The Trickle-Down Case for Indulging Wall Street

Colbert Interview with Eliot Spitzer

I'm not a Stephen Colbert regular, but I did catch his interview the other night with "disgraced former New York Governor Eliot Spitzer" (that's now Spitzer's official moniker, by the way).

Colbert's cut-to the chase question: even if Wall Street is full of inept crooks and greedheads, as most everyone outside of Wall Street now agrees, isn't short-circuiting their gaudy gravy train just a case of "cutting off our noses to spite our faces?"

In other words, Colbert asked, don't Wall Street-types spend their multi-million dollar bonuses on drivers, cooks, tailored clothes, second (and third, and fourth) homes, expensive restaurants, etc. ???

And if that spending vanished, wouldn't all those other individuals and businesses suffer?

I have a two-part answer to that.

First, to the extent that it's necessary to stimulate our economy (to offset the catastrophic financial damage Wall Street engineered), my preferred instruments for doing so . . . would hardly be the very same people who caused the catastrophe.

Not only does that offend any moral person's sense of justice, it literally encourages more of the very same behavior!

Personally, I would like to now spend a few years without the term "moral hazard" dominating the Op-Ed pages and blogosphere.

Give it to "the Bernie's!"

If the goal is simply to put money in the hands of people who will spend it, why not pluck Bernie Madoff, Bernie Ebbers (Worldcom), Jeff Skilling (Enron), and other scoundrels from their jail cells and bestow upon them the billions being showered on Wall Street?

To paraphrase Ben Stein's stump speech, let's instead lavish the money on the people who are the true backbone of this country: the servicemen and women serving abroad, and especially their families sacrificing back home.

And while we're at it, let's earmark a little of Wall Street's money to care for soldiers who've sustained life-altering combat injuries.

Second, it's far from clear that handing out financial "goodies" -- to anyone -- is advisable.

Just as there's no free lunch, there's no such thing as "free stimulus."

Basically, it's just added to our national credit card -- a credit card balance that already comes to something like $35,000 for every man, woman, and child in the U.S.

If open-ended, poorly targeted stimulus (deficit) spending worked, Japan's economy would be the world's most robust now.

Instead, Japan is entering its second (or third) "lost decade," depending on who's counting.

The bottom line?

Saddling our economy with crushing debt to enable -- and then mitigate the consequences of -- still more Wall Street greed and misbehavior is to compound one mistake with a second, equally big one.

Deal(ing) with the Devil

Why Be a Goldman Sachs Client?

I'd rather have the SOB in the tent and pissing out, then the other way around.

--Lyndon Baines Johnson

He may be a son of a bitch, but he's our son of a bitch.

--FDR

It's a question that's been gnawing at me since at least last December, when Bernie Madoff was arrested, and has only grown stronger as various and sundry accounts of Goldman Sachs' machinations have come to light.

Namely, if you suspect (or worse) that someone you have business dealings with is "ethically challenged," why hang around? Why not simply run for the exit, like a rational person would?

Background

You'd have to have been in a cave the last six months not to be at least dimly aware of the charges and recriminations hurled at Goldman Sachs.

Namely, that Goldman Sachs wields undue influence over U.S. financial and monetary policy, and benefits mightily from same; that it has inside information that it uses to game the markets; and that the firm, in Matt Taibbi's infamous words, is a "great vampire squid wrapped around the face of humanity."

If you were a Goldman Sachs client, you'd think that all that might at least give you pause.

Unless.

Unless you actually believed the allegations, in which case you might rationally decide that it was better to be on the inside of whatever scam(s) Goldman was running -- presumably benefiting from them -- than being on the outside, victimized like everyone else.

Doing Business with the Devil

Interestingly, a similar theory emerged around the time Bernie Madoff was arrested.

According to some news accounts, at least a few Madoff clients suspected that his returns were too consistent to be legitimate. In fact, they believed Madoff was actually engaged in "front-running," i.e., illegally trading ahead of his (brokerage firm) clients to snag guaranteed profits.

Whether true or a canard, it would explain why at least some putatively sophisticated (but ethically deficient) Madoff clients stuck with him.

At least until it all blew up.

Then, they discovered another lesson: sometimes, even people supposedly "inside the tent" end up getting pissed on, too.

Cracked Crystal Ball

I'm a Contrarian Indicator (at least on stocks)

On March 9, I wrote:

Until investors are satisfied that the Madoff's of the world have been dealt with appropriately, and convincing steps have been taken to assure that there won't be any more . . . don't hold your breath waiting for a sustainable stock market rally.

