Archive for the ‘Systems’ category

Why 2010 will be Challenging for Goldman Sachs

December 30, 2009

I figured I’d let 2009 go out with a bang and post another of my contrarian views: 2010 will be rough for Goldman Sachs. Why? Well, to know the answer to that, you should head on over to the Huffington Post where the full piece is online.

Happy New Year!

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A Recounting of Recent History

July 28, 2009

Yes, I’m alive! I’m terribly sorry for the extended silence, but I’ve had some big changes going on in my personal life and have been out of the loop for a while (honestly, my feed reader needs to start reading itself–I have over 1,000 unread posts when looking at just 4 financial feeds). So, here’s what I haven’t had a chance to post…

1. I totally missed the most recent trainwreck of a P.R. move at Citi. There is so much crap going on around Citi… I really intend to write a post that is essentially a linkfest of Citi material that stitches together the narrative of how Citi got into this mess and how Citi continues to do itself no favors. There was also a completely vapid opinion piece from Charlie Gasperino that said absolutely nothing new, save for one sentence, and then ended with a ridiculous comparison that was clearly meant to generate links. I’m not even going to link to it… It was on the Daily Beast, if you must find it.

2. I haven’t really had the opportunity to comment on the Obama administration’s overhaul of the financial regulatory apparatus. Honestly, it sucks. It doesn’t do much and gives too much power to the Fed. You’d think that after that recent scandal within the ranks of the Fed there would be a political issue with giving it more power. Even more interestingly, all other major initiatives from the Obama administration have been drafted by congress. Here, the white paper came from the Whitehouse itself. That won’t do too much to quiet the critics who are claiming that the Whitehouse is too close to Wall St. Honestly, if one is to use actions instead of words to measure one’s intentions, then it’s hard to point to any evidence that the Obama administration isn’t in the bag for the financial services industry.

3. The Obama administration did an admirable job with G.M. and Chrysler. They were both pulled through bankruptcy, courts affirmed the actions, and there was a minimal disruption in their businesses. Stakeholders were brought to the table, people standing to lose from the bankruptcy, the same people (I use that word loosely–most are institutions) who provided capital to risky enterprises, were forced to take losses, and the U.S.A. now has something it has never had: an auto industry where the U.A.W. has a stake and active interest in the companies that employ its members. Perhaps the lesson, specifically that poorly run firms that need to be saved should cause consequences for the people who caused the problems (both by providing capital and providing inadequate management), will take hold in the financial services sector too–I’m not holding my breath, though.

4. Remember this problem I wrote about? Of course not, that is one of my least popular posts! However, some of the questions are being answered. Specifically, the questions about how and when the government will get rid of its ownership stakes, and at what price, are starting to be filled in. It was rather minor news when firms started paying T.A.R.P. funds back. However, the issue of dealing with warrants the government owns was a thornier issue. Two banks have dealt with this issue–Goldman purchased the securities at a price that gives the taxpayers a 23% return on their investment and JP Morgan decided that it would forgo a negotiated purchase and forced the U.S. Treasury to auction the warrants.

On a side note: From this WSJ article linked to above, its a bit maddening to read this:

The Treasury has rejected the vast majority of valuation proposals from banks, saying the firms are undervaluing what the warrants are worth, these people said. That has prompted complaints from some top executives. […] James Dimon raised the issue directly with Treasury Secretary Timothy Geithner, disagreeing with some of the valuation methods that the government was using to value the warrants.

(Emphasis mine.)

If I were on the other end of the line, my response would be simple: “Well, Jamie, I agree. The assumptions we use to value securities here at the U.S. government can be, well … off. So, we’ll offer you what you think is fair for the warrants if you’ll pay back the $4.4 billion subsidy we paid when we initially infused your bank with T.A.R.P. funds.” Actually, I probably would have had a meeting with all recipients about it and quoted a very high price for these warrants and declared the terms and prices non-negotiable–does anyone really think that, in the face of executive pay restrictions, these firms wouldn’t have paid whatever it would take to get out from under the governments thumb? As long as one investment banker could come up with assumptions that got the number, they would have paid it. Okay, that’s all for my aside.

5. I’m dreadfully behind on my reading… Seriously. Here’s a list of articles I haven’t yet read, but intend to…

I hope to get more time to post in the coming days. Also, I am toying with the idea of writing more frequent, much shorter posts. On the order of a paragraph where I just toss out a thought. Not really my style, but maybe it would be good. Feedback appreciated.

Making the Financial Networks Useful

June 14, 2009

Starting with the little spat between John Stewart and CNBC I started to think seriously about how the financial news stations are extremely broken. Now, I’ve mused on specific parts of this equation before. However, I’ve been writing this post, a more complete look, for a while. So, imagine my surprise when Barry Ritholtz beat me to the punch! Barry’s look, though, seems to focus more on the “low-hanging fruit” when it comes to improving CNBC. Personally, I think there is a massive overhaul needed. So, instead of taking the same approach as Barry (telling a network how to improve itself) I’ll focus on describing what my ideal financial news network would look like.

