Rain-Soaked, But Still Fearless

On this dank Friday morning in lower Manhattan, I endured the raindrops for a few blocks for a brief morning walk.  When I’m on the road I like to check out the environs and see if there is anything interesting.  This morning, my goal was Fearless Girl — the sculpture positioned directly opposite the iconic charging bull down by Wall Street.

“Fearless” is a good description of the young girl, but “defiant” or “resolute” might be even better.  She stands fists on hips and legs firmly anchored, chin raised and ponytail fluttering in the breeze, but her face is very placid, without a trace of emotion except, perhaps, a slight smile.  Fearless Girl is ready for anything.

Fearless Girl apparently has become something of a tourist attraction — although nobody else was around on this rainy Friday morning — but some people question what message is intended by her placement across from a bull ready to charge.  The naysayers wonder is the juxtaposition is supposed to convey that women oppose rising stock values, or that Wall Street is anti-woman, or some other quasi-political/economic message.  I don’t know about the intended message, but I did like the portrayal of a girl calmly facing down a dangerous bull that seems to be made wary of by her very presence and determination.  It makes for a very cool picture.

Another Bank On The Brink

The Masters of the Universe on Wall Street, and in financial capitals around the world, will be holding their breath today.  They’re waiting to see what happens to Germany’s mighty Deutsche Bank, the latest big bank to fall into crisis and roil the international markets.

deutsche-bank-1If you are unfortunate enough to own Deutsche Bank shares, you know what I mean.  The value of its common stock has fallen more than 65 percent in the past year, and a credit rating agency has moved its outlook to negative.  The Department of Justice has demanded that Deutsche Bank pay $14 billion to settle an investigation into residential mortgage-backed securities, although the Bank hopes to negotiate down to a lower payment figure.  Deutsche Bank has been removed from  European blue chip stock index because its share price has fallen so far, so fast, and now there are reports that some hedge funds are moving holdings out of Deutsche Bank to other banks.

Why should we care?  Because earlier this year the International Monetary Fund issued a report that found that Deutsche Bank “appears to be the most important net contributor to systemic risks in the global banking system.”  “Systemic risks in the global banking system” — there’s a phrase that should send shivers down your spine.  The bank has substantial exposure in derivatives . . . and equally important, it has significant connections to the big banks in America, Great Britain, China, Japan, and other countries around the globe.  In our modern, globalist world, that’s just how the huge financial concerns work.  That means that any serious problem at Deutsche Bank will have a ripple effect in America — an effect that is already being felt in the markets here.

So once again we are faced with the prospect of a big bank that has engaged in risky behavior teetering on the brink, with calls for a national government — in this case, Germany — to come forward and say that it is ready to step in and rescue the bank from the consequences of its own actions.

Sound familiar?  Hey, I thought this was supposed to have been fixed in 2009.


The Big Short

The Big Short is one of those movies that is intended to make you uncomfortable — and it succeeds, twice over.

The film tells the story of the housing bubble and sub-prime mortgage fiasco that led to the economic collapse and stock market crash of 2008. It begins with the handful of loners and clear-eyed if vulgar realists who investigated, read what others didn’t, identified the unsustainable reality, and then figured out a way to make lots of money, even as the financial and political establishment was smugly convinced that the impending disaster couldn’t possibly occur.

bigshortbaleDon’t worry if you don’t know much about finance or economics — as the movie progresses you’ll get humorous little tutorials on the key concepts from exotic-looking women taking bubble baths, Anthony Bourdain figuring out what to do with old fish, and a prize-winning economist and Selena Gomez playing blackjack.  And, of course, all along the viewer knows the catastrophe is coming.  Even so, it’s uncomfortable to watch it unfold and to hear once again about Bear Stearns and Lehman Brothers and Countrywide and bailouts and the other events that made some people wonder if the American economy and capitalism would even survive the cataclysm.

