Wall Street, boards and regulators take a holiday from risk and reality that can now be measured in trillions of dollars in write-downs, lost shareholder value and the worst economic crisis since the Great Depression.
Like the government-sponsored Bear Stearns rescue that preceded it, this, too, is a bailout that has the fingerprints of Wall Street all over it. Morgan Stanley played a pivotal role in advising Mr. Paulson on how the deal would be orchestrated. In fact, all of the government’s recent interventions have been done in consultation with Wall Street’s biggest firms.
With the stroke of a pen, the decision to place the strangely named pair into a “conservatorship” removes key private sector competitors from the mortgage business that was so lucrative to Wall Street’s top banks and institutions, while at the same time ensuring a steady flow of mortgage funds into the market. Wall Street got what it wanted again, and showed its gratitude by the Dow soaring more than 300 points in the first few minutes of trading after the decision was announced. And the U.S. government is now the biggest mortgage backer in the world.
Reasonable men and women will differ as to whether the bailout of these institutions was wise or not. What cannot be disputed is that it was the result of one of the most costly governance and oversight failures ever.
What brought the U.S government to this remarkable place in the history of its free enterprise system? How was it possible that these two firms were permitted to play such a pivotal role in the economy that their stake in the mortgage market was actually measured in the trillions? How could regulators and boards of directors have failed to such an extent that this mother of all bailouts became necessary?
I doubt that there will be much of an appetite to pursue these questions, which is exactly why, in a culture where accountability and good governance always took second place to short-term greed and self-interest -and that was on a good day- such a calamity happened in the first place.
Over time, investors, investment bankers and executives became incredibly wealthy from Fannie and Freddie. The two CEOs of these firms made more than $30 million last year alone. The financial rewards from these institutions were viewed as the legitimate fruits of a fabled market-driven free enterprise system which, it is claimed, operates best when government stays out of the picture. Naturally, these rewards were privatized. Now that the jig is up, it is claimed by many, including a deafening chorus on Wall Street just fresh from its long running show where it was clamoring for ever lower interest rates from the Fed, that government cash is necessary to clean up the mess and stabilize the market. The losses, which already are counted in the billions, will be socialized. And thanks for thinking about Adam Smith.
The earth did not exactly shake from the howls of outrage heard among defenders of free market capitalism when the takeovers were announced, or from the College of Wall Street cardinals where the vice of hypocrisy rarely evokes the specter of shame. And it is the idea that Wall Street winds up making money from either success or failure, that free enterprise or government bailout is just fine with this crowd as long as the money keeps rolling in, that is the most galling.
It is always a measure of the fundamental strengths of any system of government or economics that the spires of its principles are able to withstand the gales of expediency. Looking at how happily the market embraced this latest government intervention, which occurred on a draconian scale heretofore typically associated with South American dictatorships, the toppled ruins on Wall Street, and in those other places where principles are expected to matter, are not a pretty sight.
The Alice in Wonderland world into which U.S. capitalism has descended, where profits were based on flaky business models, indecipherable investment vehicles and assets held together by thin air, has long had its antecedents in a similarly dysfunctional system of CEO pay. This, too, is a world diverged from reality and common sense, where monster-size bonuses often had nothing whatever to do with performance or outcomes and where fortunes were regularly awarded by boards on the basis of shoddy results, if not outright failure. Is it at all surprising that it was this same system that tempted CEOs to misjudge the prospects of risk and to take actions that were based on how next year’s bonuses would be affected rather than what was in the long-term interests of investors. It is not that far a stretch from a boardroom culture where bonuses were routinely awarded even for poor performance to one that would see a pandemic creation of investment vehicles that proved to be empty in terms of value and risk consideration.
Criminal fraud at the level of Hollinger or Enron, or misfeasance such as was found at Fannie Mae when previous management cooked the books in order to push up their own pay, may not abound throughout corporate America. But the seeds of the folly that is at the center of CEO pay and the disaster it so often heralds may well be viewed by history as having been synonymous with the disconnection of value, values and meaningful governance/oversight that has brought the economy and the American business system to this perilous point in time.