1. Make no buy/sell recommendations. Honestly, the shameless self-promoters that  go on CNBC are quite often wrong. There is no accountability for recommendations–obviously, the logistical issues are both important and daunting. However, there is a much larger problem that is most observable with Jim Cramer. I have no doubt Mr. Cramer is intelligent, just as I have no doubt that his show is useless drivel–he needs to make so many recommendations just to fill his airtime that no one ever sees his performance, CNBC doesn’t track it, and all the studies that look at his recommendations need to make huge assumptions. But, the easiest explanation of why recommendations are bad comes from a post entitled Lawyers vs. Detectives. Clearly, also, there doesn’t exist the air time or continuity to track and update recommendations correctly–the logisitical issues I mentioned earlier. And, to be frank, any idiot can just dump ticker symbols onto the screen and say a few sentences about why those ticker symbols are good or bad… and be completely wrong or stupid. The point of a good finance network should be to bring reporting and analysis to light. (Further evidence: look at Barron’s experts who, as a whole, underperform passive indices. And they are tracked and asked for analysis of their picks regularly.)

2. Emphasize investiagtive journalism. Financially literate, intelligent people can add a whole lot of value when it comes to explaining and digging into economic and financial stories. Think Kate Kelly and her three part tick tock of the Bear Stearns situation as a good example. Think of the deep look into the mortgage industry that NPR did. Think of the detailed profiles of various individuals at the center of the finance world. Clearly, there is a lot of value to be added merely by going beyond the puff piece. Right now what people get 90% of the time when it comes to finance reporting pertains to what the Dow Jones did or is doing for the day. Guess what? When stocks go up, it’s because there are more buyers than sellers. When they go down, vica versa. Trying to divine more than that from the market move on a given day is as useless and surface as it often is wrong.

3. Hire experts and not personalities. I’ll tell you a secret… Maria Bartiromo adds no value if you know anything about markets and finance to start with. I’ve seen her provide an outlet for executives to provide narrative versions of their press releases several times. There is never a question I’ve heard her ask that was probing or had an answer I didn’t already know from reading the NY Times or the WSJ. She doesn’t even understand journalism very well! The entire lineup of attractive and vacuous seat-warmers add no value. Remember this little episode with Fox Business news? Now, that’s a little different because it was live, breaking news. However, a thinking person probably would have stopped before talking about how great a move it was for Apple to buy AMD, despite the fact that such a purchase would have been “WTF?!” move for Apple–the current anchors just talk to talk. I even remember a CNBC anchor pulling up a guest’s chart on a segment (the network had been hyping this segment for a few hours–theoretically the anchor had prepared for it) and asked why, if things were so dire, the chart showed such a strong rally/uptrend. Well, the chart was showing spreads for a certain class of bonds–and, as we all know, when yield goes up, price goes down! She was anchoring a segment on fixed income (and had already been chatting about the topic for a few minutes!) and still couldn’t figure out what was going on in a very simple chart… Surely there’s room for improvement!

The model, though, for financial news anchors should really be an engaged, credentialed moderator. Thomas Keene, honestly, is a great example of this. I don’t catch his show (or podcast) as often as I would like, but whenever I do it’s clear he’s intelligent, familiar with the underlying issues, and that he views his job as getting his guests to make their case as well as expose the “other side” of the argument. A network should be able to create a lineup of intellectual experts (with relationships and enough personality to be interesting) in equity markets, corporate credit/finance, economics, macroeconomics, currencies, commodities, personal finance, etc. Networks haven’t seemed to figure out that, unlike human interest stories and traditional news, having some domain expertise is vital to being able to ask the right questions and get the underlying reasoning out into the open.

4. Go beyond soundbites and short on-air segments. I think finance is much more complicated than normal news, in the same way that political news usually is more complicated: there are lots of underlying dynamics, complex rules, and large parts of the process are hidden from view and established through precedent. Unlike a plane crash, terrorist attack, or story about some zany celebrity antic, financial news that focuses on the “what” instead of the “why” is dull, uninteresting, and useless. This is why financial news, in the first place, tries to explain what’s going on. So, it should only be natural that financial news, if it needs the “why” to be useful and is more complicated than garden-variety news, needs to allocate more than a few minutes to a given issue. No one is going to understand what’s going on with commercial real estate in five minutes. CDOs can’t even be explained in ten minutes, let alone covered in the context of the credit crisis in that time.

How can a financial news network, then, ensure that there is enough depth to a story or segment? Well, time is obviously a big piece of the equation. To revisit a prior example, Thomas Keene usually has guests on for 30+ minutes. However, media and a command of visual aides and interactive media online is also important. Some of the most compelling explanations of how CDOs work and different aspects of the credit crisis are graphics. Further, finance is based on data–models, data highlighted in charts and stories, and other material should all be made available online.

