Plutocracy is about the Dark Side ruling, about a few people nasty enough
to think that greed, their greed, is the best light there is. ...
Besides, the plutocracy used the crisis of 2008 as rocket scientists make space probes,
fall into a planet gravitational field to grab further energy, and go further, faster.
The financial pirates are [thus] more powerful than ever.
They have stopped lending to the real economy.
Why? Because they do not need it to fake profits:
they have the alternate universe of financial derivatives, in which they can simulate profitability.
Patrice Ayme, NYT 8/12/11, comment #11

Private, national & common wealth in the post-socialism/capitalism era
Bewildered by what's been happening, both nationally and globally, in the wake of the fall of the Berlin Wall?
I.e. where the unwittingly weakened nation-state - formerly a bulwark against plain-levelling & globalization -
no longer tempers the social, economic & other pitfalls foreseen by Marx, Gramsci, Minsky, McCulley,etc.
Where - as the Laffer & Rider Curves illustrate in the tax & the social fields - excessive poor/rich gradients
upset the social fabric, wash away fertility factors with uncontrolled erosive powers & contribute to famine.
Where indeed, as Patrick Martin pointed out, monopolistic capitalism and the associated reckless greed
are no longer kept in check by Adam Smith' invisible hand, i.e. by the balance of contradictory interests.
And where the capacity for self-correction is increasingly inhibited by loss of freedom, mooring & orientation
which led to market frenzies & false alpha birds feeding on hype & bubbles, reminiscent of the Roaring 20s.
IMF & FATF estimate black funds (drugs, tax evasion etc) to be 2-5% of world's GDP (2006: $960-2400bn).
An IMF Report indicates these funds to be increasingly chased under anti-terrorism & ever flimsier pretexts.
Courtesy by the IV Reich's Secret Service, the world has indeed been made hostage of ill-considered rules
which impede more legitimate business than crime. For big time money laundering, the US Treasury set the
standard in 2001 with its 31% confiscatory backup withholding tax on unidentified investors in US securities,
turning foreign bankers from trustees of clients into IRS agents (qualified intermediaries) subject to US laws.
Private equity & hedge funds thus found a government-sponsored access to black funds, while the latters'
entry into subprime markets was also eased by the Internet. Results: predatory lending & systemic risks.
Society's organization needs re-thinking with Plato, G.Duttweiler, M,Yunus, J.M.Arizmendiarrieta etc.
For man's evolution may only be stressed by technological leaps but not accelerated beyond natural limits.
Return on investment rates above productivity gains/organic growth are not sustainable, predatory & usuric.
If driven by managers, lawyers & funds on the back of other stakeholders, M&As are thus Ponzi schemes
where shareholder value adepts can maraud with stacked Monopoly cards, helped by micro-economic laws.
Like compulsory social insurance systems whose doom is delayed or obscured only by inflation, war, etc.
And where the cunniest operators are state-supported by myopic magistrates hood-winked into fiscal deals.
Gary J. Aguirre's US Senate testimony details fraud & market mechanics which were at work before 1929,
e.g. Ponzi structures, unregulated pools of money, siphoning from unsuspecting mutual fund investors, and
abuse-prone market dominance: hedge funds' $1.5 trillion drive half of the $28 trillion NYSE's daily trading.
Tongue-in-cheek, Warren Buffet famously opined: "derivatives are financial weapons of mass destruction";
yet, under increasing performance & compliance pressures, some bankers still see a future in fee hunting.
Society wised up against churning of accounts by undelicate trustees, but not yet against macro-parasitism
which feasts on ignorance, sucks & devours a firm's life-preserving substance, & weakens society's pillars.
Which turns economic rat races into societal tailspins with early burn-outs & senior citizens being wasted,
& instills values causing youth to be educated out of sync, resulting in drug, violence & €1000 generations.
With profit-driven quarterly thinking & cost-cuttings also eroding due infrastructure maintenance & renewal,
& democracy's promises ridiculed by Fatf, EU & UN bureaucratic lawmaking as if Berlin Wall fell eastwards.
So why not thinking things over & Revisiting Das Kapital while some dance on the Titanic”?   Iconoclast

Buccaneers on the Titanic
courtesy by: Swiss Investors Protection Association - url: ¦
.../brink.htm ¦ .../capitalism.html ¦ .../1929.htm ¦ .../barbarians.htm ¦ .../bubbles.htm ¦ .../caisses.htm ¦ .../hedge.htm ¦ .../goldies.htm
.../M3.htm ¦ .../porkbellies.htm ¦ .../swissbanks.htm ¦ .../costbenefit.htm ¦ .../oecdmandate.htm ¦ .../GAFI.htm ¦ .../crime.htm
tks 4 notification of errors, comments & suggestions: +4122-7400362 ¦

The U.S. Gross National Debt
globally floating IOUs tied to US housing: $7.5 trillion
hedge-fund asset growth 2001-06: $0.539 to 1.43 trillion
IRS-protected & FATF-targeted black funds: $1 to 2.4 trillion
M&A totalling in 2006: $3.8 trillion ¦ billion dollar bonus gurus
paycheck devide: food for next revolution

Private equity: Locusts and asset strippers or dynamic saviours of clapped-out companies?
Current players  ¦  Past negative headline makers: after a bout with the law, where are they now?
1929 crash mechanism spinning again? ¦ TV's Big Brother Ponzi scam ¦ Gold matters ¦ The €1000 Generation
Le capitalisme est en train de s'autodétruire ¦ Le nouvel âge du capitalisme: Bulles, krachs et rebonds
Switzerland. tax eldorado for failed golden boys, greed gurus, hedge fund managers & other apprentice-sorcerers?

20.Nov 12    SNB und Finma ohne genaue Kenntnisse: Schwer fassbare Schattenbanken, NZZ, gho./ti
20.Nov 12    Financial Stability Board: Die Schattenbanken im Visier, NZZ, Martin Lanz
20.Nov 12   Blackrock: Die grösste Schattenbank der Welt, Tages-Anzeiger, lü
20. Nov 12   Schattenbanken sind unverzichtbar fürs System, finews, Martin Hess
19.Nov 12   Unbeaufsichtigte Finanzgeschäfte:Schattenbanken sind größer als vor der Finanzkrise, Süddeutsche Zeitung
19.Nov 12   Maurice Pedergnana: «Schattenbanken sind ein Schönwettersystem», Tages-Anzeiger, Simon Schmid
19. Nov 12   Schattenbanken-System wächst bedrohlich, finews
18 Nov 12   Global Shadow Banking Monitoring Report 2012, Financial Stability Board FSB
8.Nov 12   Wer gilt denn überhaupt als Schattenbank?, finews, Martin Hess
2.Okt 12   Susanne Schmidt: "Banker meinen, der liebe Gott hätte sie zum auserwählten Volk erklärt", Süddeutsche Zeitung. Oliver Das Gupta et al.
3 Aug 12   J.P. Morgan 'Whale' Was Prodded; Bank's Probe Concludes,, Gregory Zuckerman et al.
3 Aug 12   With Knight Wounded, Traders Ask if Speed Kills,, Tom Lauricella et al.
2 Aug 12   Knight Capital Group seeks to reassure
29.Jul 12   Libor-Skandal: IIn Verruf geratene Ex-Banker mit Steueranreizen nach Genf gelockt, NZZ, Sebastian Bräuer
2.Juli 12   Gezinkte Karten, manipuliertes Roulette, Tages-Anzeiger, Philipp Löpfe, Kommentare
26 May 12   JPMorgan blues: The Hunch, the Pounce and the Kill, NYT, AZAM AHMED
20 May 12   Heist of the century: Wall Street's role in the financial crisis, Guardian, Charles Ferguson
12 May 11    Preet Bharara: U.S. Attorney Sends a Message to Wall Street, NYT, By BENJAMIN WEISER et al.
22 Dec 10   How Merrill Lynch Traders Helped Blow Up Their Firm,, Jake Bernstein et al., comments
24 nov 09   Des rumeurs de bulle agitent le marché de l’aluminium, Le Temps, Pierre-Alexandre Sallier
23 nov 09   Sécurité alimentaire: Marchés agricoles, le grand brouillage, Le Temps, Pierre-Alexandre Sallier
22 Nov 09   Mirosoft, Hershey and other locusts:My Chocolate Meltdown, NYT, ARTHUR LUBOW
18 Nov 09   SocGen tells clients how to prepare for potential 'global collapse', Telegraph, Ambrose Evans-Pritchard, Comments
11 Nov 09   Goldman bonus'  scandalous origin: $2.5 Trillion global oil scam,, Wallace
11 Aug 09   Unfair at Any Speed - Why success itself is the true target, Traders Magazine,Dan Mathisson, Commentary
6 Aug 09   Despite Bailouts, Business as Usual at Goldman, NYT, JENNY ANDERSON
18 Mar 09   Clausula rebus sic stantibus: A.I.G.’s Bonus Blackmail, NYT, LAWRENCE A. CUNNINGHAM
16 Mar 09   AIG bailout & bonuses: Bracing for a Bailout Backlash, NYT, ADAM NAGOURNEY
15 Mar 09    Infuriating lawmakers: Huge AIG Bonuses After $170 Billion Bailout, NYT, Edmund L. Andrews et al.
9 Mar 09   On the Origin of Bankers’ Giant Bonuses, NYT, EDUARDO PORTER
26 Feb 09   Are Executives Paid Too Much?, WSJ, JUDITH F. SAMUELSON et al.
25 Feb 09   Bailout money used for entertainment splashes & golf junkets, NYT, MAUREEN DOWD
27 Jan 09   MERRILL LYNCH lost $27 billion last year, still managed to pay $4 billion bonuses, NYT, Dave Krasne
19 Nov 08   Discarding some self-gratifying myths about what a big bonus really buys, NYT, DAN ARIELY
18 Oct 08   What's good for GM [& UBS?] is good for America [& CH]!: a managed bankruptcy, NYT, Mitt Romney
17 Nov 08   No regulation can match a gold peg's disciplinary effects on central & other banks, WSJ, G.O'Driscoll
17 Nov 08   On the pillory: Deregulator & UBS lobbyist Phil Gramm Looks Back, Unswayed, NYT, Eric Lipton et al.
17 Oct 08    Hedge Fund Guru A.Lahde's farewell letter: "people stupid enough to take the other side of my trades."
16.Nov 08   2008 UBS- und 1933 Volksbank-Rettung - verblüffende Parallelen, NZZ am Sonntag, Beat Kappeler
15 Nov 08   Did steam-rolled Swiss lawmakers unleash the financial tsunami?, WSJ, Iconoclast
15 Nov 08   Growing Sense Of Outrage Over Executive Pay, WP, Heather Landy, pay ratio graphics
15 nov 08    X.Oberson: Les banques du monde entier sont devenues des agents du fisc américain, LT, Myret Zaki
14 Nov 08   Stable, Real-Value Money, e.g. Gold, Is the Key to Recovery, WSJ, Judy Shelton, comments
13 Nov 08   It's Time to Rethink Our Retirement Plans, WSJ, Roger W. Ferguson Jr., comment
13 Nov 08   UBS' QI ties with IRS are bad for Top Banker & Banking Secrecy, WSJ, Evan Perez et al.
12 Nov 08   Replacing the cancerous fiat (un-backed) currency system, The Big Picture, Lee Quaintance et al.
10 Nov 08   Where are the enlightened modern Pharaos of salvation?, The New Yorker, John Lanchester
5 Nov 08   Salve Obama!, Washington Post, Iconoclast
5 Nov 08   In Collusion with One-Eyed Financial Engineers, Model Carpenters & Apprentice-Sorcerers, NYT, Steve Lohr
5 Nov 08   CDS Data Show Scope of Wagers on Nations, WSJ, SERENA NG et al.
4 Nov 08   Five Myths About the Great Depression, WSJ, ANDREW B. WILSON
4 Nov 08   Seven principles to guide reform, here and abroad, WSJ, Stephen Schwarzman
4 Nov 08   Private Equity Draws the Cold Shoulder, WSJ, PETER LATTMAN et al.
4 Nov 08   Convertible Bonds Cause Hedge Funds Serious Pain, WSJ, GREGORY ZUCKERMAN
4 Nov 08   Long live activism, FT
4 Nov 08   Darwinian rules threaten hedge funds, FT, Kate Burgess
3 Nov 08   When Hedge Funds Grease Instead of Slow the Slide, The New Yorker, James Surowiecki
3 Nov 08   G-20 Washington meeting: Beware of monopolists for good ideas!, WP, Iconoclast, comment
2 Nov 08   Hedge fund problems reach far wider, FT, Lawrence Cohen
2.Nov 08   Sternstunde: "Der Schwarze Herbst", SF1, Hansjörg Siegenthaler im Gespräch mit Roger de Weck
2 Nov 08   Discord on Economies In a World Of Trouble, WP, Steven Mufson et al.,comment
Nov 2008   Actions for G20 leaders to stabilise economy & fix financial system,, Barry Eichengreen et al.
31 Oct 08   DTCC opens up registry servicing global credit default swaps market valued at US$40 trillion
31 Oct 08   Behind AIG's Fall: One-Eyed Model Carpenters, WSJ, Carrick Mollenkamp et al.
31 Oct 08   Hank Paulson's $125 Billion Mistake, WP, Steven Pearlstein
31 Oct 08   Greenspan Slept as Off-Books Debt Escaped Scrutiny,, Alan Katz et al.
31 Oct 08   Banks Owe Billions to Executives, WSJ, ELLEN E. SCHULTZ
31 Oct 08   A $50 Billion Bailout in Russia Favors the Rich and Connected, NYT, ANDREW E. KRAMER
30 Oct 08   Credit `Tsunami' Swamps Trade as Banks Curtail Loans,, Michael Janofsky et al.
30 Oct 08   U.S. Treasury Program Shuns Banks That Need Cash Most, Bloomberg, David Mildenberg et al.
30 Oct 08   World According to TARP No Laughing Matter for U.S.,, Abigail Moses et al.
30 Oct 08   Mizuho $7 Billion Loss Turned on Toxic Aardvark Made in America,, Finbarr Flynn
30 Oct 08   UK Bank insider David Blanchflower urges deep rate cut,
30 Oct 08   Securities-Lending Sector Feels Credit-Crisis Squeeze, WSJ, By CRAIG KARMIN et al.
30 Oct 08   Layoffs Sweep From Wall St. Across New York Area, NYT, PATRICK McGEEHAN
30 Oct 08   NY AG Cuomo: Disproportional pay may violate NY law - banks investigated, NYT, Ben White et al.
30 Oct 08   A Question for A.I.G.: Where Did the Cash Go?, NYT, MARY WILLIAMS WALSH
29 Oct 08   Loans? Did We Say We’d Do Loans?, NYT, editorial
29 Oct 08   Reserve Fund’s Investors Still Await Their Cash, NYT, DIANA B. HENRIQUES
28 Oct 08   Chicken coming back to roost in Mr. Ponzi's Wall Street henhouse,, Mark Pittman
27.Okt 08   Wir brauchen ein Bretton Woods III,, Henrik Müller, Kommentar
27 Oct 08   G-20 meeting: Wall Street's Trojan Horse, Global Research, Michel Chossudovsky
27.Okt 08   Protest gegen Finanzmärkte: Attac-Aktivisten stürmen Frankfurter Börse, Spiegel online, cvk/dpa/Reuters/ddp
27 Oct 08   Morgan Stanley Propped Up Money-Market Funds With $23 Billion,, Miles Weiss
25 Oct 08   The not-so-invisible hand: How the Plunge Protection Team killed the free market,, Ellen Brown
24 Oct 08   Ruble's Fall Puts Russia on Defense Amid Crisis,, ALAN CULLISON et al.
24.Okt 08   Völlig orientierungslos,, Jörg Eigendorf, Kommentar
24.Okt 08   Was muss sich am globalen Finanzsystem ändern?, Spiegel online forum, onemanshow
23.Okt 08   FundamentalistInnen am Werk, WOZ, Andreas Missbach, Standpunkt
23.Okt 08   Drohende Pleiten: Schwellenländer schlittern tief in die Krise,, Frank Stocker
23.Okt 08   Fortsetzung der Plünderung: Der Transkapitalismus, WOZ, Oliver Fahrni
23 Oct 08   NYU's Roubini: 'Worst is Ahead'Some Predict Hedge Fund Failures, Panic, Bloomberg, Tom Cahill et al.
23 Oct 08   The rogue trader is back: A rogue system with lax limits on risk-taking,, John Gapper
23 Oct 08   Is America self-destructing & bringing down the rest of the world?, Global Research, Tanya Cariina Hsu
23 Oct 08   Hedge Funds’ Steep Fall Sends Investors Fleeing, NYT, LOUISE STORY
23 Oct 08   Bubble & Crash: Engineered by Government, FED & Wall Street?, Global Research, Richard C. Cook
22 Oct 08   A Matter of Life and Debt, NYT, MARGARET ATWOOD
22.Okt 08   Jetzt droht ein weltweites Währungsbeben,, Daniel Eckert
22.Okt 08   Die soziale Marktwirtschaft ist lebendig!,, Wolfgang Schüssel
21 Oct 08   The Dangers of a Diminished America, WSJ, AARON FRIEDBERG et al.
21 Oct 08   Get Ready for the New New Deal, WSJ, PAUL H. RUBIN
21 Oct 08   The Iceland Syndrome, WP, Anne Applebaum
21.Okt 08   Ein nüchterner Blick auf die Geschehnisse der vergangenen Wochen, IFW
21 Oct 08   Die Zeit für fette Boni ist vorbei, Spiegel online, Michael Kröger
21 Oct 08   USA: 1607-2008: Aufstieg und Krise einer Weltmacht, Spiegel Spezialausgabe
21 Okt 08   Bild-Illustration: Wie es zur Finanzkrise 2008 kam, Spiegel online
21.Okt 08   Die Zocker von der Wall Street, Spiegel online, Christiane Oppermann
20 Oct 08   Is Capitalism Dead? The market that failed was not exactly free, WP, editorial
20 Oct 08   The price of mathematical, often outsourced & self-serving risk analysis, New Yorker, James Surowiecki
20 Oct 08   Bretton Woods, The Sequel?, WP, Sebastian Mallaby
19 Oct 08   The Bubble Keeps On Deflating, NYT, editorial
18 Oct 08   Anna Schwartz: Bernanke Is Fighting the Last War, WSJ, Brian M. Carney, Interview
17 Oct 08   The Wall Street Ponzi [pyramid] scheme has reached its mathematical limits, Global Research, Ellen Brown
17 Oct 08   THE GLOBAL CRASH: Saving What Can Still Be Saved, Spiegel
16 Oct 08   Cuomo Seeks Recovery of Bonuses at A.I.G., NYT, JONATHAN D. GLATER et al.
15 Oct 08   Banks’ Bailout Unlikely to Crimp Executive Pay, NYT, REED ABELSON
15.Okt 08   Soziologe Ulrich Beck: "Die Finanzkrise hat aus Schurken Helden gemacht", Spiegel, Hannes Koch
13.Okt 08   Die Wiedergeburt des Eigentums, Wegelin Anlage-Kommentar 259, Konrad Hummler
13 Oct 08   Back to ownership, Wegelin Investment Commentary 259, Konrad Hummler
13 oct 08   Renaissance de la propriété, Wegelin Commentaire d’investissement 259, Konrad Hummler
13 ott 08   La rinascita della proprietà, Wegelin Bollettino finanziario 259, Konrad Hummler
12 Oct 08   Liaquat Ahamed's Lessons of the Great Depression, The New Yorker, Steve Coll
11 Oct 08   Who is Behind the Financial Meltdown? Global Research, Michel Chossudovsky
10.Okt 08   Staat oder Markt? Hochkonjunktur für Ideologen, Das Magazin, Daniel Binswanger
10 oct 08   La stratégie suisse toche à ses limites, Le Temps, Roger de Weck
9 Oct 08   Behind the Panic: Financial Warfare and the Future of Global Bank Power, Global Research, F. William Engdahl
8 oct 08   Bonus et salaires: Des dysfonctionnements à tous les étages, Bilan, interview avec Katia Rost
7 Oct 08   The FED now owns the world's largest insurance company - It's time to buy the FED,, Ellen Brown
3.Okt 08   Die Schweiz nach dem Crash: neue Ideen sind gefragt, Das Magazin, Roger de Weck
3 Oct 08   Bretton Woods Successor Conference & Currency Self-Protection, Swiss Lawmaker Motion 08.3718
30 Sep 08   THE END OF ARROGANCE: America Loses Its Dominant Economic Role, Spiegel
30 Sep 08   Prelude to War? Bernanke Knows What We Have to Fear, WP, Richard Cohen
30 Sep 08   How Voter Fury Stopped Bailout &  Put Plan on the Ropes, WSJ, Stephen Power et al.
30 Sep 08   Too Much Money Is Beyond Legal Reach, WSJ, Robert M. Morgenthau
30 Sep 08   Loose Money And the Roots Of the Crisis, WSJ, Judy Shelton
29 Sep 08   French and German anger misses the fact, FT, Charles Wyplosz
29 Sep 08   Those whom the gods would destroy, they first make mad, FT, Willem H. Buiter
29 Sep 08   J.P.Morgan was more effective than Paulson & Bernanke combined, WSJ, L. Gordon Crovitz
29 Sep 08   What We Can Learn From Chile's Financial Crisis, WSJ, Mary Anastasia O'Grady
29 Sep 08   Shorting Financial Stocks Should Resume, WSJ, Arturo Bris
29 Sep 08   Credit Markets and the Real Economy, WSJ, Michael T. Darda
29 Sep 08   Bankrupt Economics: A Crisis Resists The Usual Remedies, WP, Robert J. Samuelson
29.Sep 08   WEF in China: «Wer rettet den Wall-Street-Retter Uncle Sam?», Neue Zürcher Zeitung
29 Sep 08   A Cure for Greed, NYT, EDUARDO PORTER
29 Sep 08   WaMu’s Lesson for Private Equity, NYT,, ROB COX
29 Sep 08   The Real Costs of the Bailouts, WSJ, SUDEEP REDDY
29 Sep 08   A Bailout Is Just a Start, WP, FT, Lawrence Summers
28 Sep 08    Evolution of US Capitalism: Long Tradition of State Roles, WP, Robert J. Shiller
28 Sep 08    How J.Pierpont Morgan defused the 1907 Wall Street panic, WP, Jean Strouse
28 Sep 08   What’s Free About Free Enterprise?, NYT, PETER L. BERNSTEIN
28 Sep 08   Wall Street, R.I.P.: The End of an Era, Even at Goldman, NYT, Julie Creswell et al.
27 Sep 08   In praise of free markets, FT, editorial
27 Sep 08   An Alternative Way to Save the (Financial) World, NYT,  Joe Nocera, 37 comments
27.Sep 08   Die sieben Mythen zur Finanzkrise der USA, Die Welt, Sebastian Jost
27.Sep 08   Was Hayek erkannt und die experimentelle Forschung bestätigt hat, NZZ, Vernon L. Smith
26 Sep 08   Don't disregard all structured products, Telegraph, Chris Taylor
25 Sep 08   Back to Basics: Responsibility! Accountability! Discipline! Oversight! Rules! WSJ, Daniel Henninger
25 Sep 08   "Keynes wouldn't have wanted to nationalize that casino", WP,. David Ignatius
25 Sep 08   Economists Of The World, Unite!, NYT, Joe Nocera, 24 comments
25 Sep 08   U.S. Losing Finance Superpower Status, Germany Says, Bloomberg, Leon Mangasarian
25 Sep 08   A Bailout We Don't Need, WP, James K. Galbraith
25 Sep 08   The Paulson Plan Will Make Money [also] For Taxpayers, WSJ, ANDY KESSLER
24 Sep 08   Financial rescue models: solutions past and present, FT
24 Sep 08   After Wall Street firms paid out over $100 billion in bonuses: Crash, NYT,Timothy Egan
24 Sep 08   How Main Street Will [also] Profit, WP, William H. Gross
24 Sep 08   Top Executives at Bruised Firms Among Wall Street's Highest Paid, WP, Cecilia Kang
24 Sep 08   Bringing Down Wall Street as Ratings Let Loose Subprime Scourge, Bloomberg, Elliot Blair Smith
24 Sep 08   Bailout Proposal Meets Bipartisan Outrage, WP, Lori Montgomery et al.
24 Sep 08   "I'm sorry": The Words Left Unspoken in the Bailout Debate, WP, Steven Pearlstein
24 Sep 08   Faith-Based $ Mainly Dependent on Alien Constituency: Buck Stopped in 1971, NYT, James Grant
24 Sep 08   Congress wants Wall Street to feel it where it hurts: the wallet, NYT, Steve Lohr
24 Sep 08   Traders Sowing Seeds of Destruction Prompt Crackdown, Bloomberg, Shannon D. Harrington et al.
23 Sep 08   Darling tells regulator to curb City's bonus culture, The Guardian, Jill Treanor
23 Sep 08   Experts See a Need for Punitive Action in Bailout, NYT, PETER S. GOODMAN
23 Sep 08   Countdown to a Meltdown, Washington Post, editorial
23 Sep 08   M3 figures hidden since March 2006: Currency's Dive Points to Further Pain, WP, Anthony Faiola et al.
23 Sep 08   A Bailout or a Bonanza?, WP, Eugene Robinson
23 Sep 08   Hard Landing for the Golden Parachute, WP, Dana Milbank
22 Sep 08John McCain: $400000 executive pay cap for bailed-out firms, CNBC, Reuters
22 Sep 08   The Pain of Deleveraging Will Be Deep and Wide, Barrons, Lawrence C.Strauss, INTERVIEW
19 Sep 08   Bankers and Their Salaries, NYT, Editorial
19 Sep 08   A Bid to Curb Profit Gambit as Banks Fall, NYT. VIKAS BAJAJ et al.
19 Sep 08   Present at the Crash, NYT, SAM G. BARIS
19 Sep 08   Peering Over the Cliff, Saying 'I Told You So', WP, Steven Mufson
18 Sep 08   "Wall Street's investment banks plainly deserve to die", Washington Post, Harold Meyerson
18 Sep 08   Scrambling to Clean Up After A Category 4 Financial Storm, WP, Steven Pearlstein
18 Sep 08   The King Is Dead, NYT, Roger Cohen
15 Sep 08   After Bear Stearns, Lehman, Merrill Lynch, etc.: Jittery Road Ahead, NYT, Floyd Norris et al.
12 Sep 08   Lehman: Short Raiders 1: Regulators Nil, Heinz Geyer
12 Aug 08   Sovereign Funds Become Big Speculators, WP, David Cho
18 juin 08    Est-ce prudent d'attirer des hedge funds à Genève?, Bilan
1 May 08   Moles on the board: Why German companies should not appoint bankers to the board, The Economist
1 May 08   Numbers Racket: Why the economy is worse than we know, Harper's Magazine, Kevin Phillips
17 Apr 08   Hedge Fund Manager Reaps $3.7 Billion in Casino on the Titanic, WP, David Cho
9 Apr 08   A Silicon Valley Slowdown, NYT, MATT RICHTEL and BRAD STONE
8 Apr 08   Looking for an End to Deleveraging, New York Sun, Liz Peek
3 avr 08   Quel future pour la finance canibale où le serpent se mord la queue?, Maitre JR, satire
29 Jan 08   "Economic Amaggedon": artificial & deliberate!,, Lyndon LaRouche, video
29.Jan 08   Der Finanzcrash und der Betrug im Weltwährungssystem,
27 Jan 08   Responsibility on Wall Street: $34 billion big time loosers' comeback, NYT, Landon Thomas Jr.
23 Jan 08   Worries That the Good Times Were a Mirage, NYT, David Leonhardt
23 Jan 08   The interest of gold: confidence, Iconoclast
23 Jan 08   From Storage, Moving & Mutual Back-scratching Back to Confidence Business, NYT, Iconoclast
23.Jan 08   Harvard's Kenneth Rogoff: "Viele Banken werden nicht überleben“, HANDELSBLATT, Ingo Narat
23.Jan 08   Asiaten und Araber werden nervös, HANDELSBLATT, Pierre Heuman
22 Jan 08   The worst market crisis in 60 years, FT, George Soros, Davos Video
22.Jan 08   „Gier frisst Hirn“, HANDELSBLATT, Jörg Hackhausen
18.Jan 08   Peer Steinbrück re Nokia: Karawanenkapitalismus, Vertrauensverlust 'ist eminent gefährlich', HB
18 Jan 08   Dire Wall Street Year With Record Bonuses of $39 Billion, WP, Bloomberg, Christine Harper
16 Jan 08   Why regulators should intervene in bankers' pay, FT, Martin Wolf
16 Jan 08   Could subprime crisis trigger credit default swaps CDS tsunami?, Chronique Agora, Dan Denning
10 Jan 08   Exchequer Club speech by Fed-Chairman Ben S. Bernanke
9 Jan 08   Bankers' pay, often based on fake alpha, is deeply flawed, FT, Raghuram Rajan
4 Jan 08   The Next Credit Crisis Will Originate in China, Seeking Alpha, J. Christoph Amberger
1 Jan 08   '07: Buyouts and Bailouts, WP, Allan Sloan
31 Dec 07   Wall Street is about smart guys thinking about ways to make money from dumb ones, NYT, Dash
29 déc 07  Quand le rêve américain tourne au cauchemar planétaire, Le Temps, Marie-Laure Chappatte et al.
24 Dec 07   Dollar's Fall Is Felt Around The Globe, WP, Anthony Faiola
24 Dec 07   Swiss bank regulator to probe UBS: report, WP - Reuters, Jonathan Lynn
23 Dec 07   This Is the Sound of a Bubble Bursting, NYT, Peter S. Goodman
22 Dec 07   A Major Subprime Victim: the American Dream, NYT, Bob Herbert, Op-Ed Columnist
21 Dec 07   Wall Street to get fatter bonuses while many stakeholders suffered huge losses, CNN, AP
21 Dec 07   Blindly Into the Bubble, NYT, Paul Krugman, Op-Ed Columnist
18 Dec 07   Fed Shrugged as Subprime Crisis Spread, NYT, Edmund L. Andrews
2.Dez 07   Hans-Jörg Rudloff: «Ein unglaubliches Desaster», SonntagsZeitung, Victor Weber
28 Nov 07   Why banking remains an accident waiting to happen, Financial Times, Martin Wolf
28 Nov 07   Bankers are in the confidence, not in the storage or even moving business, FT, Peter Thal Larsen
24 Nov 07   At the gates of hell: Now the misery is spreading, Economist
23.Nov 07   UBS: Das angekündigte Debakel; Ospels Abgang im Frühling 08?, BILANZ, Lukas Hässig
23.Nov 07    Ken Moelis: Zur Branchenkrise, Geldgier und Aufspaltung der UBS, BILANZ,  Enk Nolmans
27/07   Die Deutschland-Chefs der großen Fonds, WirtschaftsWoche
11/07   Helmut Maucher: «Wir degenerieren allmählich», Weltwoche, Ralph Pöhner
26 Sep 07   U.S. Aims to Limit Funds' Risk, Washington Post, Carrie Johnson, comment
11 Sep 07   KKR: the fortunes of more than the firm are at stake, Washington Post, David Cho
25 Aug 07   Carlyle Founder on Cheap Debt, Credit Crunch & New Buyout Landscape, WSJ, Henny Sender
21 Aug 07   For Wall Street's Math Brains, Miscalculations, Washington Post, Frank Ahrens
20 Aug 07   Herding Scapegoats: Who's to blame for current lending mess? Barrons, T.G.Donlan, Editorial
20 Aug 07   Easy Credit, Bubbles and Betrayals, NYT/IHT, Roger Cohen, edpage comment
20 Aug 07   Market turmoil and threats to the broader economy, NYT, Editorial
19 Aug 07   Watershed: excesses in lending and derivatives threaten system, NYT, Editorial
18 Aug 07   Hyman Minsky Long Argued Markets Were Crisis Prone, WSJ, Justin Lahart
16 Aug 07   Hold tight: a bumpy credit ride is onlyjust beginning, FT, Avinash Persaud
15 Aug 07   In a world of overconfidence, far makes a welcome return, FT, Martin Wolf
14 Aug 07   No longer dancing: How the music stopped for buy-out buccaneers, FT, James Politi et al.
14 Aug 07   Surviving a credit market meltdown, FT, Martin Arnold
13 Aug 07   Banking bail-out sows seeds of future crises, FT, Paul de Grauwe
13 Aug 07   21st Century Bank Run Version: Why the Blowup May Get Worse, Barrons, Randall W. Forsyth
13 Aug 07   Appropriately, the Bill Lands on Wall Street's Desk, Barrons, Andrew Bary
12 Aug 07   Tight Credit Could Stall Buyout Boom, Washington Post, David Cho and Thomas Heath
11 Aug 07   Bubble and Bust, Washington Post, editorial
11.Aug 07   Zusammenbruch des US-Immobilienmarktes, Deutschlandfunk, Presseschau
11 Aug 07   Central Banks Intervene to Calm Volatile Markets, NYT, VIKAS BAJAJ
11 Aug 07   Subprime Turmoil Catches Funds Off Guard, WSJ, ELEANOR LAISE
11 Aug 07   US$ 1 trillion/y black funds sinking "white economy"?, Iconoclast
11 Aug 07   Payback time: A case from the Californian Front, FT, J.E. Morgan, Letter to the Editor
10 Aug 07   Markets abhor the vacuum left by derivatives, FT, Frank Partnoy
10 Aug 07   New Order Ushers in A World of Instability, Washington Post, Steven Pearlstein
10 Aug 07   Very Scary Things, NYT, Paul Krugman
10 Aug 07   A New Kind of Bank Run Tests Old Safeguards, NYT, FLOYD NORRIS, News Analysis
9 Aug 07   Subprime bites, US investigators look for culprits, FT, Brook Masters et al.,ANALYSIS
9.Aug 07   Die Mutter aller Krisen: Der tickende Zusammenbruch, WOZ, Till Hein
4 Aug 07   Report Says S.E.C. Erred on Pequot, NYT, Gretchen Morgenson et al.
1 Aug 07   Rupert Murdoch's WSJ acquisition: Public Good versus Ponzi schemes, edpage draft, Anton Keller
Aug 07   The Firing of an SEC Attorney and the Pequot Investigation, US Senate Report
30 Jul 07   Trustees or vulgar fee-hunters? Bankers must relearn their craft, Financial Times, John Gapper
30.Jul 07   Wufflis Abgang: UBS in den USA über den Titsch gezogen, SonntagsZeitung, Arthur Rutishauser
29 juil 07   Union mondiale se dresse contre des éléphants financiers en argile, Le Temps, interview
26 Jul 07   'Locusts' enrich our society: Private Equity and Public Good, WSJE, Wilfried Prewo
25.Juli 07   HEDGE-FONDS: Unbehagen ja, aber harte Kritik fehlt, Handelszeitung, Synes Ernst
25.Jul 07   HEDGE FONDS-Debakel: Spitze der Verluste noch nicht in Sicht, Handelszeitung, Samuel Gerber
20 Jul 07   UBS falls from grace, Economist
19 Jul 07   The fair way to tax private equity, FT, editorial
18. Juil 07  Privatsphäre in Gefahr, NZZ, Kommentar
18.Juli 07   Glaubenssätze in der Vermögensverwaltung, NZZ, Roland Hengartner
17 Jul 07   UBS settles New York InsightOne suit over charging excessive fees, WSJ, Chad Bray et al.
16. Juli 07  Jens Ehrhardt: „Es ist die größte Blase, die es je gab“, FAZ, Catherine Hoffmann, Interview
15.Juli 07   UBS riskiert mehr in den USA, Sonntags-Zeitung, ARTHUR RUTISHAUSER
15 juil 07   Notes de frais des fonds de private equity: $8 mia, Agefi, Alexandre Sonnay
25 Jun 07   Raising Taxes on Private Equity, NYT, editorial
13 Jun 07   Scrutiny on Tax Rates That Fund Managers Pay, NYT, JENNY ANDERSON
12 Jun 07   There are the rich and the very rich. Now meet the private equity kings, Guardian, Andrew Clark
10 Jun 07   Time is running out for tax privateers, Observer, Ruth Sunderland, Comment
9 Jun 07   Unfair tax break for buy-out barons, Economist, leader
6 Jun 07   Buy-out bonanzas, Financial Times, editorial
5.Jun 07   Mehr - nicht weniger - Steuer-Verantwortung für Macro-Parasiten, Neue Zürcher Zeitung
5 juin 07   Moins taxés «qu'une femme de ménage»!, Le Temps, Myret Zaki
2 Jun 07   On Winners & Losers from Hedge Funds and Private Equity, Economist, Buttonwood
16 May 07   DaimlerChrysler adventure: From 38+ to $1.5 bn in 10 years, WP, Sholnn Freeman et al.
16 May 07   End of the DaimlerChrysler marriage: How to become so cheap so fast, NYT, editorial
15 May 07   DaimlerChrysler splitup: Cerberus's Sharp-Toothed Ways, Washington Post, Frank Ahrens
11 May 07   How families keep private equity 'locusts' at bay, Guardian, David Gow
Apr/May 07   $600-2000 mio boni for the 2/20 to 5/44 percent fee structure gurus, Trader Monthly
Apr 07   Large banks and private equity-sponsored leveraged buyouts in the EU, ECB
25 April 07  Social cost of private equity, The Guardian, Phillip Inman
20 Apr 07   Top Moneymakers: James Simons, Kenneth Griffin, and Edward Lampert,
13 Apr 07   Stakeholders Borrow To Pay Themselves Pre-Sale Dividends, WSJ, KATE KELLY
12 Apr 07   American hedge fund trader to earn £2.7m a day, Guardian, Andrew Clark
12 Apr 07   Dutch MPs: hedge funds & private equity plunder Holland, Telegraph, A. Evans-Pritchard
11 Apr 07   Private equity collapse on cards, says IMF, Telegraph, Edmund Conway ¦ IMF Report
5.Apr 07   Gebühren 2006: Hedge-Funds ($1500 Mia) 84 vs 80 für Anlagefonds (20000), NZZ, ra
4 Apr 07   The Money Binge, NYT, comments ¦ Masters of the New Universe, NYT, comments
4 Apr 07   After the Buyouts, Bankruptcy Lawyers ahoi!, NYT, PETER EDMONSTON, reader comments
24 Feb/27 Mar 07  Taming the new capitalism ¦ Let there be light, Guardian, leaders, reader comments
7 Mar 07   Private equity predicted to spark company collapses, Guardian, Phillip Inman
23/24 Feb 07  New gold rush ¦ Private equity plutocratic shadow, Guardian, W.Hutton, reader comments
24 Feb 07   One in five in private sector works for firms owned by controversial funds, Guardian, D.Teather
6 Feb 07   Barbarians or benefactors? The rise and rise of private equity, Guardian, Jill Treanor
26 Jan 07   'Buy it, strip it, flip it' acquisitions denounced by global union, Guardian, Larry Elliott
2007    Creating New Jobs and Value with Private Equity, A.T.Kearney Consultancy
14.Dez 06   CS & UBS füttern Heuschrecken mit CHF20 Mia Boni ¦ Wall Street dances on Titanic, Cash
8 Nov 06   $128 Bn Revenues, $37 Bn Bonuses & $23 Bn Salaries at 5 US Investment Banks, Bloomberg
28 Jun 06   1929 crash mechanism spinning again?, US Senate Judiciary Committee, Gary J. Aguirre
19 mar 98   Apprenti sorcier vs une Suisse éclairée: à l'origine du problème/solution, GHI, Anton Keller

The Guardian    January 26, 2007

Trade unions attack 'corporate greed' of private equity firms
'Buy it, strip it, flip it' acquisitions denounced by global union

Larry Elliott, economics editor

The growing influence of private equity companies was strongly attacked by global coalitions of trade unionists yesterday as they used the gathering of executives from some of the world's biggest companies to condemn "corporate greed".
Phillip Jennings, general secretary of the UNI global union - which has 15 million members in 150 countries - said organised labour had come to Davos with the intention of forcing the activities of private companies into the spotlight.

"They are like a global vacuum cleaner hoovering up assets any place, anywhere, any time and we want to bring them out of the shadows," Mr Jennings told a press conference. "They should no longer consider themselves untouchable."

He said unions intended to press the European Union and the G8 to force private companies to abide by established rules of corporate governance, adding that there would also be union pressure on pension funds financing the purchases of public companies by private concerns. "Unions need to be aware that the money they are paying into pension funds is feeding the beast that may devour them," Mr Jennings said.

A long period of growth coupled with low interest rates and rising stock markets has created the conditions for private entrepreneurs to borrow money for takeover bids. Private equity companies were responsible for one fifth of last year's $3.8 trillion (£1.9 trillion) worth of mergers and acquisitions, with supporters of the process saying it leads to more efficient and profitable companies.

Unions said yesterday, however, that private equity companies were "sweating assets" and that the rates of return expected by the new private entrepreneurs were incompatible either with good corporate governance or the fight against climate change. "The philosophy is buy it, strip it and flip it," Mr Jennings said. "It's all about value extraction and not value creation."

Richard Lambert, the director general of the CBI, said the private equity model could be "extremely efficient" but that the growing importance of private equity companies would inevitably lead to more public scrutiny of their activities.

"Private equity companies are now a significant part of the economy in the UK. Around 10% of people working in the private sector are employed by firms that are organised on a private equity basis. In the US [the private equity firm] Blackstone is one of the top 15 employers," he said. "These firms, which have been operating very much in the dark, are going to have to come out and discuss what they are doing. They have to engage with the public and shareholder groups in a more active way than in the past," he added.

The unions launched their attack on private equity at Davos in response to what they considered to be a downgrading of labour issues at this year's World Economic Forum. They feared a backlash by the corporations who finance the annual get-together following several years in which unions had successfully pushed their issues up the agenda.

John Evans, general secretary of the trade union body at the Organisation for Economic Cooperation and Development, said that in the US the ratio of chief executives' pay to that of the average production worker had risen from 30 to 1 in 1970 to 500 to 1.

"The share of corporate profits taken as personal compensation by the top five executives in the 1,500 largest US public companies has doubled - from 5% to more than 10% of total corporate profits over the past decade - to a total of more than $40bn a year. That leaves a lot less for reinvestment, for wage increases for ordinary workers, for shareholders, or to fund pension plan liabilities."

Pay for executives will be discussed at a lunch in Davos today, although none of the six speakers will be a trade unionist. Sharan Burrow, president of the International Trade Union Confederation, said corporate greed was the "gorilla in the room" at Davos and that business leaders needed to wake up to growing inequality.

The Guardian    January 29, 2007

Record year for private equity

Last year set another record for private equity, with the total value of European private equity-backed deals reaching €178bn (£117.5bn), a 41% increase on 2005. Candover, a pan-European buyout specialist, found that of the €56bn of private equity transactions completed in the last quarter of 2006, €55bn were buyouts.

The private equity boom continued to be boosted by larger deals, with 13 transactions in the final quarter worth more than €1bn. Together, these larger deals made up 70% of the value of the whole European private equity market in the fourth quarter.

Three of these 13 deals took place in the UK: the £1.6bn sale of United Biscuits to Blackstone and PAI Partners, the £1.15bn sale of Birds Eye to Permira and the £559m sale of Gondola Holdings (which runs the Pizza Express and Ask restaurants) to Cinven.

Colin Buffin, managing director of Candover, said: "This has been another remarkable 12 months for private equity, with more and more large scale buyouts driving the growth of the industry."

He remains confident that the private equity market will continue to thrive in 2007 on the back of a strong deal pipeline across Europe.


The Guardian    February 6, 2007

Barbarians or benefactors? The rise and rise of private equity
Poll: should private equity be more tightly regulated? yes: 87%, no: 13%

Jill Treanor and Terry Macalister

A possible £8bn bid by a trio of private equity houses for supermarket group J Sainsbury demonstrates just how bold and brave the fast-growing industry has become. If the deal succeeds - and there are plenty of obstacles to a takeover by private equity houses CVC, Blackstone and Kohlberg Kravis Roberts - the supermarket chain would follow United Biscuits, Birds Eye and Pizza Express parent Gondola into private hands.

Success would herald a landmark for the industry as it would be the biggest deal yet in Europe. Failure could prove to be the watershed moment for a business that has started to face critics, even from within the City.

Private equity - and its sister sector venture capital, both of which draw together funds from individuals and corporate investors - shot to prominence in the 1980s when KKR launched a hostile bid for RJR Nabisco - now immortalised in the book The Barbarians at the Gate. In the 1990s and 2000s the business gathered pace, helped by the dotcom boom and bust, but it really flew last year.

About 1.2 million people are employed by private equity firms. Data compiled by the BVCA, the British venture capital and private equity association, shows the business represents 7% of the total annual turnover of the UK financial services industry.

Yet the industry is uncomfortable with public scrutiny despite having lured some high-profile figures - such as U2 singer-cum-poverty fighter Bono, who is linked to Elevation Partners, and John Studzinski, the former HSBC banker, who has pitched up at private equity house Blackstone.

Private equity and venture capital also attracts a wide array of investors - pension funds and university endowments are among the biggest.

Precise figures about the size of investments can be difficult to come by but the INSEAD business school believes there could be up to $300bn (£150bn) "committed capital" in the hands of private equity and it is growing at 200% a year.

High risk
The investors are usually willing to put a small amount of their total funds into investments that are considered high risk but potentially high reward. They are high risk because of the amount of debt employed relative to the amount of equity, but once the debt is paid off, the profits can be huge.

It is the debt - and the idea that private equity firms run businesses for cash to pay that debt off - that is at the root of much of the controversy. But Christoph Zott, associate professor of entrepreneurship at INSEAD, says venture capitalists can bring financial experience and advice that can help a badly managed company. "Debt can be a very strong disciplining device, while taking a company private can shield it from the short-term pressures of public markets."

Other pressures of being listed on stock markets such as disclosing directors' pay and controls can be avoided.

Questions about the seemingly unstoppable business are coming not only from the trades unions worried about job losses but also from City big hitters and even regulators.

Michael Gordon, chief investment officer of Fidelity Investments, said: "What is starting to worry me is when talking to our clients - pension fund trustees - they are seeing private equity as some sort of panacea."

Clients such as pension fund trustees are moving into private equity believing it offers diversification to their investments. Mr Gordon believes it does not. Instead they are taking on higher risks because of the leverage and receiving less information about their investment than they would from listed stocks. They also pay higher fees.

City investors, which fell over themselves to encourage boards to accept bids by private equity firms, are beginning to urge more caution from sitting management teams. Signet and HMV have both been the target of mooted private equity approaches but, so far, bids have not materialised. Estate agency Countrywide survived one private equity takeover attempt last month but yesterday received another.

Laden with debt
Companies that have been listed on the stock market, bought by private equity and then relisted - notably Debenhams - have also done little to win the confidence of investors. Debenhams was taken private in 2003 only to come back to the stock market barely two years later - with a market value greater than it was sold for and laden with debt. Mr Gordon notes this will be one way to measure the success of any Sainsbury's bid. "The Sainsbury's bid will succeed if investors sell to them and then buy the asset back when it comes back to the market," he said.

The UNI global union - which has 15 million members in 150 countries - used the recent Davos economic forum to condemn private equity companies for "corporate greed". Philip Jennings, UNI general secretary, said: "They are like a global vacuum cleaner hoovering up assets at any price, anywhere, any time and we want to bring them out of the shadows." The Transport & General Workers' Union warned yesterday about the potential Sainsbury's bid. Brian Revell, T&G national organiser for food and agriculture, said: "Such a takeover would be based on borrowed money followed by extracting as much wealth as possible from the company ... Private equity does not create wealth; they extract it for their shareholders." Mr Gordon has some sympathy. "Employees are a little further down the pecking order in private equity," he said.

Concerns have also been raised about the standard of corporate governance at private equity firms. Sir Derek Higgs has suggested they could comply with the corporate governance standards he devised for stock market listed companies. But the industry argues it is transparent and clear. The BVCA says investors in private equity funds provide "complete and comprehensive" information to their investors and its members also follow a code of conduct. This is a point taken up by a senior venture capitalist. "Our investors can ring us up at any time and ask how investments are going. Every half year they get official updates," the venture capitalist said. He says investors in private equity funds actually get more information than they would for stock market listed companies. Private equity firms can know personally all the investors in their funds - a few hundred, say, compared with the millions on the registers of the biggest stock market companies.

Job cuts
Some attempts by the industry to answer critics have backfired. The launch of the Private Equity Foundation, which is to make donations to children's charities, was picketed by unions upset at job cuts at venture capital-owned businesses Little Chef and Birds Eye. Others note that the increasing interest by the Financial Services Authority in the sector may also be helping to focus minds.

Hector Sants, managing director of wholesale markets at the FSA, last month met the heads of the biggest venture capital firms. The meetings came after the FSA's warning in November that it was "inevitable" that a large private equity-backed firm would default on its debt and that it was concerned there was potential for insider dealing in the industry.

By March 6, the industry and other interested parties are required to tell the FSA what they think. In the coming months, the industry will find out whether the FSA is satisfied that it has answers to the potential risks.

Going private: Debt is the key
The terms private equity and venture capital are used interchangeably in the City to describe deals that involve buying companies listed on the stock market and taking them into private hands. (In the US venture capital tends to be used to describe investment in early-stage and expanding companies.)

The deals are usually associated with high levels of borrowing - known as leverage - relative to the amount of equity in the business.

The BVCA, the British venture capital and private equity association, says most of the publicity the industry attracts is for a dozen or so of the big value deals on the stock market. Most private equity deals - those conducted by 80% of the members of the BVCA - are for £2m or less. Some do not involve stock market listed companies, as private equity-owned firms can keep changing hands in the private sector.

Even so, an obvious exit route for private equity owners is to float the business on the stock market. The BVCA says this is an important discipline in running the companies - they have to be managed well so they can be sold on.

The big difference between private equity and stock market listed companies is that the private equity firm is the only owner of the business - while investors in stock market listed companies only influence rather than control them.

Private equity investments are said to grow faster than stock market listed companies. Over the past 10 years, the best buyout funds have outperformed stock market indices. Some of this is due to the leverage and has prompted analysis by Citigroup into whether simply buying a stock and increasing the size of your investment by borrowing money can replicate private equity returns. The answer is sometimes.

The Guardian     February 24, 2007

Taming the new capitalism

    Whatever the rights and wrongs, the present controversy about buying companies using private equity has generated a rare public debate in which the protagonists are actually listening to each other. Such deals have already seen household names such as the AA and Little Chef taken over - with Sainsbury's mooted as the next target - and have naturally provoked opposition from unions fearing job losses. Instead of denying this, Michael Gordon, chief executive of Fidelity Investment, actually admitted that "employees are a little further down the pecking order in private equity". In yesterday's Financial Times two private-equity groups put their heads above the water. Permira, Europe's biggest - which owns New Look and the AA - pledged to provide more information about what it owned in response to criticism that private-equity firms were not required to make quarterly reports as publicly quoted companies are. Steven Rattner, co-founder of Quadrangle, while rigorously defending private equity as "a constructive force in making capitalism work" admitted that at the moment there was a "credit-fuelled bubble driving private-equity deals that would not happen in a normal credit market". To cap it all, Britain's biggest charity, the Wellcome Trust - also the biggest institutional owner of private-equity buyout funds in the UK - warned against changing the tax treatment of these funds, arguing that this would reduce the income the trust uses to maintain Britain as a world leader in biomedical research, thereby forcing it to redeploy more of its investments abroad. Some pension funds, also heavy investors in these funds, would agree.
    Anyone with memories of the "asset stripping" boom of the 1960s and 1970s may be unsurprised by the phenomenon. What is new is the scale of it. More money was raised through private equity in the first half of last year than through stock-market flotations. Private equity embraces everything from providing vital venture capital for new start-ups to short-term moves to strip companies of their property assets before selling these firms, laden with debt and without any of that concern for staff that has allowed some businesses, such as the John Lewis Partnership, to thrive.
    It is good that equity firms are responding to public concern. They have even produced a survey claiming that they generate jobs much faster than traditionally financed ones. That needs a lot more scrutiny before it is taken seriously. Even if it were true that they merely accelerate the destructive forces necessary to make economies more productive, it ought to be done in a more opaque and humane way. If they do not learn from the current debate and stop treating companies as if they were objects in a private game of Monopoly then they should be unsurprised if the government is forced by public opinion to curb their excesses.

The Guardian     February 24, 2007

Corporate buccaneers caught in a political storm
One in five in private sector works for firms owned by controversial funds

David Teather and Jill Treanor

Stephen Thompson started working as an AA patrolman in April 1985. It was, he says, his perfect job. On several occasions he was named patrolman of the year in his region. But 20 years to the day after joining, he left with a payout of just £18,000. His marriage has since broken up from the stress. Thompson, now 46, has no doubt who to blame - the private equity owners of the AA who bought the business in 2004. "I'm very angry," he says. "All they are here for is for profit making. They ripped the guts out of the AA."

If critics are to be believed many more workers will share Mr Thompson's fate if the private equity juggernaut is not checked. In the past few weeks, this burgeoning but secretive industry has been catapulted out of the shadows and into the political spotlight. Private equity has become so powerful that a handful of firms own businesses that employ one in every five workers in the private sector in Britain. The firms are largely secretive, rarely give interviews and do not disclose who invests in their funds. The industry meanwhile has made a small number of people who manage the funds immensely rich. Sir Ronald Cohen, the Labour donor and adviser to chancellor Gordon Brown who founded private equity firm Apax, is said to be worth £250m. Damon Buffini, who grew up on a Leicester council estate and is now a managing partner at Permira, is estimated to be worth £100m.

Few people outside the business world would have heard of these companies just a short time ago. But now they find themselves the latest flashpoint in a broader debate on social divisions as City financiers bank billions of pounds in bonuses while ordinary workers struggle. Within months of buying the AA for £1.75bn, the private equity owners Permira and CVC Capital had cut 3,400 jobs. Permira, the largest private equity group in Europe, last year bought Birds Eye from Unilever and pledged to keep workers' employment terms for at least three years. Within five months it had closed a plant in Hull at
the cost of 600 jobs.

Unions have now forced the issue on to the agenda in the battle for the Labour leadership and on to the front pages. Workers at NCP, the UK's biggest car-parking group, picketed the offices of private equity owners 3i this week complaining of a pressure-cooker environment and failure to recognise the union. They were met by John McDonnell, a Labour MP and candidate for party leader. He said it was a "national scandal that the casino capitalists from global private equity groups are allowed to treat British workers and some of our biggest companies as nothing more than pawns in a game of

Buffini broke cover yesterday and gave interviews to Radio 4 and the Financial Times in an effort to calm the growing political storm. "People don't quite understand what we do and the benefits we do bring to the economy," he said. "There is a positive story about productivity and job creation. Those messages have not gotten through."

Private equity has been described by The Economist as a "superior model of capitalism". It can generate huge rewards for its investors in a short period of time. One City dealer described it as akin to trading companies like secondhand cars. There are two kinds of private equity deals. The first, sometimes referred to as venture capital, involves investment in small start-up businesses. The second is the more contentious; the aim is to target businesses that may be badly run, undervalued or in need of an overhaul. Private equity firms buy the companies with money from rich individuals and financial institutions such as pension funds, alongside large debts. Private equity has flourished in Britain because firms can claim tax relief on interest payments on the debt used to buy the businesses; a loophole unions want to close. The aim is to sell the business again or float it on the stock market, typically within three to five years, at a profit.

The amount spent buying public companies in Britain last year reached a record £26.3bn. There have been so many buyouts that the combined value of companies on the stock market is shrinking. Other household names bought by private equity last year include United Biscuits, Matalan, Travelodge, John Laing, Associated British Ports and Phones4U. The US private equity firm Apollo this week bid £1bn for Countrywide, the UK's biggest estate agency.

And they are getting more ambitious. It emerged this month that a consortium of four private equity firms is running the slide rule over the supermarket group Sainsbury's. If the £10bn takeover were to happen, it would enter the history books as the largest private equity deal ever done in Europe. "It is about extracting as much as you can as quickly as you can," says Karel Williams at Manchester Business School. "It is part of a broader series of changes in capitalism.

These intermediary groups, like private equity and hedge fund managers, are able to enrich themselves in ways thought unimaginable a few years ago. "The ultimate question is whether this behaviour becomes normalised and accepted. This is a socio-cultural change. The culture of naked self-interest among private equity managers is characteristic of the elites in third world countries."

Senior managers are also getting a share of the spoils, raising questions about their decisions to sell out companies. "In the debate on private equity, it is important to recognise the potential conflict of interest for senior management," says Michael Gordon, chief investment officer at Fidelity, one of the biggest fund managers in the world. "They become highly incentivised to sell out to new owners."

Debenhams has become the text book case. CVC, Texas Pacific and Merrill Lynch Private Equity used £600m to buy the business in 2003. They increased the retailer's debt from £100m to £1.9bn and paid themselves a dividend of £1.2bn. They sold the freehold of the stores for £500m and leased them back. They then floated the business and took another £600m. In a little over two years, they made around three and a half times their investment. Debenhams now faces huge interest payments and rent on stores it once owned. Yesterday, its shares rose 10% on speculation that the private equity
industry may try to buy it back again - in a clear illustration of the need by private houses to find homes for their cash.

Anger at NCP has been stoked by reports that 3i is preparing to sell the business to another private equity group after just 18 months for a profit of £245m. Francis Fordjour is a parking attendant at NCP in Enfield, north London and has joined colleagues on strike. "Working conditions at NCP are horrible," he says. "All they are interested in is how many tickets you have issued."

Patrick Dunne, a 3i director, says the image of a ruthless owner wringing the business dry is far from the truth. "No one wants to buy a business that has been starved of investment or has a reputation for mistreating its workforce. "The other social issue that isn't mentioned is that millions of people benefit from private equity because their pensions are invested in these funds. There is, he says, no intention to "flip" NCP quickly, but adds that "we have a duty to our shareholders to consider any proposals".

Permira is equally dismissive of the claims of unfair treatment by Thompson at the AA. "He left voluntarily with a generous financial package which followed a performance review in March 2005 when all patrolmen were reviewed," an AA spokesman said.

There are signs that the private equity fad might be running out of steam. Company shareholders and directors have begun to fight harder and demand higher prices for their businesses. Approaches for the likes of ITV, EMI and HMV failed. And the latest offer for Countrywide is a second attempt which may fail again.

Economists fear a downturn in the economy or higher interest rates could spell disaster. Companies that private equity firms have loaded with debt and liabilities like rent are much more vulnerable. We have been here before. Highly leveraged management buyouts became popular in the 1980s. They fell out of favour as the economy dived and a couple of high-profile companies defaulted on heavy debts.

The Financial Services Authority recently warned that the City should get ready for some "short sharp shocks". Former AA patrolman Thompson, might argue that the short, sharp shock has already been delivered.

The Guardian    February 24, 2007

Very private plutocrats leading new gold rush
Men behind the millions

Philip Yea - Chief executive, 3i Group

Philip Yea runs 3i, the only private equity firm in the FTSE 100. He joined the business in July 2004 while the company was still struggling with the legacy of a clutch of poor investments during the dotcom boom. He has shifted the business away from technology, invested more in fast growing markets overseas and sharply reduced the portfolio. By last year profits were back up at £855m, from £500m in the previous year. Before private equity, Mr Yea, 51, spent most of his career in the corporate world. He was with Guinness and then its latter day incarnation Diageo for 13 years, six of them as group finance director.
Guy Hands - Chief executive, Terra Firma

Hands is one of the highest profile financiers in the City, perhaps best known for a string of deals that made his then employer, the Japanese bank Nomura, Britain's biggest (and unlikeliest) pub landlord. Hands joined Nomura in 1994 and spent billions of the bank's money on a succession of less than glamorous assets including the former British Rail leasing company Angel Trains and 57,600 Ministry of Defence-owned homes. Hands, 46, set up Terra Firma in 2002. He has pledged £65m of his own money to the firm's next fund, which is looking to raise £3.5bn. Terra Firma owns the Odeon and UCI cinema chains in Britain.

Damon Buffini - Managing partner, Permira

Buffini, 43, has become the poster boy for the private equity industry and Permira Europe's biggest private equity firm. The son of a black American serviceman, Buffini was brought up by his mother on a Leicester housing estate. He went to grammar school, Cambridge University and Harvard before ending up at the investment bank Schroders and engineering the management buyout that created Permira. Some of the most stinging campaigns orchestrated by the GMB union against private equity have targeted him personally. The firm already owns household names such as the AA, Little Chef and New Look. Buffini's personal fortune is estimated at at least £100m.

Henry Kravis - Founding partner, Kohlberg Kravis Roberts

Arguably, Kravis is the founding father of the private equity business and the rightful owner of the sobriquet "big swinging dick". With his first cousin George Roberts and their mentor Jerome Kohlberg, he set up Kohlberg Kravis Roberts 1976. The deal for which they are best known is the record-breaking buyout of RJR Nabisco in 1989 which was immortalised in the book Barbarians at the Gate. Two decades on, KKR is still doing deals including buying toy retailer Toys "R" Us. Married three times, he has had three children including a son who died in a car crash aged 19.

Sir Ronald Cohen - Founder, Apax Partners

A grandee of the British venture capital business, Sir Ronald set up Apax in 1971 with three friends at the age of 26. Apax invested in firms including PPL Therapeutics, which cloned Dolly the sheep, and the computing group Autonomy as well as Virgin Radio and Waterstones. He retired from the business 18 months ago and is actively involved in the Middle East, directing funds to Palestinian businesses. He is a Labour donor and well known for parties at his home in Notting Hill. Born in Egypt, Sir Ronald arrived in Britain at the age of 11 unable to speak English. Today he is worth some £250m.

Philippe Costeletos - Head, European team, Texas Pacific

Philippe Costeletos is the venture capitalist who masterminded the buyout of Debenhams three years ago. Now relisted on the stock market, it is held up as the textbook "flip it and spin it" venture capital deal. When Debenhams was relisted, the retailer was laden with debt after the venture capitalists had taken their spoils. Texas Pacific also became a household name after it prompted a staff walkout at the airline catering firm Gate Gourmet and sacked the strikers. A native of Greece, he has been with Texas Pacific since 2003, joining from Investcorp where he was involved in a number of buyouts in Switzerland, Norway, the Netherlands and the UK.

Michael Smith - Chairman, CVC Capital Partners

Smith joined the firm in 1982 when it was part of Citigroup, the biggest banking group in the world. He became managing director in 1986 then led a management buyout of the business to create CVC, one of Europe's leading private equity groups. The firm has made billions buying and selling companies including Kwik-Fit and Debenhams. It managed to earn four times its original £137m investment in the Halfords bike and car chain. It is now moving aggressively into the Asia Pacific region. Smith, 54, avoids publicity. He has homes in Berkshire and Monaco and is married with two children.

Jon Moulton - Alchemy

Moulton is still best known for a deal he never did. Villified at the time as a "ruthless asset-stripper", Moulton had attempted to buy the MG part of MG Rover in 2000. He lost out to rival bidder Pheonix Partners, who promised to save all 6,000 jobs, rather than the fraction offered by Moulton. Rover collapsed anyway and Moulton has since described feeling "an awful shame" about the affair. Moulton was one of the first private equity specialists to give interviews and defend the industry. Before Alchemy he was in charge of buyouts at Apax and was once a player at Schroder Ventures, the business that has now become Permira. His wealth is estimated at £50m.

The Guardian  February 23, 2007

Private equity is casting a plutocratic shadow
over British business
Both main parties are in thrall to this damaging drive
to maximise short term profits and avoid corporate accountability

Will Hutton

    It is time to come to the defence of the public limited company, one of the great Enlightenment gifts to western civilisation. Increasingly capital, in the quest for higher returns to make vast personal fortunes, is going private to escape the demands of public accountability on stock markets. If uninterrupted, the long-term adverse consequences of this privatisation of capital for our economy, society and democracy will be profound.
    Even six months ago, very few outside the City or the readers of business pages had come across the idea of private equity. Today, as Sainsbury's is stalked by a club of four private equity firms allegedly plotting a £10bn bid and the GMB has ignited a campaign against job losses incurred in private equity restructurings by comically embarrassing one its leading lights - Damon Buffini, the boss of Permira - private equity is news. It is even becoming an issue in the contest for the deputy leadership of the Labour party.
    Quite right. Private equity is now the dominant element in the stock market. According to the Financial Services Authority, in the first six months of 2006 private equity firms raised £11.2bn in capital on the London Stock Exchange. Ordinary firms raised £10.4bn. So many public companies are being taken over by private equity companies, or retiring their own shares to head off the risk, that the London stock market, despite rising average share prices, shrank by nearly £50bn in the same period. More than 2.5 million people in Britain work for private equity companies.
The story, as recounted by consensus opinion from the shadow chancellor, George Osborne, to the CBI, and eagerly rehearsed by the private equity industry itself, is that the emergence of more than 700 private equity companies deploying saving and borrowing power of more than £1 trillion is crucial to wealth generation. By taking public companies out of the public arena of accountability, regular reporting and scrutiny, they can instead enjoy the benefits of engaged, committed ownership.
    Too many companies, they allege, are just not trying hard enough to maximise their profits, indulged by disinterested pension fund and insurance company shareholders. They need the managerial alchemy of private equity investors who, aiming to make "life-transforming" money for themselves, will give them the necessary managerial and strategic shock treatment.
    One truth about private equity shines out: the extravagant management fees and annual "carry" (the share in profits) certainly means life-changing fortunes. Researchers at Manchester University's ESRC Centre for Socio-Cultural Change recently got hold of the internal management accounts of one fund with up to £8bn of funds under management. After five years 30 full partners expected to make between £25m and £50m each.
    The rest of the industry's claims about creating jobs, investment and exports do not bear close scrutiny. Much of the alleged managerial alchemy is no more than old-fashioned financial engineering - that is, leveraging up returns by incurring lots of debt. One study by Citigroup showed that if pension funds and insurance firms had borrowed money themselves and invested in a basket of companies in which private equity groups invested, they would have made higher returns than even the best-performing private equity firms.
    Mortgaging the future to capture gains for personal enrichment in the present is easy - as one chief executive of a well-known public company told me recently, the task of the good manager is to resist it. Managers have to balance the interests of today's shareholders with tomorrow's shareholders. Private equity drives a coach and horses through the proposition. And as Paul Myners, the former chairman of Marks & Spencer and chairman of Guardian Media Group, has remarked: "The one party that is not rewarded is the employees, who generally speaking suffer an erosion of job security and a loss of benefits."
    The catalogue of firms thus financially engineered is endless. A consortium bought the car rental company Hertz in 2005, packaged up the car fleet in blocks of tradeable assets that could be bought and sold by banks, and sold the weakened company back to the stock market. Others have bought media outfits such as PanamSat in the US or EirCom in Ireland - not to develop a free media that holds truth to power but, as Columbia University's Eli Noam argues, to weaken that capacity while remaining unaccountable owners themselves.
    In Britain Debenhams was bought, its stores sold off to be leased back by the enfeebled company, which was then sold back to the stock market. And other public companies, including ICI, Amec and EMI, are being stalked, and adjusting their strategies accordingly. The shadow of private equity falls everywhere, making the gamut of British business hyper short-termist.
    This is not pro- but anti-wealth-creation. In this respect the attitude of private equity closely mimics that of the Chinese communist party. Both conceive of companies as networks of contracts between capital and labour that generate revenue streams to be manipulated by whoever has central control for personal or political advantage. Neither has any conception of companies as Enlightenment institutions that incorporate real-life human beings into a joint enterprise, in which being publicly scrutinised and held to account helps managers make better decisions. The foundation of a durable business, as James Collin and Jerry Porras argued in their famous book, Built to Last, requires vision, values, leadership and purpose around an organisation's "reason to be" - the antithesis of everything private equity stands for.
    So if we want such companies, shareholders have to give managers room for manoeuvre and back long-term business strategies. But British shareholders are not required by law to take their ownership responsibilities seriously (it would be a "burden on business"). Nor are British companies required to give them the range and quality of information that might help them. As a result, British shareholders are extraordinarily neglectful of their ownership responsibilities.
    Pension funds and insurance companies are myopic and short-term enough, but because takeover is so easy in Britain private equity has been able to carry short-termism to new extremes. This is said to raise productivity and performance. I would argue the opposite. The chief reason British business remains at the bottom of the international league tables for innovation, research and development, and productivity growth is because of too much takeover and too much private equity. Innovation lowers short-term profits.
    The answer is obvious. Private equity cannot be outlawed; in any case it can do a good job. Rather, the perverse incentives in Britain that favour takeover need to be removed. We need to defend the public company and create conditions in which it can prosper. But who is going to do that? Not the Conservative party, in thrall to private equity, and not, judging by its legislative record, the government. Our politicians are confused. There is more to wealth creation than constructing a plutocracy of private equity partners.

· Will Hutton is chief executive of the Work Foundation and author of The Writing on the Wall.


Koolio    February 23, 2007 6:06 AM
    Having railed against stock market capitalism, I find it interesting to see Will Hutton defending the companies listed on the stock market.
    It takes two to tango, in order to buy the companies, institutional investors like pension funds and insurance companies, who tend to own most of the shares, have to be willing to sell.
    Taking Sainsburys, the shares were trading at 400p before the possible buyers were flushed out, now the shares are valued at over 500p and any expected offer is likely to come in north of 550p. So if a take-private deal can prove the market - all those traders, fund managers and city analysts - wrong, and pay 25% more than the market price, let them put their money on the table. In some cases, as with Marks & Spencer and plenty of others, investors will reject offers and back the incumbent management.
    Hutton says that "if pension funds and insurance firms had borrowed money themselves and invested in a basket of companies in which private equity groups invested, they would have made higher returns than even the best-performing private equity firms." Yes, but they didn't do this. Is Will Hutton calling for pension funds companies to load themselves up with debt?
    The debate about the wealth of the partners involved is really a separate matter. There are many others in the City from traders to hedge fund partners who are making a lot more money. I suppose I can see how talk of these big salaries is useful for the Labour Party's internal politics but listing people's wages is only good for demagogy and cheap newspaper headlines.
    Finally, all this is a topical subject but it'll blow over. No one has yet to even make an indicative offer to the board of Sainsburys. Right now, money is very cheap at the moment and the stock market has been rising, two conditions ideal for private equity houses. As the credit cycle is perhaps turning now, things should look different in a year's time and those private equity might rhyme with negative equity.
Offensive? Unsuitable? Email us

steerforth    February 23, 2007 6:28 AM
Will        Private equity has enjoyed very good returns on capital in the last 4 years for the simple reason that they
have been operating in an environment of low interest rates and rising stock markets. They have benefited in
exactly the same way as people who were lucky enough to have purchased houses utilising low mortgage rates. Any
time a private equity company buys a quoted company and tries to develope it for a profit it is engaging in a
high risk activity as it uses its own capital and a large amount of debt.
    You seem to be a little naive in your glowing description of public companies and how they came from the enlightenment
era. Public companies have never been properly accountable to their shareholders since the directors have always
been able to use proxy votes to act in their own interest which is often not aligned with the shareholders. The incentives to act for short term profitablity is just as strong for options holding directors as it is for the private equity companies.
Offensive? Unsuitable? Email us

fortyniner    February 23, 2007 6:32 AM
    Looks like we have a new version of "selling off the family silver". Only this time, it is the private sector which is the target. In the old days, this sort of activity was called "asset stripping" and "the unacceptable face of capitalism". But in a society where money has become "god" those who makes loads of it are worshipped as "gods".
    But as the Native Americans would say "you can't eat money". We have been warned.
Offensive? Unsuitable? Email us

TimWorstall    February 23, 2007 9:15 AM
    A quick question for Will Hutton if he's ever going to demean himself by getting down and talking to us plebs in the comments.
    Your argument is that there is something vastly better about companies being public than there is in their being private.
    Excellent, so when is The Guardian being floated?
    Of doesn't it work like that? I'm sure I saw pieces a year or two back, around the time of the changeover to the Berliner format, stating that it was in fact the paper's private ownership which enabled it to make the huge investment required, freed from the short termism of the public equity markets.
    Do as I say, not as I do perhaps, from one of the trustees of the Scott Trust, who own The Guardian?
Offensive? Unsuitable? Email us

englandismdotcom    February 23, 2007 9:28 AM
    Go to Guardian Unlimited and peruse 'neo-liberal' McGreevy's stalwart defence of private equity houses:
"I believe that private equity houses and activist fund managers of all kinds, including hedge funds, play a much more valuable role than any government or regulator in propelling the liquidity of our capital markets, in reducing the cost of capital, in driving forward Europe's growth and in equipping European industry to survive and compete in the more challenging global markets we now face."
    And, then if you missed it, go to Radio 4 Today and listen to the interview with Damon Buffini of Permira.
    A more 'neo-liberal' champion it would be hard to find given his background and rise from the 'underclass' but still this does not prevent the TUC from launching an animal rights style campaign of personally targeted public vilification.
Offensive? Unsuitable? Email us

GJTORY    February 23, 2007 9:32 AM
    It is worth pointing out, Mr Hutton, that in order for the these private equity partners to earn the £25m - £50m you write of, if they get a 20% share of profits as carry, they would have to generate returns of about 20% per year for those 5 years on £8bn.
    That is a pretty good return by anyone's standards. If they generate it, why should they not be paid?
    fortyniner - private equity funds plan on selling the 'family silver' back to you after 5 years - and in considerably better shape than when they bought it, for more money.
    But no one forces the buyers of those companies to buy them. They only do so if they think it is a good deal. Therefore private equity is incentivised to deliver healthy companies. Short termisim does not prevail in private equity. That is a myth peddled by unions.
    What is more, Koolio is right (IMO). Currently there are a lot of private equity funds with a lot of money to spend because it is easy to raise funds. With higher interest rates or a recession this will cease to be the case and private equity may go back to being the niche investment style that it used to be.
Offensive? Unsuitable? Email us

eleuthera    February 23, 2007 9:46 AM
    Hutton lauds the public listed company as "a great Enlightenment gift to Western civilisation". The reason for his enthusiasm? "Being publicly scrutinised and held to account helps managers make better decisions."
    What he fails to understand is that, in relation to public companies, mechanisms of accountability have had to be developed because of the separation of ownership and control. Since ownership of the company rests with a diverse population of shareholders (often pension funds and insurance companies), whereas control rests with the board of directors, accountability mechanisms have been developed to allow the owners (shareholders) to keep an eye on what the directors are doing with their property (the company).
    Where a private equity firm purchases a company and takes it off the stock market, ownership and control are much more closely aligned. The population of shareholders is far less diverse, reduced to a population of one or two (or, in the unusual case of the Sainsbury's bid, four). This concentration of ownership means that formal accountability mechanisms (quarterly reports, regulatory announcements, etc.) become far less important; the owners are actively engaged in supervision and management of the business.
    What Hutton has overlooked is that these accountability mechanisms are not an end in themselves; they were designed as a solution to the problem of a diverse and therefore disenfranchised shareholder base. A privately owned company does not suffer this underlying problem, therefore the formal accountability Hutton desires is not relevant.
    A couple of weeks ago, Hutton wrote similar a peice in the Observer,,2010611,00.html
which laughably sought to link the Sainsbury's bid with the Bernard Matthews contamination. He asserted (with absolutely no justification at all) that managers of companies owned by private equity firms would be more likely to turn a blind eye to breaches of health and safety laws.
    This analysis is at best lazy if not mendacious. It shows little understanding of the nature, purpose or function of private equity in the economy. Observer and Guardian have far better economic and business writers on their staff (Larry Elliot, William Keegan, Richard Wachman). Why do these papaers continue to publish such undistinguished thoughts from a writer who has repeatedly been found wanting? Oh yes, that seat on the Scott Trust....
Offensive? Unsuitable? Email us

Accor    February 23, 2007 9:55 AM
    Notwithstanding the arguments above, Hutton is arguing that Britain is less innovative because it is tied down by short-termism and PE. If this were true, wouldn't the United States, which has a significantly more advanced PE culture, be saddled with the same problem? Under Hutton's reasoning, the US should be the least innovative and productive nation, rather than consistently one of the most. Could it be that Hutton's desire to make a political point has interfered with his analysis?
Offensive? Unsuitable? Email us

Trilobyte    February 23, 2007 10:48 AM
    I'm inclined to agree that Private equity largely appears to be geared to cherry picking the profitable parts of a business for the short term benefit of a very few people, but I need convincing that public listed companies are paragons of probity and virtue just because they are accountable to the stockmarket and have to publish accounts-Enron, Parmalat, MCI, BAE anyone?
Offensive? Unsuitable? Email us

Margin    February 23, 2007 11:01 AM
    It should also be pointed out that a factor in the rise of private equity is not the cheap debt they use to buy firms, but the fact that so many firms have failed to take up the advantage of cheap debt to improve their business.
    When debt is cheap public companies should be in a good position to take out debt to expand their business or invest in cost reducing technology. That might mean building new stores at home or abroad for a supermarket. Or it could mean installing new robotics equipment in a factory.
    The rise of private equity clearly suggests that not only are a lot of public listed firms being badly run, but that there are major opportunities for expansion out there being missed by UK firms.
    The UK’s biggest economic weakness is the low standard of managers in its firms. They lack ambition. They lack vision. And they lack the will to act.
    So if private equity is widening the influence of the very best managers in the world, that must surely help Britain?
Offensive? Unsuitable? Email us

CityBoy2006    February 23, 2007 11:14 AM
    Some good posts debunking the frankly poor arguments put forward that somehow PE is a house of cards waiting to tumble and is somehow screwing the workers / pension funds / society etc as it does it.
    PE works by identifying underperforming companies and unlocking efficiencies that the incumbent management either lacked the vision to do, or as is more usually the case, were too constrained by governance, board inaction and lobbying by interest groups such as unions. PE often returns these companies to the market or sells them on to other PE groups (see the recently proposed NCP deal). If these companies had been gutted and were being returned to market as basket cases don’t you think that the institutional investors, PE buyers etc would realise this and not touch the stock?
    PE takes on risk (often the partners doing so personally) and speculate where others can’t. But it is a typical labour left response to a perceived problem, not if they can do it, why not other bright guys? Rather if the majority can’t do it lets stop those that can.
Offensive? Unsuitable? Email us

Ieuan    February 23, 2007 11:28 AM
    eleuthera said: "accountability mechanisms are not an end in themselves; they were designed as a solution to the problem of a diverse and therefore disenfranchised shareholder base. A privately owned company does not suffer this underlying problem".
    Surely what Hutton is saying is that 'a diverse......shareholder base' is not a problem, in fact it is a benefit (as said also Maggie Thatcher, remember that we were 'all' going to be shareholders, owning British business as 'stakeholders'). Disenfranchisement is a problem, but needs other methods to solve it, scrapping the diverse shareholder base to get rid of the disenfranchisement really would be throwing the baby out with the bathwater.
    A couple of decades ago the behaviour of the private equity firms would have been simply called 'asset stripping' (as has been pointed out before). This was roundly condemned and steps were taken to prevent it. But, as always, those who make money out of money (rather than by doing anything productive) found a way to get round any restrictions and go on looting the work and creations of others for their own short term benefit.
Offensive? Unsuitable? Email us

Cameron1    February 23, 2007 11:45 AM
    Since when did Private Equity become responsible for the following: "The one party that is not rewarded is the employees, who generally speaking suffer an erosion of job security and a loss of benefits."? Final salary pension schemes have become hen's teeth without the so-called malign influence of private equity. I agree with eleuthera that much of your analysis is recycled horseshit. Private equity has succeeded in transforming some of the UK's worst commercial laggards: Travelodge anyone? Don't forget that for Debenham's to be re-floated, institutions clearly wanted to buy it back which they did. Why? Because it was still worth buying and it floated successfully. The underperformance of many plc's is in fact due to reticent pension funds who have themselves become too bureaucratic and obsessed with computer models to take an active interest in their holdings and reprimand poor managers. I am afraid you're just a johnny come lately in joining the already overcrowded train of private equity bashers. PS if you wish to produce convincing analysis, you have to at least skim over both sides of the story to form an argument.
Offensive? Unsuitable? Email us

recklessinspector    February 23, 2007 11:47 AM
    Will Hutton seems to be arguing for more responsibly monitored public companies as the solution to the alleged 'problem' of private equity. However, I would tend to look at things from the other way round: isn't private equity actually an imperfect and problematic solution to the long-standing accountability problems that continue to plague our listed company sector.
    The US Enron fiasco and dotcom bubble problems showed that, despite the expertise of institutional investors and stock analysts, such parties are always at an informational disadvantage relative to managerial 'insiders'. In any event, the inherent liquidity of public capital markets means that they are naturally limited as a source of long-term, large-scale or high-risk investment capital (as Mr Hutton himself argued in his excellent work 'The State We're In'). This no doubt partly explains the current popularity of public infrastructure businesses in the eyes of private equity funds, whose more concentrated ownership and incentive structures arguably make them better placed to support extensive investment projects carrying considerable economic and/or political risk.
    Furtheremore, despite the best intentions of policy-makers, recent regulatory initiatives such as the Combined Code on Corporate Governance have only served to burden UK listed company boardrooms with American-esque independence and sub-committee structures, without any obvious benefits in terms of either improved informational flows to shareholders or more responsible share pricing practices. So, whilst private equity is undoubtedly a highly problematic institution, let's not allow it to blinker us from the more fundamental accountability and incentive problems that it is (albeit indirectly) trying to solve.
    And, as a final matter, I fear that by making the wholesale assumption that private equity investors are a bunch of short-termist asset strippers, influential commentators from the left (such as Mr Hutton) risk being excluded a voice in the debate about the future of this highly complex investment phenomenon. For instance, regardless of one's opinion on the wider merits of private equity transactions, is it wise that BAA, the operator of seven British airports including Heathrow, should be burdened with multi-billion pound debt liabilities on top of a huge government-agreed investment schedule? More worryingly, what would happen if a major private equity-funded instution like BAA or Thames Water went bankrupt due to a change in the credit environment? Would the government sit back and allow this to happen, or would we, the taxpayers, be force to step in and act as a creditor of last resort?
    However, these are specific consequences of private equity infrastructure investments that need to be investigated urgently, and I feel that by simply denouncing the institution of private equity as a whole, we are only helping to mask these extremely serious but specific risks to Britain's economy and society as a whole. So, for the sake of Britain's future, the left urgently needs a voice in the private equity debate. And, by making broad-brush negative conclusions about what is both a highly valuable but also highly risky feature of our current corporate governance landscale, I feel that we only risk discrediting the case for considered regulatory reform.
Offensive? Unsuitable? Email us

Gumbo    February 23, 2007 12:05 PM
    The article completely glosses over the fact that when these supposedly crippled companies are sold back onto the stock market, they attract perfectly willing investors to buy them. Implicit in this is that Hutton believes that somehow the entire market is being somehow mislead and that perhaps only he has spotted that the company is a shell now.
    Or on the other hand he could be talking rubbish. Companies relisted after PE firms have been owners actually outperform the market. Those buying these companies - ie the future shareholders - get a good deal. What's more the consumer gets a great deal too, because PE firms are relentless on cutting off dead wood and improving efficiency. In some cases they do heavily gear the company, but basically any reasonably solid non-cyclical company probably ought to be heavily geared anyway. What's more, PE firms are less reliant on borrowing to achieve their aims than they are on getting the right management in place and setting up good incentives.
Offensive? Unsuitable? Email us

PeterHCT    February 23, 2007 12:11 PM
    Will Hutton - "The answer is obvious. Private equity cannot be outlawed; in any case it can do a good job....defend the public company"
    GJTORY - "it is easy to raise funds. With higher interest rates or a recession this will cease to be the case and private equity may go back to being the niche investment style that it used to be."
    Well, we are getting higher interest rates. Need to check the source, but read since 9/11 money supply grew at perhaps twice what might have been justified by growth+inflation, if that is the correct equation. So lots of cash sloshing about to be lent, hence silly property prices [1], availablity for privateering equity, etc.
    As far as I can follow it, the maxim nowadays is that interests rates are a tool for the Bank of England to control inflation. All jolly fine as far as that goes, but interest is basically a price. Market forces eventually dictate prices.
    There are mutterings that inflation is more than not the Governments quoted rate against which the Bank's performance is measured.
    There are doubts on the extent to which PFI has obscured HMG's borrowing position.
    Oh, wars and rumours of wars. Iran?
    What if - or indeed when - this lot comes unstuck? Not neatly and gradually, as economists like to forecast, but abruptly with an 'Oh, shit' factor as tends to happen in the imperfect real world??
    Just how robust are these private equity firms' calculations on debt and interest cover? One publicised disaster, and it might all look a bit silly.
    I'd like to think I'm being over-pessimistic, but I really can't convince myself that it's anything more than healthy scepticism.
    [1]FSA "We believe that, at this point in time and reflecting current market conditions, an average reduction of 40% in property sales price forms an appropriate reference point when assessing downturn LGD for mortgage portfolios."
Offensive? Unsuitable? Email us

Agog    February 23, 2007 12:55 PM
    More British anti-business sentiment. What is this country going to fall back on when the finance industry goes into a spin?
Offensive? Unsuitable? Email us

North2South    February 23, 2007 1:07 PM
    Despite economists' assumption that firms maximise profits, in reality many (most?) firms could operate more efficiently - they just need a kick up the backside to do so. Often, that comes through competition from a new entrant to the industry, or from a sudden and sharp rise in one of their costs (eg energy). In this case, it comes from the fact that low interest rates and sophisticated financial markets raise the threat of leveraged buy-outs and repackaging of financial agreements. If it increases the efficiency of production, it is no bad thing. And other posters are right to say it won't last forever.
    In my view, more of a concern is when profits are made by removing rights from the workforce. If private equity firms are able to make large amounts of cash by stripping workers of security and entitlements, that is an unhealthy situation for society, and adds to the perception that British capitalism is working wholly to the advantage of the wealthy and to the disadvantage of the poor. But the minimum wage and other measures to strengthen workers' rights is the way to tackle that - not to favour some kinds of ownership over others.
Offensive? Unsuitable? Email us

duroi    February 23, 2007 1:10 PM
    May I request the Guardian to ensure that all columnists who write about economic issues have passed an Economics 101 exam?
    Even The Sun's agony aunt columnists would blush before writing such drivel as "balance the interests of today's shareholders with tomorrow's shareholders"
Offensive? Unsuitable? Email us

Tzimisces    February 23, 2007 1:21 PM
    Good article- not sure about some of the comments.
    First of all, the point is not about the distinction between private and public limited companies. The point is about private equity companies' behaviour. This is why Tim Worstall's comment is irrelevant. The Scott Trust are not asset- strippers, private equity companies can be.
    Secondly, constructing fantasy pictures about how firms should behave (eleuthera, GJTORY) is bad economics. Managers who own a firm are just as capable of behaving badly if they are effectively in debt to banks or investors. Their incentives are skewed away from long term investment to short- term debt repayment. THis is what is actually happening. Economics has long ago moved away from fantastical, fully informed, hyperrational profit maximisation as an assumption.
    Finally, (GJTORY and eleuthera again), Will Hutton is taking a Social Welfare viewpoint of the economy. He thinks that these companies are behaving pathologically and are harming the economy and overall social welfare. Simply assuming that profit- making is always socially enhancing or that the divide between owners and managers is the only problem is ridiculous.
    Will Hutton has taken a perfectly sound position. Is there any serious criticism out there?
Offensive? Unsuitable? Email us

rightwinggit    February 23, 2007 1:47 PM
    Why Doesn't WH just come out and say that the only people who should own the means of production are the workers.
Offensive? Unsuitable? Email us

Noah88    February 23, 2007 1:50 PM
    If it's so easy, why doesn't the GMB and the TUC run their pension funds as a private equity scheme and earn these magnificent returns for their members?
Offensive? Unsuitable? Email us

emillee    February 23, 2007 2:45 PM
    Will - If you want to have a go at private equity the place to start is those lovely PFI contracts that Brown donors like Sir Richard Cohen are mopping up. Fixed, 30 year investment terms (unheard of) plus tax-free profits.... Basically robbing taxpayer Peter to pay Labour donor Paul. If only I had a look-in, but I'm not a Labour donor so I haven't got a hope in hell.
    As for public companies being more moral and accountable, I just can't see it - if anything the profit motive is stronger because of the increased scrutiny. And there were plenty of excellent posts by other bloggers which you've obviously decided to ignore on that point.
    And the pensions disaster - I think we can partly thank Gordon for plundering the private pensions for that as well.
Offensive? Unsuitable? Email us

chrish    February 23, 2007 2:48 PM
    The success of private equity companies in buying companies from the equity market, selling assets and increasing debt and them selling them back on to the market does raise questions, as to whether the equity market gives eenough emphasis on the quality of a company's earning and assets.
    I do accept that it is not that easy and the post above (eleuthera February 23, 2007 9:46 AM) does provide some reasons why private equity can make money, but the mispricing of companies by the equity market must play some part as well. Valuations are often to geared towards financial ratios such as PE and EV/Ebitda measures rather than more closely examining the company as a whole and hidden assets. The current trend towards sale and lease back of property and other assets is surely a case in point.
Offensive? Unsuitable? Email us

melo    February 23, 2007 2:49 PM
    So when there are no British companies left and all the work has been outsourced to India and the private equity fund managers have gone to live in a more civilised country abroad (the majority of them being foreign anyway), what will the Government do then?
Offensive? Unsuitable? Email us

mhenri   February 23, 2007 3:01 PM
    Interesting, and in places not unpersuasive argument. Pity then, that Mr Hutton feels compelled to 'strengthen' it by dragging an entirely irrelevant red herring - that of those wicked and wickedly stupid 'Chinese Communists' who like private equity capitalists don't understand the great benefits of the publicly-owned corporation - across our path. Was Mr Hutton afraid that a discussion of the workings of the City in London wouldn't stand on its own without the Chinese spectre ? He reminds of those politicians who find it necessary to drag the name of Hitler into every discussion of the policies of adversaries.... Henri    Offensive? Unsuitable? Email us

mhenri    February 23, 2007 3:04 PM
    Interesting, and in places not unpersuasive argument. Pity then, that Mr Hutton feels compelled to 'strengthen' it by dragging an entirely irrelevant red herring - that of those wicked and wickedly stupid 'Chinese Communists' who like private equity capitalists don't understand the great benefits of the publicly-owned corporation - across our path. Was Mr Hutton afraid that a discussion of the workings of the City in London wouldn't stand on its own without the Chinese spectre ? He reminds of those politicians who find it necessary to drag the name of Hitler into every discussion of the policies of adversaries.... Henri
Offensive? Unsuitable? Email us

radished    February 23, 2007 3:40 PM
    "Observer and Guardian have far better economic and business writers on their staff (Larry Elliot, William Keegan, Richard Wachman)."
    Nothwithstanding the shoot the messenger criticism Hutton comes in for we should most definitely have more from Larry Eliot
    "Yet, according to Nesta, Britain still seems to be doing just fine and "has one of the strongest economies in Europe". This, says Nesta, is a paradox. If innovation is so important, how come the UK has been growing robustly? Its answer is simple: the data is misleading. "The resolution of this paradox lies in the way in which innovation has typically been measured."
    Well, that might be one explanation. Another might be that growth in Britain has been boosted by a substantial expansion of the public sector. Another might be that a colossal boom in the property market has allowed consumers to borrow against their main asset and so live beyond their means for a prolonged period.
    The lack of rigour in this analysis of Britain's recent macro-economic performance hardly inspires confidence. If the traditional measures of R&D do not really reflect the dynamism and creativity of the UK, why is that over the past 15 years Britain's trade balance has dived deeper and deeper into the red while those countries that score well on R&D and product innovation - Sweden and Finland, for example - run healthy trade surpluses? The suspicion that Nesta, a body funded by the national lottery, is scratching around for some good news only deepens when it lists examples of Britain's hidden innovation. These include creating the National Cycle Network, regulations and incentives to improve social housing, networking among NHS scientists that has resulted in new genetic tests, and "aggressive" tax planning.
    It is clear that if you adopt a liberal enough definition you can describe just about everything as innovation. Within a 10-minute walk of the Guardian there is a barber's shop where the staff -allegedly - offer their male customers extra "services". This, presumably, would be seen as product innovation in Britain's thriving service sector. Most of us would call it prostitution.
    There are some bright spots. A group of executives from Japan's equivalent of the CBI were in town recently and were impressed by London as a centre for design. Some firms, such as Nissan, have already set up design centres in the capital. But some businessmen are concerned about design becoming divorced from manufacturing.
    Writing in the recent journal for the Royal Society for Arts, Ivor Tiefenbrun, who founded Linn Products, a Glasgow-based company making sound systems, said: "What I call design is so closely coupled to manufacturing and so competitive that it cannot survive if the links are too tendentious."
    Mr Tiefenbrun takes a somewhat gloomier view of things than Nesta. "The sad truth is that nobody in Britain has built a major manufacturing company from scratch since the time of the Attlee Labour government in 1945. All our major manufacturers pre-date the second world war. And yet countries that didn't exist, were only partially literate or were engaged in endless conflict 20, 35 or 45 years ago have managed to build major manufacturing businesses from scratch",,1928870,00.html
    The finance side has done a fantastic job, obviously
Offensive? Unsuitable? Email us

blowme    February 23, 2007 4:11 PM
    Surely the best form of company is one where the owners have the most control - in which case, private trumps public.
    The private equity boom is just another example of the effects of massive amounts of liquidity/cash sloshing about in the global marketplace. In itself, it is not a particularly pernicious force.
Offensive? Unsuitable? Email us

CityBoy2006   February 23, 2007 4:19 PM
    Why is the page not updating, haven't see any of the new posts since about 9.30 this morning
Offensive? Unsuitable? Email us

gordong156    February 23, 2007 4:47 PM
    It is interesting that so little of the wealth washing around the UK appears to have been earned through productive labour within the UK.
    Meanwhile debt, in all its forms, grows...
Offensive? Unsuitable? Email us

tommydog    February 23, 2007 5:35 PM
    It is amusing to see the Guardian refer to public companies as a great "Enlightenment give to Western civilization" and then to go on to criticize present shareholders of not living up to their responsibilities. I was unaware there was such sympathy and respect for the management of public firms.
    Mr Hutton says that British law does not require shareholders to take their responsiblities seriously and give management chance to manoeuvre and implement their strategies - shareholders are too focussed on short term gain. I am curious as to what rules Mr. Hutton would like to see imposed.
    The management of public companies do have opportunties to sell their ideas and strategies to the investment community. That's much of what investor relations departments do and what analyst conference calls are all about.
    However, fund managers' responsiblities are to maximize the returns their funds can achieve. Many mutual funds, pension funds, and individual investors do hold their shares for a long time. As long as they feel a shareholding will help accomplish that goal they may hang on to it. Some activist investors may even endeavour to influence management.
    To argue that shareholders have a responsiblity to provide company's with room to manoeuvre is to put them in a conflict of interest position as regards to their responsiblity to achieve (or more accurately "try to achieve") the highest returns possible for their investors.
    Furthermore, sometimes a shareholder might just think that the management's strategy is a crock of bull and that the firm is run by a bunch of Bozos. In Mr. Hutton's world what would be the shareholders' responsiblity under those conditions, especially if others (such as the CEO's mother) disagree with that assessment? At the moment you can simply either sell your shares or possibly try to beat up on the management. Neither action would meet Mr. Hutton's suggestion that management be given room to manoeuvre.
    PE firms are not necessarily buying up well run, highly valued public firms that "are built to last." Such firms firms by being highly valued are, therefore, expensive to acquire and wouldn't offer the potential to make an outsized gain.
    PE often target firms that they believe are not being run particularly well and aren't "sweating" their assets enough. They can give the management a well needed boot in the tail, or even bring in new management. Often they may invest significant amounts of capital. If they succeed they may have built something to last, or at least made it an attractive enough candidate for someone else to acquire once they're done making some "quick fixes."
    Many public companies probably shouldn't be public in any event. With the passage of Sarbanes Oxley in the US the costs of regulatory reporting and compliance increased several fold. Accountants are making a fortune. One may feel that after Enron, etc. this is all well and good, but there are many relatively small firms that are publicly listed. These have seen substantial amounts of their profits gobbled up by increased regulatory burden, reducing the earnings that they might otherwise utilize to implement their grand strategies.
    As a private company they may be perfectly decent, profitable firms, possibly even good acquisition candidates for a larger public firm. But as public firms they are not all that profitable and therefore often not worth much on the public market.
    Mr Hutton and The Guardian have been beating this drum for several weeks, and it seems as though he is mainly upset that someone might make a "life changing" fortune. True enough; someone might. It's possible that someone could also write a book, a song, a software program, or invent a new gizmo that might also result in a life changing fortune. So what?
    Frankly, this dog don't hunt.
Offensive? Unsuitable? Email us

guernica    February 23, 2007 8:11 PM
    There is an Australian Air line QANTAS, derived from Q- eensland And Northern Territory Airways. It is listed on international stock markets. The vultures (private equity) are circling to acquire the company using a technique of public bribery (offering to purchase current shares from stock holders at a premium )which caused the expected rise in the current value of each share. The offer amounts to a premium of 37% increase over the average broker price target of $4.09 / share. The offer is also accompanied by intimidation of current stock holders, by threatening a decline in the stock price if the offer is rejected. This rabid (a term derived from "rabies" a fatal disease, sometimes spread by the bite of a rabid dog) form of capitalism is accelerating homo sapiens to the inevitable abyss of extinction. Bribery, intimidation, corruption and false promises about efficiency - that's private equity. Incidentally, air travel, a major contributor to global warming/greenhouse gases is not discussed in the prospectus. Self-promoting thugs are begging the question "what is wrong with the current board, directors who are responsible for Qantas ?" I'll tell you what: they have accepted what amounts to a huge bribe.
Offensive? Unsuitable? Email us

emillee    February 23, 2007 10:36 PM
    Will - forgot to mention that other delightful private equity firm Carlyle, which this government has netted over £300m in a few years. And like Brown with Cohen, Blair is set to tidy up very nicely when he leaves office as a result. The whole Nulabour policy of giving taxpayers' money and government wealth to these firms is verging on treason.
Offensive? Unsuitable? Email us

The Guardian    March 7, 2007

· Debts will unravel deals, says Ernst & Young
· Treasury select committee starts inquiry into industry
Private equity predicted to spark company collapses

Phillip Inman

A string of corporate collapses is likely next year as debt-laden private equity deals begin to unravel, a leading firm of accountants said yesterday.
The complexity of the deals and the timing of debt repayments will undermine companies that under previous ownership structures might have survived, said insolvency experts from Ernst & Young.