It’s a powerful story, and The Big Short tells it well.  Its ensemble cast, which features Christian Bale, Brad Pitt, Ryan Gosling, and Steve Carell, is excellent, but it’s not an ensemble movie in the traditional sense, because some of the principal players never interact on screen.  They’re each running their own funds, dealing with their own investors and institutional pressures and insecurities, seeing the overall mess from different perspectives and wondering whether they are witnessing fraud or imbecility or incompetence.  And, as the movie reaches the point where the world economy teeters on the brink, they convincingly portray the sense of astonishment and shaken wonder at how the hell it all happened in the first place.

So, reliving those grim days when fortunes were lost and the country plunged into recession is uncomfortable, for sure.  And the second uncomfortable moment comes when the movie ends — because the final message of The Big Short questions whether the same thing could happen again and whether new bubbles are percolating even as we speak.  One of the core themes of the film is that most of the Wall Street wizards really aren’t so wizard-like after all — just greedy hustlers who don’t really sweat the details or even fully understand why they’re making the obscene amounts of money they’re making and are oblivious to the risks they are creating for the rest of us who have to deal with the aftermath.

It doesn’t exactly make you feel super secure about your 401(k) plan, now does it?

In The Blink Of An Eye

At kitchen tables all over America today, husband and wife Baby Boomers are drinking coffee and talking soberly about their retirement plans.  They’re doing so because those plans may have just changed in the blink of an eye, as the stock market has shed a big chunk of its value in the last few trading days and they have seen their nest eggs take a big hit.

IMG_20150823_083542The stock market analysts are talking about a market “correction.”  It doesn’t seem like the right word, does it?  A correction typically fixes an error.  It’s hard to think of a major drop in the stock market that causes hard-working Americans to lose a chunk of their carefully accumulated savings as fixing anything.

Why the sudden plunge and sell-off?  Is it China, or general skittishness, or a concern about American and global debt, or a belated realization that the economy still is weak, or just the backroom decision of some Wall Street titans to create some turmoil that might add to their profits?  The little guys will never know what spooked the markets, and whether we’re in for more of the wild ride this coming week.  We’ll just hold on tight and try not to panic and make things worse for ourselves.

In the meantime, we’ll all be drinking coffee, scratching figures on notepads, and talking about what this means for us.  We’ll tighten our belts and shake our heads and work a little longer and think about how this might change our little corner of the world.

What else can we do?

Wall Street, Main Street, and 401(k) Plans

In the wake of the Massachusetts special election loss, President Obama has struck a more populist tune.  He and his supporters have been talking about “getting our money back” from “fat-cat bankers” on Wall Street who took TARP money.  Siding with “Main Street” rather than “Wall Street” is a time-honored theme in American politics.

I wonder whether the “Wall Street vs. Main Street” pitch still has resonance, however.  The reality is that many working Americans have 401(k) plans or some other form of retirement savings or pension plan that is invested in stocks and bonds.  According to the Investment Company Institute website, in 2008 49.8 million Americans had 401(k) plans that held an estimated $2.4 trillion in assets.  In short, lots of American families are invested with Wall Street.  They watch the Dow and the S&P 500 and hope that their 401(k) plans will appreciate in value and allow them to retire earlier and wealthier.

As a result, in the 1930s or 1950s there may have been a bright-line distinction between “Main Street” and “Wall Street,” but that bright-line exists no longer.  People may be upset by the size of the bonuses paid by banks that took TARP money, but I think many Americans not only aren’t reflexively opposed to Wall Street bankers, they hope that those investment bankers do their jobs well and create wealth that their 401(k) plans will share in.

If I am right in that perception, then politicians who want to rip into Wall Street should proceed with extreme caution.  In the last few days, the stock market has fallen at the same time President Obama has attacked Wall Street bankers and Senators have declared they won’t vote for a second term for Federal Reserve Chairman Ben Bernanke.  It may be coincidence, but it may cause many Americans to wonder why the President and the Senate seem to be playing politics with their retirement funds.