5. Embrace new media. As far as I can tell, no financial news station has a strong online presence. If a strong group of credentialed experts is the backbone of the network’s on-air talent (see #3 above) then they should have deeper, more valuable insights than what they can cover on the air. These thoughts should be blogged about, tweeted, and whatever else to make them as accessible as possible–more and more the “conversation” is online and to join it one must have their thoughts online. The NY Times does a good job at this–their columnists and reporters write all sorts of blog entries ranging from deep, researched pieces to random musings and clever one-line arguments.

Further, with my idealized network, all the content from on-air segments would be put on YouTube and made available to whomever wants to link or embed it. Openness and access would be key strategies for the network. A part of this is also making the on-air personalities and others who contribute regularly interact with the public as much as possible (currently, Twitter is a great medium for this).

6. Emphasize standards–make objectivity, fairness, and accountability the network’s core values. Barry talked about this in his list:

7.  Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.

Now, this ties in with some of what I’ve said above. However, my point goes beyond this. Executives should not want to go one my idealized network when they need to “get out a statement”–the “narrative press release” as an interview is useless and doesn’t hold the subject of the interview accountable for their words. Similarly, when a guest comes on and makes an assertion that is incorrect it needs to be challenged at the time and corrected later–I clearly take a harder stance on this issue than Barry does. If people will be making their investment decisions based on information presented on the network and then they need to trust the network–viewers need to know the network strives to prove correct information and puts every effort into doing just that. Also, the rules of “journalistic engagement” for the network (things like policies on anonymous sourcing) should be public.

7. Make education a pillar of the network. Finance and markets, as I describe in multiples places above, are complicated and often counter-intuitive–a fair amount is “inside baseball.” Having a section of the website and some on-air time dedicated to explaining both terms and important but obscure facts and market dynamics is an important service. Simple things, like bond math, are important and static–these concepts (that subtly undergird all other topics–remember the anecdote about the misread chart above) should be revisited whenever absolutely necessary while being available at all times.

If these simple pieces were all followed, I believe there would exist a simple to follow, engaging financial network that would add a ton of value where there currently is a void. Then, maybe, the other networks would need to follow suit. I won’t hold my breath.

Mild Skepticism: Credit Card Bill of Rights Edition

May 21, 2009

Well, we can all rest assured that H.R. 627, the Credit Cardholders’ Bill of Rights Act of 2009, will indeed pass. I’ve been a huge advocate of strengthening consumer protection in the past, so this is a welcomed change.  However, I’m worried that legislators have managed to put restrictions and requirements on credit card companies without taking the last step: making them ineligible to be waived in boiler-plate language. Or, more importantly, the difference between “opt out” and “opt in” … From the text of the bill:

‘(k) Opt-in Required for Over-the-Limit Transactions if Fees Are Imposed-

‘(1) IN GENERAL- In the case of any credit card account under an open end consumer credit plan under which an over-the-limit fee may be imposed by the creditor for any extension of credit in excess of the amount of credit authorized to be extended under such account, no such fee shall be charged, unless the consumer has expressly elected to permit the creditor, with respect to such account, to complete transactions involving the extension of credit under such account in excess of the amount of credit authorized.

‘(2) DISCLOSURE BY CREDITOR- No election by a consumer under paragraph (1) shall take effect unless the consumer, before making such election, received a notice from the creditor of any over-the-limit fee in the form and manner, and at the time, determined by the Board. If the consumer makes the election referred to in paragraph (1), the creditor shall provide notice to the consumer of the right to revoke the election, in the form prescribed by the Board, in any periodic statement that includes notice of the imposition of an over-the-limit fee during the period covered by the statement.

‘(3) FORM OF ELECTION- A consumer may make or revoke the election referred to in paragraph (1) orally, electronically, or in writing, pursuant to regulations prescribed by the Board. The Board shall prescribe regulations to ensure that the same options are available for both making and revoking such election.

‘(4) TIME OF ELECTION- A consumer may make the election referred to in paragraph (1) at any time, and such election shall be effective until the election is revoked in the manner prescribed under paragraph (3).

(Emphasis mine.)

Now, you’ll notice that any election remains in force until one revokes it. Also, you’ll notice that there are periodic disclosure requirements. For educated consumers (for example, readers of The Consumerist or the Wall St. Journal’s personal finance blog “The Wallet”) this should sound familiar.  It’s well established that credit cards already contain language describing how they treat information they collect on you–most sell or share this information. As this FDIC page says, though, you can usually opt out. Raise your hand if you’ve ever, in all your time on this round ball of dirt, seen how to opt out or been told of this ability by anyone (other than me, just now). If more than 0.5% of you are raising your hand, there are liars galore reading. Now, opting out on those particular issue is a different animal–there are lots of forms of information sharing you cannot opt out of. In fact, credit bureaus can sell your information too. (Wouldn’t it be nice if this legislation fixed these practices as well?) Despite these differences, the point remains that opt in protections can be abused and aren’t really protections at all. As a matter of fact, it would be nice if we saw protections that were non–waive-able.

Just goes to show that, even when considering laws strengthening consumers’ protection against abusive practices, it pays to read the fine print.