The firm's analysis of corporate buyouts and potential losses for investors is likely to increase pressure on private equity firms under fire from unions over job cuts.

The government has called on the industry to be more transparent. The purchase of Madame Tussauds by US private equity firm Blackstone this week follows high-profile deals including Permira's buyout of breakdown recovery firm AA from Centrica and Birds Eye from Unilever
The Treasury select committee yesterday launched an inquiry into the private equity industry to review its impact on the economy and various stakeholders. The committee was responding to intense criticism by unions and senior Labour politicians following allegations of profiteering and anti-labour practices.

A report by the Financial Services Authority also prompted the review, the powerful all-party committee said.

Last week the industry said a working group chaired by former Bank of England director and Morgan Stanley banker, Sir David Walker, would examine the need for more disclosure by private equity firms and debt funds set up to buy companies.

The British Private Equity and Venture Capital Association (BVCA), which will publish the results of Sir David's inquiry, welcomed the intervention of the Treasury committee yesterday and said it would be pleased to make representations to MPs.

Private equity deals often involve buying companies with billions of pounds of bank loans and other funding through the international debt markets. Private equity firms often target stock market listed companies that they hope to revamp and re-sell in three to six years.

Unions say they are only able to manage dramatic increases in profits in a short time because they are largely based offshore and avoid corporation tax, avoid tax on much of their debt interest and use anti-labour tactics to drive down wages and other costs. Unions feared that a possible takeover of supermarket chain J Sainsbury by private equity firms would result in cuts to staff terms and conditions.

Fees paid to private equity firms have also attracted criticism. Partners in private equity firms have enjoyed bonuses that in some cases have dwarfed the sums offered by London investment banks, unions said.

Keith McGregor, an insolvency partner at Ernst & Young, said the complex nature of many private equity deals was likely to make them more prone to collapse if they suffered a downturn in sales or increase in costs.

"The quality of the debt has dropped off in the last few years. Debt with a CCC rating has a one in three chance of going bust within two years. But it is the fastest growing element of debt in private equity structures," he said.

He said the situation would worsen next year when a significant increase in costs would begin to hurt companies when they needed to fund the second tranche of their debt repayments. The first level of debt, known as senior debt, is paid back in instalments and lenders have the first call on the company's assets if it should go bust. The second and third tier of debt is typically paid back after four and six years respectively.

"Around 90% of the debt issued in the world is less than three years old. That means tranche two and three are still one and three years away from being repaid. There is no reason why the default rate will go up this year. I don't think it will hit until 2008," Mr McGregor said.

The big deals
Ten years ago a private company would only need to think about its overdraft and bank loans. Depending on the size of the company, the loan might be held by one bank or several. As Ernst & Young partner Alan Hudson describes it, one bank would act as sheriff if there was any problem making repayments. Those uncomplicated days have gone. A company subject to a takeover by a private equity firm will find itself with a layer of debtors, all with different rights and expectations. They might be hedge funds or pension funds. If the company gets into trouble it might find itself negotiating with a gang of distressed debt buyers looking for a quick profit.

In a typical deal, the owners of the first level of debt are paid first.

When a company fires its first distress signal these creditors may be in line to get 90% of their money back and care little if the whole enterprise goes under.

Other creditors, further down the hierarchy, may want the company to keep trading to give them a chance of recouping losses. Mr Hudson says firms like his have already seen creditors fighting so hard the company is paralysed and eventually broken up.

Leader, reader comments
The Guardian     March 27, 2007

Let there be light

Finance's more esoteric reaches may not lend themselves naturally to a gag , but some wits in the City are proposing a new definition of the verb "to privatise". No more should it refer to a state-run business being placed in the public stock market, they suggest. Now privatisation means whisking a firm away from the enormous exposure to the light of a public listing and into the hands of a private-equity firm.

Not the stuff of belly laughs, admittedly, but that jokes are being cracked at all is evidence of how private equity has entered the public consciousness. The practice of buying up companies on credit, making them leaner, and then selling them on at a profit has been around for decades, although it has rarely attracted public attention. All that has changed, however, with the sector's own ambitious growth. This explains why unions and thinktanks are on its case this week. Private-equity firms have already bought such names as Madame Tussauds and Birds Eye. Now they are circling over Sainsbury's and Boots. Going after such high-profile names means that private equity is also courting more scrutiny. Yet the industry has been slow to acknowledge this. Perhaps it is simply unused to the exposure. Even the humblest firm listed on the stock market has to report and justify its results at regular intervals. But there is no such requirement on private equity and the dominant attitude often seems to be: never apologise, never explain.
This may be changing. First, the outside world is trying to get a peek inside what is sometimes called "the dark box". MPs on the Treasury select committee have launched an inquiry into the sector. The Work Foundation's report on the industry yesterday shows that life for employees can get markedly worse after a private-equity takeover. Where a new management is simply imposed by the acquiring firm, the report finds, big lay-offs can result, with one in five jobs going within six years. Wages too can fall, leaving workers on average £231 a year worse off than their counterparts in the rest of the private sector.

The bete noire, for critics of the industry is what happened to the AA after it was taken over by two of the industry's giants, Permira and CVC, in the summer of 2004. More than 3,000 jobs - nearly 30% of the workforce - were axed. The GMB trade union also says that it has been derecognised by the AA's owners. GMB is finally to meet Permira this morning. It was only after a large publicity campaign (they took a camel along to one meeting) that the union secured the meeting. But the concession is a welcome one for the entire industry. The sector may be private in name, but that does not mean it should be unaccountable.

Reader comments

suraci    March 27, 2007 8:02 AM
    The AA was decimatd after the take over. The patrolmen are disillusioned and demotivated. I broke down, called the AA out and it took them 4 hours just to get to me, another 7 hours to get my car back to my home, 80 miles away. The attitude of the patrolmen was one of resigned apology, they were sorry for all the inefficiency but this was the neww AA, run with a skeleton patrol force that frequently runs out of driving time in the middle of recoveries and has to ditch the motorist at a service station until another recovery vehicle becomes available.
    Private equity firms are financial rapists. Their mission is to screw over succesful companies, draining out all available profit, not reinvesting it into the company, laying off half the workforce and forcing those left to renegotiate their contracts and work harder or packs their bags.
    All those big bonuses in the city, propping up the housing boom in London along with foreign dirty money, are coming from somewhere.
Offensive? Unsuitable? Email us

kaskasi    March 27, 2007 8:58 AM
    Acquisition preceeding that of the AA by private equity fund managers amply illustrate the socially devastating consequences of their ballooning personal fortunes.
    Is it possible some of those invloved with the AA were also responsible for the 'restructuring' of UK businesses begining with Thorn EMI Kenwood in the late 80's, followed by Clarks the shoe company, and on it went, on it goes.
    The GMB and the press ought to look at the players, and ask what has been their contribution to the common wealth.
Offensive? Unsuitable? Email us

SwissBob    March 27, 2007 12:09 PM
    "The sector may be private in name, but that does not mean it should be unaccountable."
    Accountable to whom? The management of privately owned companies is accountable to the owners, who else should they be accountable to? Neither the public nor the government has any right to know about the internal details of private companies, just like they have no right to know about your own private dealings. Its called freedom.
Offensive? Unsuitable? Email us

firsttimer    March 27, 2007 2:52 PM
    @SwissBob        Every private individual is accountable for their actions - it's called responsibility.
offensive? Unsuitable? Email us

sedan2    March 27, 2007 4:21 PM
    There's a part of it all I don't understand.
    I borrow billions of pounds to buy up a company, then I sell the company on a few years later at a handsome profit. But what of the debt I incurred to buy the company? Everything that I have read and heard about private equity says that the company is left saddled with the debt.
    How can that be right? If I borrowed to buy a company that's [paid with] my debt surely, so how can I offload the debt on to the company I just bought? Okay it may be legal, but it certainly seems wrong to me. That seems to me to be the root of the whole problem.
Offensive? Unsuitable? Email us

Reader comments

April 4, 2007

The Money Binge


LESS than a decade ago, Stephen A. Schwarzman, the chairman of the Blackstone Group, used to spend his days flying from city to city to drum up money for his private equity funds. “If I could raise $10 million, that was a good day,” he recalled recently.

How times have changed. “Now, someone who doesn’t know you will just come into our office and say, ‘I’d like to give you $200 million,’ ” Mr. Schwarzman told a conference in January.

The shift shows partly how Blackstone has grown in size and reputation. Mr. Schwarzman co-founded the firm in 1985 with $400,000; it now manages more than $78 billion and is planning to go public.

But the change also reflects the deluge of money that has washed over private equity and hedge funds in recent years. The multitrillion-dollar infusion is remaking the deal economy and corporate America, creating a buyout boom not seen since the 1980s, when Michael R. Milken helped takeover artists finance deal after deal with seemingly unlimited cash.

But where is this money storm coming from? How long will it last? Mr. Schwarzman, whose firm recently closed a $39 billion takeover of Equity Office Properties Trust, said at the conference: “You look at these numbers, and they are stunning. It’s like an out-of-body experience.”

Mr. Milken, in a rare interview, recently compared the latest buyout wave with the one he helped set off. “You have substantially more debt than you did 20 years ago,” he said. He noted, however, that debt is far cheaper and may be less risky this time around because interest rates are so much lower.

Nine of the 10 largest leveraged buyouts in history have been announced in the last year and a half. These include the proposed $45 billion buyout of the Texas energy giant TXU; the $33 billion acquisition of the hospital operator HCA; and the proposal on Monday of a $29 billion acquisition of the payment processor First Data.

Much of the capital for these transactions is flowing from institutional investors and pension funds, which have pulled money out of the stock market in search of higher returns. Just as important, though, are the banks that are willing to lend huge sums on friendly terms. These lenders have allowed buyers to leverage their investments with cheap debt to new levels. Hoping to win lucrative business from private equity firms, banks are taking extraordinary steps. Besides loans, some banks are agreeing to provide “equity bridges” — contributions toward the equity portion of a deal — akin to a mortgage lender covering part of a down payment. The banks’ appetite for risk shows little sign of fading, but if it did, the private equity deal machine would lose an important fuel source.

If there is anyone to thank — or blame — for the free-flowing credit, it is Alan Greenspan, the former chairman of the Federal Reserve, who brought interest rates to near-record lows, allowing borrowings to hit record highs. “Low risk-free, long-term rates worldwide seem to be one factor driving investors to reach for higher returns,” Mr. Greenspan said in 2005, when he was chairman. “The search for yield is particularly manifest in the massive inflows of funds to private equity firms and hedge funds.”

All that low-cost credit has allowed private equity firms to leverage their investments, amplifying their buying power to some $1.5 trillion, according to Morgan Stanley. Blue-chip companies that once seemed out of reach are now relatively easy targets for a take-private transaction.

In an odd twist, all the money going to private equity has helped buoy shares of public companies. Nearly every day seems to bring another rumor of a multibillion-dollar buyout opportunity, prompting investors to pile into shares of companies they expect to be acquired.

The speculative investing creates another potential obstacle to the private equity juggernaut because it forces buyout firms to pay even more for companies they take private, which could end up crimping their returns.

The top buyout firms appear to be producing remarkable profits. When Blackstone filed for its initial public offering two weeks ago, it disclosed a 30.8 percent annual rate of return on its private equity funds since 1987, far outpacing the Standard & Poor’s 500-stock index during the same period. (After Blackstone took its fees, the returns were 22.8 percent, much higher than the S.& P., which was about 11.1 percent.)

Some have suggested that the above-market returns enjoyed by Blackstone and other firms are mostly a result of leverage — which can supercharge returns but only by adding risk — as opposed to smart investing by fund managers.

Steven Kaplan, a professor of entrepreneurship and finance at the University of Chicago, has estimated that if similar leverage were applied to investments in the S.& P. 500 index, the returns would exceed those of private equity.

Whatever the reason for their success, these glittering returns are a major reason investors have reallocated more of their money into the industry. Consider one of the larger pension funds, the Employee Retirement System of Texas, which manages $23 billion of state workers’ retirement plans. It has put 7 percent to 8 percent of its funds into private equity investments to help balance its budget.

In some cases, there is a whiff of desperation in pension funds’ leap into private equity. Many funds have fallen behind on their future obligations to workers, so they are plowing money into higher-risk assets to try to close the gap. More than 51 of 64 state pension plans were underfinanced last year, compared with about 25 in 2000, according to a recent report by Wilshire Associates.

Less often acknowledged in the recent deal boom is the role of hedge funds, which have also been raising huge sums from institutional investors and rich individuals. In search of higher returns, these funds have been increasingly buying stakes in companies and then pressuring them to sell themselves, so they can pocket the premium when a buyer emerges.

The result is more companies on the auction block, ripe for acquisition by private equity investors. With so many investors jumping into the private equity game, some are wondering if the buyout business’s best days might be over. “It’s hard to imagine it can get better than it is,” Mr. Schwarzman said to the audience at Wharton School of the University of Pennsylvania in January. “We’re at maximum advantage in all probability right around now.”

Reader comments

1.    April 4th, 2007 1:23 pm     Brings to mind the high flying investment trusts of the Roaring 20s.
A shareholder in most of the first quality money center banks I’m not happy with risk taking like ““equity bridges” —contributions toward the equity portion of a deal — akin to a mortgage lender covering part of a down payment.” That said I remain convinced following a global bust they’ll pay dividends. Suspect yields would rise to compensate for depressed bank share prices. (Probate to probate blue chip investors sleep very soundly.)
On the hustlings these days meeting lots of ordinary Americans who are really hurting. Today’s Masters of the Universe behave like the French Court before the revolution. Think we are very close to a fundamental rupture of the public’s basic trust in our leadership elites.
— Posted by Mark Klein, M.D.

2.    April 4th, 2007 2:05 pm     Having been witness to some of the early period of the blackstone group i can remember mr schwarzman as being the least likely to call attention to himself compared with with mr peterson, mr altman, mr engleman, mr stockman et al who all had their gravitational pulls on all that was around them they were each very important people then but a lot has happened to each of them in the last ten years my guess is that today mr schwarzman is more humble than he was back then
— Posted by frank daddario

3.    April 8th, 2007 7:52 pm     One comment ends on the following:” My guess is that today Mr. Schwartzman is more humble than he was back then” Huh?
Does a humble man invite 1000 nearest and dearest to celebrate his 60th birthday?, does he buy ephemeral art pieces for $800,000.00? Does he pay hundreds of millions for fashionable art instead of donating the money for research, hospitals and schools?
Methinks Mr. Schwartzman behaves more like the Sun King with leveraged money.
As an investors I just hope all this hubris ends well.
— Posted by Freda Neuwirth

4.    April 8th, 2007 9:36 pm     “my guess is that today mr schwarzman is more humble than he was back then” psychology studies have shown that people become more extroverted when they gain power.
Can someone summarize the basic tenets of the advantage created by private equity investing? My understanding is that basically a private management can implement changes that one serving a board and shareholders can’t. This must translate into plans for longer term increases in profitability that compromise shorter term numbers. Yet, there is an amazing amount of flipping that goes on within private equity.
If Greenspan is responsible for the increase in funding liquidity, why didn’t the boom reach a peak closer to the low in the fed funds rate? Has the spread of activist investing as a “style” changed things? Have pension obligation shortfalls increased precipitously in recent years?
— Posted by Skeptical Investor

5.    April 8th, 2007 11:25 pm     A hedge-fund collapse is due to occur. 30% returns come with the risk of heavy losses, which investors have overlooked as their portfolios have grown and the downside hasn’t materialized. Amaranth’s bad bet on natural gas was a harbinger of things to come. Once the market manipulations of hedge funds are exposed, for example, the practice of naked short selling to keep stock prices down, major hedge funds will collapse and take their places in history next to the collapse of Drexel Burnham Lambert, the savings and loan crisis, the long-term capital management fund collapse, and the scandals at Enron and Worldcom.
— Posted by Yves Grant

6.    April 11th, 2007 9:33 pm     I agree that “humble” may not be what comes to mind to describe certain stereotyped individuals but in comparision to the other names based on what i know i do stick to my premise moreover look at what other leaders have produced in the last decade given the resources at their disposal - which were far and away greater than the blackstone group had access to ten or so years ago furthermore it was mr peterson in an interview with charlie rose who stated words to the effect he would NOT hire dubbya to run a company controlled by the blackstone group which is his position he is entitled to but considering when he gave that opinion (immediately before the second election) it could be taken as having significantly more weight additionally mr altman (redacted recusal) and mr stockman (bankruptcy) have found themselves in a mess during the last decade when one comes from ordinary origins and reaches stupendious heights yet sees others with the greater advantages of life going into the game only to crumble, yes i do believe one becomes “humble”
— Posted by frank daddario

Reader comments

April 4, 2007

Masters of the New Universe


THE transactions are big, but Wall Street’s top tier of deal making can seem like a small world. Many of the marquee mergers and buyouts of recent years have been dominated by a relatively short list of players, notably kingpins from private equity and some billionaire financiers, advised by investment bankers, lawyers and other professionals.

Their universe is one of shifting alliances and strange bedfellows, in which professionals on the same team in one deal may be on opposite sides of another fierce bidding war — in a conference room across the hall.

The links have grown as takeover targets have gotten larger, often requiring buyers to band together. Consider last year’s deal for Freescale Semiconductor, in which two consortiums — each of which included four major private equity firms and an armada of advisers — battled to acquire the chip company, which was eventually sold for $17.6 billion.

A result is a six-degrees-of-Henry-Kravis separation (or Stephen Schwarzman), in which much of the community is connected through a dozen or so high-profile deals.

GRAPHIC: Masters of the New UniverseHere is a snapshot of the current deal ecosystem: we played connect-the-dots with 100 deal makers on Wall Street.

Some caveats: Each deal includes many more advisers than are listed, and many significant deals of the last few years are not represented. As a result, many top bankers, lawyers and buyout professionals are not here.

The chart is also selective in the transactions, so that some executives who are connected to only one deal could be connected to more. Because the mergers and acquisitions game has been skewed so heavily toward private equity deals recently, executives like James B. Lee Jr. of J.P. Morgan Chase, who has advised and financed many of the biggest leveraged buyouts, is linked to eight deals; while Felix G. Rohatyn, who has acted as sage on many big mergers over his career, is linked to only one deal. As megadeals keep coming, the ecosystem will also change, creating new connections and power brokers.

Reader comments

1.    April 5th, 2007 5:28 pm     Wow, what an amazing map of relationships. I knew that the PE industry is connected, but didn’t realize that they are THAT connected!!!
— Posted by Sam Ng

2.    April 5th, 2007 6:47 pm     Couldn’t believe New York Times will create a specail section, lionising works of Gordon Gekkos of the world. Yeah, couldn’t agree more, you never know, if NYT is bought private one day by a bunch of Mid Age, Mid-East PE folks and dedicate a specail fortnightly supplement dedicated on them.
— Posted by amit agrawal

Reader comments

April 4, 2007

After the Buyouts, Lawyers Prepare to Wrap Bandages


AS the chiefs of private equity pull off one highflying buyout after another, bankruptcy lawyers are beginning to get their safety nets and first-aid kits ready.

Many Chapter 11 casualties are expected to come from the dozens of companies that have been taken private in the last few years in debt-financed transactions. Anticipating that the long lull in corporate bankruptcies may finally be over, law firms are bulking up their bankruptcy and restructuring groups.

Harvey Miller, perhaps the nation’s pre-eminent bankruptcy lawyer, said in March that he would leave the investment bank Greenhill & Company to return to the law firm Weil Gotshal & Manges. Later, four Weil Gotshal bankruptcy partners jumped to Cadwalader, Wickersham & Taft, the counsel to Northwest Airlines in its Chapter 11 case.

Skadden Arps Slate Meagher & Flom, adviser to some of the biggest companies in bankruptcy, including Kmart, Polaroid and US Airways, is also hunting for restructuring talent. J. Gregory Milmoe, a co-head of Skadden’s corporate restructuring group, said he thought a bankruptcy surge was coming soon. “We are hiring people and training them with the expectation that it is going to be happening this year,” he said.

It has been a relatively quiet period for J. Gregory Milmoe of Skadden Arps Slate Meagher & Flom, but he doesn’t expect that to last. He suggested that the ocean of capital that has kept many companies afloat in recent years might begin to dry up. This is especially likely, he said, if investors are rattled by more hedge fund collapses, like the one last year at Amaranth Advisors.

Mr. Milmoe, who led the Skadden team that advised Refco, the commodities broker that collapsed into bankruptcy in October 2005, was asked recently about the next wave of bankruptcies. Following are excerpts from the discussion.

Q. Why has corporate bankruptcy activity been so slow?
A. It’s part of a normal cycle. Over 35 years, give or take, we see high levels of activity every five to seven years with some regularity. The deals most easily charted are the ones that are a function of economic policies: easy money versus tight money. At the moment, we are experiencing a massive amount of available cash, and that cash for investment has been available for two and a half to three years. What we’re predicting is that companies who were bailed out of a difficult situation two or three years ago are now coming up on a situation where they will have gotten in trouble again. Some percentage of those companies will continue to be rescued by available capital. But with others, people will say, “This was a bad investment, and we’re not going to throw more good money after bad.”

Q. When you look at the recent boom in leveraged buyouts, do you think of it as bankruptcy work in the making?
A. During the last cycle there was — or there used to be — a stigma associated with private equity firms’ having their portfolio companies go into bankruptcy. But if you look back at the period from 1999 to about 2002, enough portfolio companies went in that a flippant kind of remark gained some currency: “If at least one of your companies doesn’t go into bankruptcy, you’re not trying hard enough.” The analogy is: “You’re not going to hit home runs unless you strike out.” Of course, I’m a lawyer, and I bill by the 10th of an hour. There are multibillionaires out there who got to be multibillionaires by taking risks, identifying companies that had the wherewithal to load up on leverage and still make wonderful equity returns. Still, you hate to see decisions being made that are not wise.

Q. How has the proliferation of hedge funds affected the bankruptcy business?
A. I think that it’s likely there will be a few more situations like Amaranth. There are so many hedge funds that as those situations come to light, the pools of capital will become a bit more cautious about investing in risky situations. Which would mean that the portfolio companies that were being bailed out at these extremely high-leverage ratios will not be able to be bailed out at those extremely high ratios anymore. Some of them will have to go into bankruptcy and undergo a very painful right-sizing of their business and their capital structure.

Q. How has the new bankruptcy code changed the Chapter 11 process?
A. One of the much-talked-about provisions was a prohibition, except under very strict conditions, of KERPs — key employee retention programs, what we used to call golden parachutes. Reasonable people can debate this as a matter of social policy and business sense, but it is not an easy job to run a troubled or bankrupt company. So to the extent a company has an opportunity to prepare for bankruptcy, what you need to do is plan to have the appropriate people assured, or reassured, that they should stay there and help rather than doing what’s best for their families by getting out while the getting is good. That’s significantly more difficult now under the new program.

Q. What will you do until the bankruptcy wave hits?
A. I personally am enjoying a much more relaxed schedule. I’m speaking at symposia and catching up on scholarship, which I just did not have time to do in the last 14 to 16 months. On a firmwide basis, our group is underutilized and, perhaps counterintuitively, we are actively seeking to expand. Skadden has the luxury of being able to plan and to invest, so we are trying to get terrific lawyers on board and get them trained. We’re running internal seminars on things to think about from a restructuring and bankruptcy perspective. This is really a good thing — because when the onslaught comes, there’s not a lot of time to think.

Reader comments

1.April 12th, 2007 9:41 am     Continuing on Greg’s comment re: “not a lot of time to think” it may be important now for fund investors, public company directors, institutional equity and debt holders and other potentially affected parties to re-educated themselves on the laws, processes, tactics/strategies, pitfalls, “lessons learned”, etc. and to think about where their exposures might be on multiple fronts. Not false firedrills but thoughtful, focused reflection/attention. Having been through two rounds of this cycle myself there is some level of updating, familiarity and advanced preparation that can be taken. And there are some do’s/don’ts that should be provided by counsel. Especially: call us first. It may be time to sit down with firms such as Skadden, S&C, DP&W and others who have the talent and experience. And there will be substantial opportunity for those investors who understand (and act on) the Rothschild adage: “buy on bad news and sell on good”.
— Posted by Hank Devine

Daily Telegraph    April 11, 2007

Private equity collapse on cards, says IMF
By Edmund Conway, in Washington DC

The International Monetary Fund has issued an unprecedented warning to the private equity industry, saying that a large-scale collapse in the sector is increasingly possible and that many of the major deals currently being mulled could prove a disappointment.

It said that potential problems with the buy-out industry were among the biggest risks facing the global economy in its latest survey of the financial system. The warning comes at a time when the appetite for private equity deals is at an all-time high.

The IMF, which hosts its spring meetings alongside the G7 summit of finance ministers at the end of the week, also warned that the risks to the economy from defaults in the US sub-prime mortgage market had increased. It said that because of these two issues, the chances of a worldwide financial crisis rose over the past six months - though it is not a likely outcome.

However, it is the IMF's warning on private equity that will strike a particular chord in the City, where the industry has become a formidable part of the financial landscape.

In the Global Financial Stability Report, the fund said: "Financial market investors may be giving insufficient weight to downside risks [to private equity deals], assuming that low-risk premia and low volatility are a more permanent feature of the financial market landscape. The situation bears careful attention, especially if a large high-profile deal runs into difficulty, as this could trigger a wider reappraisal of the risks involved."

The size of the industry has increased rapidly in recent years, and it is expected to raise $500bn (£253bn) this year, compared with $430bn in 2006.

But the IMF warned that this is largely because conditions are particularly kind at the moment, with money cheap and the economy strong. If these circumstances deteriorated, it added, "deals that looked promising in a benign environment could suddenly appear much less attractive. It is therefore likely that some private equity deals will fail to live up to expectations."

The private equity phenomenon is not a new one, and it bears some resemblance to the leveraged buy-out craze in the 1980s. But the IMF said: "The recent wave of M&A is exhibiting some worrying symptoms of the past, and has introduced some new risks." These risks are, it said:

• While low interest rates are reducing debt servicing costs, this is encouraging firms to increase their debt burden. "Higher debt levels potentially increase the vulnerability of acquired firms to economic shocks."

• Rising corporate debt levels make it more likely that there will be an increase in defaults.

• The banks financing the deals face the risk that changes in the market after they have committed the money could make the deal unattractive and lose them money. • Private equity firms are providing less of the money themselves, so more is coming from outside investors.

• Anecdotal evidence suggests that the due diligence being performed by some investors may be weakening as the demand for deals takes hold.

• More firms are chasing fewer attractive deals.    12/04/2007

Dutch MPs seek to rein in private equity
By Ambrose Evans-Pritchard

Hedge funds and private equity groups have been accused of "plundering" Holland at a tense session of the Dutch parliament, as leading politicians called for new laws to curb their activities.
The Dutch pride themselves on being as free-market as the British. A roster of British and American names operating in The Netherlands were summoned to The Hague yesterday to justify ever bolder raids on Dutch companies - the latest sign of a growing political backlash across Europe against the Anglo-Saxon funds.
Britain's CVC Capital Partners and the US groups Centaurus and Cerberus were among the list of witnesses subjected to a day's grilling from hostile Dutch MPs of all parties.
"This ransacking of the country is not welcome" said Elly Blanksma, a senior MP for the ruling Christian Democrats. "We need to get a grip on these hedge funds and find out what their intentions are."
The panel suggested a slew of legal changes to force buyers out of the shadows and curb boardroom coups.
These include lowering the threshold at which shareholders have to identify themselves from 5pc to 1pc, banning "contracts for difference" that allow funds to vote by borrowing shares, and lifting the threshold for moves to dissolve the board from 51pc to two-thirds.
Nout Wellink, the central bank chief, said private equity helps lubricate the economy and should be welcomed, but he also suggested changes compelling shareholders to secure his go-ahead when buying more than 5pc of any company - down from 10pc now.
Although the Dutch pride themselves on being as free-market as the British, they have been shocked by the moves of Anglo-Saxon funds to break up the Dutch conglomerate Stork despite vehement protests by management and unions.
Socialist MP Ewout Irrgang said there have been bitter feelings ever since Apax Partners took over publisher PCM. "They completely emptied that company and gave back nothing to society," he said Apax insists it turned around a loss-making company.
The Dutch mood turned hostile when Mayfair-based TCI attempted to set in motion the break-up of ABN Amro, the country's biggest bank.
Separately, US Federal Reserve chief Ben Bernanke yesterday expressed concerns about hedge funds.
"The failure of a highly-leveraged fund holding large, concentrated positions could involve forced liquidation of those positions, possibly at fire-sale prices, thereby imposing heavy losses on counterparties," he said.

Wall Street Journal    April 13, 2007

Executives Hedge Their Own IPOs
Stakeholders Borrow To Pay Themselves Pre-Sale Dividends


Private-equity and hedge-fund executives have found a way to get windfalls before their companies even go public, potentially cushioning their losses if the value of their ownership stakes eventually falls on the open market.

Here is how it works: Wall Street's investment banks loan these private firms significant sums of cash as the companies consider initial public offerings of shares. The loan money then is used to pay fat dividends to top stakeholders, typically
senior executives in the companies, and can be paid down later with IPO proceeds or management fees and the like.

•  The Issue: Private-equity and hedge-fund executives have found a way to use their ownership stakes to get cash windfalls before their companies go public.
•  Background: These payments will cushion losses for these executives if their shares later fall in the open market.
•  Behind the Scenes: Wall Street firms, keen to win lucrative investment-banking assignments, are taking on more risk. If a firm that takes a dividend decides not to go public, it could take years for the loan extended to pay the dividend to be paid back.
This upfront payment allows the company's owners an early opportunity to parlay their equity stakes into cash. If their company's stock falls after the public offering, they already have benefited from some of their holdings, potentially mitigating
their losses. Often, top executives in companies are prohibited from selling for a certain period after a public offering. So, an early dividend frees up some money beforehand -- a bit like getting a bonus before the year starts, reducing the risk of a lower bonus if your performance tanks.

Executives at Apollo Management, which is moving toward a $1.5 billion private sale of 10% of the private-equity firm and considering a public offering later this year, are among those looking to get a dividend, according to people familiar with the
matter. Bankers at J.P. Morgan Chase & Co., which is representing Apollo, have spent recent weeks trying to persuade other Wall Street firms to help provide Apollo with a $1 billion loan, these people say. The loan would be used to fund a pre-offering dividend to Apollo's top executives, including founder Leon Black, who owns about half the company. A spokesman for Apollo declined to comment.

Last year, Fortress Investment Group, the New York money manager that recently became the first U.S. hedge fund to sell shares in an IPO, borrowed $750 million from a consortium of lenders, freeing up $250 million that it put toward a dividend
to five key executives in the process.

Blackstone Group, which announced plans late last month to undertake a roughly $4 billion IPO by selling a 10% stake of the company, is also contemplating a similar dividend, according to people familiar with the matter.

Banks' willingness to lend money for such dividends, even before a company's offering is a sure thing, is a testament to the growing clout of private money managers on Wall Street, where hedge funds and private-equity firms contribute ever-larger portions of firms' investment-banking fees. Securities firms are keen to loan the money, as they hope it will help them
win lucrative underwriting business down the road.

The dividends can have a downside. Investors considering buying the stock of these newly public companies may become leery about the additional debt, say investment bankers, and that could end up lowering the initial price of the shares. If the offering doesn't come together as planned, the money manager may have to pay down the debt with revenue from other sources. A
shelved IPO could also be bad news for the lenders, which may have to wait years to get their money back. And some people say the move by some of Wall Street's shrewdest players to lock in their profits quickly is also a sign these firms may not be a good buy.

"Smart people sell when they think they're overvalued," says Steve Kaplan, a finance professor at the University of Chicago's graduate school of business who teaches private equity. "Here, they can borrow in order to pay themselves a dividend because I'm sure they have management fees locked in for a while, so they're able to pay off the loan. But why they want to do it so quickly and lock it in, suggests that they're overvalued."

Not everyone agrees. While "some investors may balk at the large distributions the principals have given themselves, we note that each of the 5 principals [at Fortress] created this firm from 'scratch' and continue to own a majority of it," Bank of America Corp. research analyst Michael Hecht wrote in a recent research note. He has a "buy" rating on the firm.

These early dividends -- which some money managers consider to be part of the normal cash distributions to their principal players -- are ripped from the traditional private-equity playbook. Companies taken private by firms such as Apollo often
borrow money to pay dividends to their owners before going public again, a way of returning cash immediately to the private-equity firms. On Wall Street, these are sometimes known as a "midnight dividend" because the dividend is often paid out just before the IPO.

Fortress, whose successful offering of approximately $600 million in early February is regarded as a bellwether deal in the money-management industry, paid out hundreds of millions in dividends before its offering. Last June, Fortress borrowed
$750 million from a group of banks that included a number of the underwriters of its eventual IPO, according to people familiar with the matter.

According to regulatory filings, $250 million of the June loan was used to pay out a cash "distribution" that same year to Fortress's five principal shareholders, including Chairman and Chief Executive Wesley Edens. In total, they received about
$600 million more before the offering from other sources. They then paid down $250 million of the June bank loan by using proceeds from the IPO.

Write to Kate Kelly at

The Guardian     April 25, 2007

Social cost of private equity
Phillip Inman

Private equity firms are reshaping the American economy to the detriment of workers and local communities, one of the largest trade unions in the US said yesterday after publishing a report into the industry's growing influence.
The almost two million-strong Service Employees International Union said the booming private equity buyout industry had turned back the clock on community involvement and workers' rights. In a dossier documenting private equity deals in the US over recent years, the union highlighted buyouts that it argued left companies "hollowed out" or even bankrupt. Others saw gains that were paid exclusively to the new private equity owners.

Claims that the private equity industry created jobs and boosted the economy were unfounded, said the union, pointing out that there was little quantitative research in the US to support the view. It said the only detailed study was carried out in Britain and while it showed that buyouts increased the number of jobs in 60% of cases after six years, almost all workers suffered cuts in pay. The union, has launched a website,, to act as a forum for information on the private equity industry.
Private equity deals could work in the interests of all parties, its report said, pointing to one example of a buyout where workers were consulted and included in profit sharing. This example had rarely been repeated, the union said.

The report gave the example of the £150m buyout of KB Toys in 2000 by Bain Capital, which had loaded the company with "a second mortgage" and debt repayments of such magnitude that it dragged it into insolvency four years later. Meanwhile, Bain, which put £9m of its own funds into the deal, benefited from a £60m debt refinancing in 2002 that was used "to pay Bain and several KB Toys executives a special dividend", the report said.

The Economist    May 1st 2008

Why German companies should not appoint bankers to the board

BANKERS who sit on the supervisory boards of non-financial firms in Germany benefit their bank but not necessarily the company—or so concludes a recent study* for the European Corporate Governance Institute, a [industry-supported] think-tank. The three authors examined the record of 137 German companies and 11 banks between 1994 and 2005, and found that the mere presence of bankers in the boardroom appears to increase a company's debt and diminish its overall performance. But the board-member's bank tends to win merger-and-acquisition business from the firm. It also tends to increase its loans to the firm's competitors—perhaps thanks to the expertise in the industry the banker gained while serving on the board.

That last finding is perhaps the most surprising. German banks must report all loans over €1.5m ($2.3m) to the Bundesbank, Germany's central bank. When the researchers examined this data, which is normally secret, they discovered that a bank represented on a board in one year tended to lend more to other companies in the same industry the next.

German companies, especially big ones, tend to have at least one banker on their supervisory board. Of the non-financial companies in the DAX 30 stock index only four do not. Of the companies examined in the study, 46% had a banker on the board, compared with 32% for equivalent firms in America.

Why is this practice so widespread? To some extent it is a hangover from the days when banks owned stakes in many German firms. As recently as 1994 they owned an average of 4% of all non-financial firms. But after 2002, when the government exempted the sale of these stakes from capital-gains tax, the banks sold out. By 2005 they held a mere 0.4%. That may have skewed the interests of bankers on boards away from improving the firm's profits and towards peddling their services—to rivals if need be.

Bankers on the Boards of German Firms: What they do, what they are worth, and why they are (still) there”. By Ingolf Dittmann, Ernst Maug, Christoph Schneider.

Washington Post     May 15, 2007

Cerberus's Sharp-Toothed Ways
Firm Has History Of Turnarounds Fueled by Cuts

By Frank Ahrens

In more than a decade of buying into down-and-out companies across three continents, Cerberus Capital Management has applied a similar strategy to most of its targets: cut, cut and cut some more.

Now Chrysler is set to join a list of acquisitions that includes long-haul trucker Fruehauf, Air Canada and lingerie maker Frederick's of Hollywood. Many of those companies have experienced turnarounds under Cerberus's slashing ways, but not without pain.

New York's Cerberus bought more than 600 struggling Albertsons supermarkets last year and laid off nearly 1,000 workers within months. Last fall, the firm bought the on-the-brink Blue Bird school bus manufacturer; earlier this month, Cerberus closed its Canadian bus plant and let go 130 workers. Cerberus bought a North Carolina textile company out of bankruptcy in 2004 and closed two mills within the year. It bought the Alamo and National car rental chains out of bankruptcy in 2004 and moved them from high-rent South Florida to more-affordable Tulsa.

Cerberus's sharp-toothed ways may be inspired by its namesake: Cerberus was the three-headed canine guardian of the gates of Hades in Greek mythology.

Cerberus the company maintains an even lower profile than its rivals, such as Providence Equity Partners, Blackstone Group and Washington's Carlyle Group. Cerberus has $25 billion under management and in funds and accounts. With just 200 of its own employees, Cerberus owns or has pieces of about 50 companies with more than 175,000 employees and a combined annual revenue of $60 billion, the company says.

The firm is run by financier Stephen Feinberg, who was a trader at Drexel Burnham Lambert in the 1980s, when the firm popularized the use of "junk bonds" for corporate takeovers. Former Treasury secretary John W. Snow was named chairman of Cerberus in October. Former vice president Dan Quayle is on the board.

Cerberus distinguishes itself from other private-equity firms by maintaining a staff of in-house operations executives. Meaning: When it takes over a company, it often doesn't have to recruit a new chief executive; it puts one of its own in place.

"This is a bit of an unusual transaction for them in that it does now make them very, very public," said Boston University law professor Charles Whitehead, who studies equity firms. "It's like the Japanese buying Pebble Beach -- if you want to get attention, this is the way to do it."

These are flush times for Cerberus and all of private equity. Moneyed investors seeking big payoffs have created an equity pool estimated at $500 billion, up from $8 billion at the beginning of the 1990s, according to the Columbia Business School.

Nearly $400 billion in private-equity transactions have taken place so far this year, nearly doubling the dollar amount by this point last year, Thomson Financial reported.

Investors are attracted to the high returns generated by equity funds. Among Cerberus's investors is the California State Teachers' Retirement System.

Generally, equity money seeks struggling industries where cuts can be made and profits quickly increased. Some firms seek to flip their companies soon after paring them to the bone. Others have a longer-term view, taking their annual guaranteed profit and helping turn around ailing companies.

Cerberus would not comment yesterday on its strategy but appears to be in an automotive buying cycle. Previously, the company passed through a fashion and retail stage by acquiring textile mills, Mervyns discount department store and Frederick's.

Cerberus bought 51 percent of GMAC, General Motors' financing unit, last year, and it owns auto parts maker Peguform Group in Germany and is trying to buy into troubled parts maker Delphi. Now, the buyout firm is set to add an entire automaker to its portfolio.

A look at Cerberus's track record with its previous acquisitions may indicate how it will treat Chrysler and raise the question: Under a Cerberus ownership, will one of Detroit's Big Three remain so, or will it become a substantially smaller automaker, more analogous in size to Mitsubishi than Ford?

Albertsons was a supermarket chain based in Boise, Idaho, that spread throughout the West. Hurt like all supermarket chains by Wal-Mart, the company's sales went flat and profits dropped. Cerberus joined supermarket chain SuperValu to buy 655 Albertsons stores in January 2006 in a $17.4 billion deal.

Cerberus went to work fast. In June 2006, nearly 200 Albertsons warehouse workers were laid off in Northern California. The next month, a number of Albertsons stores ended their costly online grocery-shopping services. In November, Cerberus sold 132 Albertsons in California and Nevada. A year later, Cerberus-owned Albertsons closed nine Colorado stores, laying off 750.

Shoppers have noticed improvements at Cerberus-owned Albertsons in Florida, the St. Petersburg Times reported last month, and the chain has installed efficient new registers, raised some prices and instituted systematic employee training for the first time.

In 2004, Cerberus targeted Mervyns, an underperforming chain owned by Target and squeezed by rivals such as Wal-Mart and Kmart.

Cerberus paid $1.7 billion for 257 Mervyns stores and started cutting. In September 2005, the company said it had decided to concentrate on California, exiting poorer markets in Michigan and Oklahoma. As a result, the company closed 62 stores and laid off 4,800 full- and part-time workers. Four months later, Mervyns pulled out of Washington state, closing 20 stores and letting go 880 full- and part-time workers, and closing stores in Oregon, as well.

Now, Mervyns is trimmed down to 189 stores, including four new stores opened in October in California, Texas and Arizona, the first since the Cerberus acquisition. Cerberus's Vanessa Castagna is chairman of Mervyns' board and said at the time that the company will continue to "expand in our core markets."

Staff writer Thomas Heath contributed to this report.


May 16, 2007

End of the Affair

It is tempting to look at the dissolution of the ill-starred union of Daimler-Benz and Chrysler and chalk it up to an irreconcilable clash of cultures and question the very tenability of trans-Atlantic mergers. But that would be the wrong lesson.

Not only can such a linkage work, Daimler has succeeded with one before. In 1981 the German concern bought Freightliner — which builds heavy-duty commercial vehicles — and today Daimler, with the help of Freightliner, is the world’s largest truck manufacturer. Automobile mergers can also transcend the divide between luxury vehicles and more functional ones. BMW has been successful with Mini, while Volkswagen has done well with Lamborghini and Bentley.

Daimler spent $36 billion to buy Chrysler and sunk tens of billions more into its North American subsidiary in less than a decade. Yet the private equity firm Cerberus Capital Management had to shell out only $7.4 billion to take it off Daimler’s hands.

How does an American manufacturing icon get so cheap so fast?

An overreliance on large gas guzzlers certainly hurt. And the Mercedes-Benz elites never embraced the mass-market Chrysler sufficiently to truly integrate it. Still, those problems might have been solved. What seemed intractable was the tremendous drag of Chrysler’s legacy costs. The pension and health-care commitments for employees and retirees come to a whopping $18 billion.

This is a role reversal: it is the American free-market system that is supposed to be maneuverable like a snazzy little sports car and the German social welfare state that is supposed to groan under the weight of high costs.

Cerberus will try to lower those costs at the negotiating table with the United Automobile Workers. But policy makers in the United States will also have to confront the increasingly obvious fact that the American health-care morass does not just leave close to 50 million people without insurance, it is a drag on our most important industries.

Washington Post    May 15, 2007

Daimler to Split With Chrysler, At a Cost
By Sholnn Freeman and Dale Russakoff

DaimlerChrysler agreed yesterday to a costly deal with Cerberus Capital Management to undo Daimler's merger with Chrysler, ending a partnership hailed nearly 10 years ago as a model of global cooperation and underscoring the shaky financial state of Detroit auto companies.

The breakup of the Daimler-Chrysler marriage poses fresh uncertainty for Chrysler's 80,000 employees. More than most buyout firms, New York-based Cerberus is noted for targeting underperforming companies or ones in bankruptcy protection -- such as Air Canada and Alamo car rental -- and making quick, deep cuts to workforces and overhead. Cerberus would assume control of 80 percent of the carmaker, and Daimler would retain the remaining 20 percent.

In taking the American icon, Cerberus would lift private-equity investment into the highest ranks yet of the struggling auto industry. The firm agreed to contribute $6.05 billion to Chrysler and pay Daimler $1.35 billion. But through a complicated set of transactions and other considerations, Daimler would be about $1.5 billion, including a $400 million loan to Chrysler, to relieve itself of the American automaker. Daimler paid $36 billion for the company in 1998.

As part of the deal, Daimler also would no longer have the massive $19 billion burden of Chrysler's pension and health liabilities, which were an increasing aggravation to investors.

Despite the uncertainties, United Auto Workers President Ron Gettelfinger endorsed the deal. In a Detroit radio interview, Gettelfinger said he and another senior UAW official made a "last-ditch" appeal to Chrysler Chairman Dieter Zetsche on Saturday to keep Chrysler under the Daimler umbrella. He said Zetsche made it "absolutely clear" that Daimler holding on to Chrysler "was not an option."

Gettelfinger said Zetsche spent an hour and a half with him, going over every consideration that went into the choice of Cerberus and noting the firm's financial commitments to Chrysler. He said the UAW is scheduled to meet with Cerberus on Tuesday to confirm its promises. "I want to make sure the commitments made to us along the way will be kept," Gettelfinger said on "The Paul W. Smith Show" on WJR radio.

He went out of his way to express optimism about the arrangement: "It's time for us to get all of this behind us and move forward to make this company successful for our membership and for the shareholders. . . . In fact, our goal now will be to prove that Daimler made a mistake because we're going to make this thing successful."

John W. Snow, former U.S. Treasury secretary and chairman of Cerberus, also took to the Detroit radio waves yesterday to promote the Chrysler deal.

"We want to be part of restoring Chrysler to the front ranks of the auto industry, where it belongs," Snow said. He promised to maintain good labor relations and to shield Chrysler managers from the scrutiny of Wall Street, giving the automaker room to make a new start. "The great name of Chrysler is coming home," Snow said on Smith's show.

But the question raised throughout the industry yesterday is what a new Chrysler might look like. Aaron Devers, a 46-year-old repairman at Chrysler's Sterling Heights assembly plant, near Detroit, said worker morale was low yesterday. He said plant workers expect more job cuts.

"We already know we are under the hatchet," Devers said. "This particular company has a reputation for that."

Salespeople at a Chrysler-Jeep dealership in Gaithersburg were confused about the deal, according to sales manager Greg Lewis. Late in the day, Chrysler's corporate office sent over a six-page explainer document with 34 questions. Among them: "Why is Cerberus purchasing Chrysler? What does Chrysler have to gain? Who is Cerberus Capital Management?"

Lewis said, "We don't really know anything about our new parent company."

Private equity's entrance into the U.S. auto industry is part of the historic changes forced on the automakers by increasingly hard times, said David Cole, chairman of the Center for Automotive Research.

"You just can't escape the fact that we're in a transformational period," Cole said. "The old way is not survivable. Investors, managers and labor all have accepted that big things have to be done."

Among the many factors that led to this milestone was the diminishing clout of organized labor in the auto industry. Labor historian Nelson Lichtenstein of the University of California at Santa Barbara said Gettelfinger -- who once vocally opposed the entrance of private equity into the U.S. auto industry -- had little choice but to go along with the Cerberus purchase because of the UAW's inability to organize foreign automakers in the United States.

"When you can't organize Toyota and other [foreign carmakers], then you're wedded to trying to save Chrysler. It's a bad marriage, and you're stuck with it," he said. "This is only the latest shoe to drop. What we're witnessing, slowly, over many years, is the death of unionism in the American auto industry."

For DaimlerChrysler, the big reward of the deal was getting Cerberus to assume the $19 billion in health-care and retirement costs for Chrysler retirees and their families. Cerberus is expected to ask the union to share those costs when the UAW contract expires in September, if not before.

Officials of both Ford and General Motors have expressed interest in a model adopted last year by Goodyear Tire and Rubber and the United Steelworkers, in which Goodyear agreed to pay the union a lump sum, which the union will invest and use to pay for future health-care costs. The result is that the union, rather than the company, has to cover the cost of inflation.

Chrysler's legacy costs are much larger than Goodyear's, but industry officials said Cerberus, with its deep pockets, would have an easier time dealing with the union than would Chrysler.

Harley Shaiken, a labor economist at the University of California at Berkeley who knows Gettelfinger well, said the UAW may have accepted the Cerberus buyout as inevitable, "but if Cerberus has in mind a strategy of slash and burn, they'll be on a collision course. The UAW and Cerberus have a common interest in a more competitive Chrysler. The key issue is how Chrysler becomes competitive."

The Guardian    May 11, 2007

How families keep private equity 'locusts' at bay
Companies on the other side of the Channel are resisting UK-style bid fever

David Gow in Brussels

The private equity bug that is sweeping through the ranks of British companies shows no sign of abating. Companies previously thought immune are becoming targets and it has claimed its biggest scalp so far with the imminent departure of Alliance Boots from the first FTSE100. In mainland Europe the big names are also being lined up. Carrefour, the number two global retailer, saw its shares climb 2.6% in Paris yesterday on talk of a renewed takeover attempt.

In Germany, the technology giant Siemens may be worth around €80bn (£54.5bn) but it lost its chairman and chief executive in six days last month and there is speculation that it could be prey to a takeover bid from private equity.
But there is one problem - families. Putting aside the enormous premium that any successful bid would have to command, the family of Werner von Siemens, the firm's founder more than 150 years ago, is the biggest single shareholder with 6% of the equity. Peter von Siemens, a great-grandson of the founder, sits on the supervisory board. His control over more than 4% of the voting rights might not prove enough to fend off the rampant corporate raiders in the way the Sainsbury family's 18% holding recently deterred a £9.6bn bid, but it represents a formidable obstacle.

Carrefour has been the subject of bid talk for some time since Colony Capital joined forces with billionaire Bernard Arnault to buy a 9.1% stake through their Blue Capital vehicle. But the Halley family, which owns 13% of the equity and 20% of the voting rights, says it has no plans to sell. The model is repeated throughout Europe where family-owned or family-controlled firms - ranging from Germany's BMW and Haniel to Italy's Benetton - have built up ownership structures that are deterrents against attacks from the "locusts" as the private equity and hedge funds are known in Germany. It is in sharp contrast to the Anglo-Saxon business world, where the Sainsbury family's ability to fight off the raiders is the exception and not the rule.

Listed family firms, in which founders or their relatives retain at least a quarter of the ownership, are outperforming their publicly owned counterparts. In Germany, where three-quarters of firms are in family hands - many of them the famous Mittelstand or medium-sized companies that still employ 70% of the workforce. The Gex-index of such companies, set up by Deutsche Börse in July 2004, has risen more than 20%. "We can look calmly into the future," says Siegfried Dais, deputy chief executive of Bosch, which is 8% owned by the founding family and 92% by a foundation - with voting rights exercised by a trust. The group's ownership structure, he says, enables it to plan for the long term without worrying about short-termist reaction to each quarterly set of results.

Lack of capital or difficulty in obtaining access to capital markets is one reason family-owned or family-controlled firms have turned to listings or even private equity firms to help their growth. This was one of the main reasons behind the 1,000-plus leveraged buyouts in Europe worth an estimated €125.3bn in 2005 - with 57 family-owned firms in France, 37 in Italy, 23 in Spain and 22 in Germany among those sold off.

Another is the tendency, especially strong after the third generation, for family members to fall out over the spoils or to show no interest in the business (or even to spend the family fortune on drugs). In France the 38 members of the Taittinger dynasty, owners of the champagne business, disagreed over how to sell their shares but, in the end, sold out to Starwood Capital for €2.6bn two years ago. In the late 1990s a clan dispute in the Bahlsen cake empire in Germany led to the break-up of the company.

The problems of finding a successor to run the business, according to consultants PwC in Germany, affect 70,000 family firms in Germany each year, with 30,000 forced to close. But others in Europe succeed in handing over the baton from one generation to the next over decades and even centuries, with the Michelin family controlling the 120-year-old tyre-maker even though up to a half of its stock is held by overseas investors, while the Peugeot family owns 45% of the voting rights of the car firm.

In France, where about a quarter of the CAC-40 top firms are family-controlled, even a 12% share in Pernod Ricard can give the founding Ricard family control and, in the case of Danone two years ago, the 0.1% held by chief executive Franck Riboud, son of the founder, was enough to fend off a potentially hostile bid (from Pepsi) only because the "political class" saw this as an assault on a French national citadel.

The barbarians have tended to target smaller fry among family firms and there are some companies which appear impregnable. German carmaker BMW, which is around 46% owned by the Quandt family, has become a byword for cautious long-term planning and strong profitability and is always compared favourably with DaimlerChrysler, owner of arch-competitor Mercedes.

BMW's rival Porsche, which has made Volkswagen immune from hostile takeover by acquiring a 31% stake, is owned by the Porsche and Piech families on a roughly 50/50 split. "They watch each other's every move like hawks. So you can be sure the locusts won't get a look in," says one insider. But Siemens may be the barbarians' biggest coup yet.

The Dynasties

Porsche Ferdinand Piech, 70, grandson of Ferdinand Porsche, who designed the Beetle for Hitler. Mr Piech expanded Porsche VW holding.

Carrefour Born 1934, Paul-Louis Halley merged French grocer Promodes with biggest rival, Carrefour, to create world's second largest retailer.

Benetton Luciano Benetton and sister Giuliana launched jumpers' range in 1956. Brothers Gilberto and Carlo joined. Siblings' net worth is $10bn.

Isabelle Chevallot

Economist    2nd June 2007

Buttonwood: Who's the patsy?
The winners and losers from hedge funds and private equity

     «IF you've been in the [poker] game for 30 minutes and you don't know who the patsy is," said Warren Buffett, "you're the patsy". As the world watches hedge-fund and private-equity managers build up billion dollar fortunes, many people are wondering where all this money is coming from. In short, who is the patsy?
    To a left-wing politician, the answer is obvious: the ordinary worker. Financial speculators and corporate raiders force companies into short-term decisions, which increase share prices by holding down wages, sacking workers or skimping on capital expenditure.
    To a free-market enthusiast, the question might seem misguided. There need be no patsy, because the economy is not a zero-sum game. Private-equity and hedge-fund managers improve economic welfare by allocating capital more efficiently.
But even if such people create wealth, they may create losers too. After all, even though the growth of trade is a blessing all things considered, some people might suffer as it happens. In fact, economic progress hardly ever succeeds in malung some people better off, without also making someone eise worse off.
    Take Peter Wood, the British entrepre-neur who created the Direct Line insur-ance group in the 19805. Telephone-based insurance was undoubtedly more efficient. And British drivers, who saw their premiums slashed, probably did not be-grudge sharing their gains with Mr Wood, who became fabulously wealthy. But the innovation also created losers: the insurance salesmen who used to operate from offices all around the country.
    Private-equity funds profit by arbitraging between private and public markets, exploiting their different attitudes towards debt for example. In 1989, Michael Jensen of the Harvard Business School argued that the owners and managers of quoted companies were doomed to squabble over cashflow. "The pressure on management to waste cash flow through organisational slack or Investment in unsound projects is often irresistible."
    By gearing up companies, private-equity groups withdraw managers' freedom to decide what to do with cashflow. In theory, this maximises the value of the firm. The losers are the shareholders of public companies who miss out on these gains by selling too early. Shareholders are suspicious of too much debt on the balance sheet, perhaps because heavily geared firms have more volatile profits.
    Indeed, shareholders such as pension funds and insurance companies may be the patsies in another way. They are re-allocating assets from public markets to "alternative assets", including private equity. So they end up owning stakes in the same underlying businesses, but paying higher fees for doing so.
    Hedge funds are equally controversial. Arguably, they improve economies in two big ways. They provide liquidity to mar-kets, thanks to their high trading volumes.
     Other things being equal, the more liquid a market, the lower the cost of capital. Second, they act as financial-risk insurers. Just as entrepreneurs are happier to set up businesses if they know they can protect themselves against fire and theft, so they are more willing to establish companies if they can protect themselves against inter-est-rate and currency moves.
    Credit derivatives, for example, allow investors to separate the risk of default from other risks, such as interest-rate movements. Among the beneficiaries are companies that issue investment-grade debt. These firms have traditionally faced interest rates that seem unjustifiably high given their low risk of default. The advent of credit derivatives seems to have forced down these premiums.
    In this case, the patsies are other financial institutions. The big banks have lost out now that companies no longer depend on them to offer hedges on interest-rate and currency movements. The banks can easily cope with the loss, since hedge funds are such huge money-spinners for their prime broking arms.
    The hotshots who run hedge funds also have some skill to offer, academic research suggests. But thanks to performance fees, they keep most of the benefits of their abilities. So the patsies are those investors who pick the below-average managers. The same is probably true in the world of private equity, except that it is easier to spot the best-performing managers in advance. Even so, investors who are desperate to diversify may end up giving money to the poorer performers in the hope they will improve.
    When they contemplate their portfolios in a few years' time, such investors may regret their decisions. But at least they can bask in the knowledge that the global economy is the better for their folly

Neue Zürcher Zeitung    5.Juni 2007

Mehr Verantwortung für Private Equity
Britische Diskussion um Schulden, Steuern und die Gesellschaft

Nicht immer agieren hochrangige Exponenten einer Branche als klassische Interessenvertreter. Zuweilen durchbricht jemand die sonst geschlossene Front und vertritt als «Freigeist» Ansichten, die nicht im unmittelbaren Eigeninteresse liegen. In diesem Sinne hat der Verwaltungsratspräsident der britischen Private-Equity-Gruppe SVG Capital die tiefen Steuern von Private-Equity-Managern kritisiert. Die Steuersätze seien niedriger als diejenigen einer Putzfrau, hatte er in einem Interview erklärt. Dies sei nicht richtig und er habe noch von niemandem eine klare Rechtfertigung dafür bekommen, sagte Ferguson weiter. Der Private-Equity-Manager bezog sich mit seiner Kritik auf die in Grossbritannien besonders günstige Besteuerung von «carried interest», den Kapitalgewinnen, die die Manager bei ihren Investitionen erwirtschaften.  Diese werden nicht zum maximalen Einkommenssteuersatz von 40% versteuert, sondern nur zu 10%. Finanzprofis aus der Private-Equity-Szene oder Hedge-Funds-Manager profitieren von dieser Regelung besonders, da sie in der Regel mit eigenem Kapital hoch in ihren eigenen Vehikeln investiert sind und keinen «normalen» Lohn beziehen bzw. dieser nur einen kleinen Teil ihres Verdienstes ausmacht. Da die Private-Equity-Deals immer grösser werden, steigt auch der Gewinn für die führenden Partner.
Die Kritik von Ferguson, der allerdings auch betonte, das Kind nicht mit dem Bade ausschütten zu wollen, kommt in einer für die Private-Equity-Branche heiklen Zeit. Lange bewegte sich die Branche mehr oder weniger ausserhalb des Radarschirms von Politik und Öffentlichkeit.
     Wegen des «privaten» Charakters der Investitio-nen abseits einer Börsenkotierung mit Aktien-gewinnen oder -Verlusten für eine Vielzahl von Anlegern blieb das Interesse gemässigt. Die Übernahmen bzw. die Übernahmeversuche von Grossunternehmen mit mehreren zehntausend Angestellten wie Boots und Sainsbury haben dies jedoch geändert. Angesichts der neuen Grössen-ordnungen wird von den Private-Equity-lnvesto-ren mehr Rechenschaft gefordert. Sich der Öf-fentlichkeit einfach über den Rückzug in die «Pri-vatsphäre» zu entziehen, entspreche nicht mehr der gesellschaftlichen Bedeutung, die die Investo-rengruppe mittlerweile erlangt habe.
    Die Rolle, die Private Equity in Grossbritannien einnimnit, wird damit zunehmend zum Gegenstand der Politik. Der parlamentarische Wirtschaftsausschuss hat für Ende Juni eine Anhörung mit hochrangigen Private-Equity-Vertretern anberaumt. Aufgeboten sind Dämon Buffini, Managing Partner von Permira, und Dominic Murphy von Kohlberg Kravis Roberts, dem Private-Equity-Haus, das unlängst für 10 Mrd. £ die Apotheken- und Drogeriekette Boots gekauft hat. Geladen sind ferner Philip Yea, CEO von 3i, David Blitzer von Blackstone und Robert Easton von Carlyle. Höchstwahrscheinlich stehen das Steuerregime, das regulatorische Umfeld und die Risiken durch die hohe Fremdfinanzierung der Gebote hoch auf der Agenda der Parlamentarier. Die Gewerkschaften haben unlängst kritisiert, dass im britischen Steuerregime Fremdkapital gegenüber Eigenkapital begünstigt wird. Das ist zwar kern spezielles Privileg für Private-Equity-Gesellschaften, sondern gilt für alle Unternehmen. Allerdings profitieren die Finanzinvestoren von dieser Regelung de facto besonders, da sie mit hohen Fremdkapitalanteilen arbeiten.

Le Temps    5 juin 2007

Moins taxés «qu'une femme de ménage»!
Gérants alternatifs - Tabou brisé par un caïd du private equity
Myret Zaki

    Nicholas Ferguson, l'une des sommités du private equity européen, a brisé le tabou au sujet de la fiscalité des gérants alternatifs dans une interview au Financial Times.
    Le président de SVG Capital et fondateur de Permira, un fonds qui pèse 11 milliards d'euros, a estimé «injuste» que les cadres du private equity, grassement payés, «paient moins d'impôt qu'une femme de ménage ou d'autres travailleurs à bas salaires. Je n'ai pas encore en-tendu une explication claire qui justifie cet état de fait», a-t-il déclaré.
    Cet aveu intervient au moment où la Grande-Bretagne s'apprête à modifier les règles fiscales les plus attrayantes au monde pour les gérants alternatifs. Le régime d'exemption britannique permet aux associés de firmes de private equity et de hedge funds enregistrés offshore et conseillés depuis l'Angleterre d'être taxés à seulement 10% de leurs gains. Des syndicats britanniques mènent campagne contre cet avantage fiscal.
    Aux Etats-Unis aussi, où les gérants sont taxés à 15%, des syndicats font pression sur le Congrès pour corriger cette situation. Des membres du Congrès parlent de normaliser leur taxation à 35%. Max Baucus, chef du comité financier du Sénat, envisage depuis début mai une législation modifiant le régime fiscal pour les gérants de private equity et de hedge funds.

Financial Times    6 June 2007

Buy-out bonanzas
Private equity plays fair but UK tax rides are generous

    Explaining away nasty stains on the carpet after an office Christmas party is one thing. But Britain's private equity chiefs are going to struggle to tell their cleaners why they pay tax on the "carried interest" in their investment partnerships at a lower rate than those who tidy up after them do on their wages. Private equity, however, is simply adapting to the tax System as it stands and part of the problem with that System is tax reliefs introduced by Cordon Brown, chancellor.
    Nicholas Ferguson, the chairman of SVG Capital and a leading figure in Britain's private equity industry, told the Financial Times "... that a highly paid private equity executive paying less tax than a cleaning lady or other low-paid workers ... can't be right". Few would disagree.
    There are two reasons for such low tax rates: first, Britain taxes the carried interest on a private equity fond as a capital gain and second, capital gains on business assets attract generous tax relief.
    In two separate agreements with thé industry body, in 1987 and again in 2003, Britain's tax authorities agreed that carried interest should be taxed as a capital gain and not as income. This is because thé général partners of a fund usually put up 20 per cent of the capital, though this may only cost a few thousand pounds, even if the fund's value
 runs into billions, because limited partners can provide almost ail of their money in the form of loans.
    There is no doubt that, technically speaking, these profits are capital gains. They arise from a capital investment. But because that investment is so small and because private equity partners only get to make it by virtue of their jobs, the question is whether such gains are actually not employment income. It is a question that the Treasury's current inquiry into private equity taxation should revisit.
    The distinction only matters, however, because of generous tax reliefs that can eut capital gains tax on shareholdings by three-quarters. The resuit, for a private equity partner who would normally pay tax at 40 per cent, is an effective rate of just 10 per cent.
    These tax reliefs were supposed to encourage small businesspeople to risk their savings in start-ups. But fiddling with thé tax System ahnost always produces unintended consequences and unintended beneficiar-ies. This taper relief cost £6.3bn in revenue foregone during the last tax year and there is no.w a strong case for limiting its scope.
    Private equity is playing by the rules but those mies are very generous. For now, at the least, buy-out firm partners had better buy their cleaners a nice bunch of flowers.

Economist    9th June 2007

Carried Away
One tax break for private equity is unfair - but don't blame the buy-out barons

    ON BOTH sides of the Atlantic private-equity firms have faced all sorts of populist barracking recently for profiting at the expense of workers. The financiers have sidestepped most of these charges with pin-striped aplomb - and rightly so.
The debate has been more about class war than economics. Most of the accusations against the locusts and barbarians
have been false; virtually all the remedies would do more harm than good to an industry that has been remarkably useful, not least when it comes to creating jobs.
    Tax has always been part of this assault. Critics initially focused on the fact that interest payments are tax deductible, but dividends are not. This attack seemed unconvincing: interest deductibility does help highly leveraged firms more than most, but borrowing money is hardly an Option just limited to private-equity ones. Now a new tax-related criticism has emerged - to do with the low taxes that private-equity partners pay on their income. Once again, it comes suspiciously larded in the language of envy (shadowy moneymen are dodging taxes that decent workers pay). But this time the critics have apoint. The rules should be changed.
    The argument centres on one long-established discrepancy - the gentler tax treatment of capital gains than annual income. In America this dates back to the 1920s, and was originally intended to reward small-business owners and entrepreneurs for "sweat equity" - the hard work they put in to building a business from scratch. Now it is benefiting people in private-equity firms (and to a lesser extent hedge funds), who receive a large part of their pay in the form of "carried interest" - usually 20% of investment gains. In America these are taxed at the 15% capital-gains rate, rather than 35% income tax. In Britain the benefits are even more generous. Those who hold an investment for two years can pay 10% on the gains, compared with a 40% rate of income tax.
    In theory, an efficient tax system would tax both income and capital gains at the same rate - and allow people to make their decisions on merit alone. But even if you think capital gains and income should be taxed differently, carried interest looks like income, not equity, and should be treated as such. It is much closer to a performance fee than an equity stake (managers can only gain from the carried interest, which cannot be negative). The obvious analogy is with the share options awarded to company managers, which are taxed as income.
    One worry about closing this loophole is that venture-capital companies and other limited partnerships that focus on start-ups might well find their managers caught in the fallout. On closer inspection, this seems unlikely. Venture capitalism has done much better in America than Britain, although the incentive from carried interest is bigger in the latter. The industry's success clearly depends on other things than tax.
    A bigger danger is that in seeking to fix one relatively small thing politicians will get carried away. Gordon Brown, courting the unions this week on his coronation march to Britain's highest office, talked about ensuring "justice and integrity" in the tax treatment of private equity; one union boss was quick to crow that "the fat cats are losing the argument on tax". London's tabloids are also hunting for tubby felines: a British private-equity investor, Nicholas Ferguson, won approving head-lines on June 4th when he protested that private-equity executives were charged less tax than office cleaners.
    In America the issue is being dealt with more cautiously, partly because of intense lobbying by the venture capitalists who have a much better standing in Congress than private-equity firms do. Even so, two prominent members of the Senate Finance Committee, Max Baucus and Chuck Grassley, met industry executives and academics last month to explore the tax treatment of private-equity fees. Increasingly, American unions are returning to the language of redistributive justice.

Concentrate on the good part of the story
    The private-equity industry would do well to heed this populism. It has, on the whole, a good story to teil. As a force for efficiency, the industry is more often a source of investment and new Jobs than a rapacious asset stripper. To work its magic, private equity does not need an unfair tax break, designed for another age and another set of entrepreneurs.
    There are lessons too for politicians. When authorities tinker with the tax System to favour some forms of capital over another, the distortions they create usually come at a cost. If you think the tax system is unfair, blame the people who create d it, not the financiers who took advantage of it.

The Observer    June 10, 2007

Time is running out for tax privateers

Ruth Sunderland

Time is running out on the incredible tax privileges enjoyed by wealthy private equity partners. Thanks to concessions from Gordon Brown, they pay a lower rate than a nurse or a cleaning lady - a state of affairs we have criticised on these pages for months.

The situation is so absurd that City figures including Nicholas Ferguson of SVG Capital and Paul Myners, chairman of Guardian Media Group (the owner of this paper), have spoken out in public. Even the beneficiaries admit they have no defence. As one leading player put it this week, there is a 'valid debate' over tax. Translation: 'We can't quite believe we've got away with this for so long.'

Brown, having inadvertently opened this door, has been reluctant to close it; similarly, he has done nothing about the concessions for wealthy non-domiciles living here. His benign attitude to the rich contrasts with his stinginess over helping people who have lost their pensions - often when their firms have been taken over by private equity, as we report on pages 4-5.

But the pressure on Brown to act is becoming irresistible. Tax is one of the issues that will be aired at a series of select committee hearings into private equity starting this week, at which the industry will go head to head with its trade union critics. Damon Buffini of Permira and his peers, who are appearing next week, can expect a mauling.

Their rock-bottom rates of personal tax come courtesy of Brown's brainchild, 'taper relief', which cuts the amount payable on business gains to just 10 per cent on assets held for at least two years. His aim was to encourage entrepreneurs, but it has been the private equity princelings who have gained the most.

The argument in favour of tax leniency is that private equity boosts the economy and that taxing partners more heavily would drive them away. But in any sane world, this tax advantage must be seen for what it is - an unjustifiable perk. It is debatable whether fairer taxation would lead to an exodus. The UK has plenty of other advantages, including open, non-protectionist markets and a hub of world-class expertise in the City - and, despite the squeals from the industry, there is far less hostility to private equity here than in other European countries.

Reduced tax rates for private equity moguls undermine the whole principle of progressive taxation. There is also an argument that their profits are being incorrectly classed as capital gains, since partners invest relatively small stakes. If their returns were reclassified as income, they would be taxed at 40 per cent - the top rate paid by doctors, senior teachers and other professionals.

There is a separate issue around private equity's use of debt to minimise corporate tax bills. All companies are entitled to offset the interest they pay on loans against their tax bills, but private equity reaps the biggest benefit because its deals are structured around heavy borrowing. This strikes many as unjust, but in practice it is hard to tackle. The Treasury could look at limiting the amount of debt eligible for relief, but that would also hit public companies and possibly inhibit their investment plans.

Drawing attention to the tax arcana surrounding private equity is not a question of resenting the wealthy. Either billions in foregone tax have to be recouped from the rest of us, or there will be less available for public spending.

Two Treasury reviews are under way, one into the personal tax rules and one into private equity debt, which may be published with the pre-Budget report later in the year. Brown has promised the unions he will ensure fairness in the tax system. While he is at it, he might get a move on with his review into the taxation of non-domiciles, which three civil servants have been working on for the past five years.

The Guardian     June 12, 2007

There are the rich and the very rich.
Now meet the private equity kings
· Controversial industry's huge salaries revealed
· Leading lights to make millions after flotation

Andrew Clark in New York

Powerful, super-rich and flamboyant, they are revered as the new kings of Wall Street. A rare glimpse at the top ranks of executives in the private equity industry reveals a world of private jets, personal helicopters and take-home earnings running into hundreds of millions of dollars.
One of the most powerful names in private equity, the Blackstone Group, was obliged yesterday to reveal a breakdown of its finances as part of its preparations for a stock market flotation. Though little known to the public, Blackstone has snapped up businesses ranging from Madame Tussauds to Center Parcs holiday camps, Cafe Rouge restaurants and America's biggest office landlord, Equity Office Properties.

Its prospectus reveals that its chief executive, Stephen Schwarzman, enjoyed personal earnings of $398m last year. When Blackstone goes public, he will receive a windfall of at least $449m and he will retain a stake in the business worth $7.7bn.
A colourful figure known in New York for his star-studded parties, Mr Schwarzman, 60, founded Blackstone in 1985 with an investment banking colleague, Peter Peterson, who served as US commerce secretary in the Nixon administration.

Mr Peterson, who is still working at 81, took home $212m last year and will get $1.88bn by selling shares on Blackstone's flotation. A third senior executive, Hamilton James, enjoyed annual income of a $97m and stands to receive $147m.

Blackstone started with $400,000 and now manages funds of $88bn. These funds are used to buy companies, take them away from the glare of the stock market and restructure them. The firms are often returned to the public markets by being sold several years later.

The sheer scale of the wealth amassed by private equity has angered unions. The TUC's general secretary, Brendan Barber, last month warned that the rise of a super-rich class in the industry threatened to "fundamentally change" the nature of British and European capitalism.

In the US, the Service Employees' International Union has hit out at the "extraordinary riches" for a handful of individuals at the top of the industry. It says the money should be shared with workers in businesses acquired by private equity who contribute to the industry's huge returns.

Blackstone in which the Chinese government has a 10% stake, said the money paid to its top people was simply a reflection of the funds they personally staked at the firm's inception: "One of our fundamental philosophies as a privately-owned firm has been to align the interests of our senior managing directors and other key personnel with those of our investors."

A former contemporary of President Bush at Yale university, Mr Schwarzman once remarked that his working schedule never allows him to eat lunch. Blackstone's disclosures reveal that he co-owns a helicopter with Mr Peterson - and that they billed the company $158,500 for its use last year. For longer journeys, they have a part-share in a private jet.

Colin Blaydon, director of the centre for private equity at Dartmouth College, New Hampshire, said Blackstone's success meant that investors - including public employee pension funds and university endowment funds - were sharing the benefit.

"You've got to look at the way these partnerships are structured," he said. "They can only make this kind of money if their investors, who make 80% of the capital gains, are also doing extremely well."

Among the businesses targeted by private equity have been Boots and Sainsbury's in Britain, the casino owner Harrah's in America and the Australian national airline, Qantas.

Experts say the low cost of debt and the strength of corporate cashflow are among the factors helping private equity firms to snap up public companies. Ageing demographics in the US and Europe mean pension funds are increasingly searching for greater long-term returns than those traditionally provided on the stockmarket.

Blackstone and its US rival, Kohlberg Kravis Roberts, are vying for the title of the world's biggest private equity firm. Mr Schwarzman has emerged as the industry's most prominent figure.

He lives in a 35-room Manhattan apartment with his wife Christine, and his 60th birthday party in February featured private performances by Rod Stewart and Pattie LaBelle, an a capella group serenading him with "happy birthday" and a troupe of cadets from New York's Knickerbocker Greys to lead guests - including tycoon Donald Trump and city mayor Michael Bloomberg - to their seats.

Further down the ranks, Blackstone's success has paid off for its management. Vice-chairman Tomlinson Hill got $45m last year and chief financial officer Michael Puglisi received $17m. Seven more executives will have shares worth a combined $380m on flotation.

In political circles, pressure is mounting for greater transparency and taxation of private equity. The Labour-dominated Treasury select committee is due to hold hearings on the issue today.

Eli Talmor, a private equity expert at the London Business School, said the industry's rewards still pale in comparison with the billions earned by top hedge fund managers. "This money isn't really pay for their labour or for their daily involvement," he said. "They're more equivalent to shareholder returns - these partners needed to buy their positions."

He said individuals such as Mr Schwarzman could justifiably claim to offer special skills, although he asked: "Are they 500 times more special than someone who makes a million dollars? Probably not. Is there an element of luck here? Probably. But this is equivalent to establishing a start-up and taking it to stardom."

June 13, 2007

Scrutiny on Tax Rates That Fund Managers Pay

The backlash against the tremendous wealth being created by managers of hedge funds and private equity funds may be gaining strength. Yesterday, Robert E. Rubin, a former Treasury secretary in President Bill Clinton’s administration, made the case for why private equity and hedge fund managers should pay more than double the low rate in taxes they now enjoy.

Mr. Rubin, now the chairman of the executive committee at Citigroup, was responding to a question posed to him about whether the 20 percent fee on profits that most private equity firms charge should continue to be taxed at the lower capital gains rate of 15 percent or changed to the top ordinary income tax rate of 35 percent. Mr. Rubin, who said he was expressing his own views and not that of his employer, was a panelist at a tax reform conference run by the Hamilton Project, a policy group initiated mostly by moderate Democrats from business and academia that is housed at the Brookings Institution.

