On top of its disturbingly myopic reading of the subprime contagion, the Fed now thinks handing out billions more in loans to the players that created the crisis is really just a private affair. Washington, we have a problem.
When financial institutions were riding a wave of fee-generated euphoria, creating their toxic sludge of subprime investment vehicles, the U.S. Federal Reserve registered few, if any, concerns. The Fed was happy to buy into the idea that the banks and investment houses were headed by shrewd successors to the J.P. Morgan mantel who had discovered a new world of financial instruments that were producing untold wealth –at least for their creators. Even when things started to unravel, official disquiet was muted. Earlier this year, Fed chairman Ben S. Bernanke told a committee of the U.S. Congress that he didn’t expect the meltdown would spread. (more…)
The precipitous drop in the Dow Jones index on Tuesday because the Fed lowered interest rates by a quarter point, instead of a half, shows the extent of the disease with which Wall Street has become afflicted. It is behaving like a cocaine addict who cannot live without a constant fix, in this case of cheap money. Each time it gets a rate reduction it can only perform for so long before it starts thinking about the next one and soon gets very jittery. If the amount delivered does not meet with the street’s expectations, it goes into a total panic.
The reaction also manifests Wall Street’s other disorder: the need for risk to have little place in the decision making process because credit, at least for a select few, is so plentiful. Lower interest rates provide a way for the big players to load up on debt in order to do a lot of things to take the focus off the subprime fiasco they created. It is worth noting, though Wall Street clearly does not, that it was a fiasco born in a significant fashion by the availability of cheap money thanks to the Greenspan era at the Fed, where risk, it seemed, took a holiday.
Two percent plunges in the stock market should be reserved for cataclysmic disasters and major reversals of economic or political fortune -not a show of pique because interest rates that have been obligingly in decline over the past several months haven’t quite slipped out of sight altogether. It’s time Wall Street had an intervention by some experienced tough love adults to help it get back to reality and stop being hooked on the false euphoria that comes from Fed-dependent cheap money.
The real purpose behind the Bush Administration’s plan is not to help the victims of the subprime turmoil, but rather the perpetrators of the economic crime who unleashed it in the first place.
To justify their out-of-this-world bonuses, the titans of Wall Street and the kings of the home lending business, like Countrywide Financial’s Angelo Mozilo, claimed they were merely being compensated according to the dictates of the market. No mere mortal dare challenge or question the end result where many received $40- or $50- or $100-million paydays. It was the invisible hand that decided. And it was sacred.
But now the results of that invisible hand look more like a rubble of confusion and ruin, at least as they related to the subprime mortgage industry and the unsettling economic blunders created by Wall Street on a global scale. So it is government that is expected to intervene to bring stability to the market’s jittery hand. An ever-receding Fed interest rate has been one response, along with world central bankers flooding the market with cash. One wonders how the same low interest rates, which saw the concept of risk take a very long vacation, will improve over the long run a situation that was created substantially by low interest rates.
Yesterday, President George W. Bush and Secretary of the Treasury Henry M. Paulson Jr., who are generally advocates of the free market when it is more convenient than present circumstances permit, announced a plan that purports to help distressed home owners by bringing lenders and borrowers together to solve problems. Only a fraction of those expected to need help will benefit. A more realistic interpretation of what is at work here is an effort to bring stability to Wall Street’s largest institutions, which are facing giant losses, slumping share value and increasingly nervous clients.
As much as we admire the discipline and innovations a well (and we hope fair) functioning market can produce, the case for the constructive use of government policy and influence in that market is well established. Some argue that FDR did more to save capitalism than all the J.P. Morgans combined. What is galling is that Wall Street and American business are eager to accept the idea when it is in their own narrow interests, such as now, while at other times –and especially at bonus time– government is exhorted to stay out of the market. And don’t think for one moment that the big players do not see a considerable direct benefit in government efforts, supported by Fed accommodations, that help to stabilize the effects of the housing meltdown.
The plan announced yesterday is something in the nature of saving the financial community that created the ticking time bomb of subprime loans and syndications from itself. Offensive as that may be to some, the indignation pales in comparison to the fact that those who created this mess are the ones that have benefited most handsomely from it. The sting of that image is not reduced as some, like Merrill Lynch’s Stanley O’Neal, are seen making a fast exit with piles of money to ease their pain. We set out some of our views on the public stake in CEO compensation as it relates to the subprime meltdown in a recent guest column on the corporate governance blog of Harvard Law School.