And the price tag for all of the government’s actions over the past year -the Bear Stearns rescue scam (as noted on these pages before, the Fed never really took on the $29 billon loan; it bought the collateral outright), its apparently never closing and endlessly accommodating discount window, and now this latest Wall Street bailout? Nobody seems to know. And few appear to be asking even during a presidential election year. The costs seem likely just to be pushed off in one form or other, whether in the guise of soaring inflation, galloping deficits, higher interest rates or a weaker dollar, to a future generation. The rewards of the government’s latest intrusive efforts will be privatized once more. Their risks and the costs that lie ahead will be socialized again.
One more point of interest: the Fannie and Freddie move was met with approval by countries which hold substantial instruments of U.S. debt, including significant amounts of paper obligations on the part of these financial institutions. China, a totalitarian state that professes communism but increasingly practices capitalism, especially praised the move by the United States, a land which trumpets capitalism but increasingly seems to practice the fine art of socialism.
In the distorted, upside down world that America’s leaders, financial wizards, regulators and directors have created, what pleases Beijing most seems only fitting.
A brief essay on the subprime credit consequences when CEOs fail to lead, directors fail to direct and regulators fail to regulate
It began as a term that few had even heard of barely 18 months ago and most experts dismissed as an insignificant blip in a fundamentally robust economy. But yesterday, George W. Bush signed into law the most extensive -and expensive- free market repair bill since the Great Depression, thanks to what we have come to know as the subprime mortgage meltdown. The legislation marks another ironic milestone for this Republican, MBA-trained apostle of the private enterprise system. In 2002, he put his signature to the Sarbanes-Oxley Act, which, in the wake of Enron and numerous more accounting-related corporate frauds, also brought the power of the federal government closer to the boardroom than at any time since the 1930s.
The Housing and Economic Recovery Act of 2008, which also serves as a bailout for Fannie Mae and Freddie Mac, addresses precisely the flaws and failures which successive business leaders and government officials said would never occur in the modern era. Depression-time failures, runs on banks, and the collapse of huge financial institutions that were typical of the 1930s, they said, were a thing of the past. But just as those events were a product of human shortcomings and unbridled greed, so too is the present day crisis the result of CEOs whose bonus-obsessed lack of vision made them unsuited to lead, directors whose risk-oblivious nature made them incapable of directing and regulators whose focus on the battles of the past made them incapable of regulating. Exhibit One in this regard is the more than $30 million in compensation the CEOs of Fannie Mae and Freddie Mac, the struggling mortgage giants that prompted the recent government bailout, were awarded by the boards of those companies during the past year when the seeds of their horrific losses were being sewn.
Only a few months ago, the priority of the new treasury secretary, Henry M. Paulson Jr., and the Bush administration was to roll back enforcement under Sarbanes-Oxley, which many in the business community claimed was hampering American competitiveness. Blue ribbon committees composed of impressive and accomplished corporate men and women were formed to look at ways of blunting the regulation of business. All the time they were focused on this objective, the time bomb of the subprime credit disaster was ticking away. But the business world, and Wall Street in particular, disposed typically to hearing only the siren song of great bonuses and increased fees, did not heed the tick, tick, tick of impending calamity that was of their own making. No alarm bells sounded, at least on Wall Street, about the overly complex financial instruments that were being created, or the possibility that the ever- faster moving gravy train would meet with an abrupt generational derailment. So much has the landscape shifted that the man from Wall Street who was brought in to loosen the reins of corporate regulation has now become the architect of the most sweeping government intervention since FDR. And his boss, the first MBA graduate in presidential history, will have presided over the most staggering run up of the national debt in U.S. history.