“It seems to me what is happening is people are performing a service, managing peoples’ money in a private equity form, and fees for that service would ordinarily be thought of as ordinary income,” Mr. Rubin said. He made clear that he was not a tax expert but said the issue should be looked at “with great seriousness” by the appropriate tax committees in Congress.

The compensation of private equity and hedge fund managers has become a hot button issue as their pay has skyrocketed. James Simons, chairman of Renaissance Technologies, earned $1.7 billion last year while the average compensation of the top 25 managers was $570 million, according to Institutional Investor’s Alpha magazine.

Stephen A. Schwarzman, the co-founder of the Blackstone Group, which is in the process of going public, made $400 million last year. He plans to cash out up to $677.2 million after the initial public offering and will own a stake worth $7.5 billion if the offering is priced in the range the company’s underwriters have planned.

Congress, searching for alternate sources of revenue, has taken notice. A few months ago, staff members of the Senate Finance Committee started to examine taxes on the 20 percent fee on profits, which private equity firms call “carry” and hedge funds call performance fees, as well as other tax issues involving hedge funds and private equity.

Another area of interest to the committee is the ability of hedge fund managers and private equity managers to defer large portions of their income offshore, where it can increase tax free (they pay taxes when they bring it back into the United States). The chairman of the Senate Finance Committee, Max Baucus, Democrat of Montana, recently said the committee was not close to doing anything.

Private equity firms and hedge funds are generally structured as partnerships, which means they have “flow-through” accounting: every owner receives his or her share of the profits and pays taxes on it. No corporate entity is taxed.

Most private equity funds and hedge funds receive two kinds of fees: a 2 percent management fee (2 percent of the assets they manage), and a 20 percent incentive fee, or a 20 percent cut of the profits.

There are crucial differences though. Many hedge funds trade in and out of liquid securities, like stocks, very rapidly, so their gains are taxed as ordinary income (because they do not hold them for more than a year). Private equity funds, by contrast, borrow money to buy companies, strive to improve the company’s operations in the private market and take it public or sell it, generally in five to seven years (though that time has recently been shrinking).

The dispute does not center on whether the income generated by the transaction should be treated as a long-term capital gain, but whether private equity managers, who are not risking significant amounts of their own money, but managing money for others, should get the lower capital gains tax treatment.

Jason Furman, director of the Hamilton Project, framed the issue this way: “Is it an employee doing a service and getting a fee, or is it more like a business owner selling their business at a profit?” (The Hamilton Project is not an advocacy organization and does not have a view).

While the tax treatment of so-called carried interest focuses more directly on private equity managers, many hedge funds are getting more involved in buying and selling more illiquid assets, including companies, which would bring the issue closer to home for them. At the same time, private equity funds and hedge funds are increasingly getting into each other’s business.


June 25, 2007

Raising Taxes on Private Equity

So much for the argument often made by managers of hedge funds and mavens of private equity that higher taxes would cripple their business.

The prospect of higher taxes did not dent, in the least, the initial public offering on Friday of the Blackstone Group, the giant private equity firm. The week before, a bill was introduced in the Senate to raise taxes on private equity firms that go public. On the day of the offering, a House bill was introduced that would raise their taxes, whether they’re publicly traded or not.

And yet, Blackstone had a debut that was one of Wall Street’s biggest, its thunder muted only by the announcement by its longtime rival, Kohlberg Kravis Roberts, that it, too, planned to go public.

The bills in Congress take aim at a provision of the tax law that has allowed private equity and hedge fund operators to pay a lower capital-gains tax rate of 15 percent, instead of the ordinary top income-tax rate of 35 percent, on the performance fees that make up the bulk of their huge paychecks.

With income inequality surging along with the need for tax revenue, the bills’ supporters rightly conclude that it is untenable for the most highly paid Americans to enjoy tax rates that are lower than those of all but the lowest-income workers.

Fairness is not the only reason to change the rules. The private equity industry is on shaky ground when it claims that current practice is a correct application of the law.

Many of the firms’ partners are not investing their own money in the various funds and ventures, and so have no direct risk of loss, the general test for claiming capital-gains treatment on one’s earnings. Moreover, the tax rules in question were developed decades ago for enterprises that had passive investors to whom gains were passed along. Hedge fund managers and private equity partners are not passive. They’re actively managing assets, and should be taxed accordingly as managers earning compensation.

The challenge now is to develop a single bill that can withstand the formidable lobbying efforts of the private equity industry to water it down.

To do so, the final bill should clearly apply to other firms where partners may also receive most of their pay as capital gains, such as oil and gas partnerships. It will also be necessary to narrow the bill, where appropriate. For instance, it could include a mechanism to allow some compensation to be taken in a form similar to incentive stock options.

Congress will achieve a significant victory, for fairness and for fiscal responsibility, if it ends the breaks that are skewing the tax code in favor of the most advantaged Americans.

WirtschaftsWoche    27/2007

Die Deutschland-Chefs der großen Fonds

   Private Equity» Mit der Übernahme der Hilton-Hotels ist dem US-Finanzinvestor Blackstone gestern eine milliardenschwere Überraschung gelungen. Wer steckt hinte den Private-Equity-Fonds. veröffentlicht die Portraits der Deutschland-Chefs (alle Illustrationen: Bernd Schifferdecker)

Doch ist es nicht das erste Mal, dass eine Private-Equity-Firma Interesse an der Touristik zeigt. Finanzinvestoren und Investmentbanken halten schon seit einiger Zeit Einzug in eine Branche, um die sie lange Zeit einen großen Bogen gemacht haben.

Auch Blackstone ist im Freizeit- und Hotelsektor längst präsent und hat dort offensichtlich positive Erfahrungen etwa mit Hotels von „La Quinta Inns and Suites“ und der Luxusmarke LXR gesammelt. Vor allem in Nordamerika haben Investoren die Hotelbranche entdeckt. Die Investmentbank Morgan Stanley kaufte zu Jahresbeginn für knapp sieben Milliarden Dollar den Immobilienfonds CNL Hotels & Resorts.

Vor wenigen Wochen kündigte der Immobilienfonds Whitehall der Investmentbank Goldman Sachs den Kauf der Hotelkette Equity Inns an. Der kanadische Hotel-Investmentfonds Legacy gilt ebenfalls als attraktives Übernahmeziel für Investoren und hat nach eigenen Angaben bereits mehrere Angebote erhalten. Einen Gruppe um Microsoft-Gründer Bill Gates stieg im Februar beim Luxus-Hotelbetreiber Four Seasons ein.

3i Stephan Krümmer

Funktion: Deutschland-Geschäftsführer

Alter: 50 Jahre

Standort: Frankfurt

Fondsgröße: 5 Mrd. Euro Buyout-Fonds

Investments: Scandlines, Norma/Rasmussen, früher DocMorris, Betapharm

Gesellschaft: Die britische Gesellschaft ist der älteste Finanzinvestor der Welt. Sie entstand 1945 aus zwei Mittelstandsförderbanken. Der Name steht für „Investors in Industries“. Seit 1984 ist 3i in Deutschland, seit 1994 an der Londoner Börse notiert. 3i engagiert sich in allen Segmenten des Private-Equity-Geschäfts: Venture Capital, Wachstumsfinanzierungen, Buyouts und Infrastruktur.

Person: Stephan Krümmer übernahm das Deutschland-Geschäft Anfang 2005. Vorher führte der Opernliebhaber das deutsche Investmentbanking von Rothschild und arbeitete elf Jahre bei Bertelsmann. Krümmers erste Ehefrau Renate leitet heute das Deutschland-Geschäft des US-Finanzinvestors J.C. Flowers. Der 3i-Chef ist ein exzellenter Skifahrer. Als gebürtiger Hamburger hat er eine Schwäche für den Norden behalten und verbringt seine freie Zeit am liebsten in Hamburg oder auf Sylt.    Allianz Capital Partners (ACP) Thomas Pütter

Funktion: Vorsitzender der Geschäftsführung

Alter: 49 Jahre

Standort: München

Fondsgröße: ACP ist kein Fonds, sondern eine 100-prozentige Tochter der Allianz und investiert konzerneigene Mittel

Investments: MAN Roland, Scandlines, früher Tank & Rast, Schmalbach-Lubeca

Gesellschaft: ACP ist der größte deutsche Investor in Private Equity und profitiert von den Kontakten der Konzernmutter. Die Allianz-Tochter kann aus eigener Kraft Übernahmen bis zu zwei Milliarden Euro stemmen und so als einziger Deutscher im Spiel der Großen mitmengen. Schiffbruch erlitt Pütter mit der Übernahme des Flugzeugbauers Fairchild Dornier und der Bundesdruckerei.

Person: Pütter verbrachte den größten Teil seines Lebens in Großbritannien und ist mit einer Engländerin verheiratet. Erst mit 40 kehrte er für die ACP-Gründung zurück nach Deutschland. Pütter und Cinven-Partner Peter Gangsted sind enge Freunde aus Kindertagen. Ihre Väter arbeiteten für Coca-Cola. Gangsted war bei ACP früher ein Kollege von Pütter. Auch mit dem Gründer des Ven-ture-Fonds Wellington, Rolf Dienst, verbindet den ACP-Chef ein enger Kontakt aus gemeinsamen Zeiten bei der Matuschka-Gruppe, der Mutter aller deutschen Private-Equity-Gesellschaften. Jüngst übernahm Dienst von Pütter den Vorstand beim deutschen Private-Equity-Verband. Pütter hat drei Kinder – und zwei Labrador-Hunde. In seiner Freizeit spielt der frühere Leistungsschwimmer „gerne, aber schlecht Golf“. Außerdem sammelt er gute Weine.    Apax Michael Phillips

Funktion: Deutschland-Chef

Alter: 45 Jahre

Standort: München

Fondsgröße: 4,3 Milliarden Euro, der neue 11-Millliarden-Euro-Fonds steht kurz vor dem Abschluss

Investments: Versatel, Sulo, früher Bundesdruckerei, Tank & Rast, Nordsee

Firma: Apax gehört zusammen mit Permira zu den Private-Equity-Gesellschaften, die am längsten in Deutschland aktiv sind. Früher engagierte sich Apax bei Startups, heute hat sich die Gesellschaft auf große Buyouts konzentriert. Größte Schlappe für Apax in Deutschland war der gescheiterte Kauf der Bundesdruckerei.

Person: Der gebürtige Kanadier Phillips lebt seit 1989 in Deutschland. Er ist ein großer Eishockeyfan und spielt selber auch in einem Hobbyverein. Er hat vier Kinder, mit denen er von München aus gern zum Skifahren fährt.    Bain Capital Ulrich Biffar

Funktion: Deutschland-Chef

Alter: 45 Jahre

Standort: München

Fondsgröße: 7,5 Mrd. Euro (10 Mrd. Dollar)

Investments: Bavaria Yachtbau, früher Brenntag, ProSieben Sat.1, Treofan, Jack Wolfskin

Gesellschaft: Bain Capital gehört zu den erfolgreichsten Private-Equity-Firmen der Welt. Biffar sagte einmal: „Uns ist nicht bekannt, dass irgendeine andere Beteiligungsgesellschaft auf Dauer höhere Renditen geliefert hätte.“ Nach Informationen der WirtschaftsWoche lagen sie historisch bei über 90 Prozent (WirtschaftsWoche 10/2006). In Deutschland machte Bain jüngst von sich reden, als Biffar mit seinen Münchner Büro-Nachbarn von General Capital die Übernahme des Reifenherstellers Continental plante. Die Aktion scheiterte, weil sich jemand verplapperte – und der Kurs stieg.

Person: Biffar war früher mit der Olympia-Dressur-Reiterin Nadine Capellmann aus der Aachener Reiter-Dynastie verheiratet. Sein Ex-Schwiegervater Kurt Capellmann war nicht nur Reitstall-Besitzer und Chef des Chio-Turniers, sondern auch Inhaber der Aachener Waggonfabrik Talbot. Biffar übernahm Anfang der Neunzigerjahre die Geschäftsführung des Familienunternehmens in fünfter Generation, um den Betrieb 1995 an Bombardier zu verkaufen. Danach ging Biffar zunächst zum britischen Finanzinvestor BC Partners, bevor ihn Bain als Deutschland-Chef holte. Vergangene Woche kaufte Freizeit-Segler Biffar für den Finanzinvestor den Yachtbauer Bavaria.    BC Partners Jens Reidel

Funktion: Chairman und Deutschland-Chef

Alter: 56 Jahre

Standort: Hamburg

Fondsgröße: 5,9 Milliarden Euro

Investments: Brenntag, Unitymedia, früher Grohe, Techem

Gesellschaft: Die Herren von BC Partners sind die Nice Guys im Haifischbecken der Finanzinvestoren. Über das Team um Reidel und seine fünf Partner in Hamburg hört man kaum ein böses Wort. BC Partners gilt als fair, umgänglich und partnerschaftlich, dabei professionell. Einzig der Verkauf des Armaturenherstellers Grohe an die Kollegen von Texas Pacific kratzte am Ruf. Die Gesellschaft überlegt derzeit, in New York das erste Büro außerhalb Europas zu eröffnen.

Person: Reidel ist begeisterter Golf-Spieler (Handicap 21), kommt allerdings nur zu selten dazu. Früher hat er Handball gespielt. Der gebürtige Frankfurter sammelt Kunst der klassischen Moderne – und ist Eintracht-Frankfurt-Fan. Er hat sieben Kinder, die ihn in seiner Freizeit beschäftigen. Damit ist er unter den generell kinderreichen Private-Equity-Managern absolute Spitze. Sein ältester Sohn macht gerade ein Praktikum bei einer Investmentbank, könnte also vielleicht in Vaters Fußstapfen treten. Reidel: „Als ich mit meinem Sohn nach seinem Abitur sechs Tage verreiste, war er sauer auf mich, weil ich so oft telefonieren musste. Aber im Moment arbeitet er mehr als ich.“    Blackstone Thorsten Langheim

Funktion: Managing Director, zuständig fürs Deutschland-Geschäft

Alter: 39 Jahre

Standort: London

Fondsgröße: 13,6 Mrd. Euro (18,1 Mrd. Dollar)

Investments: Klöckner Pentaplast, Deutsche Telekom, Sulo

Gesellschaft: Blackstone ist der größte börsennotierte Finanzinvestor der Welt. In Deutschland machte Blackstone vor allem mit seiner untypischen 4,5-Prozent-Beteiligung an der Deutschen Telekom von sich reden. Das macht nur Sinn, weil sich der Bund als Großaktionär und Sparringspartner „wie ein Private-Equity-Investor verhält“, sagt ein Insider. Bundesfinanzminister Peer Steinbrück will die Beteiligung nämlich auch innerhalb der nächsten Jahre verkaufen. Als Duo können die beiden viel bewegen: Der Bund hat die Stimmen, Blackstone das Know-how und den Kampfgeist.

Person: Thorsten Langheim ist als Managing Director zwar noch nicht in den erlauchten Partnerkreis von Blackstone aufgenommen worden. Doch als ranghöchster Deutscher koordiniert er die hiesigen Aktivitäten, auch wenn im Telekom-Aufsichtsrat Blackstone-Partner Lawrence Guffey sitzt. Langheim war bei allen Transaktionen in Deutschland mit von der Partie. Er kam 2004 von JP Morgan zu Blackstone und lebt mit seiner Familie in London.    Carlyle Gregor Böhm

Funktion: Partner, zuständig fürs Deutschland-Geschäft

Alter: 42 Jahre

Standort: München

Fondsgröße: 7,8 Mrd. Euro in zwei Fonds (10,1 Mrd. Dollar)

Investments: Edscha, HT Troplast, H.C. Starck

Gesellschaft: Carlyle gehört in den USA zu den traditionellen Schwergewichten der Branche. In Deutschland kam das Geschäft nur schwer in Gang und liegt von der Größenordnung der Investments unter dem internationalen Niveau der Gesellschaft. Bisher hat Carlyle in Deutschland zwar kein einziges Verlustgeschäft gemacht. Allerdings sind die Erträge durch Restrukturierungen wie bei den Automobilzulieferern Honsel und Edscha hart erarbeitet. Carlyle sucht einen weiteren Managing Director für Deutschland, ist dabei seit dem Abgang von Heiner Rutt Anfang 2006 jedoch nicht erfolgreich.

Person: Seitdem leitet Gregor Böhm als einziger deutscher Partner das Münchner Büro der Carlyle Group. So bleibt es dem eher zurückhaltenden Wirtschaftswissenschaftler nicht erspart, sich gelegentlich auch der Öffentlichkeit zu stellen. Böhm wohnt mit Ehefrau Sabine, einer promovierten Patentanwältin, und seinen drei Töchtern im Münchner Süden. In seiner Freizeit joggt er und fährt als Wahl-Münchner natürlich Ski. Außerdem sammelt er moderne Kunst und interessiert sich für Literatur.    Cerberus David Knower

Funktion: Deutschland-Chef

Alter: 46 Jahre

Standort: Frankfurt

Fondsgröße: nicht bekannt, insgesamt 16,9 Mrd. Euro (22 Mrd. Dollar) verwaltetes Vermögen

Investments: Baubecon, Peguform, Ströer, GSW Berlin, Chrysler, Bawag, GMAC

Gesellschaft: Im Gegensatz zu vielen anderen Finanzinvestoren schreckt Cerberus vor schwierigen Fällen und Restrukturierungen nicht zurück. Gerade in den vergangenen Monaten machte Cerberus durch die Übernahme des Autobauers Chrysler von sich reden. Auch in Deutschland hat Cerberus noch große Pläne und hat ein Gebot von acht Milliarden Euro für den Ruhrkohlekonzern RAG abgegeben. Cerberus hat es in Deutschland mit einem so Furcht einflößenden Namen nicht leicht und steuert gegen – etwa mit der Förderung von 600 Lehrstellen mit sechs Millionen Euro.

Person: David Knower baut seit Februar 2003 das Frankfurter Büro von Cerberus auf. Vor seiner Zeit bei den Höllenhunden arbeitete er lange bei Procter & Gamble und als Personalberater. Der gebürtige Bostoner lebt schon seit über 20 Jahren in der Nähe von Frankfurt, seit Neuestem Mitten in der Stadt im Westend. Knower war bereits das erste Mal 1978 als Austausch-Schüler in Deutschland, damals in Neustadt an der Weinstraße. Später verbrachte er als Student ein Jahr in Freiburg. Knower hat zwei Kinder und spielt in seiner Freizeit gerne Golf und Fußball.    Cinven Peter Gangsted

Funktion: Partner, bisheriger Deutschland-Chef

Alter: 48 Jahre

Standort: London

Fondsgröße: 6,5 Mrd. Euro

Investments: Springer Science + Business Media, früher Klöckner Pentaplast, CBR

Gesellschaft: Cinven gehört zu den großen Finanzinvestoren in Europa, ist in Deutschland allerdings relativ zurückhaltend mit Investitionen. Aktuell ist der Fonds lediglich noch zusammen mit Candover an Springer Science + Business Media beteiligt.

Person: Der gebürtige Däne Peter Gangsted gehört mit seiner ruhigen Art zu den Sympathieträgern der Branche und den wenigen mit langjähriger Industrie-Erfahrung. Gangsted war früher 15 Jahre bei Unilever, unter anderem als Deutschland-Chef. Von dort lockte ihn sein Jugendfreund Thomas Pütter zu Allianz Capital Partners (siehe Porträt Pütter). Dort wiederum warb ihn Cinven ab, um das Deutschland-Geschäft aufzubauen. Gangsted ist komplett unprätentiös. Bis vor Kurzem fuhr er entweder mit seinem alten Mercedes oder dem Mountain-Bike durch Bad Homburg. Ende vergangenen Jahres verließ er den Taunusvorort allerdings mit seiner Familie und ging zurück nach London. Das Deutschland-Geschäft übernehmen seitdem offiziell fünf jüngere Geschäftsführer in Frankfurt.    CVC Steve Koltes

Funktion: Deutschland-Chef

Alter: 50 Jahre

Standort: Frankfurt

Fondsgröße: 10,1 Mrd. Euro

Investments: Flint-Gruppe, Elster, Formel 1, Debenhams, früher Ista

Gesellschaft: CVC wurde 1981 als Citicorp Venture Capital gegründet. 1993 kauften sich die Partner frei. Der Fonds gehört seitdem kontinuierlich zusammen mit Permira, Apax und BC Partners zu den größten in Europa. CVC genießt einen Top–Ruf, weil es dem britischen Finanzinvestor stets gelang, die Wachstumsversprechen zu erfüllen. Nur ein Börsengang fehlt CVC in Deutschland noch zur Glückseligkeit. Den sollte eigentlich der Energiedienstleister Ista liefern. Doch angesichts des üppigen Gebots des britischen Finanzinvestors Charterhouse wurden die begraben. Dafür trägt sich CVC angesichts des erfolgreichen Blackstone-Börsengangs selber mit Parkett-Plänen.

Person: Deutschland-Chef Steven Koltes ist für das öffentliche Image von CVC in Deutschland ein Glücksfall. Der sympathische Amerikaner spricht fließend deutsch und wickelt mit seiner lockeren Art nicht nur die Öffentlichkeit, sondern auch noch die Gewerkschaften um den Finger. Der sportliche Co-Gründer von CVC lebt mit seiner Frau und den beiden Kindern in der Schweiz – offiziell wegen der Lebensqualität, tatsächlich wohl aber eher wegen der Steuersätze. In seiner Freizeit ist Koltes so oft wie möglich in Bewegung: beim Wandern, Fahrradfahren, Schwimmen, Golfen oder Skifahren. Aber immer mit Telefon am Mann.    EQT Marcus Brennecke

Funktion: Deutschland-Chef

Alter: 45 Jahre

Standort: München

Fondsgröße: 4,3 Mrd. Euro

Investments: Tognum, Kabel Baden-Württemberg, Symrise, CBR, Carl Zeiss Vision

Gesellschaft:: Der schwedische Finanzinvestor EQT hat seine Präsenz in Deutschland in den vergangenen Jahren enorm ausgebaut. Zweitgrößter Geldgeber von EQT sind nach der schwedischen Familie Wallenberg die Duisburger Haniels. EQT arbeitet stärker als andere Fonds mit industriellen Ratgebern und macht grundsätzlich keine Club-Deals mit anderen Finanzinvestoren. Mit seinem wachstumsgetriebenen Ansatz hat sich EQT in den vergangenen Jahren einen hervorragenden Ruf in Deutschland erarbeitet.

Person: Wer Marcus Brennecke googelt, könnte meinen, der Mann sitzt kaum im Büro, sondern ständig nur in seinem Segelboot. Brennecke ist mehrfacher deutscher Meister in der Drachen-Klasse. Außerdem soll er eine Schwäche für blonde Frauen haben. Vor zehn Jahren heiratete er die Milliardärstochter Alexandra Flick, mit der er einen Sohn hat. Das Paar lebt seit Jahren getrennt. Inzwischen erwartet Brennecke von seiner neuen Partnerin sein drittes Kind. Der gebürtige Hamburger gehört seit 20 Jahren zusammen mit Emanuel Prinz zu Salm-Salm und Hans Graf zu Rantzau zu den Organisatoren der „Hamburger Nächte“, einer der exklusivsten Partyreihen der feinen Hamburger Gesellschaft.    Goldman Sachs Alexander Dibelius

Funktion: Deutschland-Chef

Alter: 46 Jahre (ungefähr, Dibelius macht zu seinem genauen Alter keine Angaben)

Standort: Frankfurt

Fondsgröße: 6,5 Mrd. Euro, der Nachfolgefonds mit 15 Mrd. Euro (20 Mrd. Dollar) wird derzeit eingesammelt.

Investments: Kion, Cognis, Karstadt-Immobilien

Gesellschaft: Goldman Sachs ist nicht nur eine der erfolgreichsten Investmentbanken der Welt, sondern auch einer der größten Investoren im Bereich Private Equity. Beliebt bei den Bankern ist das sogenannte Triple-Play, das dreifache Verdienen an einer Transaktion: Goldman berät Finanzinvestoren bei Übernahmen, finanziert die Deals und beteiligt sich als Co-Investor gerne noch mit eigenem Geld am Unternehmen. Das gelang Deutschland-Chef Alexander Dibelius zum Beispiel bei der Übernahme des Chemieunternehmens Cognis.    KKR Johannes Huth

Funktion: Europa-Chef

Alter: 47 Jahre

Standort: London

Fondsgröße:16,4 Mrd. Euro (zwei Fonds mit 11,9 und 4,5 Mrd. Euro)

Investments: Kion, ProSieben Sat.1, DSD, früher Zumtobel, MTU Aero Engines, Demag Holding, Wincor Nixdorf

Gesellschaft: KKR ist eine der größten und wohl die bekannteste Private-Equity-Gesellschaft der Welt. In den vergangenen 18 Monaten hat KKR das Tempo seiner Investitionen extrem beschleunigt und kommt in 2007 bisher auf einen Marktanteil von 44 Prozent aller Private-Equity-Deals. Europachef Johannes Huth belegt eindrucksvoll, dass ein US-Fonds auch aus London Geschäfte in Deutschland machen kann.

Person: Johannes Huth lebt mit seiner Frau, einer Iranerin, in London und hat fünf Kinder. Der gebürtige Heidelberger spricht fünf Sprachen; Russisch lernt er gerade – die sechste. Huth ist Harley-Davidson-Fan, fährt gerne Ski und Rennrad. Sein Bruder Martin führt den Finanzinvestor Triton in Frankfurt, einen Investor in mittelgroße Unternehmen. Huth kam 1999 als Quereinsteiger von Investcorp zu KKR. Vorher war er bei Salomon Brothers. Er studierte an der Pariser Sorbonne, der London School of Economics und machte seinen MBA an der Universität von Chicago.    Odewald & Cie. Jens Odewald

Funktion: Gründer und Deutschland-Chef

Alter: 66 Jahre

Standort: Berlin

Fondsgröße: 600 Millionen Euro

Investments: Transoflex, Kaffee-Partner, TFL, Westfalia

Gesellschaft: Odewald & Compagnie gehört wie Quadriga Capital zu den größten deutschen Fonds. Gegründet 1997 vom ehemaligen Kaufhof-Chef Jens Odewald hat sich der Fonds zu einem wichtigen Spieler im deutschen Mid-Market entwickelt. Neben Odewald sind der frühere Dresdner-Bank-Vorstand Ernst-Moritz Lipp und der frühere Bertelsmann-Manager Klaus Eierhoff Partner des Fonds.

Person: Odewald hat die Attitüde eines Vorstandschefs noch immer nicht so ganz abgelegt. Die früheren Funktionen als Kaufhof-Vorstand und Verwaltungsratschefs der Treuhandanstalt bleiben wahrscheinlich kaum einem Gesprächspartner verborgen. Odewald übernahm als Kaufhof-Chef den Wettbewerber Horten und kaufte für die Metro die erfolgreichen Saturn-Märkte. Das macht auch bei Mittelständlern Eindruck. Odewald setzt mit seinem Team sehr stark auf Industrieerfahrung und hat sich angesichts der Erfolge die Anerkennung der Branche erarbeitet. Er hat vier Kinder und lebt in Köln.    Permira Thomas Krenz

Funktion: Deutschland-Chef

Alter: 46 Jahre

Standort: Frankfurt

Fondsgröße: 11 Mrd. Euro

Investments: ProSieben Sat.1, Debitel/Talkline, Cognis, Takko, früher Kiekert, Premiere, Sirona Dental, Rodenstock

Gesellschaft: Permira war eine der ersten Private-Equity-Gesellschaften, die mit Thomas Krenz in Deutschland im großen Stil aktiv war. Die Gesellschaft hat früher spektakulär erfolgreiche Übernahmen in Deutschland gesteuert. Der Ruf hat in den vergangenen Jahren etwas gelitten, unter anderem wegen der Krise beim Automobilzulieferer Kiekert, wo Permira von den Gläubigern aus dem Eigenkapital gedrängt wurde. Auch bei der Einzelhandelskette Takko musste restrukturiert werden. Trotzdem gehören die Permira-Fonds weltweit stets zu den Fonds mit der besten Rendite.

Person: Krenz sagt, sein Hobby sind seine beiden Kinder. Abgesehen davon geht er manchmal Joggen. Da dürfte er angesichts seines Zigarillo-Konsums gelegentlich aber mal kräftig hustend Pause machen müssen. Für mehr bleibt neben seinem Job keine Zeit, sagt der Permira-Chef. Krenz ist berüchtigt für mitternächtliche E-Mails an Mitarbeiter und Dienstleister. Er bezeichnet sich selbst als Adrenalin-Junkie.    Quadriga Capital Max Römer

Funktion: Gründer und Deutschland-Chef

Alter: 55 Jahre

Standort: Frankfurt

Fondsgröße: 525 Millionen Euro

Investments: Jack Wolfskin, Palmers, Süddekor

Gesellschaft: Quadriga Capital gehört zusammen mit Odewald & Cie. zu den größten deutsch-stämmigen Fonds. Die Gesellschaft investiert erfolgreich in Mittelständler, Familienunternehmen und kleine Konzern-Spin-offs. Quadriga gelang es auch, einen erfolgreichen Russland-Fonds mit derzeit 140 Millionen Euro aufzulegen.

Person: Römer gehört zu den Urgesteinen der deutschen Private-Equity-Szene. Sein Handwerkszeug lernte er bei CVC. 1995 gründete er mit Partnern Quadriga Capital. Der erste Fonds hatte 100 Millionen Euro, der jüngste 525 Millionen Euro. Quadriga hat in der Vergangenheit rund zur Hälfte Unternehmen aus Familienbesitz gekauft. Das gelingt sicher auch, weil die Quadriga-Herren so bodenständig und vertrauenerweckend auftreten. Römer, ein gebürtiger Westfale, hat zwei Kinder. In seiner Freizeit malt er und schreibt Gedichte, die er auch gemeinsam mit seiner Schwester veröffentlicht. Er hat allerdings auch schon langweiligere Artikel zum Thema Management-Buyouts geschrieben.    Terra Firma Guy Hands

Funktion: CEO

Alter: 47 Jahre

Standort: London

Fondsgröße: 5,4 Mrd. Euro

Investments: Deutsche

Annington, Tank & Rast, Odeon und UCI

Gesellschaft: Terra Firma investiert am liebsten in infrastruktur-nahe Unternehmen, die einen steten Zufluss an Geld versprechen. Mit der Deutschen Annington ist der britische Finanzinvestor der größte Wohnungsbesitzer in Deutschland. Die Autobahnraststätten-Kette Tank & Rast gehört Terra Firma seit 2004, gerade wurde die Hälfte davon wieder verkauft. Hands machte sich unter anderem einen Namen mit innovativen Finanzierungsinstrumenten wie der Verbriefung von Krediten.

Person: Hands liegt das Unternehmertum im Blut. Schon als Kind verkauft er Spielzeug, als Oxford-Student gründete der Hobby-Fotograf eine Galerie. In dieser Zeit lernte der Legastheniker auch seine Frau Julia kennen, die in Cambridge studierte, und zwar bei ihrem gemeinsamen Engagement für die konservative Partei. Trauzeuge der Hands ist der frühere Parteivorsitzende der britischen Konservativen, William Hague. Hands ist einer der wenigen Private-Equity-Pioniere, die auch eine erfolgreiche Frau haben. Julia Hands ist Inhaberin und Geschäftsführerin der Hand Picked Hotels, einer Kette von 14 Edel-Country-Hotels in Großbritannien. Dafür wurde sie 2005 als eine von Englands Top-Unternehmerinnen ausgezeichnet. Das Paar hat vier Kinder und steht mit einem geschätzten Vermögen von 200 Millionen Pfund (rund 300 Millionen Euro) laut „Sunday Times“ auf Platz 351 der reichsten Briten.    Texas Pacific Group (TPG) Matthias Calice

Funktion: Partner, zuständig fürs Deutschland-Geschäft

Alter: 38 Jahre

Standort: London

Fondsgröße: 11,2 Mrd. Euro (14,5 Mrd. Dollar)

Investments: Grohe, Gate Gourmet, früher Mobilcom

Gesellschaft: TPG hat sich den Ruf in Deutschland durch das ruppige und ungeschickte Vorgehen bei Grohe vermasselt. Dabei gehört TPG in den USA zu den erfolgreichsten und angesehensten Private-Equity-Fonds. TPG hat spektakuläre Sanierungen hinbekommen. Unter anderem von der Fluglinie Continental. In Europa hatte TPG-Gründer David Bonderman zum Beispiel früh auf die Billig-Fluglinie Ryanair gesetzt.

Person: Calice lebt mit seiner italienischen Frau und seinen zwei Kindern in London. An Office-Tagen bringt er seine ältere Tochter selber in die Vorschule, und versucht, vor 19.30 Uhr wieder zu Hause zu sein, um die Kinder noch zu sehen. Als gebürtiger Österreicher fährt Calice natürlich leidenschaftlich gerne Ski. In London geht er ersatzweise mit seinem Bruder – einem Investmentbanker – joggen. Außerdem interessiert sich Calice für Kunst.
[05.07.2007] (Frankfurt)
Aus der WirtschaftsWoche 27/2007.
Alle Rechte vorbehalten.

Die Web-Seiten von, ihre Struktur und sämtliche darin enthaltenen Funktionalitäten, Informationen, Daten, Texte, Bild- und Tonmaterialien sowie alle zur Funktionalität dieser Web-Seiten eingesetzten Komponenten unterliegen dem gesetzlich geschützten Urheberrecht der ECONOMY.ONE GmbH. Der Nutzer darf die Inhalte nur im Rahmen der angebotenen Funktionalitäten der Web-Seiten für seinen persönlichen Gebrauch nutzen und erwirbt im übrigen keinerlei Rechte an den Inhalten und Programmen.
Die Reproduktion oder Modifikation ganz oder teilweise ist ohne schriftliche Genehmigung der ECONOMY.ONE GmbH untersagt. Unter dieses Verbot fällt insbesondere die gewerbliche Vervielfältigung per Kopie, die Aufnahme in elektronische Datenbanken und die Vervielfältigung auf CD-Rom.

© ECONOMY.ONE GmbH, 2000-2007

Handelszeitung    25.Juli 2007

In der Schweiz waren viele Institutionelle an strukturierten Krediten interessiert.
Spitze der Verluste noch nicht in Sicht

HEDGE-FONDS Das Debakel um die Vehikel von Bear Stearns birgt Gefahr: Es sei nicht auszuscliliessen, dass sich die Turbulenzen auf dem Kreditmarkt ausbreiten, warnen Schweizer Experten. Geraten die Anleger in Panik, droht ein Domino-Effekt. Und der würde nicht nur der Hedge-Branche schaden.
    Erstes Glimmen» und «Epizentrum» - das sind Worte, die für sich selbst schon Ungutes erahnen lassen. Erst recht beunruhigend wirken sie jedoch, wenn sie aus dem Mund führender Schweizer Hedge-Fonds-Experten stammen.
    Mit «Epizentrum» ist der Ausfall von zwei Hedge-Vehikeln der US-Investmentbank Bear Stearns gemeint. Die beiden Vehikel hatten in Hypotheken von minderer Bonität, in sogenannte «Subprime-Mortgages», investiert. Die Folgen warenfatal, als jenes Marktsegment wegen zahlungsunfä-higer Schuldner ins Rutschen ge-riet. Mittlerweile ist das Geld, das die Anleger in die beiden Bear-Stearns-Fonds - rund 1,6 Mrd Dollar Kapital plus fast 20 Mrd Dollar an aufgenommenen Mitteln - investiert hatten, so gut wie verloren. Die Bank selbst muss damit rechnen, verklagt zu werden.

«Unheimliches Geschäft»
    Doch das ist noch nicht alles: Die Subprime-Hypotheken wurden vielfach mit anderen Schuldscheinen tranchenweise zu Bündeln gepackt und am Markt weiter verkauft. Diese strukturierten Kredite sind nun durch die Subprime-Krise kontaminiert.
    Keiner weiss mit Sicherheit, ob sich das Glimmen nicht zum Brand ausweitet. Die Verunsicherung ist greifbar. So haben die Riskoprämien auf Schuldbriefen in den USA deutlich zugenommen - die Schuldner müssen also mehr dafür bezahlen, dass sie noch jemand finanziert. Diese Bewegung hat mittlerweile sogar Firmenanlei-hen erfasst. Gleichzeitig ziehen immer mehr Anleger Qualität einem hohen Zins vor - ungünstig für die risikoreichen Tranchen in strukturierten Krediten, denn mit schwindender Nachfrage fällt ihr Preis. Kein geringerer als US-Notenbank-Chef Ben Bernanke zeigt sich inzwischen besorgt über ein Übergreifen der Subprime-Turbulenzen auf andere Kreditinstrumente.
    Ivo Felder, Head of Funds-of-Hedge-Funds bei der auf alternative Investments spezialisierten Horizon21,sieht bis jetzt noch keinen «Flächenbrand». Er gibt aber zu bedenken: «Die Möglichkeit besteht, dass das Debakel bei Bear Stearns weitere Kreise zieht.»
    Wie gross diese Kreise sein könnten, steht noch aus. «Das unheimliche am Geschäft mit den strukturierten Krediten ist, dass sie so breit unter die Investoren gestreut sind. Das macht es schwierig, eine Reaktion vorauszusagen», sagt Christophe Grünig, CIO der zur Vontobel-Gruppe gehörenden Hedge-Investorin Harcourt. Tatsächlich sind nicht nur Hedge-Fonds, sondern auch Banken, Versicherer und Pensionskassen in strukturierte Kredite investiert. «In der Schweiz waren viele institutionelle Investoren an dem Marktsegment interessiert», sagt Grünig.

«Respekt vor der Situation»
    Von den grossen Schweizer Hedge-Anbietern will die Mehrheit nicht oder nur zu kleinen Teilen in strukturierte Kredite angelegt haben. Grösser sind dagegen die Hoffnungen. «Der Subprime-Markt ist ein relativ kleines Segment. Daher rechne ich nicht mit einer grösseren Krise, auch nicht für die Hedge-Branche», sagt Steffen Meister, CEO der an der SWX kotierten Partners Group, die alternative Anlagen anbietet.
    Viel hängt jetzt von den Investoren ab. «Für die betroffenen Hedge-Fonds hätte eine Krise bei den strukturierten Krediten im besten Fall Buch- oder Bewertungsverluste zur Folge», sagt Felder von Horizon 21. Schwieriger werde es, wenn die Investoren ihr Geld zurückhaben wollen - denn dies könne einen gefährlichen Domino-Effekt auslösen. «Vor der heutigen Situation sollte man nicht Angst, aber Respekt haben», sagt Felder.
    Damit die Domino-Steine nicht zu fallen beginnen, gehen hiesige Hedge-Anbieter nun aktiv auf ihre Kundschaft zu (siehe Kasten).

Worauf Hegde-Anleger jetzt achten müssen
Information     Anleger sollten jetzt nicht in Panik ihr Geld abziehen, sondern bei ihrem jeweiligen Anbieter nachfragen, wo das anvertraute Vermögen genau investiert sei, sagt Ivo Felder von Horizon 21.
Indizien     Einen möglichen Hinweis auf strukturierte Kredite liefert das Etikett «Fixed Income» innerhalb von Hegde-Investitionen. Solche Produkte sind oftmals in den risikoreicheren Segmenten des Kreditmarkts angelegt. Einzelne dieser Fonds haben aber offenbar von der Subprime-Krise profitiert und in den letzten zwei Monaten bis zu 30% zugelegt. Ebenfalls zu untersuchen sind «Event-Driven»-Strategien. Diese wetten unter anderem auf Kursbewegungen bei Firmenübernahmen, wo heutzutage jeder dritte Deal von Private-Equity-Investoren getätigt wird. Weil Letztere nun Mühe bekunden, am Kreditmarkt ihr Risikokapital zu finden, lässt sich nicht mehr jeder Kauf durchziehen.
Performance     Nach einer Rendite von 8 bis 10% bei Dachfonds seit Januar wird fürs restliche 2007 eine leichte Verlangsamung erwartet.

Wall Street Journal Europe    26 July 2007

The 'locusts' enrich our society, and a few pockets here and there
Private Equity and Public Good
By Wilfried Prewo

    Private equity funds have few admirers outside their own circles. Their seemingly ruthless actions in restructuring companies and their oversized profits give them the image of cold-hearted, greedy profiteers. The Left defames them as parasites which, for short-term profit, suck out whatever juice is left in the companies they invest in. For example, when he was chairman of the Social Democratic Party, current German Vice Chancellor Franz Müntefering repeatedly vilified them as swarms of locusts and used them as the prime example in his critique of Anglo-Saxon-style business methods. Tlie ugly face of capitalism, he said, is not a museum piece but very much alive today. That's why we supposedly need the state to intervene in the economy to preserve our welfare.
    In stark contrast to this ideologically distorted view, the track record shows that private equity does much for the public good. Private Equity has raised our wealth in four major ways.
    First, private equity funds are not charities. They buy companies, or at least a significant stake, with the aim of reselling after between five to seven years at a considerably higher price. Their job is to make money for their Investors. Their short time frame puts them under pressure to raise a company's valuation, or net worth, fast. They are, therefore, not passive investors. Instead, private equity funds attempt to exert influence on strategie decisions that will raise the valuation of a company in the short to medium term.
    While their take-no-prisoners attitude in restructuring has not endeared private equity funds to labor unions and politicians, layoffs are usually outweighed by later employment growth. The public view has been distorted since the short term pain of restructuring receives much press, while the ensuing recovery and long-term job gains get short shrift.
    Of course, not all actions taken by private equity funds have turned out to be right. Easy credit has tempted some to
overdo their financial engineering, sail too close to the wind and saddle their portfolio companies with too much debt. Some of these companies have failed, but these are few compared with those that succeeded.
    In a 2006 survey, the consultancy A.T. Kearney found that private equity firms contribute to sustained net job gains and revenue growth in Europe. This is good news for society. The profits earned by the funds when they exit are a reflecüon of
the value they have added. The gain to the overall economy comes in the form of more competitive companies with solid
prospects for growth and jobs.
    Second, private equity offers an alternative new form of corporate finance. Financial innovatiön has allowed private equity funds to earn a high return where conventional finance could not. They have, on more than one occasion, taken over companies that were on the brink of disaster and that nobody eise wanted to touch. When DaimlerChrysler sold off its flailing U.S. unit earlier this year for example, the only interested buyers were a combination of industrial and private equity funds.
Likewise, private equity has elevated many sound companies to new heights. With access to investors' funds and cheap credit, private equity firms can see opportunities which family-owned, closely held companies cannot.
    In Germany, many closely held small and medium-sized companies are short of equity and struggle to finance their growth. Globalization requires taking leaps in investment, not small steps, in order to build new production facilities in other countries, enter new markets, develop new products, or acquire other companies. Since family-owned companies often cannot finance this on their own or through traditional lending channels, private equity funds can provide the fresh money needed for a quantum move. The gain to the economy is obvious.
    Third, private equity recharges entrepreneurship. "Family-owned" also means that the family are the prime source for managerial talent. But there is no guarantee that a great founder's entrepreneurial genes are passed on to subsequent generations; they may have the desire to be boss but not the DNA of a leader. In many private equity takeovers, fresh entrepreneurial spirit has been injected by putting second-tier, non-family managers in charge and giving them an equity stake in the venture as an incentive to perform.
    Finally, private equity transactions have created a wider and more competitive market for buying and selling closely held companies. Before private equity firms came in, a Company that was for sale usually attracted only few potential buyers, typically competitors from the same industry or large companies seeking to expand. With private equity funds, both the number of potential buyers and their purchasing power have increased. Potential buyers and sellers of companies can now find out more and better price information from comparable sales. Valuations are now also much higher than in the past.
    Higher and more transparent valuations benefit all companies. not only those that are under the auspices of private equity. By the same token, a higher valuation imposes higher expectations and discipline on all companies to earn a commensurate return. The economy is elevated to a higher level of efficiency.
    Think about how patents and technological innovation increase the efficiency and growth prospects of the economy. In short, they improve the supply side by allowing companies to offer better products at a lower price and, thus, increase social welfare. Financial innovation such as private equity does the same. If an inventor's patent makes him rich, we applaud. Likewise, we should not resent a financial innovator because of his profit.
    At the end of 1999, the previous German government of Chancellor Gerhard Schröder announced a corporate tax reform that abolished tlie capital gains tax on the sale of corporate subsidiaries äs of 2001. The imintended consequence was to help restructure German corporations and dismantle many corporate cross-holdings. What once was called Deutschland AG, or Germany, Inc., is now history. German industry owes much of its regained competitiveness to this and other supply side moves.
    Private equity has a similar supply side effect. What the capital gains tax reform was for restructuring corporate Germany, private equity may do for closely held companies. As a capitalist tool of our time, it is proof that capitalism does not just enrich investors but improves social welfare as well.

Mr. Prewo is chief executive ofthe Han-nover Chamber of Commerce and is affili-ated with the Center for the New Europe.

edpage draft
1 August 2007

Public Good versus Ponzi schemes

Rupert Murdock's successful bid for the Crown jewel of economic and political journalism may change the reputation of private equity deals somewhat - the jury is now out on that one. But even the impressive arguments laid out by Wilfried Prewo in "Private Equity and Public Good" (WSJE, July 26, 2007) may not really stand the test of time if the lead decisions in this and other mergers and acquisitions will not indeed remain inspired and driven by that commanding, yet elusive and thus most often ignored entity called Public Good. To wit:
As a long-time student of Friedrich List, Max Weber and Edgar Salin, I should be less bewildered
than I am by what is happening, both nationally and globally, in the wake of the fall of the Berlin Wall.
I.e. where the unwittingly weakened nation-state - formerly a bulwark against plain-levelling & globalization -
no longer tempers the social, economic and other pitfalls foreseen by Karl Marx, Antonio Gramsci, etc.
Where - as the Laffer & Rider Curves illustrate in the tax & the social fields - excessive poor/rich gradients
are upsetting the delicate social fabric, thus washing away fertility factors with uncontrolled erosive powers.
Where indeed, as Patrick Martin pointed out, monopolistic capitalism and the associated reckless greed
are no longer kept in check by Adam Smith' invisible hand, i.e. by the balance of contradictory interests.
And where the capacity for self-correction is increasingly inhibited by loss of freedom, mooring & orientation
which led to market frenzies & false alpha birds feeding on hype & bubbles, reminiscent of the Roaring 20s.
IMF & FATF estimate black funds (drugs, tax evasion etc) to be 2-5% of world's GDP (2006: $960-2400bn).
An IMF Report indicates these funds to be increasingly chased under anti-terrorism & ever flimsier pretexts.
Helped by the US Secret Service, the world economy has indeed been made hostage of ill-considered rules
which impede more legitimate business than crime. For big time money laundering, the US Treasury set the
standard in 2001 with its 31% confiscatory backup withholding tax on unidentified investors in US securities,
turning foreign bankers from trustees of clients into IRS agents (qualified intermediaries) subject to US laws.
Private equity & hedge funds thus found a government-sponsored access to black funds, while the latters'
entry into subprime markets was also eased by the Internet. Results: predatory lending & systemic risks.
Society's organization needs re-thinking with Plato, Gottlieb Duttweiler, José María Arizmendiarrieta etc.
For man's evolution may only be stressed by technological leaps but not accelerated beyond natural limits.
Also: return on investment rates above productivity gains & organic growth are predatory & not sustainable.
If driven by managers, lawyers & funds on the back of other stakeholders, M&As are thus Ponzi schemes
where shareholder value adepts can maraud with stacked Monopoly cards, helped by micro-economic laws.
Like compulsory social insurance systems whose doom is delayed or obscured only by inflation, war, etc.
And where the cunniest operators are state-supported by myopic magistrates hood-winked into fiscal deals.
Gary J. Aguirre's US Senate testimony details fraud & market mechanics which were at work before 1929,
e.g. Ponzi structures, unregulated pools of money, siphoningfrom unsuspecting mutual fund investors, and
abuse-prone market dominance: hedge funds' $1.5 trillion drive half of the $28 trillion NYSE's daily trading.
Tongue-in-cheek, Warren Buffet famously opined: "derivatives are financial weapons of mass destruction";
yet, under increasing performance & compliance pressures, some bankers still see a future in fee hunting.
Society wised up against churning of accounts by undelicate trustees, but not yet against macro-parasitism
which feasts on ignorance, sucks & devours a firm's life-preserving substance, & weakens society's pillars.
Which turns economic rat races into societal tailspins with early burn-outs & senior citizens being wasted,
& instills values causing youth to be educated out of sync, resulting in drug, violence & €1000 generations.
With profit-driven quarterly thinking & cost-cuttings also eroding due infrastructure maintenance & renewal,
& democracy's promises ridiculed by Fatf, EU & UN bureaucratic lawmaking as if Berlin Wall fell eastward.
So why not thinking things over & Revisiting Das Kapital while some dance on the Titanic”?.   Iconoclast

Deutschlandfunk    11.August 2007

Zusammenbruch des US-Immobilienmarktes

Dazu schreibt die finnische Zeitung HUFVUDSTADSBLADET:
"Früher führten solche Krisen zu langen Schlangen vor den Banken, wo Kunden in Panik ihre Konten leerten. Heute gibt es Institutionen, die einen finanziellen Kollaps abwenden können. Am Donnerstag leitete die Europäische Zentralbank 95 Milliarden Euro in einen nervösen Geldmarkt, um die Lage zu normalisieren, der größte Betrag dieser Art, der jemals eingesetzt wurde. Die amerikanische und japanische Zentralbank folgten mit etwas kleineren Summen nach. Gestern hat die EZB erneut 61 Milliarden Euro aufgewendet, enorme Summen also. Durch so schwere Geschütze haben die Zentralbanken die Zinsen in einem erträglichen Rahmen und das Bankenwesen am Laufen gehalten. Der Rest besteht nun aus Psychologie. Geht alles gut, herrscht bald wieder Ruhe, denn in Europa besteht kein Anlass zur Panik. Aber der Einsatz derart schwerer Abwehrgeschosse könnte auch das Misstrauen stärken",
gibt das HUFVUDSTADSBLADET aus Helsinki zu bedenken.

Die tschechische Zeitung LIDOVE NOVINY hält es für wichtig,
"dass dass die Lage nicht außer Kontrolle gerät. Bislang scheint das den Zentralbanken zu gelingen. Die tschechische Krone profitiert indes als einzige Währung von der Krise. Sie gilt momentan als eine Art mitteleuropäische Insel der Sicherheit und wird in den nächsten Tagen offenkundig noch weiter anziehen. Aber auch der amerikanische Bankenmarkt ist trotz der jüngsten Erschütterungen letztlich stabil und die Investoren werden sich spätestens in ein paar Wochen wieder beruhigt haben",
ist sich LIDOVE NOVINY aus Prag sicher.

Die spanische Zeitung DIARIO SUR hält fest:
"Die Maßnahmen haben weltweit für Panik gesorgt, nicht zuletzt in Spanien, wo der Kreditmarkt für Immobilien ähnliche Schwächen hat wie in den USA. Der rasche und konzertierte Einsatz der Zentralbanken hat Vorbilder, wenn es um die Bewahrung der Wechselkursstabilität ging. Aber die Ursache war diesmal die Warnung vor einem Kollaps der Kreditmärkte. Die Zentralbanken haben reagiert, aber die Frage ist, wie Gefahren dieser Art künftig reduziert werden können",
kommentiert DIARIO SUR aus Málaga.

Für den britischen INDEPENDENT waren die Turbulenzen absehbar:
"Eine Riesenmenge billigen Geldes schwappte in den vergangenen Jahren dank historisch niedriger Zinsen durch die Märkte. Kreditnehmer wie Kreditgeber waren durch die Fülle von Angeboten in einer Welt, in der Renditen für immer zu steigen schienen, in ihrer Urteilskraft beschränkt. Das Risiko war schlecht eingeschätzt. Zu viele Schulden wurden aufgenommen. Um es kurz zu machen: Die Leute wurden gierig. Die Experten sprachen von einem neuen Paradigma der niedrigen Inflation, des billigen Geldes und des niemals endenden Wachstums. Wenn man solch eine Anmaßung hört, ist es eigentlich an der Zeit, sich Sorgen zu machen",
findet THE INDEPENDENT aus London.

Die ebenfalls in der englischen Haupstadt erscheinende TIMES fordert:
"Die Nutzer des Finanzmarkts müssen ihre Lehren aus dem Geschehen ziehen. Hedge Fonds und andere ähnlich aggressive Investoren haben viel zu den Turbulenzen beigetragen, weil sie sich zu sehr spezialisiert haben, weil sie voller Gier Megagewinne in doppelter Geschwindigkeit erreichen wollten und weil sie sich törichte Summen geliehen haben. Mr. Smith aus Sheffield sollte sich genauso wie der im Steuerparadies beheimatete Hedge Fond daran erinnern, dass nachhaltige Finanzierung mit Risikostreuung, Geduld und dem vernünftigen Umgang mit Schulden einhergeht",
mahnt die TIMES aus Großbritannien.

Die polnische Zeitung RZECZPOSPOLITA hält fest:
"Heute ist schwer vorherzusagen, wie lange sich die Phase der Kursstürze auf den internationalen Finanzmärkten hinziehen wird. Vielleicht haben wir in einigen Wochen schon alles wieder vergessen, vielleicht steht uns aber auch ein längerer Zeitraum der Stagnation bevor. Möglicherweise werden andere Wirtschaftssegmente in den Strudel hineingezogen. Wichtig ist vor allem eines: Wir werden wieder einmal daran erinnert, dass das Risiko ein untrennbares Element des freien Marktes ist",
notiert die RZECZPOSPOLITA aus Warschau.

Nach Auffassung der französischen Zeitung LE MONDE - Zitat:
"ist es das wichtigste Ziel für die EZB und die anderen Zentralbanken, zu verhindern, dass die Finanzkrise sich auf die gesamte Wirtschaft ausweitet. Bis vor kurzem schien die Globalisierung der Finanzmärkte, durch die sich die Risiken auf mehrere Akteure verteilten, als die beste Garantie gegen eine größere Krise. Die kommenden Wochen werden zeigen, ob die Akteure mit dem Feuer gespielt haben oder nicht".
Das war LE MONDE aus Paris.

Der schweizerische TAGES-ANZEIGER führt aus:
"Bislang versuchten uns Experten mit dem Hinweis zu beruhigen, dass die Banken mit Hilfe neuer, ausgefeilter Finanzprodukte wie Derivate in der Lage seien, ihre Kreditrisiken zu portionieren und dann bei Investoren im weiten Universum des Finanzmarktes zu platzieren. Die Kernschmelze in Amerikas Hypo-Markt und dessen Ausläufern rund um den Globus fördern nun die Kehrseite zu Tage: Die ach so praktische 'Feinverteilung' der Risiken ließ die Finanzinstitute bei der Bewertung dieser Risiken zusehends sorgloser werden. Und kaum jemand hat noch einen verlässlichen Überblick, wer die Kreditrisiken letztlich zu tragen hat. Die Finanzmarktaufseher – wie auch die Anleger – stehen vor strapaziösen Zeiten",
prophezeit der TAGES-ANZEIGER aus Zürich.

Die portugiesische Zeitung DIARIO DE NOTICIAS beleuchtet einen anderen Aspekt:
"Einige Analysten weisen auch auf die Notwendigkeit hin, dass die EU, die USA und Japan künftigt verstärkt mit den Finanzbehörden aufstrebender Wirtschaftsmächte wie Brasilien, Russland, Indien oder China zusammenarbeiten. Denn diese haben heute ein deutlich größeres Gewicht als noch vor zehn Jahren".
Das war DIARIO DE NOTICIAS aus Lissabon.

Washington Post    August 12, 2007

Crunch Complicates Some Pending Deals
Tight Credit Could Stall Buyout Boom

By David Cho and Thomas Heath

The severe turmoil in the credit markets last week has raised serious questions about the future of the buyout craze that gave rise to the biggest deals in U.S. corporate history.

For the past few years, a group of elite Wall Street players have been buying up major American icons and taking them private. These massive acquisitions have depended on access to cheap credit, which is supplied by a complex relationship between investment banks and hedge funds.

But with credit markets tightening, the pace of these deals, at least in the short run, is expected to dramatically slow. Already-announced multibillion-dollar buyouts, like Tribune Co., Sallie Mae and Hilton Hotels, are likely to be far more complicated to close, analysts said.

If one or two of these big deals were to collapse, it might not send the economy into a downturn. But it would profoundly shake investors' confidence in a financial system already under siege from billions of dollars in losses from home mortgage defaults. That could make it even more difficult for companies and home buyers to get loans.

Private-equity firms, which use big pools of private money to buy companies, generally describe the tightening credit as a temporary setback. But some market watchers are predicting the end of the buyout boom. Either way, both sides say, the private-equity movement is at a crossroads.

"There is a crisis of confidence in the credit markets that is . . . letting a little helium out of the buyout balloon," said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship.

Buyouts are credited with bringing efficiency to industries such as steel and airline parts. But they are also criticized for forcing employees to take on more risk for the success of their companies, as in the case of Tribune. The deals created a new class of powerbrokers, like Stephen A. Schwarzman, who made $400 million last year and holds about a $6.4 billion stake in his company Blackstone Group. But they also enriched universities and pension funds that have been increasingly investing in private-equity funds and helped propel the stock market to new highs.

Fueled by easy-to-get money from the credit markets, buyout shops gained the ability to acquire all but the largest corporations in the past few years. Many companies began to see the benefits of going private -- they could get funding from buyout firms and did not have to deal with the scrutiny that comes from being public.

This year, buyout shops announced $600 billion worth of acquisitions and were on track to set a record, according to Thomson Financial. But in July, the number of deals dropped considerably. And many companies that had agreed to be bought out by private-equity firms are now seeing their shares slump before the deals have been consummated, a Wall Street bet that these agreements will be renegotiated or fall apart.

The stock of Tribune Co. closed Friday 22 percent below the price real estate mogul Samuel Zell agreed to pay in April. Zell is acquiring the media company for $13.2 billion. Shares of Hilton Hotels recently have traded 12 percent below what private-equity giant Blackstone consented to spend in July. It agreed to buy the hotel chain for $26 billion.

One deal that analysts say is particularly vulnerable is the $25 billion acquisition of Sallie Mae. Its stock closed 20 percent below its deal price Friday.

In April, the student loan giant announced that it had agreed to be acquired by buyout firm J.C. Flowers for $25 billion. The deal was hailed as a breakthrough for private equity which had never before been able to acquire a major financial firm. Other financial stocks, such as Bank of America and Student Loan Corp., rose on the news as traders speculated the Sallie acquisition would lead to a frenzy of new buyouts in the financial sector.

Now four months later, the Sallie Mae acquisition is facing difficulties and none of the other deals have happened. On Thursday and Friday, as the market scrambled to cope with the global credit crunch problems, Sallie's share price fell about 3 percent.

One problem with the deal is that it is being funded with $16.5 billion in debt. Borrowing that amount of money was cheaper earlier in the year. But it is far more expensive now because the credit markets are more sensitive to risk and are less willing to issue loans with generous terms and low rates, noted Richard Hofmann, analyst at CreditSights, who has followed the Sallie Mae situation closely.

"We believe [J.C. Flowers] wants to walk away because of what's happening in the credit markets," Hofmann said.

A person who spoke on the condition of anonymity because he is not authorized to speak publicly about the deal said that J.C. Flowers is fighting to back out of the deal or at least lower its price. A J.C. Flowers official declined to comment Friday, while a spokesman for Sallie Mae said the firm expects the buyout to close in October.

As deals stall, the two most powerful players on Wall Street that rode the buyout wave to riches -- investment banks and private-equity firms -- are suddenly locked in a contentious battle over who is going to pay for the mess.

"It's kind of a game of chicken right now," said Greg Peters, chief credit strategist at Morgan Stanley. "There is not a lot of give and take going on, and ultimately that's what you are going to need."

The problem is that large investment banks, including Lehman Brothers, Goldman Sachs, J.P. Morgan and Morgan Stanley, have committed to provide money for private-equity firms to make these deals. They were willing to do this because in the past they could slice and dice these loans into pieces and sell them to hedge funds and other investors around the world, including major financial institutions in Japan, France and Germany.

It was the willingness of these investors to take on these pieces of debt that fueled the era of easy money over the past few years. The risk of lending could be spread across many players. Now, spooked by several big hedge fund collapses and a widening crisis in the mortgage industry, these investors are saying no.

"The whole system is choked up," said a hedge fund manager, who spoke on the condition of anonymity because he did want to endanger deals he has in the works. "The buyers, like us, are saying -- 'Not a chance.' . . . We are getting calls today from banks that have this inventory they want to get rid of. They want to get rid of everything they can, even if they have to take a hit on it."

With hedge funds and other investors refusing to buy such debt, investment banks have to sell them at a severe discount to investors or hold on to them. Keeping the debt can be painful for investment banks because they would have to absorb the losses if the borrowers default. A large inventory of unsold loans also means less revenue for banks. Wall Street banks are currently holding $289 billion in unwanted debt, according to research firm Dealogic.

Alarmed bankers are pushing private-equity firms to scuttle deals or renegotiate prices, which most private-equity firms do not want to do. Such disputes are putting the relationship between these powerful players in jeopardy. Their partnership has been at the heart of the buyout boom and the source of enormous wealth for Wall Street.

No activity has been more profitable to investment banks than private-equity buyouts, which typically provide more than $1 billion in fees every year.

Wall Street insiders acknowledged that the buyout run is being tested. "The process is slowing down because everybody is more cautious," said Donald Marron, chairman and founder of private-equity firm Lightyear Capital. "Everybody wants to think about things a little more."

Wall Street Journal    August 25, 2007

Carlyle Founder on Cheap Debt, Credit Crunch and the New Buyout Landscape
'How Could Buyers Resist Taking Those Terms?'

The buyout boom that saw a handful of investment firms snap up ever larger public companies seems to be fizzling as the debt market used to fuel these takeovers  seizes up.

Carlyle Group's David Rubenstein says private equity is no longer too 'private.' David Rubenstein, who co-founded Carlyle Group in 1987, has seen his share of deal cycles. With deals harder to finance, private-equity firms will have to live with  their companies for longer now. In an interview with The Wall Street Journal, Mr. Rubenstein struck an optimistic tone despite the challenges facing the industry.

WSJ: How serious a setback for private equity is the turmoil in the debt markets?
Mr. Rubenstein: Cheap debt fooled people. Because financing was so cheap relatively in the past few years, many people think all we do is buy companies with cheap  debt, wait a short while and then sell them. But most private-equity firms are about hard work, not just financial engineering.
    In the near future, we won't see buyout deals of the size we saw 60 days ago due to the debt-market uncertainty. And available debt will be more expensive. The  sellers will have to adjust to lower prices. This is not a calamity. What we have now is just a temporary imbalance of credit. When the debt market returns to  equilibrium, a lot of companies will be available and there will be clear bargains. Private-equity firms will continue to buy companies with a bit more expensive debt but  also a bit more pricing discipline.

WSJ: But isn't it true that in recent years, financial engineering was a big part of what drove deals? Your partner Bill Conway himself described cheap debt as the "rocket fuel" of this cycle.
Mr. Rubenstein: We got labeled with the financial engineering label because in the early days, the deals were done with only 5% to 7% equity and the companies were  highly levered. Today, the average equity is between 32% and 35%. Deals aren't as heavily engineered or have as levered structures.

WSJ: How dramatic is the change in the debt market today?
Mr. Rubenstein: The banks found that providing financing to private-equity firms was very attractive and profitable, so the banks made it easier and easier to accept  their financing. They offered us relatively low interest loans. They later said they didn't need "mac" clauses (which give the banks an out if circumstances change). Then  they offered us covenant-lite loans and pik toggles (which give borrowers much more flexibility). And then they offered to bridge some of our equity. How could  buyers resist taking those terms, knowing the result would be better returns for their investors.
    And because of this favorable financing, we could pay a bit more for companies. For the last five years, there was almost no penalty for overpaying by 5-10%, for we  were emboldened by these attractive loan features. Now these things are probably a relic of the past, or at least for the next few years. We won't see many  covenant-lite or pik toggles. That will no doubt mean more discipline in assessing deals. But private equity can do quite well in this changed environment, as it has in  previous times of retrenchment. Prices will return to more normal levels. And that will be quite helpful to the industry.

WSJ: Can you describe the dialogue between the banks and the private-equity firms now?
Mr. Rubenstein: Now there is a Kabuki dance going on among the buyer, the seller and the lenders. Everyone is assessing what to do. Some deals announced in the past 60 days will close as negotiated and some will be renegotiated and some will never close.
    Our attitude has been we live with the banks every day. They help us get our deals done. We are not in the business of saying we win and you lose. You create more animosity and you don't live to play the next day. Our attitude is we want everyone to make a profit and we are willing to have discussions to get deals done on sensible terms. You make more friends when you help when there are problems.

WSJ: Are there other sources of capital to tap?
Mr. Rubenstein: Five years ago, a lot of buyers, including [managers of collateralized loan obligations] and hedge funds realized the debt financing buyouts is a good  investment. They liked the higher fees and the higher interest rates on [leveraged-buyout] debt. As a result, a great deal of debt money came into the market so there were many sources of capital for debt deals. But at some point, you will see pension funds and sovereign wealth funds, especially those with fixed-income investment departments, come in as sources of debt. It won't happen overnight or dramatically but it will happen.

WSJ: How will private-equity firms evolve in coming years?
Mr. Rubenstein: Private equity is in the process of becoming bifurcated. There are eight to 10 brand names and thousands of other private-equity firms. Most make investments in small firms and do so profitably, but they don't get publicity and they should still be able to raise money. However, the better known private-equity firms will benefit from a flight to quality, for many investors will want to invest in brand-name firms, assuming their returns stay consistent.
    You will also see more mergers and acquisitions, especially after some of the private equity go public and have currencies in the form of stock. When investment banks went public, they bought niche firms. Large private-equity firms might do the same, especially when expanding abroad.

WSJ: How is Carlyle itself changing?
Mr. Rubenstein: We are a deeper, more global organization today. We have 425 investment professionals, operating in all continents and in many different investment disciplines. We can clearly add more value than we did in our early years. We also have dozens of individuals who have been CEOs and CFOs at other companies, and  they can now add real value through their experience to our portfolio companies. Twenty years ago, we couldn't say that. If the economy slows, our companies and all companies will feel the effects. It will delay returns and slow down exits. We are not magicians. But we are not as vulnerable to downturns as in earlier years.

WSJ: How do you feel about the limelight into which private-equity firms have been thrust?
Mr. Rubenstein: In the current environment, private equity is not so private. We need to deal with Congress, regulators, environmental groups, trade unions, the media and community organizations. It is a complicated shift. Now we recognize that we must explain to other constituencies -- and to the public -- how we add value and why we are productive forces in the national economy and contributors to local communities.

WSJ: Was Blackstone Group's going public a mistake in that it brought attention to the industry and its big profits? What are Carlyle's plans to go public?
Mr. Rubenstein: The private-equity industry was attracting attention for its considerable success and growth in size long before that offering. If we feel it is necessary to be public to be competitive and to maintain our track record, we would look at it. But we are comfortable now with our posture of the last 20 years -- privately owned.

WSJ: What's your prognosis on the Grassley-Baucus bid to raise taxes on private-equity firms?
Mr. Rubenstein: Treating private equity differently will likely bring back the Law of Unintended Consequences -- the same law which gave us the [alternative minimum tax], an earlier effort to produce a tax "fix" on a few. It now covers 50 million Americans.

Write to Henny Sender at

Washington Post     September 11, 2007

KKR Buyouts to Test the Stretched Credit Market
KKR has taken the private-equity acquisitions boom to extremes. But
as its biggest deal yet awaits financing, the fortunes of more than the firm are at stake.

By David Cho and Thomas Heath

Wall Street may be facing its worst financial storm in years, but billionaire buyout king Henry Kravis is forging ahead with the biggest deals in U.S. history. Kravis's firm, Kohlberg Kravis Roberts, has made deals for $123 billion in acquisitions this year, more than its three chief rivals combined.

Much as KKR's acquisition of RJR Nabisco came to symbolize the buyout boom of the 1980s, the firm's record $45 billion purchase of Texas utility giant TXU, approved by shareholders last week, exemplifies the freewheeling borrowing that defined the golden age of private equity in the past few years.

Now debt markets are closely watching the latest drama involving KKR -- the attempt to push its massive, debt-laden purchases through the financial system. Wall Street banks need to find investors and hedge funds to back the $36 billion to close the TXU deal, and success is far from certain. If they fail, several analysts said, it could well mark the end of the private-equity frenzy that has transformed the financial world.

"This is probably the high-water mark of the buyout boom of 2007," said Peter Fitzgerald, a former U.S. senator from Illinois whose family has been in the banking industry for decades. "KKR is stretched. The banks that have been backing KKR may be the ones left holding the bag because they have given commitments to fund those buyouts and they have to live up to those commitments."

From his firm's flashy, big-ticket acquisitions to his philanthropy and his status in New York social circles, Kravis, 63, has long played a larger-than-life role on Wall Street.

He practically invented a new sector of Wall Street when he formed his private-equity firm with his cousin George Roberts in 1976. (The other founding partner, Jerome Kohlberg Jr., left KKR in 1987.) He pioneered ways to use massive pools of money to take companies off the stock markets, put them under the control of investors who operate beyond the public eye and sell them later at a profit.

In 1988, KKR stunned the financial world when it agreed to buy RJR Nabisco for a whopping $31.4 billion, even though the junk-bond market, which helped fund buyout deals, was collapsing. The size of the takeover was so extraordinary -- and the burden of the debt KKR took on so immense -- that it became the subject of a best-selling book, "Barbarians at the Gate," which detailed the corporate egos surrounding the deal.

In recent years, KKR has had some notable successes, including a foray into the power business. In 2003, the firm bought privately held ITC Holdings, a power company in Michigan; when it took the company public two years later, KKR made a 500 percent return on its investment.

KKR had required ITC's chief executive, Joe Welch, to put his own money into the company. Welch said he ended up betting his entire life savings. Now he is a millionaire several times over and a believer in KKR. "Of all the people I've ever done business with," Welch said, "the folks at KKR, starting with Henry Kravis, are the most honorable, stick-by-your-word people that I've ever met."

In recent years, KKR has paid more fees to Wall Street banks than any other firm -- about $2 billion since 2000, according to several bankers. Those lucrative fees made bankers eager to help KKR as it reached for ever more expensive and riskier deals.

Now KKR's bankers face their biggest challenge ever -- finding investors for the TXU deal as the credit markets are unraveling.

The Texas utility provides electricity for 2.4 million customers in Texas and has a network of generating stations, including two nuclear-powered and nine coal-fired plants that have been the target of environmentalists.

The private-equity buyers, known more for pursuit of profits than for environmental sensitivity, agreed to several concessions to help sell the deal to the Texas public and regulators. KKR and its partners, Texas Pacific Group and Goldman Sachs, agreed to cancel construction of eight of 11 coal-fired plants that TXU planned to build in Texas, as well as others slated to go up in Pennsylvania and Virginia. The buyout firms also agreed to back federal legislation that would require reductions in carbon dioxide emissions and to spend $80 million a year promoting energy efficiency.

Some experts question whether KKR has overreached with TXU. "KKR has a history of doing courageous deals with large amounts of debt," said James Angel, associate professor of finance at Georgetown University. "But often, investors who have been successful in one investment become overconfident on the next one. Could this be the bridge too far for KKR?"

Others say the deal could work out for everyone involved, though the banks that need to sell the debt to investors are at greater risk.

"I don't think the fundamentals have changed materially on a long-term basis from when KKR struck this deal," said Douglas A. Fischer, an analyst with A.G. Edwards. Fischer said that the shareholders received an appropriate price and that KKR would probably do well in the long run, but added, "It probably is less of a good deal for the banks."

Even the nation's biggest labor unions have a stake in the deal. The AFL-CIO said its pension funds, which serve 55 unions across the country, own TXU stock and invest in KKR funds. The same is true of the California Public Employees' Retirement System, which runs nearly $250 billion in investments. A CalPERS spokesman said the pension fund also will probably buy portions of the debt instruments from the deal.

"It wouldn't be unusual if we had an interest on both sides of this equation," said Clark McKinley, a spokesman for CalPERS. "Because of the size of the fund, with something approaching $250 billion, we are all over the market in every asset class, public equity and private equity." Meanwhile, KKR is moving ahead with its own initial public offering. The firm, which rarely speaks publicly about its own business, declined to comment for this article because of the quiet period that federal regulators impose in the run-up to an IPO.

But according to filings with the Securities and Exchange Commission, a key KKR subsidiary, KKR Financial, is under siege from its investors after making bad bets on securities backed by subprime mortgages. And KKR said in SEC filings that it had received a request for documents from the Justice Department, which is investigating possible anti-competitive behavior among private-equity firms, which frequently team up for acquisitions.

KKR has been locked in contentious negotiations with its banks over how to fund its $26 billion acquisition of First Data, which processes credit card transactions. KKR is trying to raise $14 billion in buyout debt, plus another $8 billion in junk bonds, to fund the transaction. It is the first big test of the markets' appetite for a KKR mega-deal since the credit crunch began, and according to published reports this week, KKR has already made a concession that will make the loans easier for banks to sell to their investors.

The firm also faces other challenges. Congress is considering legislation that would significantly increase the taxes paid by private-equity firms, while the credit crunch is threatening to eat into private-equity profits.

None of this seems to have dampened KKR's appetite for risk. It is raising $2.5 billion in new financing for one of its hedge funds. The fund is promising an "unprecedented opportunity to invest in current corporate credit 'meltdown' and earn estimated gross returns in excess of 20 percent," according to an investor who received one of its brochures.

The fund will seek to buy at a discount the debt that was generated by KKR's own deals -- the same loans that other investors consider too risky to buy.

December 31, 2007

Wall Street is about smart guys thinking about ways to make money from dumb ones
Wall St. Way: Smart People Seeking Dumb Money

On Wall Street, buyout professionals are seen as the smart money. But their new shareholders are starting to look like the dumb money.

The gilded realm of private equity — in which moguls use private money to buy stockholder-owned companies — has turned into dross for everyday investors this year. And hedge funds, those secretive investment pools for the rich and, increasingly, the not-so-rich, have been losers for the investing public as well.

The Blackstone Group, the private equity powerhouse lead by Stephen A. Schwarzman, has lost a quarter of its value since it went public in June. Fortress Investment Group, a diversified alternative asset management company, and Och-Ziff Capital Management, a hedge fund run by Daniel Och, a former Goldman Sachs trader, have also stumbled after initial public offerings.

As the financial markets brace for another wave of large losses at Wall Street banks, the outlook for these newly public firms and their as-yet-private brethren has darkened starkly. The tightening credit squeeze has sent the buyout industry into a funk and left some hedge funds with steep losses.

Kohlberg Kravis Roberts & Company, which invented the modern buyout industry, is now struggling to get its own I.P.O. off the ground. AQR Capital Management, a $38 billion hedge fund, has suspended its plans for an offering. Citigroup, which helped take Och-Ziff public in November, recently warned that Och-Ziff is likely to face headwinds for the foreseeable future.

Mr. Schwarzman, by contrast, cashed out in June, a few weeks after he said that public markets were “overrated.” He and his partner, Peter Peterson, sold while business was still booming.

“These are sophisticated investors, and they certainly know how to time their own exits,” said Adam Zoia, managing partner and founder of Glocap, an executive search firm focusing on the alternative asset industry.

Blackstone’s shareholders — among them Fidelity Investments, the mutual fund giant, and the Ohio Public Employees Retirement System — have not been so fortunate. They would have made more money this year investing in an old-fashioned index fund that tracks the S.& P. 500-stock index, which is up 4.24 percent.

For now, Henry Kravis, a founder of K.K.R., is pressing ahead with plans to take it public. But selling stock may not be easy given the turmoil in the financial markets. Deals, and the cheap money that private equity firms have come to depend on to pay for them, have grown increasingly scarce.

After the credit markets became unhinged at midyear, United States merger activity fell 46 percent during the second half, according to Thomson Financial, the research firm. Merger volume in 2007 still hit a record $1.57 trillion in the United States, thanks to all the deal-making early in the year.

Life may not get easier for the buyout crowd any time soon. Weakened by mounting losses on mortgage-related investments, big banks are reluctant to risk capital on leveraged buyouts. Many are still struggling to sell the loans and bonds used to finance previous deals.

According to a recent report by PricewaterhouseCoopers, banks are sitting on about $245 billion of buyout-related debt, a backlog that could take months to clear. The likelihood that rising financing costs will pinch private equity returns, coupled with the possibility that Congress may eliminate a tax loophole enjoyed by buyout funds, adds to the gloom hanging over the industry.

Blackstone’s sinking stock price will not help other alternative investment firms looking to tap stock market investors, said John E. Fitzgibbon, the publisher of, an online newsletter. “When the leader of the group goes public and hits the wall, the rest don’t go out the door,” he said.

While many on Wall Street have focused on Blackstone’s slump, several large hedge funds have also disappointed new shareholders. Brevan Howard Asset Management, a British investment firm, raised only $1 billion in an initial public offering in March, half as much as it had hoped. New shares of GLG Partners, one of Europe’s biggest hedge fund managers, and of Third Point Offshore, a public offshoot of the New York hedge fund run by Daniel Loeb, have fallen too.

Despite all the gloom, more private equity and hedge fund firms are likely to go public once the markets stabilize, said Mr. Zoia of Glocap. But these latecomers may have to accept lower valuations, he said. “This is the tip of the iceberg,” he said.

Wall Street, after all, adheres to theory that you can always make money trading in securities, whether they are overvalued or not, because there will always be someone willing to pay more for them than you did. As Mr. Fitzgibbon put it: “What Wall Street is about is smart guys thinking about ways to make money from dumb ones.”

Washington Post    January 1, 2008

'07: Buyouts and Bailouts
By Allan Sloan

When I sat down for my annual review of what I've written over the past year, something jumped out at me. Usually, I write about widely diversified subjects. But in 2007, I devoted an inordinate number of columns to the shenanigans of leveraged buyout firms and the attempts by the world's central banks to rescue financial markets.

That's an accurate reflection, I think, of how business news played out in 2007. For the first half of the year, the leveraged buyout industry -- which has renamed itself "private equity" -- seemed poised to take over the world, which I knew wouldn't happen. In the second half of the year, problems in the debt markets made it look as if the world was ending, which I knew wasn't happening, either.

The credit market meltdown wasn't exactly a shock to anyone who can count and has a sense of business history. In fact, I devoted most of my 2006 year-end column to predicting the end of the buyout boom. Making that call was like shooting fish in a barrel -- the boom was fueled by ridiculously cheap and abundant credit, which I knew would eventually dry up because it always does. But the boom took longer to end than I thought it would, and the credit crunch is proving nastier and more widespread than I expected.

I wrote four columns that focused on Blackstone Group, the big LBO -- excuse me, private-equity -- house, including three in a row about its initial public offering. (The Washington Post March 20, March 27, and April 3.) It's the first time I've gone the three-peat route since I became a columnist in 1989. But who could resist? The Blackstone deal was so complex and so much fun to dissect, and the firm was being treated with such undeserved reverence. Besides, a giant private-equity firm going public screamed "top-of-the-market" -- which, in fact, it was.

Then, piling pig on pork, as they say on Wall Street, my first column after joining Fortune this summer was the way Blackstone's partners (perfectly legally) got public investors to pick up most of their capital gains tax tab for selling some of their Blackstone stake in the offering. Nice work if you can get it -- which with luck, may not be for long.

Congressional loophole closers have zeroed in on Blackstone's game and on two other games I wrote about -- Sam Zell's tax-dodging on his purchase of Tribune Co. and tax deferrals involving exchange-traded notes. The IRS, to its credit, also is pursuing the ETN loophole and seems likely to try to close it before it becomes too popular.

Alas, the Senate, in a display of total cowardice, wouldn't touch the most offensive loophole of all -- the way that private-equity players and hedge fund operators pay only 15 percent federal income tax on their piece of their investors' long-term gains, which is really fee income, while mere mortals pay up to 35 percent on their fees and salaries. Having buyout billionaires pay just 15 percent tax on their fees is ludicrous.

I spent a lot of time in 2007 trying to understand how the subprime meltdown happened and why it spread so wide. In the process, I came upon a particularly wretched 2006 issue of mortgage securities underwritten by Goldman Sachs in which two-thirds of the value of second-mortgage loans that individually were toxic waste was rated AAA (if only briefly) by Moody's and Standard & Poor's. Goldman, being Goldman, figured out early in the game that these markets were heading south and made a fortune betting against them. However, also being Goldman, the firm didn't pass on that insight on to buyers of the securities it underwrote.

Shortly after I joined Fortune, the debt market meltdown began in earnest. (No, I don't think it was cause and effect.) In recent months, I've focused -- some would say obsessively -- on the fact that the too-big-to-be-allowed-to-fail firms that enabled financial excesses are getting bailed out at the expense of those of us who have behaved properly. It's obvious that this is going on, but not too many people are saying it, at least not in public.

Let me hasten to add, however, that the cards that Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson have to play are much weaker than most people realize. One reason is that their predecessors allowed enablers of previous excesses to escape, reducing their credibility and clout in the markets. A second reason: the Fed and Treasury now need cooperation from foreigners, on whom the United States has become financially dependent.

So what's ahead? Amid all the gloom and doom, I see at least one encouraging thing: Some financial firms are being forced to raise new capital on terms that dilute the stakes of existing shareholders by selling new stock at below-market prices. But if I ran the world, I'd go one step further. I'd force these firms to eliminate their cash dividends and do huge, horribly dilutive offerings as a condition of getting help. The point? Even though we can't allow these firms to fail, lest the world financial system implode, we ought to teach them -- and their shareholders -- the penalty for engaging in excesses. That painful memory might inhibit excess in the next upcycle.

Finally, a contrarian and optimistic thought: The same kind of thinking that foresaw endless leveraged buyouts a year ago now foresees a worldwide financial meltdown that will go on indefinitely. Maybe this is really a signal that things will stop getting worse sometime in 2008. I'm not predicting that, but I'd sure welcome it.

And on that note, a successful, happy and prosperous New Year to you and yours.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address is

Financial Times    9 January 2008

How can untalented investment managers justify their pay?
Unfortunately, often it is by creating fake alpha
Bankers' pay is deeply flawed
Raghuram Rajan

    Banks have recently been acknowledging enormous losses, yet those losses are barely reflected in employee compensation. For example, Morgan Stanley announced a $9.4bn (€6.4bn) charge-off in the fourth quarter and at the same time increased its bonus pool by 18 per cent. The justification was that many employees had a banner year and their compensation should not be held hostage to mistakes that were made in the subprime market. John Mack, chief executive, however, assumed some responsibility and agreed to take no bonus for 2007 - although he got a $40m payout for 2006. Even so, most readers would suspect something is not right here. Indeed, compensation practices in the financial sector are deeply flawed and probably contributed to the ongoing crisis.
    The typical manager of financial assets generates returns based on the systematic risk he takes - the so-called beta risk - and the value his abilities contribute to the investment process - his so-called alpha. Shareholders in asset management firms, such as commercial banks, investment banks and private equity or insurance companies are unlikely to pay the manager much for returns from beta risk. For example, if the shareholder wants exposure to large traded US stocks she can get the returns associated with that risk simply by investing in the Vanguard S&P 500 index fund, for which she pays a fraction of a per cent in fees. What the shareholder will really pay for is if the manager beats the S&P 500 index regularly, that is, generates excess returns while not taking more risks. Hence they will pay for alpha.
    In reality, there are only a few sources of alpha for investment managers. One of them comes from having truly special abilities in identifying undervalued financial assets. Warren Buffett, the US billionaire Investor, certainly has it, yet this special ability is, by definition, rare.
    A second source of alpha is from what one might call activism. This means using financial resources to create, or obtain control over, real assets and to use that control to change the payout obtained on the financial investment. A venture capitalist who transforms an inventor, a garage and an idea into a fully fledged, profitable and professionally managed corporation creates alpha.
    A third source of alpha is financial eutrepreneurship or engineering - creating securities or cash flow streams that appeal to particular investors or tastes. As long as the investment manager does not create securities that exploit investor weaknesses or ignorance (and there is unfortunately too much of that), this sort of alpha is also beneficial, but it requires constant innovation.
    Alpha is quite hard to generate since most ways of doing so depend on the investment manager possessing unique abilities - to pick stocks, identify weaknesses in management and remedy them, or undertake fmancial innovation. Such abilities are rare. How then can untalented investment managers justify their pay? Unfortunately, all too often it is by creating fake alpha - appearing to create excess returns but in fact taking on hidden tail risks, which produce a steady positive return most of the time as compensation for a rare, very negative, return.
    For example, an investment manager who bought AAA-rated tranches of collateralised debt obligations (CDO) in the past generated a return of 50 to 60 basis points higher than a similar AAA-rated corporate bond. That "excess" return was in fact compensation for the "tail" risk that the CDO would default, a risk that was no doubt perceived as small when the housing market was rollicking along, but which was not zero. If all the manager had disclosed was the high rating of his investment portfolio he would have looked like a genius, making money without additional risk, even more so if he multiplied his "excess" retum by leverage. Similarly, the management of Northern Rock followed the old strategy of taking on tail risk, borrowing short and lending long and praying that the unlikely event of a liquidity shortage never materialised. All these strategies essentially earn the manager a premium in normal times for taking on beta risk that materialises only infrequently. These premiums are not alpha, since they are wiped out when the risk materialises.
    True alpha can be measured only in the long run and with the benefit of hindsight - in the same way as the acumen of someone writing earthquake insurance can be measured only over a period long enough for earthquakes to have occurred. Compensation structures that reward managers annually for profits, but do not claw these rewards back when losses materialise, encourage the creation of fake alpha. Significant portions of compensation should be held in escrow to be paid only long after the activities that generated that compensation occur.
    The managers who blew a big hole in Morgan Stanley's balance sheet probably earned enormous bonuses in the past - Mr Mack certainly did. If Morgan Stanley managed its compensation correctly those bonuses should be clawed back and should be enough to pay those who did well this year without increasing the bonus pool. At the very least, shareholders deserve better explanations. More generally, unless we fix incentives in the financial system we will get more risk than we bargain for. Unless bankers offer these better explanations, their enormous pay, which has been thought of as just reward for performance, will deservedly come under scrutiny.

The writer is a professor of finance at the Graduate School of Business at the University of Chicago and former chief economist at the International Monetary Fund

Washington Post, Bloomberg News    January 18, 2008

Dire Year on Wall Street Yields Gigantic Bonuses
Biggest Firms Pay Record $39 Billion

By Christine Harper

Wall Street's five biggest firms together paid a record $39 billion in bonuses, even though three of them suffered the worst quarterly losses in their history and shareholders lost more than $80 billion.

