It was a week that illustrated how not to be a leader.
The CEOs of the big three auto makers appeared before the United States Congress, and showed a level of ill preparedness on even rudimentary questions about their bailout pleas that would have incurred the ire of a fifth grade teacher. Their separate arrivals in three luxury private jets reminded us of when Robert Nardelli, then head of Home Depot, cut off shareholder questions at the company’s annual meeting after 60 seconds. (more…)
In a time when the restoration of confidence, perhaps more than even financial liquidity, is paramount in calming markets and providing stability, neither the Treasury secretary nor the chairman of the Fed acquitted themselves well this week.
As the war in Iraq unfolded, and then morphed into disaster in its first several years, the world discovered the consequences when what is given with absolute assurance as the urgent reason for taking action turns out not to be the case.
As the current economic crisis unraveled, the Bush administration claimed that it had spotted the greatest danger to the economy and the credit markets in generations. Toxic mortgage based assets held by financial institutions were cited as the threat and a $700 billion government intervention was needed to buy them up.
As President George W. Bush said in September:
Under our proposal, the federal government would put up to $700 billion taxpayer dollars on the line to purchase troubled assets that are clogging the financial system.
It had to be done immediately, he said, or a grave and gathering peril in the financial system would make its pain felt soon on Main Street. The President painted a bleak picture of what the world would look like without the bailout.
More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically. And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession.
We expressed some skepticism on these pages as the President’s words were being digested. Portraying financial Armageddon if American taxpayers did not come up with the largest government expenditure in history struck us as not a very faint replay of the approach taken in Iraq, where the administration not only claimed that weapons of mass destruction posed an immediate threat but that it knew where they were.
So we posed the question nobody else it seemed was even considering:
Is America stumbling into a financial Iraq? … Are we dealing here with the financial equivalent of threatened mushroom clouds and weapons of mass destruction?
As it turned out, toxic assets, like weapons of mass destruction, were not the real problem. In the case of Iraq, they were never found. In the situation involving the credit crisis, none were ever bought under the government’s rescue plan. And a new solution was pursued instead: taking equity positions in financial institutions.
This week,Treasury secretary Henry M. Paulson Jr. announced that the original plan, the one upon which the $700 billion bailout was approved and which so many officials and commentators said was absolutely essential to financial stability, would be abandoned.
Even before the Bush-Paulson plan was approved by Congress, we had some doubts about its principal focus:
How the Bush bailout plan will be managed, what assets it will buy, how it will value and how long it will hold them are all undisclosed. It is hard not to be doubtful that the compromise proposal now being discussed will offer much more information. There is considerable dispute that the plan even addresses the fundamental problems in the banking sector.
And the astronomical $700 billion that Mr. Paulson initially insisted was needed in one fell swoop? Congress gave Mr. Paulson $350 billion and required reauthorization for the remaining amount. Mr. Paulson said he had no plans to ask for it now.
Elsewhere last week, the Fed refused requests by Bloomberg News and others to account for the more than two trillion dollars it has pushed out its lending window. It apparently believes the country is not entitled to know how much the Fed is lending, whom it is lending to, or details about the collateral that is being offered.
Both Fed chairman Ben S. Bernanke and Mr. Paulson have said that an absence of openness and transparency were factors that helped to create the current financial crisis in the first place. But transparency is something the Fed talks; it does not walk.
Last spring, we suggested what the Fed had said about the Bear Stearns collateral did not fully compute.
Actually, the Fed did not make a traditional $29 billion loan to JPMorgan Chase, as its official statements would have us believe. It was more of a wink-and-a-nudge deal to take on the poorer assets without going through the formality (and the barrage of questions that would follow) of actually purchasing them.
In a time when the restoration of confidence, perhaps more than even financial liquidity, is paramount in calming markets and providing stability, neither the Treasury secretary nor the chairman of the Fed acquitted themselves well this week. Mr. Paulson only added to the impression that what he and the administration say cannot be trusted or taken at face value. Mr. Bernanke showed his commitment to transparency is a one-way street. What the world needs from its leaders is candor, clarity and competency. It did not find these virtues in either man, which is why the actions of the secretary and the chairman are the Outrage of the Week.
The funny thing about prescience, Mr. Secretary, is that it should occasionally bear some relationship to the future, or even just next week.
Treasury Secretary Henry M. Paulson Jr’s announcement today of yet another rejiggered financial recovery plan contained enough reversals in direction to make an Olympic swimmer dizzy. But it was his Carnac statement that really got our attention. He actually claimed to be prescient. Here’s part of what he said at today’s press conference:
We were prescient enough, and Congress was, that we got a wide array of authorities and tools under this legislation.