What might have restored confidence in the moral underpinnings of this system–without which it cannot continue to function– would have been a statement from President Bush or Secretary Paulson that they have also worked out a plan whereby a substantial part of the compensation and bonuses that were derived from these toxic loan concoctions would be given back and placed into a fund to assist distressed homeowners. The symbolism would have been significant and a major boost to the idea that fairness, too, is a commodity that the marketplace values.
That did not happen because the real purpose behind the Administration’s plan is not to help the victims of the subprime turmoil, but rather the perpetrators of the economic crime who unleashed it in the first place.
The Cisco move is just the latest example of companies that put too much time and creativity into dreaming up elaborate financial schemes —schemes which, by some remarkable consistency of nature, always wind up adding to the CEO’s pay package.
I am not a big fan of company stock repurchasing. While I am the first to admit that today’s global corporations are complex institutions on almost every level, including financial, I think stock buybacks often drain potentially valuable funds that could be put to better use in research or in adding value to the traditional business chain, and serve to benefit insiders and the investment bankers arranging the deals more than anyone. One of the pluses that private equity advocates often talk about is that corporate funds for unlisted companies don’t need to be diverted into exercises like buying back stock because the price can’t be raised any other way. I don’t usually align myself with the private equity crowd, but on this point they seem to make sense.
And so it was with a somewhat jaded eye that I read of Cisco Systems’ plans to add billions to its already lavishly endowed program to buy back its stock. It just kicked in $10 billion more to an already huge $52 billion pot. And who do you suppose will come off best from the deal? How about Cisco insiders, like CEO John T. Chambers, who typically receives most of his compensation in the form of stock options. The company’s 2007 proxy circular notes:
During fiscal 2007, as part of the on-going companywide grant, the Compensation Committee granted Mr. Chambers an option to purchase up to 1,300,000 shares of Cisco common stock at an exercise price of $23.01 per share…. The option grant places a significant portion of Mr. Chambers’ total compensation at risk, since the option grant delivers a return only if Cisco’s share price appreciates over the option’s exercisable term.
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In September 2007, the Compensation Committee also made an annual stock option grant to Mr. Chambers to purchase up to 900,000 shares of Common Stock, and the right to receive a target of 200,000 future restricted stock units based on Cisco’s financial performance in fiscal 2008.
So we have a situation at Cisco where the CEO, who also chairs its board, stands to gain significantly from a buy-up of stock that is being paid for with shareholder money from a company where the CEO is the chief decider on how it is used. An interesting moving around of the financial shells on the boardroom table, don’t you think?
The old fashioned idea of issuing a dividend —one that worked very well in the era of the Fedora CEO, as I have affectionately called them— is just too passé for Cisco. They don’t do dividends. I guess that would be too much like something that could benefit all investors in equal proportion to the shares they actually own —not the shares that might be bought on a discounted basis by a lucky CEO if things pick up.
The Cisco move is just the latest example of companies that put too much time and creativity into dreaming up elaborate financial schemes —schemes which, by some remarkable consistency of nature, always wind up adding to the CEO’s pay package— when the time and creativity and investment banking costs could instead be used for purposes of product innovation, employee education and in finding better and more efficient ways to add value to the customer.
There was one of those syrupy pieces in The New York Times business section the other day that I can read only so long before an overdose of sugar in the blood forces me to look for the antidote. This time, it was about the wonder and magic of Goldman Sachs, which, they say for decades, “has churned out a golden list of corporate executives and statesmen, wealthy financiers and nonprofit managers.” Maybe so. But the idea that these are supermen who glide above the earth and only touch the ground as a courtesy to convention is a bit much.
Robert Rubin was no better a secretary of treasury than a lot of his predecessors who had no financial background at all. And his return to Wall Street so soon after that stint raised a few eyebrows. It’s really not supposed to be that seamless a transition. Governor John Corzine spent more than anyone in history to win a seat in the U.S. senate, which he gave up after one term and a rather lackluster one at that. He then threw record more wads at the New Jersey governorship. He seems best known today as the governor who forgot to wear his seat belt and just narrowly escaped death. To me, he always seemed to be a man who had a problem articulating what this great drive to serve in public life was all about. Current Treasury Secretary Henry Paulson is spending a good deal of his time contradicting what he said earlier, like how the subprime mortgage meltdown would not affect the broader economy. All his Goldman experience didn’t help him see that one coming, or the falling icon of market capitalism –the American dollar. It can be painful to listen to him in an unscripted moment, too. Then there is Joshua Bolten, another Goldman alumnus, who currently is chief of staff to an unpopular president now facing a domestic economic downturn to cap off what is probably the greatest foreign policy reversal in American history: Iraq in turmoil, Iran going nuclear, Pakistan teetering on the edge and Russia retreating to Soviet-style belligerence.