And Another Thing . . . .

One other point should be made about the Chrysler bankruptcy issue. Currently, managers of investment funds are measured against a simple performance standard — in effect,they have a fiduciary duty to make as much money as they can, in compliance with the law, through investments that fall within their defined investment area. For example, managers of high-yield debt investment funds have a fiduciary obligation to maximize the legal return on their investments in high-yield debt, by making wise choices in their initial investment decisions and then pursuing every penny of return if the issuer of the debt goes into bankruptcy.

What happens, then, if a manager of a fund that invested in Chrysler debt caves in to government pressure and takes much less than the fund might have recovered through a bankruptcy proceeding? Is that person thereby breaching his or her fiduciary duties? If an investor brings a lawsuit claiming a breach of fiduciary duty, would it be a defense to say: “The President made me do it?”

Capitalism may seem cold-blooded, but the mission of a fund manager to maximize the legal return of an investment is a simple, straightforward obligation that can be assessed and measured. If you start to introduce other variables to the equation — politics, the environment, community goodwill, and so forth — you make the equation much more complicated. If people want to investment in “green” investment funds, or labor-friendly funds, they can do so. Most people, though, simply want their investment managers to provide as much money for their retirement as possible. If those managers allow themselves to be bullied into accepting less than they have a right to obtain, they aren’t really doing their job.

If You Break It, You Bought It

Prior to the invasion of Iraq, Secretary of State Colin Powell supposedly told President Bush: “If you break it, you bought it.” His point was that, if U.S. actions in Iraq caused the Iraqi state to fall into chaos, the U.S. would assume a special long-term responsibility to pay for its actions by ensuring that the Iraq was returned to a state of stability.

I wonder if the same could not be said for what the current Administration is doing with Chrysler and the securities and debt markets. The Administration has inserted itself into the bankruptcy process to an unprecedented degree, browbeating creditors to accept much less than they would be entitled to receive otherwise. That activist approach may have short-term political gains, by advancing the interests of the United Auto Workers and its members who are Chrysler employees, but it also may have a significant long-term negative impact on how our economy operates.

Capitalism works only if investors are willing to assume risk. The priority rule helps to quantify what the risk really is. Under that rule, there is a pecking order that establishes where people line up in the event of a corporate failure. Secured creditors and unsecured creditors, for example, both have priority over simple stockholders.

By injecting politics into the equation, the Administration is changing the risk analysis. Such changes, in turn, inevitably will affect the willingness of investors to assume risk. If investors have no assurance about where their investments will fall on the priority list, they will be less likely to assume the risk of their investment — or will require a higher interest rate to compensate for the risk that the President or Congress will try to intimidate them into accepting less in a bankruptcy than they would have received if the priority rules were inviolate.

We may not care about Chrysler — it builds crappy cars, which is part of the reason why it has failed — but we should all care about continuing to have an economic system where people can make reasoned judgments about investment risk and whether they should assume that risk. Some years ago I worked on a case involving “high-yield debt,” known colloquially as “junk bonds,” and was fascinated to learn a bit about how that part of our economic markets worked. Essentially, the ability to sell high-yield debt gave some struggling companies a possible mechanism for survival, if they could convince investors that they had a business plan that could turn the company around and, if that plan failed, that they had assets sufficient to allow investors to recoup a reasonable portion of their investment in a bankruptcy proceeding. The individuals who managed the high-yield investment funds were impressive, bright, hardworking, savvy individuals who were committed to carefully examining the risks presented by each offering and deciding which companies offering high-yield debt best merited an investment. Many of the companies offering such debt in fact succeeded with their business plans and were able to retire their high-yield debt, return to profitability, and survive to this day. Those companies employ thousands of workers — workers who would not be employed if the high-yield debt offerings were not available. If there had been no certainty in the bankruptcy priority equation, however, those bonds may never have been marketed at all, or perhaps only at crushingly high interest rates that would have made it much more difficult for the issuer companies to pay the interest and principal and survive.