--Ross Kaplan, "Bernie Madoff & the Path to Recovery"; City Lakes Real Estate Blog

So when did the Dow Jones bottom?

On March 6, at 6443.27 (intraday). Of course, it's up more than 50% since then.

On the other hand, Bernie Madoff has now been sentenced to 150 years in prison, and it appears to only be a matter of time before his inner circle is also behind bars.

P.S.: contrary (no pun intended) to popular opinion, contrarian indicators can be extremely valuable prognosticators.

Like "Opposite George" on Seinfeld, you just do the opposite. In fact, that's how I decide what movies to see: I simply ask my sister what she's seen lately that she hated.

Madoff Musings

Sightseeing in NY City

So, how do you spend a week in New York City with a couple kids?

The usual: Empire State building, Statue of Liberty, Museum of Natural History, Central Park Zoo, Bernie and Ruth Madoff Penthouse.

OK, that last one I added on my own. And as of last week, it's not theirs anymore -- federal marshalls seized it (Good!).

It wasn't hard to find: the paparazzi in front gave it away.

Never having talked to one, my image of them was of a half-man, half-barracuda. In fact, they were quite amiable -- and mostly bored. When I asked one of them why Ruth Madoff would ride the subway, as she had done the previous week to a crush of humiliating publicity, he simply remarked, "stupid."

So were there any surprises?

Actually, yes.

In the Midwest, the term, "Bernie Madoff's $7 million penthouse apartment" immediately conjures up images of lavish 5th Avenue digs overlooking Central Park.

In fact, those apartments cost anywhere from $25 million to $50 million (still).

Seven million just buys you a very nice unit, at the top of an undistinguished pre-War building, a block from the 63rd and Lexington subway stop (still a high-rent neighborhood, to be sure).

Who Can You Trust?

(More) Recession Trend Spotting

If you want a friend in Washington . . . get a dog.

--President Harry Truman

To my mind, what's unique about this recession isn't just the damage to people's pocketbooks -- bad as that may be so far -- but to something more fundamental: their trust.

You don't have to have invested with Bernie Madoff to worry about getting "burned": today, the safety of your savings, the balance in your 401(k), even the food you buy is potentially suspect.

So who can you trust?

Yourself, for starters. You'd guess that that at least partly explains the appeal of vegetable gardens (Burpee seed sales: up 30% so far this year).

But maybe the question should also be "what can you trust?"

It might just be my imagination, but it seems like people are spending more of their (shrinking) disposable income on . . . pets.

You may not have much faith in Wall Street or Washington, but Fido (or Rover or Boots) will always be there for you.

Cuomo Does Heavy Lifting

Bernie Madoff Gets Sued . . . in NY, MA

[NY Attorney General Andrew] Cuomo Sues Over Madoff Investments

--Headline, The New York Times (4/6/09)

How is it that Bernie Madoff broke state laws in New York and Massachusetts (that state is also suing), but not Minnesota? Doesn't Minnesota have an attorney general -- and almost 200 assistant attorneys general?

And didn't I read about Minnesotans losing hundreds of millions to Madoff? (As I've posted earlier, I know of at least four homes locally that are for sale because the owners were victimized by Madoff.)

Just asking . .

"One Down, 999 to Go" (cont.)

Financial Res Ipsa Loquiter - Part 2

[Note: please return to this post after reading Part 1]

Even people who agree that holding Wall Street accountable is a laudable goal are likely to raise four objections. The most serious arguments -- and the rebuttals -- are:

One. "No laws were broken."

Specifically, the SEC allowed Wall Street investment banks to borrow 35:1; the Financial Accounting Standards Board ("FASB") permitted companies to keep toxic debt off their balance sheets; and even the credit rating agencies put their "seal of approval" on the securitized debt.

Rebuttal: This is nothing more than financial chutzpah (the regular kind is defined as killing your parents, then throwing yourself on the mercy of the court because you're an orphan).

When it comes to regulation, Wall Street got exactly the rules it wanted, or, in the case of credit derivatives, forbearance on the ones it didn't.

Investment banks, led by Goldman Sachs head (and future Treasury Secretary) Henry Paulson pressured the SEC to raise permissible leverage. The same crew dismantled Glass-Steagall, the Depression-era bulwark separating investment and commercial banking. FASB has long been intimidated by the companies it purports to regulate. And companies like Standard & Poor's and Moody's were co-opted by gaudy Wall Street fees much the same way Arthur Andersen was seduced by Enron.