Goldman Sachs doesn’t need exaggeration and myth-making. It does well at its job and there are many institutional factors that make that possible. It does not, however, produce genius that is immediately transferable to other forms of economic and political leadership. Quite possibly, we are dealing with human beings after all; smart fellows, to be sure, but they put their pants on one leg at a time, too. It is bad enough when they forget that basic fact. It is a sure road to folly when the public forgets it.
Merck pays out nearly $5 billion to settle Vioxx claims, Yahoo incurs the wrath of legislators, and another poisoned child’s toy made in China is recalled. The growing credit market implosion threatens recession. These are the predictable consequences of the subprime leadership and ethics in our boardrooms and in our institutions of government over the past number of years.
The Outrage generally prefers to focus on a single event. This week, however, there was a common theme among several events. There was the Merck $4.85 billion settlement over its Vioxx debacle. Next, there was the appearance of Yahoo CEO Jerry Yang before the U.S. House Foreign Affairs Committee to answer questions about his company’s turning over information that led to the arrest and imprisonment of Shi Tao, a Chinese journalist and political activist.
The week ended with revelations that yet another toy made in China contained toxic chemicals and with officials ordering that Aqua Dots, distributed in North America by Toronto-based Spin Master, recall more than four million units.
What these incidents share is a betrayal on the part of the companies and leaders who could have done better, but failed miserably in their ethical performance. Merck is one of the world’s leading drug companies, yet it continued to market this highly profitable product even after company officials were warned by their own medical researchers of serious problems.
The company pulled Vioxx off the market in 2004, citing increased cardiac risk. But, as the Wall Street Journal reported at the time, Merck had earlier indications of serious problems. A March 2000 internal email shows company research chief Edward Scolnick warning that cardiovascular events “are clearly there.” Still, Merck continued to deny any link between heart attacks and Vioxx.
Yahoo is a company founded and headed by a brilliant billionaire who one might have thought had enough money and youth to still have a social conscience. But doing business in a multi-billion consumer market headed by a corrupt authoritarian regime was too tempting to resist, it seems. And so it was that Yahoo became an adjunct of the Chinese secret police –spying and snitching on its customers and thereby poisoning a name and a brand that had become known world-wide for its sense of innovation and exploration of the limitless knowledge held in cyberspace.
We don’t know who is really behind this latest toxic threat to our children. And maybe that’s the real problem here. Distant manufacturers operating under opaque regulations and dubious enforcement, vague distributors, off-shore companies and the lure of huge profits all conspire to put health and safety way down the line and out of the mind of any responsible entity. These kinds of incidents have happened too often in recent months to be a mistake. They reflect a cultural and ethical deficit endemic to the way global business is being done with despotic regimes.
Among the factors that are causing a crumbling of the pillars of confidence, the subprime mortgage scandal also figures prominently. Here, once again, the too-clever-by-half characters who concocted these elaborate schemes and got paid a sultan’s treasure for their efforts have turned out to be not quite as clever as they wanted us to think. It is unlikely they will have to repay any of the stratospheric bonuses they were receiving while creating these artifices that, like the dot.com bubble and the Enron-era accounting shenanigans, foolishly attempted to defy the rules of basic economics and common sense as only those infused with the curse of hubris will do.
And the figures touted for their wisdom and vigilance who are supposed to be monitoring the actions of these other bright fellows whom history has shown to have gotten carried away with themselves on more than a few occasions, seem not to have been as wise and as vigilant as advertised. Having underestimated the effects of these toxic credit toys before with assurances that the subprime mortgage defaults would not intrude into the broader economy, one wonders if they are any better prepared for the wider economic crisis that seems to be looming.
There will be many casualties before the full extent of the great unfolding 21st century credit debacle is over. There have already been a few CEOs who are taking a very well paid early retirement. More will follow. Some companies will not survive. The stock market will continue to experience unsettling jolts, like its more than 600 point drop this week. But, unfortunately, it will be the ordinary consumer —not the central bankers or the treasury luminaries or the credit agency raters or the boardroom directors who permitted this fiasco and were blind to its early signs— who will suffer most from the turmoil and set backs that lie ahead. So too will the idea that we can look to the icons at the top to do the right thing because their wealth and privilege bestow on them a higher level of accountability to do the right thing. That moral touchstone seems to have vanished, along with the primacy of the common stakeholder —something that has been a recurring theme at Finlay ON Governance.
These events have been the predictable consequence of what has amounted to decidedly subprime leadership and ethics in our boardrooms and in our institutions of government over the past number of years. They are a harbinger of the further crumbling of the pillars of public confidence and trust, which make them our choice for the Outrage of the Week.