Goldman Sachs Group, Morgan Stanley, Merrill Lynch, Lehman Brothers Holdings and Bear Stearns together paid $65.6 billion in compensation and benefits last year to their 186,000 employees. Year-end bonuses usually account for 60 percent of the total, meaning bonuses exceeded the $36 billion distributed in 2006 when the industry reported all-time high profits.

The bonuses are larger than the gross domestic products of Sri Lanka, Lebanon or Bulgaria.

"To many people, it will be shocking and questionable," said Jeanne Branthover, managing director of Boyden Global Executive Search. "People in New York in the world of investment banking will understand it. It's critical that pay is still there or you're going to lose really good people."

The five firms' combined profit for the full year was $11.5 billion, the lowest since 2002. The firms, based in New York, have said they would eliminate at least 4,900 jobs as losses mount from the collapse of the subprime mortgage market.

Shareholders in the securities industry had their worst year since 2002, as Merrill Lynch and Bear Stearns slumped more than 40 percent in New York trading, costing the chief executives their jobs. Morgan Stanley fell 21 percent and Lehman dropped 16 percent. Only Goldman rose, gaining 7.9 percent.

Bonuses paid for 2007 probably will mark a high point as revenue declines stretch into this year, said Charles Geisst, a finance professor at Manhattan College in Riverdale, N.Y.

"The gilded age just ended," he said. "Ferrari dealers are going to be selling Tata cars. I think this is going to be the worst year we've had in a very long time."

Management teams at Morgan Stanley, Merrill and Bear Stearns, which each recorded their worst quarters in history, rewarded employees who made money in the first half of the year, and who work in fastest-growing businesses, by lifting the percentage of revenue they pay in salaries, bonuses and benefits. At Morgan Stanley and Bear Stearns, the chief executives did not accept bonuses.

January 27, 2008

Big time loosers' rebound
What’s $34 Billion on Wall Street?

UNDER the stewardship of Dow Kim and Thomas G. Maheras, Merrill Lynch and Citigroup built positions in subprime-related securities that led to $34 billion in write-downs last year. The debacle cost chief executives their jobs and brought two of the world’s premier financial institutions to their knees.

In any other industry, Mr. Kim and Mr. Maheras would be pariahs. But in the looking-glass world of Wall Street, they — and others like them — are hot properties. The two executives are well on their way to reviving their careers, even as global markets shudder at the prospect that Merrill and Citigroup may report further subprime losses in the coming months.

Mr. Maheras, who left his job as co-president of Citigroup’s investment bank this fall after being demoted, has had serious discussions with several investment banks, including Bear Stearns, about taking on a top management position, people who have been briefed on the situation said. And he has also been approached by investment firms willing to back him to the tune of $1 billion or more if he decides to start his own hedge fund, these people said.

Mr. Kim, who until this spring was a co-president at Merrill Lynch with oversight of the firm’s trading and market operations, has been crisscrossing the globe in recent months raising money for his new hedge fund, Diamond Lake Capital.

The ease with which Mr. Maheras and Mr. Kim have put themselves back in play is a reminder that for many top Wall Street executives, humiliation and defeat need not result in a professional exile. And they aren’t the only ones. Zoe Cruz, the Morgan Stanley co-president who was forced to leave her job after $10.8 billion in subprime losses, has been approached by investment banks, hedge funds and private equity funds about a senior management role, people briefed on those discussions say.

“It is always an assumption on Wall Street that it is not the individuals that lose money; it’s the system,” said Charles R. Geisst, a Wall Street historian and a finance professor at Manhattan College. “You can fail big time, but you can also succeed big time.

“They think it’s bad luck,” he said, so the attitude is “let’s give them another chance.”

The quick comebacks of these executives stand in stark contrast to the plight of the hundreds of investment bankers who have received pink slips in the last two weeks. They also illuminate a peculiar aspect of Wall Street’s own version of a class divide. Senior movers and shakers often land on their feet, no matter how egregious the losses tied to them. The industry rank and file, however, from mergers-and-acquisitions bankers at Bank of America to sales executives in Citigroup’s hedge-fund servicing business, see their jobs eliminated despite being far removed from the subprime crisis.

Perhaps the most notorious example of failure leading to prosperity is John Meriwether. Ousted from Salomon Brothers in 1991 for his role in a bond trading scandal, he became a co-founder of Long Term Capital Management, the hedge fund that nearly collapsed in 1998, rattling markets worldwide. He has since founded a second fund, JWM Partners, with assets of around $3 billion.

More recently, Brian Hunter, the energy trader at Amaranth Advisors whose disastrous bets led to the disintegration of that $9 billion hedge fund, is now advising a private equity fund called Peak Ridge on starting a hedge fund. Howard A. Rubin, a trader at Merrill Lynch, who lost $377 million in 1987, quickly landed a job at Bear Stearns, where he had a successful career.

But last week, as markets worldwide gyrated, lower-level bankers braced themselves for bad news. Bank of America, whose profit fell 95 percent last year from mortgage-related exposure, has said it would pare down its trading and investment banking operations and cut more than 1,000 positions. Citigroup has also laid off investment bankers in recent weeks and has said it would cut 4,200 jobs, with more expected to follow. Morgan Stanley said Thursday that it would cut 1,000 operational jobs, and Merrill Lynch was expected to reduce its staff.

With a recession looming, the deal-making and underwriting environment is looking stagnant. Banks are cutting costs and taking a hard look at their head counts. All these developments do not bode well for bankers’ chances of landing another job anytime soon.

MR. KIM and Mr. Maheras, both 45, took different routes to the top at their respective banks. Born in South Korea, Mr. Kim received an elite education in the United States, attending the prep school Phillips Academy in Andover, Mass., and earning undergraduate and graduate degrees from the Wharton School of the University of Pennsylvania.

In 2001, Merrill’s new leader at the time, E. Stanley O’Neal, plucked him from his job as a bond derivatives expert and put him in charge of the firm’s bond business. A promotion followed just two years later, and he became president of Merrill’s overall markets and trading operations. In taking the job, he was given a mandate by Mr. O’Neal to enhance Merrill’s risk profile, and in the ensuing years, Mr. Kim’s business became a prime generator of profits. One area Mr. Kim leaped into with the encouragement of Mr. O’Neal was the market for collateralized debt obligations, complex pools of securities tied to assets like subprime mortgages. Under his watch, Merrill’s exposure to these securities climbed to $52 billion in 2006 from $1 billion in 2002, making the firm the top underwriter of C.D.O.’s on Wall Street.

Always interested in running his own fund, Mr. Kim left Merrill in May 2007, just a few months before his big C.D.O. position collapsed, causing the largest losses in Merrill’s history and pushing it into the arms of foreign investors.

In a statement, Mr. Kim said that in late 2006 he and his team put in place a program to reduce Merrill’s mortgage-related securities exposure. He said that after his departure in May, he had no authority over Merrill’s risk management, trading or other operations and was not consulted on those issues.

As recently as a month ago, Mr. Kim was telling investors he planned to raise about $2.5 billion, and he highlighted his abilities as a business builder and risk manager, people briefed on his plans said. But the turbulent markets over the last month have forced Mr. Kim to scale back his ambitions, and he is no longer discussing such a sum, said people who have spoken with him.

He has established headquarters in Midtown Manhattan but has not hired any portfolio managers, a person who had knowledge of his plans said.

While respected for his intelligence, Mr. Kim has never been a money manager, and hedge fund experts say that his experience at Merrill could be an impediment to raising money. “He has no track record, and the business he built wrote down billions in losses,” said Tim Cook, the president of Kailas Capital, an investor in hedge funds. “He has some questions to answer.”

Mr. Maheras, the son of a Greek immigrant, is a Notre Dame graduate who got his first taste of markets as a runner on the Chicago Mercantile Exchange. He started out at Salomon Brothers in 1984 and by the early 1990s had become one of Wall Street’s top traders of junk bonds. By 1996, he was running Salomon’s bond trading business, and after the 1997 merger of Travelers and Salomon, became a favorite of Sanford I. Weill, rising to co-president in 2007 with oversight of Citigroup’s trading and bond operations.

As the head of its large capital markets division, Mr. Maheras had broad oversight for all aspects of trading and investment.

IN 2004 and 2005, senior executives at the bank, including Robert E. Rubin, Citi’s influential director, urged it to become more actively involved with in-vogue areas like structured credit, pools of securities backed by different assets, and commodities. The buildup in C.D.O.’s began at this time, several reporting layers beneath Mr. Maheras. By 2006, Citigroup had become the second-leading underwriter of C.D.O.’s.

Mr. Maheras declined to comment for this article, but a person who worked closely with him said that Mr. Maheras had been aware of the broad exposure, but that he, along with others, had been caught by surprise when some of the most highly rated securities imploded so quickly.

As the size of the write-downs grew, so did pressure on Charles O. Prince III, then the chief executive, to hold someone accountable. In October, he demoted Mr. Maheras, who then chose to leave the only firm where he had ever worked. It was a move that still irks James Dimon, the chief executive of JPMorgan Chase, who worked closely with Mr. Maheras while they were at Citigroup and who has counseled him in recent months.

“The great shame is that people are often never as good or as bad as they are held up to be,” Mr. Dimon said. “Tom is a class act personally and professionally.”

Mr. Maheras has told friends that he feels horrible about the recent events. A direct, ingenuous man who lacks the guile and gloss of most bankers who have reached such a high position, he has told colleagues how upset he is that he did not discover the scale of the losses sooner, though he has not pointed fingers.

“I wish I could turn back the clock,” he has told peers. “But it happened on my watch.”

He has said that he expects to take 6 to 12 months to weigh his next move. However, he has been courted by Wall Street firms, which may push him to take a new post sooner than he might have thought. Since leaving Citigroup, he has had conversations with chief executives at most of the large banks, people who have been briefed on his plans say. At Bear Stearns, the talks have centered on his heading the firm’s trading operations, a job formerly held by the co-president, Warren Spector, who was pushed out last summer.

What explains such an interest? To some extent, it is personal: Mr. Kim and Mr. Maheras have a web of relationships with Wall Street’s top executives. And many seasoned investors think that surviving such a crucible gives a person a degree of savoir faire and understanding of risk.

“People develop relationships that transcend the professional role so that they can rationalize away performance,” said Clayton S. Rose, a former senior executive at JPMorgan who now teaches a course on corporate leadership at Harvard Business School. “There is also a view that they have learned from their mistakes and have now figured it out.”

RIGHTLY or wrongly, there is not likely to be such a generosity of spirit for Jean Larkin, who until recently was a sales executive in Citi’s prime brokerage division. Mr. Larkin was a 17-year veteran of the firm and was coming off a profitable year for the unit, during which it increased its market share. Last week, just days before getting news of his bonus, he was laid off. Mr. Larkin, who is 43 and lives in New York, would not comment on his departure, but people who have spoken to him say he had no idea that his job was at risk. People who know him say he does not hold out high hopes of finding another job anytime soon.

More recently, Stefan Gerhard, a mergers-and-acquisitions banker for Bank of America, was told Wednesday that his San Francisco job was being eliminated. Mr. Gerhard, 35, also declined comment on his departure, but a person who knows him said the news came as a shock — he had been promoted from principal to managing director in December after a successful year in which he worked on several major technology deals.

He received the news just two days before getting notice of his bonus and, people who have spoken with him said, he was offered a severance package of just 10 percent of the amount that he had been expecting to receive as his bonus. His career outlook, these people say, is gloomy, and he does not expect to make any serious effort to find work given the current industry conditions.

“Wall Street firms are downsizing considerably,” said Leah Peskin, a recruiter at Cromwell Partners. “It will be a hard year for many of those who get downsized."

April 8, 2008

Looking for an End to Deleveraging


Finally, a deal! The chairman of Lightyear Capital, Donald Marron, told me that we would know we have hit bottom when deals start to flow again. Yesterday’s announcement that Novartis will acquire Nestle’s holding in eye-care company Alcon for about $11 billion could be a harbinger of the tap opening, ever so gingerly.

Deals have been off the table (and falling off the table) for months as the financial system “deleverages.” The question of late has been: Can we deleverage the economy without killing it?

One of New York’s top fund-of-funds recently held a phone-in session with investors to bring them up to date on the financial situation. If it was meant to be calming, it should have been conducted in a foreign language. The message was: The economy is still so gummed up with bad credit that hedge funds are setting the price of, well, practically everything.

Here’s how it works. The banks and investment banks (except for Goldman Sachs) are trying to reduce the debt on their balance sheets by selling loans and other securities. All the normal opportunities to offload such loans by bundling them and selling them through structured investment vehicles are dead. (For instance, new collateralized debt obligation issues this past quarter totaled $6.4 billion, versus $103.6 billion a year ago.) Banks would like to dump their shakiest assets, but there are no buyers. So they have to sell high-grade assets instead.

The “next marginal buyers” for such assets are, mostly, hedge funds. However, hedge fund managers are also reducing the debt on their balance sheets, some through their own volition, and others due to margin calls from the banks that have put several funds out of business this year. Overall, the hedge fund industry has “deleveraged” in two of the past three months, paying off trillions, it is said, in debt.

Here’s the messy part. To entice hedge funds to buy, the triple-A rated securities being sold by banks have to be priced to yield something between 8% and 12% — or in other words, a yield that would satisfy an aggressive hedge fund without adding any leverage.

This trend has played out in some startling transactions. About three weeks ago, a large bank sold an $18 billion portfolio of “money good triple-A rated paper” to yield 9%, the effects of which apparently “rippled across the market.” I bet it did.

Translated, that means that the perfectly sound top-grade debt of leading corporations and banks that was selling to yield perhaps 6% took a 33% haircut, granting the buyer a 9% yield. Welcome to the other side of the credit mountain.

On the deal side, little money has been available to finance takeovers, for essentially the same reason. As the banks reduce their debt, they have become exceedingly picky about making new loans. Loan provisions have tightened up (covenant lite has become covenant tight), and they are not willing to finance takeovers using historically high leverage. As a result, one private equity player says, deals that used to get done easily with eight times leverage are now being priced using borrowings of six or six-and-a-half times equity. That sets the bar a lot higher; fewer transactions can still make sense.

Consequently, it was likely that strategic buyers would emerge as the next round of bidders for corporate assets. These would-be purchasers were left behind in the great overleveraged takeover boom, outbid by private equity firms able to borrow gobs of money to finance otherwise unappealing deals. Today, though, they are the ones who still have money, and a rationale for getting transactions done.

That said, there is no lack of money available. Leveraged buyout firms reportedly raised $50 billion in new funds in the fall, and the hedge funds that are still healthy are said to be sitting on large amounts of cash as well. One major prime broker reported to clients that its equity hedge fund clients have average net exposure of only 28%, a level not seen since 2002. That compares with an average net exposure of 55% to 60% this time last year. Cash balances for many representative funds are up 100% so far this year.

There is money to invest, but at the moment, no reason to invest it. “Wait and see” has become “wait and prosper” as prices for nearly every kind of asset have declined and continue to fall. Hedge funds and others perceive an opportunity cost to investing today; they want to stay liquid.

How does this turn? It will be, partly, a matter of perception. Eventually a desirable asset will become the target of a bidding war, and the price will move up. Buyers who hesitate will eventually be penalized for doing so. Or assets will be sold for prices that are simply too tempting to resist.

In the leveraged loan market, for example, the pricing today suggests default rates way above what is actually taking place, or is likely to take place. This anomaly may be explained in part by a shortage of liquidity in the marketplace. Dealers are not committing capital to the sector, as they are part of the deleveraging scenario, too.

Also, investors in hedge and private equity funds will eventually demand action. They will not be pleased to be paying fees to have their money invested in money market funds.

In the meantime, cash is king.

Washington Post    August 12, 2008

Pools of Foreign Wealth Move Into Commodities
Sovereign Funds Become Big Speculators

By David Cho

Sovereign wealth funds, the massive investment pools run by foreign governments, are now among the biggest speculators in the trading of oil and other vital goods like corn and cotton in the United States, according to interviews with brokers who handle their investments at leading Wall Street banks, veteran traders and congressional investigators.

Some lawmakers say the unregulated activity of sovereign wealth funds and other speculators such as hedge funds has contributed to the dramatic swing in oil prices in recent months.

The agency regulating the market said it had not picked up on this activity by sovereign wealth funds. In a June letter, the Commodity Futures Trading Commission told lawmakers that its monitoring showed that these funds were not a significant factor in commodity trading.

But the CFTC is not detecting the growing influence of foreign funds because they invest through Wall Street brokers known as "swap dealers" who often operate on unregulated markets, sources familiar with the transactions said.

Several Democrats said the Republican-led CFTC won't use its authority to clamp down on such unregulated activity because it doesn't want to hurt the influential Wall Street firms it favors.

"It took prodding from Congress to persuade the CFTC to finally request information from swap dealers about the participation of sovereign wealth funds in the commodity markets," said Rep. John D. Dingell (D-Mich.), chairman of the Committee on Energy and Commerce. "The regulatory body in charge of policing our futures markets has been remarkably incurious about the role sovereign wealth funds play in commodity markets."

CFTC officials say their data show that fundamental factors of supply and demand, not financial actors, are the best explanation for the run-up in oil prices and their precipitous fall.

The officials have ordered swap dealers to open their books and reveal to the agency more information about the unregulated activities of sovereign wealth funds and other financial actors, CFTC spokeswoman Ianthe Zabel said. The findings will be published in a report in mid-September, she said.

Like most speculators, sovereign wealth funds have moved into U.S. commodity exchanges for profit, not to accumulate goods. In general, they make these investments through index funds, a kind of mutual fund composed of commodity futures contracts, which bet on the price the goods will fetch at a future date.

The index allows investors to enjoy the returns of a commodity investment without actually buying futures contracts on an exchange. For this reason, the extent of their activities may be known only to the swap dealers at investment banks such as Goldman Sachs, Lehman Brothers and Morgan Stanley, which handle such transactions.

The foreign funds involved in commodity trading are not those from oil-producing nations from the Middle East, according to a large swap dealer. Instead they are mainly from countries, such as those in Asia, that do not already make money from producing oil.

While it is difficult to quantify how large foreign funds have become, they now represent 12 percent or more of the overall commodity business for some of the largest investment banks, said an industry veteran who spoke on condition of anonymity because he had proprietary data about those firms.

Other sources familiar with the activities of sovereign wealth funds spoke on condition of anonymity because their firms did not give them permission to speak publicly.

After spiking to a record high of $147.27 a barrel on July 11, crude oil settled at $114.45 yesterday, a plummet of 22 percent in a few weeks.

Although some analysts have attributed the recent reversal in oil prices to a stronger dollar and a sluggish U.S. economy, other experts in commodity trading have suggested that the price shifts have been accentuated by unregulated, speculative activity.

Over the past year, sovereign wealth funds have become increasingly active in the broader U.S. markets, investing more than $40 billion in Wall Street's biggest names, including UBS, Morgan Stanley and Bear Stearns. China put $3 billion of its $200 billion fund into private-equity giant Blackstone. Abu Dhabi, part of the United Arab Emirates, invested $1.35 billion of its estimated $875 billion fund into District private-equity giant Carlyle Group.

About two dozen countries have established or are in the process of forming large funds, including Iran, Norway, Singapore, Kuwait, Australia, Russia and Libya. While precise data about each of the funds can be difficult to obtain, Wall Street analysts say their collective value has exceeded $2 trillion and will probably grow at least fivefold by 2012.

In a June 20 letter to the House Committee on Energy and Commerce, CFTC acting chairman Walter Lukken wrote, "The growth of sovereign wealth funds and their collective investment in U.S. markets is of interest to a number of U.S. regulators."

He said the agency was aware of only one sovereign wealth fund with large holdings trading on regulated U.S. exchanges. He added that his staff had "not observed any positions of sovereign wealth funds in the data received to date" from a London exchange that shares information with the CFTC. Trading activity anywhere else would not be regulated or captured by CFTC surveillance reports, agency officials said.

Some Democrats greeted Lukken's responses with skepticism. Sen. Maria Cantwell (D-Wash.), for one, has put a hold on Lukken's nomination in the Senate, preventing him from becoming the permanent chairman of the CFTC on the grounds that he has not kept speculation under control.

Speculators, she said, "are causing a colossal impact on the markets, and we don't have the right team to oversee and analyze whether the consumer is being protected."

The CFTC, she added, is "banking on this being too complicated for anyone to understand."

  Object:     Lehman: Short Raiders 1 : Regulators Nil
  Date:        Fri, 12 Sep 2008 11:19:30 +0100
   De:        "Heinz Geyer" <>
    A:        <>

Lehman: Short Raiders 1 : Regulators Nil

That is the score in the game of chicken played between the band of short sellers intent on pushing another Investment Bank over the brink and the regulators - in particular the SEC - who fiddle while Rome burns.

Last July the SEC imposed a ban on 'naked' short selling of bank shares which in our opinion was much too weak a measure given the pervasiveness of short selling and the fire power that the raiders have at their disposal. Naked short selling was illegal in any case, so to finally enforce it was just a pathetic gesture.

Financial Institutions are critically dependent on public trust as ALL banks would be bankrupt in a second if all depositors and creditors would demand repayment at any point in time. There was a time when short selling was limited to a small group of sophisticated investors and to market professionals such as NYSE specialists. Now this cottage industry has morphed into a monster that threatens the stability of whatever target the 'shorties' decide to take aim at.

Recent trading volumes in the shares of Lehman Brothers are so enormous that they cannot be simply the result of long-term shareholders deciding to sell. Activity in the shares is more akin to the frenetic buzz normally limited to betting shops. The SEC so far has failed to call an end to this and we fear that the taxpayer will have to pick up the bill when the music stops.

This shall not be construed to be a defense of the actions of Lehman management. That huge bets were made on property-related holdings is testimony to a serious lack of discipline on the part of top management.

Heinz Geyer
Temple Associates Consulting and Recruitment Ltd.
Banking | Fund Management | Securities | Corporate Finance
T +(44) 20 8343 7785

Confidentiality Notice:  The information in this e-mail and any attachment(s) is confidential and for the use of the addressee(s) only.  If you have received this e-mail in error, please delete this e-mail. Internet communications are not secure and therefore the Temple Associates does not accept legal responsibility for the contents of this message.  Although Temple Associates operates anti-virus programmes, it does not accept responsibility for any damage whatsoever that is caused by viruses being passed. Should you have received this message in error please contact us on

Washington PostSeptember 19, 2008

Peering Over the Cliff, Saying 'I Told You So'

By Steven Mufson

James Grant, whose cluttered office at Two Wall Street overlooks Trinity Church, has been warning about financial disaster of one form or another for nearly 25 years. Two years ago, for example, when the now-beleaguered Morgan Stanley was trumpeting a 61 percent jump in profits, Grant wrote a pessimistic analysis titled "over the cliff with Morgan Stanley."

Now much of the financial industry has gone over the cliff. And as one of the most incorrigible bears on the street, the editor and author of the gloomy Grant's Interest Rate Observer should be doing a victory lap and saying "I told you so."

When reached by phone yesterday, Grant tried not to gloat. "What are the costliest words in finance?" he said. "One is 'it's different this time' and the other is 'I told you so.' It brings down the wrath of the gods."

The gods have sent down plenty of wrath already, so much that even Grant admits he has been surprised by the "ferocity and violence" of events that have shaken the financial world over the past two weeks.

"Nobody has been bearish enough," Grant said. "I, looking back on it, was not nearly enough of a calamity hollerer. What you did not read in Grant's was that the socialization of credit risk, a long-run trend, would yield in a few weeks an outright nationalization of our financial system. That sentence we did not write. So many things have happened in so dramatic and so violent a way that one is thunderstruck."

Kenneth Rogoff, an economics professor at Harvard University and former chief economist of the International Monetary Fund, also has reason to point to his foresight. At a conference a year ago, he predicted that a major bank would fail. In July he doubted Treasury Secretary Henry M. Paulson Jr.'s assertion that Fannie Mae and Freddie Mac could remain in the same form. They were "toast," Rogoff said.

And then a month ago, after many analysts thought the worst of financial instability had passed with the rescue of Bear Stearns, Rogoff told another group that more failures were on the way among the financial institutions that had been reporting awe-inspiring profits and annual bonus payments in the tens or even hundreds of millions of dollars.

"We on the outside have been saying: 'How is it possible to manufacture money like that? How can Goldman give out those bonuses? How could financial services be a third of the economy?' " Rogoff said. "And the answer was that it was taking much bigger risks than it should have."

Profiting from that sort of wisdom is no easy thing, however. Charles D. Zender, co-portfolio manager of the Grizzly Short Fund at Leuthold Weeden Capital Management in Minneapolis, says that his fund has been betting largely on a decline in financial stocks for the past two years. Recently it has been betting against some consumer discretionary shares. It has about 75 equally weighted positions.

But Zender cautions that the fund is one of the smallest at Leuthold Weeden, where other funds search for stocks that will rise. "Our philosophy has always been that there have been up markets and down markets," he said. "They go up about 70 percent of the time and down about a third of the time. This is one of those ugly times."

That's made the Grizzly fund look like a beautiful creature -- at least for now. It was up 40 percent from Jan. 1 through the close of business Wednesday. It was down 5 percent or so Thursday. It isn't meant to be a buy and hold fund, he says; over the past five years, its returns are slightly negative.

"Who knows where it will be tomorrow," Zender said.

When it comes to tomorrow, the long-term pessimists are still, well, pessimistic. "I think the central banks are going to next wear the goat horns," said Grant, saying that the Fed and other central banks would lose credibility as they wade deeper into managing banks and insurance companies.

Referring to former Federal Reserve chairman Alan Greenspan and current chairman Ben S. Bernanke, Grant said that "in the old days, when the maestro ran the Fed, people attributed to him qualities of clairvoyance. Then the next guy came and, though mere mortal, was given the benefit of doubt. He turns out not to have been much of a prophet."

Rogoff says, "I think the government will ultimately be pressed to take more radical measures." He predicts an expansion of federal deposit insurance, a new institution similar to the Resolution Trust Corporation, which bailed out savings and loan institutions two decades ago, and the need for the Treasury and Fed to shell out $1 trillion to restore stability.

Among the gloomiest -- and most prescient -- of economic prognosticators has been Nouriel Roubini, an economic professor at New York University and founder of RGE Monitor, an economic consulting and commentary firm.

In the past two weeks, Roubini has been lashing out at the Bush administration on his blog. He calls the president, Treasury secretary and Fed chairman "comrades Bush, Paulson and Bernanke" and brands them as "laissez faire voodoo-economics zealots." He says the United States has turned into the "United Socialist State Republic of America," bringing "socialism for the rich, the well-connected and Wall Street" and making sure "profits are privatized and losses are socialized."

Grant, for one, has a bit more humility. One reason may be that in March, he recommended that people buy American International Group, the insurance giant that the federal government just seized control of to prevent the cash-short firm from causing even greater market turmoil. He points out, however, that he reversed his opinion in May, at which point, he notes, "the stock still had two digits attached to it." After the federal takeover, AIG now sells for $2.69 a share.

"The best words I wrote this year were 'I was wrong on AIG,' " Grant said.

September 19, 2008

Present at the Crash

ON the subway, a stranger in a suit knowingly eyed my Lehman Brothers ID badge in its Bear Stearns holster. With a look of detached curiosity, he expressed his condolences. This is not the way I thought my Wall Street career would begin.

During college, I was an intern at Bear Stearns. There, I toiled at the lowest levels of Wall Street, fetching coffee, moving boxes, filing papers.

In my final summer at Bear, I was promoted to intern in the marketing department of the asset management division. There, I worked on some hedge funds that invested in stuff called “mortgage-backed securities.”

Several months later, the hedge funds went down the tubes, dragging Bear Stearns behind them.

After I graduated from college, Lehman Brothers hired me to help settle trades in complex derivatives, the very derivatives that led to the company’s demise. I helped resolve trading issues involving tens — hundreds — of millions of dollars.

And now? Now from my desk here in the trenches, my colleagues and I watch CNBC reports on the collapse of Wall Street. Over the months, we have watched our stock price plummet 99.8 percent, from $65 per share to 15 cents.

The news provides grist for the rumor mill. I trade notes with my colleagues here. Though some more senior people have lost their entire life savings, the steady stream of bad news and uncertainty are also difficult for those of us at the bottom of the Wall Street food chain. It is dizzying.

Most of the time, in the office and out, I feel like I am on display, an object of pity or fascination. Friends and family send frequent expressions of concern and empathy by phone, e-mail and text message.

Even though I had little — nothing, actually — to do with the real estate losses that led to Lehman’s problems, or the hedge funds that precipitated Bear’s demise, the only conclusion I can draw is that I’m a jinx. Prospective employers will take one look at my résumé and call security to escort me out the door lest my mere presence infect their otherwise healthy businesses [*].

Meanwhile, I sit at my desk. “Your password will expire in nine days,” my computer informs me. “Would you like to change it?” Each time, I click “No.”

Sam G. Baris is an analyst at Lehman Brothers.

[*]    [Would somebody please tell this hapless fellow that he still might have a chance in Switzerland, where some leaders of various trade groups, like the Swiss Bankers Association and Geneva Place Financière, have successfully leaned on the federal and the cantonal tax authorities in order to attract - rather than keep away - these financial apprentice-sourcerers by way of special tax rates and immigration facilities]

September 19, 2008

A Bid to Curb Profit Gambit as Banks Fall


Traders who have sought to profit from the financial crisis by betting against bank stocks were attacked on two continents on Thursday.

The Securities and Exchange Commission is considering a temporary ban on short sales of some or all shares and an announcement could be made as early as Friday morning. Earlier Thursday, the S.E.C. scrambled to put together an emergency rule to force major investors to disclose their short sales daily.

In Britain, regulators announced new rules to bar short selling.

Short selling — a bet that a stock price will decline — is the practice of selling stock without owning it, hoping to buy it later at a lower price, and thus make a profit. It has often been blamed for forcing prices down in times of market stress, but the level of anger has intensified as the American government has been forced to bail out major financial institutions and the leaders of some investment banks have asked for action to protect their shares.

Both the S.E.C. and the New York State attorney general promised to intensify investigations into short selling abuses. “They are like looters after a hurricane,” said Andrew M. Cuomo, the attorney general. “If you pass a rumor in a normal marketplace, people are calm, they check it out, they do their due diligence. When you get the market in this frenzied state and they are on pins and needles, any false information is much more impactful.”

Short sellers say that the criticism directed at them, and any restrictions on their activity, are wrong-headed, because they were among the first to raise the alarm about the risky mortgage lending practices that led to the current financial crisis.

Senator John McCain, the Republican presidential candidate, said the S.E.C. had “kept in place trading rules that let speculators and hedge funds turn our markets into a casino” and said that the S.E.C.’s chairman, Christopher Cox, had “betrayed the public’s trust.”

Speaking at a rally in Cedar Rapids, Iowa, Mr. McCain said, “If I were president today, I would fire him.”

The White House immediately said it supported Mr. Cox, who has said he will resign at the end of the Bush administration. Mr. Cox said he had moved against short sellers and was doing all he could to stem the financial crisis.

“Now is not the time for those of us in the trenches to be distracted by the ebb and flow of the current election campaign,” Mr. Cox said in a statement released by the commission. “It is precisely the wrong moment for a change in leadership that inevitably would disrupt the work of the S.E.C. at just the wrong time.”

Mr. Cox is a former White House aide to President Ronald Reagan and a former Republican congressman from California. Some conservative columnists and commentators, including Robert Novak, supported him as a running mate for Mr. McCain. Writing in the American Spectator earlier this year, Quin Hillyer said that conservatives would rally to a Cox selection and called him “the best choice, bar none.”

In recent weeks, Mr. Cox has also stepped up his criticism of short sellers, particularly those who engage in “naked” short selling. While short sellers are supposed to borrow shares before selling them, naked shorts do not borrow. That saves the cost of borrowing, though the trader is still vulnerable to losses if the share price rises.

Opponents of short selling believe that it can force share prices down and destroy confidence in a company that might otherwise survive. Regulators have long thought that the practice was crucial for efficient markets to function, but earlier this year the S.E.C. imposed temporary limits on short selling of some financial stocks. Financial share prices rallied when those limits were announced but fell during the period in which the rule was in effect.

Share prices for many financial companies shot up Thursday afternoon after plunging the day before in the wake of the government decision to take control of the American International Group, a large insurance company, to prevent it from collapsing. Financial shares were especially hard hit Wednesday, with Morgan Stanley plunging 24 percent, to $21.75, and its chief executive, John J. Mack, blaming false rumors spread by short sellers. On Thursday, Morgan Stanley regained part of that loss, rising 3.7 percent to close at $22.55.

The latest moves against short sellers began Wednesday. In the morning, Mr. Cox announced new rules to prevent brokerage firms from selling a stock short if they previously had sold the stock short without having borrowed it. That night, he said that he would propose more rules, to force large short sellers to disclose their positions.

The rules were needed, he said, “to ensure that hidden manipulation, illegal naked short selling or illegitimate trading tactics do not drive market behavior and undermine confidence.”

Details of the possible new disclosure rule were not released, and it is not clear how much authority the S.E.C. has over hedge funds, which have successfully sued to prevent the commission from forcing them to even register with it. Institutional investors, including some hedge funds, provide details of stocks they own every three months but do not disclose short positions. Mr. Cox said he wanted daily disclosure of short positions, which he said would be made public, though he did not say how quickly.

By late Thursday, the S.E.C. was considering a temporary ban of some or all short selling. Mr. Cox told reporters in Washington late Thursday that he had discussed the ban with other senior administration officials but no decision had been made yet.

Richard Baker, the president of the Managed Funds Association, a hedge fund trade group, said the funds would comply with any rules but said that disclosure of their trading positions should not be made so quickly that it would harm them in the market.

Mr. Cox also said the S.E.C. would intensify its investigations of short selling by hedge funds and would demand their records on trading in certain securities.

In Britain, the Financial Services Authority said that beginning Friday it would bar traders from taking new short positions in listed stocks of financial companies, and that starting next week, investors would have to disclose their short positions if they were at least 0.25 percent of a company’s outstanding shares.

This week, the British bank Lloyds TSB took over HBOS, a mortgage lender, after HBOS’s stock tumbled. That fall was widely blamed on short sellers, and Prime Minister Gordon Brown vowed to clean up the financial system.

To obtain shares to sell short, traders often borrow them from institutional investors, who receive small fees for the loans. But public pension funds in New York and California said Thursday that they would stop lending shares of some financial companies.

New York State’s comptroller said the state’s Common Retirement Fund would temporarily stop lending the shares of 19 banks and brokerage firms to short sellers. “This speculative selling has put downward pressure on the entire stock market and threatens to drive our national economy deeper into decline,” Thomas P. DiNapoli, the comptroller, said in a statement.

The suspension removes 105 million shares from the fund’s securities lending program. It will last until market conditions stabilize, a spokesman said.

New York City’s comptroller announced the same move, as did officials in California.

“We’re pulling them back because of the unfortunate predators that are out there right now, trying to be greedy,” said Patricia K. Macht, an official of the California Public Employees’ Retirement System.

Landon Thomas Jr. contributed reporting.


September 19, 2008

Bankers and Their Salaries

With the nation’s financial system teetering on a cliff, the compensation arrangements for executives of the big banks and other financial firms are coming under new scrutiny.

Bankers’ excessive risk-taking is a significant cause of this financial crisis and has contributed to others in the past. In this case, it was fueled by low interest rates and kept going by a false sense of security created a debt-fueled bubble in the economy.

Mortgage lenders blithely lent enormous sums to those who could not afford to pay them back, dicing the loans and selling them off to the next financial institution along the chain, which took advantage of the same high-tech securitization to load on more risky mortgage-based assets.

Financial regulation will have to catch up with the most irresponsible practices that led banks down this road, in hopes of averting the next crisis, which is likely to involve different financial techniques and different sorts of assets. But it is worth examining the root problem of compensation schemes that are tied to short-term profits and revenue, and thus encourages bankers to take irresponsible levels of risk.

The banks recognize that pay is a problem. “Some firms” used “compensation incentives that exacerbated the weaknesses and contributed to the market turmoil,” admitted the Institute of International Finance, a lobby group for big banks.

One direct way to address this problem is for bankers to have more of their own money at risk in the bets they are making.

The regulator of Fannie Mae and Freddie Mac set an example when the government took over the mortgage finance companies last week — barring them from paying their former chief executives severance packages worth millions that were stipulated in their contracts. It is proper for the federal government to intervene in executive compensation or exit pay when it takes over a bank. When the federal government assumed a huge ownership stake in the American International Group, it fired the chief executive.

But that was a drastic measure. Banks’ boards of directors, encouraged by their shareholders, must look hard at reforming the pay of top bankers. The core problem is this: bankers get stellar rewards in the good times and don’t have to give money back when their strategy sinks the bank a few years down the road. They might miss a bonus, or even get fired — and float down to earth on the “golden parachute” negotiated in the flush years.

One way to change this would be for banks to hold a big chunk of bankers’ pay in escrow, to be doled out over several years. A bigger share of a bankers’ pay could be made in restricted stock that can only be sold over a fairly long period of time. Golden parachutes could depend on good performance through the executive’s tenure.

Now, there’s a concept.


AN INTERVIEW WITH FELIX ZULAUF: A bleak long-term view on stocks.
The Pain of Deleveraging Will Be Deep and Wide
Felix Zulauf, Founder, Zulauf Asset Management

AS THE CREDIT CRISIS INTENSIFIED LAST WEEK, radically altering the Wall Street landscape and the government's role in stabilizing the financial system, Barron's sought out Switzerland-based Felix Zulauf for  a global macro perspective. A longtime member of Barron's Roundtable, the founder of Zulauf Asset Management is now equity-averse -- he prefers gold and government bonds -- but further out, sees untapped  growth potential in emerging-markets.
Barron's: It's been an unprecedented time in the financial markets, with Lehman filing for bankruptcy protection, Merrill Lynch being bought by Bank of America and AIG getting rescued by the U.S. government.  What's the fallout going to be?
Zulauf: The leveraging-up in this cycle is reversing, and we are now deleveraging. When a huge system -- that is, the global credit system dominated by the investment-bank giants that have been the major  creators of credit in the last cycle -- turns down, the fallout is going to be terrible.

Deleveraging is a very painful process, and will run longer and deeper than anybody can imagine. I've been fearful of this.

So far, what we're seeing is the pain in the financial system. Later on, we'll see the echo effect of the pain in the real economy. I can't understand economists talking about no recession or mild recession. This is  the worst financial crisis since the 1930s. It's different than the '30s, but is the worst since then, and the consequences will be very, very painful for virtually everybody in our economies.

So it's a global downturn?
That's right. It started out in the U.S., but it is a global event, led by the [excessive lending practices that grew up in the] housing boom in the U.S. But we also had housing booms in some of the European  countries, and in some of the emerging countries. People are already talking about a glut of unsold homes in China.

How will these countries fight this severe downturn?
Governments, particularly those in the industrialized economies, will use fiscal stimuli to prop up the system and prevent them from collapsing. Usually, those stimuli are a little too small to really have a lasting  impact, which is usually spent after two to three quarters. So we could have a pop in the market in '09 and the economy into 2010, and then it disappears again; then there is the next fiscal program, and so on.  That can go on for a long time.

By issuing more debt, all of these governments are trying to stimulate deteriorating economies. But what do you see as some of the other consequences of all that additional debt?
Government debt is going to rise dramatically over the next five to 10 years. Government debt is at 300% of [gross domestic product] in most industrialized countries, if you calculate correctly. That can increase  to 400% and 500%, but at some point the government-bond market will not take this without any consequences. That will lead to rising long-term interest rates. But because the economy is not on solid footing  yet, short-term rates will stay low for a long time. So you will have a very steep yield curve for many, many years, and this is bearish for bonds since their prices keep falling.

What's your take on the inflation outlook?
Most governments and central bankers are still concerned about the inflation rate. I think for cyclical reasons that inflation will probably drop sharply into '09, partly due to lower commodity prices. But what's more  important thereafter is that there will be a secular rise of the inflation rate, because governments and central bankers will be forced to reflate these economies in a big, big way, and this will be bad for nominal  assets, whose value decreases because of less purchasing power. But it will be good for real assets at some point of time in the future. For example, companies can adjust by raising their prices and growing  their incomes.

What does all of this deleveraging, in which firms try to get various forms of debt off their balance sheet, mean for those involved?
When the deleveraging starts due to declining asset prices, there is no one there to reverse it. I cannot see the private sector stopping this and turning it around. It has to be the government, together with the  central banks, and they are starting to do that.

What's your assessment of the steps Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson have taken to stem these problems?
It's a challenging job. Bernanke and his team and Treasury are doing the utmost, but doing the utmost means they're always one step behind. So far, it seems that the Fed is constrained by not being able to  expand its balance sheet. It has replaced a lot of Treasury paper with other paper of lower quality, and the level of Treasury paper on the Fed's balance sheet has now reached such a low point that it cannot  expand more without really monetizing debt.

You can't stop this [downturn] or turn it around without going to monetization, a step the central bank hesitates to take. But eventually the developments will force the Fed to do it.

What's your reaction to Friday's announcement that Paulson is crafting a plan for the federal government to buy illiquid assets from various financial firms?
Treasury, together with the Fed, is taking a big step forward to keep the system from melting down. It will work, but it has to be at least $1 trillion in size and the Fed has to help by cutting rates. The idea is good;  now the Treasury has to make it solid and the Fed has to lend its support. This is probably the beginning of a medium-term bottom. Usually a good bottom, even medium term, doesn't stand on one leg. In the  coming three or four weeks, the low will be tested, but from there we have a chance for a good medium-term rally.

Could you elaborate?
What the Fed has to do is buy paper in the asset market, including Treasuries and corporate bonds, and create new money in the financial system -- because the deflationary process created by the  deleveraging is at work. Deflationary power is growing dramatically, and the Fed has to replace the dollars that have disappeared into a black hole. The private credit system cannot do that anymore. The Fed  and government are really the lenders of last resort.

From your vantage point, what do you see happening to the Eurozone's economy?
Short term, it will probably get a little bit worse in Europe, because we have a different policy mix than in the U.S. Your central bank has cut rates. They've been aware of the problem. The fiscal situation is  expansive already, whereas in Europe we have tightening fiscal policy, and we have still a restrictive central bank that's looking at holding the value of the euro. So Europe could get hurt a little more than the  U.S. in the short term, but I think it will do better over the medium term.

Why is that?
First of all, Europe can finance itself, meaning it's not dependent on outside money. It runs a slight current-account surplus and, net-net, it is not indebted to the rest of the world. The U.S. is indebted to the rest of  the world; that's a major difference. Also, Eurozone households [collectively] run a financial surplus, while U.S. households have deficits. So when you look at the large European economies such as those in  Germany or France, the consumer is in much better shape and the banks are probably in a little bit better shape than in the U.S., although some internationally active banks and investment banks are like their  U.S. competitors.

What about emerging-market economies?
Even emerging economies are getting hurt. We have seen how real-estate prices in some emerging economies, from the Baltic States to some Asian countries, are coming down. But these countries have a  better situation from a very, very long-term point of view because of demographics. They are much younger nations. They are much lower in their standard of living, they are going up the ladder, and they are  competitive.

Another thing to consider is that current-account and trade deficits will shrink. So what used to be a big stimulus for emerging economies will be curtailed and it will hurt those economies in the short run much  more than the markets assume.

What do you see ahead for the U.S. economy and elsewhere?
The U.S. economy goes flat for several years, and from time to time there probably will be major fiscal programs, each one bigger than the previous one, to help the economy. Europe will be similar; its potential  growth is relatively low, with a stagnating population.

The emerging economies have much higher potential growth rates. They are going through a down-cycle, but they will come up again in the next cycle and have higher growth rates. But it is going to be a very  tough 2009, a global recession. Whoever gets elected president in November will come through with a fiscal program. Monetary policy is really ineffective in this situation. When you have a balance-sheet  recession and everybody is deleveraging, monetary policy cannot do the trick. It doesn't work because there is no one willing to leverage up their own balance sheet.

Around these parts there has been a lot of focus on Merrill, Lehman and AIG, not to mention Fannie Mae and Freddie Mac, which the U.S. government bailed out recently. What does the future hold for financial  firms globally?
Bankers have to learn that banking is an industry like any other industry. The financial sector has grown dramatically over recent decades, and I think it has grown to a level that is too big in proportion to total  GDP.

Global financial-sector debt has gone up fivefold in the last 25 years relative to GDP. So what you now see is a reversal back to the mean. That means that the financial sector as a profit generator, as an  employer and as a provider of services will shrink over many years -- back to a level that is more normal than in recent years. The financial-services industry has been treated extremely well for a long time and  people made a lot of money and created careers, etc. But it is going to be much, much tougher in the next 10 years globally.

Do you see any industries that look promising at the macro level?
First, we go through a down-cycle, and it will affect virtually every industry. After that down-cycle is over, particularly in the emerging economies that have higher growth potential, it will turn up again. It could again  be infrastructure-related assets or commodity-related assets that will perform very well. If I'm right in this scenario, what will happen is we will create a stimulus to grow in the future. And those who grow the best in  a world of stimuli will be those that have the highest growth potential, namely the emerging economies. And then we will see rising bond yields. They will go in cycles, of course, and they will not shoot up  straight. But they will go up.

What investments look interesting to you?
In this environment, those who do not lose win. For the average guy, I'd say go into the most defensive position. I'm not really interested in any longs in equities. I'm holding a lot of government bonds on the  long side. I suggest that American investors stick to shorter-term Treasuries with maturities of up to two years.

Any other suggestions for equity holdings?
If you have extra money left and want to be more aggressive, you can play the markets short-term. There are going to be a lot of runs up and down in a declining market.

This is all sounds very bleak, Felix.
I'm not interested in any longs in equities. If you are an optimist by nature and if you want to be long, the one area that you should look at is daily necessities, notably consumer staples. Companies like Procter &  Gamble [ticker: PG], General Mills [GIS] and maybe Johnson & Johnson [JNJ]. Those are the defensive names. But I have absolutely no interest in investing on the long side in anything that is cyclical in nature,  because this cycle could last longer on the downside and go deeper than most investors assume.

Thanks very much.

CNBC, Reuters    September 22 2008

McCain urges broad oversight of massive bailout

WASHINGTON - U.S. Republican presidential candidate John McCain on Sunday called for broad oversight of the Bush administration's $700 billion plan for rescuing Wall Street.

In an interview on financial cable TV channel CNBC, McCain said responsibility for the bailout should be spread beyond Treasury Henry Paulson.

"I think we need to appoint an oversight board of the most respected people in America, such as maybe Warren Buffett, who's an Obama supporter, Mitt Romney, Mike Bloomberg, so that there can be some kind of oversight of, instead of just putting all this responsibility on a person who may be gone in four months," McCain said.

The Arizona senator also said the bailout should set limits on compensation for chief executives of financial institutions that would be rescued by the federal government.

"No CEO of any corporation or business that is bailed out by us, that is rescued by American tax dollars, should receive any more than the highest paid person in the federal government," McCain said.

Treasury Department staff is working through the weekend with members of Congress and their aides to craft a plan that would absorb bad mortgages and related assets from banks and other institutions to keep the U.S. financial system from collapsing.

Copyright 2008 Reuters     September 24, 2008 (update2)

Traders Sowing Seeds of Destruction Prompt Crackdown
By Shannon D. Harrington, Caroline Salas and Pierre Paulden

Sept. 24 (Bloomberg) -- The $62 trillion market for credit- default swaps, created to protect banks from loan losses, helped fuel a near-meltdown in the financial system and now may be regulated for the first time.

The derivatives precipitated plunges in the shares and debt of Wall Street firms, accelerating the collapse of Lehman Brothers Holdings Inc. and the U.S. takeover of American International Group Inc., the  biggest U.S. insurer. Now, regulators want to bring oversight to a part of the credit market that may be more susceptible to manipulation than selling stocks short, according to U.S. Securities and Exchange  Commission Chairman Christopher Cox.

Banks ``are suffering the consequences of their own actions,'' said Thomas Priore, chief executive officer of Institutional Credit Partners, LLC, a New York-based hedge fund with $13 billion in assets. ``They  created a mechanism through default swaps to reflect a view on credit that has taken on a life of its own.''

The swaps became one-way bets on the demise of financial institutions as traders hedged the risk that their partners might implode, said Gary Kelly, a strategist at broker Tradition Asiel Securities Inc. in New  York. The wagers sent distorted signals about credit risk, he said.

The resulting run on shares of financial companies prompted Cox yesterday to seek enforcement powers over the market. New York State will also start regulating some sales of the derivatives, according to  Governor David Paterson.

Loan Protection
``The absence of regulatory oversight is the principal cause of the Wall Street meltdown we are currently witnessing,'' Paterson said in a statement Sept. 22.

Banks started buying and selling credit derivatives in the mid-1990s to protect loan portfolios, Andy Brindle, the former head of JPMorgan Chase & Co.'s credit-derivatives group, said in 2003. The International  Swaps and Derivatives Association started reporting credit-derivative volumes in 2001, when volume stood at $919 billion.

The contracts trade in over-the-counter deals, leaving each side exposed to the risk their partner will default. There's no exchange or clearinghouse for the swaps and no system for publicly reporting trades.

Credit-default swaps aren't issued or repaid by the companies referred to in contracts. The instruments pay the holder the face value of the amount protected in exchange for the underlying securities if a  borrower fails to adhere to debt agreements.

Death Spiral
The market helped set off a death spiral for Lehman and AIG as a jump in the cost of protecting debt, or credit spreads, pushed down their shares. That eroded capital and prompted credit-rating companies to  threaten downgrades. Bear Stearns Cos. met a similar fate in March before JPMorgan took the bank over in a rescue orchestrated by the Federal Reserve and Treasury.

Credit spreads were exaggerated as banks and investors hedging the risk of their trading partners defaulting rushed to buy swaps. That sent the price of protection soaring.

``The risk concerns became massively overblown,'' said Tradition's Kelly, who for the past three years made recommendations on stocks based on signals from credit-default swaps. ``Now, the time that the  equity market starts heavily focusing on the CDS market, it's probably a period where its reliability is the most questionable.''

`Nonsense' Trades
The difference between the cost at which dealers sell and buy protection on Merrill Lynch & Co., AIG, Morgan Stanley, Goldman Sachs Group Inc. and Wachovia Corp. widened last week to an average of about  63 basis points, compared with 10 basis points the previous week, according to quotes from London-based CMA Datavision. A basis point is 0.01 percentage point.

Trading in the derivatives became ``nonsense,'' Morgan Stanley Chief Financial Officer Colm Kelleher, 51, told investors after reporting third-quarter earnings Sept. 16.

The New York-based securities firm had net income of $1.43 billion in the quarter and reported $175 billion of cash and available equivalents, up from an average of $135 billion the prior quarter. Credit swaps  showed a higher risk of default for the broker than homebuilder Lennar Corp., which reported losses in each of the last six quarters.

Credit-default sellers on Sept. 17 demanded as much as $2.1 million upfront and $500,000 a year to protect $10 million in Morgan Stanley bonds from default for five years. The price implied a 65 percent chance  the company would go bust within five years, based on a valuation model created by JPMorgan. The cost today was $790,000 a year, implying it has a 50 percent chance of failing.

`No Rational Basis'
The price moves had ``no rational basis,'' and helped touch off a 66 percent slump in his firm's stock last week, said CEO John Mack, 63.

``Why should CDS spreads be having such a big impact on the stocks?'' Glenn Schorr, a UBS AG analyst in New York, wrote in a Sept. 17 report. ``Isn't this a bit disconcerting that the illiquid CDS market, or the  rating agencies, can have so much influence on the fate of these companies and alter the landscape of the brokerage industry?''

Merrill Lynch, seeking to prevent itself from being the market's next target, agreed to be bought by Bank of America Corp. last week after credit-default swaps implied a one-in-three chance of default in five years  and the shares plunged 31 percent in four days.

`Default Risks'
Morgan Stanley and Goldman Sachs, the last of the five big U.S. investment banks, sought approval to become bank holding companies, allowing them to build deposit bases and move away from a business  model that investors had deemed too dependent on borrowed money, or leverage.

Credit-default swap traders shouldn't be blamed for pushing Lehman into its grave, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

``A company that relies on short-term funding and high leverage is destined to face higher default risks,'' he said.

Lehman spokesman Mark Lane in New York didn't return calls for comment.

Credit-default swap buyers and sellers don't need to own bonds or other debt of the company referred to in a contract. This leads to ``outsized incentives'' for investors to bet on an issuer defaulting, Cox said in  Congressional testimony yesterday.

``We are looking at the effects of short-selling'' of shares, he said. ``Greater opportunities for manipulation exist in the CDS market.''

`Ill-Fitting' Regulation
Short sellers borrow shares and attempt to profit by repurchasing the securities later at a lower price and returning them to the holder.

``Proposals which would seek to treat privately negotiated contracts as securities, or otherwise apply ill-fitting regulatory regimes to these agreements, are likely to deter healthy economic activity,'' Robert  Pickel, ISDA's CEO, said in a statement yesterday.

Banks face pressure from regulators to create a clearinghouse by the year-end that would back trades between dealers and absorb the failure of a market-maker. New York State also plans to regulate some  credit-default swaps as insurance policies after AIG sold protection on more than $400 billion of debt that led to $18 billion of losses in three quarters. New York said its new rules will take effect in January.

``I hope that by then there is maybe even a more holistic solution that we can discuss,'' New York Insurance Superintendent Eric Dinallo said in a Bloomberg Television interview today.

Collateral Demand
The surge in AIG's credit spreads and slump in the shares prompted Moody's Investors Service and Standard & Poor's to cut the insurer's ratings on Sept. 15. That allowed counterparties to demand more than  $13 billion in collateral on swap trades and forced the company to cede control to the government in exchange for an $85 billion loan.

``A major part of AIG's problems were created when credit- default swaps were issued by a non-insurance unit that did not hold sufficient reserves,'' the statement from Paterson's office said.

Goldman Sachs, which reported $4.9 billion of writedowns and credit losses the past year, saw credit-default swaps widen to a record 685 basis points on Sept. 17 from 148 at the end of August, suggesting a 45  percent chance of default in five years. The contracts were trading at 390 basis points today after billionaire Warren Buffett said yesterday his Berkshire Hathaway Inc. is buying a $5 billion stake in the company.

Goldman shares fell to as low as $85.88 on Sept. 18 in New York Stock Exchange composite trading, and have since risen back to $133. They're down 38 percent this year. Spokesman Michael DuVally  declined to comment.

Taking Cues
Stock investors began taking cues from the derivatives in 2005, when the contracts moved before leveraged buyouts and other transactions were announced, said Tradition's Kelly. When a surge in Bear  Stearns's credit swaps preceded its collapse, investors began looking to the market for early signs of stress in other financial companies.

``It's become suddenly a huge focus of the market,'' Tradition's Kelly said. ``Credit issues have really begun to start driving the equity market.''

Lost Trust
Frank Glaser, 75, a retired Hughes Aircraft executive in Los Angeles dumped Wachovia preferred shares he bought in December after asking his broker at UBS where credit-default swaps on the Charlotte, North  Carolina, based-company were trading. The derivatives implied a 47 percent chance of default in five years on Sept. 17, the day Glaser sold the shares at a loss, based on the JPMorgan valuation model.

Wachovia is managing through the pressure in the credit markets and is financially sound, spokeswoman Christy Phillips- Brown said. The shares fell to as low as $8.50 last week and closed at $13.80 today.

``We don't trust the rating agencies,'' Glaser said last week. ``Lehman was A2 the day before it went bust, so what have I got to go on? I listen to the president of Wachovia. He sounded like he really knew what  he was doing, and I'm reasonably sure he's going to come out of it. But the market doesn't believe him because the credit-default swaps are huge.''

To contact the reporters on this story: Shannon D. Harrington in New York at; Caroline Salas in New York at; Pierre Paulden in New York at
Last Updated: September 24, 2008 17:31 EDT

Washington Post    September 23, 2008

Hard Landing for the Golden Parachute

By Dana Milbank

It's about time somebody in this town stood up for the big guy.

After 7 1/2 years of drift, President Bush has finally returned to his compassionate conservative roots with a heartfelt plea to Congress to help a needy and deserving group: those Wall Street CEOs who, for all their hard work, have been unable to lift themselves up by their wingtips.

Treasury Secretary Hank Paulson (R-Goldman Sachs) made the rounds of the talk shows on Sunday, pleading for financial executives to be allowed to keep their multimillion-dollar compensation packages even if their companies need to be rescued by the $700 billion federal bailout.

"If we design it so it's punitive and so institutions aren't going to participate, this won't work the way we need it to work," Paulson, whose net worth is said to be north of $600 million, told Chris Wallace on "Fox News Sunday." "To have this program work, we don't want to make it punitive and make it difficult," Paulson advised George Stephanopoulos on ABC's "This Week."

It was a message of mercy and humanity -- who, after all, would be so cruel to deny executives their eight-figure bonuses merely because they drove their companies into insolvency? -- and administration officials and Republican lawmakers joined the cause of the unappreciated CEOs.

"While it is very appealing to think about executive compensation as being a part of this, one of the drawbacks to that is perhaps that we would have fewer entities participate in what is essentially a voluntary act," Sen. Mel Martinez (Fla.) said on CNBC yesterday morning. "It should be up to the board of directors of a private corporation to set the compensation of an executive; it shouldn't be Congress's role," Sen. Richard Shelby (Ala.) proclaimed on CBS News.

Bush issued a statement yesterday warning lawmakers not to "insist on provisions that would undermine the effectiveness of the plan," and White House press secretary Dana Perino, asked about Democrats' plans to limit executive compensation, advised them to pass the legislation as Paulson proposed it, "the cleaner the better, and the quicker the better."

Mitch McConnell (R-Ky.), the Senate minority leader, went to the floor to decry those who would make the bailout legislation "flypaper for partisan add-ons."

As it happens, the U.S. Mint held a ceremony at the Lincoln Memorial yesterday morning to unveil designs for a new penny in time for Abraham Lincoln's 200th birthday next year. But at the other end of the Mall, Lincoln's successors in the Republican Party were battling the impression that they were building a government of the plutocrats, by the kleptocrats, for the oligarchs.

Barney Frank (D-Mass.), chairman of the House banking committee, made his way into the House media gallery to face 75 reporters yesterday afternoon. The hard-hearted chairman hitched up his trousers, took his seat, and showed no remorse toward the CEOs who stood to lose so much. "The Endangered Species Act apparently does not apply to financial institutions," he joked, cruelly. He vowed, callously, that there will be "no golden parachutes while we are the owners" of Wall Street firms' bad debts.

"It's inconceivable that people would say the taxpayer should put some money at risk because of bad decisions made by people who would then continue to be rewarded without any restriction and, in fact, would be rewarded for their mistakes," the merciless chairman argued.

He then cynically turned Paulson's defense of the Wall Street executives upside down. "Let me defend CEOs against Hank Paulson's attack on them," Frank said with feigned sincerity. "Here is this absolutely essential program that's needed to keep the economy going, but there are CEOs who won't participate in it if a few of their many millions are going to get nicked? That's really what he's saying, that some CEOs put their ability to get unrestricted excessive compensation, including rewards for failure, over and above trying to cooperate and help the economy. If that's true, we're in worse shape than we think."

It was a brazen attempt to exploit the suffering of the CEOs, but it was irresistible to Frank's fellow Democrats.

"If you're taking a federal dollar to bail yourself out, you ought to get a federal salary," Sen. Jim Webb (Va.) said on the Senate floor. "It is wrong to have executives who have created all kinds of problems and cost the taxpayer millions, if not billions, then walk away with golden parachutes," Sen. Chuck Schumer (N.Y.) told MSNBC.

Confronted with such demagoguery, the Republicans by day's end were beginning to falter in their compassion for the struggling CEOs. After Republican presidential nominee John McCain came out against golden parachutes for bailed-out executives, Rep. Louie Gohmert (Tex.), talking with fellow opponents of the rescue plan, told The Post's Paul Kane that golden parachutes are "repugnant."

After a meeting with the Senate banking committee chairman, Chris Dodd (D-Conn.), Sen. Bob Corker (R-Tenn.) was ready to sacrifice the needy CEOs on the altar of expediency. "There are things sometimes one has to accept to reach a solution," he told The Post's Lori Montgomery.

Even Martinez, who only hours earlier was on television defending the CEO pay provisions, was now of the opinion that "there needs to be some language involving executive compensation."

It was enough to make a big guy feel small.

Washington Post    September 23, 2008

The Masters of the Universe who created this mess ought to share the pain of cleaning it up.
A Bailout or a Bonanza?
By Eugene Robinson

The uber-capitalists of Wall Street are all socialists now. Free- market ideology, it turns out, doesn't pay the mortgage. That appears to be a job for, ahem, Big Government.

Let's be clear about why we're facing a crisis that could pull down the global financial system. The irresponsibility of individuals who bought houses they couldn't quite afford pales in comparison with the irresponsibility of the financial wizards who built on those shaky mortgages a towering edifice of irrational faith. Someone in the government should have looked at all those trillions of dollars' worth of mortgage-backed securities and collateralized debt obligations and credit default swaps and demanded that Wall Street prove that all, or even most, of this purported money was real. But we're in the eighth year of the Bush administration; adult supervision left the building long ago.

Now that the whole highly leveraged structure is threatening to fall, some kind of government bailout is necessary and inevitable. But Congress shouldn't approve Treasury Secretary Henry Paulson's $700 billion rescue plan without insisting on some measure of equity and accountability.

See, neglecting such details as equity -- in both senses of the word -- and accountability is what got us here in the first place.

Congress should have learned by now what happens when this administration is given a blank check. Unlike the run-up to the Iraq war, at least this time there's a genuine emergency -- we came within a whisker of a financial meltdown last week, and we're still way deep in the woods. No one thinks that delay is an option.

Not Barack Obama, who introduced legislation in 2006 to address lax mortgage lending and in March proposed a new regulatory framework for the financial markets. Not John McCain, who has been all over the map. Within one week, McCain has gone from saying the "fundamentals of the economy are strong" to declaring that "we are in the most serious crisis since World War II."

But first we need to be convinced that Paulson's proposal -- have the government purchase the bad debt -- is the best thing to do. Not all economists believe it is, although it's true that if you put six economists in a room, they'll come up with seven sharply differing, strongly held points of view about the time of day. Assuming that Paulson's plan is deemed workable, the "details" yet to be worked out involve staggering amounts of money. Hedge funds apparently don't qualify for relief, but what about insurance companies that branched out into exotic mortgage-backed investments? What about foreign banks with big U.S. operations?

Clearly there has to be some definition of just who is covered, and there has to be some oversight. And now that the government has nationalized Fannie Mae and Freddie Mac, who's going to run those still-vital institutions? Who's going to run the giant insurance company AIG, which was effectively nationalized last week?

Maybe Congress can insert a provision that broadly insists on the principle of oversight and leaves the particulars to be worked out later. But it would be unconscionable for Congress to absolve a bunch of wealthy financiers of the consequences of their bad decisions and not do the same for homeowners who showed similarly poor judgment. Paulson has indicated his awareness that this is, indeed, an election year -- and that members of Congress are not eager to go home to their districts and explain why Wall Street's pooh-bahs get to keep their mansions and their yachts while working-class families lose their modest homes.

The more contentious issue is the idea, supported thus far mostly by Democrats on Capitol Hill, that there should be salary caps for executives of companies that take advantage of the government bailout. Paulson complains that this will provide a disincentive for companies to participate in the program -- whatever the program turns out to be -- but it seems to me to be a reasonable idea, and a winner politically.

Why shouldn't the executives who put their companies at risk by making unwise investments pay a price for their lack of prudence?

We can't just let the system collapse -- nobody wins in that event. But I thought one of the fundamental tenets of capitalism was a direct relationship between risk and reward. The Masters of the Universe who created this mess ought to share the pain of cleaning it up.

Washington Post    September 23, 2008

Currency's Dive Points to Further Pain
By Anthony Faiola, Peter Whoriskey and Renae Merle

The dollar took its steepest one-day drop in years as the financial crisis eroded the nation's basic measure of value, helping to drive U.S. stocks sharply lower and the dollar-based prices of oil and gold sharply higher.

The convergence of negative sentiment came as investors focused on the uncertainties in the Bush administration's emergency plan for a massive bailout of the financial system, outlined this weekend. Indications yesterday that the administration would need more time to iron out a compromise with Congress raised questions about what the plan will ultimately look like, even as investors tried to assess how and whether it would work.

New concerns also emerged over the toll the crisis will take on the U.S. economy, with many analysts saying the slowdown could worsen, perhaps costing more jobs and hurting consumers.

The government's plan to spend up to $700 billion to take troubled assets off the books of ailing firms and billions more to guarantee money-market mutual funds will force the Treasury to add to the already massive national debt. It may have to raise that money by selling more Treasury bills and perhaps even printing more dollars. That, economists said, could trigger higher inflation and drag down the economy further.

The dollar yesterday plunged 2.2 percent against the euro -- its biggest one-day fall since January 2001. Some analysts predicted that if the dollar continues its dramatic tumble, the Bush administration would seek the assistance of foreign central banks to prop it up.

The steep drop was partly behind Monday's surge in the price of oil -- denominated in the U.S. currency -- its biggest one-day jump ever in dollar terms. The price of the benchmark crude oil catapulted to $120.92 a barrel on the New York Mercantile Exchange, a $16.37 increase. At one point, the price was up $25.55.

"This is a revaluation of the U.S.," said C. Fred Bergsten, director of the Peterson Institute for International Economics and a top Treasury Department official during the Carter administration. "Growth is going to be slower, the budget deficit higher, but mostly, the whole U.S. financial system has been thrown into question. People around the world are looking at this and saying, 'Holy Toledo.' "

The realization that the United States may find itself in worsening financial straits with or without a bailout sparked a sell-off on Wall Street. The Dow Jones industrial average fell 372.75 points, or 3.27 percent, to close at 11,016. That wiped away Friday's nearly 400-point rally that accompanied the initial unveiling of the Bush administration plan. The technology-heavy Nasdaq composite index fell 94.92, or 4.2 percent, to close at 2179. The Standard and Poor's 500-stock index was down 47.99, or 3.8 percent, to close at 1207.

The size of the bailout, analysts said, has focused attention on just how much debt the United States can handle without being forced to raise taxes or make sharp cutbacks in government spending. Peter Schiff, president of Euro Pacific Capital, said the fear of inflation provoked by the $700 billion plan -- without figuring out a way to pay for it -- was behind the market's dramatic movement.

"Where's the tax increase to fund this bailout? Where is the cut in programs? The government's not doing either -- they're just going to print money," he said. "And if you think inflation is the answer, take a trip to Zimbabwe and see how it's working for them."

He added that the new rules imposed on short selling, short-term bets that a stock's price will go down, caused a flow of money into commodities besides oil, including gold. "You can't short stocks anymore, right? So if you want to bet against the market, you need to buy commodities: gold, oil," he said.

As the market gyrations left many investors wondering what would happen next, major credit-rating agencies issued statements rejecting the notion that the AAA rating of the U.S. government might be immediate danger. Yet analysts acknowledged it was a valid question.

"This is arguably a critical question given that the U.S. Treasury's Aaa rating acts as the cornerstone of risk pricing in the global financial system," said Pierre Cailleteau, managing director of the sovereign risk unit at Moody's Investors Service and author of a report issued yesterday on the U.S. credit rating.

A loss of that status would probably mean that the United States would have to pay more to those investors, including foreign governments, that hold U.S. bonds. But the report said, "Moody's continues to view the foundations of the U.S. government rating as unshaken."

Similarly, John Chambers, a managing director at Standard and Poor's, said he viewed the United States as stable. Although some have drawn parallels between the current financial woes and those in Japan, which lost its AAA credit rating in 2001, Chambers said the United States has far greater ability to meet its obligations.

He noted that before Japan lost its AAA rating, its general government debt was more than 100 percent of its gross domestic product. By contrast, even figuring in "every last nickel" of the proposed U.S. bailouts, general government debt in the United States falls below 60 percent of gross domestic product, he said.

One key question for investors and multilateral lenders is how the U.S. bailout plan will treat foreign investors in troubled mortgage-backed securities. "A substantial amount of these securities are held by non-U.S investors," said John Lipsky, first deputy managing director of the International Monetary Fund. "Obviously, the disposition of the U.S. [toward these investors] will be important to determining future attitudes about investing in the U.S. versus elsewhere."

Foreign governments and multilateral lenders have been offering advice to the U.S. government as it moved in recent weeks to take over some financial institutions while allowing others to fail. The IMF has been subtly calling on the United States to take a broader approach to the financial crisis, and officials there applauded the administration's efforts in recent days to launch a more comprehensive plan to address core issues.

"Obviously, these events have been striking and potentially very troublesome, but the remedial actions being taken, if done right, will help to restore any confidence that might have been lost," Lipsky said.

As investors await final details of the financial rescue plan, some analysts noted that it will not address some of the economy's fundamental weaknesses, including poor housing prices and growing unemployment figures.

"With talk of the government buying assets at steep discounts and of an emphasis on taxpayer protection, the benefits to bank and thrift capital levels may be less than the market anticipates," Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey, said in a research note yesterday. "At this point, we just do not know. While the plan will most likely help, banks and thrifts still need to raise capital."

It is also unclear whether the $700 billion will be enough. Will banks be forced to open their books to their public, and how will their bad debt be evaluated? "It's not clear who is going to be allowed to participate," said Joseph Brusuelas, chief U.S. economist at Merk Investments. "How much will each individual bank be allowed to dump on the public?"

Washington Post    September 23, 2008

Countdown to a Meltdown
Congress has to act quickly but carefully to get financial rescue legislation right.

LAST THURSDAY, the top economic policymakers in the United States told congressional leaders that the financial system was only days away from a catastrophic failure -- and that the only hope was an immediate, massive government bailout. Congress agreed in principle, buoying financial markets. But five days later, the specifics of the rescue legislation remain undecided. Two of yesterday's market events -- a 372-point drop in the Dow Jones industrial average and a $16-per-barrel jump in the price of oil -- show just how rapidly the clock is ticking.

Congress and the Bush administration generally agree that the government should buy up the toxic mortgage-backed securities that are spreading losses and destroying the confidence essential for debtors and creditors to function. This taxpayer-funded bailout is not necessarily the only conceivable approach or even the most efficient one. Quite possibly, it would have been wiser instead to inject government capital directly into banks so they would be better able to work out problem assets on their own. But for better or worse, that option is off the table, and the question is how Uncle Sam can most effectively take on as much as $700 billion worth of bad debt. The basic tradeoff here is between speed and flexibility on one hand and oversight and accountability on the other.

Treasury Secretary Henry M. Paulson Jr. clearly believes that the way to get the maximum number of financial institutions to unload as much distressed paper as possible, as quickly as possible, is to keep it simple: announce that the U.S. Treasury is open for business and let the fire sale begin. That is essentially what he advocated when he asked Congress for the power to purchase troubled mortgage-backed assets from financial institutions at whatever price he and hired experts saw fit, with only minimal congressional supervision and complete immunity from lawsuits.

The problem, of course, is that this raises the risk that the government will get fleeced by the debt-sellers, raising the ultimate cost to taxpayers. It was also politically unrealistic, in that members of Congress were quite properly concerned that financial institutions accept limits on executive compensation in return for their federal lifeline. There was no provision in Mr. Paulson's proposal for taxpayers to enjoy any of the profits that financial institutions may enjoy once they have been restored to health. A new proposal by Senate Democrats seeks to correct this by requiring would-be asset-dumpers to give the government equity if Uncle Sam winds up having to sell the paper at a loss. Of course, at the margin, the proposal could deter some firms from ridding themselves of the bad loans in the first place. And that would slow the process. Democrats are also insisting on various forms of mortgage relief for the homeowners who are about to find themselves in debt to Uncle Sam. Mortgage relief might help stabilize home prices, but since the government would now own so many mortgages, taxpayers (most of whose mortgages are not in trouble) would have to foot the bill once again.

A little delay was both inevitable and desirable. Congress cannot write a $700 billion check with no questions asked. But speed and focus are still of the essence, and leaders in both parties must not use this crisis as an opportunity to refight all the political battles of the past year. They should treat it as what it is: a chance, possibly the last chance, to keep the U.S. financial system from collapsing.

September 23, 2008

Experts See a Need for Punitive Action in Bailout

As economists puzzle over the proposed details of what may be the biggest financial bailout in American history, the initial skepticism that greeted its unveiling has only deepened.

Some are horrified at the prospect of putting $700 billion in public money on the line. Others are outraged that Wall Street, home of the eight-figure salary, may get rescued from the consequences of its real estate bender, even as working families give up their houses to foreclosure.

Most economists accept that the nation’s financial crisis — the worst since the Great Depression — has reached such perilous proportions that an expensive intervention is required. But considerable disagreement centers on how to go about it. The Treasury’s proposal for a bailout, now being negotiated with Congress, is being challenged as fundamentally deficient.

“At first it was, ‘thank goodness the cavalry is coming,’ but what exactly is the cavalry going to do?” asked Douglas W. Elmendorf, a former Treasury and Federal Reserve Board economist, and now a fellow at the Brookings Institution in Washington. “What I worry about is that the Treasury has acted very quickly, without having the time to solicit enough opinions.”

The common denominator to many reactions is a visceral discomfort with giving Treasury Secretary Henry Paulson Jr. — himself a product of Wall Street — carte blanche to relieve major financial institutions of bad loans choking their balance sheets, all on the taxpayer’s bill.

There are substantive reasons for this discomfort, not least concerns that Mr. Paulson will pay too much, thus subsidizing giant financial institutions. Many economists argue that taxpayers ought to get more than avoidance of the apocalypse for their dollars: they ought to get an ownership stake in the companies on the receiving end.

But an underlying source of doubt about the bailout stems from who is asking for it. The rescue is being sold as a must-have emergency measure by an administration with a controversial record when it comes to asking Congress for special authority in time of duress.

“This administration is asking for a $700 billion blank check to be put in the hands of Henry Paulson, a guy who totally missed this, and has been wrong about almost everything,” said Dean Baker, co-director of the liberal Center for Economic and Policy Research in Washington. “It’s almost amazing they can do this with a straight face. There is clearly skepticism and anger at the idea that we’d give this money to these guys, no questions asked.”

Mr. Paulson has argued that the powers he seeks are necessary to chase away the wolf howling at the door: a potentially swift shredding of the American financial system. That would be catastrophic for everyone, he argues, not only banks, but also ordinary Americans who depend on their finances to buy homes and cars, and to pay for college.

Some are suspicious of Mr. Paulson’s characterizations, finding in his warnings and demands for extraordinary powers a parallel with the way the Bush administration gained authority for the war in Iraq. Then, the White House suggested that mushroom clouds could accompany Congress’s failure to act. This time, it is financial Armageddon supposedly on the doorstep.

“This is scare tactics to try to do something that’s in the private but not the public interest,” said Allan Meltzer, a former economic adviser to President Reagan, and an expert on monetary policy at the Carnegie Mellon Tepper School of Business. “It’s terrible.”

In part, Mr. Paulson’s credibility has been dented by his pronouncements in previous weeks that the crisis was already contained. Some suggest this was a well-intentioned effort to stem panic. But the aftermath complicates his quest for the bailout.

“If you view your public statements as an instrument of policy, people don’t believe you anymore,” said Vincent R. Reinhart, a former Federal Reserve economist and now a scholar at the conservative American Enterprise Institute.

The biggest point of contention is over whether and how taxpayers would benefit if the bailout succeeded in righting the financial system, sending banking stocks upward.

In Mr. Paulson’s plan, the Treasury would have the right to buy as much as $700 billion worth of troubled investments, with the taxpayer recouping the proceeds when those investments were sold over coming years. But many economists — Mr. Elmendorf among them — argue that taxpayers should get more out of the deal, securing stock in the banks that make use of the bailout. The government could then sell off that stock at a profit when conditions improve. A similar approach was used successfully in Sweden in the early 1990s when its financial system melted down.

Others argue that any bailout must pinch the people who have run the companies now needing rescue, along with their shareholders, addressing the unseemly reality that executives have amassed beach houses and fat bank accounts while taxpayers are now stuck with the bill for their reckless ways.

“It absolutely has to be punitive,” Mr. Baker said. “If they sell us the junk, then we own the company. This isn’t a way to make these companies and their executives rich. This should be about keeping them in business so the financial system doesn’t collapse.”

Other questions center on how to value what the Treasury aims to purchase — an issue that goes to the heart of the crisis itself.

The financial system got to its dangerous perch by betting extravagantly on real estate. When housing prices began plummeting and borrowers stopped making payments, financial institutions found themselves with huge inventories of bad loans. Not simple loans, but complex investments created by pooling millions of mortgages together and then slicing them into pieces. These were the investments that Wall Street bought, sold and borrowed against in cooking up the money it poured into housing.

The trouble is that these investments are so intertwined and complex that no one seems able to figure out what they are worth. So no one has been willing to buy them. This is why banks have been in lockdown mode: with mystery enshrouding both the value of their assets and their future losses, banks have held tight to their remaining dollars, depriving the economy of capital.

Now, the Treasury aims to clear the fog by buying up these investments. But their value is as mysterious as ever.

“There’s a tendency for people to think these are stocks and bonds and you know what the price is,” said Bruce Bartlett, a former White House economist under President Reagan. “The problem is people are operating in a world in which nobody knows what the hell is going on. There’s some naïve assumptions about how this would function.”

If Mr. Paulson pays the market rate — whatever that is — that presumably would not be enough to persuade banks to sell. Otherwise, they would have sold already. For the plan to work, Treasury has to pay a premium.

“It’s a straight subsidy to financial institutions,” said Martin Baily, a former chairman of the Council of Economic Advisers in the Clinton administration, and now a senior fellow at the Brookings Institution. “You’re essentially giving them money.”

Mr. Baily favors the basics of the Paulson plan, albeit with some mechanism that would give the government a slice of any resulting profits. And yet he remains troubled by the dearth of information combined with the abundance of zeroes in the bailout request.

“I’d like a clearer statement of what we were afraid was going to happen that requires $700 billion,” Mr. Baily said. “Maybe they don’t want to talk about it because it would scare everybody, but it’s a bit much to ask.”

The Guardian    September 23 2008

Darling tells regulator to curb City's bonus culture
Firms rewarding excessive risk-taking may be ordered to put aside more capital
Jill Treanor, Andrew Clark in New York

Big City firms which encourage traders to take too many risks to win their annual multimillion pound bonuses could face stiff penalties from the Financial Services Authority.

The City regulator could demand financial firms put aside a bigger capital cushion if their pay schemes incentivise traders to take short-term risks that could backfire in the longer term.

Bonuses are paid annually, sometimes before it is clear whether traders' bets have paid off or proved disastrous. Trading losses have contributed to the demise of leading firms such as Lehman Brothers, mired in controversy as its Wall Street staff seem likely to receive their bonuses after being taking over by Barclays.

Chancellor Alistair Darling yesterday put the onus on the FSA to tackle "the culture of huge bonuses" in the City.

"It's essential that bonuses don't result in people being encouraged to take on more and more risk without understanding the damage that might be done, not just to their bank but to the rest of us in the wider economy," Darling told the Labour conference.

The authority has begun scrutinising bonus policies during its regulatory visits. But the unions yesterday called on the chancellor to take direct action through taxation. Derek Simpson, leader of Unite, spoke of a "powerful mega elite with no connection to ordinary people, an amoral class without a care for how their reckless behaviour is now wrecking lives. If you can't regulate the bonus culture, then tax it out of existence."

The FSA does not intend to regulate individual bonuses, but pay deals will be analysed as part of the risk assessments of firms it regulates. A spokeswomen said: "What might happen if we don't like [what we find]? If we believe the pay deal creates additional risks, we could make a requirement to put more capital aside."

Hector Sants, the FSA's chief executive, has been warning City firms since the spring that the regulator is playing close attention to the way they pay their staff.

But Peter Hahn, banking specialist at the Cass business school, warned against scrutiny of the bonus pool, and instead urged the FSA to focus on senior executives. "If the top five people are paid the right way, so will the rest of the organisation. If the chief executive isn't incentivised for traders to take risk, the traders won't take risks," said Hahn.

In the US, the debate is also raging. John McCain has unexpectedly backed calls by Democrats for a cap on executive pay at struggling banks. Citing large salaries at Lehman as an example of unacceptable conduct, he suggested institutions benefiting from a bail-out by taxpayers should have their salaries capped at $400,000.

"No CEO of any corporation or business that is bailed out by us, that is rescued by American tax dollars, should receive any more than the highest-paid person in the federal government," the Republican presidential candidate told CNBC. The highest paid individual in the US government is George Bush, who earns $400,000.

The Democrats are fighting to insert a pay cap in legislation for the treasury's $700bn fund to buy up banks' distressed securities. They argue that huge pay linked to profits created perverse incentives for bankers to take bigger short-term risks.

But treasury secretary Hank Paulson is resisting these efforts, seeing them as a sideshow which could delay the bill.

"There have been excesses. I agree with the American people - pay should be for performance, not for failure," said Paulson; but the bail-out urgently needed to be passed in simple form and remuneration reforms should come "afterwards".

AIG boss forgoes payoff
Robert Willumstad, the outgoing head of the stricken insurance company AIG, has voluntarily forfeited a $22m (£12m) severance package after being in effect sacked from his job as part of a bail-out by the US treasury. AIG's board decided that he was entitled to the money under his contract, which was drafted in generous terms just three months ago. But in an email to his successor, Edward Liddy, he wrote: "I prefer not to receive severance while shareholders and employees have lost considerable value in their AIG shares." AIG was kept afloat last week through an $85bn US treasury loan; the government will take an 80% stake in AIG in return.

September 24, 2008

Congress wants Wall Street to feel it where it hurts: the wallet.
In Bailout Furor, Wall Street Pay Becomes a Target

The stratospheric pay packages of Wall Street executives have become a lightning rod issue as Congress shapes a $700 billion bailout for financial firms. Proposals circulating on Capitol Hill vary, but they all would impose some limits or approval authority on salaries of executives whose firms seek help.

The moves in Washington mirror the popular outcry — in constituent e-mail messages and postings in the blogosphere — over the prospect of Wall Street’s tarnished titans walking away with tens of millions of dollars a year while taxpayers pick up the bill.

But Wall Street, its lobbyists and trade groups are waging a feverish lobbying campaign to try to fight compensation curbs. Pay restrictions, they say, would sap incentives to hard work and innovation, and hurt the financial sector and the American economy.

“We support the bill, but we are opposed to provisions on executive pay,” said Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, a trade group. “It is not appropriate for government to be setting the salaries of executives.”

Yet some formal restraint on executive pay seems unavoidable, even sensible, some finance experts and economists said.

Arthur Levitt Jr., a former Wall Street executive as well as a former chairman of the Securities and Exchange Commission, said pay curbs on executives whose firms take part in the bailout were essential for Congressional approval and were reasonable.

The finance industry, Mr. Levitt added, will continue to offer handsome salaries for the successful, though not as high as in the boom years. “The golden egg has disappeared,” he said.

Scott A. Shay, chairman of Signature Bank, which holds no high-risk securities, called a limit on executive pay for firms participating in the bailout only fair.

“If that doesn’t happen, you are effectively advantaging the institutions that made those risky bets at taxpayers’ cost,” Mr. Shay said. “What sense does that make?”

Across the Atlantic, there is also an appetite for stepping into pay practices in the finance industry. This week, Prime Minister Gordon Brown of Britain called “unacceptable” the practice of linking bonus payments to high-risk investments that delivered hefty profits in the short term.

His Treasury minister, Alistair Darling, echoed that view by saying that Britain’s main regulator, the Financial Service Authority, should take a hard look at regulating pay.

Angry sentiments on the issue in Congress were palpable on Tuesday, when Treasury Secretary Henry M. Paulson Jr. and Ben S. Bernanke, the Federal Reserve chairman, testified before the Senate banking committee.

Senator Christopher J. Dodd, chairman of the committee, said the “authors of this calamity” should not walk away enriched.

The presidential candidates, Senators Barack Obama and John McCain, have also called for pay limits.

The proposals in Washington are still tentative, and often vague. A Senate draft document calls for a ban on incentive payments that the Treasury deems “inappropriate or excessive” and a “claw-back” provision, requiring executives to give up pay or severance benefits if the firm’s financial results are later shown to be overstated.

Other proposals call for a ban on severance payments and allowing large shareholders, with a stake of 3 percent or more, to propose alternative slates of directors. This would be an effort to tackle excessive pay practices by opening up and strengthening corporate governance.

Some corporate governance experts say hastily devised compensation curbs in the bailout package would be a mistake and perhaps open the door to unintended consequences.

“Clearly, the level of pay at some of the Wall Street firms was appalling, given the performance,” said Charles M. Elson, a corporate governance expert at the University of Delaware. “But the bailout is about saving the economy, while executive pay is a separate, and complex, issue.”

In 1993, Mr. Elson noted, Congress limited the tax deductibility of executive salaries to $1 million, unless it could be demonstrated that the extra pay was linked to performance incentives. That move, he said, contributed to the practice in later years of very generous grants of stock options, which helped drive executive pay to new heights.

In 2007, the total compensation of chief executives in large American corporations was 275 times that of the salary of the average worker, the Economic Policy Institute, a liberal research organization, estimates. In the late 1970s, chief executive pay was 35 times that of the average American worker.

Wall Street has been the top tier of the corporate pay range, with executives earning eight-figure salaries. Its bonus system, which rewards short-term trading profits, has been singled out as an incentive for Wall Street executives to expand their highly profitable business in exotic securities and ignore the risks.

“This financial crisis is a direct result of the compensation practices at these Wall Street firms,” said Paul Hodgson, a senior analyst at the Corporate Library, a governance research group.

One possible answer, compensation analysts and economists say, would be to stretch out payments for several years, encouraging executives to pursue the long-term health and stability of the firms they head.

“I’m of a free-market, conservative bent, but I am sympathetic to some reshaping of executive pay on Wall Street,” said Kenneth S. Rogoff, a professor of economics at Harvard. “For sure, I would consider very long-term payouts, up to 10 years out.”

Whether Congress acts on executive pay or not, Wall Street pay levels are destined to come under pressure, said Michael Karp, chief executive of the Options Group, an executive search firm. The fallout from the financial crisis and the consolidation in the industry, he said, inevitably mean that more people will be competing for fewer jobs, dragging down salaries.

“Of course, superstars will always get paid,” Mr. Karp said. “But they won’t be the way they used to be.”

Eric Dash, Landon Thomas Jr., Leslie Wayne and Ben White contributed reporting.

Washington Post    September 24, 2008

The Words Left Unspoken in the Bailout Debate
By Steven Pearlstein

In all that's been said in recent days about the latest proposals to rescue the financial system, two words have been conspicuously absent. They are the words that Americans need to hear before they commit $2,300 for every man, woman and child to rescue the financial system. They are the words we need to hear before taxpayers are put in the position of rescuing arrogant and overpaid financiers from the full consequences of their bad bets and misguided decisions.