Here is a man who came from the upper tiers of Wall Street who apparently had no idea of the problems building in the credit default market or in the mortgage-backed securities field. His first priority as Secretary was helping to blunt the effects of what he claimed to be too much regulation that made business less competitive. He got off that train in a hurry.
As the subprime disaster unfolded, he made a number of statements that indicated he did not fully grasp the enormity of what was happening. Only a few months ago, he asserted that the economy was strong and that the worst of the crisis was behind. After Bear Stearns collapsed, he said they had saved the financial system. He said the same thing after the AIG bailout. When he went before Congress, he presented a plan to buy up toxic assets which he said was absolutely critical to the survival of the credit market and to the well-being of Main Street. Approval was urgent. He seemed shocked that there had been such an over extension of leverage on Wall Street –the place where he had earned a fabulous living for decades.
In the weeks that followed, not a single mortgage-backed vehicle was bought in the famously vaguely crafted “reverse auction” process. Instead, and following the lead set by Great Britain and Europe, Mr. Paulson decided that banks needed capital investment. AIG got not one, but two more multi-billion dollar injections of cash, and the first deal was wiped out altogether. Meanwhile, stock markets continue their downward spiral, credit remains frozen for most consumers, and mortgages -which the original TARP fund was supposed to help- remain a major source of financial distress. Now, with the plan changed yet again under Mr. Paulson, not only is there no T(roubled) A(ssets) in the TARP, there is some question as to whether there is any (R)elief, or even a P(lan) at all. If this is the result of Mr. Paulson’s prescience, we all need a dose of the unseeing Mr. Magoo. Perhaps that’s what we really have, after all.
Looking at the debris that has followed the Treasury department everywhere it has gone in recent weeks, and the confusion that continues today, one gets the impression that Secretary Paulson might have trouble finding the door, much less divining the future.
When this bill of goods was first unveiled before the American public, we said it was unlikely to be successful because it was not targeting the right problem. We said it would be a boondoggle. Today, it was announced that the program would now turn its sights to the unease faced by the securitizers of credit cards and auto and student loans. Funny how they were never part of the original TARP. Still, it’s hard to be surprised. As we noted in September:
How the Bush bailout plan will be managed, what assets it will buy, how it will value and how long it will hold them are all undisclosed. It is hard not to be doubtful that the compromise proposal now being discussed will offer much more information. There is considerable dispute that the plan even addresses the fundamental problems in the banking sector…. There is no clear statement even as to the kind of weak assets the government proposes to buy, much less how they would be valued. I suspect it will soon work its way down to student loans, car loans and credit card debt.
The funny thing about prescience, Mr. Secretary, is that it should occasionally bear some relationship to the future, or even just next week.
The British breakthrough, and how it managed to smash the U.S. bailout logjam and get it moving, is just one more of those crazy, topsy-turvy turns on the bumpy road to financial sanity -and another indication that America’s global preeminence is facing some challenges.
Finally, a coherent plan seems to be emerging to address some, and some is the operative word, of the excesses, failings and weaknesses that have arisen in the financial markets. The origin is revealing. U.S. Treasury secretary Henry M. Paulson Jr.’s plan has had more iterations and setbacks than a bad Hollywood script. They were the product of a Republican administration which had a reputation for being pro-business. The British plan, on the other hand, was not only a model of speed and simplicity, conceived and adopted in a matter of days, but it came from a Labor government. Generally, business does not find itself applauding that leaning. Credit belongs to Prime Minister Gordon Brown, who actually seems to know what he is doing and what is necessary to restore confidence in the functioning of the markets.
Now, the U.S. has decided to follow the British lead and announced tonight a massive injection of capital into nine banking institutions. These measures notwithstanding, more needs to be done to understand how the world was hurled to the shaky edge of the financial abyss, who is responsible and what the costs are for the solutions that are being proposed. No reasonable person can be happy or satisfied that the excesses and senselessness of Wall Street and its counterparts elsewhere must be underwritten by public funds that soar into the trillions. Evidence suggests that public outrage is soaring just as high.
The British breakthrough, and how it managed to smash the U.S. bailout logjam, is just one more of those crazy, topsy-turvy turns on the bumpy road to financial sanity -and another indication that America’s global preeminence is facing some challenges. Perhaps Mr. Paulson should try a cup of tea more often.