What does this mean? Only that the pieces of our economy are interrelated and are dependent on individual willingness to shoulder economic risk. In its zeal to have Chrysler survive in a fashion that benefits the UAW, the Administration may have undercut investor ability to assess risk, and thereby harmed its ability to count on private investment to help ensure the survival of GM, or struggling banks, or other businesses that are traveling a rocky road in these tough economic times. The potential consequences of such a result are profound indeed.

And Another Helpful Development . . . .

This story — http://abcnews.go.com/Business/story?id=7122282 — will just add another layer of scrutiny for companies that have accepted TARP or stimulus funds. They now know they can expect to have their bonuses and “retreats” examined and their tax status reviewed, and I think that, as public attention continues to focus on how bailout money is being used and by whom, more subject areas will pass under the microscope. Do the companies have any unfunded pension liability? Are there any pending environmental problems or workplace safety issues at their plants? Will any of the stimulus funds be used to pay pending judgments from civil lawsuits? The list could be a very long one.

Although this story suggests that the federal government really isn’t doing its job — Why should we take on faith that no taxes are owed? Is it really that hard to check? — the focus on TARP and stimulus spending may have two good side effects. First, it seems to have energized the press to actually dig into issues and do some investigating, rather than just reporting on political horseraces and the latest opinion polls. There is every incentive for the press to do so, because the public clearly is paying attention. Second, it may cause corporations to think twice before they accept TARP or stimulus funds. If concern about this kind of scrutiny causes a company not to accept federal help, maybe they really didn’t need federal help in the first place.

Unnecessary Withdrawals from the Credibility Bank

I’ll make one last point about the current economic problems and our governmental responses to it, and then I will leave it be for a bit.

My grandmother used to say that you have only one chance to make a good first impression. If you were going out with a girl on a first date, you wanted to impress her parents as someone who was decent, trustworthy, and responsible. If you built up credibility, it could help you in the future. If you got your date home by her curfew the first 10 times, her parents might give you the benefit of the doubt if you were late on date #11.

I think the same holds true for Presidents and other political figures. Most voters are willing to give our newly elected leaders a fair chance. If initial performance doesn’t suggest credibility or competence, however, it can be difficult to recover from that first impression. This is why President Obama, and Congress, should be very careful about what they are trying to accomplish and what they are saying about it. President Obama clearly has an ambitious agenda, but sometimes people who try to accomplish everything end up accomplishing nothing. Are education or health care reform, for example, really as important as the current banking and credit problems? Isn’t the most important issue right now to make sure that the awesome sums we are spending to try to stimulate the economy are spent wisely and well? If the public has the feeling that the Administration and Congress are trying to do too much, outraged complaints from the Administration and Congress about the AIG bonuses may come across as naive or reflective of a lack of attention to important details. If some members of the general public in fact are having such reactions — and I suspect they are — it means that Congress and the Administration are making entirely unnecessary withdrawals from the credibility bank.

Edited to add: This kind of story — http://politicalticker.blogs.cnn.com/2009/03/18/breaking-i-was-responsible-for-bonus-loophole-says-dodd/ — isn’t going to help any.

The Latest Outrage

The current stories about AIG, its bonuses, and its uses of the bailout money it has received — see http://www.msnbc.msn.com/id/29728732/, for example — are infuriating, and I think are just going to feed the populist feelings of many Americans. When you read such stories, it’s hard not to think that the federal government — the Administration (current and former), Congress, and regulators — have been asleep at the switch. Why are they all acting surprised that AIG would pay its traders and executives massive bonuses? After all, personal greed on Wall Street is what helped to get us into this mess in the first place. How could federal money have been paid out to AIG without at least addressing these kinds of issues in advance?