The 91% Solution

The Quick & Simple Way to Fix Wall Street

[Editor's Note: in a post last week, "Financier, Heal Thyself? Don't Count On It," I promised a part 2. This is it. Heads up: if you read this blog purely for real estate content, or want a post with a little levity -- skip this one.]

Want to test your knowledge of political Americana?

Answer this puzzler:

Which U.S. Presidential candidate endorsed a 91% marginal tax rate on income?

A. George McGovern
B. Dennis Kucinich
C. FDR
D. Dwight Eisenhower

Answer: D.

In fact, the question is a bit of a curve ball: Eisenhower never campaigned on a platform of 91% marginal tax rates -- he didn't have to. That's because Eisenhower inherited a 91% marginal rate from the Truman administration -- and saw fit to leave it there during his eight years in office.

Dwight D. Eisenhower: West Point graduate. Supreme Allied Commander in World War II. President of Columbia University. Two-term Republican(!) U.S. President . . . wealth-redistributing, Commie radical!

Beaver Cleaver

If you don't remember the '50's -- and you won't unless you're at least 60 years old -- it wasn't exactly a Communist love-fest.

On the contrary, that era notably witnessed the Cold War, "duck-and-cover," and Joe McCarthy and his anti-Communist witch hunts ("are you now, or have you ever been . . .?").

Some other tidbits of '50's culture: Beaver Cleaver, "Father Knows Best," Bob Hope, Doris Day, and drive-in movies. (And to be sure, "colored-only" drinking fountains, restrooms, etc. in the South.)

Still, not exactly Haight-Ashbury in the '60's.

And yet.

And yet society and its lawmakers saw fit to levy a 91% marginal rate on annual income over $400,000 (equivalent to about $3 million today).

What were they thinking?!?

Values, Then & Now

A couple things, perhaps.

--That the country's social fabric was more important than the (very) well-being of its richest .05%.

--That the pursuit of ungodly sums of money was unhealthy -- even corrosive -- to one's self, and one's larger community.

--That the ability to make such ungodly sums of money was itself due to a peculiar historical confluence of built-up legal and political institutions; heretofore unimaginable gains in technology and productivity; and the sacrifices of many, many preceding generations.

Isaac Newton said that "if I have seen further, it's because I have stood on the shoulders of giants."

Today's CEO's are pygmies who think they are giants -- and that modern economic life began with them (obviously not true, but if we're not careful, it certainly may end with them).

It's hard to tell which trait best defines today's CEO's: hubris -- or greed.

Financial Reform, Circa 2010

Which brings us back to financial reform.

First, three stipulations:

One. The current financial system is so enormous and complicated, and has so many moving parts and interconnections, that few people understand half of it. Unfortunately, almost none of those people are elected officials in Washington.

Two. Even if FDR and his brain trust somehow sprang back to life with a divinely inspired blueprint for reform, they would be thwarted by today's political system. Too partisan, too balky, too corrupt.

Three. More limited, strategic reforms have either been ineffective -- or backfired spectacularly.

Case in point: legislation passed by Congress in 1993 to limit executive compensation -- considered excessive back then, even though it was a fraction of today's levels.

Barred from deducting executive salaries greater than $1 million, publicly traded corporations simply switched to awarding stock options and bonuses to CEO's.

More accurately, CEO's -- via their handpicked boards of directors -- started paying themselves in stock options and bonuses.

The 91% Solution, or, "I Like Ike"

Add the foregoing "stipulations" together and what do you get?

A broken, dysfunctional financial system that cannot be fixed.

Or can it?

To paraphrase Albert Einstein, the problem of Wall Street cannot be solved at the same level of thinking with which it was created.

So, go up a level.

What is Wall Street ultimately about, at least today?

Not service to one's fellow man ("God's work" -- the real kind); one's country (the definition of patriotism); or even just providing and efficiently allocating capital to the rest of the economy (Wall Street's putative purpose and raison d'être).

It's all about making money.

Obscene, unprecedented tidal waves of money.

To pick just one example, last year -- not a banner year for most, to put it mildly -- the top 25 hedge fund managers averaged $1 billion in compensation. That they paid 15% income tax on.

$30 Million a Year

Such a financial bonanza also suggests the solution: go back to Eisenhower-era marginal tax rates.

Hell, bump them up 10-fold, just to account for today's more expensive luxuries and toys (tycoons really couldn’t buy Lear Jets in 1955).

So, the John Paulson's and Lloyd Blankfein's of the world can make up to $30 million annually before coughing up the lion's share of it to Uncle Sam. Thirty million a year -- still not too shabby.

Such a remedy has the virtue of being simple, efficient, and laser-focused on the underlying problem plaguing today's financial system.

Oncologists now understand that the best way to kill an advanced or otherwise inoperable tumor (because of its proximity to vital organs) is to cut off its blood supply.

Raising marginal tax rates to 91% will have the same effect on the metastasizing cancer that modern-day Wall Street has become.

"Restraint," Wall Street-Style

Wall St. Pay: the (Dis)Honor System Lives!

So, how do people on Wall Street -- and their defenders, like The Wall Street Journal -- define "restraint?"