Notes and Predictions: The Stress Test

May 6, 2009

As the results of the stress test start leaking out slowly, it’s a fun exercise to make some educated guesses/predictions about what the future holds and take note of pertinent facts. As we’ve discussed before, there is a lot to take issue with when considering the results of the stress test at all, especially given the added layers of uncertainty stemming form the limited information provided in the scenarios. So, without further delay, let’s get started.

1. The baseline scenario will prove wholly inadequate as a “stress test.” Please, follow along with me as I read from the methodology (pdf).  I’ll start with the most egregious and reckless component of the mis-named baseline scenario (I would rename it the, “if payer works” scenario) : what I will refer to as “the dreaded footnote six.” From the document:

As noted above, BHCs [(Bank Holding Companies, or the firms being stress tested)] with trading account assets exceeding $100 billion as of December 31, 2008 were asked to provide projections of trading related losses for the more adverse scenario, including losses from counterparty credit risk exposures, including potential counterparty defaults, and credit valuation adjustments taken against exposures to counterparties whose probability of default would be expected to increase in the adverse scenario.(6)

[…]

(6) Under the baseline scenario, BHCs were instructed to assume no further losses beyond current marks.

(Emphasis mine.)

Holy <expletive>! In what alternate/parallel/baby/branching universe is this indicative of anything at all? Assume no further losses beyond current marks? Why not assume everything returns to par? Oh, well, that actually was a pretty valid assumption for the baseline scenario. From the document:

New FASB guidance on fair value measurements and impairments was issued on April 9, 2009, after the commencement of the [stress test].  For the baseline scenario supervisors considered firms’ resubmissions that incorporated the new guidance.

(Emphasis mine.)

Thank goodness! I was worried that the “if prayer works” scenario might have some parts that were worth looking at. Thankfully, for troubled banks, I can skip this entire section. (Confidence: 99.9999%)

2. Trading losses will be significantly understated across all five institutions that will need to report them. First, only institutions with over $100 billion in trading assets were asked to stress their trading positions. Second, from the section on “Trading Portfolio Losses” from the document:

Losses in the trading portfolio were evaluated by applying market stress factors … based on the actual market movements that occurred over the stress horizon (June 30 to December 31, 2008).

(Emphasis mine.)

Okay, well, that seems reasonable, right? Hmmmm… Let’s take a look. Here is what some indicative spread movements for fixed income products looked like January 9th of 2009, according to Markit (who has made it nearly impossible to find historical data for their indices, so I’m resorting to cutting and pasting images directly–all images are from their site):

yearendgraph

(Click on the picture for a larger version.)

Well, looks like a big move is taken into account by using this time horizon. Clearly this should provide a reasonable benchmark for the stress test results, right? Well, maybe not.

currentgraph

(Click on the picture for a larger version.)

Yes, that’s right, we’ve undergone, for sub-prime securities a massive widening during 2009 already. Also, as far as I can tell, the tests are being run starting from the December 2008 balance sheet for each company. So, if I’m correct, for the harsher scenario, trading losses will be taken on December 2008 trading positions using December 2008 prices and applying June 2008 to December 2008 market movements. For sub-prime, it seems pretty clear that most securities would be written up (June 2008 Spread: ~200, December 2008 Spread: ~1000, Delta: ~800, Current Spread: ~2600, December 2008 to Today Delta: ~1600, Result: firms would take, from December 2008 levels, half the markdown they have already taken).

Also, it should be a shock to absolutely no one that most trading assets will undergo a lagged version of this same decline. Commercial mortgages and corporate securities rely on how firms actually perform. Consumer-facing firms, as unemployment rises, the economy worsens and consumption declines, and consumers default, will see a lagged deterioration that will appear in corporate defaults and small businesses shuttering–both of these will lead to commercial mortgages souring.  Indeed we’ve seen Moody’s benchmark report on commercial real estate register a massive deterioration in fundamentals. That doesn’t even take into account large, exogenous events in the sector. Likewise, we see consistently dire predictions in corporate credit research reports that only point to rising defaults 2009 and 2010.

In short, for all securities, it seems clear that using data from 2H2008 and applying those movements to December 2008 balance sheets should produce conservative, if not ridiculously understated loss assumptions. (Confidence: 90%)

3. Bank of America will have to go back to the government. This, likely, will be the end of Ken Lewis. It’s not at all clear that Bank of America even understands what’s going on. First, if I’m correctly reading Bank of America’s first quarter earnings information, the firm has around $69 billion in tangible common equity. Also, it should be noted that the FT is reporting that Bank of America has to raise nearly $34 billion.  Now, with all this in mind, let’s trace some totally nonsensical statements that, unlike any other examples in recent memory, were not attributed to anonymous sources (from the NYT article cited above):

The government has told Bank of America it needs $33.9 billion in capital to withstand any worsening of the economic downturn, according to an executive at the bank. […]

But J. Steele Alphin, the bank’s chief administrative officer, said Bank of America would have plenty of options to raise the capital on its own before it would have to convert any of the taxpayer money into common stock. […]

“We’re not happy about it because it’s still a big number,” Mr. Alphin said. “We think it should be a bit less at the end of the day.” […]

Regulators have told the banks that the common shares would bolster their “tangible common equity,” a measure of capital that places greater emphasis on the resources that a bank has at its disposal than the more traditional measure of “Tier 1” capital. […]

Mr. Alphin noted that the $34 billion figure is well below the $45 billion in capital that the government has already allocated to the bank, although he said the bank has plenty of options to raise the capital on its own.