Most of all, they are the words that elected senators and representatives need to hear before they entrust the secretary of the Treasury with extraordinary power and discretion to spend public money and actively manage the markets and the economy:

"We're sorry." As in, "We're sorry that those of us who were supposed to be stewards of the world's deepest and most trusted capital markets have violated that trust by putting our own interests ahead of those of our customers and the country."

We've now entered the political phase of this financial crisis, in which the outcome will be determined not by the fear and greed of investors but by the hopes and anxieties of the voters. Their decision won't be based on some collective assessment of the efficacy of reverse auctions in the price discovery process, or whether it is better to prop up the market for mortgage-backed securities or inject fresh capital into the banks that are holding them.

Their decision -- our decision -- will come down to a much simpler question: We've got one last chance to fix this thing. Are we willing to put our fate once again in the hands of financiers who have already abused our trust?

And that's where the two magic words come in. In Japan, great ritual accompanies such apologies, which are viewed as the first step in fixing a problem and restoring frayed relations. Here, by contrast, corporate apologies are viewed as unnecessary concessions to business and political adversaries and dangerous ammunition in the hands of prosecutors and plaintiffs lawyers.

You'll have to take it from me that it's probably not a good idea to put in legislation a requirement that any financial institution that wants to participate in the rescue program has to cap executive compensation at $400,000 a year -- the same as the president -- and eliminate all severance pay from executive contracts.

On the other hand, it would certainly capture people's attention if the heads of Citigroup, Goldman Sachs, Bank of America and Morgan Stanley were to stand before the cameras in the Capitol rotunda, apologize for letting down their investors and their employees and voluntarily offer to suspend their extravagant compensation schemes until the crisis has passed and new regulations are in place.

Because all financial institutions will benefit from a federal program to jump-start the markets in asset-backed securities, whether they participate in the program or not, it is hard to figure out which companies should be required to give taxpayers some of the "up side" if and when the markets recover.

But it would surely make it easier for members of Congress to defend this program to their angry constituents if the industry could express its appreciation for the government's extraordinary effort by voluntarily offering the Treasury an option to buy 5 percent of each company's stock at today's depressed prices at some time in the future.

Some Democrats are demanding that the bailout plan have a provision allowing any homeowner facing foreclosure to file for bankruptcy and get a bankruptcy judge to reduce the mortgage to whatever she can afford. Again, another bad idea. But what's to prevent the industry from agreeing to engage in a mediated workout process with any borrower facing foreclosure?

These are the kinds of things that responsible, honorable people do when they screw up and are forced to ask their neighbors for help. They don't point the finger at greedy short-sellers and misguided regulators for the disaster that occurred on their watch. They don't hire lobbyists to see how they can tweak the bailout to be even sweeter for them than it already is. And they certainly don't threaten to bring on financial Armageddon if people refuse to help them out.

What responsible, honorable people do is apologize for their mistakes, promise that it won't happen again and vow that they'll make it up to us once the crisis has passed. But in the past year, we've not heard any of that from the titans of Wall Street.

Political systems, communities, markets all share one common characteristic -- at their core, they all require a level of trust among the participants if they are going to work. In recent years, we have allowed that trust to erode to the point that our political system is paralyzed by partisan bickering and communities are fractured into enclaves of race and class. Now markets are collapsing because investors realize they have been misled by corporate executives, investment banks, ratings agencies and regulators.

As a country, there is an urgent need to rebuild that trust. In different ways, that is what both the McCain and Obama campaigns are all about. And it is the same challenge that now faces us in this financial crisis. At some level, we all know that we've driven the economy and the financial system into a ditch and that we're going to have to spend some money to get out of it. But until Wall Street can muster the decency, the humility and the good sense to acknowledge its colossal screw-up, it shouldn't be surprising that Americans are balking at writing the check.

Steven Pearlstein will host a Web discussion at 11 a.m. today at He can be reached

Washington Post    September 24, 2008

Bailout Proposal Meets Bipartisan Outrage
Lawmakers Balk as Officials Press Case For Quick Action
By Lori Montgomery, Paul Kane and Neil Irwin

The Bush administration sent some of its most powerful figures to Capitol Hill yesterday to rally support for a $700 billion plan to revive the U.S. financial system, but they encountered stiff resistance from lawmakers who are deeply skeptical of the proposal and angered by the administration's push for its speedy approval.

Vice President Cheney, White House Chief of Staff Joshua B. Bolten and other Bush advisers shuttled from meeting to meeting, selling privately to worried lawmakers what Treasury Secretary Henry M. Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke pitched publicly at a Senate hearing: a massive bailout for the financial markets. They urged Congress to authorize the plan quickly and without many alterations.

The issue transcended party lines. Democrats voiced doubts, and many Republicans, particularly in the House, balked at the entreaties from Cheney, Bolten and other officials.

"Just because God created the world in seven days doesn't mean we have to pass this bill in seven days," Rep. Joe Barton (R-Tex.) said after exiting a two-hour meeting with Cheney.

Democratic leaders warned that they would not approve the biggest government intervention in the private markets since the Great Depression without significant Republican support.

"It's their problem. It's their bill. And they're going to have to figure out if they can support it," said House Speaker Nancy Pelosi (D-Calif.).

Paulson and Bernanke, meanwhile, defended themselves before the Senate Banking, Housing and Urban Affairs Committee, where senators fumed that the administration had abetted the meltdown in the markets by failing to halt the spread of exotic home loans that are now falling into foreclosure at a record pace. A wide array of firms bought complicated financial instruments backed by those mortgages; the administration is proposing to purchase those troubled assets to help those firms stay afloat.

At times yesterday, Paulson and Bernanke almost seemed to echo the outrage from their questioners.

"I'm not only concerned, I'm angry about the things that got us here," Paulson said. "It makes me angry, and it makes you angry. You talk about taxpayers being on the hook? Guess what? They're already on the hook. If the system isn't stabilized, they're going to bear the cost."

The vice president got a warmer reception during a luncheon with Senate Republicans. But afterward, key GOP senators announced that they now agree with Democratic demands that the bailout package set limits on executive salaries at financial institutions that participate in the program. Democrats have argued that chief executives whose companies accept taxpayer money should not be permitted to pocket millions of dollars in bonuses or big severance packages known as "golden parachutes."

Paulson and the White House have objected to limits on executive compensation, saying limits would discourage successful firms from participating in the bailout. "These are not all weak or troubled firms that own mortgage-backed securities," said White House spokesman Tony Fratto. "They were not necessarily irresponsible players, and so you have to be careful about how you deal with them."

But Republican senators, many of whom face voters in six weeks, have concluded otherwise. "I think executive compensation ought to be part of this," Senate Minority Leader Mitch McConnell (R-Ky.) told reporters. "I think the taxpayers should expect no less than strict limits on what kind of executive compensation might be possible for those involved in these partially government-controlled enterprises."

With McConnell's announcement, the broad outlines of a consensus on the bailout plan appeared to be taking shape. Rep. Barney Frank (D-Mass.), who is leading negotiations with Paulson, said Treasury officials have agreed to accept key changes to their proposal, including an oversight board to monitor the program. Treasury is also discussing provisions to help distressed borrowers avoid foreclosure and to guarantee taxpayers an equity stake in companies that take advantage of the plan.

The remaining sticking points in talks with the Treasury, Frank said, are whether to limit executive pay and whether bankruptcy judges should be given authority to modify mortgages on primary residences. But the bankruptcy provision, which is fiercely opposed by the banking industry and many Republicans, is widely viewed as a bargaining chip. And if Republican lawmakers accept limits on executive pay, the White House may find it difficult to resist.

Frank yesterday floated another approach to executive pay, one that would require firms that take taxpayer money to permit shareholders to nominate members to their boards. Some Republicans have complained that corporate boards, not the government, should decide issues of executive pay.

Frank shot down as "highly unlikely" a separate idea, gaining traction among some lawmakers, that calls for limiting the initial size of the program and releasing the full $700 billion later if early efforts prove effective.

"We're moving forward," Pelosi said. "I think we are making some progress."

But Democratic leaders, who said they hope to approve the bailout plan by the end of the week, were having their own trouble rallying the rank and file. House Democrats summoned to a lunchtime meeting to discuss the proposal yesterday received a glossary of financial terms, such as "credit default swap" and "illiquid assets." Many nonetheless emerged unconvinced of the need for speed, comparing the administration's warnings that the economy will collapse unless Congress acts to warnings they received regarding the invasion of Iraq.

"Where have I heard this before? 'The Iraqis have weapons of mass destruction, and they're ready to use them,' " said Rep. Gene Taylor (D-Miss.). "I'm in no rush to do this."

Lawmakers from both ends of the Capitol, in both parties, said the White House needs to make a stronger public pitch for the bailout. Congress had planned to adjourn Friday for an election season in which dozens of House and Senate incumbents are feeling political heat back home. Bush, who spent his first five years in office overpowering Congress in a variety of high-stakes showdowns, is an unpopular figure, even among many Republicans. Meanwhile, Paulson is asking lawmakers to approve the largest bailout in the nation's history even though he won't be around to monitor the success or failure of the program.

"You've got the succession question. What happens in the next administration?" said Sen. John Thune (R-S.D.), warning that the plan is being pushed "in the fog of an election."

At the Senate hearing, Paulson and Bernanke were met with a nearly universal tone of disgust. Many senators expressed concern that the proposal is moving ahead without more deliberate consideration and that it could amount to a giant bailout of the very companies whose risky investments have upended the financial system.

"While Wall Street banks get to sell their bad investments to the Treasury Department, homeowners will still be saddled with mortgages they cannot afford," said Sen. Richard C. Shelby (Ala.), the banking committee's ranking Republican.

Those complaining did not say they would vote against the bailout plan and instead argued for changes to the administration's proposal. Paulson and Bernanke expressed openness to those suggestions, acknowledging that the program needs to have strong oversight and provisions to protect taxpayers.

Both men also stressed that they are still working through details of how the government would price the troubled mortgage assets it buys under the $700 billion plan. They asked Congress to give them maximum flexibility to design auctions or other procedures. Bernanke said he had heard from all sorts of experts on designing auctions, which are one way the purchases might be structured, and that it will take time to figure out how exactly to execute them.

At one point during yesterday's Senate hearing, the Fed chairman tossed aside his prepared testimony -- and the reserved language he usually uses in such formal settings -- to strongly argue that the consequences of inaction could be dire.

"I'm a college professor. I never worked in Wall Street," he said. "My interest is solely for the strength and the recovery of the U.S. economy. I believe if the credit markets are not functioning, that jobs will be lost; the unemployment rate will rise; more houses will be foreclosed upon; GDP will contract; that the economy will just not be able to recover in a normal, healthy way, no matter what other policies are taken."    24 September 2008

Bringing Down Wall Street as Ratings Let Loose Subprime Scourge
By Elliot Blair Smith

Sept. 24 (Bloomberg) -- Frank Raiter says his former employer, Standard & Poor's, placed a ``For Sale'' sign on its reputation on March 20, 2001. That day, a member of an S&P executive committee ordered him, the company's top mortgage official, to grade a real  estate investment he'd never reviewed.

S&P was competing for fees on a $484 million deal called Pinstripe I CDO Ltd., Raiter says. Pinstripe was one of the new structured-finance products driving Wall Street's growth. It would buy mortgage securities that only an S&P competitor had analyzed; piggybacking  on the rating violated company policy, according to internal e-mails reviewed by Bloomberg.

``I refused to go along with some of this stuff, and how they got around it, I don't know,'' says Raiter, 61, a former S&P managing director whose business unit rated 85 percent of all residential mortgage deals at the time. ``They thought they had discovered a machine for  making money that would spread the risks so far that nobody would ever get hurt.''

Relying on a competitor's analysis was one of a series of shortcuts that undermined credit grades issued by S&P and rival Moody's Corp., according to Raiter. Flawed AAA ratings on mortgage-backed securities that turned to junk now lie at the root of the world financial  system's biggest crisis since the Great Depression, according to Raiter and more than 50 former ratings professionals, investment bankers, academics and consultants.

``I view the ratings agencies as one of the key culprits,'' says Joseph Stiglitz, 65, the Nobel laureate economist at Columbia University in New York. ``They were the party that performed that alchemy that converted the securities from F- rated to A-rated. The banks could  not have done what they did without the complicity of the ratings agencies.''

Gold Standard

Driven by competition for fees and market share, the New York-based companies stamped out top ratings on debt pools that included $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes between 2002 and 2007. As subprime borrowers  defaulted, the companies have downgraded more than three-quarters of the structured investment pools known as collateralized debt obligations issued in the last two years and rated AAA.

Without those AAA ratings, the gold standard for debt, banks, insurance companies and pension funds wouldn't have bought the products. Bank writedowns and losses on the investments totaling $523.3 billion led to the collapse or disappearance of Bear Stearns Cos.,  Lehman Brothers Holdings Inc. and Merrill Lynch & Co. and compelled the Bush administration to propose buying $700 billion of bad debt from distressed financial institutions.

McCain, Obama

``This is appalling,'' says Douglas Holtz-Eakin, the former director of the Congressional Budget Office from 2003 to 2005 who is now a senior policy adviser to the presidential campaign of Republican Senator John McCain. ``It is exactly the kind of behavior that has so  badly hurt the financial markets.''

Senator Barack Obama, the Democratic nominee, said in a Sept. 15 interview, ``There's a lot of work that has to be done in examining the degree to which ratings agencies were involved in making some of this debt -- some of the leverage taken on -- look like it was  much safer and less risky than it was.''

S&P, a unit of McGraw-Hill Cos., and Moody's substituted theoretical mathematic assumptions for the experience and judgment of their own analysts. Regulators found that Moody's and S&P also didn't have enough people and didn't adequately monitor the thousands of  fixed-income securities they were grading AAA.

Raiter and his counterpart at Moody's, Mark Adelson, say they waged a losing fight for credit reviews that focused on a borrower's ability to pay and the value of the underlying collateral. That was the custom of community bankers who extended credit only as far as they  could see from their front porch.

`Didn't Want to Know'

``The part that became the most aggravating -- personally irritating -- is that CDO guys everywhere didn't want to know fundamental credit analysis; they didn't want to know from being in touch with the underlying asset,'' says Adelson, 48, who quit Moody's in January  2001 after being reassigned out of the residential mortgage-backed securities business. ``There is no substitute for fundamental credit analysis.''

S&P hired him in May 2008 as chief credit officer, responsible for setting the company's ratings criteria as part of a broader management shakeup. Raiter served on the S&P structured-finance group's executive rating committee until 2000, when he says he was demoted  for his clashes with his bosses. The former Marine and community banker retired in March 2005, when he became eligible for company-paid medical benefits.

Beating Exxon's Margin

The rating companies earned as much as three times more for grading complex structured finance products, such as CDOs, as they did from corporate bonds. Through 2007, they had record revenue, profits and share prices. Moody's operating margins exceeded 50  percent for the past six years, three to four times those of Exxon Mobil Corp., the world's biggest oil company.

By 2000, structured finance was the companies' leading source of revenue, their financial reports show. It accounted for just under half of Moody's total ratings revenue in 2007.

While prospectuses don't disclose fees, Moody's says it charged as much as 11 basis points for structured products, compared with 4.25 basis points for corporate debt. A basis point is a hundredth of a percent. S&P says its fees were comparable. A typical CDO paid 6 to  8 basis points, according to Richard Gugliada, 46, S&P's global ratings chief for CDOs until 2005. That would make rating the Pinstripe deal worth $300,000 or more.

Toughening Criteria

Now facing the threat of lawsuits and tighter regulation, Moody's and S&P say they are adopting tougher criteria to more accurately evaluate and monitor the debt. In January, S&P reassigned Joanne Rose, 51, its top structured-finance ratings executive since 1999, to a  new position as executive managing director for risk and quality policy. In May, Brian Clarkson, 52, resigned as president of Moody's Investors Service. He was the company's top structured-finance executive for most of this decade.

``Independence, integrity and quality remain the cornerstones of everything we do and everything we stand for,'' S&P Vice President of Communications Chris Atkins said last week in a written response to Bloomberg questions. ``We have an important role to play in  helping to restore confidence and increase transparency in the credit markets, and we are determined to play a leadership role.''

``We are certainly not going to respond to a disaffected ex-employee's statements,'' Atkins added in an e-mail, without specifying any individual.

Anthony Mirenda, a Moody's spokesman, declined to respond to questions submitted in writing and by phone.

Rise of the Quants

AAA ratings on subprime mortgage investments can be traced to the rise on Wall Street of quantitative analysts, or quants, with advanced degrees in math, physics and statistics. They developed computer-driven models that didn't rely on historical performance data,  according to Raiter and others. If the old rating methods were like Rembrandt's portraiture, with details painted in, the new ones were Monet impressionism, with only a suggestion of the full picture.

S&P and Moody's built their reputations over generations, starting with Henry Varnum Poor's publication in 1860 of ``History of Railroads and Canals in the United States'' and John Moody's ``Moody's Manual of Industrial and Miscellaneous Securities'' in 1900. Since the  Great Depression, U.S. agencies have relied on the companies to help evaluate the credit quality of investments owned by regulated institutions, gradually bestowing on them quasi-regulatory status. Yet as the 21st century began, much of that knowledge became  obsolete.

Moody's Spinoff

Banks were combining thousands of fixed-income assets into custom blends of high-yield bonds, aircraft leases, franchise loans, mutual fund fees and mortgages. These structured investment pools didn't have the performance history that lay behind the corporate bonds.

The spinoff of Moody's by Dun & Bradstreet Corp. in September 2000 changed the service's focus from informing investors to responding to the demands of banking clients and shareholders, say several former Moody's analysts. They requested anonymity because  they signed non-disclosure agreements when leaving or because they now do business with the company.

``Up until that point, there was a significant emphasis on who's got the right criteria,'' says Gugliada, the former S&P global ratings chief for CDOs. He retired in 2006. ``Then Moody's went public. Everybody was looking to pick up every deal that they could.''

Clarkson became Moody's group managing director for structured finance in August 2000, a month before the spinoff. He replaced Adelson and other analysts to make the residential mortgage securities unit more responsive to clients, say several former Moody's  professionals who requested anonymity because of confidentiality agreements.

`Less Collegial'

The executive visited Wall Street banking customers to pledge a closer, more cooperative relationship and asked whether any of his analysts were particularly difficult to work with, former Moody's managers say.

``Things were becoming a lot less collegial and a lot more bottom-line driven,'' says Greg Gupton, senior director of research in Moody's quant group at the time. He is now managing director of quantitative research at New York-based Fitch Solutions, a consulting unit of  Fimalac SA, based in Paris. Fimalac also owns Fitch Ratings, the third-largest bond analysis company.

Clarkson didn't respond to requests for comment in messages on his home answering machine and in a note left on his door in Montclair, New Jersey.

The efforts initially produced results. Moody's share of rating mortgage-backed securities jumped to 78 percent in 2001 from 43 percent a year earlier, according to the industry publication Inside Mortgage Finance in Bethesda, Maryland.

Rating Pinstripe Deal

It was in this environment that the Pinstripe deal landed on Raiter's desk. The underwriters were units of what now are the investment banks Credit Suisse Group AG, based in Zurich, and RBS Greenwich Capital Markets Inc., in Greenwich, Connecticut.

The CDO packaged residential mortgage securities and real estate investment trusts, according to Fitch Ratings, which, unlike S&P, had reviewed the underlying loans, according to Raiter.

``We must produce a credit estimate,'' Gugliada, a member of the structured-finance rating group's executive committee, wrote to Raiter in a March 2001 e-mail. ``It is your responsibility to provide those credit estimates, and your responsibility to devise a method for doing  so. Please provide the credit estimates requested!'' he wrote, signing off with his nickname ``Guido.''

``He was asking me to just guess, put anything down,'' says Raiter, interviewed at his home in rural Virginia, 69 miles (111 kilometers) west of Washington. ``I'm surprised that somebody didn't say, `Richard, don't ever put this crap in writing.'''


Gugliada, like Raiter, now says that he views as flawed many of the ratings S&P and Moody's assigned.

``There was the self-delusion, which hit not just rating agencies but everybody, in the fact that the mortgage market had never, ever, had any problems, and nobody thought it ever would,'' Gugliada says.

Drawing on a competitor's analysis, and assigning a slightly lower rating because of the uncertainty of the judgment, is called ``notching.'' Securities and Exchange Commission Chairman Christopher Cox proposed in June 2008 to prohibit a government-recognized  rating service from issuing a grade unless it has information on the underlying asset.

``Because credit-rating agencies relied on others to verify the quality of the assets underlying the structured products they rated, it is very likely those ratings were often based on incorrect information,'' Cox said in a statement at the time.

Over Raiter's objections, S&P graded 73 percent of the Pinstripe bonds AAA. Managed by New York-based Alliance Capital Management, now AllianceBernstein Holding LP, the CDO paid off investors in November 2004. Other deals wouldn't fare as well.

Not `Straw to Gold'

S&P outlined the alchemy of structured finance in a March 2002 paper for clients entitled ``Global Cash Flow and Synthetic CDO Criteria.'' While arguing that the process wasn't ``turning straw into gold,'' the authors said ``the goal'' was to create a capital structure with a  higher credit rating than the underlying assets would qualify for without financial engineering.

By estimating the percentage of a debt pool that would pay off, the raters could assign AAA grades to the safest portion of the investment and lower marks on the rest. About 85 percent of structured finance CDOs qualified for the top grade, according to Moody's.

The deal sponsors could bolster the structure by buying protection from the two largest bond insurers, New York-based Ambac Financial Group Inc. and MBIA Inc. of Armonk, New York.

Strategos Capital CDOs

This way, subprime mortgages with elevated default risks could be pooled into CDOs with top ratings. As lending standards fell, earlier deals performed better than later ones.

Strategos Capital Management LLC, an affiliate of Philadelphia-based Cohen & Co., which manages more than $30 billion in CDOs and other investments, packaged three Kleros Real Estate CDO Ltd. investments between June and November of 2006.

All three Kleros CDOs defaulted after credit downgrades last year. While Strategos liquidated Kleros III, the most recent of the investment pools, in June, it still manages the two earlier ones for investors.

The annual volume of mortgage securities sold to private investors tripled to $1.2 trillion between 2002 and 2005, according to Inside Mortgage Finance. The subprime portion of the CDOs rose fourfold, to $456.1 billion.

Low interest rates fueled the home-financing boom while investor demand for yields encouraged banks to structure subprime mortgages into higher-paying securities. Between 2001 and 2005, the annual value of asset-backed CDOs surged 11-fold to $104.5 billion, and  then more than doubled to $226.3 billion in 2006, according to the industry newsletter Asset-Backed Alert in Hoboken, New Jersey.

Basic Conflict

Through it all, the rating companies had a basic conflict: They were paid by the businesses whose products they rated. Moody's told the Paris-based Committee of European Securities Regulators in November 2007 -- in the 49th footnote of a 35-page response to its  questionnaire on structured-finance -- that it allowed managers who supervised analysts to ``provide expert input'' on fees ``in a limited range of circumstances.''

SEC Chief Cox said in June that the rating companies engaged in the ``lucrative business of consulting with issuers on exactly how to go about getting'' top ratings.

In a July report that examined the credit rating companies' practices, the SEC said they ``appeared to struggle'' in hiring adequate staff to handle the growth of their business, particularly for evaluating CDOs.

`Spread Very Thin'

The government agency didn't quantify the problem. Moody's annual financial statements show that the company's global employment more than doubled to 3,600 between 2001 and 2007. Its structured-finance revenue more than tripled during that time, peaking at  $885.9 million last year.

``It was very difficult to get people in, train them up sufficiently to really understand this stuff -- from structure to quantitative issues -- and then to keep them, because investment banks were very keen to get good people to help them optimize their trade ideas,'' says Kai  Gilkes, 40, a former S&P quantitative analyst in London who left in April 2006.

``Analysts were getting spread very thin,'' Gilkes says. ``I remember analysts who would keep their phones on voice mail 24 hours a day. They would only check messages and decide who to get back to. It was crazy.''

Some investors became nervous that the rating companies' mathematical models and AAA grades were out of touch with reality.

`Train Wreck Waiting'

``There was no model -- there was nothing -- that could work for modeling interest-only, adjustable, non-payment liar's loans,'' says Stephen Berger, 69, chairman of Odyssey Investment Partners LLC, a New York-based private equity firm.

In California, fixed-income investor Julian Mann feared the worst as subprime lending fanned out across the country.

``We said this is a train wreck waiting to happen,'' says Mann, 49, a vice president of the Los Angeles-based investment management firm First Pacific Advisors LLC.

The 90-day delinquency rate on subprime mortgages rose from 5.14 percent in 2003 to 6.37 percent in 2004 and 8.63 percent in 2005, according to First American Core Logic Inc., a San Francisco-based data provider.

S&P's Raiter says he was urging management to develop more sophisticated financial models and buy more detailed loan data for monitoring securities the company graded.

``We knew the delinquencies were bad,'' he says. ``The fact was, if we could have hired a supreme being to tell us exactly what the loss was on a loan, they wouldn't have hired him because the Street wasn't going to pay us extra money to know that.''

Subprime Tour Fails

In late 2005, First Pacific's Mann says, he invited East Coast investors to take a subprime mortgage tour up California's main interstate artery, to see the problem for themselves. The I-5 runs from San Diego to Sacramento, passing through Orange County, Bakersfield  and Stockton.

``Nobody wanted to do it,'' he says. ``Unfortunately, most of the models were constructed by people who hadn't seen most of America and certainly weren't familiar with the areas they were rating.''

That September, Mann's boss, Thomas Atteberry, acted while others hesitated. He told investors in a monthly letter that he was liquidating the highest-risk real estate securities in First Pacific's New Income fund, which held $1.85 billion in bonds.

Atteberry, 55, wrote that he was ``very concerned about the subprime sector'' and ``that these trends may be a very early sign of the emergence of credit quality deterioration in general.'' It was 22 months before S&P and Moody's started downgrading mortgage  securities and CDOs that held similar loans.

He had no idea how right he would be.

 In August 2004, Moody's Corp. unveiled a new credit-rating model that Wall Street banks used to sow the seeds of their own demise. The formula allowed securities firms to sell more top-rated, subprime mortgage-backed bonds than ever before.

A week later, Standard & Poor's moved to revise its own methods. An S&P executive urged colleagues to adjust rating requirements for securities backed by commercial properties because of the ``threat of losing deals.''

The world's two largest bond-analysis providers repeatedly eased their standards as they pursued profits from structured investment pools sold by their clients, according to company documents, e-mails and interviews with more than 50 Wall Street professionals. It  amounted to a ``market-share war where criteria were relaxed,'' says former S&P Managing Director Richard Gugliada.

``I knew it was wrong at the time,'' says Gugliada, 46, who retired from the McGraw-Hill Cos. subsidiary in 2006 and was interviewed in May near his home in Staten Island, New York. ``It was either that or skip the business. That wasn't my mandate. My mandate was to  find a way. Find the way.''

Wall Street underwrote $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes from 2002 to 2007. Investment banks packaged much of that debt into investment pools that won AAA ratings, the gold standard, from New York-based Moody's and  S&P. Flawed grades on securities that later turned to junk now lie at the root of the worst financial crisis since the Great Depression, says economist Joseph Stiglitz.

`Would Have Stopped Flow'

``Without these AAA ratings, that would have stopped the flow of money,'' says Stiglitz, 65, a professor at Columbia University in New York who won the Nobel Prize in 2001 for his analysis of markets with asymmetric information. S&P and Moody's ``were trying to please  clients,'' he said. ``You not only grade a company but tell it how to get the grade it wants.''

Presidential candidates John McCain and Barack Obama lay responsibility for the carnage with Wall Street itself. The Securities and Exchange Commission in July identified S&P and Moody's as accessories, finding they violated internal procedures and improperly  managed the conflicts of interest inherent in providing credit ratings to the banks that paid them.

S&P and Moody's earned as much as three times more for grading the most complex of these products, such as the unregulated investment pools known as collateralized debt obligations, as they did from corporate bonds. As homeowners defaulted, the raters have  downgraded more than three-quarters of the AAA-rated CDO bonds issued in the last two years.

`Cut Too Many Corners'

Facing the threat of lawsuits and tighter regulation, Moody's and S&P now say they are adopting tougher requirements to more accurately evaluate and monitor debt.

``We have made significant progress in achieving these goals,'' Chris Atkins, S&P's vice president of communications, wrote last week in a statement to Bloomberg. ``Working with policy makers and market participants around the world, we will continue to take steps to  meet and exceed the high standards for quality we have put in place.'' He wouldn't respond to specific questions for this story.

Moody's spokesman Anthony Mirenda declined to comment after Bloomberg submitted questions in writing and by phone.

``The rating agencies' models were too flawed and cut too many corners, and the raters got pressured by the bankers,'' says Tonko Gast, the chief investment officer of the $5.1 billion New York hedge fund Dynamic Credit Partners LLC. He reverse-engineers the raters'  models as part of his investing strategy.

``That's how the race to the bottom was kind of invisible for a lot of people,'' he says.

Favoring Diversity

Starting in 1996, Moody's used a framework known as the binomial expansion technique for rating CDOs, structured funds consisting of aircraft leases, franchise loans, high-yield bonds, hotel mortgages and mutual-fund fees. On the theory that diversification reduced risk,  the BET formula rewarded balanced portfolios and punished concentrations of assets, using a proprietary measurement Moody's called the diversity score.

On Aug. 10, 2004, Moody's Managing Director Gary Witt introduced a new CDO rating method that dispensed with the diversity test and made other adjustments to the evaluation of structured-finance products.

``People were just starting to do deals that were all residential,'' says Witt, 49. He retired from Moody's this year and is now an assistant professor of statistics at Temple University's Fox School of Business in Philadelphia. The BET model ``is not as well suited for the  highly correlated portfolios that were becoming common in 2004,'' he says.

The emphasis on diversity turned into an obstacle after the 2001 recession, when some assets plummeted in value. Home mortgages, auto loans and credit-card receivables offered higher returns for CDO managers. As mortgage rates fell and the market boomed,  investment firms argued the risks in housing were small.

`Moody's Obliged'

``I know people lobbied Moody's to accommodate more concentrated residential mortgage risk in CDOs, and Moody's obliged,'' says Douglas Lucas, 52, the head of CDO research at UBS Securities LLC in New York. The former Moody's analyst says he invented the  diversity score in the late 1980s.

A statistical tabulation appearing in the appendix of Witt's paper represented the new formula as more rigorous in calculating risks than the BET. A side-by-side comparison showed that the new model projected losses that were 24 to 165 percent higher than forecast by  the old, on a hypothetical investment pool.

Bankers ``could put together a deal with greater concentrations in one area or another,'' says Jeremy Gluck, 52, a former Moody's managing director, who worked with Witt at the time.

Fewer Defaults Projected

In September 2005, Witt and colleagues published a follow-up analysis. Compared with the BET, the new model now projected that the likelihood of collateral defaults affecting CDO bonds rated at least Aa could be 73 percent lower at the extreme, in a range of  possibilities.

The new comparison was based on a hypothetical investment pool in which 75 percent of the assets were residential mortgage- backed securities, including 30 percent that were subprime.

Moody's could produce a lower default rate by incorporating a decade of ratings stability for structured finance into its assumptions. The average five-year loss rate on U.S. structured finance products between 1993 and 2003 was 1.9 percent, compared with 6.3 percent  for corporate bonds, the company had said in September 2004. A drawback was that raters didn't have data going back to the 1920s, as they did on corporate bonds.

In a press release on the report, Moody's said ``structured- finance ratings are broadly comparable in quality to the ratings of corporate bonds.''

`More Aaas'

Philippe Jorion, 53, a finance professor at the University of California, Irvine, criticizes the Moody's decision to factor ratings stability into its evaluations.

``This uses the output of their model as input into their models,'' Jorion says. ``This type of model is totally out of touch with the underlying economic reality.''

Witt declined in an e-mail exchange to discuss the September 2005 findings or his earlier projections from August 2004.

``The effect that had on structures was to create more Aaas,'' says Thomas Priore, 39, chief executive officer of Institutional Credit Partners LLC in New York, which oversees $13 billion of fixed-income investments.

The Moody's share of the market for rating CDOs was falling before the change, to 76.8 percent in 2004 from 91.5 percent a year earlier, according to the industry publication Asset-Backed Alert in Hoboken, New Jersey. It climbed afterward, to 85.1 percent in 2005 and  96.8 percent in 2006. S&P had 97.5 percent that year, the publication said. Underwriters made obtaining a top grade from one or both raters a condition for the sale of the investment pools.

E*Trade's CDO

The value of asset-backed CDOs tripled to $30 billion in the fourth quarter of 2004, according to the London-based monthly journal Creditflux. The yearly total increased 87 percent to $104.3 billion in 2005. Subprime mortgages came to account for about half the collateral  on all asset-backed CDOs issued that year, according to a Moody's estimate.

In December 2005, New York-based E*Trade Financial Corp. raised $300 million to fund E*Trade ABS CDO IV Ltd. It followed the formula Witt and co-authors outlined in the September paper.

Moody's assigned Aaa grades to three-quarters of the CDO's rated bonds, which invested 73.5 percent of the fund's assets in mortgages backed by loans to homeowners with bad credit and limited income documentation. As the subprime market deteriorated, the  company in June 2008 lowered $137.3 million of the bonds initially rated Aaa to Baa2 and the rest to speculative.

Gast's Reverse Engineering

Investors began to recognize that Aaa ratings on asset- backed CDOs weren't equivalent to top grades on corporate debt. Dynamic Credit Partners' Gast, 35, a Dutch-born quantitative analyst, says he began to discern that Aaa ratings weren't consistent even between  CDOs. He says this demonstrates erosion in the rating companies' standards.

``In '05 already what was clear, I think, was that there was a deteriorating underwriting trend,'' Gast says. ``Because we had it all in-house, we were able to figure out: `Wow, you can tweak so many different parameters to come to the same result.'''

Two CDOs issued two years apart illustrate the point. Both invested in subprime and other mortgage securities, and received AAA ratings on their senior bonds from Moody's and S&P.

In December 2004, NIB Capital Bank NV of The Hague, the Netherlands, and UBS AG of Zurich jointly issued the $1 billion Belle Haven ABS CDO Ltd. The fund manager, an arm of NIB Capital, borrowed 45 times investors' equity to buy real estate securities and other  assets, according to the prospectus. That magnified potential gains, while also increasing possible losses.

Tale of Two CDOs

The least-protected bondholders were backed by collateral equal to 102.26 percent of their stake, according to the prospectus, providing a cushion against declines.

Two years later, in December 2006, a U.S. arm of the Zurich investment bank Credit Suisse Group AG issued the $1.5 billion McKinley Funding III Ltd. CDO. The manager, New York-based Vertical Capital LLC, borrowed 84 times investors' equity, and junior investors  were backed by a narrower cushion of assets equal to 100.98 percent of their stake, the prospectus shows.

While Belle Haven could put 20 percent of its assets in other CDOs, further magnifying the risks and returns, McKinley could place twice that percentage.

Both CDOs were downgraded as the subprime market deteriorated, with the earlier CDO holding up better than the later one.

Belle Haven's most senior Aaa tranche today retains a Moody's investment-grade rating of A1- and an S&P grade of BBB-. By contrast, Moody's lowered the top tier of the McKinley CDO to junk status, Ca, on September 23. S&P's rating is CCC-.

Because the funds are registered in the Cayman Islands and don't disclose holdings, it isn't known how much investors may have lost.

S&P's Model Changes

Meanwhile, S&P tinkered with its methodology for grading CDOs that bought commercial mortgage securities backed by apartments, hotels, offices and stores, according to an Aug. 17, 2004, e-mail obtained by Bloomberg. Managing Director Gale Scott warned of the  ``threat of losing deals'' to Moody's unless the company relaxed its rating requirements.

``OK with me to revise criteria,'' replied Gugliada, then S&P's top CDO-rating executive, the e-mail exchange shows.

In an interview, Gugliada confirmed the e-mail's contents and said it led to one of S&P's adjustments to accommodate clients. He says Scott did research supporting a relaxation of S&P's assumptions about how closely correlated the default probabilities were for  commercial real estate securities.

More Flexibility

The changes gave S&P's clients more flexibility. The switch directly preceded ``aggressive underwriting and lower credit support'' in the market for commercial mortgage-backed securities from 2005 to 2007, according to an S&P report that Scott co-wrote in May 2008.  This led to growing delinquencies, defaults and losses, the report said.

Scott left in August as S&P cut staff. The company declined to make her available for comment before her departure, and subsequently she couldn't be reached.

Errors sometimes worked their way into the analysis. Kai Gilkes, 40, a former S&P quantitative analyst in London, says he discovered a flaw in the company's main CDO model, the CDO Evaluator, which he updated in late 2005.

In some cases, the S&P system overstated the quality of synthetic CDO Squared securities, Gilkes says. These complex investment pools are based on credit default swaps, a type of insurance against corporate default.

``On collateral rated AA or higher, the S&P model did not properly stress the default behavior of the underlying CDOs, resulting in assets with a lower default probability than their ratings suggested,'' Gilkes says.

`Line in Sand Shifts'

He says he fixed the glitch during ``a major revision'' that December and doesn't know whether any investment was inappropriately rated as a result of the error.

Still, Gilkes says he believed that competitive considerations, as communicated by management, intruded on S&P's ratings decisions up until he left the London office in 2006.

``The discussion tends to proceed in this sort of way,'' he says. ```Look, I know you're not comfortable with such and such assumption, but apparently Moody's are even lower, and, if that's the only thing that is standing between rating this deal and not rating this deal, are  we really hung up on that assumption?' You don't have infinite data. Nothing is perfect. So the line in the sand shifts and shifts, and can shift quite a bit.''

`Golden Goose'

Gugliada says that when the subject came up of tightening S&P's criteria, the co-director of CDO ratings, David Tesher, said: ``Don't kill the golden goose.''

S&P declined to make Tesher available for comment.

In the SEC's July 8 report examining the role of the credit rating companies in the subprime crisis, the agency raised questions about the accuracy of grades on structured-finance products and ``the integrity of the ratings process as a whole.''

``Let's hope we are all wealthy and retired by the time this house of cards falters,'' one unidentified analyst told a colleague in a December 2006 e-mail, according to the SEC report. The e-mail was signed with a computerized wink and smile: ``;o).''

Moody's stock peaked at $74.84 on Feb. 8, 2007, a day after London-based HSBC Holdings Plc said it would set aside about $10.56 billion for losses on U.S. home loans. That statement was among the first signs of the subprime meltdown.

The reckoning swept Wall Street five months later. On July 10, Moody's cut its grades on $5.2 billion in subprime-backed CDOs. That same day, S&P said it was considering reductions on $12 billion of residential mortgage-backed securities.

More Aaas

Still, they continued stamping out AAA ratings.

Moody's announced Aaa grades on at least $12.7 billion of new CDOs in the last week of August 2007. Five of the investments were lowered by one or both companies within three months. The rest were cut within six months.

``The greed of Wall Street knows no bounds,'' says Stiglitz, the Nobel laureate. ``They cheated on their models. But even without the cheating, their models were bad.''

By last month, Moody's had downgraded 90 percent of all asset-backed CDO investments issued in 2006 and 2007, including 85 percent of the debt originally rated Aaa, according to Lucas at UBS Securities. S&P has reduced 84 percent of the CDO tranches it rated,  including 76 percent of all AAAs.

``Credit in Latin means `to believe,''' says former Moody's analyst Sylvain Raynes, 50, now the head of his own New York bond-analysis firm, R&R Consulting. ``Trust and credit is the same word. If you lose that confidence, you lose everything, because that confidence  is the way Wall Street spells God.''

Washington Post    September 24, 2008

Top Executives at Bruised Firms Among Wall Street's Highest Paid
By Cecilia Kang and Annys Shin

Some of the biggest financial firms that could benefit from the government's rescue plan also handed out some of Wall Street's biggest paychecks to their top executives.

Goldman Sachs chief executive Lloyd Blankfein, for instance, took home nearly $54 million in salary, perks, bonuses and other stock awards in 2007. J.P. Morgan Chase chief executive James Dimon collected $30 million in cash, stock and options. And former Wachovia chief executive G. Kennedy Thompson received total compensation of about $15.6 million.

As Congress and the Bush administration wrangle over the details of a $700 billion bailout plan for the financial-services industry, lawmakers are moving to make sure executives at firms that take taxpayer money don't continue to receive gigantic paychecks or walk off with huge severance payments. The details on how such curbs would work have yet to be finalized.

Spokesmen for J.P. Morgan Chase and Wachovia declined to say whether their firms would take part in the bailout or to comment on the proposed restrictions on executive pay. Representatives for Goldman Sachs did not return phone calls.

The pay cap "is a huge point for us," said Scott Talbott, head lobbyist for the Financial Services Roundtable, a trade group that represents large financial institutions. "Each company has a compensation board with people who are closest to the all facets of a business to be able to weigh compensation levels. But it's an uphill battle politically to fight against executive compensation as part of a $700 billion bailout."

At the heart of the debate is the notion that Wall Street's lucrative, incentive-laden pay packages encourage executives to make ever riskier bets on future business. During the boom, such actions produced spectacular results. But now, as the markets unwind, that risk-taking is considered a liability and damaging to a firm's long-term health.

There is a precedent for capping executive pay as a condition of receiving federal aid. When Chrysler took a federal bailout in 1979, executive salaries were cut as much as 10 percent and chief executive Lee Iacocca's paycheck that year was $1.

More recently, when regulators took over mortgage finance Fannie Mae and Freddie Mac this month, they eliminated $12.59 million in exit payments for executives Daniel H. Mudd of Fannie Mae and Richard F. Syron of Freddie Mac. The executives will now get a combined $9.43 million upon their exit.

At a Senate banking committee hearing yesterday, panel Chairman Sen. Christopher J. Dodd (D-Conn.) insisted executives be held accountable for driving their firms into financial turmoil, should they seek federal help.

He said the Bush administration's plan presented would do "nothing to stop the very authors of this calamity to walk away with bonuses and golden parachutes worth millions of dollars."

Treasury Secretary Henry M. Paulson Jr. responded that placing restrictions on executive pay could undermine the plan.

"We must have that critical debate, but we must get through this period first. Right now, all of us are focused on the immediate need to stabilize our financial system," Paulson said in the hearing.

Limits on executive pay run counter to a long-standing Wall Street practice of granting annual bonuses based on profit growth.

"It goes against the grain of the culture of the industry where people expect to work hard and take risks and get rewarded through pay for that hard work," said Alexander Cwirko-Godycki, research manager for executive compensation research firm Equilar.

Indeed, Goldman Sachs said in a filing with the Securities and Exchange Commission that its compensation awards reflected the firm's very strong financial performance "relative to our core competitor group in terms of year-over-year growth in net revenues, net earnings and earnings per share. Based on final 2007 results, we had the highest growth in the group for each of these measures."

At J.P. Morgan Chase, the compensation committee said in a spring SEC filing that it paid Dimon $30 million because the company's performance was strong relative to other competitors. They said he "continues to skillfully lead the Firm through a very challenging financial and credit environment."

Wachovia justified Thompson's compensation for the year because "earnings per share growth and Wachovia's tangible return on equity have been at or above the median of its peer group for 2007," according to an SEC filing. The firm noted, however, that Thompson did not get cash or stock bonuses because, "Wachovia did not achieve its threshold performance goals."

Thompson was ousted in June amid billions of dollars in losses on mortgage-related investments. He was replaced by former Treasury undersecretary Robert K. Steel, who will receive an salary of $1.1 million and a $6 million bonus, as well as additional incentive pay worth up to $15 million, according to an SEC filing.

Restricting the way banks can compensate their leaders could hinder the sector's recovery, some argue. It can make it harder to attract top talent, especially during a crisis.

"When the tough gets going, you don't want to bring in your B team. You want your A team," said Brian Foley, who runs a compensation consultancy in White Plains, NY.

September 24, 2008

 In 2006 alone, Wall Street firms paid out $62 billion in bonuses.
By Timothy Egan

The big guy with the crew cut and a hand that lost three fingers to a meat grinder looked out at the most powerful men in global capitalism Tuesday, and asked a pointed question:

“I’m a dirt farmer,” said Senator Jon Tester, the Montana Democrat who still lives on his family homestead. “Why do we have one week to determine that $700 billion has to be appropriated or this country’s financial system goes down the pipes?”

Good question, one that Treasury Secretary Henry M. Paulson and Federal Reserve Chairman Ben Bernanke have yet to adequately answer. If they seemed flummoxed, perhaps it’s because they still can’t explain what will be accomplished by nearly nationalizing the banking system and giving the treasury secretary more power than a king.

Another question — since we now own a big part of the world’s largest insurance company, A.I.G., does that mean I can save a load of money on my car insurance? — might be easier to answer.

This bailout, in present form, is toast. Now, with John McCain offering to suspend his campaign and delay Friday’s debate, it looks like the drainage of years past is pulling him down. He wants to back out of facing Barack Obama at the height of the campaign. Why not change the topic, from foreign affairs to the economy?

Some have already tried to protect the true villains of the crash of 2008. Witness Neil Cavuto of Fox News, he of the sycophantic questions to Enron executives and other thieves just before they were exposed, blaming the mortgage crisis on banks lending to “minorities and risky folks,” as he said last week.

There is certainly a food chain of greed, from the lowliest house-flipper in the Southern California exurbs to the Hamptons hedge fund manager. We all put reason in a box and buried it for a time. But before $700 billion is committed to a secretary whose decisions “may not be reviewed by any court of law or any administrative agency,” as the original draft of the bailout states, it’s worth remembering where the biggest heist took place, and how Wall Street dragged down the rest of the country once before. You could hear the echoes of history in Tester’s question, riding the fierce urgency of now at a time when the Great Depression and all its gloomy atmospherics are in the air again.

When the stock market crashed in 1929, losing 40 percent of its value over a brutal autumn, barely 2 percent of Americans owned stocks. People asked, sensibly: how could this affect me? Who cared about those swells on Wall Street when cars were rolling off factory lines and the big open expanse of middle America was flush with wheat and corn?

Today, with more than 90 percent of all homeowners paying their mortgages on time and on budget, the parallel question arises: how could this minority of bad loans drag down Western capitalism? It may be news to Joe Biden — with three gaffes this week, he’s approaching a record, even for him – but Franklin Roosevelt was not yet president during the crash. Herbert Hoover was, and there we have the reason why so many people cringed when John McCain said last week that the fundamentals of the economy were sound.

In his first days in office, Hoover said, “Americans are nearer to the final triumph over poverty than ever before in the history of the land.” Oops. And just before he was swept to the dunce corner of history, Hoover said, “No one has yet starved.” At the time, people in rural America were eating brined tumbleweed and road-kill rabbits; the unemployment rate was 25 percent.

But the larger lesson is how Wall Street brought down Main Street. Banks were largely unregulated then, free to gamble people’s savings on stock market long-shots. When the market collapsed, the uninsured deposits went with it. By the end of 1932, one fourth of all banks were shuttered, and 9 million people lost their savings.

In this century, thanks to the deregulatory demons released by former McCain adviser Phil Gramm and embraced by just enough lobbyist-greased Democrats, Wall Street was greenlighted again to act like a casino. Banks in the heartland passed on their mortgages to Wall Street, where they were sliced and diced in hundreds of largely incomprehensible ways. And while few people understand how those investment giants made money, this much is clear: it was a killing. In 2006 alone, Wall Street firms paid out $62 billion in bonuses.

With all the urgency of that famous National Lampoon magazine cover that showed a cute pooch with a gun to its head, and the line “If You Don’t Buy This Magazine, We’ll Kill This Dog,” President Bush says the biggest bailout in American history must be passed now or the world will crumble. He said a similar thing in the run-up to war.

Just once, it might be worthwhile to listen to a dirt farmer like Jon Tester, who wonders why the same breathless attention is not given to the concerns of average Americans. Ah, but he’s only been in the Senate two years. Give him another term and he may start quoting Phil Gramm with approval.

Washington Post    September 24, 2008

How Main Street Will Profit
By William H. Gross

Capitalism is a delicate balance between production and finance. Today, our seemingly guaranteed living standard is threatened, much like it has been in previous recessions or, some would say, the Depression. Finance has run amok because of oversecuritization, poor regulation and the excessively exuberant spirits of investors; the delicate balance has once again been disrupted; production, and with it jobs and our national standard of living, is declining.

If this were a textbook recession, policy prescriptions would recommend two aspirin and bed rest -- a healthy dose of interest rate cuts and a fiscal package that mildly expanded the deficit. That, of course, has been the attempted remedy over the past 12 months. But recent events have made it apparent that this downturn differs from recessions past. Today's housing bubble, unlike that of the stock market's before it, was financed with excessive and poorly regulated mortgage debt, and as housing prices began to tumble from the peak, the delinquencies and foreclosures have led to a downward spiral of debt liquidation that in turn led to even lower prices and more foreclosures.

And so, instead of mild medication and rest, it became apparent that quadruple bypass surgery is necessary. The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that.

In effect, the Treasury will have the fate of the American taxpayer in its hands. The Resolution Trust Corp., created in the late 1980s to deal with the savings and loan crisis, dealt with previously purchased real estate, which was flushed into government hands with a "best efforts" future liquidation. Today, the purchase of junk mortgages, securitized credit card receivables and even student loans will be bought at prices significantly below "par" or cost, and prospectively at levels allowing for capital gains. This is a Wall Street-friendly package only to the extent that it frees up funds for future loans and economic growth. Politicians afraid of parallels to legislation that enabled the Iraq war are raising concerns about a rush to judgment, but the need for speed is clear. In this case, there really are weapons of mass destruction -- financial derivatives -- that threaten to destroy our system from within. Move quickly, Washington, with appropriate safeguards.

The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic. Democratic Party earmarks mandating forbearance on home mortgage foreclosures will be critical as well. If this program is successful, however, it is obvious that the free market and Wild West capitalism of recent decades will be forever changed. Future economic textbooks are likely to teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient over the long term when there is another delicate balance -- between private incentive and government oversight.

The writer is chief investment officer and founder of the investment management firm PIMCO.

SEPTEMBER 25, 2008

The Paulson Plan Will Make Money For Taxpayers

In 1992, hedge-fund manager George Soros made $1 billion betting against the British pound. In 2007, John Paulson's Credit Opportunities fund correctly bet against subprime mortgages, clearing $15 billion for  the year and $3.7 billion for him. Warren Buffett is now hoping to make big money on Goldman Sachs.

But these are small-time deals. My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion  dollars and maybe as much as $2.2 trillion -- yes, with a "t" -- for the United States Treasury.

Here's what's happened so far. New technology like electronic trading meant that Wall Street's bread-and-butter business of investment banking and trading stocks stopped making much money years ago. So  investment banks took their enormous capital and at first packaged yield-enhanced, subprime mortgage loans into complex derivatives such as collateralized debt obligations (CDOs). Eventually and stupidly,  these institutions owned them for themselves -- lots of them, often at 30-to-1 leverage. The financial products were made "safe" by insurance products known as credit default swaps, a credit derivative from  companies such as AIG. When housing turned down, the mortgages and derivatives were worth a lot less and no one would lend Wall Street money anymore.

Then the piling on started. Hedge funds could short financial stocks and then bid down the prices of CDOs stuck on Wall Street's balance sheets. This was pretty easy to do in an illiquid market. Because of the  Federal Accounting Standards Board's mark-to-market 157 rule, Wall Street had to write off the lower value of these securities and raise more capital, diluting shareholders. So the stock prices would drop, which  is what the shorts wanted in the first place. It was all legit.

There is a saying on Wall Street that goes, "The market can stay irrational longer than you can stay solvent." Long Term Capital Management learned this lesson 10 years ago when it got its portfolio picked off by  Wall Street as its short-term financing dried up. I had thought the opposite -- hedge funds picking off Wall Street -- would happen today. But in a weird twist, it's the government that is set up to win the prize.

Here's how: As short-term financing dried up, Fannie Mae and Freddie Mac's deteriorating financials threatened to trigger some $1.4 trillion in credit default swap payments that no one, including giant insurer AIG,  had the capital to make good on. So Treasury Secretary Henry Paulson put Fannie and Freddie into conservatorship. This removed any short-term financing hassle. He also put up $85 billion in loan guarantees  to AIG in exchange for 80% of the company.

Taxpayers will get their money back on AIG. My models suggest that Fannie and Freddie, on the other hand, are a gold mine. For $2 billion in cash up front and some $200 billion in loan guarantees so far, the  U.S. government now controls $5.4 trillion in mortgages and mortgage guarantees.

Fannie and Freddie each own around $800 million in mortgage loans, some of them already at discounted values. They also guarantee the credit-worthiness of another $2.2 trillion and $1.6 trillion in mortgage- backed securities. Held to maturity, they may be worth a lot more than Mr. Paulson paid for them. They're called distressed securities for a reason.

Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic  activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the  last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.

Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion.

So the U.S. will be stuck with a portfolio in the trillions of dollars in bad loans and last-to-be-paid derivatives. Where is the trade in that?

Well, unlike Mr. Buffett or any hedge fund, the Treasury and the Federal Reserve get to cheat. It's not without risk, but the Feds, with lots of levers, can and will pump capital into the U.S. economy to get it  moving again. Future heads of Treasury and the Federal Reserve will be growth advocates -- in effect, "talking their book." While normally this creates a threat of inflation and a run on the dollar, and we may see  dollar exchange rates turn south near term, don't expect it to last.

First, with Goldman Sachs and Morgan Stanley now operating as low-leverage bank holding companies, a dollar injected into the economy will most likely turn into $10 in capital (instead of $30 when they were  investment banks). This is a huge change. Plus, a stronger U.S. economy, with its financial players having clean balance sheets, will become a safe haven for capital.

Europe is threatened by an angry Russian bear. The Far East, especially China, has its own post-Olympic banking house of cards of non-performing loans to deal with. Interest rates will tick up as the economy  expands -- a plus for the dollar. Finally, a stronger economy driven by industry instead of financials means more jobs, less foreclosures and higher held-to-maturity payouts on this Fed loan portfolio.

You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion --  the greatest trade ever. Every hedge-fund manager will be jealous. Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.

Over 10 years this could change the budget scenario in D.C., which can also strengthen the dollar. The next president gets a heck of a windfall. In the spirit of Secretary of State William Seward's purchase of  Alaska for $7 million in 1867, this week may be remembered as Paulson's Folly.

Mr. Kessler, a former hedge-fund manager, is the author of "How We Got Here" (Collins, 2005).

Washington Post    September 25, 2008

A Bailout We Don't Need
By James K. Galbraith

Now that all five big investment banks -- Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs and Morgan Stanley -- have disappeared or morphed into regular banks, a question arises.

Is this bailout still necessary?

The point of the bailout is to buy assets that are illiquid but not worthless. But regular banks hold assets like that all the time. They're called "loans."

With banks, runs occur only when depositors panic, because they fear the loan book is bad. Deposit insurance takes care of that. So why not eliminate the pointless $100,000 cap on federal deposit insurance and go take inventory? If a bank is solvent, money market funds would flow in, eliminating the need to insure those separately. If it isn't, the FDIC has the bridge bank facility to take care of that.

Next, put half a trillion dollars into the Federal Deposit Insurance Corp. fund -- a cosmetic gesture -- and as much money into that agency and the FBI as is needed for examiners, auditors and investigators. Keep $200 billion or more in reserve, so the Treasury can recapitalize banks by buying preferred shares if necessary -- as Warren Buffett did this week with Goldman Sachs. Review the situation in three months, when Congress comes back. Hedge funds should be left on their own. You can't save everyone, and those investors aren't poor.

With this solution, the systemic financial threat should go away. Does that mean the economy would quickly recover? No. Sadly, it does not. Two vast economic problems will confront the next president immediately. First, the underlying housing crisis: There are too many houses out there, too many vacant or unsold, too many homeowners underwater. Credit will not start to flow, as some suggest, simply because the crisis is contained. There have to be borrowers, and there has to be collateral. There won't be enough.

In Texas, recovery from the 1980s oil bust took seven years and the pull of strong national economic growth. The present slump is national, and it can't be cured that way. But it could be resolved in three years, rather than 10, by a new Home Owners Loan Corp., which would rewrite mortgages, manage rental conversions and decide when vacant, degraded properties should be demolished. Set it up like a draft board in each community, under federal guidelines, and get to work.

The second great crisis is in state and local government. Just Tuesday, New York Mayor Michael Bloomberg announced $1.5 billion in public spending cuts. The scenario is playing out everywhere: Schools, fire departments, police stations, parks, libraries and water projects are getting the ax, while essential maintenance gets deferred and important capital projects don't get built. This is pernicious when unemployment is rising and when we have all the real resources we need to preserve services and expand public investment. It's also unnecessary.

What to do? Reenact Richard Nixon's great idea: federal revenue sharing. States and localities should get the funds to plug their revenue gaps and maintain real public spending, per capita, for the next three to five years. Also, enact the National Infrastructure Bank, making bond revenue available in a revolving fund for capital improvements. There is work to do. There are people to do it. Bring them together. What could be easier or more sensible?

Here's another problem: the wealth loss to near-retirees and the elderly from a declining stock market as things shake out. How about taking care of this, with rough justice, through a supplement to Social Security? If you need a revenue source, impose a turnover tax on stocks.

Next, let's think about what the next upswing should try to achieve and how it should be powered. If the 1960s were about raising baby boomers and the '90s about technology, what should the '10s and '20s be about? It's obvious: energy and climate change. That's where the present great unmet needs are.

So, let's use the next few years to plan, mapping out a program of energy conservation, reconstruction and renewable power. Let's get the public sector and the universities working on it. And let's prepare the private sector so that when the credit crunch finally ends, we'll have the firms, the labs, the standards and the talent in place, ready to go.

Some will ask if we can afford it. To see the answer, don't look at budget projections. Just look at interest rates. Last week, in the panic, the federal government could fund itself, short term, for free. It could have raised money for 30 years and paid less than 4 percent. That's far less than it cost back in 2000.

No country in this situation is broke, or insolvent, or even in much trouble. For once, Wall Street's own markets speak the truth. The financially challenged customer isn't Uncle Sam. He's up on Wall Street, where deregulation, greed and fraud ran wild.

James K. Galbraith is the author of "The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too."

Washington Post    September 25, 2008

Keynes wouldn't have wanted to nationalize that casino
What Keynes Could Tell Paulson
By David Ignatius

In times like these, when even the most sober analysts are wondering if we're heading for another Great Depression, it's wise to take a deep breath, head to the basement and dust off a copy of John Maynard Keynes's modestly titled 1936 treatise, "The General Theory of Employment, Interest and Money."

Most of us remember Keynes from our college economics courses as the guy who advocated deficit spending to "prime the pump" during downturns. And that was certainly part of his argument. But revisiting "The General Theory," what's striking is that it's a book about economic panics and the market psychology that produces them -- and the consequent need for government intervention. Parts of it could have been written this week to describe the cascading defaults of Bear Stearns, Lehman Brothers and AIG.

The problem with financial markets, Keynes argued, was that investors were periodically seized by an extreme form of what he called "liquidity preference," which made them wary of putting their money into anything but the safest investments. "It is of the nature of organized investment markets . . . that, when disillusion falls upon an over-optimistic and over-bought market, it should fall with sudden and even catastrophic force," he wrote. "Once doubt begins it spreads rapidly."

That's a pretty good description of what has been happening on Wall Street over the past few months. We've gone from a bubble of overenthusiasm, in which interest-rate spreads took little account of risk, to a state of panic in which financial institutions are so risk-averse that they don't want to lend to anyone. As Keynes observed, "the actual, private object of the most skilled investment today is . . . to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow."

Keynes's revolutionary idea was that financial markets were not inherently self-correcting, as classical economics had argued. Left to itself, Wall Street might remain in a liquidity trap in which the markets would stay frozen and productive investment would cease. So it fell to the government to take actions that would restore confidence and stimulate investment. "I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands," he wrote.

Which brings us to Treasury Secretary Henry Paulson and the present financial crisis. Since he intervened to rescue Bear Stearns in March, Paulson has been trying to pump cash into markets that are locking up because of the extreme liquidity preference of investors. But each rescue measure only sets up the next disaster -- so that Paulson lurches from Bear Stearns to Fannie and Freddie to AIG, and now to a government pledge to buy up $700 billion or more of mortgage-backed securities.

What advice would Keynes offer Paulson and Fed Chairman Ben Bernanke? His first instinct, I think, would be to reiterate that markets, left to themselves, will not solve this sort of crisis. They need government help -- in this case, on a scale that would have daunted even Keynes -- including underwriting mortgage loans, backstopping the market for credit swaps and other steps. But if these measures are taken piecemeal, without broad political support, they may only add to the public's anxiety. Indeed, that's a real worry now: A Wall Street panic may become a Main Street panic.

Keynes's biographer, Robert Skidelsky, makes clear that at every stage of Keynes's career, he tried to think broadly about the social and political consequences of economic policy. That was true in his famous denunciation of onerous German reparations payments after World War I, which he correctly warned would lead to a future war; it was true in the magnanimity of the post-World War II international financial system he helped create at Bretton Woods.

A truly Keynesian rescue plan should do more than bail out foolish investors. How might the pieces fit into a larger design? Well, if the taxpayers are going to acquire a stake in the nation's largest insurance company, perhaps that company can be the cornerstone of a new system of universal private health coverage. If the taxpayers are going to acquire $700 billion in real estate assets, perhaps the eventual profits can fund new investments in infrastructure or energy technology.

Keynes spoke in the finicky English of a Cambridge don, but listen to what he said: "When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill-done." Keynes wouldn't have wanted to nationalize that casino; he was an active investor himself. But he reminds us that public purposes are best served by public institutions.

The writer is co-host of PostGlobal, an online discussion of international issues. His e-mail address is

SEPTEMBER 25, 2008

Give Me That Old-Time Religion

Responsibility! Accountability! Discipline! Oversight! Rules!

The canyons of Wall Street are ringing with Democratic politicians and liberal pundits crying out for the renewal of ancient values and a return to basics. The political right wants market failures to be punished with Old Testament ruin.

So we're all agreed: Standards of behavior matter.

All that remains is to see if this week's left-right consensus on standards can be extended to any corner of American life beyond "CEO pay" and other sitting ducks.

Once we're done imposing Spartan discipline on the dining rooms of Wall Street, how about some of the same for the halls and classrooms of the average inner-city high school? A nation in panic at the sight of banks imploding has yawned for years while the public-school system melted down.

A handful of Supreme Court decisions going back 40 years relaxed standards of oversight for dress codes, comportment, speech and expulsion, and the average school principal or teacher threw in the towel on daily discipline. Not my job.

Many school administrators can relate to the frontline mortgage-lending officers, some of them old-school bankers who used to help young borrowers understand the difference between the real world and probable ruin. That's what high-school principals used to do. No more.

Suddenly, local lenders were toiling (if they survived) in the easier liar-loan world fostered by Congress, Fannie and Freddie and guys with great tans in Los Angeles. The old public-school system, once a tight ship in countless towns, knew that game. The schools learned to shove another class of semi-educated bodies into the street every June and call them "graduates" the same way lenders called zero-down-payment borrowers "homeowners."

This column isn't a rant about the ruined schools. It's about spotting a ray of hope amid the past week's rubble in the financial markets. Something positive has been in the air this election, and all the calls now for a return to financial rectitude is part of it.

On Monday, Barack Obama gave a tough speech on cleaning up Washington. The details may be blather, but the cleanse-the-temple tone was out of a Jerry Falwell sermon circa 1980. He appealed to "our core values" and denounced an "ethic of irresponsibility." Both John McCain and Sen. Obama are selling repentance in politics.

Two months ago, one of the campaign's most important events took place at Saddleback Evangelical Christian Church, the Rev. Rick Warren presiding.Before that in April, Hillary Clinton and Mr. Obama did a "Compassion Forum" at Messiah College in Grantham, Pa. Sen. Clinton talked about feeling the Holy Spirit "on many occasions." Mr. Obama was still wearing sackcloth for "cling to religion."

This election may be won by whichever man looks better riding an economic surfboard the next month, but the campaign's undercurrents are pushing the basics back to the surface.

Yes, politicians will bend to any new wind that blows through, but this past week of financial turmoil has shown there's a strong whiff in the air for the values of the greatest generation. This was the 20% generation. In the post-war years, young couples knew they'd somehow have to save 20% of the down payment on a home mortgage. That's thrift, an archaic word I think is still in most dictionaries.

Push this idea far enough, and you're talking the world of "Ozzie and Harriet" (ABC-TV 1952-1966) versus "Sex and the City" (HBO, 1998-2004). Push further and you arrive at happy Sarah Palin and that family of hers. What Sarah represents produces pushback from the smart-set women on "The View" and big-city comedians and newspaper columnists, all trying to knock Little Miss Muffet off her too-perfect tuffet.

This, in short, is the culture wars -- endless and unwinnable. Until this week. This week revealed that when real money is on the line, even the left starts screaming for old-fashioned standards. Thus rose a shout for regulatory "oversight" of markets, and they don't mean some vague, Googlie "don't be evil." They want tough, punishing rules.

This won't wash. You can't claim, as holier-than-thou politics is now, that sending an army of regulatory storm-troopers into Wall Street will ensure integrity in mere bankers who themselves come from a broader, anything-goes culture.

There's a reason Barack Obama is delivering secular sermons in places like Green Bay, Wis. Green Bay's beef with a culture of corner-cutting predated Bear Stearns. Wall Street hasn't been the only font of wretched excess. More than opportunism has landed this presidential campaign in places that represent standards, like Saddleback in California and Messiah in Pennsylvania. People want standards again because they work -- in business, in schools, in daily life.

In my ear, I can hear one of the four candidates giving a speech connecting Wall Street to the nation's Main Streets. Standards, responsibility, accountability, rules? You bet. Bring 'em all back. I wonder which one of them would give it.

Write to

Bloomberg    September 25, 2008  11:08 EDT

U.S. Losing Finance Superpower Status, Germany Says (Update3)

By Leon Mangasarian

Sept. 25 (Bloomberg) -- German Finance Minister Peer Steinbrueck said the U.S. will lose its position as the world's undisputed financial ``superpower'' and called for a ban on speculative short-selling to help restore the global economy.

Steinbrueck, in a speech on the financial-market crisis to lawmakers in Berlin today, set out an eight-point plan urging greater regulation and larger capital reserves for banks. He championed the German banking system over its U.S. counterpart, dismissing the ``Anglo-Saxon'' model as having ``an exaggerated fixation on returns.''

``The long-term effects of the crisis are impossible to gauge,'' Steinbrueck said. ``One thing seems probable to me: The U.S. will lose its status as the superpower of the global financial system. The global financial system will become multipolar.''

Steinbrueck's comments underline a deepening divide between European and U.S. attitudes to the financial system and how to resolve the rout triggered by the worst U.S. housing slump since the Great Depression. European members of the Group of Seven leading industrial nations refused to back a U.S. bank-rescue plan Sept. 22, with Steinbrueck saying that the U.S. situation ``is not comparable'' to that in Germany.

`Purely Speculative'

In his speech, Steinbrueck targeted short-selling, where traders borrow shares with the hope of buying them back later at a lower price. The global financial community ``must together agree to a ban on purely speculative short-selling at the international level.''

He said in a later interview with Bloomberg Television that someone looking back from 2018 would regard the events of today as the beginning of a ``slight erosion'' in the status of the U.S. in financial terms.

``America will not be the only power to define which standards and which financial products will be traded all over the world,'' he said. ``The dollar will remain a very reliable and important currency, as well as the euro as well as the yuan and the yen, so I think it will perhaps be the starting point of some changes.''

Steinbrueck said that sovereign wealth funds and banks from Asia, the Middle East and Europe will play a bigger role in the new financial world. In the medium- and long-term, ``new pledges of voluntary action or self-regulation by the financial sector'' will not resolve the current crisis, he said.

`Not Enough'

``That's not enough,'' he said in the speech. ``For me the important answer is stronger, internationally agreed regulation at the international level because the crisis goes beyond measures that can be taken by nation states.''

Steinbrueck is a deputy leader of the Social Democratic Party, coalition partners to Chancellor Angela Merkel's Christian Democrats. A former prime minister of North Rhine- Westphalia, Germany's most populous state and home to the industrial Ruhr Valley, Steinbrueck became finance minister in 2005 after Merkel came to power. The two parties will compete against each other in national elections in September 2009.

Merkel pressed for an international framework to bring greater transparency to financial markets during Germany's Group of Eight presidency last year. She returned to that theme this week, welcoming the conversion of the U.S. and the U.K. to her cause while bemoaning them for not listening to her sooner.

Merkel's Mantra

Economic players ``must accept'' rules on strengthening the independence of ratings companies, greater transparency in financial markets and the fact that high-risk products entail big risks, Merkel told employers in Berlin on Sept. 22.

``These measures aren't new; they were spelled out at the G-7 meeting in Heiligendamm,'' northern Germany, Merkel said. ``Germany has always pointed out how necessary they are.''

Steinbrueck, in his speech to the lower house of parliament, the Bundestag, blamed the U.S. as the source of the current crisis that will leave ``deep scars'' globally.

``The U.S. is the origin and the clear focal point of the crisis,'' Steinbrueck said, adding that the ramifications are now ``spreading worldwide like a poisonous oil spill.''

The world will have to brace itself for lower economic growth rates, he said, without giving any new projections for Germany. The government forecasts 1.7 percent growth this year and 1.2 percent in 2009.

Steinbrueck said the root cause of the crisis lies far deeper than the collapse of the U.S. subprime mortgage market.

``In my view, it's the irresponsible overemphasis on the `laissez-faire' principle, namely giving market forces the most possible freedom from state regulation in the Anglo-American financial system.''

To contact the reporters on this story: Leon Mangasarian in Berlin at


September 25, 2008, 6:16 pm

Economists Of The World, Unite!
By Joe Nocera

This just in:

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

Signed (updated at 9/25/2008 8:30AM CT)
Acemoglu Daron (Massachussets Institute of Technology)
Adler Michael (Columbia University)
Admati Anat R. (Stanford University)
Alexis Marcus (Northwestern University)
Alvarez Fernando (University of Chicago)
Andersen Torben (Northwestern University)
Baliga Sandeep (Northwestern University)
Banerjee Abhijit V. (Massachussets Institute of Technology)
Barankay Iwan (University of Pennsylvania)
Barry Brian (University of Chicago)
Bartkus James R. (Xavier University of Louisiana)
Becker Charles M. (Duke University)
Becker Robert A. (Indiana University)
Beim David (Columbia University)
Berk Jonathan (Stanford University)
Bisin Alberto (New York University)
Bittlingmayer George (University of Kansas)
Boldrin Michele (Washington University)
Brooks Taggert J. (University of Wisconsin)
Brynjolfsson Erik (Massachusetts Institute of Technology)
Buera Francisco J. (UCLA)
Camp Mary Elizabeth (Indiana University)
Carmel Jonathan (University of Michigan)
Carroll Christopher (Johns Hopkins University)
Cassar Gavin (University of Pennsylvania)
Chaney Thomas (University of Chicago)
Chari Varadarajan V. (University of Minnesota)
Chauvin Keith W. (University of Kansas)
Chintagunta Pradeep K. (University of Chicago)
Christiano Lawrence J. (Northwestern University)
Cochrane John (University of Chicago)
Coleman John (Duke University)
Constantinides George M. (University of Chicago)
Crain Robert (UC Berkeley)
Culp Christopher (University of Chicago)
Da Zhi (University of Notre Dame)
Davis Morris (University of Wisconsin)
De Marzo Peter (Stanford University)
Dubé Jean-Pierre H. (University of Chicago)
Edlin Aaron (UC Berkeley)
Eichenbaum Martin (Northwestern University)
Ely Jeffrey (Northwestern University)
Eraslan Hülya K. K.(Johns Hopkins University)
Faulhaber Gerald (University of Pennsylvania)
Feldmann Sven (University of Melbourne)
Fernandez-Villaverde Jesus(University of Pennsylvania)
Fohlin Caroline (Johns Hopkins University)
Fox Jeremy T. (University of Chicago)
Frank Murray Z.(University of Minnesota)
Frenzen Jonathan (University of Chicago)
Fuchs William (University of Chicago)
Fudenberg Drew (Harvard University)
Gabaix Xavier (New York University)
Gao Paul (Notre Dame University)
Garicano Luis (University of Chicago)
Gerakos Joseph J. (University of Chicago)
Gibbs Michael (University of Chicago)
Glomm Gerhard (Indiana University)
Goettler Ron (University of Chicago)
Goldin Claudia (Harvard University)
Gordon Robert J. (Northwestern University)
Greenstone Michael (Massachusetts Institute of Technology)
Guadalupe Maria (Columbia University)
Guerrieri Veronica (University of Chicago)
Hagerty Kathleen (Northwestern University)
Hamada Robert S. (University of Chicago)
Hansen Lars (University of Chicago)
Harris Milton (University of Chicago)
Hart Oliver (Harvard University)
Hazlett Thomas W. (George Mason University)
Heaton John (University of Chicago)
Heckman James (University of Chicago - Nobel Laureate)
Henderson David R. (Hoover Institution)
Henisz, Witold (University of Pennsylvania)
Hertzberg Andrew (Columbia University)
Hite Gailen (Columbia University)
Hitsch Günter J. (University of Chicago)
Hodrick Robert J. (Columbia University)
Hopenhayn Hugo (UCLA)
Hurst Erik (University of Chicago)
Imrohoroglu Ayse (University of Southern California)
Isakson Hans (University of Northern Iowa)
Israel Ronen (London Business School)
Jaffee Dwight M. (UC Berkeley)
Jagannathan Ravi (Northwestern University)
Jenter Dirk (Stanford University)
Jones Charles M. (Columbia Business School)
Kaboski Joseph P. (Ohio State University)
Kahn Matthew (UCLA)
Kaplan Ethan (Stockholm University)
Karolyi, Andrew (Ohio State University)
Kashyap Anil (University of Chicago)
Keim Donald B (University of Pennsylvania)
Ketkar Suhas L (Vanderbilt University)
Kiesling Lynne (Northwestern University)
Klenow Pete (Stanford University)
Koch Paul (University of Kansas)
Kocherlakota Narayana (University of Minnesota)
Koijen Ralph S.J. (University of Chicago)
Kondo Jiro (Northwestern University)
Korteweg Arthur (Stanford University)
Kortum Samuel (University of Chicago)
Krueger Dirk (University of Pennsylvania)
Ledesma Patricia (Northwestern University)
Lee Lung-fei (Ohio State University)
Leeper Eric M. (Indiana University)
Leuz Christian (University of Chicago)
Levine David I.(UC Berkeley)
Levine David K.(Washington University)
Levy David M. (George Mason University)
Linnainmaa Juhani (University of Chicago)
Lott John R. Jr. (University of Maryland)
Lucas Robert (University of Chicago - Nobel Laureate)
Luttmer Erzo G.J. (University of Minnesota)
Manski Charles F. (Northwestern University)
Martin Ian (Stanford University)
Mayer Christopher (Columbia University)
Mazzeo Michael (Northwestern University)
McDonald Robert (Northwestern University)
Meadow Scott F. (University of Chicago)
Mehra Rajnish (UC Santa Barbara)
Mian Atif (University of Chicago)
Middlebrook Art (University of Chicago)
Miguel Edward (UC Berkeley)
Miravete Eugenio J. (University of Texas at Austin)
Miron Jeffrey (Harvard University)
Moretti Enrico (UC Berkeley)
Moriguchi Chiaki (Northwestern University)
Moro Andrea (Vanderbilt University)
Morse Adair (University of Chicago)
Mortensen Dale T. (Northwestern University)
Mortimer Julie Holland (Harvard University)
Muralidharan Karthik (UC San Diego)
Nanda Dhananjay (University of Miami)
Nevo Aviv (Northwestern University)
Ohanian Lee (UCLA)
Pagliari Joseph (University of Chicago)
Papanikolaou Dimitris (Northwestern University)
Parker Jonathan (Northwestern University)
Paul Evans (Ohio State University)
Pejovich Svetozar (Steve) (Texas A&M University)
Peltzman Sam (University of Chicago)
Perri Fabrizio (University of Minnesota)
Phelan Christopher (University of Minnesota)
Piazzesi Monika (Stanford University)
Piskorski Tomasz (Columbia University)
Rampini Adriano (Duke University)
Reagan Patricia (Ohio State University)
Reich Michael (UC Berkeley)
Reuben Ernesto (Northwestern University)
Roberts Michael (University of Pennsylvania)
Robinson David (Duke University)
Rogers Michele (Northwestern University)
Rotella Elyce (Indiana University)
Ruud Paul (Vassar College)
Safford Sean (University of Chicago)
Sandbu Martin E. (University of Pennsylvania)
Sapienza Paola (Northwestern University)
Savor Pavel (University of Pennsylvania)
Scharfstein David (Harvard University)
Seim Katja (University of Pennsylvania)
Seru Amit (University of Chicago)
Shang-Jin Wei (Columbia University)
Shimer Robert (University of Chicago)
Shore Stephen H. (Johns Hopkins University)
Siegel Ron (Northwestern University)
Smith David C. (University of Virginia)
Smith Vernon L.(Chapman University- Nobel Laureate)
Sorensen Morten (Columbia University)
Spiegel Matthew (Yale University)
Stevenson Betsey (University of Pennsylvania)
Stokey Nancy (University of Chicago)
Strahan Philip (Boston College)
Strebulaev Ilya (Stanford University)
Sufi Amir (University of Chicago)
Tabarrok Alex (George Mason University)
Taylor Alan M. (UC Davis)
Thompson Tim (Northwestern University)
Tschoegl Adrian E. (University of Pennsylvania)
Uhlig Harald (University of Chicago)
Ulrich, Maxim (Columbia University)
Van Buskirk Andrew (University of Chicago)
Veronesi Pietro (University of Chicago)
Vissing-Jorgensen Annette (Northwestern University)
Wacziarg Romain (UCLA)
Weill Pierre-Olivier (UCLA)
Williamson Samuel H. (Miami University)
Witte Mark (Northwestern University)
Wolfers Justin (University of Pennsylvania)
Woutersen Tiemen (Johns Hopkins University)
Zingales Luigi (University of Chicago)
Zitzewitz Eric (Dartmouth College)

Dails Telegraph    26 Sep 2008

Don't disregard all structured products
Structured products have been roundly criticised by many fund managers,
but they may still have a place in some investors' portfolios
By Chris Taylor

These are turbulent times for long-term investors. The fund management industry has plenty of advice to offer, but investors themselves are voting with their feet. Investment Management Association (IMA) figures show £27.5bn in redemptions of UK-domiciled funds in 2008, to the end of May. Total fund outflows across  Europe in the first quarter of this year were €133bn (£106bn), according to Lipper Funds. In America, 24 out of 25 of the largest mutual fund providers saw assets decline during that three-month period.

Much of the money exiting funds is no doubt now in cash, but "safe haven'' sectors such as cautious managed funds and bonds have attracted investors. This highlights what investors are actively looking for.

However, more than any other sector, industry sales data is highlighting the appeal of structured investments to investors. Data from StructuredRetail shows European structured product sales of €263bn in 2007, up from €190bn in 2006, American sales were $114bn from $61bn and Asian sales were $116bn from $78bn. UK retail sales touched £7bn in 2007 and are on track  for £8bn to £ 10bn in 2008.

This highlights why the IMA has decided it needs to make the case for traditional funds, at the expense of structured investments.

Structured investments link to underlying assets and/or markets and provide investors with pre-defined levels of risk and performance potential. The benefits and advantages of a pre-defined and engineered formula approach to investing - not subject to the vagaries of  active fund management - are increasingly recognised by investors.

However, the IMA recently suggested that investors should be sceptical of financial engineering, and the costs of capital protection, taking the example of products from National Savings & Investments. Further, according to the IMA, mutual funds "manage risk'' through  "diversification'' and "time''.

I would claim that the IMA's analysis is simplistic because just one provider was used to castigate the entire industry. Such sweeping statements cannot be valid and the IMA would rightly not accept criticism of all its funds based on one provider.

The obvious fact is that there are leading providers and stellar funds in the traditional funds world, just as there are superior structured investment providers and value-adding structured investments in the structured products arena, products which maximise returns and  do so with capital protection or defined and controlled risk.

That is a key point. Mutual funds do not control risk. They might "manage risk'', as the IMA suggests, but they rely on diversification and time to do so. Claims to manage capital risk are wholly subject to the success of the managers' techniques - and much data shows most  funds fail against their own benchmarks.

Diversification is also tricky. Few investors are wealthy enough to invest across 30 IMA sectors - nor do all investors have the time for diversification to work.

It is misguided because superior structured investments provide intelligent solutions for investors - which explains why fund managers at IMA member firms use structured investments themselves. The IMA should consider this.

The IMA should also note that many investors only want to invest with the foresight of capital protection. Of course, protection can have a cost, as for any insurance.

But the IMA comments are also provocative because they are far from being in the best interests of investors. Some structured products are mediocre. But the same can be said about many funds. Especially in such a difficult investment climate, investors should be  differentiating within various investment sectors, and aligning the best strategies available.

Structured investments do deliver against benchmarks - what you see is what you get.

Chris Taylor is chief executive of Blue Sky Asset Management.    27. September 2008, 12:52

Die sieben Mythen zur Finanzkrise der USA
Von Sebastian Jost

Am Ende haben es alle gewusst: Weil Amerika die skrupellosen Finanzjongleure nicht rechtzeitig an die Leine genommen hat, ist die Wirtschaft jetzt am Ende. Doch die Totengräber der heutigen Finanz- und Wirtschaftsordnung könnten sich irren. WELT ONLINE räumt  auf mit den Mythen zur US-Finanzkrise.
1. Mehr Kontrolle ist die Rettung

Der Ruf nach mehr staatlicher Aufsicht hat sich zum parteiübergreifenden Dauerton entwickelt. Kanzlerin Merkel packt ihre Pläne vom vergangenen Jahr wieder aus, um Hedgefonds an die Leine zu nehmen, und Altkanzler Helmut Schmidt entwirft Pläne für eine  Weltfinanzaufsicht. Was sie alle zu übersehen scheinen: Hauptverantwortlich für diese Krise sind die Banken – und damit der am strengsten regulierte Teil des Wirtschaftssystems. Zumindest in der Theorie.

Denn in der Praxis haben die Aufseher weltweit versagt. Weder die amerikanische Notenbank Fed noch die sonst als besonders streng bekannte Börsenaufsicht SEC haben rechtzeitig erkannt, dass den Banken der schwungvolle Handel mit verbrieften Krediten über  den Kopf wuchs. Hierzulande ist die Bilanz der Aufseher nicht besser: Weder Bundesbank noch die Finanzaufsicht BaFin oder das Finanzministerium haben das Desaster kommen sehen, das sich bei der Staatsbank KfW und ihrer Tochter IKB anbahnte –obwohl es  frühzeitig Hinweise gab. Auch bei der SachsenLB ergab eine Prüfung kurz vor der Quasi-Pleite noch: alles okay!

Angesichts dessen ist es naiv zu glauben, es brauche nur weitere Kontrollregeln, um künftige Krisen zu vermeiden. Auch wenn einzelne Korrekturen wie höhere Eigenkapital-Rücklagen sinnvoll sind: Vor allem kommt es darauf an, bestehende Befugnisse der  Kontrolleure ordentlich umzusetzen. Dafür sollten sich die Aufseher gerade nicht in jedes Detail neuer Finanzprodukte einfuchsen müssen, sondern sich auf die zentralen Fragen konzentrieren: Womit verdient eine Bank ihr Geld, wo liegen ihre Risiken und was heißt das  für das Finanzsystem? „Solange die Polizei die Verkehrsregeln nicht effektiv überwacht“, sagt ein Bankenvorstand, „bringt es nichts, mehr Verkehrsschilder aufzustellen.“

2. Der Markt hat versagt

Politiker und Kommentatoren werten die Finanzkrise als Bankrotterklärung des freien Marktes. Und die große Mehrheit der Deutschen schließt sich in Umfragen diesem Urteil an. Schließlich haben die Investmentbanken reihenweise Bonussysteme geschaffen, die zur  Zockerei einladen. Allerdings hat der Staat kräftig dazu beigetragen, dass es überhaupt so weit kam. Die Immobilienfinanzierer Fannie Mae und Freddie Mac, die den Bauboom in Amerikas Vorstädten erst möglich gemacht haben, sind quasistaatliche Anstalten. Sie  handelten im Auftrag der Bush-Regierung, wenn sie jedem Amerikaner den Traum vom eigenen Haus erfüllen wollten. Dazu kam eine Notenbank, die unter ihrem legendären Chef Alan Greenspan ab dem Jahr 2001 den Markt mit Geld überschwemmte, um die  Wirtschaft anzukurbeln – womöglich auch, um Bushs Irakkrieg zu finanzieren, wie Wirtschaftsnobelpreisträger Joseph Stiglitz ätzt. „Alan Greenspan hat die Krise erfunden“, sagt Bankenprofessor Wolfgang Gerke.

3. Gewinne wurden privatisiert, Verluste werden sozialisiert

Auf den ersten Blick ist allein der Steuerzahler der Dumme. Jahrelang haben Wall-Street-Banker Millionengehälter kassiert – und nun ist es der Staat, der 700 Milliarden Dollar aufbringen soll, um das Finanzsystem zu retten. „Wir setzen ein System fort, bei dem die  Gewinne privatisiert und die Verluste sozialisiert werden“, sagt der New Yorker Ökonom Nouriel Roubini.

Auch wenn die Finanzkrise für die Steuerzahler fraglos zu einem Fiasko zu werden droht: Es ist nicht richtig, dass sie allein drauflegen. Zehntausende Banker von der Wall Street verlieren ihren Job. Und: Gerade in den Top-Positionen wurden die Verantwortlichen in  der Regel zu einem großen Teil in Aktien bezahlt. Da diese in der Regel erst nach zwei bis drei Jahren verkauft werden dürfen, haben die Boni erheblich an Wert verloren. Die Kursverluste treffen auch die übrigen Anteilseigner der Banken. So soll das Vermögen von  Maurice Greenberg, dem langjährigen Chef des nun quasi verstaatlichten Versicherers AIG, seit Januar 2007 von 1,25 Milliarden auf 50 Millionen Dollar geschrumpft sein.

Außerdem: Von den billigen Häuserkrediten in der Immobilienblase haben Millionen Amerikaner über Jahre profitiert. Und die 700 Milliarden Dollar, mit denen Finanzminister Henry Paulson jetzt Problempapiere aufkaufen will, werden nicht komplett verloren sein. Wie  groß das Verlustgeschäft für den amerikanischen Steuerzahler wird, ist daher noch offen.