Paul Krugman made some interesting observations on these points in The New York Times on the day the Nobel committee announced his prize for economics. It’s good to see someone win who has demonstrated a keen grasp of the human dimension to economics. A giant of that field, the late John Kenneth Galbraith, never received the Swedish honor, though many of his followers, including this observer, felt it was an unfortunate omission. Just before his death, Mr. Galbraith predicted the coming of a major disruption in the banking and credit sectors. He was a student of the market crash of 1929 and never really bought into the idea that it couldn’t happen again. He was correct.
Mr. Krugman is in good company taking up the Galbraith banner of making economics accessible to the people most affected. We wish him well and salute him for his distinguished achievement.
Incidentally, Mr. Krugman publicly became one of America’s newest millionaires today. The prize is accompanied by a cash award of $1.5 million. I believe the technical term economists use to describe such events is “awesome”.
Making bad investment decisions over risky products that people did not fully understand is what brought the United States and Wall Street to the brink. Is another terrible folly about to be repeated, even with echoes of the costs and misadventures of the Iraq war booming loudly across the land?
Investors generally like a few details before laying out their money. A knowledge of the investment’s business plan, its costs, its expected return and its risk –above all, its risk– are key to the decisions investors make. It should be no different for citizens when they are asked to put $700 billion on the line for the private sector.
In this case, however, basic rules for the informed citizen/stakeholder are being thrown out the window. How the Bush bailout plan will be managed, what assets it will buy, how it will value and how long it will hold them are all undisclosed. It is hard not to be doubtful that the compromise proposal now being discussed will offer much more information. There is considerable dispute that the plan even addresses the fundamental problems in the banking sector. A rare and impressive collection of more than 200 economists, including Nobel laureates from both the left and the right, have raised serious questions about the plan and have urged Congress to reject it and to hold hearings into alternatives.
Making bad investment decisions over risky products that people did not fully understand is what brought the United States and Wall Street to the brink. And the sums stagger the mind. When you make a decision involving this amount of money, every detail matters. Probably even the spin of the earth should be calculated in the analysis for good measure. But what utterly takes the breath away is the lack of transparency and specifics offered as they relate to the single largest expenditure by any government in the history of the world. There is no clear statement even as to the kind of weak assets the government proposes to buy, much less how they would be valued. I suspect it will soon work its way down to student loans, car loans and credit card debt. Given the desperate picture portrayed by Fed chairman Ben S. Bernanke –who claimed in testimony before Congress on Tuesday, “I believe if the credit markets are not functioning that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way…”– and Treasury Secretary Henry M. Paulson Jr. –who resorted to begging House Speaker Nancy Pelosi, on a bended knee, for her support– don’t be surprised to see some banks even scurrying to trade in the trashy boardroom artwork selected by the chairman’s wife for some quick government cash.
Then there is that convenient cash and carry discount window the Fed is providing on a 24/7 basis. In the course of less than a year, deposit taking and investment banking institutions have so far borrowed a record $262.34 billion. The amount doubled in just the course of one week, the Fed said in its September 25th report. Total average daily borrowing also jumped to $187 billion from $50 billion in the previous week.
This unheard of level of borrowing from the Fed has received nothing near the reporting it deserves. To some observers it suggests that bank liquidity problems may be even more serious than are being disclosed. How much more will the taxpayer be on the hook for in addition to the $700 billion now being sought by the administration, which in turn is on top of the hundreds of billions that are on the line for all the other bailouts to date? If ever there was a time when the voices of the best economic minds in the world needed to be heard by lawmakers and citizens alike, it is now. Yet there has been no organized forum for either informed debate or Congressional testimony. Not only is $700 billion at stake, but much more will be at risk if the wrong decisions are made or the wrong problem is attacked. And what does the government do if it gets it wrong? Will the administration’s massive proposal stabilize a weakening housing market, which is the driving force in the erosion of corporate balance sheets and the unraveling of debt obligations, or will it merely be a prisoner in an even faster moving express ride downwards?
Institutions are failing, to be sure. Just this week Washington Mutual became the largest failure of its kind in history. But if the $700 billion dollar fund had been up and running, it is unclear whether it would have made any difference. And no one from the administration or Congress has weighed in on that issue. Even before this deal was proposed, Fed and U.S. government commitments and costs related to this crisis totaled more than a trillion dollars. Still, we are told a credit market calamity unlike anything since the Great Depression is possibly hours away unless taxpayers pony up hundreds of billions more.