“There are several ways to deal with this,” Mr. Alphin said. “The company is very healthy.”

Bank executives estimate that the company will generate $30 billion a year in income, once a normal environment returns. […]

Mr. Alphin said since the government figure is less than the $45 billion provided to Bank of America, the bank will now start looking at ways of repaying the $11 billion difference over time to the government.

(Emphasis mine.)

Right around the time you read the first bolded statement, you should have started to become dizzy and pass out. When you came to, you saw that the chief administrative officer, who I doubt was supposed to speak on this matter (especially in advance of the actual results), saying that a bank with $69 billion in capital would be refunding $11 billion of the $45 billion  in capital it has already received because they only need $34 billion in capital total. Huh? Nevermind that the Times should have caught this odd discrepancy, but if this is the P.R. face the bank wants to put on, they are screwed.

Now, trying to deal with what little substance there is in the article, along with the FT piece, it seems pretty clear that, if Bank of America needs $34 billion in additional capital, there is no way to get it without converting preferred shares to common shares. There is mention of raising $8 billion from a sale of a stake in the China Construction Bank (why are they selling things if they are net positive $11 billion, I don’t know). That leaves $26 billion. Well, I’m glad that “once a normal environment returns” Bank of America can generate $30 billion in income (Does all of that fall to T.C.E.? I doubt it, but I have no idea). However, over the past four quarters, Bank of America has added just $17 billion in capital… I will remind everyone that this timeframe spans both T.A.R.P. and an additional $45 billion in capital being injected into the flailing bank. Also, who is going to buy into a Bank of America equity offering now? Especially $26 billion of equity! If a troubled bank can raise this amount of equity in the current environment, then the credit crisis is over! Rejoice!

I just don’t see how Bank of America can fill this hole and not get the government to “bail it out” with a conversion. The fact that Bank of America argued the results of the test, frankly, bolsters this point of view. Further, this has been talked about as an event that requires a management change, hence my comment on Lewis.  (Confidence: 80% that the government has to convert to get Bank of America to “well capitalized” status)

Notes/Odds and Ends:

1. I have no idea what happened with the NY Times story about the results of the “Stress Test.” The WSJ and FT are on the same page, but there could be something subtle that I’m misunderstanding or not picking up correctly. Absent this, my comments stand. (Also, if might have been mean.unfair of me to pick on the content of that article.)

2. The next phases of the credit crisis are likely to stress bank balance sheets a lot more. The average bank doesn’t have huge trading books. However, they do have consumer-facing loan and credit products in addition to corporate loans and real estate exposure. In the coming months, we’ll see an increase in credit card delinquencies. Following that, we’ll see more consumer defaults and corporations’ bottom line being hurt from the declining fundamentals of the consumer balance sheet. This will cause corporate defaults. Corporate defaults and consumer defaults will cause commercial real estate to decline as well. The chain of events is just beginning. Which leads me to…

3. Banks will be stuck, unable to lend, for a long time. I owe John Hempton for this insight. In short, originations require capital. Capital, as we see, is in short supply and needed to cover losses for the foreseeable future. Hence, with a huge pipeline of losses developing and banks already in need of capital, there is likely not going to be any other lending going on for a while. This means banks’ ability to generate more revenue/earnings is going to be severely handicapped as sour loans make up a larger and larger percentage of their portfolios.

4. From what I’ve read, it seems that the actual Citi number, for capital to be raised, is between $6 billion and $10 billion. This puts their capital needs at $15 billion to $19 billion, since they are selling assets to raise around $9 billion, which is counted when considering the amount of capital that needs to be raised (according to various news stories). Interestingly, this is 44% to 55% of Bank of America’s needed capital. This paints a very different picture of the relative health of these two firms than the “common wisdom” does. Granted, this includes a partial conversion of Citi’s preferred equity to common equity.

5. I see a huge correlation between under-performing portfolios and a bank trying to negotiate it’s required capital lower by “appealing” the stress test’s assessment of likely losses in both the baseline and adverse scenarios. As I’ve talked about before, not all portfolio performance is created equal. Citi has seen an increasing (and accelerating) trend in delinquencies while JP Morgan has seen it’s portfolio stabilize. So, for the less-healthy banks to argue their losses are overstated by regulators, they are doubly wrong. It’ll be interesting to see how this plays out–for example, if JP Morgan’s credit card portfolio assumes better or worse performance than Citi and Bank of America.