4. Der Staat wird es jetzt richten

Die Finanzkrise hat die öffentliche Hand in den USA zu einer gigantischen Finanzholding gemacht. Die Regierung kontrolliert die Hypothekenfinanzierer Fannie Mae und Freddie Mac, die Notenbank Fed AIG. Und Experten wie der Wirtschaftsweise Peter Bofinger  fordern als nächsten Schritt bereits eine Verstaatlichung von Ratingagenturen. Doch nichts deutet darauf hin, dass die USA nun deutsche Verhältnisse kopieren werden – hierzulande liegt der Staatsanteil im Bankensektor bei 50 Prozent. „Die Rettungsaktionen der US- Regierung sind zu vergleichen mit einem Feuerwehreinsatz“, sagt der Frankfurter Bankenprofessor Jan Pieter Krahnen. Dass Paulson und Bernanke dabei Aktien einkassieren, ist nur der Ausgleich für die Milliardenhilfen – so hat der Steuerzahler die Chance, über  einen späteren Wiederverkauf einen Teil des Geldes zurückzubekommen. Schließlich haben die USA auch die nach der „Savings & Loan“-Krise in den 80er-Jahren verstaatlichten Institute zügig wieder privatisiert.

5. Amerika wird sozialistisch

Paulsons Feuerwehreinsätze werden von zahlreichen Kommentatoren als Zeitenwende interpretiert. „Die Krise ist das Ende der Ideologie, dass freie, deregulierte Märkte immer funktionieren“, sagt Ökonom Joseph Stiglitz. Er schreibt dem Bush-Kabinett die  „sozialistischsten Regierungsakte seit Jahrzehnten“ zu. Nur: Selbst glühende Verfechter freier Märkte haben kaum etwas gegen die Rettungsaktionen einzuwenden. Schon der Vater des Ordoliberalismus, der deutsche Ökonom Walter Eucken, warnte den Staat  ausdrücklich davor, die Wirtschaft sich selbst zu überlassen. Dass die Regierung bei existenziellen Krisen eingreift, gehört zum modernen Verständnis einer Marktwirtschaft – solange die der Staat nicht zum dauerhaften Machtzentrum im Wirtschaftsleben wird. „Die völlig  freie Marktwirtschaft ist ein Mythos“, sagt Stig?litz. Genau deswegen macht aber auch ein „sozialistischer Akt“ noch keinen Sozialismus.

6. Die Investmentbanken sind tot, es lebe die Universalbank

Die Finanzkrise hat die Hackordnung an der Wall Street auf den Kopf gestellt. Von fünf stolzen unabhängigen Investmentbanken sind nur zwei übrig geblieben, und selbst die – Goldman Sachs und Morgan Stanley – haben sich offiziell in normale Geschäftsbanken  umgewandelt. Ökonomenrebell Roubini ruft bereits das Ende der „Schattenbanken“ aus und den Beginn einer neuen Ära, in der Universalbanken mit mehreren Sparten den Ton angeben. Das gängige Argument dafür: Banken mit Zugang zum Privatkundengeschäft  sind stabiler, weil sie nicht darauf angewiesen sind, sich ständig Geld am Kapitalmarkt zu leihen. Doch wenn dieses Postulat absolut gelten würde, gäbe es noch eine Bank namens Washington Mutual. Tatsächlich ist die einst führende Sparkasse der USA jetzt  zusammengebrochen, weil die Kunden ihre Einlagen abzogen – sie trauten der Bank nicht mehr. „Jede Bank geht unter, wenn sie kein Vertrauen mehr genießt“, sagt der Bankenprofessor Martin Weber von der Universität Mannheim. Dazu kommt: Die Krisenbilanz  großer Universalbanken wie Citi oder UBS ist äußerst bescheiden.

7. Die Spekulanten sind schuld

Spekulanten sind als Sündenböcke bei Politikern und Konzernchefs gleichermaßen beliebt. Sie haben, so der Vorwurf, zunächst den Preisverfall bei verbrieften Hypothekenkrediten angeheizt und parallel auch noch auf sinkende Kurse bei Bankaktien gewettet. Richtig  ist, dass einzelne Aktien in den vergangenen zwei Wochen auch wegen solcher Aktionen um mehr als 50 Prozent eingebrochen sind. Doch auch ohne Spekulanten wären sie abgestürzt, wenngleich in geringerem Ausmaß. Peer Steinbrück pflegt dennoch das alte  Feindbild und will Spekulationen auf sinkende Kurse verbieten.

Die meisten Experten schütteln da nur den Kopf: Solche Leerverkäufe gehörten zu einem funktionierenden Kapitalmarkt, sagt Martin Weber: „Wenn der Preis überhöht ist, muss dagegen handeln dürfen.“ Die Kursblase am Neuen Markt zu Beginn des Jahrtausends  wäre kleiner ausgefallen, wenn Leerverkäufe schon verbreitet gewesen wären. So gesehen hätte der US-Hypothekenmarkt eher mehr als weniger Spekulation gebraucht – allerdings in die richtige Richtung.


September 27, 2008, 5:48 pm

An Alternative Way to Save the (Financial) World
By Joe Nocera

In my column this week — which is basically a plea for Congress to agree to the Paulson plan before the markets open on Monday morning — I spend a few paragraphs introducing an idea by Andrew Feldstein, who runs Blue Mountain Capital Management, a hedge fund that specializes in credit instruments.

I got to know Mr. Feldstein and his partner Stephen Siderow a few years ago, and found them to be among the smartest — and most sensible — people on Wall Street. Mr. Feldstein has a way of proposing solutions to problems that are striking for their originality. His notion — that the government should establish a “good bank” to buy solid assets, instead of a $700 billion fund to buy bad assets — certainly qualifies.

Although the Paulson plan will almost surely be approved by the end of the weekend, I still think Mr. Feldstein’s idea is worth exploring. Here is a memo he wrote a few days ago explaining it in more detail:

The main thrust of the Administration’s proposal is for the government to buy “bad assets” from financial institutions, thereby cleaning up toxic balance sheets and creating “good banks”, restoring investor confidence and restarting the flow of credit through the broken financial intermediation system. In this approach the government owns the bad bank.

The government has two valid objectives. Provide assistance to struggling homeowners; and stabilize the US financial system, which is tilting toward a meltdown of epic proportions. Of course the objectives are related. Banks are struggling in large part due to defaulting mortgage borrowers. Support to those borrowers might improve asset quality. At the same time, the credit freeze is disabling corporations and consumers, undermining the economy, which further worsens the prospects for all Americans.

Concerns and criticisms can be grouped into five related categories
- Price discovery
- Valuation conflict
- Risk/return to tax payers
- Rewarding the perpetrators
- Uncertainty whether the plan benefits Main Street as well as Wall Street

How will the price of heterogeneous, complex, illiquid assets be determined? Even if the prices were susceptible to easy valuation, what should the government pay? If the government pays anything approaching market value, it would likely result in significant write downs to the sellers (because most have not fully written down their troubled assets). Further write downs will further impair the reported capital of the sellers, making it even harder for them to intermediate liquidity between savers (or the Fed) and borrowers. But overpaying for the asset versus fair market value will reward the perpetrators to the detriment of the taxpayer. Finally, how can the government be sure that proceeds from the asset sales will find their way to individual borrowers? What if the selling banks simply use the proceeds to recapitalize, hunker down and weather the storm?

It might be more productive to separate the two objectives. Assistance to struggling mortgage borrowers might be provided directly (as opposed to hoping that indirect assistance via struggling banks will find its way to the desired place).

A better way to achieve the objectives of restoring financial stability might be to adopt the inverse of the Administration’s proposal. That is, create a new “good bank” owned in whole or part by the government.

- Create a new entity with access to the Fed discount window and other liquidity facilities (all secured by good collateral)

- The good bank’s mandate will extend to high quality assets only. Corporate bonds and loans, prime mortgages, etc. To ensure a limited life to the entity, and avoid competition with private sector banks, this good bank would only purchase assets originated prior to September, 2008.

- With $300bn of equity capital the fed might provide leverage of 20x (again only against good collateral). This would provide $6 trillion of balance sheet for “good assets”. The government could provide some or all of the initial equity capital – creating upside for taxpayers when the government later sells its stake. There would likely be strong interest from private investors in the equity capital of this institution.

- Highly qualified managers could be induced to manage this new entity through a combination of equity stake and commitment to public service. Indeed a number of investment managers have offered to manage assets acquired through a government assistance program on a nonprofit basis.

- There is much less confusion around valuation of good assets. And demand for the assets would quickly meet supply, allowing the market to set a clearing price.

- Now credit would again flow to deserving borrowers (whether those be corporate or consumer). That flow is currently interrupted because the traditional intermediation system (banks) are broken. It’s as if the highway connecting savers and good borrowers had a huge traffic jam preventing the savings from getting through. The Federal Reserve has tried in vain to get liquidity through the broken banking system, but it’s like trying to send an ambulance through the traffic jam. The government is trying to clean up the traffic jam by towing away the broken cars. A better approach might be to build a detour around the traffic jam.

- This would present much lower risk to the taxpayer and not reward the perpetrators (as the toxic assets stay with their original owners).

- It would increase the likelihood that truly bad banks would go under. But at least there will be a market into which they could sell their good assets as they liquidate or are combined into solvent entities.

- It would also stabilize banks that are fundamentally sound but are “under attack”. By creating this “new balance sheet”, fundamentally healthy banks could more easily de-lever without incurring capital destroying write downs (sound banks have predominantly good assets which they presently cannot sell because the credit markets have seized up for all assets).

- It also creates meaningful upside to the taxpayer, as the bank could ultimately be sold (probably in the very near term) at much lower risk.

Finally, it would leave the government which substantially more resources to devote in direct assistance to struggling borrowers.

editorial    September 27, 2008 03:00

In praise of free markets

THE FINANCIAL SYSTEM HAS REACHED the point of maximum peril. After years of profligacy, banks have all but stopped lending to each other as the US Congress decides whether to extend support. If the unravelling of the banking system continues, the economic consequences will be dire.

Yet there is an even greater risk: that the politicians now contemplating Wall Street's follies draw the wrong conclusions and take the wrong decisions, losing their confidence in markets altogether.

It would not be the first time. After the Wall Street Crash, markets were deemed to have failed and US lawmakers attempted to regulate short-cuts through the crisis. The widely copied Smoot-Hawley Tariff Act quadrupled the effective tax rate on thousands of imports and deepened the "Great Contraction" of 1929 to 1933. The price of popular anti-market sentiment was much higher in some of Europe's fledgling democracies: fascism.

Despite the severity of the current crisis, such extreme reactions remain very unlikely. Yet there is plenty of room for policymakers to compound the damage already inflicted by the irresponsible conduct of the financial sector. It is time, then, to remember what open markets have achieved, and what lies in wait for societies that suppress them.

It is no help that some of the loudest critics have little interest in what went wrong, less in how to fix it, and none at all in safeguarding against problems in future. Rowan Williams, the archbishop of Canterbury, this week applauded the UK government's ban on short selling. His colleague, John Sentamu, declared that the short sellers of bank shares were "clearly bank robbers and asset strippers". These are the words of a well-meaning man who can see no moral or practical difference between a car thief, a scrap-yard mechanic, and a person who insures a car and thus profits if it is stolen.

Andrew Cuomo, New York's Attorney General, went one step further - "looters after a hurricane" was his ill-judged analogy. Are short sellers also to be shot by the National Guard? The trouble with such sentiments is that they solve nothing.

Criticise in metaphors - "unbridled capitalism"; "unfettered greed" - and you duck the tiresome task of specifying what bridles and fetters you have in mind.

Consider the Washington rescue package first. Why should taxpayers bail out millionaire bankers, and what should we force them to give back in return? Those are natural questions but not the only ones. We should also ask whether taxpayers will profit, directly or indirectly, from spending money to shore up the banking system. The answer is "yes". The system is close to collapse, and the consequences of collapse would be misery for Main Street. Profitable businesses and creditworthy consumers would suffer. A successful rescue would prevent that and there is even a small chance that it would be profitable in its own right. That is the justification for the rescue. Congress was right to scrutinise it - especially its lack of oversight - but has become distracted by a desire to clip Wall Street's wings.

The case for more effective regulation is nevertheless undeniable. It is hard to defend a system where top banking executives walk away with millions in compensation when their businesses are, in retrospect, fundamentally flawed. This looks like a reward for failure. We have witnessed two financial crises - the dotcom crash and the current banking disaster - in the first decade of this century. That is hardly a record which inspires confidence in the current efficiency of capital markets or their transparency.

The current crisis is routinely described as a symptom of deregulation, but it is equally the child of earlier, ill-fated interventions. Subprime mortgages grew because the prime mortgage sector was dominated by Fannie Mae and Freddie Mac, two institutions founded, regulated and effectively underwritten by the government. Securitisation was an effort to sidestep capital requirements. But it also created instruments that few could understand and, in Warren Buffett's prophetic words, really were " financial weapons of mass destruction".

Capital markets clearly need better regulation but policymakers should guard against unintended consequences. Markets are places of trial and, very frequently, error. Their genius is not perfect efficiency, but the rewarding of success and the weeding out of failure. No better alternative has ever presented itself.

This is a difficult time to defend free markets. Nevertheless they must be defended, not only on their matchless record when it comes to raising living standards, but on the maxim that it is wise to let adults exercise their own judgment.

Market freedom is not a "fundamentalist religion". It is a mechanism, not an ideology, and one that has proved its value again and again over the past 200 years. The Financial Times is proud to defend it - even today.

Washington Post    September 28, 2008

How J.Pierpont Morgan defused the 1907 Wall Street panic
Here's How It's Done, Hank:
A Parable From a Crisis of a Century Ago.
By Jean Strouse

Watching the Sunday morning talk shows last week, I found myself sympathizing with Henry Paulson. It's not that the Treasury secretary needs me to feel his pain, though he did look completely exhausted and had scarcely any voice left. My concern derived from having "lived" through the Panic of 1907 with J. Pierpont Morgan.

Over the calamitous past couple of weeks, I've heard people ask in despairing jest, "Where's J.P. Morgan now that we really need him?" In today's immense and vastly complex financial markets, no one man could play the role that Morgan played at the beginning of the 20th century, when, by persuasion, fiat, threat, loan and sheer force of character, he managed to stop a full-fledged panic.

If Morgan were looking on today, from wherever he is, as value and dollars disappear in a miasma of securitized subprime loans and credit default swaps, he might be thinking how relatively easy he'd had it. For the most part, he could see what he was bailing out. He didn't have to answer to Congress or the press -- at least not right away -- or deal with presidential politics. He might be amused to see the descendant of his firm, now called J.P. Morgan Chase, as the buyer of last resort for such companies as Bear Stearns and Washington Mutual. And he'd probably be invisibly backing Paulson and Federal Reserve Chairman Ben S. Bernanke as they try to unlock seized-up credit markets.

A hundred and one years ago, in another early autumn, a worldwide credit shortage had been roiling global markets for months. The 9-year-old Dow Jones industrial average had lost 25 percent of its value in the first three months of the year, and the U.S. stock market had crashed in March, in spite of record corporate earnings. That spring, banks failed all over Japan, the Egyptian stock market collapsed, and the city of San Francisco could not float a loan. After the U.S. stock market tanked again in August, the New York Times estimated the losses at $1 billion (roughly $15 billion in today's dollars -- quaint sums in light of the proposed $700 billion bailout but enormous at the time).

What set a match to the tinder in October 1907 was a run on New York trust companies. Morgan, 70 years old and the most powerful private banker in the world, was attending an Episcopal Church convention in Richmond when the panic started: An attempt by speculators to corner the stock of a copper company failed, and as word got out that trust companies had made loans to the speculators, people with money on deposit at the trusts lined up to take it out. The trust companies, the weakest link in the financial system, operated like commercial banks -- accepting deposits, issuing loans and financing speculative schemes -- only with no regulatory supervision or mandated reserves.

Morgan's partners kept him apprised of the situation by messenger and by wire but insisted that he not return to New York early since a sudden change in his plans might cause further panic. When he did return, arriving early Sunday morning, Oct. 20, he went straight to his private library on East 36th Street. There his partners brought him up to date. Reporters stationed themselves across the street. Bankers stopped by all day and into the night as Morgan gathered information and resources.

He left no record of his thoughts during this crisis. Neither intellectual nor introspective, he was, as Henry Adams said of Theodore Roosevelt, "pure act." But he knew from long experience how quickly a few big failures could lead to cascading disaster. The Fed did not yet exist, and for two decades, Morgan had been acting as the country's unofficial lender of last resort, quietly working to amass reserves and supply capital to the markets in periods of crisis.

Late that Sunday night, Treasury Secretary George Cortelyou sent word: The government would deposit $6 million in New York's banks. President Theodore Roosevelt was off shooting game in the Louisiana canebrakes. He told a reporter on Oct. 20: "We got three bears, six deer, one wild turkey, twelve squirrels, one duck, one opossum and one wildcat. We ate them all, except the wildcat."

By the time the meetings at the library broke up early Monday morning, Morgan had appointed two groups of men to handle whatever came next: a high command consisting of himself, George Baker, head of the First National Bank, and James Stillman of National City Bank -- and three young lieutenants who would supply the senior trio with information. Their first job was to determine which trust companies were essentially healthy and could be saved with fresh infusions of cash, and which were hopelessly overextended and should be allowed to fail.

The Morgan team did not have enough time to study the most besieged of the trusts, the Knickerbocker, which shut its doors on Tuesday. Banks around the country began withdrawing money from New York. Stock prices plummeted. The Treasury secretary took an afternoon train to Manhattan. Morgan came down with a heavy cold.

The next domino to totter was the Trust Company of America. The young bankers working for Morgan had examined its books and determined that although the company's surplus was gone, its assets were essentially intact. The bankers traded cash for collateral. TCA stayed open.

On Thursday, the panic spread to the Stock Exchange. Financial institutions calling in loans were choking off the market's money supply. Stock prices plunged. At 1:30 p.m., the Exchange president told Morgan that he would have to suspend operations before the 3 p.m. close. Out of the question, said Morgan: He would find money to lend the brokers. He summoned the presidents of New York's major commercial banks to his office and quickly came up with $23.5 million. He sent word to the trading floor. "The rebound was instantaneous," reported the Times.

Saturday's newspapers reported that $5 million in gold would be sent from London, that confidence had returned to the French Bourse "owing to the belief that the strong men in American finance would succeed in their efforts to check the spirit of the panic," and that "J.P. Morgan has a cold."

The old man, who hadn't slept more than five hours a night all week, spent most of the weekend at home. Roosevelt had been on the sidelines while Morgan handled the crisis. On Sunday, the newspapers published a letter from the president saying that the fundamentals of the economy were sound.

Still, the bankers had to bail out a near-bankrupt New York City, and the trust companies, source of the original trouble, weren't in the clear. Sunday night, Nov. 3, Morgan gathered 50 trust company presidents at his library, told them they had to come up with $25 million on their own and left them in a large room filled with Renaissance bronzes, Gutenberg Bibles and tiers of books. He withdrew to his librarian's office. At 3 a.m., he called in one of his sleep-deprived lieutenants, Ben Strong, for a review of a trust company's books. Strong gave his report, then headed to the library's front doors and found them locked. Morgan had the key in his pocket. No one would leave until the trusts ponied up. The presidents continued to talk. At 4:15, Morgan walked in with a statement requiring each trust company to share in a new $25 million loan. One of his lawyers read it aloud, then set it on a table. "There you are, gentlemen," said Morgan.

No one moved.

Morgan took the arm of Edward King, the head of the Union Trust, and drew him to the table. "There's the place, King," he said, "and here's the pen." King signed. The other presidents signed. They set up a committee to handle the loan and supervise the final-stage bailouts of endangered trusts. At 4:45, the library's heavy brass doors swung open and let the bankers out.

As the stock market rallied and gold began to arrive from Europe, the two long weeks of crisis came to an end. For a moment, Morgan was a national hero. Crowds cheered as he walked down Wall Street, and world leaders saluted his achievement. The next moment, however, the exercise of that much power by one private citizen terrified a nation of democrats and revived America's longstanding distrust of plutocrats and concentrated wealth.

The 1907 panic convinced the country that its financial welfare could no longer be left in private hands. It led to the establishment of a National Monetary Commission and ultimately, in 1913, nine months after Morgan died, to the founding of the Federal Reserve.

Morgan had a strong sense of financial public duty, but he wasn't acting as proto-Fed out of pure altruism: The people he represented had billions of dollars invested in the emerging U.S. economy. Critics who thought he had engineered the panic for his own profit would have been surprised to learn that his U.S. firms lost $21 million in 1907. The crisis itself was relatively brief, but it brought on a severe nationwide contraction that destroyed not only speculative ventures but healthy banks and businesses as well, and threw people all over the country out of work -- a scenario that everyone working around the clock to resolve the crisis of 2008 has to hope will not sound familiar down the line.

Jean Strouse is the author of "Morgan, American Financier" and director of the Dorothy and Lewis B. Cullman Center for Scholars and Writers at the New York Public Library.

Washington Post    September 28, 2008

Seen in Light of the Evolution of American Capitalism
Everybody Calm Down.
A Government Hand In the Economy Is as Old as the Republic.
By Robert J. Shiller

It has become fashionable to fret that the current crisis on Wall Street marks the end of American capitalism as we know it. "This massive bailout is not the solution," Sen. Jim Bunning (R-Ky.) warned Tuesday. "It is financial socialism, and it is un-American." It is neither. The near-collapse of the U.S. financial system and Washington's sudden and massive intervention to try to shore it up certainly mark a major turning point, but a bailout would represent a thoroughly American next step for our economic system -- and one that will probably lead to better times.

Americans may assume that the basics of capitalism have been firmly established here since time immemorial, but historical cataclysms such as the Great Depression strongly suggest otherwise. Simply put, capitalism evolves. And we need to understand its trajectory if we are to bring our economic system into greater accord with the other great source of American strength: the best principles of our democracy.

No, our economy is not a shining example of pure unfettered market forces. It never has been. In his farewell address back in 1796, 20 years after the publication of Adam Smith's "The Wealth of Nations," George Washington defined the new republic's own distinctive national economic sensibility: "Our commercial policy should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences; consulting the natural course of things; diffusing and diversifying by gentle means the streams of commerce, but forcing nothing." From the outset, Washington envisioned some government involvement in the commercial system, even as he recognized that commerce should belong to the people.

Capitalism is not really the best word to describe this arrangement. (The term was coined in the late 19th century as a way to describe the ideological opposite of communism.) Some decades later, people began to use a better term, "the American system," in which the government involved itself in the economy primarily to develop what we would now call infrastructure -- highways, canals, railroads -- but otherwise let economic liberty prevail. I prefer to call this spectacularly successful arrangement "financial democracy" -- a largely free system in which the U.S. government's role is to help citizens achieve their best potential, using all the economic weapons that our financial arsenal can provide.

So is the government's bailout a major departure? Hardly. Today's federal involvement offers bailouts as a strictly temporary measure to prevent a system-wide financial calamity. This is entirely in keeping with our basic principles -- as long as the bailout promotes, rather than hinders, financial democracy.

Which, so far, it seems to. Congressional critics may be right to demand more help for homeowners and more accountability for Wall Street blunders, but the core idea of the plan is sound: to protect the financial infrastructure. Remember, Fannie Mae used to be a government entity, and by taking it over, the federal government is merely returning to the status quo ante. The measures to take toxic debts off the hands of financial and insurance firms are intended only to deal with a crisis, not to transform our financial system. The proposals do not represent any landmark change in the American way of prosperity. Everyone should take a deep breath. Changing our thinking about finance does not mean abolishing capitalism, but it does raise questions about what the changes mean.

Whenever the public endures a crisis, ordinary citizens start to wonder how -- and whether -- our institutions really work. We no longer take things for granted. It is only then that real change becomes possible.

So the current crisis got me thinking back to 1990, the year before the collapse of the Soviet Union, when I worked with two Soviet economists, Maxim Boycko and Vladimir Korobov, to try to understand the different belief systems in their country and mine. We carried out identical surveys in Moscow and New York, comparing answers about fundamental notions of capitalism, and published our results in the American Economic Review. We expected to find that the Muscovites possessed scant understanding of how capitalism really works. But we found that they actually understood free-market dynamics better than the New Yorkers. We concluded that the Muscovites had proved more savvy precisely because their system was in crisis -- something that encouraged them to rethink their most fundamental notions.

We Americans are going through a similar change right now. We no longer think that our financial future will be determined by securities brokers or inhumanly large investment banks. The most important question is not, "What form should these temporary bailouts take?" It is, "What are we really learning from all this?"

We should be learning a great deal. The current crisis offers us a singular opportunity to reevaluate fundamentally the safety and permanence of the master financial institutions that we have come to take for granted as part of the national economic landscape. Over these past few turbulent weeks, we have learned that the monolithic investment banks are mortal: They are mostly gone, or absorbed by other banks. We have learned that what we called "cash" and considered perfectly safe is not necessarily so secure.

So we are groping around for something else to trust. We should be open to thinking about a new set of financial arrangements -- a better financial democracy -- that can restore the public's faith in the economic principles espoused by Washington more than two centuries ago. Here are some key features:

1. Handle moral hazard better. The term "moral hazard" refers to the pernicious tendency some people have of failing deliberately if they think it's advantageous to do so. Moral hazard is used to justify teaching people a lesson for their failures -- the same logic that once justified "debtors' prisons." (Yes, we really did have them.) But over the course of the 19th century, Americans grew more realistic about laying blame for economic catastrophes and started eyeing other parties besides the hapless and the bankrupt. The demise of the debtors' prisons reflected Americans' changing ideas about the meaning of a contract.

By rescuing Wall Street tycoons who succumbed to the lure of an irrationally exuberant housing bubble, the bailouts today do pose something of a moral-hazard problem. But we can more than repair it by defining a new generation of financial contracts, with a continuation of our evolving thinking about moral hazard, reflecting greater enlightenment, greater understanding of human psychology and the means to deal with financial failure. For example, I have proposed replacing the conventional mortgage with what I call the "continuous-workout mortgage" -- one that would spell out in advance the conditions under which borrowers would see their debt reduced in a rocky economy. These conditions would be designed to minimize moral hazard: The borrowers would not be able to make the debt reduction happen deliberately.

2. To limit risks to the system, build better derivatives. Some of today's derivatives -- the complex bundles of toxic real estate loans that helped drag Lehman Brothers down -- turned out to be "financial weapons of mass destruction," as the legendary investor Warren E. Buffett warned back in 2003. The problem isn't derivatives per se but a certain kind -- derivatives that spun a massive web of over-the-counter contracts, relying on the solvency of countless banks and other institutions, and ultimately endangered the entire financial system when they fell apart. Some kinds of derivatives, such as those maintained by futures exchanges using procedures that effectively eliminate the risk that the other party in the agreement will default, are more useful -- and far safer -- than others. It is high time to redesign derivatives to avoid what Buffett called "mega-catastrophic" risks.

3. Trust markets, not Wall Street titans. If institutions can be said to have charisma, such giants as Lehman Brothers and Merrill Lynch certainly had it in spades. But these firms proved not to be the sole source of financial intelligence. They were merely meeting places for smart, financially savvy people -- and for some reckless folks besides. We need to learn to trust people and markets rather than institutions. This means developing better markets that will allow us to hedge against the kinds of risks that dragged us into this crisis, such as real estate gambles.

4. Ideas matter. Maybe next time, we will listen more closely to financial theorists who think in abstract, general terms. Consider the Long-Term Capital Management debacle in 1998, when the Federal Reserve leaned on financial titans to rescue a massive hedge fund and stave off global fallout. Lots of people hold that the moral of the LCTM story was the failed thinking of two of the firm's founders, Robert Merton and Myron Scholes, both of whom were Nobel Prize-winning financial theorists. In fact, the collapse of LTCM was largely due to the overconfidence of bond trader John Meriwether and some of his other LTCM colleagues, who were gambling in the markets. The disgraced Merton has been working for the last decade trying to build better risk-management systems, mostly to little avail. Maybe he will be heard now. People still seem to want to trust businessmen who have made bundles and have a huge investment bank behind them, rather than listen to experts who are thinking about the fundamentals of risk management. We would have been better off this month if we'd been ignoring the former and listening to the latter.

These and other improvements in the contemporary economy -- a better financial information infrastructure (so that people can gauge risks better), broader markets (so that people can manage big risks, such as real estate loans) and better retail products (such as continuous-workout mortgages) -- will need to be discussed, debated and delivered in the days ahead. If we move smartly, Americans can have a better, more robust financial democracy along the lines of the system envisioned by our first president. The current crisis does not mean the end of American capitalism. But if we are lucky, it will mean an important step in its evolution.    Robert J. Shiller is a professor of economics at Yale and chief economist of MacroMarkets LLC. His books include "Irrational Exuberance" and, most recently, "The Subprime Solution: How Today's Global Financial Crisis Happened and What to Do About It."

September 28, 2008

Wall Street, R.I.P.: The End of an Era, Even at Goldman

WALL STREET. Two simple words that — like Hollywood and Washington — conjure a world.

A world of big egos. A world where people love to roll the dice with borrowed money. A world of tightwire trading, propelled by computers.

In search of ever-higher returns — and larger yachts, faster cars and pricier art collections for their top executives — Wall Street firms bulked up their trading desks and hired pointy-headed quantum physicists to develop foolproof programs.

Hedge funds placed markers on red (the Danish krone goes up) or black (the G.D.P. of Thailand falls). And private equity firms amassed giant funds and went on a shopping spree, snapping up companies as if they were second wives buying Jimmy Choo shoes on sale.

That world is largely coming to an end.

The huge bailout package being debated in Congress may succeed in stabilizing the financial markets. But it is too late to help firms like Bear Stearns and Lehman Brothers, which have already disappeared. Merrill Lynch, whose trademark bull symbolized Wall Street to many Americans, is being folded into Bank of America, located hundreds of miles from New York, in Charlotte, N.C.

For most of the financiers who remain, with the exception of a few superstars, the days of easy money and supersized bonuses are behind them. The credit boom that drove Wall Street’s explosive growth has dried up. Regulators who sat on the sidelines for too long are now eager to rein in Wall Street’s bad boys and the practices that proliferated in recent years.

“The swashbuckling days of Wall Street firms’ trading, essentially turning themselves into giant hedge funds, are over. Turns out they weren’t that good,” said Andrew Kessler, a former hedge fund manager. “You’re no longer going to see middle-level folks pulling in seven- and multiple-seven-dollar figures that no one can figure out exactly what they did for that.”

The beginning of the end is felt even in the halls of the white-shoe firm Goldman Sachs, which, among its Wall Street peers, epitomized and defined a high-risk, high-return culture.

Goldman is the firm that other Wall Street firms love to hate. It houses some of the world’s biggest private equity and hedge funds. Its investment bankers are the smartest. Its traders, the best. They make the most money on Wall Street, earning the firm the nickname Goldmine Sachs. (Its 30,522 employees earned an average of $600,000 last year — an average that considers secretaries as well as traders.)

Although executives at other firms secretly hoped that Goldman would once — just once — make a big mistake, at the same time, they tried their darnedest to emulate it.

While Goldman remains top-notch in providing merger advice and underwriting public offerings, what it does better than any other firm on Wall Street is proprietary trading. That involves using its own funds, as well as a heap of borrowed money, to make big, smart global bets.

Other firms tried to follow its lead, heaping risk on top of risk, all trying to capture just a touch of Goldman’s magic dust and its stellar quarter-after-quarter returns.

Not one ever came close.

While the credit crisis swamped Wall Street over the last year, causing Merrill, Citigroup and Lehman Brothers to sustain heavy losses on big bets in mortgage-related securities, Goldman sailed through with relatively minor bumps.

In 2007, the same year that Citigroup and Merrill cast out their chief executives, Goldman booked record revenue and earnings and paid its chief, Lloyd C. Blankfein, $68.7 million — the most ever for a Wall Street C.E.O.

Even Wall Street’s golden child, Goldman, however, could not withstand the turmoil that rocked the financial system in recent weeks. After Lehman and the American International Group were upended, and Merrill jumped into its hastily arranged engagement with Bank of America two weeks ago, Goldman’s stock hit a wall.

The A.I.G. debacle was particularly troubling. Goldman was A.I.G.’s largest trading partner, according to several people close to A.I.G. who requested anonymity because of confidentiality agreements. Goldman assured investors that its exposure to A.I.G. was immaterial, but jittery investors and clients pulled out of the firm, nervous that stand-alone investment banks — even one as esteemed as Goldman — might not survive.

“What happened confirmed my feeling that Goldman Sachs, no matter how good it was, was not impervious to the fortunes of fate,” said John H. Gutfreund, the former chief executive of Salomon Brothers.

So, last weekend, with few choices left, Goldman Sachs swallowed a bitter pill and turned itself into, of all things, something rather plain and pedestrian: a deposit-taking bank.

The move doesn’t mean that Goldman is going to give away free toasters for opening a checking account at a branch in Wichita anytime soon. But the shift is an assault on Goldman’s culture and the core of its astounding returns of recent years.

Not everyone thinks that the Goldman money machine is going to be entirely constrained. Last week, the Oracle of Omaha, Warren E. Buffett, made a $5 billion investment in the firm, and Goldman raised another $5 billion in a separate stock offering.

Still, many people say, with such sweeping changes before it, Goldman Sachs could well be losing what made it so special. But, then again, few things on Wall Street will be the same.

GOLDMAN’S latest golden era can be traced to the rise of Mr. Blankfein, the Brooklyn-born trading genius who took the helm in June 2006, when Henry M. Paulson Jr., a veteran investment banker and adviser to many of the world’s biggest companies, left the bank to become the nation’s Treasury secretary.

Mr. Blankfein’s ascent was a significant changing of the guard at Goldman, with the vaunted investment banking division giving way to traders who had become increasingly responsible for driving a run of eye-popping profits.

Before taking over as chief executive, Mr. Blankfein led Goldman’s securities division, pushing a strategy that increasingly put the bank’s own capital on the line to make big trading bets and investments in businesses as varied as power plants and Japanese banks.

The shift in Goldman’s revenue shows the transformation of the bank.

From 1996 to 1998, investment banking generated up to 40 percent of the money Goldman brought in the door. In 2007, Goldman’s best year, that figure was less than 16 percent, while revenue from trading and principal investing was 68 percent.

Goldman’s ability to sidestep the worst of the credit crisis came mainly because of its roots as a private partnership in which senior executives stood to lose their shirts if the bank faltered. Founded in 1869, Goldman officially went public in 1999 but never lost the flat structure that kept lines of communication open among different divisions.

In late 2006, when losses began showing in one of Goldman’s mortgage trading accounts, the bank held a top-level meeting where executives including David Viniar, the chief financial officer, concluded that the housing market was headed for a significant downturn.

Hedging strategies were put in place that essentially amounted to a bet that housing prices would fall. When they did, Goldman limited its losses while rivals posted ever-bigger write-downs on mortgages and complex securities tied to them.

In 2007, Goldman generated $11.6 billion in profit, the most money an investment bank has ever made in a year, and avoided most of the big mortgage-related losses that began slamming other banks late in that year. Goldman’s share price soared to a record of $247.92 on Oct. 31.

Goldman continued to outpace its rivals into this year, though profits declined significantly as the credit crisis worsened and trading conditions became treacherous. Still, even as Bear Stearns collapsed in March over bad mortgage bets and Lehman was battered, few thought that the untouchable Goldman could ever falter.

Mr. Blankfein, an inveterate worrier, beefed up his books in part by stashing more than $100 billion in cash and short-term, highly liquid securities in an account at the Bank of New York. The Bony Box, as Mr. Blankfein calls it, was created to make sure that Goldman could keep doing business even in the face of market eruptions.

That strong balance sheet, and Goldman’s ability to avoid losses during the crisis, appeared to leave the bank in a strong position to move through the industry upheaval with its trading-heavy business model intact, if temporarily dormant.

Even as some analysts suggested that Goldman should consider buying a commercial bank to diversify, executives including Mr. Blankfein remained cool to the notion. Becoming a deposit-taking bank would just invite more regulation and lessen its ability to shift capital quickly in volatile markets, the thinking went.

All of that changed two weeks ago when shares of Goldman and its chief rival, Morgan Stanley, went into free fall. A national panic over the mortgage crisis deepened and investors became increasingly convinced that no stand-alone investment bank would survive, even with the government’s plan to buy up toxic assets.

Nervous hedge funds, some burned by losing big money when Lehman went bust, began moving some of their balances away from Goldman to bigger banks, like JPMorgan Chase and Deutsche Bank.

By the weekend, it was clear that Goldman’s options were to either merge with another company or transform itself into a deposit-taking bank holding company. So Goldman did what it has always done in the face of rapidly changing events: it turned on a dime.

“They change to fit their environment. When it was good to go public, they went public,” said Michael Mayo, banking analyst at Deutsche Bank. “When it was good to get big in fixed income, they got big in fixed income. When it was good to get into emerging markets, they got into emerging markets. Now that it’s good to be a bank, they became a bank.”

The moment it changed its status, Goldman became the fourth-largest bank holding company in the United States, with $20 billion in customer deposits spread between a bank subsidiary it already owned in Utah and its European bank. Goldman said it would quickly move more assets, including its existing loan business, to give the bank $150 billion in deposits.

Even as Goldman was preparing to radically alter its structure, it was also negotiating with Mr. Buffett, a longtime client, on the terms of his $5 billion cash infusion.

Mr. Buffett, as he always does, drove a relentless bargain, securing a guaranteed annual dividend of $500 million and the right to buy $5 billion more in Goldman shares at a below-market price.

While the price tag for his blessing was steep, the impact was priceless.

“Buffett got a very good deal, which means the guy on the other side did not get as good a deal,” said Jonathan Vyorst, a portfolio manager at the Paradigm Value Fund. “But from Goldman’s perspective, it is reputational capital that is unparalleled.”

EVEN if the bailout stabilizes the markets, Wall Street won’t go back to its freewheeling, profit-spinning ways of old. After years of lax regulation, Wall Street firms will face much stronger oversight by regulators who are looking to tighten the reins on many practices that allowed the Street to flourish.

For Goldman and Morgan Stanley, which are converting themselves into bank holding companies, that means their primary regulators become the Federal Reserve and the Office of the Comptroller of the Currency, which oversee banking institutions.

Rather than periodic audits by the Securities and Exchange Commission, Goldman will have regulators on site and looking over their shoulders all the time.

The banking giant JPMorgan Chase, for instance, has 70 regulators from the Federal Reserve and the comptroller’s agency in its offices every day. Those regulators have open access to its books, trading floors and back-office operations. (That’s not to say stronger regulators would prevent losses. Citigroup, which on paper is highly regulated, suffered huge write-downs on risky mortgage securities bets.)

As a bank, Goldman will also face tougher requirements about the size of the financial cushion it maintains. While Goldman and Morgan Stanley both meet current guidelines, many analysts argue that regulators, as part of the fallout from the credit crisis, may increase the amount of capital banks must have on hand.

More important, a stiffer regulatory regime across Wall Street is likely to reduce the use and abuse of its favorite addictive drug: leverage.

The low-interest-rate environment of the last decade offered buckets of cheap credit. Just as consumers maxed out their credit cards to live beyond their means, Wall Street firms bolstered their returns by pumping that cheap credit into their own trading operations and lending money to hedge funds and private equity firms so they could do the same.

By using leverage, or borrowed funds, firms like Goldman Sachs easily increased the size of the bets they were making in their own trading portfolios. If they were right — and Goldman typically was — the returns were huge.

When things went wrong, however, all of that debt turned into a nightmare. When Bear Stearns was on the verge of collapse, it had borrowed $33 for every $1 of equity it held. When trading partners that had lent Bear the money began demanding it back, the firm’s coffers ran dangerously low.

Earlier this year, Goldman had borrowed about $28 for every $1 in equity. In the ensuing credit crisis, Wall Street firms have reined in their borrowing significantly and have lent less money to hedge funds and private equity firms.

Today, Goldman’s borrowings stand at about $20 to $1, but even that is likely to come down. Banks like JPMorgan and Citigroup typically borrow about $10 to $1, analysts say.

As leverage dries up across Wall Street, so will the outsize returns at many private equity firms and hedge funds.

Returns at many hedge funds are expected to be awful this year because of a combination of bad bets and an inability to borrow. One result could be a landslide of hedge funds’ closing shop.

At Goldman, the reduced use of borrowed money for its own trading operations means that its earnings will also decrease, analysts warn.

Brad Hintz, an analyst at Sanford C. Bernstein & Company, predicts that Goldman’s return on equity, a common measure of how efficiently capital is invested, will fall to 13 percent this year, from 33 percent in 2007, and hover around 14 percent or 15 percent for the next few years.

Goldman says its returns are primarily driven by economic growth, its market share and pricing power, not by leverage. It adds that it does not expect changes in its business strategies and expects a 20 percent return on equity in the future.

IF Mr. Hintz is right, and Goldman’s legendary returns decline, so will its paychecks. Without those multimillion-dollar paydays, those top-notch investment bankers, elite traders and private-equity superstars may well stroll out the door and try their luck at starting small, boutique investment-banking firms or hedge funds — if they can.

“Over time, the smart people will migrate out of the firm because commercial banks don’t pay out 50 percent of their revenues as compensation,” said Christopher Whalen, a managing partner at Institutional Risk Analytics. “Banks simply aren’t that profitable.”

As the game of musical chairs continues on Wall Street, with banks like JPMorgan scooping up troubled competitors like Washington Mutual, some analysts are wondering what Goldman’s next move will be.

Goldman is unlikely to join with a commercial bank with a broad retail network, because a plain-vanilla consumer business is costly to operate and is the polar opposite of Goldman’s rarefied culture.

“If they go too far afield or get too large in terms of personnel, then they become Citigroup, with the corporate bureaucracy and slowness and the inability to make consensus-type decisions that come with that,” Mr. Hintz said.

A better fit for Goldman would be a bank that caters to corporations and other institutions, like Northern Trust or State Street Bank, he said.

“I don’t think they’re going to move too fast, no matter what the environment on Wall Street is,” Mr. Hintz said. “They’re going to take some time and consider what exactly the new Goldman Sachs is going to be.”

September 28, 2008

What’s Free About Free Enterprise?

THERE was a time, in my childhood during the Great Depression, when the streets of Manhattan were filled with unshaven men in threadbare clothes, their coat collars turned up against the cold, their shoes stuffed with newspaper to plug holes in the soles. And there were bank failures.

A huge bailout plan is being hammered out in Washington precisely to avert this kind of economic calamity. The plan is needed, and it needs to be put in place quickly. But at the same time, we need to ask how the financial system came to require a rescue of this magnitude.

This time around, assets are evidently so rotten in so many places that no financial institution wants to risk doing business with any other financial institution without a government backstop.

Such fear recently threw a huge bucket of sand into the wheels of commerce, because business cannot function without credit and banks cannot function without the ability to draw on one another’s resources as needed. Some radical, comprehensive step from government was necessary, or else outcomes as bad as — and perhaps even worse than — those of 1931 and 1932 would have been inescapable.

Naturally, a plan of this magnitude has stirred a storm of commentary, but two important potential results deserve more attention than they have received.

The first is the risk of moral hazard within the bailout itself. That is, if government is going to make good so many losses throughout the system, why would anyone set limits on future risk-taking? The situation could turn into a free-for-all that makes the recent disregard of risk look like child’s play.

The second problem is more philosophical, involving what the bailout plan reveals about the functioning of the free enterprise system. This raises disturbing questions. Although I agree with President Bush’s observation that “the risk of not acting would be far higher,” we should be aware of the secondary effects of what we are getting into.

My position on government bailouts of institutions on the verge of failure has been clear ever since the procedure was formalized in the savings-and-loan crisis in 1989, under the first President Bush. I have favored these steps, even though such rescues reward those who took more risks than they should have and are ultimately paid for by those who were more prudent.

FROM this viewpoint, government bailouts create moral hazard and therefore might seem a mistake. If the government always comes to your rescue when the chips are down, why limit your risks? Why not go for the gold every time? What does it matter if you put the system over the edge, so long as you have a chance to make money and Uncle Sam will take care of everything if you lose? How could any rational individual pass up those kinds of opportunities?

We could avoid this conflict of interests by refusing to bail out the risk-takers and letting the financial miscreants squirm in their own juice. That might provide satisfaction to moralists, but life is not so simple. An epidemic of unpaid bad debts would devastate lenders and ignite a conflagration that could pull down the economic and financial structure, ruining everybody.

We were on the verge of such an outcome in the last few weeks, as banks froze up in fear that every piece of paper was tainted. As a result, they refused to enter into the most routine kinds of transactions with one another. The choice is between two cruel outcomes: the high probability of an irreparably damaged financial system, or an overload of moral hazard. I prefer dealing with moral hazard later; preserving the system — and society — must now have top priority.

My views have developed over the years, from the bailouts of single entities like Long-Term Capital Management or Bear Stearns, or small groups of companies like savings institutions. But these relatively simple transactions have only a distant family resemblance to the Paulson-Bernanke plan for a huge bailout of countless financial institutions, to say nothing of possible help to households that took on mortgages that would work out only if the home price kept rising.

There is an immense difference between a plan for a comprehensive bailout and the far simpler process of bailing out Bear Stearns or even a dozen or so Bear Stearnses. The justification is the same, but the grim consequences in terms of moral hazard are of an incomparably greater order of magnitude.

Once the federal government declares, “Thou shalt not fail,” there are no limits to how far future risk-takers will go. Who will see any need to pay attention to the possible consequences for the government’s budget, the market for its bonds, the taxpayers, its creditors and, indeed, the whole economic structure?

Furthermore, there are limits to how freely Washington can dispense largess. We no longer owe the national debt to ourselves, as we did in the 1930s, when deficit financing was first proposed as viable policy to overcome the Depression. Financing the government today depends heavily on foreigners’ willingness to buy our bonds, but foreigners accept our obligations only when they see some kind of control over the volume of issuance. They will perceive very little control in plans whose limits are porous and uncertain.

My second issue goes to the foundations of the economic system in which most Americans believe and take for granted. Though we sometimes give it more lip service than respect, it is rooted in individual decision-making in free markets. In theory, at least, the less government intervention, the better; the mantra is that markets know best.

We often hear this refrain, and history confirms its importance in the most profound issues of economic policy. It justifies our revulsion with Communism, our philosophical distance from the current Chinese system, and our distaste when politicians, not markets, try to shape our system.

Faith in free markets made icons of Ronald Reagan and Margaret Thatcher, who made deregulation a policy cornerstone. An echo in our own time was the 1999 repeal of the Glass-Steagall Act, legislated in 1933 to separate investment banking and commercial banks. Its repeal was a key contributor to the calamities now gripping the banking system.

TODAY’S crisis thus emerged from a combination of disasters operating in free markets, but wreaking ruin as they developed. The subprime mortgage mess, the huge leverage throughout the system, the insidious impact of new kinds of derivatives and other financial paper, and, at the roots, the vast underestimation of risk could not have happened in a planned economy. A superjumbo bailout is the inescapable result, but at some point we must confront its more profound implications.

As we move into the future, and as the crisis finally passes into history, how will we deal with this earth-shaking blow to the most basic principle of our economic system? I do not know how to answer that question. But we need to ask it.

Peter L. Bernstein, a financial consultant and economic historian, is the editor of the Economics & Portfolio Strategy newsletter.

SEPTEMBER 28, 2008

The Real Costs of the Bailouts

    Last week, as federal regulators seized Washington Mutual in the largest U.S. banking failure, Congress was grappling with whether to spend $700 billion of public money to fix the financial industry's troubles.
    Lawmakers' initial reaction to the Treasury Department's staggering request: shock. That sum amounts to about a quarter of the U.S. government's annual spending. It's more than the Pentagon's annual budget, more than the nation pays out each year in Social Security benefits and more than the federal government's cost for Medicare and Medicaid.
    Members of Congress then asked the questions that continue to be on many Americans' minds: How will the U.S. pay for this program and the previously announced aid to Bear Stearns, Fannie Mae, Freddie Mac and American International Group? (The Washington Mutual seizure doesn't add to the U.S. tab because the bulk of WaMu's operations are being taken over by J.P. Morgan Chase without cost to the Federal Deposit Insurance Corp.)
    And what will these efforts end up costing us all in taxes?
    Part of the answer is known today but other aspects -- including the ultimate tab for these rescue programs -- may not be clear for years or even decades.

$1 Trillion Commitment
    The total government commitment so far in its current and proposed bailouts: $1 trillion. But most of that money would give the government a claim on assets -- such as home mortgages and insurance operations -- that have actual value.
    In each case, government officials took action because they believed the nation's financial system -- including banks where you deposit your money and Wall Street firms that run many markets -- risked a breakdown. Such a meltdown would make it harder for regular consumers and businesses to borrow money and make major purchases, putting a major dent in the $14 trillion U.S. economy.
    The plumbing of the financial markets and economy "is all esoteric Wall Street stuff," Federal Reserve Chairman Ben Bernanke, a former college economics professor, explained to lawmakers last week. "It doesn't have any meaning to people on Main Street, but it connects very directly to their lives. If the credit system isn't working, then firms cannot finance themselves. People cannot borrow to buy a car, to send a student to college, to buy a house."
    Most of the government's bailouts are tied to the housing-market slump and all the toxic mortgage loans and mortgage-backed securities held by banks and other financial institutions.

Biggest U.S. Bailout
    In the rescue plan Congress was negotiating last week -- at $700 billion the biggest bailout in U.S. history -- a key goal is to remove much of those soured mortgage securities from banks' books, possibly through an auction system.
    The government -- taxpayers, essentially -- would then hold those assets until they can be sold off in a more normal market once the economy and housing market recover.
A key point: The $700 billion would come from selling debt to the public, raising the total federal debt, which is approaching $10 trillion now. But it's not direct government spending, which shows up as part of the U.S. budget. If the mortgage debt loses value over time, however, the U.S. would have to record those losses as spending. That could increase the budget deficit, which eventually must be offset by higher taxes or lower spending.
    So taxpayers face the risk of losing some part of the $700 billion -- but could also turn a profit if the U.S. ends up selling those holdings for more than the purchase price.

First Up: Bear Stearns
    The earlier rescue efforts also involve uncertainty about the ultimate cost to taxpayers. Back in March, the government worried that the failure of investment bank Bear Stearns would lead markets to fall apart globally. So it agreed to take on $30 billion worth of the firm's assets, including some of those bad mortgages, to help its new buyer, J.P. Morgan Chase.
    The Federal Reserve plans to hold onto those assets for perhaps a decade before selling. J.P. Morgan will cover the first $1 billion in losses, if any. Taxpayers are highly unlikely to lose all $29 billion they have on the line, but could lose some of it.
Earlier this month, the action moved to mortgage giants Fannie Mae and Freddie Mac. Because many investors assumed they were like public entities, the U.S. stepped in and took them over when the companies became too unstable to support the housing market by providing enough new mortgages.
    The Treasury Department plans to inject up to $200 billion in capital into the firms. Some of that money may be lost because the firms' mortgage securities continue to lose value as home prices decline. But it's still unclear how much money taxpayers will kick in.
    Less than 10 days later, the government stepped in again, to aid giant insurer AIG. The U.S. provided a loan of up to $85 billion. Half of that had been tapped by the middle of last week. But the terms were onerous: An interest rate above 11% and rights to an 80% government stake in the company. AIG still has profitable insurance lines, and some of its businesses could be sold to pay the government back. So that bailout may not cost taxpayers anything directly.
    With all these rescue efforts, even if the U.S. government profits after its expenses, there's still a broader unquantifiable cost: whether bailing out financial institutions and markets will create expectations for more taxpayer support down the road when Wall Street or big businesses get into trouble.
    Government officials acknowledge that risk. But they say taxpayers are being helped in the long run because stronger financial markets will translate into more economic growth and higher tax revenue.

Write to Sudeep Reddy at

Washington Post    September 29, 2008
Financial Times    September 29, 2008

A Bailout Is Just a Start
The $700bn bail-out and the budget
By Lawrence Summers

Congressional negotiators have completed action on a $700 billion authorization for the bailout of the financial sector. This step was as necessary as the need for it was regrettable. In the coming weeks, the authorities will need to consider hugely important tactical issues regarding the deployment of these funds if the chance of containing the damage is to be maximized.

Right now, what must be considered are the conditions necessitating the bailout and its impact on federal budget policy. The idea seems to have taken hold that the nation will have to scale back its aspirations in areas such as health care, energy, education and tax relief. This is more wrong than right. We have here the unusual case where economic analysis suggests that dismal conclusions are unwarranted and recent events suggest that in the near term, government should do more, not less.

First, note that there is a major difference between a $700 billion program to support the financial sector and $700 billion in new outlays. No one is contemplating that $700 billion will simply be given away. All of its proposed uses involve purchasing assets, buying equity in financial institutions or making loans that earn interest. Just as a family that goes on a $500,000 vacation is $500,000 poorer but a family that buys a $500,000 home is only poorer if it overpays, the impact of the $700 billion depends on how it is deployed and how the economy performs.

The American experience with financial support programs is somewhat encouraging. The Chrysler bailout, President Bill Clinton's emergency loans to Mexico and the Depression-era support programs for the housing and financial sectors all ultimately made profits for taxpayers. While the savings and loan bailout through the Resolution Trust Corp. was costly, this reflected enormous losses exceeding the capacity of federal deposit insurance. The head of the FDIC has offered assurances that nothing similar will be necessary this time.

It is impossible to predict the ultimate cost to the Treasury of the bailout and the other commitments that financial authorities have made -- this will depend primarily on the economy as well as the quality of execution and oversight. But it is very unlikely to approach $700 billion and will be spread over a number of years.

Second, the usual concern about budget deficits is that the need for government bonds to be held by investors will crowd out other, more productive, investments or force greater dependence on foreign suppliers of capital. To the extent that the government purchases assets such as mortgage-backed securities with increased issuance of government debt, there is no such effect.

Third, since Keynes we have recognized that it is appropriate to allow government deficits to rise as the economy turns down if there is also a commitment to reduce deficits in good times. After using the economic expansion of the 1990s to bring down government indebtedness, the United States made a serious error in allowing deficits to rise over the past eight years. But it would compound this error to override what economists call "automatic stabilizers" by seeking to reduce deficits in the near term.

Indeed, in the current circumstances the case for fiscal stimulus -- policy actions that increase short-term deficits -- is stronger than ever before in my professional lifetime. Unemployment is almost certain to increase -- probably to the highest levels in a generation. Monetary policy has little scope to stimulate the economy given how low interest rates already are and the problems in the financial system. Global experience with economic downturns caused by financial distress suggests that while they are of uncertain depth, they are almost always of long duration.

The economic point here can be made straightforwardly: The more people who are unemployed, the more desirable it is that government takes steps to put them back to work by investing in infrastructure or energy or simply by providing tax cuts that allow families to avoid cutting back on their spending.

Fourth, it must be emphasized that nothing in the short-run case for fiscal stimulus vitiates the argument that action is necessary to ensure the United States is financially viable in the long run. We still must address issues of entitlements and fiscal sustainability.

From this perspective the worst possible actions would be steps that have relatively modest budget impacts in the short run but that cut taxes or increase spending by growing amounts over time. Examples would include new entitlement programs or exploding tax measures. The best measures would be short-run investments that will pay back to the government over time or those that are packaged with longer-term actions to improve the budget, such as investments in health-care restructuring or steps to enable states and localities to accelerate, or at least not slow, their investments.

A time when confidence is lagging in the consumer, financial and business sectors is not a time for government to step back.

Well-designed policies are essential to support the economy and, given the seriousness of health-care, energy, education and inequality issues, can make a longer-term contribution as well.

The writer, who served as Treasury secretary from 1999 to 2001, is a managing director of D.E. Shaw &amp; Co. He writes a monthly column for the Financial Times, where this article also appears today.    September 29, 2008

WaMu’s Lesson for Private Equity

The new era of private equity is proving treacherous for some old hands. The collapse of the nation’s largest savings and loan, Washington Mutual, highlights the point. The lender’s demise handed TPG, one of the buyout world’s kingpins, the kind of crushing body blow that has laid similar firms low in the past.

The bursting of the credit bubble brought an end to the easy money that allowed TPG to take big public companies private, including Harrah’s Entertainment, MGM and Neiman Marcus. This drought led many buyout firms to pursue smaller stakes, not financed by debt, in public companies, where they hoped to negotiate terms and conditions that would give them an investment edge.

Among the biggest of these deals was TPG’s injection of $2 billion into WaMu in April. TPG, led by David Bonderman, dove in with a flotilla of other top WaMu shareholders to collectively invest $7 billion in the struggling thrift. In return for precious capital, TPG received an array of advantages over WaMu’s other common shareholders that made it a sweetheart deal.

This helped sustain the argument that private equity firms — despite the implosion of their leveraged buyout businesses — were still worth the huge fees their investors paid. After all, if private equity firms like TPG were just taking minority stakes in public companies, what would be the logic of paying them the industry standard 20 percent of any profits they make, as well as an annual retainer of up to 2 percent of the money they were given to manage?

That logic, however, now looks specious. On Thursday, regulators declared WaMu insolvent and sold its carcass to JPMorgan Chase for $1.9 billion, vaporizing TPG’s investment. But TPG was not alone among private equity firms that, once the buyout boom turned, decided to take stakes in public companies.

Nor was TPG alone among its peers in mistiming the financial turmoil. Warburg Pincus, for example, is still under water on its infusion of $800 million into the bond insurer MBIA. The buyout group reached twice into its $8 billion fund — first in December and then in February. This double-dip brought Warburg’s average price paid down to around $19.59 a share. MBIA stock closed Friday at $13.74.

And Corsair Partners has taken a hit from its $985 million investment in the Cleveland banking company National City. The bank’s shares slid almost 26 percent on Friday alone, to $3.71, on concerns that it may follow WaMu into the arms of a deal, euthanized by worried regulators.

But TPG’s loss is the biggest of this vintage of private equity into public company deals — and it is the first to crystallize a major loss for investors. So all eyes in the industry will be on Mr. Bonderman. They will want to see how he tries to convince his limited partners — the providers of TPG’s $50 billion of funds under management — that WaMu was a one-time event, perhaps a learning experience that will not be repeated.

Judging by the history of the relatively young private-equity industry, this will not be a cinch to pull off. During the last financial market crisis, after the dot-com bust, two other pioneers of the buyout business — Forstmann Little and Hicks Muse — strayed from their usual discipline of taking full control of their quarry. Both lost large amounts of money for investors on stakes in publicly traded telecommunications firms, the end of their firms as major private equity players.

Like TPG, Forstmann Little must have believed it was investing near the market’s bottom when it plowed $1.5 billion into XO Communications in 2001. The company went bankrupt a year later, prompting a public lawsuit by the Connecticut state employees’ pension fund, which claimed the firm had strayed from its mission.

The WaMu debacle may be easier for TPG’s investors to forgive. The investment amounted to less than 5 percent of TPG’s assets under management. But for all those buyout barons trying to adjust to life without unfettered access to cheap capital, it will be a lesson they hope to learn vicariously.

For more independent financial commentary and analysis, visit

Editorial Notebook

September 29, 2008

A Cure for Greed

Of course, it’s all Gordon Gekko’s fault! “Greed and irresponsibility,” blasted Barack Obama. “Greed and excess and corruption,” charged John McCain. President Luiz Inácio Lula da Silva could tell from as far away as Brazil that the “boundless greed of a few” blew up the American financial system. Why didn’t I think of that?

With the eureka moment behind us, I would suggest that this insight offers a way to try to restore the abused financial markets to health. If greed is to blame, the question is whether we can line up a reasonable array of alternative incentives — and disincentives — to do away with greed for good.

This will be no easy task. From populist opprobrium to elitist disdain — standard social behavioral devices have proved unable to dent humanity’s greedy nature.

The Soviet Union deployed the entire power of the state to stamp out greed — and ensured that the state was the greediest actor of all. Even religion’s not insubstantial powers of persuasion (think Hell) and coercion (think Inquisition) have proved insufficient to blot out this insidious sin.

The free market, it should be obvious by now, hasn’t been up to the task either. Capitalism, in all its cleverness, decided that what you can’t beat, you should use. It worked to harness greed. To be able to discuss it in polite company, economists renamed it “maximization of utility,” and built a theory of the world that everyone benefits when we seek to maximize our own individual welfare.

Greed reached its zenith in the 1980s, when the Reagan Revolution brought us supply-side economics and its bedrock belief that the path to prosperity for all required removing every obstacle to utility maximization, including most regulations and taxes. Then financial markets crashed. On the campaign trail, the Rev. Jesse Jackson lambasted America’s greedy corporations. And one survey found that 83 percent of Americans blamed “unmitigated greed” for the financial crisis. A few years later the markets were again soaring; greed was back in style.

Yet despite the consistent failure to temper our greedy nature, I still have hopes. Because there is a crucial brake that has been missing from the edifice of high-tech financial capitalism — a counterbalance at the other end of the scale from where utility gets maximized. That piece is fear. My suggestion, then, is to put fear back in the picture. When the banker who loses his or her bank also loses his or her shirt, greed will be tempered. At least for a while.

Neue Zürcher Zeitung    29. September 2008,

«Wer rettet den Wall-Street-Retter Uncle Sam?»
Die Finanzkrise prägt die Diskussionen am WEF-Forum der «New Champions»

Sorgen über die US-Bankenkrise haben eine Tagung des World Economic Forum in China geprägt. Unternehmer und Politiker erachten die Wiederherstellung des Vertrauens für zentral, befürchten aber eine anhaltende Schwächung der US-Wirtschaft und des Dollars.
pfi. Tianjin, 28. September    Letztes Jahr herrschte noch überschäumender Optimismus, dieses Mal prägten tiefe Verunsicherung über die Turbulenzen an den Finanzmärkten und Rufe nach neuer Leadership die Jahrestagung der sogenannten «New Champions» des World Economic Forum  (WEF), die sich am Wochenende im chinesischen Tianjin versammelt haben. Vor allem die USA hätten in einer verrückten Welt des billigen Geldes jahrelang über ihre Verhältnisse gelebt, lautete die allgemeine Diagnose. Weitgehende Einigkeit herrschte darüber, dass  Transformationsländer wie China, Russland oder Brasilien von den Auswirkungen nicht verschont bleiben würden und deshalb ein reges Interesse an einer möglichst koordinierten Bewältigung der Krise hätten.

Kreditverknappung und Inflationsgefahr

Teilnehmer aus der Finanzwelt und der Politik erachten eine Wiederherstellung des Vertrauens als vordringliches Gebot der Stunde, damit die Märkte wieder einigermassen funktionieren können. Das geplante, bis zu 700 Mrd. $ teure Banken-Rettungspaket der USA  wird deshalb allgemein begrüsst, doch gehen die Ansichten über dessen weltwirtschaftliche Auswirkungen auseinander. Der Chef der chinesischen Bankenaufsicht, Liu Mingkang, warnte wohl aus eigener Anschauung, dass Finanzmarktteilnehmer ein kurzes  Gedächtnis haben. Wenn die Regulatoren nicht weltweit stärker zusammenarbeiten und für eine bessere Erkennung transnationaler Systemrisiken sorgen würden, bestehe die Gefahr, dass das teure US-Rettungspaket bloss «Fast Food» bleibe. Verschiedene WEF- Teilnehmer bemängelten, dass der Währungsfonds im Gegensatz zur asiatischen Finanzkrise bei den neuesten Entwicklungen eine viel zu passive Rolle spiele, doch fühlten sich die USA wohl vorläufig auf diesen nicht angewiesen.

Zhu Min, der exekutive Vizepräsident der Bank of China, traf mit seiner Feststellung auf viel Zustimmung, es sei ja schön, dass Uncle Sam die Wall Street rette, doch frage er sich, wer denn den Retter retten werde. Die Staatsgelder, welche die USA zur Stabilisierung  ihres Bankensystems aufwenden wollten, beliefen sich bereits auf die astronomische Summe von weit über 1 Bio. $, die zusätzlich zum sowieso schon vorhandenen Defizit finanziert werden müssten. Zhu hält die Gefahr für gross, dass die US-Zentralbank Fed über kurz  oder lang die Notenpresse werde anwerfen müssen, was zu grossem Inflationsdruck führen werde. Seine Bank rechne kurzfristig mit einem sehr volatilen Dollar und längerfristig mit weiteren schlechten Neuigkeiten und einem dauerhaft schwächeren Greenback.  Sayanta Basu, der CEO der Dubai Financial Group, erwartet deshalb mittelfristig die Bildung eines stärker bipolaren internationalen Währungsregimes, bei dem mehr Reserven und Anlagen in Euro getätigt würden. Die meisten Banker waren sich allerdings einig, das es  zumindest mittelfristig zum Dollar keine Alternative gebe, weil die nicht in Dollar denominierten Finanzmärkte zu wenig entwickelt seien.

Der amerikanische Ökonom und ehemalige Chefvolkswirt der Zürich-Gruppe, David D. Hale, hält die von vielen geäusserten Inflationsgefahren der US-Krisenbewältigung allerdings für übertrieben. China werde auch im nächsten Jahr einen riesigen  Handelsbilanzüberschuss erwirtschaften und mit mindestens 200 Mrd. $ das amerikanische Staatsdefizit mitfinanzieren, gab sich Hale optimistisch. Viel schwerwiegender dürften die Auswirkungen der Gleichstellung amerikanischer Investmentbanken mit normalen Banken  sein, prophezeite Hale. Sie bedeuteten, dass die Investmentbanken ihren Fremdfinanzierungsgrad drastisch reduzieren müssten, was zu einer starken Kreditverknappung mit deflationären Wirkungen führen werde.

Auch für den Asien-Chef und Chefökonom von Morgan Stanley, Stephen Roach, ist klar, dass eine Genesung von Uncle Sam schmerzhafte realwirtschaftliche Anpassungen erfordern werde. Die Amerikaner müssten weniger Schulden machen und wieder mehr  sparen. Amerika werde deshalb mindestens für die nächsten zwei Jahre als Konjunkturlokomotive ausfallen, prognostizierte Oki Matsumoto, der CEO der Monex Group, der wie andere Japaner drohende Parallelen zur grossen Depression in seinem Land sah.

China will weiterwachsen

Der chinesische Premierminister Wen Jiabao versicherte in Tianjin, China habe grosses Interesse daran, dass die USA ihre Bankenkrise möglichst bald bewältigen könnten. Er sehe den besten Beitrag seines Landes darin, selber weiter zu wachsen. Wen liess durchblicken, dass er es derzeit wieder für wichtiger hält, Chinas Wirtschaft vor einer harten Landung zu bewahren, als rigoros die Inflation zu bekämpfen. Der chinesische Premier stellte die Fortführung der chinesischen Öffnungs- und Reformpolitik und eine allmähliche  Ausweitung der Sozialversicherungen auf alle Bevölkerungsteile in Aussicht. Das sollte dazu beitragen, dass nun die Chinesen mehr konsumieren und weniger sparen und so der Wirtschaft Wachstumsimpulse verleihen. Den Skandal mit der krankmachenden Milch  bezeichnete Wen als schmerzhafte Lehre, die zeige, dass auch in China Fragen der Geschäftsmoral grössere Bedeutung beigemessen werden müsse. Er stellte baldige, grundlegende Massnahmen zur Bekämpfung der Missstände in Aussicht, und versprach, nichts  vertuschen zu wollen.

Der EU-Handelskommissar Peter Mandelson sah in der Krise das Gespenst des Protektionismus wieder virulenter werden. Mandelson forderte China deshalb dazu auf, mit besserem Beispiel voranzugehen. EU-Unternehmer würden die chinesischen Türen immer  noch zumindest halb geschlossen vorfinden. Premier Wen versprach, das Investitionsregime weiter zu verbessern, doch warten ausländische Unternehmer nun schon länger vergeblich auf konkrete Schritte.

Washington Post    September 29, 2008

Bankrupt Economics
A Crisis Resists The Usual Remedies
By Robert J. Samuelson

What we are witnessing, in the broadest sense, is the bankruptcy of modern economics. Its conceit has been that we had solved the problem of stability. Oh, there would be periodic recessions, but the prospects of a major economic collapse were negligible because we knew how the system worked and could take steps to prevent it. What's been so unsettling about the present crisis is that it has not conformed to the standard model of business cycles and has not submitted to familiar textbook solutions.

A hallmark of the crisis has been the stark contrast between the "real economy" of production and jobs and the tumultuous financial markets of stocks, bonds, banks, money funds and the like. Even with the 60 percent drop in housing construction since early 2006, the real economy has so far suffered only modest setbacks. Yes, there are 605,000 fewer payroll jobs than there were in December; still, 137.5 million jobs remain. Meanwhile, financial markets verge on hysteria. The question is whether this hysteria will drive the real economy into a deep recession or worse -- and what we can do to prevent that.

The word that best epitomizes mainstream "macroeconomics" (the study of the entire economy, not individual markets) is demand. If weak demand left the economy in a slump, government could rectify the situation by stimulating more demand through tax cuts, higher spending or lower interest rates. If excess demand created inflation, government could suppress it by cutting demand through more taxes, less spending or higher interest rates.

Economists of this tradition watch consumer and business behavior. Are car sales soft? How much are companies raising prices? What about profits? The $152 billion "stimulus" program earlier this year was a classic exercise in "demand management." It didn't work well mainly because this crisis originated in frightened financial markets. Massive losses on mortgage-related securities caused some financial institutions to fail. As fear spread, financial institutions grew wary of dealing with each other because no one knew who was solvent and who wasn't.

To Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, this financial breakdown now threatens the real economy. Companies depend on bank borrowings and sales of commercial paper (in effect, short-term bonds) to conduct everyday business -- to buy inventories, to pay suppliers and workers before cash arrives from sales. Credit markets were freezing, Paulson and Bernanke decided. Panicky investors were shifting from commercial paper to Treasury bills; banks weren't lending to each other. If it continued, consumers and firms wouldn't get essential credit.

If you reject that conclusion, then the whole crisis has been a contrived farce. Some economists do; they note that downturns always involve losses and disruptions. This one isn't so different. But many economists agree with Paulson and Bernanke. "If we can't calm down short-term credit markets, we're looking at a pretty severe recession," says Michael Mussa of the Peterson Institute for International Economics. "If businesses can't roll over their short-term debt, [they] ask where can we cut back" -- firing workers, reducing spending -- "to avoid bankruptcy."

Unfortunately, we lack experience with stabilizing financial markets, and the issue has been at the fringes of economics. Mostly, markets should operate freely. When is intervention justified? How?

Of course, economists recognized that the Federal Reserve should act as a "lender of last resort" and that permitting two-fifths of banks to fail in the 1930s aggravated the Depression. But the creation in 1933 of deposit insurance (now up to $100,000) was thought to prevent most bank runs, and the "lender of last resort" role never anticipated a worldwide financial system that mediated credit not just through banks but also through hedge funds, private equity funds, investment banks and many other channels. In congressional testimony last week, Bernanke admitted the Fed has been "shocked" at how elastic the "lender of last resort" role has become.

The resulting intellectual vacuum has spawned political chaos. Unpleasant and untested ideas invite opposition. Paulson's plan to buy up to $700 billion of impaired securities is wildly unpopular. It may not work and raises many problems. If the government pays too little for the securities, financial failures may mount; if it pays too much, it may create windfall profits for some investors and losses for taxpayers. But Paulson's plan has better prospects for restoring confidence by removing suspect securities from balance sheets than suggested alternatives would. Selective injections of capital into banks, for instance, might involve favoritism and operate too slowly to improve confidence. Psychology matters.

The economy will get worse. Mussa thinks unemployment (now 6.1 percent) could peak near 7 percent; other projections are higher. The harder question is whether financial turmoil heralds an era of instability. Our leaders are making up their responses from day to day because old ideas of how the economy works have failed them. These ideas were not necessarily wrong, but they're grievously inadequate at the moment.

SEPTEMBER 29, 2008

Credit Markets and the Real Economy

    The Treasury bailout plan to recapitalize the U.S. banking system may help the U.S. avoid a deep and protracted recession. But even if the plan succeeds, it almost surely will not prevent a recession.
    The major reason for this is that the credit markets have been under incredible stress for well over a year, and have recently taken a significant turn for the worse. During the last two weeks, the spread between Libor (the cost of borrowing between banks) and the rates on zero-risk Treasury bills exploded to more than 300 basis points, the widest gap since October 1987.
    This kind of stress reflects fear and a lack of trust among banks, which will be reflected in the real economy with a lag.
    The commercial-paper market -- which funds auto loans, credit cards, and short-term working capital for businesses -- also is under incredible stress. Spreads on asset-backed commercial paper relative to comparable maturity Treasurys rose to more than 500 basis points in recent weeks. Not surprisingly, the commercial-paper market shrank by more than $100 billion in the last two weeks. It's down by more than $520 billion since the summer of 2007, when the credit crisis began.
    The Federal Reserve's Senior Loan Officer's Survey also shows record fractions of loan officers reporting tighter lending standards for the broad swath of business and household credit. Similar spikes in lending standards during 1990 and 2001 were marked by recession.
    If a recession is unavoidable, the question is how deep and long it will be. While second quarter real GDP showed respectable 2.8% growth, trade was the only thing keeping the economy above water: Gross domestic purchases contracted during the second quarter. Gross domestic purchases also contracted during the fourth quarter of 2007, and only rose by 0.1% at an annual rate during the first quarter.
    More bad news: Real retail sales growth has been negative on a year-to-year basis for nine consecutive months, the longest streak of declines since 1991. This data, and the tremendous spike in both jobless claims and the unemployment rate, are telltale signs of an economy that is in reverse gear.
    The best we can hope for is that the downturn remains mild -- and for a modest recovery to take shape in the second half of 2009. But the fiscal policies of the next administration will play a crucial role here. If tax rates on capital and labor are raised sharply, a hoped-for recovery may be jettisoned altogether.
    Some have suggested we're close to the housing price bottom. That's hard to imagine, as new home sales just sunk to new cycle lows in August while inventories remain at elevated levels. New home sales bottomed three years before prices in the housing recovery of the early 1990s. Home prices also remain elevated relative to rents in a way they were not at the bottom of the home-price cycle in the early 1990s.
    On the inflation front, the most recent bout of credit stress has a silver lining: Industrial commodity prices have declined sharply. At the same time, bond market inflation expectations recently receded to the lowest level in six years. Gold has risen aggressively off the lows of mid-September but remains below the March peak. The dollar is off the September highs, but is also well above the record lows seen in April. Collectively, these market-based signals suggest that headline inflation will ease from the 17-year highs seen in July.
    The likely easing in inflation in the months ahead may not be permanent. In the past two weeks, the Fed's balance sheet (the asset side of the monetary base) has exploded by nearly $300 billion. Yet this avalanche of liquidity has done little to relieve strains in credit markets. In other words, we cannot expect central-bank liquidity to be a substitute for financial-sector solvency.
    The long-term outlook for price stability now depends on whether the Treasury pays for the bailout by selling U.S. debt to the public, or if the Fed finances it with printing-press money. If it is the latter, there will be an inflationary legacy that long outlasts the 2007-2008 credit crises.

Mr. Darda is the chief economist of MKM Partner

SEPTEMBER 29, 2008

Shorting Financial Stocks Should Resume

    The emergency ban imposed last Monday by the Securities and Exchange Commission on short selling for all "financial" stocks has done more harm than good. A close examination of recent trades on the New York Stock Exchange suggests it has exacerbated fluctuations in the affected securities' prices, and disrupted the functioning of fair, orderly equity markets. These are the very problems the ban was suppposed to prevent, if not end.
    Worse, the commissioners are likely to extend the ban before it expires this Thursday. Should the SEC do so, it could further stress America's markets in a time when investors need tremendous amounts of liquidity, robust price discovery and regulatory certainty. Obstructing the dynamics that make financial markets work could cause the U.S. and the world to slide into more difficult times ahead.
    The case against the ban is easy to make. Data from the ban's first week reveal the same problems we saw this summer (the SEC's July 15 emergency order, which proscribed naked short sales on 19 financial stocks) -- and, indeed, have seen repeatedly world-wide whenever short selling is constrained.
    What follows is a snapshot of the landscape before the SEC took action, and then the subsequent findings from my study of the 799 stocks initially covered in the ban. First, the "before" trends:
    - Short selling activity was not excessively high for the 799 stocks from January to the ban's start. While the percentage of short sales to total shares outstanding hit 19.1% in March, that percentage fell to 14.8% in July, when the sector's stock prices experienced the greatest drops since March 2007. From Sept. 1 to Sept. 12, short sales in the 799 stocks amounted to a low 6% of shares outstanding. Short sales in relation to trading volume display the same pattern.
    - Short-selling activity typically picked up after a stock fell in price, not generally before. Increases in short selling of individual stocks more often occurred the day after a sharp price drop, not before. This is consistent with research conducted by Karl Diether and Ingrid Werner of Ohio State University, and Kuan-Hui Lee of Rutgers, showing that short sellers trade in response to past negative news, and that they reveal information about forthcoming price drops. They may also want to protect their long positions from further declines by locking in prices through short sales.
    A detailed look at the short-selling transactions on Sept. 9, 2008 -- the day Lehman Brothers fell 45% -- shows that short sales were much more frequent during the second part of the day, after Lehman shares had already fallen 30%.
    - Market quality in trading was average. Prior to the ban's start, spreads, liquidity and other metrics for the financial services sector roughly matched the entire market's norms.
    After the ban took effect last week, we saw a dramatic shift for the worse (market quality and stock liquidity declined) as investors found it increasingly difficult to hedge market risks.
    - Liquidity dried up. With lenders halting their stock loans, volume down and regulatory uncertainty high, less capital flowed into trading of the 799 stocks. Bid-ask spreads increased more for the 799 stocks than for the market overall.
    Comparing the period Jan. 1, 2008, through the ban's first week shows that relative spreads (that is, the bid-ask spread relative to the quote mid-point) increased from 3.38% to 5.33%. This increase is not due to the financial crisis itself, as relative spreads have also increased from the beginning of September to the past week (from 3.87% to 5.33%).
    The intra-day trading range has almost doubled for the 799 stocks over the past week. This means that liquidity deteriorated. Less liquidity makes it more difficult for investors to trade without a severe market impact, and prices are less transparent.
    - Investors had difficulty getting pricing for stocks. Trading was down, stock-borrowing costs had soared, and uncertainty hung over the market due to the bailout's fate and the SEC's increase of stocks the ban originally covered. The balance of buying and selling that is so critical for markets to function was effectively gone.
    By last Friday, share prices for the 799 stocks did rise 0.11% relative to the market and adjusted for risk. However, such an increase is not statistically significant. The 799 stocks had performed much better in the two previous weeks: Between Sept. 1 and Sept. 19, they outperformed the market on a risk-adjusted basis by 6%. To be sure, one has to believe that much of this movement was attributed to the likelihood of some type of bailout package being passed.
    - Stocks reacted sluggishly to news. The 799 shares reacted more slowly to news than stocks outside the ban's umbrella -- a key sign of market inefficiency. In an efficient market, individual stocks should be affected primarily by company-specific news rather than overall market activity.
    Taken in full, the preliminary findings run counter to the SEC's stated rational for imposing the ban. Furthermore, additional erosion in the quality of U.S. financial markets could follow if this ill-conceived ban on short selling continues, disrupting the forces that have driven capital to where the best returns can be earned at the lowest risks.
    The past week's trends only serve to underscore why short selling in financial markets is critical to aligning equity prices with fundamental values. For every short sale, there is a commitment to buy. That generates liquidity. Giving pessimists and optimists equal opportunities to commit their capital engenders competition that enhances price discovery. Since much short selling in equity markets is done to hedge risks, market volatility suffers in its absence.
    Liquidity, price discovery and, above all, allowing both optimism and pessimism to act, unfettered, will bring back investors' confidence. America's market is one of the world's most resilient; its leaders can guide the way out of this difficult time if they learn from the mistakes and work together.
    Chairman Cox, the decision that you and your commissioners must make this week, then, is an easy one. Stop the folly. End the ban.

Mr. Bris is a professor of finance at IMD (the business school in Lausanne, Switzerland), a research associate at the Yale International Center for Finance, and a research fellow at the European Corporate Governance Institute.

SEPTEMBER 29, 2008

What We Can Learn From Chile's Financial Crisis

    You wouldn't know it from all the panicky headlines but the current turmoil on Wall Street is not the world's first financial crisis. Latin America has suffered more than a few, and many were on a larger scale relative to the economies they hit. One was triggered by Chile's 1982 economic collapse. For a small country it was a lot worse than what is happening in the U.S. today. The Bush economic team could learn from how it was handled.
    The solution to Chile's 1982 banking crisis is a model other countries can follow, Mary Anastasia O'Grady tells Kelsey Hubbard. The Chilean plan helped the banks recapitalize and protected depositors. It also minimized moral hazard and kept the government's role from expanding. The intellectual support for economic liberty was preserved and this protected the market system, which over the past 25 years has not only survived but prospered.
    The Hank Paulson-Ben Bernanke testimonies before Congress last week warned of a looming crisis of biblical proportions. President George W. Bush went on television Wednesday night to stir even more public fear. This produced a predictable result: It spooked holders of dollars around the globe, and by Thursday credit spreads had widened to record levels. Over the weekend pressure on Congress was increased to hand over the $700 billion Mr. Paulson said he needs to execute his plan.
    That plan proposes to spend taxpayer money to buy the bad debt of speculators. By wiping impaired assets off the balance sheets, the idea is that new investors will be willing to come in and recapitalize the banks.
    It may be too late to reverse the effects of the hysteria that the Bush administration created last week. A solution that would let the market sort out the mess -- once it gets clear signals from Washington that no money is forthcoming -- may no longer be tenable. But even if federal help is needed, there are alternatives to the Paulson plan.
    The main problem with buying distressed and hard-to-value assets from a bank is that, if the bank is to attract new capital, it is necessary for the government to overpay. And while the value of those assets may eventually move higher, the taxpayer is exposed to great risk, risk that really belongs to the bank and its shareholders. Such a huge federal expenditure also raises the risk of inflation.
    A further problem is that the Treasury is itself engaging in hedge-fund speculation. This expands the role of the state in the economy at a time when downsizing that role is more important than ever.
    One alternative to the Paulson plan would be to provide secured loans to troubled institutions as a way to allow them to recapitalize. The collateral against the loans would be bank assets (presumably impaired assets) but the transaction would be similar to a "repurchase agreement." In this transaction, otherwise known as a "repo," the borrower is required to repurchase the securities, with interest, in the future in order to retire the loan.
    Chile used such an instrument to recover from its 1983 banking crisis. It is true that the government intervened directly in two banks, wiping out shareholders, removing management and nationalizing the firms. Those banks were later re-privatized in a sale that gave tax incentives to encourage Chileans to participate in the offering.
    The many other banks that were in trouble were handled differently. For those, the government provided loans that were secured by bank assets, with an agreement that the banks would later repurchase those assets. These "repos" had conditions attached, including a provision that the shareholders could not take profits out of the company until the loan was repaid. This meant that shareholders were asked to give something in return for getting rescued by taxpayers; and it gave the bank a strong incentive to get back on its feet and return the money.
    Another advantage of this model over the Paulson plan is that although the Chilean government took the bank assets as collateral against the loan, it did not adopt responsibility for managing the assets. That role stayed with the bank.
    It was important that the government was a subordinated creditor; otherwise it would have been difficult to bring new capital into the bank. But if the U.S. were to use secured loans, it might not be necessary to make the loans at subsidized rates, as Chile did. Chile was in a depression. In the U.S. case, a penalty rate might be preferred in order to ensure that the banks will use the facility only as a last resort.
    It took several years for Chile to recover from its banking crisis and the U.S. will also need time to work off its credit mania. Federal assistance may be required. But that doesn't mean that we need to hand a blank check to the government that will allow it to expand its powers yet again.

Write to O'

SEPTEMBER 29, 2008

Calling J.P. Morgan
He was more effective than Paulson and Bernanke combined

    In the fall of 1907, it took J.P. Morgan just eight weeks to resolve a credit crisis similar to ours. Several years of buoyant growth and too much risk-taking in poorly understood investments led to needs for capital that could not be met. Morgan, then 70, locked the nation's top bankers into the ornate library at his home for late-night confession sessions. He asked them to lay bare their balance sheets, keeping himself alert with endless Havana cigars.


    The bankers reviewed one another's assets and liabilities. Morgan then decided which financial institutions had to go and which would live, getting commitments from the survivors and from the U.S. Treasury for infusions of capital. This Panic of 1907 had rattled the New York Stock Exchange and the markets for gold and municipal bonds, ruined several banks and trust companies, and nearly bankrupted New York City. Share prices fell by half. But once Morgan was done knocking banking heads together, markets swiftly recovered.
    In other words, Morgan was more effective in his day than the combination of Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have been in ours. We're now well over a year into this credit crisis. One big difference is that each of the bankers in Morgan's smoke-filled room actually knew the details of his bank's respective assets and liabilities. Today, financial instruments are so complex that banks are still trying to unravel the different pieces of mortgage-related securities.
    "J.P. Morgan and his men had direct access to the books of nearly every troubled institution, enabling them to fairly appraise their value," wrote Robert Bruner and Sean Carr, authors of "The Panic of 1907," in Newsday. Now, "despite mandated regulatory reporting, it is difficult, if not impossible, for financial decision-makers to know with clarity what is going on."
    As sophisticated as we are now, with hundreds of categories of debt available on a single trading screen, in some ways more information about assets and liabilities was available in 1907, when the workflow device for traders was a simple pencil and scrap paper. We also seem to have forgotten a basic point well known to Morgan, who would have recalled the panics of 1837, 1857, 1873 and 1897: Until prices are established, credit panics will not end and financial firms will remain frozen. The lesson of previous credit crises is that the sooner new valuations are set for bank assets and liabilities, the sooner recovery begins.
    A key holdup to getting past this crisis is the continuing unknown of the remaining value of mortgage-based securities. In Morgan's day, price discovery resulted when he went around the room seeking details of balance sheets. Today we need to achieve price discovery more actively, such as by holding auctions of the bad debt so that the market can find a new normal. Getting our arms around the scope of the bad debt would define the capital needs for banks, and there would be prices set that potential private-sector buyers of the debt could consider.
    There have been few efforts to determine the true value of the mortgage-related securities. One was the 22 cents on the dollar that Merrill Lynch got in July by selling some $30 billion in supposed value of mortgage-backed derivatives for just under $7 billion. The average portfolio might be worth closer to 60 cents on the dollar, but whatever the level, once prices settle, financial recovery can begin.
    The difficulty in establishing value suggests the need for more disclosure. Added transparency is a familiar goal for regulators, with the 1933 and 1934 Securities Acts based on the idea that disclosure makes for the most efficient markets, with the fewest surprises. Many of today's most mispriced financial instruments have no disclosure requirements.
    Indeed, perhaps the biggest remaining unknown is the some $60 trillion of notional debt outstanding in credit-default swaps. This instrument was a smart innovation, even if there was too much of a good thing. These swaps give lenders protection from bad borrowers, thus increasing funds available for investments. But swaps are private contracts, not securities, and because they don't trade on exchanges, they are not subject to disclosure requirements. Securities and Exchange Commission Chairman Chris Cox has urged that some level of disclosure be required.
    We can't stop credit crises, which inevitably occur as innovative financial instruments are periodically put to the test. As we're now painfully reminded, trial and error is a tough system, but it's also the only system known to markets. We're not powerless, however. We can make it easier to resolve future panics with a more transparent investing environment. More disclosure, to match the complexity of evolving financial instruments, would at least make the next credit crisis less of a surprise and ultimately more manageable.