So what exactly is the problem this bailout is supposed to be addressing and is it the right one? What if banks, having sold off their bad loans to the government, decide not to lend any money, except to other banks and their wealthiest clients? What will be the costs to the economy and to small business owners as well as ordinary Americans? Taxpayers should not be left scratching their heads for the answers. Some may recall that, as noted on these pages, just after the $21 billion takeover of AIG, the White House admitted that taxpayers may not see their money returned.
Here’s an idea: Why don’t Wall Street and the private sector take a more prominent role in cleaning up the problem that was of their creation? We are told that trillions of dollars is sitting on the sidelines and is ready for the right opportunity. But little effort is being made to corral these resources into an overall plan. It is just another inexplicable piece of a puzzle that has been turned into a masterpiece of confusion and uncertainty. Another nagging item: If the world is hanging on by the finger nails over the abyss of financial collapse which can only be averted by the steps the Congress is being asked to take, and so much anxiety centers on how the Asian markets will react on Sunday night (EDT) if the deal is not approved, why have governments around the world not proposed their own contributions to global economic salvation? Why do we not see their lawmakers meeting around the clock and over the weekend to do something to appease the markets?
Is America stumbling into a financial Iraq? The rush to attack a problem that did not exist on the basis of costs and consequences that were not anticipated have already taken their toll on America, its brave young troops, their families and the reputation of the country. The financial price tag for the Iraq misadventure is also counted in the hundreds of billions. Some estimate that it will soar into the trillions. Are we dealing here with the financial equivalent of threatened mushroom clouds and weapons of mass destruction? Another echo from that lamentable miscalculation is the idea that government cash may wind up making money for taxpayers. And the Iraq war was supposed to be self-funding from that country’s extensive oil reserves. Americans are still waiting for that windfall.
This much is clear from that costly experience: When principles that affect public confidence are sacrificed for the expectation of immediate gain, both stand at risk of being lost.
What is worrisome is that few leaders in business and government have demonstrated any grasp of the larger picture. Not only is there an apparent inability on the part of both Democrat and Republican legislators to connect the dots between the Fed’s record loans, the costs of the recent torrent of bailouts, the extent of the subprime mortgage mess, the swelling deficit and shrinking U.S. dollar and this latest government proposal, it is unclear that they even see the dots at all. The lack of leadership in providing the public with clear answers was especially apparent in Friday’s first debate among presidential hopefuls John McCain and Barack Obama.
The way Wall Street has been working is no way to run a business. The way the Bush bailout plan is being decided is no way to run a government. We are already seeing the consequences of the first fiasco. One shudders to think of what might await in the mismanagement of the second.
The promise of this new era of market miracles has been shamefully betrayed by a self-serving collection of greedy CEOs, disengaged directors and regulators who, far from envisioning the new frontier of the global economy, have shown themselves unable to see even into the next week.
It was advertised as a sure path to wealth and prosperity for the world. If only American capitalism could be left unfettered. If only regulations would be loosened. If only CEOs could be incentivized with huge bonuses that would be paid out when their efforts resulted in a rise in stock. Just let the market work its magic, and the world would be changed forever. History will record that, in September of 2008, part of that promise was fulfilled. The world was changed, but not exactly in the way that was promoted. Over the course of a day or so, the world actually held its breath while the financial system glided Titanic-like ever so close to the iceberg that was Wall Street’s creation.
During the years leading up to the near calamity and the tsunami of disbelief that finally overtook Wall Street this week, more wealth was transferred by shareholders to CEOs than to any similar group or at any other time in history. Directors, too, made a huge cash grab to compensate, they claimed, for the heavy work load that was now being required of them. And regulators, like the Federal Reserve, were willing to do whatever Wall Street and the financial sector needed to keep the fees rolling in.
Wall Street and American business had pretty much all they wanted, except for those nagging requirements of the Sarbanes-Oxley Act of 2002. They, too, were well on the road to being blunted with the arrival on the job a couple of years ago of Henry M. Paulson, Jr. as the fresh-from-Wall Street Treasury secretary. Loosening the clutches of regulation was his first priority. “We must be careful not to kill the goose that lays the golden egg,” was the mantra of lobbyists, the Business Roundtable, right-wing think tanks, dark paneled boardrooms and not a few well-financed politicians.
But the promise of this new era of market miracles has been shamefully betrayed by a collection of greedy CEOs, disengaged directors and regulators who, far from envisioning the new frontier of the global economy, have shown themselves unable to see even into the next week. A few months ago, Secretary Paulson claimed we were closer to the end of the crisis than the beginning. Two weeks ago, he asserted that “the American people can remain confident in the soundness and resilience of the financial system.” His opinion seems to have changed with each of the crises he was incapable of foreseeing until it struck.