How to Fix the Compensation Issue… Yesterday!

April 15, 2009

With all the tone-deafness that followed the great compensation debate of 2009, I have a very simple solution. The problem, despite what people commonly believe, is not the absolute level of compensation. No, it’s the fact that management’s personal incentives and employees’ incentives are aligned–shareholders are still in the wilderness. How many times have we heard the trite, absolutely silly refrain stating “we need to pay the valuable people that know where the bodies are buried so they can dispose of them!”? Way too many. Although, there are dozens of examples of retention bonuses being paid to people as they resign… Idiots.

So, what do I suggest? Add all compensation, beyond a base limit, say $250,000, as T.A.R.P. debt to institutions who have already received funds under the program–and the interest rate from this new debt should be very high. I would suggest… okay, I never merely suggest… I would demand (better!) that this new debt carry a high coupon. Maybe even ensure the interest owed is cutely linked to the way these publicly owned (partially, anyway) institutions are negatively impacting our economy. One example: this new debt could carry an interest rate equal to the greater of the (a) median of the top quartile of credit card interest rates issued by the company in question and (b) 24.99%.

Now, what does this do? It better aligns management and shareholders. How can a C.E.O. allow divisions that lost billions to run up it’s debt? And, how can an institution award these bonuses necessary to pay people, right out of taxpayer money, if they aren’t willing to pay it back later? By definition, every dollar that flows into the pockets of employees can’t go back to the taxpayers whose money saved these same institutions. Once managers need to actually justify why they are paying people, due to the higher cost, I guarantee fewer employees will receive these higher bonuses. Gone will be the cuspy performers who are being paid because Wall St. is a creature of habit. This will create a wholesale re-thinking of compensation at many institutions. And, honestly, it’s long overdue. To be honest, I don’t really view this higher cost as excessive, either. People being paid 8-12% of profits (it’s actually revenue traders are compensated on, but don’t tell anyone that) should wind up actually costing 10%-20% of profits with this excess debt, perhaps as high as 30%–but these employees continue to be employed and able to profit due to taxpayer funds to begin with. It’s time managers are required justify, to their boards and owners, why high compensation for various employees is necessary. And, since companies say a surtax or banning of bonuses is bad and bonuses are absolutely required, they should be more than willing to pay these higher rates–they need these people after all!

To Understand the A.I.G. Problem, Look no Further than the Public Resignation Letter

April 2, 2009

I’ll admit it, Jake DeSantis’ resignation letter got me extremely annoyed. It’s a bait-and-switch–a one-sided telling of the story that doesn’t even jive with itself. I’ve been a bit torn about whether or not to write about it, but here we are. So, let’s get started (my comments are interlaced, in bold).

Dear Mr. Liddy,It is with deep regret that I submit my notice of resignation from A.I.G. Financial Products. I hope you take the time to read this entire letter. Before describing the details of my decision, I want to offer some context:

First of all, why is this letter public? They even have a screenshot of an email being sent from Mr. DeSantis to Mr. Liddy. To me, this is a huge P.R. ploy. When one writes a letter, knowing it will be made public, it immediately destroys the ability to “take it at face value.”

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

Ahhhhhh… Herein lies the most major problem. This is the common thread people are likely to hear over and over again. “It wasn’t my division/trading book/group that lost the money.” Well, unfortunately, this is completely and totally irrelevant. First of all, did anyone complain when that group was “juicing” the returns of your equity compensation? Did anyone hear, “I can’t take this! It wasn’t my group that made all this money!” No. Hypocrite. Second, you work at the same firm. This firm, 400 people large, as the letter states, is around the same size as my high school class. There are two possibilities for any front-office employees claiming to not know what the credit default swap businesses were doing: they are lying (highly, highly likely) or their head was in the sand (less likely). Firms like this have “town hall meetings.” There are transactions that cross areas and force people to work together and meet one another. Senior management (What is Mr. DeSantis’ title? Ahhh, yes, “Executive Vice President” …. Thank you screenshot) sits on executive committees, working groups, and other teams for business development, strategy sessions, and to ensure that everyone knows what is going on. In fact, we know that even accountants asked questions and saw enough inconsistencies to blow the whistle on A.I.G.! So, yes, very few people actually executed the trades. But, no, no one who worked there bears no responsibility for asking the right questions or raising concerns over things they didn’t understand.

This is exactly the same problem that existed in many other firms, so it’s not unique to A.I.G. This is one reason why Goldman is so successful, their co-presidents walk the floor and know traders and senior executives from all the businesses. A wide net is cast for opinions when doing a transaction or making a large decision. The partnership mentality exists there in a huge way, versus this “fiefdom” or “silo” mentality where people talk about “their business.”

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

Honestly, I’ll believe it when I see it. You shouldn’t get the credit for saying you’ll give away your money, you should get credit for giving away your money. Also, please note this: A.I.G. reassured them many times they would be rewarded… Doesn’t sound like a formal contract, does it? As for being “persecuted” … Show me the harm that elected officials have actually done. The T.A.R.P. surtax measure looks dead to me. And, if you’re giving it away anyway, not much harm there. Maybe you should have used another word, like, “lectured” or “scolded.”