Two. Holding Wall Street's senior executives accountable for their actions will be bad for the market and the country's morale.

Rebuttal: Not holding them accountable is bad for the markets and morale.

Three. It's logistically impractical -- and legally cost-prohibitive -- to figure out which executives did what, when, and what their motives were. In a world where Exxon is still appealing liability for the Exxon Valdes spill, Hell will freeze over before Wall Street executives head to prison en masse.

Rebuttal: That's why the burden of proof needs to be shifted to the companies. In fact, don't stop there: require the companies to identify which individuals were most responsible for their corporate conduct -- after all, they're the ones in the best position to know. Such a tack also avoids the inevitable, Eichmann-style "we were just following orders" defense.

If the companies don't finger the responsible persons . . . hold the board of directors responsible instead.

Four. Such an approach smacks of collective -- not to mention "cruel and unusual" -- punishment.

Rebuttal: Collective punishment for collective behavior is eminently appropriate.

Just like Madoff, none of these senior executives acted alone; they were part and parcel of a culture that partook of the rewards and sloughed off the risks and responsibility.

Given the economic harm wrought by their actions, it's hard to argue that any punishment, however severe, would constitute "cruel and unusual." Besides the direct economic cost -- already in the trillions -- the indirect cost to the financial system, measured in broken lives and destroyed trust, is incalculable.

In any case, there is ample precedent for imposing disproportionately harsh punishment when the public policy stakes are so high.

That's exactly what the Supreme Court has opined in numerous cases brought by members of the posse comitatus, famous for filing expletive-filled tax returns (if they file them at all) -- and drawing very long prison sentences as a result.

According to the Supreme Court, the Internal Revenue Service relies on a system of voluntary compliance. It is allowed to make examples of the few to "encourage" the majority to do their duty.

Capitalism is no different. If the worst kinds of greed and self-dealing go unchecked, why should ordinary citizens behave? Or trust such a system with their life savings?

Before taxpayers replenish the hen house that has just been so spectacularly looted -- or set about the long-term task of restoring security -- it would seem wise to apprehend the foxes who made off (sorry, couldn't resist) with the chickens.

Or, to put it in slightly less modern terms, society should take steps to assure that "as you reap, so shall you reap."

"One Down, 999 to Go"

Financial Res Ipsa Loquiter

If the stock market surged 15% in the week since Bernie Madoff finally went to prison, just imagine what it would do once the senior management at companies like AIG, Citigroup, Goldman Sachs, and Fannie Mae are held accountable for their behavior.

And why shouldn't they be?

Thanks to the legal principle of res ipsa loquiter (Latin for "the thing speaks for itself"), when a patient finds a scalpel in his back after surgery, he doesn't have to prove negligence to prevail in a malpractice suit against his surgeon(s). Rather, the surgeons have to prove that they didn't commit malpractice.

So, too, when a company requires $5 billion -- or 10X or 50x(!) that -- from the U.S. Treasury to prevent a melt-down in the U.S. (no, global) financial system . . . the burden of proof to show gross negligence should be deemed to shift -- to the company receiving the bailout. (Don't need the $5 billion? Then pay it back.)

The best way policymakers can restore confidence in the ailing financial system isn't by devising some miracle cure that will suddenly make sick banks healthy. Rather, it's by demonstrating that there are consequences -- not rewards -- for reckless, outrageous behavior.

"One Down, 999 to Go"

So here's my proposal.

For every $5 billion in taxpayer money that a company has received, hold one executive at that company personally responsible. If the number trips $100 billion, send the whole board of directors to prison. After all, under state law, which governs most corporate conduct, it is the board that is ultimately responsible for the company's actions.

Assuming that the U.S. Treasury has now spent or guaranteed about $5 trillion in bad debts, the number of executives subject to such an enforcement action would be around 1,000.

Here's what a partial breakdown (pun intended) by company would look like:

AIG: Cost to taxpayers -- $200 billion; Responsible executives -- 40
Citigroup: Cost to taxpayers -- $150 billion; Responsible executives -- 30
Bank of America: Cost to Taxpayers -- $100 billion; Responsible executives -- 20
Fannie Mae, Freddie Mac, Goldman Sachs: Cost to Taxpayers -- $75 billion; Responsible executives -- 15 apiece
Merrill Lynch: Cost to Taxpayers -- $50 billion; Responsible executives -- 10
Washington Mutual, Wachovia, Bear Stearns, Countrywide: Cost to taxpayers -- $25 to $50 billion; Responsible executives -- 5 to 10 apiece

But, you object, wouldn't such a tactic be nothing more than an extra-legal, torch-and-pitchfork mob action?