A. Turning down the heat to 65 degrees.
B. Cancelling their cable subscription.
C. Taking public transportation to work, instead of the car.
D. Paying one's self only $9 million, instead of $68.5 million like in 2007 (when A LOT fewer people were paying attention).

If you need an answer key . . . you're a newcomer to this blog!

And exactly who is this paragon of virtue and self-restraint?

None other than Lloyd Blankfein, CEO of Goldman Sachs.

The Journal was quick to paint Blankfein's 2009 bonus (yes, we're talking about a bonus -- not base pay, not benefits, not lots of other goodies) . . . . as an act of sublime selflessness.

The steep drop from 2007 pay was a "bow" to public pressure, it declared in its headline.

Not only that, the compensation was all-stock.

The Journal's not-so-subtle (or convincing) defense of Blankfein's pay continues:

As Goldman rebounded in 2009 to its most profitable year ever, the 55-year-old Mr. Blankfein became the focus of anger about sky-high bonuses on Wall Street. That criticism continued even after Goldman said last month that it would make the smallest employee payouts relative to to revenue since the firm went public in 19999.

--"Goldman CEO Bows on Pay"; The Wall Street Journal (Feb. 6-7, 2010)

How reasonable of Goldman and Blankfein.

How fair of them.

How disgusting.

Party Like It's 2007

The truth is, Goldman and Blankfein's record 2007 compensation was a lot like popping champagne on the Titanic at midnight the night it sank.

Incredibly, instead of feeling horror and shame for steering the financial system into an iceberg -- and make no mistake, Wall Street was doing the steering -- Wall Street effectively engineered a bailout that made itself (more than?) whole.

At the taxpayers' expense.

And they're still at the helm! (versus, say, in jail, or, banned from the financial industry for life, like disgraced Merrill Lynch analyst Henry Blodget was for causing .000001% of the havoc.)

As I said before, "disgusting."

Pro Athletes' Pay

I remember a cartoon that ran several months into the last baseball players' strike (in the early '90's?), when ballplayers made a whole lot less than they do now.

The cartoon showed an unshaved, unwashed baseball player knocking on a suburban front door, with the caption, "mow your lawn for $25,000, Ma' am?"

In fact, I don't begrudge pro athletes a dime of what they make, because: a) it's not coming out of my pocket; and b) it's truly set by the marketplace.

For the vast majority of pro athletes, stratospheric pay is also extremely short-lived, and limited to a handful of truly gifted, high-performing individuals.

None of the above is true of Wall Street pay.

Crack Dealers vs. Wall Street: 'Top 10' Differences

Selling Tainted, Addictive Products

What's the difference between crack dealers and Wall Street?

Here's my "Top Ten" list:

Ten. The "product" crack dealers sell is a lot less tainted.

Nine. Crack dealers don't take out life insurance policies on their victims, er . . . clients.

Eight. Crack dealers don't plough a share of their profits back into hiring lobbyists to re-write the nation's drug laws to suit their interests. Or donate millions to the campaign coffers of key members of Congress overseeing them.

Seven. Speaking of profits . . . Crack dealers don't get multi-million dollar bonuses.

Six. Crack dealers wreck blocks, and sometimes even whole neighborhoods. Wall Street has laid waste to an entire economy and jeopardized its currency -- not to mention savaging millions of homeowners, savers, investors, retirees, and small businesses.

Five. Crack dealers don't require bailouts adding trillions to the U.S. deficit.

Four. The police prosecute crack dealers.

Three. Crack dealers don't become senior advisers to the President, Federal Reserve, and U.S. Treasury.

Two. Crack dealers don't solicit business (usually) from retired teachers, firefighters, etc.

One (Tie). Wall Street's "supplier," The Federal Reserve, operates legally and in plain sight//Crack dealers aren't under the illusion that they're "doing God's work" (as Goldman Sachs CEO Lloyd Blankfein was recently quoted as saying).

Speaking of Mr. Blankfein . . . consider this exchange yesterday between him and Phil Angelides, head of the Commission investigating the financial crash:

It sounds like you’re selling a car with faulty brakes and then buying an insurance policy on the car,” Mr. Angelides said. Mr. Blankfein emphatically responded that the investors buying these products were sophisticated and some of the biggest institutions in the world. Mr. Angelides [then] pointed out they represent the pension funds of teachers and firefighters.

--"Live-Blogging 4 Top Bankers on Capitol Hill"; The New York Times (1/13/2010)

Actually, I think the crack analogy is better.

How else do you explain the response of millions of Americans to Wall Street's offer of essentially free mortgage money, and the chance to cash in on the real estate boom?

Sure, you pity the crack addict for their sorry state . . . but you put the pusher behind bars.

Instead, we give Wall Street billions in bonuses, and their companies trillions in bailout money. More accurately, we give them trillions of our kids' money, that they'll have to re-pay.

Disgusting. Truly disgusting.

Washington's Financial Savvy vs. Wall St: No Contest

Keith Ellison vs. Lloyd Blankfein

Even if Congress was scrupulously independent of Wall Street -- which is hardly the case -- it would be no match for Wall Street when it came to drafting legislation that made the financial system fairer and more transparent.