Write to    September 29, 2008

Those whom the gods would destroy, they first make mad
Willem H. Buiter

The US House of Representatives has voted to reject the Emergency Economic Stabilization Act - the $700bn Treasury-funded facility for purchasing and managing toxic assets held by the US banking system.

Opposition to the proposal came from two different sources.  A few remaining libertarians and believers in unfettered free enterprise voted against.  Even when they recognise the risk that a calamitous collapse in economic activity may result, they view this as a form of creative destruction that is an integral part of a Darwinian market economy.  I don’t know anything about Gresham Barrett, a Republican congressman from South Carolina but his statement fits the bill: “My fear is the government will be forever changing the face of the American free market. Because I believe so strongly in the principles of the free market and the belief in freedom, I will be opposing this bill.”  Those who genuinely hold these views are mad, but honest and principled.  I wish them a good depression.

A larger body of nay-voters consists of populist rabble-rousers or, worse, politicians who know better but follow the whims, fancies and passions of their constituents, even when this means that before long the real economy risks falling off a cliff.  The following statement by Ted Poe, a Texan Republican member of Congress is a nice example: “New York City fatcats expect Joe Sixpack to buck up and pay for all of this nonsense,”… “Putting a financial gun to the head of every American is not the answer.”

The dedicated followers of constituency fashion reckon that the date of the election is likely to be before the full impact of the financial collapse made likely by this vote will hit their constituents’ jobs and businesses.  They put re-election before the economic health of the nation and the interests of their constituents.  Opportunism guides them rather than principle.  I wish them a rather nasty depression.

What is likely to happen next?  With a bit of luck, the House will be frightened by its own audacity and will reverse itself.  If a substantively similar bill (or a better bill that addresses not just the problem of valuing toxic assets and getting them off the banks’ books, but also the problem of recapitalising the US banking sector) is passed in the next day or so, the damage can remain limited.  If the markets fear that the nays have thrown their toys out of the pram for the long term, the following scenario is quite likely:

-    The US stock market tanks.  Bank shares collapse, as do the valuations of all highly leveraged financial institutions.  Weaker versions of this occur in Europe, in Japan and in the emerging markets.
-    CDS spreads for banks explode, as will those of all highly leveraged financial institutions.  Credits spreads generally take on loan-shark proportions, even for reputable borrowers. Again the rest of the world will experience a slightly milder version of this.
-    No US bank will lend to any other US bank or any other highly leveraged institution.  The same will happen elsewhere. Remaining sources of external finance for banks, other than the facilities  created by the central banks and the Treasuries, will dry up.
-    Banks and other highly leveraged institutions will try to unload assets at fire-sale prices in illiquid markets.  Even assets not viewed as toxic before will become unsaleable at any price.
-    The interaction of a growing lack of funding liquidity and increasing market illiquidity will destroy the banks’ business models.
-    Banks will stop providing credit to households and to non-financial enterprises.
-    Banks will collapse, both through balance sheet insolvency and through liquidity insolvency.  No bank will be safe, not even the household names for whom the crisis has thus far brought more opportunities than disasters.
-    Other highly leveraged financial institutions collapse on a large scale.
-    Households and non-financial businesses revert to financial autarky, among wide-spread defaults and insolvencies.
-   Consumer demand and investment demand collapse.  Unemployment shoots up.
-    The government suspends all trading in financial stocks until further notice.
-    The government nationalises all US banks and other highly leveraged financial institutions.  The shareholders get nothing up front and have to wait for an eventual re-privatisation or liquididation to find out whether they are left with anything at all. Holders of bank debt get a sizeable haircut ‘up front’ on the face value of the debt and have part of the remainder converted into equity that shares the fate of the old equity.
-    We have the Great Depression of the 2010s.
None of this is unavoidable, provided the US Congress grows up and adopts forthwith something close to the Emergency Economic Stabilization Act as a first, modest but necessary step towards re-establishing functioning securitisation markets and restoring financial health to the banking sector.  Cutting off your nose to spite your face is not a sensible alternative.

PS My remaining financial wealth is now kept in a (small) old sock in an undisclosed location.
PPS The conduct of both US Presidential candidates in this matter makes them unfit for purpose.    September 29, 2008 19:14

French and German anger misses the fact
By Charles Wyplosz

Anger runs deep. It is aimed at financiers, who first earned huge and conspicuous bonuses and now successfully force taxpayers to pay for their mistakes. It is also aimed at financial markets, whose merits have been oversold.

The mantra that financial markets always allocate resources better was never true. Financial markets suffer from very serious failures, chiefly information asymmetry. The subprime saga started with beneficial risk diversification until it became a channel for contagion. The saga also revealed the depth of herding among financial institutions – the exact opposite of risk diversification among them. Having followed the same strategy, they all suffered simultaneous losses.

Financial operations are about risk-taking, which means uncertainty and, occasionally, crashes.

On this ground, anger is universal. US congressmen compete with themselves to lash out at the financiers who created this mess. But, outside the Anglo-American world, we see an outburst of resentment against the US and British approach to finance and banking. With people angry and scared at what may happen next, political leaders find it more difficult than usual to resist populist tendencies and seek to distance themselves from a possibly serious downturn. With market failures crudely in the limelight, they feel pressed to reassert the role of government. Nationalism is always a convenient spare wheel for difficult times.

Once again, Anglo-American capitalism is a bad word and globalisation is next in line. Speeches at this year’s United Nation General Assembly by leaders from every continent reveal the depth of contempt that has been lying low, buried underneath the apparent success of the globalisation process.

A first reason for this backlash is the delicate balance between individualism and solidarity. Americans are famously known to encourage and practise individual responsibility. In many other countries, solidarity is more highly valued and individualism is seen as the other side of egoism. Generous welfare states do not just reflect this view, they also create incentives to support collective insurance arrangements, even if they are inefficient. Adam Smith’s invisible hand, the assertion that individualism delivers the common best, is not popular: we know that his assertion is only approximately correct because it assumes that markets are perfect, which is not the case in practice.

Where individualism is considered a virtue, deviations from the ideal outcome are seen as a regrettable side-effect. But in most parts of the world, where individualism is considered morally wrong, the law of the market is tolerated as long as it delivers prosperity. When it fails, its legitimacy is soon questioned. The world’s major financial markets are in New York and London. No wonder, then, that anger is aimed at Anglo-American capitalism.

The second reason is related to the way financial markets operate. The US and the UK have championed arm’s-length finance, the financing of corporations through issuance of shares and bonds to anonymous stakeholders. Continental Europe – and south-east Asia – has long favoured face-to-face deals between entrepreneurs and bankers. Deals can be shoddy and cliquish, but they provide for some stability. Over the past two decades, arm’s-length finance has made headway in continental Europe, beating back the old boys’ networks. No wonder that the old boys are now hitting back.

Strikingly, Nicolas Sarkozy, the French president, and Peer Steinbrück, the German finance minister, have both announced the end of Anglo-American financial supremacy. It is not clear what their prediction is based upon.

They have denounced excesses, such as bonuses, but that does not even begin to address the root cause of the crisis. They have described financial markets as unregulated. This is simply wrong. Financial markets are tightly regulated. The problem is not just that the regulation is inappropriate, but also that supervisors have not enforced it.

We knew of the hundreds of billions of dollars in dubious claims parked off bank balance sheets in a clear effort at circumventing existing regulations. Regulatory arbitrage, as this is called, has gone unchecked for years.

Both leaders had harsh words for “speculation”, but this misses the fact that finance is speculation. Both zeroed in on short selling. Short selling is like cars. Drivers can be reckless; disciplining them seems more reasonable than banning cars. Denouncing market short-termism runs against evidence that markets better predict companies’ long-term performance than their own managers.

Mr Sarkozy and Mr Steinbrück may be simply captured by their own old boys, but the fate of Fortis, the Belgo-Dutch banking and insurance group, may give them second thoughts. Pain is travelling across the Atlantic and could hurt more good European banks. Mr Sarkozy promised that no French depositor would ever suffer any loss from any French bank. He might soon find the price tag pretty steep.

So will Anglo-American capitalism fade away? Maybe, but that will be decided in Washington, not Paris and Berlin. One thing is sure, neither France nor Germany can mount a serious challenge, at least as long as their people and leaders mistrust and misunderstand finance.

The professor of economics at the Graduate Institute, Geneva

SEPTEMBER 30, 2008

Loose Money And the Roots Of the Crisis
No one can believe in the omniscience of central bankers anymore.

This is the way the world ends
This is the way the world ends
This is the way the world ends
Not with a bang but a whimper.
T.S. Eliot. "The Hollow Men" (1925)
    The world is not ending. Despite the wrenching turmoil in global financial markets and morbid allusions to the death throes of capitalism, it ain't over. Not until people quit believing in themselves, not until people quit believing in a better future.


    But the whimpering is real, and justified, because it hurts to have your world come crashing down. And global financial markets are definitely crashing, even when the impact is momentarily softened through massive injections of artificial money -- "artificial" because the fiat money does not represent a store of genuine value but rather an airy government claim to future wealth yet to be created.
    In the aftermath of this financial catastrophe, as we sort out causes and assign blame, with experts offering various solutions -- More regulation! Less complex financial instruments! -- let's not lose sight of the most fundamental component of finance. No credit-default swap, no exotic derivative, can be structured without stipulating the monetary unit of account in which its value is calculated. Money is the medium of exchange -- the measure, the standard, the store of value -- which defines the very substance of the economic contract between buyer and seller. It is the basic element, the atom of financial matter.

It is the money that is broken.
    These days, we don't often refer to the validity of the money itself but rather to "monetary policy" and how the Federal Reserve has managed to calibrate the money supply to economic activity over the last two decades. There are plenty of critiques; the most pointed ones blame former Fed chief Alan Greenspan for keeping interest rates too low, too long.
    During his 19 years at the monetary helm -- from 1987 to 2006 -- Mr. Greenspan served under four different U.S. presidents. At least one of them, George H.W. Bush, blamed Mr. Greenspan for keeping interest rates too high. The stock market crash that occurred in October 1987, two months after Mr. Greenspan's confirmation under Ronald Reagan, sent the Dow Jones Industrial Average down 508 points (23%). It required huge injections of liquidity, which subsequently needed to be mopped up with tighter monetary policy. "I reappointed him," the elder President Bush said. "And he disappointed me."
    President Clinton likewise reappointed Mr. Greenspan -- and soon learned the terms of the trade-off for reduced short-term interest rates: Bring down the fiscal budget deficit. Spurred on by a Republican Congress, it actually happened; the federal budget was balanced in 1998. All too briefly, the Fed's biggest concern was how to carry out future monetary policy if we ran out of government debt securities for open-market operations. The fiscal deficit subsequently ballooned after 2001, due to spending in excess of revenue growth, while interest rates and unemployment -- and inflation, counterintuitively -- remained low. One thing for sure: We will have more than enough government debt securities.
    There's a reason for this short diversion into Mr. Greenspan's long watch. While he is readily demonized today -- Italy's finance minister recently characterized him as the man who, after Osama bin Laden, "hurt America the most" -- Mr. Greenspan is also the man who was awarded the Presidential Medal of Freedom and whose honorary titles include Knight Commander of the British Empire and Commander of the French Legion d'honneur.
    So how does such an accomplished central banker turn out to be a monetary doofus?
Scapegoats are wonderfully convenient receptacles for our collective disappointment, but that's all. When credit markets seize up, when financial instruments disintegrate, when the dollar fails -- it's not because Alan Greenspan was not sufficiently omniscient. He wasn't, true. But no one ever was. No one ever could be.
    If capitalism depends on designating a person of godlike abilities to manage demand and supply for all forms of money and credit -- currency, demand deposits, money-market funds, repurchase agreements, equities, mortgages, corporate debt -- we are as doomed as those wretched citizens who relied on central planning for their economic salvation.
    Think of it: Nothing is more vital to capitalism than capital, the financial seed corn dedicated to next year's crop. Yet we, believers in free markets, allow the price of capital, i.e., the interest rate on loanable funds, to be fixed by a central committee in accordance with government objectives. We might as well resurrect Gosplan, the old Soviet State Planning Committee, and ask them to draw up the next five-year plan.
"There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard." It would be easy to dismiss this statement as a quaint relic from Mr. Greenspan's earlier days as an Ayn Rand acolyte; his article on "Gold and Economic Freedom" appears in her 1966 compendium "Capitalism: The Unknown Ideal." But Mr. Greenspan said it, rather emphatically, last October on the Fox Business Network. He was responding to the interviewer's question: "Why do we need a central bank?"
    Whatever well-intentioned reasons existed in 1913 for creating the Federal Reserve -- to provide an elastic currency to soften the blow of economic contractions caused by "irrational exuberance" (and that will never be conquered, so long as humans have aspirations) -- one would be hard-pressed to say that the financial fallout from this latest money meltdown will have less damaging consequences for the average person than would have been incurred under a gold standard.
    Moreover, the mission of the central bank has been greatly compromised. Can anyone have faith that Fed policy decisions going into the future will deliver more reliable money? Don't we already know in our bones that the cost of this latest financial nightmare will be born by all of us who store the value of our labor and measure our purchasing power in the form of dollars? As John Maynard Keynes, the famous British economist, observed in his "Tract on Monetary Reform," published in 1923:

"It is common to speak as though, when a Government pays its way by inflation, the people of the country avoid taxation. We have seen that this is not so. What is raised by printing notes is just as much taken from the public as is a beer-duty or an income-tax. What a Government spends the public pay for. There is no such thing as an uncovered deficit."
    The entire world has been affected by the breakdown of the U.S. financial system, thanks to the globalization of investment capital. But the free flow of capital -- along with free trade -- is a good thing, the best path to global prosperity. The problem is that the role of the dollar as the world's primary reserve currency has been called into serious question, both by allies and adversaries. Writing in the People's Daily, Chinese economist Shi Jianxun laments: "The world urgently needs to create a diversified currency and financial system and fair and just financial order that is not dependent on the United States."
    Let's do exactly that. It is time to take on the task of establishing a new foundation for international economic relations and financial relations -- one dedicated to open markets and based on monetary integrity. Every country is responsible for anchoring its own currency to the universal reserve asset, and every citizen has the right to convert the national currency into the universal reserve asset.
    That's how a gold standard works. A bimetallic system, linked to silver and gold, works the same way. In either case the money is fixed to a common anchor -- and thus automatically functions as a common currency to serve the needs of legitimate producers and consumers throughout the world.
    How would such an approach cure financial market ills? Nothing can rescue humans from occasionally making bad choices or succumbing to herding instincts. But on the same principle as democracy and free elections, embedded in the aggregate judgment of individuals over time is a wisdom that outperforms the most ostensibly savvy administrator. Sound money would go a long way toward eliminating the distortions that pervert financial decisions and credit allocations. Price signals do matter; if they don't, then free markets don't matter, and capitalism doesn't work. In which case, let government dictate demand and regulate supply.

No, we need to fix the money. Literally.
    One of the candidates for president of the United States might issue the call for international monetary reform. Bad timing? The memo that resulted in the 1944 Bretton Woods international monetary agreement was written three weeks after Japan attacked Pearl Harbor. The next global conference need not take place in Bretton Woods, N.H., but rather Paris or Shanghai. Countries should participate on a voluntary basis, no coercion, in full recognition that the goal is to hammer out a new financial order where the validity of the monetary unit of account is not determined by hollow men roaming the marble halls of government central banks.
    This is where the new world of sound money begins. This is where the unknown ideal of capitalism takes form.

Ms. Shelton, an economist, is author of "Money Meltdown: Restoring Order to the Global Currency System" (Free Press, 1994)

SEPTEMBER 30, 2008

Too Much Money Is Beyond Legal Reach
New York-based funds are abusing 'secrecy jurisdictions.'

    A major factor in the current financial crisis is the lack of transparency in the activities of the principal players in the financial markets. This opaqueness is compounded by vast sums of money that lie outside the jurisdiction of U.S. regulators and other supervisory authorities.
    The $700 billion in Treasury Secretary Henry Paulson's current proposed rescue plan pales in comparison to the volume of dollars that now escape the watchful eye, not only of U.S. regulators, but from the media and the general public as well.
    There is $1.9 trillion, almost all of it run out of the New York metropolitan area, that sits in the Cayman Islands, a secrecy jurisdiction. Another $1.5 trillion is lodged in four other secrecy jurisdictions.
    Following the Great Depression, we bragged about a newly installed safety net that was suppose to save us from such a hard economic fall in the future. However, the Securities and Exchange Commission, the Federal Reserve System, the Comptroller of the Currency and others have ignored trillions of dollars that have migrated to offshore jurisdictions that are secretive in nature and outside the safety net -- beyond the reach of U.S. regulators.
    We should have learned a long time ago that totally unsupervised markets, whether trading in tulips or subprime mortgages, will sooner rather than later get into trouble. We don't have to look back very far in history to understand this.
    Long Term Capital Management, a hedge fund "based" in Greenwich, Conn., but composed of eight partnerships chartered in the Caymans, was supposed to be the wunderkind of the financial world. At its peak in the late 1990s, its gross holdings were valued at $1.8 trillion. But, regrettably, its liabilities exceeded its assets and the Federal Reserve Bank of New York had to step in and rescue it when the value of its assets plummeted.
    Most recently, two Bear Stearns hedge funds, based in the Cayman Islands, but run out of New York, collapsed without any warning to its investors. Because of the location of these financial institutions -- in a secrecy jurisdiction, outside the U.S. safety net of appropriate supervision -- their desperate financial condition went undetected until it was too late.
    Of course, BCCI Overseas, which was part of the then largest bankruptcy in history, was also "chartered" in the Caymans.
We have to learn from our mistakes. Any significant infusion to the financial system must carry assurances that it will not add to the pool of money beyond the safety net and supervisory authority of the United States. Moreover, the trillions of dollars currently offshore and invested in funds that could impact the American economy must be brought under appropriate supervision.
    If Congress and Treasury fail to bring under U.S. supervisory authority the financial institutions and transactions in secrecy jurisdictions, there will be no transparency with the inevitable consequences of the lack of transparency -- namely, a repeat of the unbridled greed and recklessness that we now face. Because of the monolithic character of world financial markets, a default crisis anywhere becomes a default crisis everywhere.

Mr. Morgenthau is the district attorney for Manhattan, N.Y.

SEPTEMBER 30, 2008

How Voter Fury Stopped Bailout
Left-Right Combo By Opponents Put Plan on the Ropes

The defeat in Congress of a proposed $700 billion economic-rescue package followed an intense outpouring of voter anger, fanned by politicians, interest groups and media on the left and right, that overwhelmed calls from the president and top lawmakers to pass the deal.

Voters opposed to the deal deluged Capitol Hill with letters, emails, phone calls and faxes over the past week. Some 23,000 signatures were collected over two days by Sen. Bernie Sanders, a Vermont  Independent, calling for a five-year, 10% surtax on the wealthiest Americans to help fund the bailout. Some prominent conservatives and bloggers criticized the deal as an unwarranted intervention in the free  market.

Fierce resistance from both ends of the political spectrum drove lawmakers to vote against the economic-rescue plan. "The vast majority of my voters looked at this as a bailout for Wall Street," said Rep. Darrell Issa of California, one of the most outspoken Republican critics of the proposal.

On his Web site in recent days, Rep. Issa has posted letters and emails from some of the more than 2,000 constituents he said had contacted him about the proposal, including one from "Greg" in Temecula,  Calif., who called the proposal "poorly thought out and rushed to the floor." "I am 45 and a husband and father of 4. I am outraged and appalled at the arrogance of my President and the lack of regard for what is right," the message said.

Among prominent conservatives who publicly assailed the administration's proposal in recent days was former Republican House Speaker Newt Gingrich. But Mr. Gingrich said in a statement posted on his Web  site Monday that he would "reluctantly and sadly" vote for the proposal if he were still in office.

"This bill is not the best proposal for solving the housing crisis. It is not even a good proposal for solving the crisis," the statement said. "However, it is the only proposal Secretary [Henry] Paulson would  support, and his support was essential in this setting."

Mr. Gingrich then capped his tepid endorsement with a call for Mr. Paulson's resignation, saying that "having a former chairman of Goldman Sachs preside over disbursing hundreds of billions of dollars to Wall  Street is a terrible concept and inevitably will lead to crony capitalism and the appearance of -- if not the actual existence of -- corruption."

The proposal's defeat was also cheered on by a number of blogs that in recent days have posted links to lawmakers' telephone and fax numbers and urged citizens to oppose the plan. They included, a Web site organized by a 37-year-old Los Angeles attorney named Morgan Ward Doran, and, run by Mike Shedlock, an investment adviser  at SitkaPacific Capital Management. Mr. Shedlock said in an interview Monday that his site had received 1.7 million page hits this month, which he said was half a million more than normal.

On his Web site, Mr. Shedlock has derided the proposed rescue as "a rush to judgment" that would benefit "high-flying financiers who chased big profits through reckless investments," and as "a complete waste  of $700 billion."

"A number of people emailed me to say this was the first time that they've written, faxed or phoned their member of Congress," said Mr. Shedlock, a 55-year-old resident of Prairie Grove, Ill. "Were going to  phone and fax every member of Congress who voted against this to thank them. ... Everyone who voted to pass this bill, we're going to actively organize to oust them."

Members of the Congressional Black Caucus felt pressure from opposition to the package that was mounted by some prominent African-American radio personalities, who objected because it failed to address  their listeners' everyday concerns, such as health-care costs. Among members of the caucus who voted against the deal were Democrats John Lewis of Georgia, John Conyers of Michigan and Jesse Jackson  Jr. of Illinois.

Bev Smith, a nationally syndicated talk-show host on American Urban Radio Networks, said the Congressional Black Caucus members might have been influenced in part by a national campaign she organized,  along with other radio hosts, calling for their audiences to contact members and voice their opposition to the plan.

When the bailout proposal was announced, she brought on economists and other financial experts to discuss the financial problems it ostensibly would solve. "Last week, I asked my audience to call their  legislators and tell them if they vote for this without thorough investigation and without knowing the impact, we're going to kick their butts out of Washington, D.C. My audience flooded the Capitol Hill lines," she  said.

The feelings were evident on blogs and Web posts. One contributor to urged others to contact their representatives and senators by email and to "Tell them to vote NO on the bailout. This  is the biggest robbery of the US in the history of this nation."

Write to Stephen Power at and Gary Fields at

Washington Post    September 30, 2008

Prelude to War? How an Economic Crisis Is Like a War
Topical Depression: Bernanke Knows What We Have to Fear
By Richard Cohen

It comforts me that Ben Bernanke, chairman of the Federal Reserve Board and an architect of the financial bailout plan the House rejected yesterday, is a specialist in the Great Depression. This, of course, was the economic calamity that beset the United States from 1929 to about 1942 and ended only when America went to war. What stopped the Depression was a worldwide bloodbath.

Anyone who knows the history of those awful times has to be chastened. The Depression was not, after all, simply an economic crisis. It was also a political and cultural one. It contributed to the rise of totalitarian movements abroad -- both in Europe and Japan -- and some pretty ugly political movements here as well. These things are hard to measure, but American democracy's closest call probably came during the Great Depression.

The rhetoric in Washington seems oblivious to history. It talks only of financial matters, and it searches, as any mindless politician must, for culprits. Greed is blamed, as if it is something new or controllable, and the entire problem is discussed as if failure will do nothing but endanger some rich institutions and their equally rich managers. The Great Depression teaches otherwise.

Throughout Europe during the Depression came the rise of fascist parties -- the Nazis in Germany, the Union of Fascists in Britain, the Croix-de-Feu in France, etc. Elsewhere, communist parties were emboldened. People were desperate, and they looked for desperate solutions.

It is hard to envision anything like this happening again. But why not? The world is a smaller place than it was in 1929. We have become globalized, financial markets intertwined as never before. During the Depression, nations moved to close their borders to refugees. How could more people be let into a country -- any country -- when those already there were out of work? America, too, clamped down on refugees -- even though many of them were fleeing for their very lives. In 1939, the St. Louis, a ship carrying Jewish refugees, went from Germany to Cuba and back to Europe because its passengers were not welcome anywhere on this side of the Atlantic.

It is harder still to envision anything like that happening today. But, again, why not? The zeitgeist changes instantly. Less than two years ago, the world was awash in credit and then, within months, there was none to be found. Credit had dried up. The housing market plummeted. Mortgages turned out not to be worth the paper they were written on -- not that anyone could find the paper, anyway. Circumstances were suddenly different. If circumstances become even more different, who knows what could happen.

Much has been made of the so-called culture wars here in America. The McCain-Palin ticket represents one culture and Obama-Biden another. But this clash is not about culture per se -- otherwise, how could the mother of an unwed pregnant teenager be the conservative while her opponents, as conventional as Saturday night at the VFW, are the liberals? No, it's really about outlook. Barack Obama's people feel they have control over their lives. Sarah Palin's people do not have a similar confidence.

This is why the Republican National Convention made war on the media. This is why Palin frequently has referred to "the pollsters and the pundits." These were the hidden manipulators of the culture and the economy, part of the often-invisible elitists who made it so bad for everyone else. They controlled the culture, the smut that came into one's home on the TV set and what was playing at the multiplex. They owned the banks and the newspapers and the TV networks -- and it didn't matter that their name could be Rupert Murdoch and they could be deeply conservative. As Don Quixote knew, "facts are the enemy of truth." Hard times are hard on truth.

The Great Depression was not just a period of wholesale unemployment and incredible poverty -- of bread lines and apple-peddlers and women selling brief intimacy for 10 cents a dance. It was also the period of Hitler and Mussolini and, in this country, of Huey Long and Father Charles Coughlin, and the belief among otherwise sane people that communism was the remedy for what ailed us. An economic crisis is like war. It's impossible to contain. It affects everything it touches.

Ben Bernanke knows all this. He might focus on the raw numbers of the Great Depression -- "I see one-third of a nation ill-housed, ill-clad, ill-nourished," Franklin Roosevelt said -- but he would also have to know the social and cultural ramifications. You can, if you want, say the bailout program is about the future. But it's really about the past.

October 15, 2008

Banks’ Bailout Unlikely to Crimp Executive Pay

Under the bailout plan for the nation’s banks unveiled on Tuesday, no heads will roll, as they did in the United Kingdom. No banking executives are likely to go hungry, either. But their parting may not be quite as sweet.

The Treasury’s plan seeks to take aim at the eight-figure pay packages given to Wall Street executives that have enraged so many Americans in the wake of the country’s financial collapse.

Banks that get an equity infusion from the government will have to follow some general rules on paying their top five executives. They will be restricted from offering golden parachutes, as rich severance packages are called, and they will have to pay more taxes if an individual’s compensation exceeds $500,000.

“The key will be how they implement it,” said Representative Barney Frank, Democrat of Massachusetts, who is chairman of the House Financial Services Committee and has long sought to restrict executive pay.

He said he did not think the Treasury plan went far enough, but he praised it as attacking the “perverse incentives” that led to the crisis.

Compensation experts say that the provisions, though politically prudent to appease public anger, will probably have little real impact on how financial executives are paid in coming years.

They predict banks will simply pay higher taxes and will find other creative ways of paying their executives as they see fit. Some say there could even be a sudden surge in compensation as soon as the government program ends, in a few years, leading to eye-popping numbers down the road.

“Congress’s record of regulating executive pay has been unblemished by success,” said Kevin J. Murphy, a finance professor at the University of Southern California, pointing to perverse outcomes of past efforts.

When Congress limited the tax deductibility of cash salaries to $1 million, for example, it simply led to an explosion in stock options used as compensation and even higher total payouts.

Like other experts, Professor Murphy expects the $500,000 cap to be largely ignored, with banks willing to accept the tax consequences. For many of the top executives, such a salary would simply not be competitive: “$500,000 was supposed to be a good week,” he said, adding that many of these executives would respond to such suggestions by leaving for jobs at unregulated banks or hedge funds.

But what Treasury cannot easily achieve under its plan might be achieved temporarily by the weak economy, falling stock prices and frustrated boards who are pressured by shareholders disgusted over past excess, say some experts. “The market may take care of it just by default,” said Paul Hodgson, a senior analyst at the Corporate Library, a governance research group.

The government’s sudden sweeping presence may prod some boards to take a harder line, said Charles M. Elson, a corporate governance expert at the University of Delaware. “Every board is going to be under tremendous pressure on compensation, by shareholders and by the government’s investment.”

Some of those discussions have already begun among board members, said Ira T. Kay, a compensation specialist at Watson Wyatt Worldwide. “These rules will have a chilling effect on executive pay practices,” he said.

Severance payments have begun to fall, he said, and he predicts there will be “much more downward pressure.”

Of course, there have been past predictions that executive pay would be crimped, but that effect tended to be a more short-term reaction to weak business results, as companies and executives simply adapted.

“Every prediction of the demise of C.E.O. pay has been overstated,” said Professor Murphy. After the dot-com bubble burst, for example, executives no longer made significant sums through stock options but turned instead to restricted stock. Compensation soon moved upward.

The new Treasury rules, which still need to be clarified, also provide some broad guidelines, requiring the banks that get government capital to make sure their compensation packages do not reward excessive risk-taking and instituting a “claw-back” rule to force repayment of compensation that was based on results that later prove to be inaccurate.

Exactly how some of these provisions will work is unclear, as well as how Treasury will eventually enforce them.

Along with banks that get government capital, banks that participate in the government’s program to buy targeted assets will have limits on compensation. Banks that sell the government more than $300 million in assets will face significant taxes if they offer a golden parachute to a departing executive.

Michael Useem, a professor at the Wharton School, said that while the Treasury proposals have shortcomings in addressing inflated pay packages, Congress had to do something. “The bigger concern is the need for strong political support of the bailout agenda,” he said.

Banks ignore the provisions at their peril, he argued. “The spirit of the provision is quite clear,” he said. “If executives begin to not follow the spirit of the provisions, they will politically weaken support for what is being done.”

October 16, 2008

Cuomo Seeks Recovery of Bonuses at A.I.G.

New York’s attorney general demanded on Wednesday that the American International Group recover bonuses and other payments from its former executives, lest he take formal action against the insurer.

Recently bailed out by the federal government, A.I.G. is afloat only because of billions of dollars in government loans. With more and more taxpayer money committed, Congress and others have expressed outrage over high pay in general at financial firms and in particular at some of the perks that have come to light at A.I.G.

The attorney general, Andrew M. Cuomo, made his demand in a letter to A.I.G.’s board, citing “unwarranted and outrageous expenditures” by the company as contrary to New York law. The letter, which described a lavish golf outing and an overseas hunting trip that cost nearly $100,000, follows other recent disclosures of excess by corporate America.

The threat against A.I.G., which Mr. Cuomo announced at a news conference on the street just a block away from the New York Stock Exchange and his office, seeks to recover multimillion-dollar payments to Martin Sullivan, A.I.G.’s former chief executive, and Joseph J. Cassano, who ran the unit blamed for the losses that pushed the company to the brink of collapse.

“A.I.G.’s belief is that they had the party, and the taxpayers will have the hangover,” Mr. Cuomo said, addressing a sidewalk throng of reporters, camera crews and tourists. He added that his office could bring civil charges if A.I.G. did not work to recover big bonuses paid to executives.

His actions are reminiscent of the sweeping attacks on Wall Street by Eliot Spitzer, who was the attorney general before his brief term as governor, which ended in scandal.

Public anger has grown the last few weeks over executive compensation. Lawmakers in Washington last week criticized the $442,000 that an A.I.G. subsidiary spent on a weeklong resort retreat for top sales staff, within days of receiving government aid. The Treasury Department, in the midst of engineering a multibillion-dollar bailout of the financial industry, has announced that it will limit compensation to top executives whose companies took advantage of federal aid.

“People are outraged that these large businesses have shafted the shareholders, that’s why were seeing this,” said Kenneth N. Klee, a law professor at the University of California, Los Angeles. “And rightly so.”

In his letter, Mr. Cuomo pointed to payments made even as A.I.G.’s losses were mounting.

“The board awarded its chief executive officer a cash bonus of over $5 million and a golden parachute worth $15 million,” Mr. Cuomo wrote. “Similarly, in February 2008, a top-ranking executive who was largely responsible for A.I.G.’s collapse was terminated, but still permitted by the board to keep $34 million in bonuses. This same individual apparently continued to receive $1 million a month from the company until recently.”

Mr. Cuomo was apparently referring to Mr. Sullivan, the former chief executive at A.I.G., and to Mr. Cassano, who ran A.I.G. Financial Products, the company unit that was heavily involved in the complex financial transactions that led to billions of dollars in losses.

An A.I.G. spokesman, Nick Ashooh, said the company had received Mr. Cuomo’s letter and “will of course fully cooperate with the attorney general’s office, and it will get the immediate attention of the board.”

Two weeks ago, long before Mr. Cuomo’s letter was sent, the company began reviewing all expenses and activities, Mr. Ashooh added.

Lawyers for Mr. Sullivan, who was ousted in June, and Mr. Cassano, who resigned in February, did not return calls on Wednesday. In his letter, Mr. Cuomo went on to cite golf and hunting trips that executives at A.I.G. took after the government extended an $85 billion line of credit to the insurance company, which has since obtained additional financing from the Federal Reserve Bank of New York.

A handful of A.I.G. officials flew to England on a private jet for a partridge hunt that reportedly cost about $90,000. The use of the plane cost about $17,000, according to a person familiar with Mr. Cuomo’s investigation.

Mr. Cuomo’s demand rests on a provision of New York law that allows creditors to challenge any payment by a company if the company did not get adequate value in exchange. In this case, the argument would be that the executives took millions of dollars in compensation and severance but did not provide service worth the money.

“Obviously, it’s a question of proof,” said Jim Cohen, a law professor at Fordham University. Lawyers for the attorney general, in the name of creditors of A.I.G. — say, the people of New York to whom the company may owe taxes — would try to convince a judge of how little executives’ services were worth.

“It’s a difficult situation, because you’re going to have to get into what the market was,” Professor Klee said. He added that if Mr. Cuomo’s tactic worked, creditors might try to use it in other contexts to pursue highly paid executives, like those who worked at Lehman Brothers, now in bankruptcy proceedings.

“It’s not going to be easy litigation,” he said, “but it certainly could be brought.”

October 31, 2008

Banks Owe Billions to Executives

Financial giants getting injections of federal cash owed their executives more than $40 billion for past years' pay and pensions as of the end of 2007, a Wall  Street Journal analysis shows.

The government is seeking to rein in executive pay at banks getting federal money, and a leading congressman and a state official have demanded that  some of them make clear how much they intend to pay in bonuses this year.

But overlooked in these efforts is the total size of debts that financial firms receiving taxpayer assistance previously incurred to their executives, which at some  firms exceed what they owe in pensions to their entire work forces.

The sums are mostly for special executive pensions and deferred compensation, including bonuses, for prior years. Because the liabilities include stock,  they are subject to market fluctuation. Given the stock-market decline of this year, some may have fallen substantially.

Some examples: $11.8 billion at Goldman Sachs Group Inc., $8.5 billion at J.P. Morgan Chase & Co., and $10 billion to $12 billion at Morgan Stanley.

Few firms report the size of these debts to their executives. (Goldman is an exception.) In most cases, the Journal calculated them by extrapolating from  figures that the firms do have to disclose.

Most firms haven't set aside cash or stock for these IOUs. They are a drag on current earnings and when the executives depart, employers have to pay  them out of corporate coffers.

The practice of incurring corporate IOUs for executives' pensions and past pay is perfectly legal and is common in big business, not limited to financial firms.  But liabilities grew especially high in the financial industry, with its tradition of lavish pay.

Deferring compensation appeals both to employers, which save cash in the near term, and to executives, who delay taxes and see their deferred-pay  accounts grow, sometimes aided by matching contributions. In some cases, firms give top executives high guaranteed returns on these accounts.

The liabilities are an essentially hidden obligation. Even when the debts to their executives total in the billions, most companies lump them into "other  liabilities"; only a few then identify amounts attributable to deferred pay.

The Journal was able to approximate companies' IOUs, in some cases, by looking at an amount they report as deferred tax assets for "deferred  compensation" or "employee benefits and compensation." This figure shows how much a company expects to reap in tax benefits when it ultimately pays  the executives what it owes them.

J.P. Morgan, for instance, reported a $3.4 billion deferred tax asset for employee benefits in 2007. Assuming a 40% combined federal and state tax rate --  and backing out obligations for retiree health and other items -- implies the bank owed about $8.2 billion to its own executives. A person familiar with the  matter confirmed the estimate.

Applying the same technique to Citigroup Inc. yields roughly a $5 billion IOU, primarily for restricted stock of executives and eligible employees. Someone  familiar with the matter confirmed the estimate.

The Treasury is infusing $25 billion apiece into J.P. Morgan and Citigroup as it seeks to get credit flowing. In return, the federal government is getting  preferred stock in the banks and warrants to buy common shares. The Treasury is injecting $125 billion into nine big banks and making a like amount  available for other banks that apply.

It's imposing some restrictions on how they pay top executives in the future, such as curtailing new "golden parachutes" and barring a tax deduction for any  one person's pay above $500,000. But the rules won't affect what the banks already owe their executives or make these opaque debts more transparent.

Asked about the Journal's calculation, the Treasury said, "Every bank that accepts money through the Capital Purchase Program must first agree to the  compensation restrictions passed by Congress just last month -- and every bank that is receiving money has done so."

Bear Stearns Cos., the first financial firm the U.S. backstopped, owed its executives $1.7 billion for accrued employee compensation and benefits at the start  of the year, according to regulatory filings. When Bear Stearns ran into trouble after investing heavily in risky mortgage-backed securities, the government  stepped in, arranging a sale of the firm and taking responsibility for up to $29 billion of its losses.

The buyer, J.P. Morgan, says it will honor the debt to Bear Stearns executives, which it said is shrunken because much of it was in stock that sank in value.

J.P. Morgan will also honor deferred-pay accounts at another institution it took over, Washington Mutual Inc. It couldn't be determined how big this IOU is.  J.P. Morgan's move will leave the WaMu executives better off than holders of that ailing thrift's debt and preferred stock, who are expected to see little  recovery. J.P. Morgan's share of the federal capital injection is $25 billion.

Obligations for executive pay are large for a number of reasons. Even as companies have complained about the cost of retiree benefits, they have been  awarding larger pay and pensions to executives. At Goldman, for example, the $11.8 billion obligation primarily for deferred executive compensation  dwarfed the liability for its broad-based pension plan for all employees. That was just $399 million, and fully funded with set-aside assets.

The deferred-compensation programs for executives are like 401(k) plans on steroids. They create hypothetical "accounts" into which executives can defer  salaries, bonuses and restricted stock awards. For top officers, employers often enhance the deferred pay with matching contributions, and even assign an  interest rate at which the hypothetical account grows.

Often, it is a generous rate. At Freddie Mac, executives earned 9.25% on their deferred-pay accounts in 2007, regulatory filings show -- a better deal than  regular employees of the mortgage buyer could get in a 401(k). Since all this money is tax-deferred, the Treasury, and by extension the U.S. taxpayer,  subsidizes the accounts.

In addition, because assets are rarely set aside for executive IOUs, they have a greater impact on firms' earnings than rank-and-file pension plans, which by  law must be funded.

Bank of America Corp.'s $1.3 billion liability for supplemental executive pensions reduced earnings by $104 million in 2007, filings show. By contrast, the  bank's regular pension plan is overfunded, and the surplus helped the plan contribute $32 million to earnings last year.

While disclosing its liability for executive pensions, the bank doesn't disclose its IOU executives' deferred compensation, and it couldn't be calculated. The  bank's share of the federal capital injection is $25 billion.

Bank of America has agreed to acquire Merrill Lynch & Co. Merrill is a rare example of a firm that has set aside assets for its deferred-pay obligation: $2.2  billion, matching the liability. Morgan Stanley also says its liability for executives' deferred pay is largely funded.

To be sure, deferred-compensation accounts can shrink. Those of lower-level executives usually track a mutual fund, and decline if it does. Often the  accounts include restricted shares, which also may lose value, especially this year. To the extent financial-firm executives were being paid in restricted stock,  many have lost huge amounts of wealth in this year's stock-market plunge.

The value of Morgan Stanley Chief Executive John Mack's deferred-compensation account declined by $1.3 million in fiscal 2007, to $19.9 million; much of  it was in company shares. Mr. Mack didn't accept a bonus in 2007.

Executives can even lose their deferred pay altogether if their employer ends up in bankruptcy court. When Lehman Brothers Holdings Inc. filed for  bankruptcy last month, most executives became unsecured creditors. The government didn't come to Lehman's aid.

In assessing liabilities, the Journal examined federal year-end 2007 filings by the first nine banks to get capital injections, plus six other banks and financial  firms embroiled in the financial crisis. In many cases, the firms didn't report enough data to estimate their obligations to executives. As for identifying amounts  due individual executives, company filings provided a look at only the top few, and not a full picture of what they were owed.

Just as banks aren't the only financial firms getting federal aid amid the crisis, they aren't the only ones facing scrutiny of their compensation programs.

Struggling insurer American International Group Inc. agreed to suspend payment of deferred pay for some former top executives pending a review by New  York state Attorney General Andrew Cuomo. Mr. Cuomo is also demanding to know this year's bonus plans for the first nine banks getting federal cash, as  is House Oversight Committee Chairman Henry Waxman.
[Executive IOUs]

Among the payouts AIG agreed not to make are disbursements from a $600 million bonus pool for executives of a unit that ran up huge losses with complex  financial products. AIG also is suspending $19 million of deferred compensation for Martin Sullivan, whom AIG ousted as chief executive in June. His  successor as CEO, Robert Willumstad, who left when the U.S. stepped in to rescue AIG in September, has said he's forgoing $22 million in severance  because he wasn't there long enough to execute his strategy for AIG.

However, the giant insurer -- whose total liability for its executives' deferred pay couldn't be calculated -- says most of the managers will receive the  compensation. "Of course, we'll be looking at all these to make sure they're consistent with the requirement of the program," said spokesman Nicholas  Ashooh.

AIG isn't eligible for the government's capital-injection plan, since it's not a bank, but it's getting plenty of U.S. aid of another sort. The Treasury has made  $123 billion of credit available, a little more than two-thirds of which AIG has borrowed so far.

Fannie Mae and Freddie Mac also don't get in on the capital-injection plan for banks. But under a federal "conservatorship," the Treasury agreed to provide  each with up to $100 billion of capital if needed. In return, the government got preferred shares in the firms and the right to acquire nearly 80% of them.

Their regulator, the Federal Housing Finance Agency, says it will bar golden-parachute severance payouts to the mortgage buyers' ousted chief executives.  The executives remain eligible for their pensions.

Fannie Mae had a liability of roughly $500 million for executive pensions and deferred compensation at the end of 2007, judging by the size of its deferred  tax assets. A spokesman for the firm wouldn't discuss the estimate or whether the executives would get the assets.

At Freddie Mac, most will. "Deferred compensation belongs to the officers who earned it," said Shawn Flaherty, a spokeswoman. Indeed, in September Freddie Mac made its deferred-compensation plan more flexible, allowing executives to receive their money earlier than initially  spelled out. "Officers were nervous about market changes," said Ms. Flaherty. "We wanted a retention tool for top talent."

Write to Ellen E. Schultz at    October 31, 2008 (Update1)

Greenspan Slept as Off-Books Debt Escaped Scrutiny
By Alan Katz and Ian Katz

Oct. 30 (Bloomberg) -- As George Miller welcomed 60 bankers to the chandeliered Charlotte City Club one evening in September, the focus was on more  than the recent bankruptcy of Lehman Brothers Holdings Inc. From their 31st-floor perch, members of the American Securitization Forum, which Miller  leads, fretted about the future of their $10.7 trillion industry.

The bankers were warned that a Financial Accounting Standards Board plan would force trillions of dollars back onto balance sheets, requiring cash  reserves to soar. Their business of pooling and reselling assets had dropped 47 percent in the first six months of the year, and the industry couldn't afford  another setback.

The next day, Miller, 39, the forum's executive director, took that message from North Carolina to a Senate hearing in Washington examining the buildup of  off-balance-sheet assets. ``There are great risks to the financial markets and to the economy of moving forward quickly with bad rules,'' he said of FASB's  proposal.

Miller was trying to preserve an accounting rule for off- the-books assets that helped U.S. banks export toxic debt around the world. It is a loophole that Jack  Reed, the Rhode Island Democrat who chairs the Senate securities subcommittee, said had contributed ``to the severity of the current crisis.'' The damage to date: more than $680 billion dollars in losses and writedowns, about one-third of that by European banks.

Unregulated Derivatives

Efforts by lobbyists have delayed FASB decisions and kept key parts of the American financial system beyond the reach of regulators. Their victories  included ensuring that over-the- counter derivatives stayed unregulated and persuading the Securities and Exchange Commission to let investment banks'  broker-dealer units reduce capital requirements. That allowed them to increase borrowing and magnify profits. Bank watchdogs also didn't move to tighten  mortgage-industry standards until after the collapse of the subprime market.

Today, a road snakes from the foreclosed homes of California and Ohio to the capital cities of Europe, where politicians and bankers have struggled to  contain a widening credit crisis by pumping hundreds of billions of euros into the financial system. The road was paved with decisions like ones by FASB  that allowed banks to keep shifting assets into blind spots outside the view of shareholders and industry overseers.

`Magic Trick'

``I've always regarded it as a bit of a magic trick,'' Pauline Wallace, a partner at PriceWaterhouseCoopers LLP and team leader in London for financial  instruments, said of off-balance- sheet accounting. ``Magicians come to parties, and they make things seem to disappear. The risk is somewhere, but you  never knew where.''

Pushed by taxpayers angry about financing a bailout of Wall Street while their retirement accounts wither, Congress is likely to shake up bank and securities  regulation, giving the Federal Reserve more power.

``I wouldn't be surprised if the Fed ends up officially becoming our systemic-risk regulator,'' said Robert Litan, an economist at the Brookings Institution in  Washington.

That's ironic to Donald Young, an investor advocate and FASB board member from 2005 until June 30. He testified at the same Senate hearing on Sept. 18  that both the Fed and the SEC joined the banks they oversaw in resisting proposals for more disclosure of off-the-books assets. ``There was an unending lobbying of FASB'' by companies and regulators, Young told the committee.

`Lack of Transparency'

The former FASB board member made a similar point in a June 26 letter to Senator Reed. ``We lacked the ability to overcome the lobbying efforts that  effectively argued that if we made substantive changes we would hamper the credit markets and hurt business,'' Young wrote. ``Our inaction did not hamper  credit markets -- it helped to destroy them.''

The issue, Young said in an interview, was the ``lack of transparency'' that comes with off-the-books accounting. ``There is a perceived free lunch that they can take on risk and not reflect it, and make things look better than they are,'' he said. ``That encourages them to  do it more and more.''

A spokesman for FASB, Neal McGarity, said in an e-mail that Young voted with the majority of the board in a January 2005 decision to expand the use of an  off-balance-sheet vehicle.

UBS Writedowns

Regulators outside the U.S. didn't do a good job policing investments in subprime-mortgage assets either. Zurich-based UBS AG, hurt the most in Europe  with writedowns and losses totaling $44 billion, told the Swiss Federal Banking Commission early last year that it was ``fully hedged, yes, even  overhedged,'' director Daniel Zuberbuehler said at a press conference in April. ``This answer subsequently proved to be wrong, because UBS did not correctly capture its actual risk exposure and seriously overestimated its hedges,''  Zuberbuehler said. The Swiss commission now says it will force the bank to hold more capital in reserve and is negotiating with UBS over new capital  requirements.

An International Monetary Fund report in April described how the housing turmoil in the U.S. ``spread quickly to Europe, prompting bank rescues and  capital injections.'' It said that as of March, European banks still had $173 billion in subprime mortgage-backed securities and collateralized debt obligations,  about the same amount as U.S. banks.

The accounting standards board, housed in a corporate office park in Norwalk, Connecticut, an hour northeast of New York City, operates in an unusual  position between the public and private sectors. It was set up in 1973 as an independent rulemaking group, though the SEC gets a say in who is named to  the board and can override its rules.

FASB Rules

For the past decade, FASB has been wrestling with how to account for off-balance-sheet assets, which include the majority of securitized financial products.  In a securitization, a company pools loans such as mortgages and credit card receivables, slices them into securities and sells them to investors, usually  through a separate trust.

The process allows the originating company or bank to get cash up front, while investors are paid off with the consumers' monthly payments. The issuer can  also record profit from the sale to the trust and take the loans off its balance sheet. That reduces the amount of capital required as a buffer against losses,  letting the company increase lending and boost earnings.

Citigroup Inc. reported that it had $1.18 trillion in off- balance-sheet holdings as of June 30, including $828.3 billion in qualified special purpose entities, or  QSPEs, a type of trust that is supposed to be beyond a lender's control.


Banks also created off-balance-sheet entities known as structured investment vehicles, or SIVs, that were marketed to outside investors. SIVs purchased  many of the mortgage-backed notes issued by QSPEs, either directly or through other structures called collateralized debt obligations.

Securitization accelerated in the mid-1990s. The total amount of mortgage-backed securities issued almost tripled between 1996 and 2007, to $7.27 trillion,  according to the Securities Industry and Financial Markets Association, or SIFMA.

Ten years ago, Wall Street was enjoying a bull market fed by a booming dot-com industry, a Fed chairman, Alan Greenspan, who trusted the market to  correct its own ills, and a Congress amenable to lightening the touch of regulators.

In 1998, the imminent collapse of hedge fund Long-Term Capital Management forced the Fed to organize a bailout by Wall Street. Investment banks had  loaned the fund billions and were among counterparties in more than $1 trillion in derivative contracts used to hedge investment risks.

Greenspan, Rubin

That same year Greenspan, Treasury Secretary Robert Rubin and SEC Chairman Arthur Levitt opposed an attempt by Brooksley Born, head of the  Commodity Futures Trading Commission, to study regulating over-the-counter derivatives. In 2000, Congress passed a law keeping them unregulated.

Levitt said he went along with concerns by Greenspan and Rubin that Born's action might throw derivatives contracts into ``legal uncertainty.'' He said he  now regrets that he didn't press a presidential advisory group ``to take a closer look'' at the issue. Rubin said in an interview that ``you could have had  chaos'' if Born's plan found existing derivatives contracts invalid because they weren't traded on an exchange. Both Born and Greenspan declined to  comment.

Outstanding credit-default swaps, derivative contracts used to hedge or speculate on a company's debt, would grow to $62 trillion from $631 billion in 2001.  While the swaps spread risk, as intended, they also helped spread fear. Ninety percent of the trades were concentrated in the hands of 17 banks, according  to the Federal Reserve Bank of New York. That left them exposed to losses if one failed, as Lehman Brothers did in September, and contributed to the  unwillingness to lend to each other that's at the center of the recent credit squeeze.

3 Percent Rule

FASB had issued off-balance-sheet accounting standards in June 1996 to deal with the growth in securitizations. They were replaced in 2000 by FAS 140,  which required more disclosures and rules for dealing with collateral.

Companies were allowed to push an entity off their books if an outside party put up as little as 3 percent of the capital. Houston-based Enron Corp. declared  bankruptcy in late 2001 when it was forced to put trusts back on its balance sheet because it hadn't met the 3 percent rule.

The Enron scandal put pressure on FASB to make it harder for companies to keep assets hidden. In January 2003, it proposed a new rule, known as FIN  46, which increased the outside-party requirement to 10 percent.

`Bill of Goods'

Banks went on the offensive. The rule ``was developed in a rush,'' the American Bankers Association wrote in a letter to FASB that July. That same month  Robert Traficanti, deputy controller of Citigroup, wrote that the proposed change would have a ``significant impact,'' forcing the lender to move the entities to  the balance sheet and raise more capital.

In December 2003, FASB published FIN 46R, a revision that gave the banks more flexibility to keep off the books investment vehicles they managed for a  fee. Banks have lobbied on the issue since at least the early 1980s, said Timothy Lucas, who was at the FASB for more than two decades starting in 1979. ``I think we were sold a bill of goods'' by banks on some off-the-books structures, Lucas said.

In 2004, the SEC allowed the biggest securities firms -- Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman and Bear Stearns Cos.  -- to set up a system giving the commission oversight of the investment banks' holding companies, rather than just their brokerage units, as had been the  case.

Increased Leverage

With the change, approved in April that year, the Wall Street firms avoided having their operations in Europe regulated by the European Union. They were  also able to reduce the amount of cash their broker-dealer units had to set aside as a cushion against unexpected losses by as much as 30 percent, Annette  Nazareth, then head of the SEC's market-regulation staff, said in an interview. Nazareth, who later became an SEC commissioner, is now a partner at New  York law firm Davis Polk & Wardwell.

That allowed the banks to increase their leverage, the ratio of borrowed funds to each dollar of equity capital held, and to invest even more heavily in  subprime-related securities. Bear Stearns increased its leverage to 33.5-to-1 after the rule change from 26.4-to-1.

The continued delays and revisions of FASB's off-balance- sheet rules let financial institutions keep the scope of their assets from public view. In May 2007, after the subprime mortgage crisis began to unfold, the accounting board proposed abolishing QSPEs altogether. It approved the move this  April.

`Time Bombs'

Under FAS 140, entities are allowed to be kept off the books only if their activities are beyond the control of the sponsor. The problem, FASB Chairman  Robert Herz said in a Sept. 18 speech in New York, was that the QSPE concept was ``stretched'' by the addition of subprime loans, which require ``active  management and large-scale restructuring'' by the lender. ``We now know with hindsight that some of these entities, treated as Qs for accounting purposes, were effectively ticking time bombs,'' Herz said, referring to  rising subprime defaults. ``And the bombs started to explode.''

Switching metaphors, he added: ``Unfortunately, it seems that some folks used Qs like a punch bowl to get off-balance- sheet treatment while spiking the  punch. That has led us to conclude that now it's time to take away the punch bowl.''

In July, FASB decided to keep the bowl on the table a little longer, postponing by a year the effective date of the changes, to Nov. 15, 2009. The decision  came after major banks, a member of Congress, Miller's securities association and other trade groups complained that the board was moving too fast and  that the results would be confusing for investors.

`Intense Pressure'

FASB was ``under intense pressure from industry,'' Alan Blinder, a former Federal Reserve Board vice chairman and now a Princeton University  professor, said in an interview. ``It's fair to say that the industry and the regulatory community alike failed to look through the off-balance-sheet entities with a skeptical eye and see the extent  of what they might be on the hook for in a bad-case scenario,'' Blinder said.

That view is shared by Susan Bies, a Federal Reserve Board governor from 2001 to 2007. ``The No. 1 reason we're in this crisis is the deterioration of underwriting of mortgage loans,'' Bies said. ``What has made it worse is the lack of transparency  in disclosures of the exact nature of assets both on and off the books. We need a clearer description of what potential exposures are out there.''

Miller said in an interview that the securitization industry got a bad rap from the Enron bankruptcy and that equating off- the-books entities with ``fraud or  abuse'' is ``clearly an over- generalization.''

Greenspan Blasted

At hearings in Congress last week, financial experts and industry groups urged House and Senate committees to consider changes, including a regulator  with overall authority to protect the system from risk. T. Timothy Ryan, SIFMA president, and Steve Bartlett, president of the Financial Services Roundtable,  both supported the idea of a clearinghouse for credit-default swaps at an Oct. 21 House hearing. The clearinghouse would help ensure payment if  counterparties failed to manage risk.

Two days later, Greenspan was blasted at another House hearing for failing to curb the growth of subprime-mortgage loans. He came out in favor of new  rules requiring issuers of securitized assets to ``retain a meaningful part of the securities they issue.''

Barney Frank, chairman of the House Financial Services Committee, said in a speech in Boston on Oct. 27 that he is also in favor of rules ``to contain the  excesses of this great innovation of securitization.''

Others took a more global view. ``We exported our toxic mortgages abroad,'' Joseph Stiglitz, a professor of economics at Columbia University and a Nobel Prize winner, said at the Oct. 21  House hearing. ``Had we not, the problems here at home would have been even worse.''

To contact the reporters on this story: Ian Katz in Washington at; Alan Katz in Paris at

January 27, 2009

Money for Nothing
MERRILL LYNCH lost $27 billion last year, and yet still managed to rush through
$4 billion worth of year-end bonuses in the days before it was taken over by Bank of America.

Because both companies have been the beneficiaries of the Treasury’s Troubled Asset Relief Program, news of these bonuses was met with predictable uproar: Attorney General Andrew Cuomo of New York threatened to investigate; any elected official with access to a microphone joined in a chorus of “shame on you”; and around every water cooler and on every cable channel, pundits offered up scathing commentaries of Wall Street greed.

Merrill Lynch is not the only irresponsible institution out there. Despite a year of record losses, despite all the taxpayer money being injected into our financial institutions, bonuses for 2008 were, in some cases, down less than 50 percent from those the previous year.

This is shocking, of course, but what’s been missed in these discussions is how completely the culture of executive compensation has permeated the financial industry. One need not even be an executive to receive a bonus far in excess of the yearly salary of people in most other professions.

Bonuses, which typically consist of some multiple of an employee’s base salary, are doled out to everyone from the 22-year-olds just out of college (these are called analysts) to managing directors (banker parlance for the most senior rank attainable).

I spent much of my early career at Merrill Lynch, and I can still remember how I yearned for the holiday season, because it signified bonus time. And by “bonus time,” I mean that brilliant 10-minute conversation during which you learned how many zeros would be on that year’s check.

The euphoria that followed justified the days on end of working into the wee hours, the months on end without a single day off, the never-ending “fire drills” — when a client wanted something and wanted it now, whether it was 7 p.m. or 7 a.m. — that kept the stress and adrenaline levels high.

For some, euphoria quickly gave way to anger and envy upon hearing what their colleagues got paid. Luckily for management and shareholders, that anger twisted itself into motivation to work even harder, get even less sleep and put up with even more in order to get a better bonus next year. For others, the days after bonus distribution were the perfect time to jump to another firm for more responsibility, authority and, no surprise, more money.

That’s not to say that bonuses are always bad. When I graduated from business school in early 2000 and returned to Wall Street, there was a war for talent raging. Without those bonuses, firms simply couldn’t attract the best and brightest and certainly couldn’t get 100-hour work weeks out of them. And when profit is created through ingenuity and hard work, it deserves to be rewarded handsomely — that is the American way.

But we’ve come to the end of outsized paper profits generated from proprietary trading operations and 30-to-1 leverage. So too has the war for talent waned. Firms are disappearing or laying off thousands. In this environment of bleak job prospects, investment bankers who got a smaller bonus in 2008 than they did in 2007 won’t be running for the exits and the greener pastures of Lehman or Bear Stearns.

Yet some institutions that begged for taxpayer aid to stave off bankruptcy — simply to stay alive — made 2008 compensation packages their first order of business after receiving their bailouts. This speaks to how completely foolhardy behavior has overtaken our industry. It certainly defies logic and sensible business practice. After all, it’s one thing to reap great rewards when creditors are being repaid and shareholders are earning a return; it’s quite another to reward failure almost as well.

Year-end bonuses also undermine the efforts of the troubled assets program. The whole point of the program was to bolster the equity capital bases of recipients. But any bonuses paid just reduce the earnings or increase the losses sustained by the firms paying them, which in turn decreases the equity capital base of those firms. Shareholders are justifiably angry and have plenty to sue about; the case could certainly be made that management and compensation committees ignored their fiduciary duty when 2008 bonuses were scheduled and paid.

Honestly, I’m not sure if I should be more offended as a taxpayer or as a shareholder of Merrill Lynch. I suppose there’s no difference nowadays, because we taxpayers are among the largest shareholders of many American financial institutions.

Regardless, financial institutions clearly relied on Uncle Sam’s largess when they agreed to authorize 2008 incentive compensation packages. Politicians will continue to wag their fingers at the greedy executives, but Washington’s actions enabled these bonuses to occur.

Without the United States government’s open wallet, after all, these teetering companies would have had to decide between offering healthy bonuses and complete insolvency.

Luckily for them — and most unhappily for us — it was a choice they never had to make.

Dave Krasne is a partner at a private equity firm.

February 25, 2009

I Ponied Up for Sheryl Crow?

Talk about being teed off. The economy is croaking and bankers are still partying at a golf tournament here on our dime.

It’s a good argument for nationalization, or better yet, internationalization. Outsource the jobs of these perfidious, oblivious bank executives to Bangalore; Bollywood bashes have to cost less than Hollywood ones.

The entertainment Web site TMZ broke the story Tuesday that Northern Trust of Chicago, which got $1.5 billion in bailout money and then laid off 450 workers, flew hundreds of clients and employees to Los Angeles last week and treated them to four days of posh hotel rooms, salmon and filet mignon dinners, music concerts, a PGA golf tournament at the Riviera Country Club with Mercedes shuttle rides and Tiffany swag bags.

“A rep from the PGA told us Northern Trust wrote one big, fat check in order to sponsor the event,” TMZ reported.

Northern No Trust had a lavish dinner at the Ritz Carlton on Wednesday with a concert by Chicago (at a $100,000 fee); rented a private hangar at the Santa Monica Airport on Thursday for another big dinner with a gig by Earth, Wind & Fire, and closed down the House of Blues on Sunset Strip on Saturday (at a cost of $50,000) for a dinner and serenade by Sheryl Crow.

In the ignoble tradition of rockers who sing for huge sums to sketchy people when we’re not looking, Crow — in her stint as a federal employee — warbled these lyrics to the oblivious revelers:

“Slow down, you’re gonna crash,
Baby, you’re a-screaming it’s a blast, blast, blast
Look out babe, you’ve got your blinders on ...
But there’s a new cat in town
He’s got high payin’ friends
Thinks he’s gonna change history.”

Northern Untrustworthy even offered junketeers the chance to attend a seminar on the credit crunch where they could no doubt learn that the U.S. government is just the latest way to finance your deals and keep your office swathed in $87,000 area rugs.

In what is now an established idiotic ritual of rationalization, the bank put out a letter noting that it “did not seek the government’s investment” even though it took it, and that it had raised $3 million for the Los Angeles Junior Chamber of Commerce Charity Foundation and other nonprofits. They riposted that they have a contract to do it every year for five years; but this isn’t every year.

The bank cloaks itself in a philanthropic glow while wasting our money, acting like the American Cancer Society when in fact it’s a cancer on American society.

It asserted that it earned an operating net income of $641 million last year and acted as though it did Americans a favor by taking federal cash.

I would ask Northern No Trust: If you’re totally solvent, why are you taking my tax dollars? If you’re not totally solvent, why are you giving my tax dollars to Sheryl Crow?

Coming in a moment when skeptical and angry Americans watched A.I.G., Citigroup, General Motors and Chrysler — firms that had already been given a federal steroid injection — get back in line for more billions, the golf scandal was just one more sign that the bailed-out rich are different from you and me: their appetites are unquenchable and their culture is uneducable.

President Obama served them notice on Tuesday night in his Congressional address, saying: “This time, C.E.O.’s won’t be able to use taxpayer money to pad their paychecks or buy fancy drapes or disappear on a private jet. Those days are over.”

But will they notice?

John “Antique Commode” Thain had to be ordered by a judge to tell Andrew Cuomo’s investigators which Merrill Lynch employees got those $3.6 billion in bonuses that Thain illicitly shoved through as his firm was failing and being taken over by Bank of America with the help of a $45 billion bailout. Kenneth Lewis, the Bank of America C.E.O., made the absurd assertion to Congress that his bank had “no authority” to stop the bonuses, even though he knew about them beforehand.

“They find out they’re $7 billion off on the estimate of losses for the fourth quarter and they never think maybe we should go back and adjust these bonuses?” Cuomo told me, as Thain was finally responding to investigators on Tuesday at the New York attorney general’s office. “He refused to answer questions on the basis that ‘the Bank of America didn’t want me to.’ You can take the Fifth Amendment or you can answer questions. But there’s no Bank of America privilege. The Bank of America doesn’t substitute for the Constitution. And who’s the Bank of America, by the way?”

He gets incensed about how ingrained, indoctrinated and insensitive the ex-masters of the universe are. “They think of themselves as kings and queens,” he said. And they’re not ready to abdicate.

FEBRUARY 25, 2009, 11:49 P.M. ET

Are Executives Paid Too Much?
Congress asks the wrong question and comes up with the wrong answer.

A last-minute provision added to the stimulus bill President Barack Obama signed into law on Feb. 17 restricts companies that accept federal bailout funds from paying performance bonuses that exceed one-third of an executive's total annual compensation. This punitive measure may be understandable as a reflection of populist fury over bonuses being paid to heads of failing companies that received billions in taxpayer money. But it utterly fails to fix the real problem with executive compensation: short-termism.

Our economy didn't get into this mess because executives were paid too much. Rather, they were paid too much for doing the wrong things.

There have been nearly as many reasons proposed for the current crisis as there are experts to propose them. But if we had to pick one overarching cause, it would be business leaders taking on excessive risk in the quest to increase next quarter's profits. This short-term thinking, in turn, was driven by two trends in the business world: shareholders' increasingly clamorous demands for higher earnings, and compensation plans that paid managers handsomely for taking on risks today that would only be realized later.

In the summer of 2006, well before most economists had any inkling of the calamity that was about to unfold, the Aspen Institute brought together a diverse mix of high-level business leaders, investment bankers, governance experts, pension fund managers, and union representatives. When you put successful people with such disparate and conflicting backgrounds and loyalties together in the same room, the result can be a shouting match. But the members of the newly formed Aspen Corporate Values Strategy Group found they shared an unprecedented consensus: Short-term thinking had become endemic in business and investment, and it posed a grave threat to the U.S. economy.

People in all walks of life need months or years to master a significant new project, whether it be getting a graduate degree or perfecting a 75 mph minor-league pitch into a 90 mph major-league fastball. Large corporations operate on a time scale that can be even longer. They pursue complex, uncertain projects that take years or decades to reach fruition: developing brand names, building specialized manufacturing facilities, exploring and drilling for oil and gas fields, or developing new drugs, products and technologies.

Yet over the past decade, corporations in general -- and banks and finance companies in particular -- have become increasingly focused on a single, short-term goal: raising share price. Rather than focusing on producing quality products and services, they have become consumed with earnings management, "financial engineering," and moving risks off their balance sheets.

This collective myopia had many causes. One cause, the Aspen Group concluded, was the demands of the very shareholders who are now suffering most from the stock market's collapse. It is extremely difficult for an outside investor to gauge whether a company is making sound, long-term investments by training employees, improving customer service, or developing promising new products. By comparison, it's easy to see whether the stock price went up today. As a result, institutional and individual investors alike became preoccupied with quarterly earnings forecasts and short-term share price changes, and were quick to challenge the management of any bank or corporation that failed to "maximize shareholder value."

Meanwhile, inside the firm, executives were being encouraged to adopt a similarly short-term focus through the widespread use of stock options. The value of a stock option depends entirely on the market price of the company's stock on the date the option is exercised. As a result, managers were incentivized to focus their efforts not on planning for the long term, but instead on making sure that share price was as high as possible on their option exercise date (usually only a year or two in the future), through whatever means possible.

Executives eager to maximize the value of stock options began adopting massive stock-buyback programs that drained much-needed capital out of firms; jumping into risky "proprietary trading" strategies with credit default swaps and other derivatives; cutting payroll and research-and-development budgets; and even resorting to outright accounting fraud, as Enron's options-fueled and stock-price obsessed executives did.

The system was perfectly designed to produce the results we have now. To get different results, we need a different system.

Simply cutting executive pay is not going to get either executives or investors to pay more attention to companies' long-term health. To get business back on track, the Aspen Group concluded, it is essential to focus on not just one but three strategies: designing new corporate performance metrics, changing the nature of investor communications, and reforming compensation structures.

Starting with metrics, we need new ways to measure long-run corporate performance, rather than simply relying on stock price. In terms of investor communications, companies need to ensure corporate officers and directors communicate with shareholders not about next quarter's expected profits, but about next year's and even next decade's.

Finally, and perhaps most importantly, companies must change the ways they reward not only CEOs and midlevel executives, but also institutional portfolio managers at hedge funds, mutual funds, and pension funds. Executives and managers should be rewarded for the actions and decisions within their control, not general market movements. Incentive-based pay should be based on long-term metrics, not one year's profits. Top executives who receive equity-based compensation should be prohibited from using derivatives and other hedging techniques to offload the risk that goes along with equity compensation, and instead be required to continue holding a significant portion of their equity for a period beyond their tenure.

It's always tempting in the midst of a crisis to look for a quick fix. But that's the kind of short-term focus that got the business world into trouble in the first place. So long as our metrics, disclosures and compensation systems encourage executives and institutional fund managers to look only a year or two ahead, we have to expect that that is what they'll continue to do. It's time for a long-term investment in promoting long-term business thinking.

Ms. Samuelson is the founder and executive director of the Aspen Institute Business and Society Program. Ms. Stout is professor of corporate and securities law at the UCLA School of Law and director of the UCLA-Sloan Research Program on Business Organizations.

March 9, 2009

On the Origin of Bankers’ Giant Bonuses

If you’re still having trouble understanding big-time bankers’ huge paychecks — and who isn’t? — try thinking of the problem in more primitive terms. Like, say, the lives of elephant seals.

Bull seals put on flab for competitive reasons: the bigger the bull, the greater its chances of thrashing other males on the beach to win a harem of cows.

The problem is that while each bull may be happy with his success, the competitive dynamic has a cost to elephant seal society. When the fattest seals always win, they will be more successful in passing their genes to the next generation —which will lead to a fatter population over time.

Elephant seal bulls can weigh 8,000 pounds. As the Cornell economist Robert Frank has pointed out, the social costs come clear when you consider that at 8,000 pounds it is pretty difficult to out-swim a great white shark.

Which brings us back to Wall Street. There are competing hypotheses about why top bankers and corporate chief executives are paid so much. Some researchers suggest a form of theft, exercised by coaxing, cajoling or browbeating pliant boards of directors to hand over more and more company money.

Bankers prefer the elephant seal theory: the humongous bonus packages are essential to attract top executives who otherwise would be nabbed by a rival. Bailed-out bankers grumble that the pay caps imposed by the Obama administration will allow better-financed hedge funds to swoop down and poach the best from their ranks.

This theory of capitalist evolution conveniently omits the part about the social costs. It is doubtful whether this executive superstar system adds any value to firms.

One study by Ulrike Malmendier of Berkeley and Geoffrey Tate of U.C.L.A. suggested that when C.E.O.’s are anointed as superstars by the media, shareholders suffer: C.E.O. performance declines relative to what it was before and to that of other C.E.O.’s. They start writing books, serving on boards and doing more work outside the company. And they become more active in tinkering with corporate earnings. Of course, the C.E.O.’s themselves get a raise.

Today we are all bearing the costs of bankers’ lopsided remuneration. The arms race in financial-sector pay that started with financial deregulation in the 1980s has grossly distorted economic incentives. Not only did handsomely compensated financiers engineer the dot-com bubble and the housing crisis, but bankers’ pay is reshaping the economy and society in other perilous ways.

Between 1980 and last year, the financial industry’s share of the nation’s corporate profits rose from 19 percent to 30 percent, government figures show. Wages followed. Research by the economists Thomas Philippon of New York University and Ariell Reshef of the University of Virginia found average remuneration in the financial industry rose from about par with wages in the non-farm private sector in 1980 to about 1.7 times today.

In the face of such odds, more of the nation’s pool of talented students decided there was no point in becoming a doctor or an engineer, when one could be a banker. In a recent research paper, the Harvard economists Claudia Goldin and Lawrence Katz reported that the share of Harvard graduates who took jobs in finance increased from 5 percent of the 1970 class to 15 percent of the 1990 class. The share going into law and medicine fell from 39 percent to 30 percent.

Perhaps the current crisis will end this trend. Finance is unlikely to recover quickly from this debacle, which has caused shares in financial companies to slide almost 60 percent in the last year. That means pay packages might return to earth, where the rest of us live. Banks could start competing for talent on the scale of hundreds of thousands of dollars, rather than in the millions.

Elephant seals don’t know that they would reduce their odds of becoming lunch if they all cut their tonnage by half — a move that would leave the competitive field unaltered. But people are smarter, we hope, and can understand that if we rein in all bankers’ pay we might be able to protect society from the fallout of their mating habits.

March 15, 2009

A.I.G. Planning Huge Bonuses After $170 Billion Bailout

WASHINGTON — The American International Group, which has received more than $170 billion in taxpayer bailout money from the Treasury and Federal Reserve, plans to pay about $165 million in bonuses by Sunday to executives in the same business unit that brought the company to the brink of collapse last year.

Edward M. Liddy, the government-appointed chairman of A.I.G., argued that some bonuses were needed to keep the most skilled executives.

Word of the bonuses last week stirred such deep consternation inside the Obama administration that Treasury Secretary Timothy F. Geithner told the firm they were unacceptable and demanded they be renegotiated, a senior administration official said. But the bonuses will go forward because lawyers said the firm was contractually obligated to pay them.

The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation. Mr. Geithner last week pressured A.I.G. to cut the $9.6 million going to the top 50 executives in half and tie the rest to performance.

The payment of so much money at a company at the heart of the financial collapse that sent the broader economy into a tailspin almost certainly will fuel a popular backlash against the government’s efforts to prop up Wall Street. Past bonuses already have prompted President Obama and Congress to impose tough rules on corporate executive compensation at firms bailed out with taxpayer money.

A.I.G., nearly 80 percent of which is now owned by the government, defended its bonuses, arguing that they were promised last year before the crisis and cannot be legally canceled. In a letter to Mr. Geithner, Edward M. Liddy, the government-appointed chairman of A.I.G., said at least some bonuses were needed to keep the most skilled executives.

“We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he wrote Mr. Geithner on Saturday.

Still, Mr. Liddy seemed stung by his talk with Mr. Geithner, calling their conversation last Wednesday “a difficult one for me” and noting that he receives no bonus himself. “Needless to say, in the current circumstances,” Mr. Liddy wrote, “I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them.”

An A.I.G. spokeswoman said Saturday that the company had no comment beyond the letter. The bonuses were first reported by The Washington Post.

The senior government official, who was not authorized to speak on the record, said the administration was outraged. “It is unacceptable for Wall Street firms receiving government assistance to hand out million-dollar bonuses, while hard-working Americans bear the burden of this economic crisis,” the official said.

Of all the financial institutions that have been propped up by taxpayer dollars, none has received more money than A.I.G. and none has infuriated lawmakers more with practices that policy makers have called reckless.

The bonuses will be paid to executives at A.I.G.’s financial products division, the unit that wrote trillions of dollars’ worth of credit-default swaps that protected investors from defaults on bonds backed in many cases by subprime mortgages.

The bonus plan covers 400 employees, and the bonuses range from as little as $1,000 to as much as $6.5 million. Seven executives at the financial products unit were entitled to receive more than $3 million in bonuses.

Mr. Liddy, whom Federal Reserve and Treasury officials recruited after A.I.G. faltered last September and received its first round of bailout money, said the bonuses and “retention pay” had been agreed to in early 2008 and were for the most part legally required.

The company told the Treasury that there were two categories of bonus payments, with the first to be given to senior executives. The administration official said Mr. Geithner had told A.I.G. to revise them to protect taxpayer dollars and tie future payments to performance.

The second group of bonuses covers some 2008 retention payments from contracts entered into before government involvement in A.I.G. Indeed, in his letter to Mr. Geithner, Mr. Liddy wrote that he had shown the details of the $450 million bonus pool to outside lawyers and been told that A.I.G. had no choice but to follow through with the payment schedule.

The administration official said the Treasury Department did its own legal analysis and concluded that those contracts could not be broken. The official noted that even a provision recently pushed through Congress by Senator Christopher J. Dodd, a Connecticut Democrat, had an exemption for such bonus agreements already in place.

But the official said the administration will force A.I.G. to eventually repay the cost of the bonuses to the taxpayers as part of the agreement with the firm, which is being restructured.

A.I.G. did cut other bonuses, Mr. Liddy explained, but those were part of the compensation for people who dealt in other parts of the company and had no direct involvement with the derivatives.

Mr. Liddy wrote that A.I.G. hoped to reduce its retention bonuses for 2009 by 30 percent. He said the top 25 executives at the financial products division had also agreed to reduce their salary for the rest of 2009 to $1.

Ever since it was bailed out by the government last fall, A.I.G. has been defending itself against accusations that it was richly compensating people who caused one of the biggest financial crises in American history.

A.I.G.’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall.

A.I.G. had set up a special bonus pool for the financial products unit early in 2008, before the company’s near collapse, when problems stemming from the mortgage crisis were becoming clear and there were concerns that some of the best-informed derivatives specialists might leave. It locked in a total amount, $450 million, for the financial products unit and prepared to pay it in a series of installments, to encourage people to stay.

Only part of the payments had been made by last fall, when A.I.G. nearly collapsed. In documents provided to the Treasury, A.I.G. said it was required to pay about $165 million in bonuses on or before Sunday. That is in addition to $55 million in December.

Under a deal reached last week, A.I.G. agreed that the top 50 executives would get half of the $9.6 million they were supposed to get by March 15. The second half of their bonuses would be paid out in two installments in July and in September. To get those payments, Treasury officials said, A.I.G. would have to show that it had made progress toward its goal of selling off business units and repaying the government.

The financial products unit is now being painstakingly wound down.

Mary Williams Walsh contributed reporting.

March 16, 2009

Bracing for a Bailout Backlash

WASHINGTON — The Obama administration is increasingly concerned about a populist backlash against banks and Wall Street, worried that anger at financial institutions could also end up being directed at Congress and the White House and could complicate President Obama’s agenda.

The administration’s sharp rebuke of the American International Group on Sunday for handing out $165 million in executive bonuses — Lawrence H. Summers, director of the president’s National Economic Council, described it as “outrageous” on “This Week” on ABC — marks the latest effort by the White House to distance itself from abuses that could feed potentially disruptive public anger.

“We’ve got enormous problems that need to be addressed,” David Axelrod, Mr. Obama’s senior adviser, said in an interview. “And it’s hard to address because there’s a lot of anger about the irresponsibility that led us to this point.”

“This has been welling up for a long time,” he said.

Mr. Obama’s aides said any surge of such a sentiment could complicate efforts to win Congressional approval for the additional bailout packages that Mr. Obama has signaled will be necessary to stabilize the banking system.

As it is, there have already been moves in Congress to limit compensation to executives at banks and Wall Street firms that are receiving government help to survive.

Beyond that, a shifting political mood challenges Mr. Obama’s political skills, as he seeks to acknowledge the anger without becoming a target of it. A central question for Mr. Obama is whether his cool style — “in a time of crisis, we cannot afford to govern out of anger,” he said in his address to Congress last month — will prove effective when the country may be feeling more emotional.

Even as Mr. Summers was denouncing A.I.G. for the bonuses, he suggested that there was little if anything the government could do to stop them, seconding the conclusion of Treasury Secretary Timothy F. Geithner. But even if their reasoning was legally sound, they also risked having the administration look ineffectual in the face of what Mr. Summers said was the worst financial abuse of the last 18 months, since the economy began turning down in earnest.

“Never underestimate the capacity of angry populism in times of economic stress,” said Robert Reich, a professor of public policy at the University of California, Berkeley, and labor secretary under President Bill Clinton. “A big challenge for President Obama will be to maintain a rational and tactical public discussion in the midst of this severe downturn. The desire for culprits at times like this is strong.”

In a further development, A.I.G. on Sunday named dozens of financial institutions that benefited from its huge rescue loan from the Federal Reserve last fall. The list included Goldman Sachs, Merrill Lynch and Wachovia.

On Monday, the White House is expected to unveil proposals to help small businesses, an effort to make clear that the administration is not only focusing its attentions on Wall Street and big corporations like the automakers.

But the financial crisis is the most acute problem facing the administration, one it will not be able to play down. Christina D. Romer, the White House’s chief economist, said Sunday on “Meet the Press” on NBC that the administration was close to unveiling details of its plan to remove the worst of the bad assets from the books of banks, a move sure to refocus attention on winners and losers from bailouts.

The disclosure that A.I.G., which has received $170 billion in government assistance to remain afloat and avert a cascade of failures in the financial system, is paying bonuses to its executives is the latest in a series of episodes that Mr. Obama’s aides said seemed to be feeding a resurgence of public anger.

The public responded angrily to previous disclosures of large bonuses on Wall Street, to auto executives who flew on corporate jets to Washington for Congressional bailout hearings, and to last week’s face-off between Jon Stewart of “The Daily Show” and Jim Cramer, the CNBC financial commentator, over the network’s reporting on the crisis.

“There’s unquestionably a strong populist surge out there,” said Joel Benenson, Mr. Obama’s pollster, citing his own polls and focus groups. “It’s been brewing for close to four years. For the last two years, Americans were clearly indicating that they believe that one of the biggest obstacles to progress on America’s toughest challenges — notably health care and energy independence — was the influence of special interests and corporate interests on the agenda in Washington.”

A New York Times/CBS News Poll in February found that 83 percent of respondents said the government should cap the amount of compensation earned by executives of companies that are getting federal assistance.

Mr. Obama’s advisers argued that to at least some extent, this was a sentiment they could tap to push through his measures in Congress, including raising taxes on the wealthy. They pointed out that in his speech to Congress, Mr. Obama denounced corporations that “use taxpayer money to pad their paychecks or buy fancy drapes or disappear on a private jet.”

“The president has been very clear about this,” Mr. Axelrod said. “There is reason for anger, but we also have to solve the problem. We need a functioning credit system. That’s our responsibility, and he intends to meet it.”

Still, aides acknowledged the risks of a backlash as Mr. Obama tries to signal that he shares American anger but pushes for more bail-out money for banks and Wall Street.

For all his political skills and his capturing of the nation’s desire for change in the 2008 election, Mr. Obama, a product of Harvard Law School who calls upscale Hyde Park in Chicago home, has shown little inclination to strike a more populist tone. The danger, aides said, is that if he were to become identified as an advocate for the banks and Wall Street, people could take out their anger on him.

“The change now is you have a free-floating economic anxiety that has expressed itself in a kind of lashing out at those being bailed out and people who are bailing out,” Michael Kazin, a professor at Georgetown University who has written extensively on populism. “There’s not really a sense of what the solution is.”

“I do think there’s a potential for a ‘damn everybody in power’ kind of sentiment,” Mr. Kazin said.

March 18, 2009

A.I.G.’s Bonus Blackmail

PRESIDENT OBAMA on Monday instructed the Treasury Department to “pursue every single legal avenue” to recover $165 million in bonus payments the insurance giant A.I.G. recently made to nearly 400 employees in its financial products unit. A.I.G. has, of course, received $170 billion in bailout funds and yet continues to incur extraordinary losses — some $62 billion last quarter alone.

A.I.G. insisted it was legally obligated to make the bonus payments and that failure to pay would breach its contracts with employees and expose it to penalties under state employee protection laws. The company also warned that breaching the agreements would amount to defaulting on numerous other business contracts, at staggering cost.

Amid this standoff, there has been an explosion of outrage against perceived excessive compensation to those who precipitated the financial crisis. Some lawmakers have threatened to impose a 100 percent tax on the A.I.G. bonuses and Senator Chuck Grassley, Republican of Iowa, even wildly suggested that the company’s executives consider suicide for their culpability. But moral outrage and public rebuke do not provide legal grounds for backing out of a contract.

If the government is serious about finding a legitimate basis for abrogating these payments, officials must look to basic legal principles. And if A.I.G. is serious that it is legally bound to pay these bonuses, it must do more than say nonpayment would expose it to damages or penalties. Nor is it enough to invoke the sanctity of contracts, because our legal and business system recognizes plenty of valid excuses from contractual duty and even justification for breaching.

There are numerous issues both sides must contend with to evaluate whether A.I.G. was bound to or excused from its payment duties. First, the specific promises that employees made or conditions stated in their agreements must be examined. Determining what promises exist requires only reading the contracts; identifying conditions (which will likely offer more wiggle room in A.I.G.’s duty to pay) requires both reading the contracts and understanding any negotiations that preceded them.

Subpoenas issued by Andrew Cuomo, the New York attorney general, have put much of this vital information into the hands of government officials. Those officials would do well to compare the provisions in these contracts to the job performance of the employees who received bonuses. If employees did not meet stated performance goals, they would be in breach of contract and A.I.G. would not have to pay.

Likewise, A.I.G. has stated that these agreements expressly state that if employees are terminated for cause, they are not entitled to any bonus payments. It follows then that the contracts may preserve the company’s power to deny bonuses to employees who could be terminated for cause but have not yet been.

Apart from specific contractual terms, there are other reasons A.I.G. might rescind these bonuses. They include the nondisclosure of important material information — for instance, if an employee failed to be absolutely candid about the size and risk of trading positions taken on the company’s behalf.

Findings of fraud on the part of an employee would certainly also excuse A.I.G.’s duty to pay. This isn’t to say that any A.I.G. employee engaged in such activity. But given the scale of problems that A.I.G. has confronted, and credible allegations of serious misconduct within the organization, it’s worth investigating.

There is also at least some chance, given A.I.G.’s functional insolvency and the government takeover, that these agreements may be rescinded either on the basis of impracticability or by virtue of unforeseeable and uncontrollable circumstances. A credible fact supporting both excuses is precisely the company’s huge loss last quarter. Courts excuse contract duties when governmental action essentially destroys the original purpose of a contract — and the taxpayers’ 80 percent stake in A.I.G. is a more extreme sort of governmental action than usually appears in such cases.

A final potential legal basis for rescinding these payments is fraudulent conveyance law. This generally limits the right of a financially troubled company to transfer property to favored claimants on sweetheart terms when doing so would hurt the interests of other claimants, like lenders and shareholders — in this case, perhaps even taxpayers. Again, this is not to say that these payments violate this doctrine, but it is a relevant question for the government to probe.

Without reading the contracts, understanding their background and learning about employee performance, one cannot say whether A.I.G. is legally bound to pay or legally excused from paying these bonuses. But we won’t resolve this question by simply trading nebulous assertions and hysterical threats.

Lawrence A. Cunningham is a professor at George Washington University Law School.

August 6, 2009

Despite Bailouts, Business as Usual at Goldman

Lloyd C. Blankfein has a story about the cataclysm that nearly brought down all of Wall Street. It goes something like this: One by one, lesser banks were swept away by the financial storm of 2008. And as the floodwaters rose, no one, not even Goldman Sachs, seemed safe.

The question, in Mr. Blankfein’s eyes, was how high the water would rise. But Washington stepped in with all those bailouts before the surge reached Goldman.

The story, which was recounted by several friends and colleagues, represents a sobering private admission from Mr. Blankfein, Goldman’s chief executive.

Publicly, it is a different story. Now that Goldman is minting money again, the bank insists that it was never in any real danger. Mr. Blankfein, in an e-mail message this week, disputed his private account, saying Goldman’s survival was never in doubt. Other Goldman executives reject the notion that the bank was rescued at all.