It needn't be, conducted properly. In fact, such a response might offer the country its best chance of averting such a mob action.

Today's financial melt-down has already destroyed more wealth -- about $15 trillion; erased more jobs; and caused the foreclosure of more homes, than any other financial calamity in history, including The Great Depression. And that's just in the U.S.

Far from being an economic Katrina, the melt-down was very much a man-made affair.

Follow the Money

Which men?

As they say, "follow the money."

Senior executives at the above-named firms collected billions for designing and running a "financial sausage factory" that churned out trillions in securitized debt (principally tied to mortgages). Thanks to the credit ratings agencies, the vast majority of this debt was highly rated, and therefore palatable to investors around the globe.

Incredibly, at least some of these companies figured out how to profit a second and third time from these toxic securities -- by "shorting", or betting against them, after they sold them to customers (Goldman Sachs); by buying insurance policies that paid off when the toxic debt inevitably exploded (Goldman Sachs, Merrill Lynch and a host of others); and by collecting premiums for insuring said toxic debt (AIG).

Incredibly, the Treasury apparently is now honoring these bets through "backdoor bailouts" via AIG.

If executives at these companies knew the egregious risks they were running, they're guilty of fraud. If they didn't know the risks . . . they're guilty of gross negligence. This is exactly the same Hobson's choice (minus three zeroes) that confronted Enron's putatively out-of-the-loop executives.

That's just for starters.

Depending on the company and individual executives, you'd guess that a complete list of misdeeds would include: filing false financial statements (all that off-balance sheet debt); breach of fiduciary duty to their shareholders (isn't that what a "heads I win, tails you lose" policy amounts to?); insider trading; and corporate waste.

Financial Res Ipsa Loquiter - Part 2

Bernie Madoff & the Path to Recovery

Stock Buyers Strike . . . For Good Reason

When will the stock market finally bottom?

Here's a thought: it won't be when P/E ratio's hit some magic level, or market cap's (capitalization's) become tantalizingly low, or even when the housing market finally stops falling.

It will be when Bernie Madoff is in prison, and he and his family are stripped of their -- his clients' -- assets. (Just plain stripped would be even better.)

For now, Madoff sits, under house arrest, in his $10(?) million Manhattan penthouse while his lawyers plea bargain and argue, however implausibly, that his wife should be allowed to keep $67 million now titled in her name.

And Madoff's victims?

Three months after their money disappeared, they are selling their homes to raise cash. I personally know of four such houses on the market in the Twin Cities, and wouldn't doubt that the number nationally is in the hundreds (don't expect an accurate tally, because in most cases, you'll never know).

Who wouldn't pull their money out of such a market?

What sane person would commit fresh money?

No wonder the stock market is suffering from the granddaddy of all buyer's strikes.

And that's before the debacle that has befallen investors in financial stocks, whose primacy in today's market was even greater than tech stocks' in the late '90's -- and whose subsequent fall has been harder.

"Madoff Homes"

Investors are right not to trust a market where the top securities cop, the SEC ("Securities and Exchange Commission"), outsources its "whistle-blowing" function. Actually, it doesn't even do that: when someone credible like Harry Markopolos presented it with credible evidence of fraud . . . it did nothing.

Meanwhile, our legal system allows well-heeled defendants to make a mockery of the presumption of innocence. Even if Madoff hadn't confessed -- which he did -- there'd be no doubt as to his guilt. (If it's all a big misunderstanding, somebody had quick better tell all those people selling their homes.)

In the meantime, any rational, functioning system would: 1) promptly incarcerate Madoff; 2) trace any assets attributable to his victims, and label them as fraudulently conveyed; and 3) confiscate such assets, and put them in trust for his victims. Done. End of Story.

Instead, Madoff is clearly using his clients' money to pay for expensive legal maneuvering. Instead of Madoff selling his homes, Madoff's victims are selling theirs. Watching all this, one would be forced to conclude that, at best, the authorities are impotent; at worst, they're corrupt.

The New Testament famously says "the poor will always be with us." It doesn't say anything about scoundrels like Madoff.

Until investors are satisfied that the Madoff's of the world have been dealt with appropriately, and convincing steps have been taken to assure that there won't be any more . . . don't hold your breath waiting for a sustainable stock market rally.

Madoff's Legacy, Cont.

Silver Linings vs. Black Linings

A silver lining is something good, usually long-term, that comes of something bad and helps redeem it, at least a little bit.