The problem is a combination of priorities and expertise.

To take just one example, consider Congressman Keith Ellison, who is now serving his second term representing Minneapolis. (He's better known nationally as the first Muslim member of Congress.)

I don't know Mr. Ellison well, but since he and I were in the same law school class (University of Minnesota, 1990), I think it's fair to say that I know him better than most voters.

Law School Recollections

Almost two decades(!) later, what I remember of Mr. Ellison from law school was his passion for civil rights, and unwavering identification with the underdog. His frequent comments in class almost always spoke to the various ways minorities face discrimination in our society -- undoubtedly still true even today.

Coming from a large family in urban Detroit, he knows those issues not just in a theoretical, academic way -- but personally and intimately.

After law school, Mr. Ellison continued to make social justice the cornerstone of his career, both as a state legislator representing Minneapolis' north side, and as a lawyer in private practice.

In fact, his passion -- and those of his supporters -- was a decided advantage in the big, fragmented field that inevitably materialized to replace Martin Sabo, Minneapolis' long-time Congressman, when Sabo suddenly announced his retirement in Spring, 2006.

Campaign Finance Stumble

Ironically, the one issue that threatened Mr. Ellison's march to the primary -- the only contest that matters in heavily democratic Minneapolis -- was campaign finance.

Specifically, Mr. Ellison's practice of filing tardy, incomplete and/or incorrect finance disclosures.

As I recall, the amounts were trivial: one report showed something like $35,000 of contributions when the correct amount was $40,000 -- or vice versa.

Mr. Ellison made the requisite apologies, promised to do better -- and proceeded to win election to what is universally regarded to be one of the nation's safest House seats.

He was easily re-elected in 2008.

Financial Background: Zip

So what's wrong with this picture?

Getting a $40,000 (or was it $35,000) campaign finance disclosure wrong is not exactly confidence-inspiring when it come to tackling TARP-size numbers, with literally eight(!) more zeroes.

Putting the best possible face on this matter, I think it's fair to say that for Mr. Ellison -- much like Barack Obama -- finance is very far afield from what excites and motivates him politically.

So, to the extent that he has to deal with those issues at all, his instinct is to delegate.

There's nothing wrong, per se, with delegating to people more knowledgeable than yourself; after all, no one can be an expert on everything.

However, what happens when the "experts" you've chosen disagree?

For that matter, how do you know which "experts" to pick?

If Congressman Ellison knew what the future held in store for him 20 years ago, I bet I would have seen more of him in my Antitrust Law, Uniform Commercial Code, and other business law classes way back in law school.

"'Things' Doesn't Cut It": NY Times

What's Goldman Up to NOW?

“Certainly, our industry is responsible for things. We’re a leader in our industry, and we participated in things that were clearly wrong and we have reasons to regret and apologize for.”

--Lloyd Blankfein, Goldman Sachs chairman and chief executive (Nov. 17, 2009)

It is widely and correctly understood that Wall Street, with Goldman as a leader and with regulators in thrall, helped to inflate and profited from a credit bubble that burst and cost tens of millions of Americans their jobs, incomes, savings and home equity. American taxpayers continue to stand behind the bailouts and other government interventions that have stabilized the financial system, including Goldman, enabling the firm to post blowout profits in 2009 and to set aside $16.7 billion for bonuses so far this year.

--"Goldman's Non- Apology"; The NY Times, house editorial (11/21/09)

The only question I have *right now is this:

If one of the most profitable investment plays at the moment is shorting (betting against) the U.S. dollar -- also known as the carry trade -- and Goldman is now making literally billions per quarter . . . is any of that money coming from shorting the dollar?

Would that really be any different than shorting mortgage-backed securities as it was busy selling trillions of them to investors (as Goldman did)?

It really does seem that what's good for Goldman is bad . . . very bad . . . for the rest of us -- and vice versa.

"Justice Delayed . . ."

Last thought on this for now:

Ohio's Attorney General just filed suit against the credit rating agencies (Standard & Poor's, Moody's, and Fitch) for misrating billions in mortgage-backed securities, costing Ohio retirees hundreds of millions.

The securities blew up starting more than three years ago.

Should it really take government attorneys (federal and state) until, say, 2015, to bring appropriate legal action against Wall Street's key players??

P.S.: Want to guess what Goldman Sachs' defense(s) would be, were it to be proven that it profited, big-time, from shorting the dollar?

Pick one (or more) of the following:

A. That that's perfectly legal to do (completely true).
B. It had a fiduciary duty to its shareholders to maximize profit.
C. Profits from the carry trade made it less dependent on Fed and Treasury guaranties and other support (that it otherwise denies benefiting from).
D. Goldman made much less shorting the dollar than many others.
E. The dollar's weakness isn't due to Goldman and others shorting it (also known as the "it's not my dog" defense).

I'm sure I could double this list if I actually thought hard about it . . .

*It was Wayne Gretsky who said: 'I don't skate to where the puck is . . . I skate to where it's going to be.'