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

I see. So you worked for eleven years because you’re dedicated and honorable, but now that you’re not getting paid for helping to maximize recovery for taxpayers, you’re leaving. Please note that, in reading this, it’s clear that the dysfunctional environment has been around before now, so that’s not the reason he is leaving. Even more amazing is the fact Mr. DeSantis agreed to work for $1 out of, “a sense of duty to the company and to the public officials who have come to its aid.” Is he <expletive> kidding? So the $1 was out pf a sense of duty, but the $742,006.40 (post taxes, we’ll come to that later!) was out of greed? Well, then I think we know what you’re about.

You and I have never met or spoken to each other, so I’d like to tell you about myself. I was raised by schoolteachers working multiple jobs in a world of closing steel mills. My hard work earned me acceptance to M.I.T., and the institute’s generous financial aid enabled me to attend. I had fulfilled my American dream.

Congratulations on a stellar achievement, getting into M.I.T.! Unfortunately, your hyperbole surrounding the phrase “American dream” is asinine. If your dream was to go into debt to go to M.I.T., and then it was fulfilled, you probably should have thought a few steps beyond that.

I started at this company in 1998 as an equity trader, became the head of equity and commodity trading and, a couple of years before A.I.G.’s meltdown last September, was named the head of business development for commodities. Over this period the equity and commodity units were consistently profitable — in most years generating net profits of well over $100 million. Most recently, during the dismantling of A.I.G.-F.P., I was an integral player in the pending sale of its well-regarded commodity index business to UBS. As you know, business unit sales like this are crucial to A.I.G.’s effort to repay the American taxpayer.

The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity — directly as well as indirectly with the rest of the taxpayers.

Ahhh, here again Mr. DeSantis changes it up a bit. Unfortunately for him, his choice of words is telling. “The profitability of the businesses with which I was associated clearly supported my compensation.” Oh? So you weren’t associated with A.I.G. the corporation? How about A.I.G. Financial Products?

As for your lost deferred compensation, well, then it worked! You were given deferred compensation, tied to the performance of your firm, to align your incentives with everyone else. This is part of the reason your attempts to disassociate yourself from the problems are meaningless. You likely made money, and cashed out portions of your deferred compensation (11 years of continued employment means a lot of it vested, I would assume). You clearly made money from this compensation scheme … Do you now intend to give back the portion you weren’t directly responsible for? No, of course not! Nor should you, by the way–live by the sword, die by the sword, as the saying goes.

Anyway, let’s make apparent what you aren’t saying. How much of this compensation, over the years, was actually in deferred equity compensation? Standard amount for a bonus of your size is 30-40% of your bonus. This could be 20-30% of your total compensation for a given year. So, for the past few years, most likely 30% of your compensation has been in equity, likely vesting over 3-5 years with equal amounts of any years award vesting over each following year… This means that for the first six years you kept 100%, for the next year you kept approximately 94%, then 88% … The lowest proportion being 65-70%. Now, these are all approximate, but unless something is very amiss, it’s all in the ballpark. It isn’t like Mr. DeSantis didn’t know his risk the entire time and one shouldn’t think, from the vagueness, that it’s much higher than it truly is.

I have the utmost respect for the civic duty that you are now performing at A.I.G. You are as blameless for these credit default swap losses as I am. You answered your country’s call and you are taking a tremendous beating for it.

No, no, for all the reasons I’ve stated before, Mr. DeSantis, Mr. Liddy is much more blameless than you are. He didn’t have 11 years to figure out what this division was doing, ask questions, raise red flags, or exercise the option to quit and sell all his unvested stock. You, however, did.

But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn’t defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut.

Ibid. (Don’t want to sound like a broken record.)

My guess is that in October, when you learned of these retention contracts, you realized that the employees of the financial products unit needed some incentive to stay and that the contracts, being both ethical and useful, should be left to stand. That’s probably why A.I.G. management assured us on three occasions during that month that the company would “live up to its commitment” to honor the contract guarantees.

Honestly, this is where this <expletive> <insulting non-expletive> really gets under my skin. Let me give Mr. DeSantis a piece of advice: When you agree to an employment contract that has a total compensation (post taxes, more on that in a second!) of over $740,000 (don’t forget, he’s getting his benefits, too!), but the salary component of that is $1, you aren’t getting farily compensated by the non-salary portion and making a huge sacrifice by working for a $1 salary. Both cannot be true! This sort of posturing and propaganda falls very nicely into the “what isn’t he saying?” overtone that colors this entire P.R. stunt. Also, note that this entire paragraph is guessing. The only objective portion of this sentence is that A.I.G. management assured a group of people that they would live up to their commitment on three seperate occasions. Keep in mind no representations were made by A.I.G. as t the tax rate they would pay. They could have! This is a common executive perk called a “Tax Gross-Up” … I wonder how it works when there is over 100% tax rate, though…

That may be why you decided to accelerate by three months more than a quarter of the amounts due under the contracts. That action signified to us your support, and was hardly something that one would do if he truly found the contracts “distasteful.”