So what is a "black lining?" A residual, negative echo of something very bad that continues to reverberate long after the original calamity has faded from memory. Bernie Madoff's $50 billion swindle is likely to have three very big, black linings.

One. Increased anti-Semitism.

As Rabbi Marc Gellman notes, Enron CEO Ken Lay was never identified as a "prominent Protestant energy broker," or Rod Blagojevich as "the prominent Serbian-American governor of Illinois." Yet every single reference to Madoff notes, without fail, his religious affiliation.

Two. Diminished trust, especially in commerce. Consider:

Another thing [Madoff] did was make life incredibly more difficult for people who sell real and honorable and legitimate money products. Now every stock broker and money manager and hedge-fund operator and insurance rep who has already had a tough time convincing prospective clients that what they are selling is good and honest must now also convince them that they are not like [him].
--Rabbi Marc Gellman; Newsweek (12/23/2008)

Three. Poorer communities, long-term.

The money that vanished was earmarked not just for yachts and mansions but things like mortgage payments, college tuition, and medical bills. To the extent that Madoff victimized charities, it's not an understatement to say he also took basic necessities like food, shelter, and clothing from those without.

Some of what Madoff stole will never be replaced. The rest will have to be made up by everyone else -- society -- by giving more and getting by with less, in what for many is already a lean time.

Bernie Madoff's Marketing Insights

"Know Your Customer (er, Mark)"

In retrospect, disgraced financier cum swindler Bernie Madoff may have been a lousy investor, but he sure was a helluva salesman. How else does one attract $50 billion from thousands of investors and financial institutions worldwide?

As best I can discern, herewith are his top five marketing insights (offered in the spirit of public service):

One. Come through the back door, not the front door.

Spam. Junk mail. Pop-up ads. Telemarketers. Embedded advertising. Interstitial ads (interstitial ads??). You'd have to be crazy to answer your front door today, or pick up your home phone anytime between 5 p.m. and 9 p.m.

The typical American consumer is so bombarded with advertising now, if Timothy Leary were still alive, he would have to update his famous advice to "turn off, tune out, and log off."

The only way to reach people who always have their guard up is to . . . figure out where they don't. Social settings. Church or synagogue. Fundraisers. The country club dining room or clubhouse.

By all accounts, Madoff was a master at insinuating himself into all of these venues.

Two. Be a tortoise, not a hare.

The stunning thing about Madoff isn't that his returns were so stellar -- it's that they weren't: about 10% annually, year in and year out, in an era when many hedge funds delivered multiples of that (it was Madoff's very consistency that was the biggest red flag).

"Smoldering" vs. White-hot

Consistent, relatively modest performance turned out to be critical for two reasons: 1) a Ponzi scheme that smolders slowly needs a lot less fuel (fresh money) -- and is therefore more sustainable -- than one that burns white hot, i.e., promises annual returns of 20%, 30% or more; and 2) people who are investing for their retirement, overseeing charitable endowments, etc. want their money managers to be stable, solid, steady.

Such investors don't necessarily want or need to treble their money -- they just don't want to lose it.

Madoff's profile -- "Uncle Bernie," "the Jewish T-bill," etc. -- played into that mindset perfectly, and showed mastery of the ultimate marketing dictum: 'know your customer, er, mark.'

Three. Cultivate an air of inaccessibility.

No, that's not an oxymoron. As Woody Allen famously observed, "no one wants to belong to a club that would have them as a member."

Well, Madoff was exclusive -- at least until the end, when his need for new money overwhelmed the exclusivity artifice. Almost like a forbidden fruit, the harder it was to hire him . . . the more people tried. Soft sell, indeed.

Four. Make the right people money.

The original viral network? It's not Facebook, MySpace, or some other product of the Internet -- it's the local country club. Who's up, who's down, who's in, who's out: all that is apparently fair game poolside or on the greens (or at least I imagine -- personally, I've never belonged).

The best possible advertising Madoff could have gotten was cultivating an early circle of clients who appeared to be in on the ground floor of something good. These strategically placed "disciples" attracted oodles more money than Madoff could ever have done solo.

Five. Start out honest.

Madoff originally made his name as a friend of the small investor: his computerized trading system dramatically reduced commissions, and therefore investors' trading costs. Who wouldn't trust someone like that? Madoff built on that reputation through his philanthropy, board memberships, etc. (Interestingly, money market innovator Bruce Bent (The Reserve) appears to have followed a similar path.)

If there's a silver lining to all the financial pain that Madoff has caused, it's that none of these "marketing strategies" is going to work again for a long, long time.