Rather than seeing itself transported to the promised land of a new prosperity, Main Street America finds itself today squarely plunked at the junction of Crisis Road and Bailout Boulevard. And those well-heeled CEOs who were trumpeted for their out-of-this-world skills with pay checks to match? They turn out to be as authentic and respectable as a third-rate circus act.
The tax-cutting Republican administration and Treasury secretary who were the biggest boosters of American business and free market capitalism have now become the biggest interventionists, writing the biggest bailout checks in American memory.
History will have much to say about the circumstances that led to this crisis. And it will ask with a decidedly more demanding voice than heard thus far among policy makers and commentators, how was it possible for American capitalism to have been permitted by its regulators, guardians and gatekeepers to have reached a point where decisions of CEOs and boards were so reckless that they ultimately brought the world’s financial system to the brink of collapse?
The answer will be seen, symbolically at least, through the prism of excessive CEO compensation, which some six years ago we described to the U.S. Senate Banking Committee as the most corrosive force in American business. We said then that the lure of huge bonuses tempted CEOs to take risks that cannot be sustained. The subprime meltdown is unsustainable risk writ large. It is another story of greed overcoming responsibility and of boards yet again, as they have in so many scandals in the past, acting more as a combination of cheerleader and ATM machine for overreaching CEOs instead of the wary sentries they are supposed to be.
As we predicted at the beginning of the year when it became apparent that Countrywide Financial would not survive on its own:
This is only the beginning of the bailout process that is unfolding…. Main Street always pays for the wild parties Wall Street throws and the cleanup required afterwards.
Significantly, all the failures, bailouts, meltdowns and write-downs have carried with them the earmarks of high abuses in CEO pay. Over the past five years, when the faulty, risk-oblivious decisions that led to the present crisis were being made, the CEOs of Merrill Lynch, Citigroup, AIG, Lehman Brothers and Bear Stearns received an aggregate compensation in excess of one billion dollars. One only has to recall the antics of Bear Stearns’s James Cayne, the colossal greed of Contrywide’s Angelo Mozilo, the dissembling of Lehman’s Richard Fuld and the narcissistic actions of Merrill Lynch’s Stanley O’Neal -who waltzed off with more than $160 million after leaving investors stung with multi-billion dollar write-downs and losses- to be persuaded of the depths to which the leadership of Wall Street and the financial community has fallen. With captains like this, and the apparently vision-blind Henry “the American people can remain confident in the soundness and resilience of the financial system” Paulson at the helm, the surprise is not that the financial system has been teetering on the abyss, but that it has not fallen in more often.
Now the $700 billion price tag for the excesses and failures of those in charge has arrived at the doorstep of every American home with a gigantic thud. This is on top of the estimated $800 billion in federal commitments and outlays caused by the subprime debacle so far.
And a larger cost is yet to be calculated. It is in the form of a crumbling in the pillars of confidence necessary to the functioning of free markets and a collapse in respect for those who claimed they could be trusted to do the right thing. As we have noted before, in many cases boards could not even be trusted to meet regularly and assess the risks they were presiding over. Another consequence of the massive sums that will require mammoth increases in foreign borrowing: the United States will be thrown further into the embrace of China, a traditional major buyer of U.S. debt. What geopolitical ramifications may result from the U.S. becoming even more beholden to that communist regime do not appear to have found their way onto the radar of most American policy makers.
But the more lasting outcome of this crisis and the cost to extricate the financial system from it will be that American citizens will have to pay for it with their own well-being. It is difficult to imagine how any universal health care plan will be possible in a new administration; nor will the huge sums being committed to the bailout of Wall Street’s excesses permit major outlays for job creation or infrastructure support. Inflation and a lower dollar will be harsh taskmasters in this new American economy and will hurt most of the very citizens on Main Street the Bush/Paulson Wall Street bailout plan purports to help.
As the United States now comes to grips with this trillion-dollar-plus inflection point in its history and how close it has come once again to a Titanic-like collision with the financial system, the enormity of the betrayal will become even more painfully evident.
Part of the social covenant binding America, built up over generations of struggle, is that capitalism must serve the public good and not just the privileged few. A stable, functioning economy and the right to prosper in it is the birthright of every American. Both have been hijacked by the self-serving purveyors of subprime governance, leadership and regulation.
They are a fitting focus for the indignation and anger of millions of Americans who have lost so much in jobs, homes and hope, and will be called upon for still more. We join them in their outrage.
We will examine the bailout plan, and the bankruptcy of the vision and moral leadership that produced it and are now seeking to profit from it, in a future commentary.