More guesses. I agree these actions seem inconsistent, though. I wonder if Mr. Liddy himself knew the specifics and timing.

That may also be why you authorized the balance of the payments on March 13.

At no time during the past six months that you have been leading A.I.G. did you ask us to revise, renegotiate or break these contracts — until several hours before your appearance last week before Congress.

I think your initial decision to honor the contracts was both ethical and financially astute, but it seems to have been politically unwise. It’s now apparent that you either misunderstood the agreements that you had made — tacit or otherwise — with the Federal Reserve, the Treasury, various members of Congress and Attorney General Andrew Cuomo of New York, or were not strong enough to withstand the shifting political winds.

I’m sure Mt. Liddy takes comfort in hearing your thoughts on his actions.

You’ve now asked the current employees of A.I.G.-F.P. to repay these earnings. As you can imagine, there has been a tremendous amount of serious thought and heated discussion about how we should respond to this breach of trust.

And yet most of the bonuses have been paid back.

As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.

Ibid.

Many of the employees have, in the past six months, turned down job offers from more stable employers, based on A.I.G.’s assurances that the contracts would be honored. They are now angry about having been misled by A.I.G.’s promises and are not inclined to return the money as a favor to you.

This is also stupid and, likely, doesn’t stand up. Likely this is built from hearsay But, I’ll give the truthfulness of this statement the validity of the doubt. First, understand the point here: the only reason these A.I.G. employees agreed to stay at A.I.G. and fix the mess they and their colleagues created is because they extracted large, guaranteed payments from A.I.G., now owned by taxpayers. Nice! Second, if they are truly the rationally thinking economic agents they claim to be, why did they turn down a job from a stable employer for a job that has an expiration date (the full unwind of A.I.G. F.P.)?

So, either these people are irrational idiots or they ransoming taxpayers and the American economy. I don’t care which they pick, honestly.

The only real motivation that anyone at A.I.G.-F.P. now has is fear. Mr. Cuomo has threatened to “name and shame,” and his counterpart in Connecticut, Richard Blumenthal, has made similar threats — even though attorneys general are supposed to stand for due process, to conduct trials in courts and not the press.

The only motivation? What about, well, Mr. DeSantis put it so well… “a sense of duty to the company and to the public officials who have come to its aid” … ? Oh, right, that was when there was a guaranteed, $700,000+ payment.

So what am I to do? There’s no easy answer. I know that because of hard work I have benefited more than most during the economic boom and have saved enough that my family is unlikely to suffer devastating losses during the current bust. Some might argue that members of my profession have been overpaid, and I wouldn’t disagree.

Woah, stop the presses. So, you’ve been overpaid, your family isn’t “suffering devastating losses,” and you’ve benefited more than most form the past few years. So why are you resigning? Oh, right … because you didn’t get over $700,000.

Well, to your question about what you should now, I have an easy answer! If you’re truly needed to unwind A.I.G. F.P., and you’re going to be available, volunteer to help! Please note: volunteering doesn’t include a $700,000+ bonus. Your $1 salary, however, is still there if you’d like.

That is why I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn. This is not a tax-deduction gimmick; I simply believe that I at least deserve to dictate how my earnings are spent, and do not want to see them disappear back into the obscurity of A.I.G.’s or the federal government’s budget. Our earnings have caused such a distraction for so many from the more pressing issues our country faces, and I would like to see my share of it benefit those truly in need.

On March 16 I received a payment from A.I.G. amounting to $742,006.40, after taxes. In light of the uncertainty over the ultimate taxation and legal status of this payment, the actual amount I donate may be less — in fact, it may end up being far less if the recent House bill raising the tax on the retention payments to 90 percent stands. Once all the money is donated, you will immediately receive a list of all recipients.

Subtext: Congress will be stealing from the needy if they pass this surtax! Also, note that it’s $742,006.40 after taxes. If his effective tax rate is 35% then the payment is $1,141,548.31. If his tax rate is higher, it’s more!

This choice is right for me. I wish others at A.I.G.-F.P. luck finding peace with their difficult decision, and only hope their judgment is not clouded by fear.

Mr. Liddy, I wish you success in your commitment to return the money extended by the American government, and luck with the continued unwinding of the company’s diverse businesses — especially those remaining credit default swaps. I’ll continue over the short term to help make sure no balls are dropped, but after what’s happened this past week I can’t remain much longer — there is too much bad blood. I’m not sure how you will greet my resignation, but at least Attorney General Blumenthal should be relieved that I’ll leave under my own power and will not need to be “shoved out the door.”

I see. So there’s too much bad blood in the place that paid you millions and millions over ten years. What’s the word… right… perspective!

Sincerely,
Jake DeSantis

Who else now supports the T.A.R.P. surtax measure?