“We did not have a near-death experience,” said Gary D. Cohn, Goldman’s president. The government saved the financial industry as a whole, but it did not save Goldman Sachs, he said.

Rarely has the view from inside a company been so at odds with the view outside it. Could Goldman Sachs have lived if all those other giant banks had failed? Could it alone survive financial Armageddon?

Goldman executives are dismissive, even defiant, when critics argue that the bank is playing a heads-we-win, tails-you-lose game with American taxpayers. And yet the questions keep coming. Last month the story of Goldman’s postcrisis success — and conspiracy theories surrounding it — leapt from the business pages to the cover of Rolling Stone.

The idea that nothing has changed for Goldman Sachs strikes many outsiders as absurd. In this era of mega-bailouts, Goldman is widely perceived, on Wall Street and in Washington, as too big and important to fail. If its bets pay off, Goldman profits and its employees get rich. If its bets go bad, ultimately taxpayers will have to pick up the bill.

“Many observers on the market believe that Goldman and others of its size now have a free insurance policy,” said Elizabeth Warren, the chairwoman of the Congressional oversight panel for the $700 billion bailout fund. “Whether they do or not is less important than the fact that many in the market believe they do. That means at some level Goldman is playing with the American taxpayers’ future.”

Is Goldman gambling at America’s expense? Of course not, Mr. Cohn said. Should it change its business strategy in the wake of the gravest financial crisis since the Depression? No. Is Goldman taking big risks to make big profits? Courting more outrage over Wall Street pay with its plans to pay lavish bonuses? Throwing its weight around in Washington?

No, no, no.

Goldman executives dispute suggestions that high-stakes market gambles are behind its big profits — $3.4 billion in the second quarter. And they are dumbfounded when people like Ms. Warren suggest companies like Goldman, which paid back its bailout money last month, now operate with an implicit taxpayer guarantee.

After so many wrenching changes on Wall Street and in the economy, it might come as a surprise that the post-bailout Goldman is virtually indistinguishable from the pre-bailout one.

The bank has strengthened its capital base and reduced its use of leverage — the borrowed money that turbo-charges profits on the way up and can prove devastating on the way down. But Goldman sees little reason to change the way it does business. In fact, its executives are surprised that anyone would suggest it should.

Even Goldman’s conversion to a traditional banking company at the height of the crisis — a step many predicted would clip Goldman’s gilded wings — has been deftly sidestepped.

It is, in other words, business as usual at Goldman — and what a business it is. Quarter after quarter, Wall Street executives scour Goldman’s results hoping to figure out how the bank makes so much money. Mr. Cohn and other executives, in recent interviews, sketched the broad outlines of an answer. Mr. Blankfein declined to be interviewed for this article.

During the second quarter, Goldman bet, correctly, that the financial markets would calm down. It wagered that market volatility would decline and that certain securities tied to the troubled home mortgage market would revive. Its securities underwriting business bounced back too.

A vast majority of profits came from trading on behalf of clients like big mutual funds, pension funds and endowments, rather than from staking Goldman’s own money in the markets, Mr. Cohn said. Proprietary trading now accounts for about 10 percent of profits, down from 20 percent in 2005. Goldman dominated institutional trades linked to changes in a closely watched stock market index, the Russell 2000, and is benefiting because old competitors like Bear Stearns and Lehman Brothers are no longer around.

“We don’t have to outsmart the market today,” said Mr. Cohn. “We just have to do what our clients want us to do.”

But unlike some of its rivals, Goldman is not shy about taking risks. The bank stood to lose as much as $245 million on any given day during the second quarter, based on a common measure known as value at risk, or VAR. That was up from $184 million in mid-2008. But VAR captures only about a fifth of Goldman’s market risks and excludes investments that are difficult to value.

“Our risk appetite continues to grow year on year, quarter on quarter, as our balance sheet and liquidity continue to grow,” Mr. Cohn said. He and other executives say Goldman carefully manages its risks, which, for the most part, it has.

Goldman’s latest quarterly disclosures to the Securities and Exchange Commission, filed on Wednesday, provide another glimpse into the bank’s activities. Aided by cheap credit, Goldman generated more than $100 million in daily revenue from trading on 46 separate days during the second quarter — a record.

Since late 2007, Goldman has reduced its exposure to illiquid investments, which can pose dangers because they are traded so infrequently, by 8 percent. Its total exposure to these so-called Level 3 assets still stood at $50.4 billion. While VAR is up, other risk measures were down, and the bank’s capital base has grown significantly. Lately, Goldman has been taking more risks in stocks, but fewer in fixed income, currency and commodities.

Some of Goldman’s recent practices are drawing scrutiny from government officials. In its filing Wednesday, Goldman said various government agencies had inquired about its compensation practices, as well as its role in the market for credit derivatives, which fueled the financial crisis.

But over all, the events of the past year have not changed the way Goldman views or manages the risks it takes, said David A. Viniar, Goldman’s chief financial officer.

“There are a few business units that are taking a little more risk. Most are taking less,” Mr. Viniar said.

Mr. Cohn, Goldman’s president, acknowledges his bank is systemically important, meaning that its failure would probably send financial shock waves around the world. But he said that the implications of this status were unclear and that Goldman had no government backing.

David A. Moss, a professor at Harvard Business School, disagrees. He says the painful lessons of the financial crisis show the federal government now stands behind all systemically important financial institutions.

“We’re in a situation where we’ve extended important guarantees, both explicit and implicit, to almost all major financial institutions, yet we don’t have the regulations in place to control the excessive risk-taking that could result,” said Mr. Moss, the author of “When All Else Fails: Government as the Ultimate Risk Manager.”

In any case, Goldman has certainly helped itself to government programs that were put in place to stabilize the financial industry. For instance, the bank has issued billions of dollars of bonds guaranteed by the Federal Deposit Insurance Corporation. Since March it has sold $3.4 billion worth without government backing.

And Goldman’s conversion to a bank holding company, executed at the height of the crisis, gives the bank access to money from the Federal Reserve. In exchange, Goldman had to increase its capital, reduce its leverage and accept Fed oversight.

Many analysts predicted that switch would force Goldman to rein in riskier businesses like proprietary trading and parts of its commodities operation. But Goldman has largely carried on as usual. It has received standard exemptions that give it two years to comply with federal regulations governing bank holding companies.

“They are very happy to go back to a business model that year-in and year-out has made them untold wealth,” said John C. Coffee, a professor of securities law at Columbia University.

Mr. Cohn concedes that Goldman, along with other banks, bears some responsibility for the financial crisis. “There’s no performance angel in this,” he said. But he bristles at all the fingers being pointed at Goldman.

“Every bank has to accept a degree of responsibility, but it sometimes feels like we’re being disproportionately blamed,” he said.

Traders Magazine    August 11, 2009

Unfair at Any Speed - Why success itself is the true target
Dan Mathisson

We are all bad guys. After reading the opinion pages in The New York Times over the past few weeks, I have been forced to confront the sad truth: that trading  profitably is a morally questionable enterprise that is damaging to society.

My awakening began when I read a recent Times column by Nobel laureate Paul Krugman, who commented that much of today's trading is a "socially useless" activity, as  opposed to a higher calling, like say, writing opinion pieces. He ripped apart traders for the crime of making money "mainly by outsmarting other investors, rather than  by directing resources to where they're needed." Dr. Krugman proposed pay restrictions and higher taxes as the solution to curbing trading activities that serve no  "useful purpose."

Next up was an opinion piece by Paul Wilmott, the quantitative researcher and hedge fund manager, who launched an attack specifically on high-frequency trading,  calling it a "morally suspect financial minefield." The two articles in concert led to a fresh explosion of anti-Wall Street sentiment among the general public, leading to  dozens more newspaper articles, CNBC interviews, calls for new regulation from politicians and thousands of angry blogs and chat-room rants demanding trader blood.

In trying to decide whether I should join the angry masses on the march, or maybe turn and run from them, I first needed to understand who they were going after. Did  I personally know any of these financial miscreants? Was it possible that I had seemingly mild-mannered clients who were really serial portfolio killers? Was I  unknowingly aiding and abetting morally suspect DELL flipping?

Fortunately, Professor Krugman outlined a clear definition that differentiates good from bad trading. He defines good and useful speculation as trading based on publicly  available information, as opposed to damaging speculation, which is based on information not available to the public at large. So far, so good--who could argue in favor of  insider trading? My conscience remained clear.

But I became a little worried when I realized how low the professor sets the bar for non-public information. He's not talking about Gordon Gekko learning about the  impending takeover at Blue Star Airlines. Far from that, Dr. Krugman first cites high-frequency traders, who by processing public information faster than the next trader,  are damaging society.

The implicit argument is that since not everyone has "superfast" computers, the information that high-frequency traders are reading from the public tape is still  essentially non-public until everyone has had time to read and digest it. It's a good point--why should a trader have an advantage over his competition just because his  broker splurged on a nitrogen-cooled, tungsten-coated nanochip processor?  Shouldn't algorithm providers be polite and wait until the old-school broker with the paper  ticker tape and the Atari 800 catches up?

Mixed into this market morality maelstrom was the simultaneous controversy over so-called "flash" orders. "Flash" refers to orders that exchanges post for a fraction of  a second to subscribers of their data feed before sending to another exchange. The order type now appears to be rapidly on the way to the ash heap of trading history,  joining other failed ideas like OptiMark and specialists.

I was happy to hear of the impending demise of flash, as I had always felt there were significant problems with the concept. Flash orders are allowed to virtually lock the  market, violating the spirit of Regulation NMS and weakening the concept of a national market system. More importantly, choosing to flash orders seems like a dubious  trading strategy, since leaking your intentions prior to trading could result in another trader running ahead.

Despite the many actual flaws of flash orders, opponents repeatedly stated an incorrect argument: that flashes represent non-public information. This is simply not true --anyone can subscribe to the exchange data feeds and anyone can read the flash quotes. Believe it or not, you don't need to be a member of a privileged cabal to get  these, and you don't even need to know a secret handshake. You just subscribe to the exchange's public data feed--getting the flash quotes doesn't even cost extra.

So, while flash orders are bad market structure for a number of reasons, let's separate the issue from Professor Krugman's "non-public information" argument, since the  opportunity to get these quotes is publicly available. Which reduces his argument to the self-created unfairness that results from some traders improving their  equipment while others don't. If as a result of a technology investment you can respond to market data faster than most, you have turned yourself into an insider, and  your profits are now ill-gotten gains.

Now this was logic I could grasp: High-speed computers are basically like those polyurethane swimsuits that were just banned. The Olympics ought to be about the  fastest swimmer, not the most expensive swimsuit. Why shouldn't the game of trading be the same? Let's permanently freeze trading technology where it was in, say,  2003, and then let the best man win.

Confident that I now understood both the problem and the solution, I was taken by surprise by Dr. Krugman's second example of a damaging trader of no social value:  Andrew J. Hall. Mr. Hall, the legendary trader from Citigroup's Phibro unit, could be considered the antithesis of a high-frequency trader.  Whereas high frequency  traders think in milliseconds, he is known to think in years. A March 2008 profile of Mr. Hall in MoneyWeek magazine stated, "Trading may be the wrong word to  describe what Hall does best; he makes very large long-term bets, and sits back." This is when I realized I needed some serious re-education. My head was spinning--I  had thought Professor Krugman said I could like the fast swimmers, and just hate the fast swimsuits. Why be against Mr. Hall, a guy who appears capable of making  money armed with a rotary telephone and a No. 2 pencil?

And then, just as I grew distraught that I would never be able to determine who the bad guys are, it suddenly dawned on me. The bad guys in this Wall Street story  aren't limited to 1985-style insider traders, or 1987-style program traders, or 1993-style SOES bandits, or 1999-style day traders or even to today's high-frequency  traders. I now understood that any trader who spends more money on data, or invests more in analysis, or is simply smarter than most, eventually comes to possess  thoughts and trading ideas that others don't have access to. As soon as those thoughts are formed, whether in the silicon of unfairly large machines, or in the carbon of  unfairly large brains, the thoughts become non-public information that other traders don't have. And according to a Nobel Prize-winning economist, trading on non- public information is not investing, it's outsmarting.

So the jig is up. Trade poorly and you will not last long in this business. Trade well and success itself proves you are guilty of outsmarting others and damaging our  society. You see, we are all bad guys.

Dan Mathisson, a Managing Director and the Head of Advanced Execution Services (AES) at Credit Suisse, is a contributing writer to Traders Magazine. The opinions  expressed in this column are his own, and do not necessarily represent the opinions of the Credit Suisse Group.    November 11, 2009

$2.5 Trillion - That’s the size of the global oil scam.
Goldman’s Global Oil Scam Passes the 50 Madoff Mark!

It’s a number so large that, to put it in perspective, we will now begin measuring the damage done to the global economy in "Madoff Units" ($50Bn rip-offs).  That’s right - $2.5Tn is 50 TIMES the amount of money that Bernie Madoff  scammed from investors in his lifetime, yet it is also LESS than the MONTHLY EXCESS price the global population is being manipulated into paying for a barrel of oil.
Where is the outrage?  Where are the investigations?

Goldman Sachs, Morgan Stanley, BP, TOT, Shell, DB and Societe General founded the Intercontinental Exchange in 2000.  ICE is an online commodities and futures marketplace. It is outside the US and operates free from the  constraints of US laws.  The exchange was set up to facilitate "dark pool" trading in the commodities markets.  Billions of dollars are being placed on oil futures contracts at the ICE and the beauty of this scam is that they NEVER take  delivery, per se.  They just ratchet up the price with leveraged speculation using your TARP money. This year alone they ratcheted up the global cost of oil from $40 to $80 per barrel.

A Congressional investigation into energy trading in 2003 discovered that ICE was being used to facilitate "round-trip" trades.  Round-trip” trades occur when one firm sells energy to another and then the second firm simultaneously  sells the same amount of energy back to the first company at exactly the same price. No commodity ever changes hands. But when done on an exchange, these transactions send a price signal to the market and they artificially boost  revenue for the company.  This is nothing more than a massive fraud, pure and simple.

    "Traders of the the ICE core membership (GS, MS, BP, DB, RDS.A, GLE & TOT) wouldn’t really have to put much money at risk by their standards in order to move or support the global market price via the BFOE market. Indeed  the evolution of the Brent market has been a response to declining production and the fact that traders could not resist manipulating the market by buying up contracts and “squeezing” those who had sold oil they did not have. The  fewer cargoes produced, the easier the underlying market is to manipulate." - Chris Cook, Former Director of the International Petroleum Exchange, which was bought by ICE.

How widespread are “round-trip’‘ trades? The Congressional Research Service looked at trading patterns in the energy sector and this is what they reported: This pattern of trading suggests a market environment in which a  significant volume of fictitious trading could have taken place. Yet since most of the trading is unregulated by the Government, we have only a slim idea of the illusion being perpetrated in the energy sector.

DMS Energy, when investigated by Congress, admitted that 80 percent of its trades in 2001 were “round-trip” trades.   That means 80 percent of all of their trades that year were bogus trades where no commodity changed hands,  and yet the balance sheets reflect added revenue.  Remember, these trades are sham deals where nothing was exchanged.  Duke Energy disclosed that $1.1 billion worth of trades were “round-trip” since 1999. Roughly two-thirds of  these were done on the InterContinental Exchange; that is, the online, nonregulated, nonaudited, nonoversight for manipulation and fraud entity run by banks in this country. That means thousands of subscribers would see false  pricing. Under investigation, a lawyer for J.P. Morgan Chase admitted the bank engineered a series of “round-trip” trades with Enron.

You can chart the damage done by Goldman Sachs and their gang of thieves by by looking at commodity pricing pre and post ICE.  Before ICE, commodities followed a more or less normal growth path that matched global GDP and  was always limited in price appreciation by the fact that, ultimately, someone had to take delivery of a physical commodity at a set price.

ICE threw that concept out the window and turned commodity trading into a speculative casino game where pricing was notional and contracts could be sold by people who never produced a thing, to people who didn’t need the  things that were not produced.  And in just 5 years after commencing operations, Goldman Sachs and their partners managed to TRIPLE the price of commodities.

Goldman Sachs Commodity Index funds accounted for $60Bn out of $100Bn of all formula-managed funds in 2007 and investors in the GSCI lost 15% in 2006 while Goldman had a record year.  John Dizard, of the Financial Times calls  this process "date rape" by Goldman Sachs as the funds index rolls cost investors 150 basis points of return annually ($9Bn on the Goldman funds) but GS, under the prospectus, is able to "manage our corresponding position,"  which means that it has to deliver a price at the end of the roll period. If Goldman can cover that obligation at a better price, they will, and GS pockets the difference.  This is why we see such wild moves in the day’s before rollover,  there are Billions riding on GS hitting their target every month…

It is not surprising that a commodity scam would be the cornerstone of Goldman Sach’s strategy.  CEO Lloyd Blankfein, rose to the top through Goldman’s commodity trading arm J Aron, starting his career at J Aron before Goldman  Sachs bought them over 25 years ago. With his colleague Gary Cohn, Blankfein oversaw the key energy trading portfolio.  According to Chris Cook:  "It appears clear that BP and Goldman Sachs have been working collaboratively – at  least at a strategic level - for maybe 15 years now. Their trading strategy has evolved over time as the global market has developed and become ever more financialised. Moreover, they have been well placed to steer the development of  the key global energy market trading platform, and the legal and regulatory framework within which it operates."  According to Cook:

    It appears to me that what has been occurring in the oil market may have been that – through the intermediation of the likes of J Aron in the Brent complex – long term funds have been lending money to producers – effectively  interest-free - and in return the producers have been lending oil to the funds. This works well for as long as funds flow into the market, or do not withdraw in quantity, but once funds withdraw money from the market, there is a  sudden collapse in price.

    A combination of market hype, the opacity of the Brent Complex and the relatively small scale of trading of the benchmark BFOE crude oil contract enabled the long run up in prices, and several observers believe that the dramatic  spike to $147.00 per barrel was the specific outcome of the collapse of SemGroup, which that company’s management subsequently blamed mainly on Goldman Sachs.

Mike Riess issued a study of "Modern Market Manipulation" in which he describes how GS, MS, DB et al have systematically created an environment that rewards those who manipulate the system, robbing the poor to send the money  up they company ladder in exchange for record bonus payouts, which (by design) are the majority of their traders’ salaries:

    Before the ‘80’s, there were just us traders. "Rogue" traders arrived on the scene with the large institutional participants, both private and public. Today’s companies and government marketing boards are large enough for senior  management to distance itself from controversy, including market manipulation.

    In a competitive, amoral environment, middle managers in these mega-organizations have the authority to hijack an institution’s reputation and the financial clout to manipulate the market—and they do. As long as they succeed,  they enjoy promotions and perks and, sometimes, the fruits of embezzlement. If the manipulation unravels, the company denies any knowledge and hangs the rogue out to dry. We’ve seen this over and over again, most recently with  D’Avila and Codelco, Hamanaka and Sumitomo, Leeson and Barings and Tsuda and Daiwa Bank.

The CFTC’s definition of manipulation is:

A planned operation that causes or maintains an artificial price

Unusually large purchases or sales in a short period of time in order to distort prices

Putting out false information in order to distort prices.

In mid-2008 it was estimated that some $260 billion was invested in the Brent energy markets on the ICE while the value of the oil actually coming out of the North Sea each month, at maybe $4 to $5 billion at most.  NYMEX trading  follows a similar path with 258,000, 1,000-barrel contracts open for December delivery (258M barrels), which were traded 327,000 times yesterday alone yet, at the end of the period, less than 40M barrels of oil will actually be  delivered as that is the total capacity at Cushing, OK - where NYMEX contract deliveries are settled.  Every single one of those traders know it is not even possible for 80% of the contracts they are trading to be fulfilled - its a joke,  but the joke is on YOU!

Over the course of an average month at the NYMEX, 5 BILLION barrels of oil will be traded, with a fee being collected on every single transaction which is ultimately passed down to US consumers, yet less than 40M barrels will  actually be delivered.  That is just 8 tenths of 1 percent of actual demand for the product that is being traded - 99.2% of the oil transaction fees being paid by the American people do nothing more than create fees for the traders and  record profits and bonuses for the trading firms!

Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic  Petroleum Reserve over the last five years.  Today, in many commodities futures markets, they are the single largest force.  The huge growth in their demand has gone virtually undetected by classically-trained economists who almost  never analyze demand in futures markets.  As money pours into the markets, two things happen concurrently: the markets expand and prices rise. One particularly troubling aspect of Index Speculator demand is that it actually  increases the more prices increase. This explains the accelerating rate at which commodity futures prices (and actual commodity prices) are increasing.

Before ICE, the average American family spent 7% of their income on food and fuel.  Last year, that number topped 20%.  That’s 13% of the incomes of every man, woman and child in the United States of America, over $1Tn EVERY  SINGLE YEAR, stolen through market manipulation.  On a global scale, that number is over $4Tn per year - 80 Madoffs!  Why is there no outrage, why are there no investingations.  Well the answer is the same - $4Tn per year buys  you a lot of political clout, it pays to have politicians all over the world look the other way while GS and their merry men rob from the poor and give to the rich on such a vast scale that it’s hard to grasp the damage they have done  and continue to do to the global economy.

CIBC Chief Economist, Jeff Rubin issued a report last year that blames the current recession on high oil prices, saying defaulting mortgages are only a symptom.  According to Rubin, these higher oil prices caused Japan and the  Eurozone to enter into a recession even before the most recent financial problems hit. Higher oil prices started four of the last five world recessions; we shouldn’t be too surprised if they started this one also:

    Oil shocks create global recessions by transferring billions of dollars of income from economies where consumers spend every cent they have, and then some, to economies that sport the highest savings rates in the world.  While  those petro-dollars may get recycled back to Wall Street by sovereign wealth fund investments, they don’t all get recycled back into world demand. The leakage, as income is transferred to countries with savings rates as high as 50%,  is what makes this income transfer far from demand neutral.

spare oil production capacityThere is NO shortage of oil.  OPEC alone has 6-7 Million barrels a day of spare capacity, more than the total disruption of any single country and any two countries other than Saudi Arabia could offset.   Additionaly ICE partners Total and JPM are part of the cartel that is totally skewing the global demand picture by storing 125M barrels of oil in offshore tankers.  That’s 15 days of US imports that have been "ordered" but never  delivered so they show up as an extra 1Mbd of global demand, even though nobody actually wants them.  Land-based storage is also bursting at the seems, with global supplies up to 61 days of total consumption (84Mbd) up from 52  days last year.

That’s 5 BILLION barrels of oil already out of the ground, in barrels and ready to go AND THEY KEEP MAKING 86M MORE EVERY   DAY!!!  Where is the shortage?  Mainly, it is media hype pushed by "analysts" at the very firms that  profit the most from high oil prices.  Goldman Sachs issues bullish opinions on oil and builds large positions in oil, while it is the cartel’s job to hide oil in off shore tankers, and then sell forward all the oil, with futures contracts,  locking in the high price.  Of course they have their media hounds as well, most notably the Drudge Report.  As noted by Goldmansachsrules:

    Type in the word "OIL" inside the "Drudge Report" search engine. It returns 1,965 headlines with the word "OIL." Over the last couple years, The Drudge Report has ran 1,965 headlines with the word "OIL." Most of these  articles were hosted by the worthless organizations of Yahoo, Breibart, APNews, and Reuters. The Drudge Report just creates the headline, and links it the article hosted by who ever is doing the "hyping."

    Search on the word "credit crisis" and you only get 12 archived headlines. The word "bailout" yields only 268. The word "bank" returns only 568. So you have the Drudge Report hyping the oil market, because they bring it up  almost 2,000 times. Unlike the "credit crisis" or "Wall Street Bailout" that actual did happen, the oil market and what did/didn’t happen between Israel/Iran is plugged 10 times more!

    Of all the 1,965 articles that the Drudge Report ran with the word "OIL" in the title, most were hyping the oil market. The most notorious cases, a few times a week, were hosted by Yahoo, Breibart, and AP News. Most of these  articles were plugged with the same paragraph that stated if "Israel were to attack Iran, Iran would retaliate by taking over the straits of Hormuz, the largest pathway for oil and we all know what that would do to the price of oil.

Global oil glutIt truly takes a global village of manipulators and their lackeys to pull off a con on the scale of oil but it’s also the most profitable scam ever perpetrated on the people of this planet as they take control of a vital resource  and then create artificial shortages and drive speculative demand in order to charge you an extra dollar per gallon of gas.  You don’t complain because it’s "only" $15-$20 every time you fill up your tank, but that’s what they count on  and that’s where you’re wrong - it’s $20 from you and $20 from EVERY SINGLE ONE of your customers once or twice a week and $20 more dollars your employees need just to get to work.  It’s money that could be going into your  business instead of a new gold bathtub for a Saudi Prince or a Goldman trader.

Global drivers consume 1.7Bn gallons of gas every single day, that $1 is $50Bn a month, a Madoff per month that is being taken away from YOU and YOUR business and the non-energy/financial businesses you invest in.  Of course we  can give up and invest in those sectors (we do) but that doesn’t do much for the global economy and, even as you sit here now, not doing anything, those oil and profits have been plowed into the copper and gold markets and now  the same Goldman energy cartel is bidding to take over you clean air (through Carbon Credit trading) and your clean water.

Maybe when they are charging you $80 a gallon for water and ten cents a breath you’ll want to do something about it.  I think I’ll start right now and you can too!  Here is the Email address and Fax numbers for all of yor Senators,  Congresspeople and Governors.  Send this article to them and let them know you’d like to see an investigation.  Take a few minutes of your time to save a few bucks on your next gallon of water!

This entry was posted on Wednesday, November 11th, 2009 at 6:18 am and is filed under Immediately available to public, Members Only. You can leave a response, or trackback from your own site. Do you know someone who would benefit from this information? We can send your friend a strictly confidential, one-time email telling them about this information. Your privacy and your friend's privacy is your business... no spam!  Click here and tell a friend!

November 22, 2009

My Chocolate Meltdown

TO investment bankers, it’s welcome news that Kraft Foods is offering more than $16 billion to acquire the British candymaker Cadbury: Maybe the frozen credit markets are thawing. As a chocolate fiend, bunkered in my kitchen alongside a simmering bain-marie, I find it an ominous prospect.

Four years ago, another American food giant, Hershey, swallowed up a small chocolate company named Scharffen Berger. Started in 1997 by a sparkling-wine producer, John Scharffenberger, and a doctor, Robert Steinberg, Scharffen Berger set out to make an American chocolate that was as delicious as a European confection. And, amazingly, the company succeeded.

First in Dr. Steinberg’s kitchen and later in a handsome factory in the industrial section of Berkeley, Calif., Scharffen Berger developed a line of products that won the brand a passionate following. I myself became devoted to the 82 percent cacao extra-dark bar, with its unctuous mouth feel and fruity, acidic punch.

On top of creating a first-rate product, Scharffen Berger kick-started a movement. High-end artisanal chocolate became the fastest-growing sector of the market. Naturally, the big boys noticed. In January 2005, Scharffen Berger received an unsolicited offer from Hershey. The owners had not yet begun to consider selling the company. Revenues had hit $10 million and were escalating quickly. It made sense to hold onto the business for a while.

But Hershey, the Pennsylvania behemoth, would not take no for an answer and kept raising its offer. That August, for a price reported to be nearly $50 million, Hershey acquired Scharffen Berger.

The company kept John Scharffenberger as a consultant and promised not to change the quality of the brand. The promise lasted as long as a Hershey’s Kiss on a summer afternoon. Soon I began noticing a marked deterioration in my beloved 82 percent bar. The texture was chalky. The cherry notes had vanished. It was becoming just another mediocre American chocolate.

But luckily, long before this year’s announcement by Hershey that it was closing the Berkeley plant and consolidating Scharffen Berger production in Illinois, I discovered an alternative. Green & Black’s, an English brand, was readily available in New York, and if its 85 percent bar didn’t have quite the flavor bouquet that Scharffen Berger 82 packed back in its heyday, it came very close, and the mouth feel was arguably better.

Interestingly, Green & Black’s had also been started by small entrepreneurs and then acquired in 2005 by a giant firm. But its new parent, Cadbury, vowed to let it operate as a stand-alone unit. Judging from my research, which has been basically confined to unwrapping the foil of countless bars and plunging in, Cadbury has been true to its word.

So it was with a sense of alarm that I read in September that Kraft, the maker of Oreo cookies and Philadelphia cream cheese, among many other brands, was trying to gobble up Cadbury, which is best known for such products as Dairy Milk chocolate and Trident gum.

For Kraft, the deal no doubt makes sense: Mars, the maker of M&Ms and the new owner of Wrigley gum, would no longer be the world’s biggest candy maker. The expanded Kraft would be at the top of the sugar hill, having ramped up its own gum offerings and, perhaps more critically, its global distribution network.

But I found it hard to care much whether Asian consumers will have an easier time procuring Planters peanut bars and Toblerone bars at their corner store. What frightened me about the proposed deal was the threat to the privileged autonomy of Green & Black’s.

Although Cadbury rejected the offer, Kraft has continued to push. Still, I began to think that maybe I was being too pessimistic. As Kraft shares dipped, its offer was diminishing in value. Cadbury might very well retain its independence.

And even if Kraft does buy Cadbury, I assured myself, the American giant will see the wisdom in maintaining the quality of Green & Black’s, a brand that has no reason to exist if it does not continue to satisfy connoisseurs who can tell that a Milk Dud is really a dud. Yes, Hershey had perversely seduced a high-quality brand and then stripped away its conquest’s quality. But perhaps Kraft would be better about honoring the artisanal excellence of my 85 percent bar than Hershey had been with the lamented 82.

Last week, it was reported that Hershey is considering its own offer for Cadbury. I have started the search for my next chocolate bar.

Arthur Lubow is a contributing writer for The Times Magazine.

Le Temps    24 novembre 2009

Des rumeurs de bulle agitent le marché de l’aluminium
Pierre-Alexandre Sallier

Les cours mondiaux du métal blanc s’envolent de 60% depuis mars, en dépit de stocks d’invendus record. Les fonds d’investissement sont soupçonnés d’alimenter ce décalage
L’une des principales questions agitant les négociants de blé du Midwest s’impose également aux combinats sibériens d’aluminium: une bulle serait en train de se reformer sur les cours mondiaux de deux produits que tout sépare. Hormis une chose: le retour en masse de capitaux sur les marchés où ils s’échangent. Selon Barclays Capital, les institutions financières auront réinvesti 60 milliards de dollars sur les matières premières en 2009, un nouveau record.

Stocks au plus haut
Ces interférences pourraient expliquer l’évolution paradoxale des cours mondiaux de l’aluminium. Depuis le plancher touché fin février, le métal blanc s’est apprécié de 60%, atteignant vendredi 2060 dollars la tonne. Un renchérissement que ne reflète pourtant aucune quête frénétique de métal. Bien au contraire, les entrepôts du LME – la bourse londonienne des métaux – recèlent 4,6 millions de tonnes ne trouvant pas preneur, autant que ce que produisent en un an l’ex-URSS et l’Europe de l’Est.

Surplus mondial
Comment en serait-il autrement? Entre janvier et août derniers, la planète a produit 1,4 million de tonnes d’aluminium en plus de ce dont elle avait besoin, un surplus qui s’est accru de 46% en l’espace d’un an. En 2009, les Etats-Unis auront diminué leurs besoins pour la troisième année consécutive, ceux de l’Europe et du Japon devant décliner de 13 à 16%…

Cela alors que les usines des métallurgistes montent de nouveau en cadence. Durant la crise, «peu de sites ont fermé leurs portes», rappelle Michael Widmer, spécialiste de Bank of America. De leur côté, les prévisions de Barclays laissent deviner un gonflement de cet excédent de 29% l’an prochain. Même le BTP et l’automobile chinoise – en hausse de 15% par an – n’absorberont pas ce surplus, en raison de l’abondance de la production locale.

Les producteurs soufflent
Et pourtant, les cours du métal montent… Les analystes de HSBC ont bien tenté d’expliquer ce comportement des marchés, en relevant que «70% des stocks du LME sont réservés pour des contrats financiers s’étalant jusqu’à mi-2010», et donc concrètement indisponibles. Ces facteurs sont cependant «appelés à disparaître», admettent-ils.

Quelle que soit son origine, cette appréciation profite déjà de façon bien réelle aux géants de l’aluminium. Alcoa a annoncé ses premiers profits trimestriels depuis un an. RusAl, qui se bat pour ne pas étouffer sous ses dettes, y trouve également une bouffée d’oxygène. Dec. 22, 2010, 3:37 p.m.

The ‘Subsidy’: How Merrill Lynch Traders Helped Blow Up Their Firm
by Jake Bernstein and Jesse Eisinger

Two years before the financial crisis hit, Merrill Lynch confronted a serious problem. No one, not even the  bank's own traders, wanted to buy the supposedly safe portions of the mortgage-backed securities Merrill was  creating.

Bank executives came up with a fix that had short-term benefits and long-term consequences. They formed a  new group within Merrill, which took on the bank's money-losing securities. But how to get the group to  accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed  portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge  of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money  machine moving long after it should have ground to a halt. "It was uneconomic for the traders" -- that is, buyers at Merrill -- "to take these things," says one former  Merrill executive with knowledge of how it worked.

Within Merrill Lynch, some traders called it a "million for a billion" -- meaning a million dollars in bonus money  for every billion taken on in Merrill mortgage securities. Others referred to it as "the subsidy." One former  executive called it bribery. The group was being compensated for how much it took, not whether it made  money.

The group, created in 2006, accepted tens of billions of dollars of Merrill's Triple A-rated mortgage-backed  assets, with disastrous results. The value of the securities fell to pennies on the dollar and helped to sink the  iconic firm. Merrill was sold to Bank of America, which was in turn bailed out by taxpayers.

What became of the bankers who created this arrangement and the traders who took the now-toxic assets?  They walked away with millions. Some still hold senior positions at prominent financial firms.

Washington is now grappling with new rules about how to limit Wall Street bonuses in order to better align  bankers' behavior with the long-term health of their bank. Merrill's arrangement, known only to a small  number of executives at the firm, shows just how damaging the misaligned incentives could be.

ProPublica has published a series of articles throughout the year about how Wall Street kept the money  machine spinning [1]. Our examination has shown that as banks faced diminishing demand for every part of  the complex securities known as collateralized debt obligations, or CDOs, Merrill and other firms found ways to  circumvent the market's clear signals [2].

The mortgage securities business was supposed to have a firewall against this sort of conflict of interest. Banks like Merrill bought pools of mortgages and bundled them into securities, eventually making them into  CDOs. Merrill paid upfront for the mortgages, but this outlay was quickly repaid as the bank made the  securities and sold them to investors. The bankers doing these deals had a saying: We're in the moving  business, not the storage business.

Executives producing the securities were not allowed to buy much of their own product; their pay was  calculated by the revenues they generated. For this reason, decisions to hold a Merrill-created security for the  long term were made by independent traders who determined, in essence, that the Merrill product was as  good or better than what was available in the market.

By creating more CDOs, banks prolonged the boom. Ultimately the global banking system was saddled with  hundreds of billions of dollars worth of toxic assets, triggering the 2008 implosion and throwing millions of  people out of work and sending the global economy into a tailspin from which it has not yet recovered.

Executives who oversaw Merrill's CDO buying group dispute aspects of this account. One executive involved  acknowledges that fees were shared, but says it was not a "formalized arrangement" and was instead done on  a "case-by-case basis." Calling the arrangement bribery "is ridiculous," he says.

The executives also say the new group didn't drive Merrill's CDO production. In fact, they say the group was  part of a plan to reduce risk by consolidating the unwanted assets into one place. The traders simply provided  a place to put them. "We were managing and booking risk that was already in the firm and couldn't be sold,"  says one person who worked in the group.

A month before the group was created, Merrill Lynch owned $7.2 billion of the seemingly safe investments,  according to an internal risk management report. By the time the CDO losses started mounting in July 2007,  that figure had skyrocketed to $32.2 billion, most of which was held by the new group.

The origins of Merrill's crisis came at the beginning of 2006, when the bank's biggest customer for the  supposedly safe assets -- the giant insurer AIG -- decided to stop buying the assets, known as "super-senior,"  after becoming worried that perhaps they weren't so safe after all. The super-senior was the top portion of CDOs, meaning investors who owned it were the first to be  compensated as homeowners paid their mortgages, and last in line to take losses should people become  delinquent. By the fall of 2006, the housing market was dipping, and big insurance companies, pension funds  and other institutional investors were turning away from any investments tied to mortgages.

Until that point, Merrill's own traders had been making money on purchases of super-senior debt. The traders  were careful about their purchases. They would buy at prices they regarded as attractive and then make side  bets -- what are known as hedges -- that would pay off if the value of the securities fell. This approach  allowed the traders to make money for Merrill while minimizing the bank's risk. It also was personally profitable. Annual bonuses for traders -- which can make up more than 75 percent of  total compensation -- are largely based on how much money each individual makes for the firm.

By the middle of 2006, the Merrill traders who bought mortgage securities were often clashing with the  powerful division, run by Harin De Silva and Ken Margolis, which created and sold the CDOs. At least three  traders began to refuse to buy CDO pieces created by De Silva and Margolis' division, according to several  former Merrill employees. (De Silva and Margolis didn't respond to requests for comment.)

In late September, Merrill created a $1.5 billion CDO called Octans, named after a constellation in the  southern sky. It had been built at the behest of a hedge fund, Magnetar, and filled will some of the riskier  mortgage-backed securities and CDOs. (As we reported in April with Chicago Public Radio's This American Life  and NPR's Planet Money, Magnetar had helped create more than $40 billion worth of CDOs [3] with a variety of  banks, and bet against many of those CDOs as part of a strategy to profit from the decline in the housing  market.)

In an incident reported by the Wall Street Journal [4] ($) in April 2008, a Merrill trader looked over the  contents of Octans and refused to buy the super-senior, believing that he should not be buying what no one  else wanted. The trader was sidelined and eventually fired. (The same Journal article also reported that the  new group had taken the majority of Merrill's super-seniors.)

The difficulty in finding buyers should have been a warning signal: If the market won't buy a product, maybe  the bank should stop making it. Instead, a Merrill executive, Dale Lattanzio, called a meeting, attended by among others the heads of the CDO  sales group -- Margolis and De Silva -- and a trader, Ranodeb Roy. According to a person who attended the  meeting, they discussed creating a special group under Roy to accept super-senior slices. (Lattanzio didn't  respond to requests for comment.)

The head of the new group, Roy, had arrived in the U.S. early in the year, having spent his whole career in  Asia. He had little experience either with the American capital markets or mortgages. His new unit was staffed  with three junior people drawn from various places in the bank. The three didn't have the stature within the  firm to refuse a purchase, and, more troubling, had little expertise in evaluating CDOs, former Merrill  employees say.

Roy had reservations about purchasing the super-senior pieces. In August 2006, he sent a memo to Lattanzio  warning that Merrill's CDO business was flawed. He wrote that holding super-senior positions disregarded the  "systemic risk" involved.

When younger traders complained to him, Roy agreed it was unwise to retain the position. But he also told  these traders that it was good for one's career to try to get along with people at Merrill, according to a former  employee.

But Roy and his team needed to be paid. As they were setting up the trading group, Roy raised the issue of  compensation. "The CDO guys said this helps our business and said don't worry about it -- we will take care of  it," recalls a person involved in the discussions.

The agreement, according to a former executive with direct knowledge of it, generally worked like this: Each  time Merrill's CDO salesmen created a deal, they shared part of the fee they generated with the special group  that had been created to "buy" some of the CDO. A billion-dollar CDO generated about $7 million in fees for  Merrill's CDO sales group. The new group that bought the CDO would usually be credited with a profit between  $2 million and $3 million -- despite the fact that the trade often lost money.

Sharing the bonus money for a deal or trade is common on Wall Street, arrangements known as "soft P&L," for  "profit and loss." But it is not typical, or desirable, to pay a group to do something against their financial  interests or those of the bank.

Roy made about $6 million for 2006, according to former Merrill executives. He was promoted out of the group  in May 2007, but then fired in November of that year. He now is a high-level executive for Morgan Stanley in  Asia. The co-heads of Merrill's CDO sales group, Ken Margolis and Harin De Silva, pulled down about $7 million  each in 2006, according to those executives. De Silva is now at the investment firm PIMCO.

By early summer 2007, many former executives now realize, Merrill was a dead firm walking. As the mortgage  securities market imploded, high-level executives embarked on an internal investigation to get to the bottom  of what had happened. It did not take them long to discover the subsidy arrangement. Executives made a sweep of the firm to see if there were other similar deals. We "made a lot of noise" about  the Roy subsidy to root out any other similarly troublesome arrangements, said one of the executives involved  in the internal investigation. "I'd never seen it before and have never seen it again," he says.

In early October 2007, Merrill began to purge executives and, slowly, to reveal its losses. The heads of Merrill's  fixed income group, including Dale Lattanzio, were fired. Days later, the bank announced it would write down $5.5 billion worth of CDO assets. Less than three weeks  after that, Merrill raised the estimate to $8.4 billion. Days later, the board fired Merrill's CEO, Stan O'Neal. Eventually, Merrill would write down about $26 billion worth of CDOs, including most of the assets that  Ranodeb Roy and his team had taken from De Silva and Margolis.

After Merrill revised its estimate of losses in October 2007, the Securities and Exchange Commission began an  investigation to discover if the firm's executives had committed securities fraud or misrepresented the state of  its business to investors.

But then the financial crisis began in earnest. By March 2008, Bear Stearns had collapsed. By the fall of 2008,  Merrill was sold to Bank of America. In a controversial move, Merrill paid bonuses out to its top executives  despite its precarious state. The SEC turned its focus on Merrill and BofA's bonuses and sued, alleging failures  to properly disclose the payments. As for the original SEC probe into Merrill Lynch's CDO business in 2007, nothing ever came of it.

ProPublica research director Lisa Schwartz and Karen Weise contributed reporting to this story.

   3. housing-bubble


James Gala
Yesterday, 5:18 p.m.
I’m a former private detective who participated in the defense of public officials and “white collar” defendants during the 70’s.  I’ve never in my eleven year career seen conduct as egregious or this criminal as you reveal in this article.  It’s perhaps the civil equivalent to war crimes against humanity.  Why is ProPublica almost alone in these vital disclosures?
-J. Gala

Dave Goes
Yesterday, 5:18 p.m.
And the answer to all of this is a bail out w/ tax payer dollars?  Lehman was allowed to fail and lo and behold we are still alive.  90% of us are still going to work every day.  Ironically, the earth did not stop spinning.  In fact, the company was dismantled and it’s valuable assets were bought by better run firms.  Imagine that - a market based economy free of Corporatism?  When will we actually wake up and realize Keynesian economics never has and never will work?  Perhaps when the largest capital market participants are actually allowed to reap what they sow?

Geoff Badenoch
Yesterday, 5:41 p.m.
“Steal a little and they put you in jail; steal a lot and they make you king.”
One of the problems with the bailouts and smoothing over that was done with regard to the problems at the companies that do billions of dollars simply trading paper—and not really producing anything—is that no lessons were learned except to be less transparent the next time. Had some people gone to jail, had stockholders been wiped out, the resulting pain would have made people demand reform and accountability.  Sometimes the going to jail is an important part of learning the lesson.  As it is, I am expecting this to happen again in my lifetime.

Yesterday, 5:47 p.m.
I am a lifetime Democrat, but we have former President Clinton and congressional republicans in office at that time to thank for the Financial Services Modernization Act of 1999 for deregulating the banks. It was this repeal of the Glass-Steagall Act of 1933 from Roosevelt’s New Deal that allowed the banks and insurance companies to run amok.  I say, instead of using my tax money to bail out those who financially raped us all, it should be used to PROSECUTE those responsible for this horribly risky behavior. Why should those criminals profit so obscenely at the expense of those of us in the middle class that truly make this country the great power that it is? I’m glad the Justice Dept. has sued them. Let’s hope they prevail on the part of the American people. “Justice for All” in this matter is LONG over-due.

Kevin Schmidt
Yesterday, 6:09 p.m.
Let them eat CDOs?
The French Revolution had a solution.
The biggest mistake many people make is denying that history can repeat itself.

Yesterday, 6:24 p.m.
AIG is mentioned as having purchased some of the CDOs.  So they were presumably burned.
I read where they used the money received from the sale of Credit Default Swaps to invest in the CDOs.  So they issued bad insurance policies in the form of CDS and were burned again.
AIG received billions from TARP and then paid out 100 cents on the dollar to Goldman Sachs, Deutsche Bank and others.  So the taxpayers got burned.
How about a story on how much of the TARP money went to these financial insttutions and why?
Now we have the investors in the CDOs or the Trusts created by Deutsche Bank and others foreclsoing on the bad mortgages.
Seems that the banks who bet against their own CDOs are the only winners.

Anita Mitchell
Yesterday, 6:42 p.m.
Screw the Justice Department.  Public Citizen just said the Justice Department under Obama filed on amicus brief with the courts siding with Citibank over changing a credit card customer’s interest rate (without notifying them) when the customer was up to date on Citibank’s bill but missed a payment or fell behind on another creditor or utility bill. A small print black hole the Credit Card companies entitled “universal default.”  If you think the Justice Department is on our side…I say think again.
I think to really put the fear of God in some of these banks, let people from law firms like the ones that sued the asbestos or tobacco industries at them for 33% of the awards. These people are fearless, motivated by money, know every trick in the book and have a proven records of smelling deep pockets, wrong-doing, and turning it into gargantuan settlements for both the States (in the case of asbestos and tobacco) and themselves.  I want a litigator like Picard from the Madoff case or the tobacco litigation lawyers, not our Justice Department.  I think Justice gets in there to say “Hey, we got them.” and then fines them something they can eminently afford to pay and everyone wipes the sweat off their brows because “justice” has been done.  Justice Department just want to get in between banks and civil litigation if you ask me and delay civil suits as long as possible.  Let their investors litigate them.  They screwed us all but they had a fiduciary duty to their investors.

Today, 12:34 a.m.
LOL, they act like this is news. This has been known for over a year and I’ve got news for you, practically every firm that was creating CDO’s in 06 had to do something similar.
Also, its not corrupt, its just really, really stupid.
Here’s what everybody already knows: A bunch of Mortgage Backed Securities are bundled up into a CDO and diced up into a bunch of tranches. In the article, they correctly point out that super senior was a problem. That is because the super senior tranches pay next to no interest. They were considered as safe as a checking account. So you had to sell the tranche at a loss to get rid of it.
Well here’s the problem. In 06, with high competition and rising interest rates the CDO market increasingly became less and less profitable. They were all competing with each other and that was driving the fee’s down very low. Before they could just sell Super Senior at a loss and still make money. Now they can’t which usually means, “Hey if you can no longer make a profit from it stop.” But if you excluded the sale of Super Senior it was actually still a good deal.
So here were your options
1. Sell the Super Senior debt.
2. Keep it on your balance sheet
3. Insure against it so that you can not be subject to your capital requirements, or
4. Create a Special Purpose Vehicle(SPV) to buy the assets
That’s the only choices you have. Well in 06 if you do number 1 you lost more money creating a CDO than you made.
2. If you keep it on the balance sheet you’re use up capital on a very low earning asset, and it accumulates to be a lot(a lot of companies did that).
3. If you insure against it at least then you have don’t reduce its exposure to capital requirements, but then it still accumulates and you have to pay the cost of insuring it. Furthermore, increasingly it became clear that they couldn’t go to the big boys like AIG anymore, and they had to go to monoline insurers who’s counterparty risk wasn’t worth squat in the event of problems. But since Super Senior was seen as incapable of any major changes in prices nobody cared.
4. Create an SPV to over pay for super senior. The problem is what group is going to want to overpay for anything. Different strategies were used. This is what the article is referring to with Merrill. Citi was the dumbest because they actually signed an obligation to buy back super senior if they ever took any loss to keep the price up.
So, since none of these companies were really getting rid of their Super Senior, it just built up and built up and was never removed as a liability to them. It eventually became the case that super senior was becoming a huge chunk of everything these banks held.
Then, when the crash started happening it wasn’t having to much of an impact on Super Senior because the tranche is just that safe. The problem was that major crashes in the lower tranches like junior and mezzanine were causing minor movements in senior, and it actually caused a tiny change in Super Senior values.
If pretty much a third of your bank is super senior tranches to a CDO and you are leveraged at lets say10 to 1(or more) a minor 5% downgrade in that super senior debt could blow up your entire company.
There you go. None of this was a root cause of the crisis, but now you know how it played out and what the authors apparently are struggling with.

Today, 12:36 a.m.
Sorry for the length, but I believe I actually succeeded in writing a better article than the original authors. So if you read the article you would probably enjoy my piece.

Today, 12:54 a.m.
Jon, thank you for taking the time and effort to write this excellent overview.

Geoff Badenoch
Today, 1:49 a.m.
Thanks, Jon, for that illuminating contribution. Still, I wonder how all these invented instruments were carried on the books. What were the auditors thinking? What was the audit committee thinking? Even if it can be attributed to “black box” investing with no apparent downside, every little kid at some point in his or her life has been told, “if it seems too good to be true, it probably is.” They were blinded by greed and too clever by half.
Where it becomes problematic is that they were creating imaginary wealth and gambling with other people’s money to do it.  If there is no accountability or sanctions levied, it will happen again.

Jim Gala
Today, 3:46 a.m.
“CDOs, tranches, and Special Purpose Vehicles” may sound like sexy sophisticated lingo from the Wall Street lexicon, but they’re fabricated words and acronyms describing fabricated “financial products” invented by soulless sociopaths to enrich themselves while appearing to possess an arcane financial knowledge.  These morons can’t build a bridge, fix a leaky faucet, or play a musical instrument, let alone heal the sick.  But they certainly know how to take your money and invent reasons to keep most of it for themselves with no regard for what happens to you, the “investor”.  I’m not religious, but when the biblical Jesus threw the money-lenders from the temple, I think he acted God-like.  At least He appeared to possess a moral compass -a term just as foreign and arcane to investment bakers as “tranches” are to their victims.
For 40 years I’ve been listening to nonsensical financial jargon excreted from the mouths of lionized “experts” like Alan Greenspan, et al, with the same outcome: the patient (us) died on their operating table.

Matt Weidner
Today, 7:32 a.m.
When will American wake up?  We have all been robbed and looted and conned and suckered. I’m an attorney who’s been defending people in foreclosure for years.  I’ve long said that the “deadbeats in foreclosure” are just canaries in our economic coal mine.  On my blog, I detail, with great specificity, how our entire legal and financial system has been corrupted through this process.  The fundamental breakdowns in the foreclosure and legal process are staggering.  The examples are mind blowing.  What people don’t get is that their 401k’s and retirement accounts have been looted….the evolving Fraudclosure Scandal is just one of the first symptoms of the much larger and far more destructive cancer that rots at our core…..We all need to do our job by not just reading these articles, but by spreading them to all our friends and points of contacts and urging them to do the same.
WE ARE AT WAR.  The good reporters and press that are doing their job are on the front lines and I am grateful for their work…KEEP AT IT!

Myron Budnick
Today, 8:17 a.m.
It seems to be the way of the western world. Take all you can for as long as you can and leave it to your decendent’s to pay the Devil when payment comes due.
Enlightened self interest does not seem to exsist except for a very few like Bill Gates Warren Buffet and Ted Turner

Richard Schmidt
Today, 8:49 a.m.
But never forget the role played in the whole financial disaster by the accounting firms. They played right along, as they always do.  We need desperately to blow up the entire accounting industry and begin anew. One approach might be to create a new Federal agency that would be responsible for hiring accounting firms to audit the books of all publically traded companies. The companies would have no say in who would audit them. The new agency would change auditors every 3-4 years, much as the State Department changes its diplomats, to avoid them being corrupted.
It is clear that US audit companies are corrupted by the millions paid to them by the companies they audit. That relationship is at the core of a fundamentally corrupt system. The companies being audited would need to pay the federal agency a fee. Those fees would be used to contract with the audit firms.

David Leith
Today, 8:50 a.m.
@Jon - Thank you for your comment. It is a helpful framework for looking at traders’ behavior. If you consider the Merrill traders’ actions, isn’t it clear that De Silva, Margolis, and Lattanzio knew that the SPV was being filled with Super Senior tranches that were worth much less than what they were being booked at? How is this different than a rogue trader hiding his trades? Except here they were still earning vast sums in bonuses, and they bought off the managers of the Merrill SPV with soft fees for as long as they could, until the fees no longer covered the losses. Then the whole thing blew up. No wonder they were fired, but Merrill covered it all up because to disclose the true extent of the problem would have been to expose their vulnerability.
Lots of lessons to be learned here. Risk managers have to beware of being stuck with the back ends of complicated trades. Fee sharing can’t be permitted for trades that aren’t sold off. And in my opinion, it sounds like Lattanzio and others are guilty of criminal fraud against their former employer. And Merrill senior management didn’t disclose in a timely manner what they knew, or at least should have known.

Sheila Torres
Today, 8:52 a.m.
Thank you Mr. Gala and Weidner for your insightful comments. I agree wholeheartedly. I’m an educated woman who feels like a victim when I hear all this. No, I haven’t lost as much personally—I still live in my home of 10 years and I’ve never been late on a mortgage payment—but I’ve been out of work far too long, able to get only temporary or part-time employment to be able to keep up my financial obligations. Hanging on to our home is still a month-to-month issue even for a middle class family like us. I have a nagging suspicion that everything we are counting on: the 401ks we’ve worked hard to preserve, the pension plans we contributed to when we were fortunate enough to have them, and of course the Social Security program that we are legally required to fund, all those things we built to try to preserve a safe life for ourselves and our families, are all going to come tumbling down because of financial predators who can act with impunity. Perhaps this is what the middle class needs in order to pay attention to some of the pain that working class people have been feeling for years: lack of stable jobs, lower wages, little or no health insurance. Or perhaps to look at itself squarely in the face and ask: what role do I play in this mess? How have I contributed?  The question is: how do we combat this in a more immediate way that does not involve the Justice Department,  a team of lawyers and years of litigation? I would very much like to hear from others who have ideas about how we as individuals can change our everyday practices so that we can begin to starve this financial predator beast and the political machine that supports it.

William Yates
Today, 9:19 a.m.
There’s no difference between what Merrill did with it’s CDOs and Bernanke’s POMO programs. The left hand sells, the right hand buys, and we split the gains. The losses go the the people.
How can you expect the Justice Department to prosecute Merril’s actions when the same actions are official US Government policy?

Jim Gala
Today, 9:26 a.m.
It isn’t the way of the western world; it’s the way of the US.  Does it ever occur to Americans why European democracies have free education and health care?  It’s because they understand that democracy and capitalism are not synonymous.  Capitalism and “free markets” are Darwinist by nature and create as many losers as as winners.  The citizens of European democracies refuse to gamble with their lives, i.e. health care and education, by leaving them to “market forces”.  This isn’t “socialism”, it’s an obvious, intelligent, humane, and eminently democratic perspective which is apparently lost on American “conservatives” and the corporate owned media who label virtually all other western democracies as “socialistic”.  Americans don’t understand that relative to Germany, France, England, and about 30 other nations, Americans have shorter life spans, higher infant mortality rates, and more poverty.  Even Cubans live longer and have better health care and literacy than Americans.  The ruling elite in America has a “plantation mentality”. They want to own the plantation while their employees (formerly US citizens) pick cotton for them.  The Republicans, who lately claim to revere the US Constitution, have in fact, and especially since the Regan administration, eviscerated it.  This is a fact, not an opinion.  Anyone who has read The Bill of Rights and The US Constitution knows this.  But the dumbing down of America has robbed many voters of their critical faculties and left them vulnerable to the hysterical rants of right-wing talk show morons.  Wake up, America.  This isn’t “reality TV”. It’s your rights, your education, your health, your standard of living, your retirement, and your freedom that are at stake -now more so than at any time since World War II.

Today, 9:35 a.m.
Good article, and also great comment by Jon.
For the rest of the commenters, pls remember that B of A bought ML. You as tax payers did not sustain a loss of any kind as a result of any of these shenannigans. To the extent TARP was used to aid B of A, it has been repaid with interest.
This is not the droid you are looking for.

Today, 9:38 a.m.
Ever pause to consider how much of these ill-gotten gains was funneled into the Republican machine that ran all of those fear/hate/anger ads before this last election?
lolll…quite a bit, I wager.  There is nothing a crook hates more than having to pay taxes on what he or she steals, and that makes the Republicans their natural choice, for even if the Republicans don’t repurpose the law to make the American people legal prey, they will shield ill-gotten gains from taxes.

Today, 9:40 a.m.
@Geoff, with exception of an SPV(which is designed to get something off the balance sheet) all this was very much above ground. An auditor would see this CDOs, and CDSs on a balance sheet and it would be like anything. I’ll give you an example of one of the real causes(by no means the biggest). The Fed’s decision to allow insured CDO’s to be subject to lower capital requirements than if your not-insured(we all know the insurance is a CDS). The Fed thought they had a pretty good understanding what these things were. It was for the most part all very much above board. As much as they all act like it was a few bad apples, it wasn’t. The fact is that practically everybody that dealt in these products believed they were useful products. It wasn’t really sinister greed. It was stupid greed, when they couldn’t stop cheering these things on when the conditions changed, they exposed themselves to way to much of them.
@Richard, the accounting firms did exactly what they were supposed to in each of these companies. In Enron that wasn’t the case, but in the banking industries there were no situations where the accounting firms didn’t report something they saw. Example the creation of an SPV isn’t within an accountants job title to know or care about. And its not like it would make any difference in how they reported things if they did see an SPV that the firm created.
@David. Well they weren’t being filled with losses(at least at that time). The best analogy I can give you is: paying someone bonuses to put all of their money into a savings account earning 2% when everybody really wants to buy junk bonds because they have a higher interest rate. So it wasn’t a question right away at least, “Lets pay them to take our losses for us.” Those losses only really occurred later. At the time it was, lets pay them some money to buy our low interest tranches. Its just like valuing a bond. If everybody is demanding higher interest from bonds than you have to sell your bond at a discount in order for the buyer to receive the interest they want. In this case the face was lets say 2% and everybody wanted 5% on them. They paid someone to buy it at 2%.

Today, 9:45 a.m.
I see from the comments that the argument of those who have benefited from the transformation of Wall Street and banking into a one-way wealth transfer machine is still “It wasn’t illegal.”.
Buying the Republicans - and the Democratic President - who brought about deregulation was one heck of a good investment, wasn’t it boyz?

Today, 10:03 a.m.
@Jim Gala:  In an America that increasingly believes Christianity demands that we amass wealth, hate our neighbors and crush the poor; in an America that believes torture is just like fraternity hazing; in an America that believes War is Peace, Four Legs Good, Two Legs Bad, Ingsoc = double-plusgood, and all those other useful slogans; in this America, there’s no waking up from the nightmare.  Belief is more real than reality, and anything bad is all the result of Enemy Action.  We just have to sacrifice more and then things will be even better.

Today, 10:14 a.m.
@ibsteve2u: So what do you think is more probably a larger culprit?
Paying a person to buy a low interest earning asset.
A bunch of 23 year old analysts at a crediting agency has a financial model in from of them. There is a part of the model that asks, “What assumption do you want to use for the appreciation of real estate?” And they type in 8% in perpetuity. Any security would get a good rating if you actually believed that real estate was going to go up 8% a year and never go down.

Today, 10:17 a.m.
There is, of course, a lesson in both the details that entities such as ProPublica reveal about the sordid nature of modern banking and Wall Street as well as the latter entities’ counter-argument of “It wasn’t/isn’t illegal.”.
To whit, Wall Street and banking have been transformed; they are no longer a source of capital and a tool to be used to build America and bring all of us wealth and a brighter future.  Far from it; their new purpose is restricted solely to transferring wealth from those who have it to themselves.
ANYBODY’s wealth, be you rich or becoming dependent upon your IRAs and 401Ks as America’s corporations - owned and operated by those who also benefit from the machinations of Wall Street’s brokers and America’s bankers - destroy pensions and so force the American people to place their life’s work within the grasping hands of high finance in America.
If you deal with American banking or Wall Street, you have been warned:  Investing with or trusting them with your assets reveals only that you are a sucker; a mark and - thanks to the Republicans and the “Blue Dog” and other forms of neoliberal Democrats like Bill Clinton - their legal prey.
When they eat you, remember that you begged for it.

54 minutes ago
To respond to your question, “Jon”, I would say that both parties are morally and ethically culpable.
But I know the direction that will go:  The representatives of Wall Street - who knew full well that the (strangely young) analysts you quote were overstating potential but nonetheless foisted the instruments off on their customers - will peel off into an argument about “fiduciary responsibility”.
An argument that is - essentially - “Yeah, we knew we were moving sucker bets, but we stood to make money from it and ‘it wasn’t illegal’ for us to permit you to be stupid regardless of the fact that the names of our firms lent credibility to the instruments.”.
I.e., high finance in American in all of its forms - from retail lending, to wholesale packaging, stocks and bonds to Wall Street itself - is corrupt.
Again, the investment in the purchasing of the Republicans and neoliberal Democrats that brought about deregulation was the most lucrative investment in American history.  The fact that it has wrought only devastation is not the problem of those who benefit from it, eh?
Because “it isn’t illegal”....

45 minutes ago
The cdo’s were managed,if you could call it that, in excel. The risk did not feed down into the firms market risk systems so little to no oversight was available on the risk amounts being carried or the mtm numbers.
Funny enough, a nice, state of the art trading system for cdo’s was completed in august 2007 ... Too late ...

36 minutes ago
LOL. Thanks for all the information, Steve, actually its the most informative piece I’ve read on the subject. You know you should go into journalism.
I’m getting bored. I hope you found the information useful. I’ve got a long drive a head of me, so everybody have a Merry Christmas.

34 minutes ago
@Laisee, interesting. The first I heard that, it makes sense though.

31 minutes ago
@mark at 9:35 AM.  I really don’t know the answer to this but are you positive that none of these investments or mortgage backed securities ended up at Fannie, Freddy or AIG or that AIG issued Credit Default Swaps to insure these obligations?

12 minutes ago
“swindle”: “To practice fraud as a way of obtaining money” “An act or instance of swindling : Fraud”
“swindle”: “Deception, Knavery, Dupe, Victimize, Defraud”
(Webster’s New World Thesaurus)
I should stop here because the above is what the whole scheme is/was based on.
Who cares what the internal scheme of things mechanical such as the why’s and wherefore’s of CDO’s, CDS’s, etc…...
The plain fact if you “follow the money” from mortgage originator to shareholders who were just as greedy for more “return on investment” to the heads of banks, financial institutions, internal departments, traders, buyers, sellers, the trail of fraud smacks you right in the face!
Those who perpetrated or participated in this grand fraud will always insist that it “....really wasn’t fraud, but just business”!
Wall Street will always use the argument that they have to protect their internal processes of how they analyze, get information and invest…what they use as their guidelines…they call it “proprietary information.”
Remember Gordon Gekko telling young Charlie Sheen, “I want you to stop giving me information; I want you to start GETTING me information”  “Tell me something I don’t know!”  “It’s my birthday!”
Laws were passed after the Great Depression to try to reign in the greedy excesses of our capitalist system…like FDIC, SEC, Glass/Steagal and also laws that tried to protect common labor also from those greedy excesses…..
For more than three decades our business world along with the corrupt politicians that we continue to elect to high office have eroded both those concepts terribly…...the final “coup de gras”  being the dismantling of Glass/Steagal during the Clinton Administration at the insistence of the same individuals like Greenspan, Rubin, Summers, Bernanke, Geithner, all who have come into this administration with the same corrupt ideas.
There have been many changes in banking/investment profit structures since the 1970’s (it’s a long, detailed but fascinating story) which of course include the continuing destruction of organized labor (the true middle class) which left that labor class with less and less assets to spend in this crazy consumer economy (buying more and more junk and bigger houses filled with that junk that they have to rent storage space offsite) which eventually proved a dilemma for business: How to sell more and more junk, including those McMansions to a dwindling middle class with less and less spendable income?
The answer (you guessed it!)...DEBT.  Debt, debt, and more debt until the whole crazy scheme has blown up not only in the faces of Wall Street (and the world who bought all the stinkie cheese mortgage backed securities) but also in the faces of the dwindling middle class, immigrants, the poorer part of our society.
The onus belongs on those who try to hide money in offshore accounts (SIV’s, etc), those who peddle snake oil mortgages or any other dumb investments, thoroughly corrupt politicians elected to be responsible to their constituents, but know as much about economics as I know about how the galaxy will perform in the next billion years…
My whole point is that there is enough blame to go around, but if nobody goes to jail because of outright fraud then the game is afoot for the next “great economic calamity” which as sure as the sun (still) comes up and goes down will happen.
This scheme morphed into one of the greatest FRAUDS ever in our history.
And, as one commenter wrote above the French had (may still have and use as things are going over there because of this fiasco) an instrument to “level the playing field”....the Guillotine!
Pro-Publica, keep up the good work.
Incidentally this is only a small part of the enormus information that is available about this FRAUD…..
There’s nothing like a good recession (depression) to focus the common peoples’ minds…and hopefully change their priorities.
We are a thoroughly corrupt nation with a thoroughly corrupt system.

Guardian    20 May 2012

Heist of the century: Wall Street's role in the financial crisis
Charles Ferguson

Wall Street bankers could have averted the global financial crisis, so why didn't they? In this exclusive extract from his book Inside Job, Charles Ferguson argues that they should be prosecuted
'When did Wall street know there was a bubble and that they could game it?' Photograph: Eric Thayer/Reuters/Corbis

Bernard L Madoff ran the biggest Ponzi scheme in history, operating it for 30 years and causing cash losses of $19.5bn. Shortly after the scheme collapsed and Madoff confessed in 2008, evidence began to surface that for years, major banks had suspected he was a fraud. None of them reported their suspicions to the authorities, and several banks decided to make money from him without, of course, risking any of their own funds. Theories about his fraud varied. Some thought he might have access to insider information. But quite a few thought he was running a Ponzi scheme. Goldman Sachs executives paid a visit to Madoff to see ifthey should recommend him to clients. A partner later recalled: "Madoff refused to let them do any due diligence on the funds and when asked about the firm's investment strategy they couldn't understand it. Goldman not only blacklisted Madoff in the asset management division but banned its brokerage from trading with the firm too."

UBS headquarters forbade investing any bank or client money in Madoff accounts, but created or worked with several Madoff feeder funds. A memo to one of these in 2005 contained the following, in large boldface type: "Not to do: ever enter into a direct contact with Bernard Madoff!!!"

JPMorgan Chase had more evidence, because it served as Madoff's primary banker for more than 20 years. The lawsuit filed by the Madoff bankruptcy trustee against JPMorgan Chase makes astonishing reading. More than a dozen senior JPMorgan Chase bankers discussed a long list of suspicions.

The Securities and Exchanges Commission has been deservedly criticised for not following up on years of complaints about Madoff, many of which came from a Boston investigator, Harry Markopolos, whom they treated as a crank. But suppose a senior executive at Goldman Sachs, UBS or JPMorgan Chase had called the SEC and said: "You really need to take a close look at Bernard Madoff. He must be working a scam."

But not a single bank that had suspicions about Madoff made such a call. Instead, they assumed he was probably a crook, but either just left him alone or were happy to make money from him.

It is no exaggeration to say that since the 1980s, much of the global financial sector has become criminalised, creating an industry culture that tolerates or even encourages systematic fraud. The behaviour that caused the mortgage bubble and financial crisis of 2008 was a natural outcome and continuation of this pattern, rather than some kind of economic accident.

This behaviour is criminal. We are talking about deliberate concealment of financial transactions that aided terrorism, nuclear weapons proliferation and large-scale tax evasion; assisting in major financial frauds and in concealment of criminal assets; and committing frauds that substantially worsened the worst financial bubbles and crises since the Depression.

And yet none of this conduct has been punished in any significant way.
Total fines on the banks for their role in the Enron fraud, the internet bubble, violation of sanctions against countries including Iran and money-laundering activities appear to be far less than 1% of financial sector profits and bonuses during the same period.

There have been very few prosecutions and no criminal convictions of large US financial institutions or their senior executives. Where individuals not linked to major banks have committed similar offences, they have been treated far more harshly.

Goldman Sachs blacklisted Madoff, but didn’t alert the authorities. Photograph: Bloomberg/Bloomberg via Getty Images

The Obama government has rationalised its failure to prosecute anyone (literally, anyone at all) for bubble-related crimes by saying that while much of Wall Street's behaviour was unwise or unethical, it wasn't illegal. With apologies for my vulgarity, this is complete horseshit.

When the government is really serious about something – preventing another 9/11, or pursuing major organised crime figures – it has many tools at its disposal and often uses them. There are wiretaps and electronic eavesdropping. There are undercover agents who pretend to be criminals in order to entrap their targets. There are National Security Letters, an aggressive form of administrative subpoena that allows US authorities to secretly obtain almost any electronic record – complete with a gag order making it illegal for the target of the subpoena to tell anyone about it. There are special prosecutors, task forces and grand juries. When Patty Hearst was kidnapped in 1974, the FBI assigned hundreds of agents to the case.

In organised crime investigations, the FBI and government prosecutors often start at the bottom in order to get to the top. They use the well-established technique of nailing lower-level people and then offering them a deal if they inform on and/or testify about their superiors – whereupon the FBI nails their superiors, and does the same thing to them, until climbing to the top of the tree. There is also the technique of nailing people for what can be proven against them, even if it's not the main offence. Al Capone was never convicted of bootlegging, large-scale corruption or murder; he was convicted of tax evasion.

A reasonable list of prosecutable crimes committed during the bubble, the crisis, and the aftermath period by financial services firms includes: securities fraud, accounting fraud, honest services violations, bribery, perjury and making false statements to US government investigators, Sarbanes-Oxley violations (false accounting), Rico (Racketeer Influenced and Criminal Organisations Act) offences, federal aid disclosure regulations offences and personal conduct offences (drug use, tax evasion etc).

Let's take the example of securities fraud. Where to begin?
When did Wall Street insiders know there was a really serious sub-prime mortgage bubble, and that they could game it? Many of the clever ones knew by about 2004, when Howie Hubler at Morgan Stanley first started to bet against the worst securities with the approval of his management. But you can only make money betting against a bubble as it unravels. As long as there was room for the bubble to grow, Wall Street's overwhelming incentive was to keep it going. But when they saw that the bubble was ending, their incentives changed. And we therefore know that many on Wall Street realised there was a huge bubble by late 2006, because that's when they started massively betting on its collapse.

Here, I must briefly mention a problem with Michael Lewis's generally superb financial journalism. In his book The Big Short, Lewis leaves the impression that Wall Street was blindly running itself off a cliff, whereas a few wild and crazy, off-the-beaten-track, adorably weird loners figured out how to short the mortgage market and beat the system. With all due respect to Mr Lewis, it didn't happen like that. The Big Short was seriously big business, and much of Wall Street was ruthlessly good at it.

To begin with, a number of big hedge funds figured it out. Unlike investment banks, however, they couldn't make serious money by securitising loans and selling CDOs (collateralised debt obligations), so they had to wait until the bubble was about to burst and make their money from the collapse. And this they did. Major hedge funds including Magnetar, Tricadia, Harbinger Capital, George Soros, and John Paulson made billions of dollars each by betting against mortgage securities as the bubble ended, and all of them worked closely with Wall Street in order to do so.

In fairness to Mr Lewis, it is true that in several major cases – most notably Citigroup, Merrill Lynch, Lehman and Bear Stearns – senior management was indeed disconnected and thus clueless, allowed their employees to take advantage too long and therefore destroyed their own firms.

But cluelessness was most definitely not an issue with the senior management of Goldman Sachs, JPMorgan Chase and Morgan Stanley. As we saw, Morgan Stanley started betting against the bubble as early as 2004. Conversely, JPMorgan Chase mostly just remained prudently above the junk mortgage fray. Goldman Sachs, though, was in a class by itself. It made billions of dollars by betting against the very same stuff that it had been making billions selling only a year or two before.

Almost all the prospectuses and sales material on mortgage-backed bonds sold from 2005 until 2007 were a compound of falsehoods. And as the bubble peaked and started to collapse, executives repeatedly lied about their companies' financial condition. In some cases, they also concealed other material information, such as the extent to which executives were selling or hedging their own stock holdings because they knew their firms were about to collapse.

In some cases, we have evidence of senior executive knowledge of and involvement in misrepresentations. For example, quarterly presentations to investors are nearly always made by the CEO or chief financial officer of the firm; if lies were told in these presentations, or if material facts were omitted, the responsibility lies with senior management. In other cases, such as Bear Stearns, we have evidence from civil lawsuits that senior executives were directly involved in selling securities whose prospectuses allegedly contained lies and omissions.

The Rico Act provides for severe criminal (and civil) penalties for operating a criminal organisation. It specifically enables prosecution of the leaders of a criminal organisation for having ordered or assisted others to commit crimes. It also provides that racketeers must forfeit all ill-gotten gains obtained through a pattern of criminal activity, and allows government prosecutors to obtain pre-trial restraining orders to seize defendants' assets. Finally, it provides for criminal prosecution of corporations that employ Rico offenders.

Bernard Madoff confessed to operating a giant Ponzi scheme. Photograph: Timothy A Clary/AFP/Getty Images

Rico was explicitly intended to cover organised financial crime as well as violent criminal organisations such as the mafia and drug cartels. A great deal of the behaviour that occurred during the bubble would appear to fall under Rico statutes. Moreover, pre-trial asset seizure is a widely and successfully used technique in combating organised crime, and asset seizures now generate more tha $1bn a year for the US government. However, there has not been a single Rico prosecution related to the financial crisis, nor has a single Rico restraining order been issued to seize the assets of any individual banker or any firm.

It is important to note here that these asset seizures would not merely represent justice for offenders but for victims as well. US law allows seized assets to be used to compensate victims. In this case, the potential economic impact of seizures could be enormous.

Finally, personal conduct subject to criminal prosecution might range from possession and use of drugs, such as marijuana and cocaine, to hiring of prostitutes, employment of prostitutes for business purposes, fraudulent billing of personal or illegal services as business expenses (sexual services, strip club and nightclub patronage), fraudulent use or misappropriation of corporate assets or services for personal use (eg use of corporate jets), personal tax evasion and a variety of other offences.

I should perhaps make clear here that I'm not enthusiastic about prosecuting people for possession or use of marijuana, which I think should be legal. In general, I tend to think that anything done by two healthy consenting adults, including sex for pay, should be legal as well.

But the circumstances here are not ordinary. First, there is once again a vast disparity between the treatment of ordinary people and investment bankers. Every year, about 50,000 people are arrested in New York City for possession of marijuana – most of them ordinary people, not criminals, whose only offence was to accidentally end up within the orbit of a police officer. Not a single one of them is ever named Jimmy Cayne, despite the fact that the marijuana habit of the former CEO of Bear Stearns has been discussed multiple times in the national media (his predecessor in the job, Ace Greenberg, called him a "dope-smoking megalomaniac").

There is also a second, even more serious, point about this. If the supposed reason for failure to prosecute is the difficulty of making cases, then there is an awfully easy way to get a lot of bankers to talk. It is a technique used routinely in organised crime cases. What is this, if not organised?

As time passes, criminal prosecution of bubble-era frauds will become even more difficult, even impossible, because the statute of limitations for many of these crimes is short – three to five years. So an immense opportunity for both justice and public education will soon be lost. In some circumstances, cases can be opened or reopened after the statute of limitations has expired, if new evidence appears; but finding new evidence will grow more difficult with time as well. And there is no sign whatsoever that the Obama administration is interested.

Charles Ferguson will appear at the Edinburgh international book festival on Sunday 12 August.

Neue Zürcher Zeitung    29.Juli 2012

Ex-Banker in Genf
Libor-Skandal: Neue Heimat für Verdächtige
Mehrere rund um den Libor-Skandal in Verruf geratene Ex-Banker
sind bei Hedge-Funds in Genf untergekommen.
Sebastian Bräuer

Christian Bittar hat bei der Deutschen Bank einen Scherbenhaufen hinterlassen. Derzeit sind  200 Mitarbeiter damit beschäftigt, die Verwicklung von ihm und anderen Angestellten in den  Libor-Skandal zu untersuchen. Die internen Kontrolleure kämpfen sich durch wahre  Datenberge, sie haben mittlerweile 34 Mio. E-Mails erfasst. Es geht darum, gegen  anstehende Vergleichsverhandlungen gewappnet zu sein: Aufsichtsbehörden in  verschiedenen Ländern ermitteln gegen die Deutsche Bank. Dem Institut drohe eine Busse  in Milliardenhöhe, heisst es in einer Studie von Morgan Stanley – Kosten aus Zivilklagen  noch nicht eingerechnet.

Es wird Jahre dauern, den Schlamassel aufzuarbeiten, nicht nur bei der Deutschen Bank.  Mehrere Institute haben jahrelang falsche Angaben gemacht, um die Referenzzinssätze Libor  und Euribor zu manipulieren. Das ist seit dem Schuldeingeständnis von Barclays auch  offiziell bekannt.

Doch Bittar ist, zumindest vorläufig, fein raus. Er hat die Deutsche Bank 2011 verlassen und  ist heute in der Genfer Niederlassung des britischen Hedge-Funds BlueCrest tätig. Ein  BlueCrest-Sprecher bestätigt das Beschäftigungsverhältnis. Mit Bittar zu sprechen, sei  allerdings nicht möglich.

Er ist nicht der einzige Händler, der vor kurzem von einer Grossbank zu BlueCrest  gewechselt ist: Gleiches gilt für Richard Fell. Von 1998 bis 2003 arbeitete Fell ebenfalls bei  der Deutschen Bank, wie aus seinem Linkedin-Lebenslauf hervorgeht, von 2003 bis 2010 bei  der Royal Bank of Scotland. Die Job-Beschreibung in beiden Fällen: Zinsderivate-Händler.  Jetzt ist er Portfoliomanager bei BlueCrest. Eine Anfrage an Fell wird ebenfalls abgelehnt.

Fünf Gehminuten entfernt arbeitete bis vor wenigen Tagen Mickaël Zrihen. Er war im  Dezember 2010 von der Crédit Agricole zu Lombard Odier gewechselt. Derzeit ist Zrihen  suspendiert: Das Management will am 19. Juli aus der Zeitung erfahren haben, dass Zrihen  im Verdacht steht, an den Libor-Manipulationen beteiligt gewesen zu sein. «Wir untersuchen  die in dem Artikel erhobenen Vorwürfe aktiv, um die Situation vollständig beurteilen zu  können», erklärt ein Sprecher. Es seien bisher noch keine Regulatoren mit ihnen in Kontakt  getreten. Zrihen werde nicht handeln, bis die Untersuchung abgeschlossen sei.

Bis jetzt ist nicht bestätigt, dass gegen Bittar und Zrihen ermittelt wird. Laut der  Wirtschaftszeitung «Financial Times» und der Agentur Bloomberg, die sich auf mehrere  Quellen berufen, gehörten jedoch beide zum Netzwerk des früheren Barclays-Händlers  Philippe Moryoussef. Er ist nach derzeitigem Erkenntnisstand eine zentrale Figur in der Libor -Affäre. Moryoussef soll die Strategien der am Betrug beteiligten Banker  institutsübergreifend koordiniert haben.

Bei Christopher Cecere waren die Behörden bereits einen Schritt weiter. Die japanische  Finanzaufsicht beschuldigte den damaligen Citigroup-Manager, an der Manipulation des Yen -Libor beteiligt gewesen zu sein. Cecere verliess die amerikanische Grossbank. Er arbeitet  heute beim Hedge-Fund Brevan Howard – ebenfalls in Genf. Ausgerechnet Brevan Howard: Der 33 Mrd. $ schwere Vermögensverwalter steht selbst im  Verdacht, an den Manipulationen beteiligt gewesen zu sein. Ein ehemaliger Händler der  Royal Bank of Scotland hat diesen Vorwurf vor einem Gericht in Singapur formuliert. Dem  Finanzplatz Genf droht bei der Aufarbeitung des Libor-Skandals ungewollte Aufmerksamkeit.

500 000 000 000 000 $    Finanzprodukte in aller Welt basieren auf den Zinssätzen Libor und Euribor. Ende 2011  summierte sich ihr Nominalwert auf mehr als 500 Bio. $. Kleinste Manipulationen haben somit  milliardenschwere Auswirkungen.    August 3, 2012

J.P. Morgan 'Whale' Was Prodded; Bank's Probe Concludes
Trader's Boss Encouraged Boosting Values of Bets That Were  Losing
By Gregory Zuckerman and Dan Fitzpatrick

A J.P. Morgan Chase & Co. executive encouraged the trader known as the "London whale" to boost valuations on some  trades, said a person who reviewed communications emerging from the bank's internal probe of recent trading losses.

After reviewing emails and voice-mail messages, the bank has concluded that Bruno Iksil, the J.P. Morgan trader  nicknamed for the large positions he took in the credit markets, was urged by his boss to put higher values on some  positions than they might have fetched in the open market at the time, people familiar with the probe said.

The bank's conclusion is based on a series of emails and voice communications in late March and April, as losses on his  bullish credit-market bet mounted, the people said. The bank believes they show the executive, Javier Martin-Artajo,  pushing Mr. Iksil to adjust trade prices higher, according to people close to the bank's investigation. At the time, Mr.  Martin-Artajo was credit-trading chief for the company's Chief Investment Office, or CIO.

Mr. Iksil agreed on repeated occasions to adjust the values, the people said. Those discoveries led the bank to determine  last month that an earnings restatement was necessary. The prices he chose were within broad market ranges, but high  enough to later raise concerns among the bank's investigators, the people said.

Among the communications uncovered by the bank's investigation are two that the bank believes show Mr. Martin-Artajo  prodding Mr. Iksil toward higher prices, the people familiar with the probe said.

"We should not be showing" a certain amount of losses from the trades "until we see where the market is going," Mr.  Martin-Artajo told the trader in one communication, according to people who have reviewed the communications from the  probe, which is continuing.

"I'd prefer" that a higher price be put on certain positions, Mr. Martin-Artajo told Mr. Iksil in another communication, said  a person close to the investigation

Last month, J.P. Morgan said both men had left the largest U.S. bank in assets and will be forced to relinquish  compensation as part of the fallout from $5.8 billion in trading losses.

Greg Campbell, a lawyer for Mr. Martin-Artajo, said his client "unequivocally denies any wrongdoing on his part and is  confident that he will be completely exonerated when the investigations into these events have been completed." Mr.  Iksil's lawyer, Raymond Silverstein, couldn't be reached but has previously denied any wrongdoing by Mr. Iksil.

It isn't clear why Mr. Iksil decided to use the higher values. Accounting rules dictate that such investments be valued at  the best estimate of where they might be sold.

Some people at J.P. Morgan concluded, based in part on references in communications to accumulating losses, that the  favorable valuations might have been aimed at giving the losing trades time to recover and avoid setting off potential  alarms at the bank, according to the people familiar with the probe.

At the same time, some people on the trading team say they had begun to doubt market prices and were convinced rivals  were manipulating markets to the detriment of J.P. Morgan, the people said.

The details of the probe, which haven't been disclosed publicly, are the latest sign of how risk-management breakdowns  mushroomed into a trading loss that might exceed $7 billion, according to the bank's latest estimate. The mess has  tarnished the reputation of J.P. Morgan Chief Executive James Dimon, who initially played down worries about the London  whale as "a tempest in a teapot" but then said he was wrong.

J.P. Morgan said July 13 that its review of roughly one million internal emails and tens of thousands of voice tapes  suggested that some traders "may have been seeking to avoid showing the full amount of losses." The discovery  prompted the New York company to declare a "material weakness" in its financial controls and restate earnings for the first  quarter.

Determining accurate prices for infrequently traded investments such as the bets made by Mr. Iksil can be difficult, and  J.P. Morgan routinely reviewed the valuations made by traders. The oversight process by the bank's so-called valuation  control group includes input from outside pricing companies and brokers, which the group uses to set what it considers an  appropriate range for various investment positions. The arrangement is a common risk-management practice among large  banks.

In Mr. Iksil's case, though, the high valuations didn't sound any alarm bells, according to people familiar with the internal  investigation. The reason: The values claimed by the trader were within the broad range set by the oversight group, so it  approved the valuations.

People close to the probe said the control group's acceptance of the numbers was the weakness referred to by J.P. Morgan  last month. As part of the company's cleanup efforts, the group will establish a narrower band of values for such positions  and check traders' valuations more frequently than its previous practice of once a month, these people said. The group  operates separately from the CIO.

Mr. Martin-Artajo joined J.P. Morgan in 2005 after three years at Dresdner Kleinwort Wasserstein, according to Financial  Services Authority records. An avid cyclist, the tall, wavy-haired man who resembles the actor Jon Hamm, cut a dashing  presence on the J.P. Morgan trading floor.

He was known for his deliberate analysis of trading positions. According to one former colleague, Mr. Martin-Artajo often  began weekly global strategy sessions by saying he had little to say—and then discussed global economies at length in his  thick Spanish accent.

From 2007 to 2011, Messrs. Martin-Artajo and Iksil generated billions in profits on a portfolio that featured bets on certain  corporate credit indexes. In late 2011, they were asked by the bank's executives to reduce the positions, but instead put  on other trades that increased the size of the overall portfolio, according to the bank.

At first, their move was profitable. But losses began to mount in mid-March, and Mr. Iksil had trouble explaining why,  according to someone close to him, believing that market prices didn't reflect underlying value.

Mr. Martin-Artajo was exasperated. "These marks just don't make sense," he said, according to a trader who heard the  comment. Mr. Martin-Artajo was referring to prices assigned to the team's positions by brokers.

J.P. Morgan had sold more than $70 billion of derivatives that serve as protection against debt defaults by various  companies, essentially a wager on their strength. But more and more hedge funds were taking the other side of J.P.  Morgan's trades by buying the same protection. That sent prices soaring, costing J.P. Morgan big money.

"Hedge funds can't keep dictating these prices," Mr. Martin-Artajo told colleagues one day, a J.P. Morgan trader recalled.

Julie Steinberg contributed to this article.
Write to Gregory Zuckerman at and Dan Fitzpatrick at    August 3, 2012

Knight Trading Fallout:
With Knight Wounded, Traders Ask if Speed Kills
By Tom Lauricella and Scott Patterson

As Knight Capital Group reels from damage inflicted by a computer-trading malfunction, the episode highlights a risk that  had previously garnered little attention: Ever-faster stock trading and complicated markets are putting greater strains on  the ability of brokerage firms to manage their financial risks.

Many of the fears originate from within the industry. "We have created a situation that is beyond our ability to control,"  said Thomas Peterffy, founder of Interactive Brokers Group and a pioneer in electronic trading. "These problems will  continue if we don't slow things down."

This is the third major computer-trading snafu in the past five months. Most troubling to observers is that these high- profile breakdowns have originated among the core participants of the stock market, not fringe players. That ups the ante  for regulators already struggling to keep up with rapid changes in how stocks are traded and adds to the list of reasons  behind declining investor con