Republicans and other traditional advocates of government restraint have fallen so far from their Milton Friedman, laissez-faire pedestals that they have given Secretary Paulson what amounts to a blank check for unlimited backing of these government-sponsored enterprises whose names sound like something out of a 1920s Gershwin musical. It is a hard swing from earlier days, when Fed chairman Ben S. Bernanke testified before Congress that he didn’t expect the credit crisis would spread to other parts of the economy. Just days before the meltdown at Fannie and Freddie, Henry Paulson was predicting “we are closer to the end of this problem than we are to the beginning.”
Much of the litter prompting the actions of the Bush clean-up crew came about through Wall Street’s obsession with bigger bonuses and more fees, and insufficient attention as to how they were achieved. A good part of the world, though happily we did not count ourselves among this group, really believed for a while that some of these fellows actually deserved and earned their bonuses, which, in many cases, amounted to $40 million, $50 million or even more than $100 million in a single year. We have long contended on the subject of excessive CEO pay that it is well to remember that its recipients are endowed with no superhuman traits.
Unfortunately, too many in the boardroom and on the stock exchange floor seemed to think the more a CEO received, the more he was able to jump over tall buildings in a single bound. But as Merrill Lynch’s Stanley O’Neal and Citigroup’s Charles O. Prince schlepped out of their offices for the last time after presiding over record multi-billion-dollar losses, they seemed remarkably fallible -even with the millions in bonuses and severance they carted away in the process. Also gone with the toppling of CEO after CEO who failed to live up to their Marvel Action Comics billing is the idea that their compensation is the business just of shareholders. Look at the casualties of home ownership and the record foreclosures that are sweeping America, a trend that can be traced to the creation of flimsy investment vehicles designed only for their quick fee and bonus producing content for Wall Street and mortgage lenders, and you see how much Main Street America has at stake in the compensation inducements that crony boards hand out to their country club CEO buddies.
It was a nice party while it lasted. Shareholders did well. Directors commanded ever higher fees for their slumbering counsel in what was an impressive reprise of their roles during the Enron era scandals and long before, during another time of Wall Street excess culminating in the market crash of 1929. Top management became elevated to god-like status with remuneration packages commensurate with that standing.
The shell game continues. Just this week, Merrill Lynch announced that it was selling off $6.7 billion in what many regard as toxic mortgage investments. The problem is, only two weeks ago those assets were valued by the company at $11.1 billion. The company’s write-downs -so far- we are told exceed some $40 billion. But to be honest, whenever numbers climb over the $25 billion mark we generally have to reach for the oxygen mask and lose track of the details in the process. Another problem: Merrill has to loan the buyer most of the money to take over the sludge. It’s a little like the Fed buying up $29 billion in feeble Bear Stearns assets to help out with the JPMorgan Chase deal. Except they called it a loan at the time. Nobody is calling it that now. Thinking about Fannie Mae, one is reminded of the scandal there when government investigators found top management fiddled with the books in order to prop up their bonuses. In 2006, U.S. regulators filed more than 100 civil charges against former CEO Franklin Raines and other officials of the company, accusing them of manipulating earnings to maximize their bonuses. It was among many ethical lapses that will be uncovered during the heady times of recent years.
Now the party is over. And, as they had to in the 1930s, it is the taxpayer who must pick up the tab for the broken furniture and all the other casualties of the splurge of over-indulgence that marked what we have called before the Modern Gilded Era. When incomes in America begin to approach the level of disparity which existed in the 1920s, as they did in the past couple of years, perhaps it is a warning sign that reason and judgment have reached a dangerous state of undersupply in the economy, and in society as well.
With the stroke of a pen this week, America’s debt will have been increased by nearly a trillion dollars; its deficit now the greatest in the country’s history. Many of the owners of the corporations who gambled and lost on these ill-conceived schemes will be bailed out. Some homeowners may benefit from the legislation, and a higher standard of regulation -which should not have required a Titanic-like catastrophe before its need became obvious, will prove beneficial in the future. But the greatest beneficiary is Wall Street, which has consistently held the view that there is no better system than modern free market capitalism, except, of course, modern government enterprise when it shows up with its purse open. For there is no more beautiful sight to the errant Wall Streeter than when Mr. and Mrs. America come to junior’s rescue after he wraps the BMW of self-aggrandizement around the lamppost of ever looming, but never fully contemplated, reality.
The point of all of this is not to disparage capitalism, especially the idea of responsible capitalism -a principle we have long advocated and believe is fundamental to the innovation, creativity and advancement of a free and prosperous society. But it is to further illustrate that capitalism is merely an engine, not an Adam Smith-invented autopilot. How well it operates, what value it creates, what havoc it wreaks are dependent upon the skills, vision and integrity of the men and women to whom it is entrusted.
Many of the wrong people were entrusted with it this time. The price has been steep. The damage to the reputation of this unique economic system has been considerable. The consequences of insatiable greed, and of governance and regulatory systems that failed to check it, have been historic.
It might be hoped that for the hundreds of billions of dollars American taxpayers are shelling out for the economic debacle which in some respects rivals the Great Depression, they also will have paid for the education of future actors on Wall Street, in the boardroom and in the regulatory halls of government, who will have learned something of the vice of unrestrained excess, something of the virtue of a financial system more grounded in both value and values and something of the sacred trust that is bestowed when society loans power and opportunity to those whom it allows to lead, direct and regulate.
It rather neatly illustrates the farce that CEO pay has largely become when Lehman Brothers chief Richard S. Fuld, Jr. announces that he will decline a bonus this year. The board compensation committee has not yet met to determine if one would even be offered to him. But that probably is just a formality because it is Mr. Fuld who is really calling the shots here in his various capacities as CEO, chairman of the board and head of the executive committee.
Of course, eschewing a bonus in a company that just posted a staggering $2.8 billion dollars loss for the second quarter is a little like the customer who breaks a Limoges vase at Tiffany and tells the clerk not to worry about the gift wrapping service. It’s hard to see why any credit is due in making such a statement. A more meaningful gesture would be to give back some of last year’s $40 million bonus that was awarded when many of Lehman’s flawed, and horrifically costly, decisions were being made. But because it would actually carry some actual sacrifice, and show genuine leadership that is sorely missing from Wall Street in recent years, Mr. Fuld will not offer to do that.
It is another example of where CEOs have gotten so far offside both reality and perception. It is that reality and perception that is today, perhaps more than Mr. Fuld, shaping the future and direction of Lehman Brothers.
A focus on shortcomings in the boardroom and fixing a broken corporate governance model should be the next move.
In the wake of the striking and surprising losses at Lehman Brothers, we noted on Tuesday:
It is traditional to ask why the CEO, and perhaps other top managers who were responsible for these decisions, are still at their desks. Many at other companies have been booted out. CEOs at Merrill Lynch, Citigroup and UBS come to mind. Accountability at Lehman seems to have no real consequence or manifestation.
The ousting of company President and COO Joseph Gregory and CFO Erin Callan, announced today, is a good start but is hardly an acceptable conclusion to the changes needed. Now the focus should be on Lehman’s shortcomings in the boardroom and fixing a broken corporate governance model.
The boardroom needs new blood. Of the investment bank’s 10 independent directors, three are in their seventies and two are in their eighties. The executive committee, which consists of CEO and board chairman Richard S. Fuld, Jr. and 80-year-old independent director John D. Macomber, should be shelved. The finance and risk committee, chaired by 80-year-old Henry Kaufman, should get active. As first revealed by Finlay ON Governance, this committee met only twice in 2007 and in early 2008 even when risk was becoming the 800-pound gorilla in everybody’s Wall Street boardroom.
As long as the CEO is permitted to head both management and the board, allowing Mr. Fuld to effectively report to himself, it is doubtful that Lehman will make the changes it needs to ensure the discipline of accountability that is essential to the survival and success of any business today.
