Nicholas Kristof got some ink for his breathless report about Richard Fuld making $17,000 per hour in 2007. For ruining a firm! Isn’t that disgusting!? Oh noes! The greed! The folly! What kind of board would allow something like that!? They must be retarded!! Kristof playfully asks: Wouldn’t you be willing to run a firm into the ground for that kind of dough?
There’s just one little problem with that $17,000 figure. It was based largely on equity that was at risk. Just like most of the half billion that Fuld has earned, and that Kristof ridiculed the board for paying him, over his Lehman tenure. It’s safe to say that that equity value is now gone.
So, let’s see, we’re down about $500 million in 2008, but that was just in the first nine months, so per hour, using Kristof’s formula, that comes to…minus $272,000 per hour. Hmm. I think I’ll pass on that job, Nick.
I understand that when those nine months were over, Fuld in fact lost over 90 percent of his personal wealth. That doesn’t exactly leave him a pauper, and I’m not playing violins for his loss. But Nick, come on down from that pedestal and honestly answer me this, when was the last time you risked 90 percent of your personal wealth on the success of a firm that you ran? Or even for a small, uncomplicated project?
That’s what I thought.
But the real reason I don’t read the NY Times, and the reason I’m over a week late in reacting to Kristof’s column, is illustrated by that paper’s choice of “Editors Picks” from the comments section. Mr. Kristof’s article garnered over 200 sympathetic responses. According to the site, “NYTimes editors aim to highlight the most interesting and thoughtful comments that represent a range of views.” One of their six picks for this article was a “thoughtful” note that referred to CEOs as “fiscal terrorists” for whom it would be “perfect justice to see them hustled off to Guantanamo and their personal assets confiscated.” I guess Kristof knows his audience, as well as his editors.
OK, it’s an increasingly debatable point that the Paulson plan will actually save the economy. But given the market’s reaction, it seems that about a trillion dollars is at stake over coming up with a viable solution to our credit crisis, and various Congressman are willing to hold it up over…a few million of CEO pay.
That’s right, our inept Congress is trying to balance a duck against a building, and call it statesmanship. Actually, what they’re doing is playing chicken with the White House in a game of brinkmanship. Their specific proposals show how truly cynical these populists are:
– Congressman Barney Frank (D-MA), chairman of the House Financial Services Committee, wants the government to restrict the bailout to firms that deny their top people golden parachutes. He probably knows that most of those pay features are contractually obligated. That means he knows that the shareholders will end up losing almost as much fighting to keep those sums as they would otherwise pay out. And they would likely pay them out anyway. Because you see, dear Congressman, in this country the government still does not have the authority to abrogate contracts by fiat.
Frank also wants to institute a “clawback” rule to revoke bonuses paid for “bogus gains,” which will more likely create bogus litigation whose costs far exceed anything the shareholders could hope to recoup.
– Sen. Max Baucus (D-MT), chairman of the Finance Committee, is proposing tax penalties on the compensation of top executives who earn more than the U.S. president ($400,000). That’s right, for every dollar that the shareholders pay to attract a person capable of running their complex, multi-billion corporation above the wage of your average division head, those shareholders will also pay the federal government an additional 35%. Mr. Baucus may be fool enough to think that the executives will be paying that tax, but then again, he may not care, as long as he ends up with the taxes for his committee to fritter away on the next fiasco.
Rep. Jack Kingston (R-GA) says, “Clipping executive compensation is easy right now — everybody wants it.” And, of course, anything that people want, Congress believes it can do with a magic wand. Like fix the economy.
Many of these public servants are making these proposals under the misimpression that lazy, stupid, or corrupt boards are giving up shareholder money beyond reason or obligation. They believe that most of these CEOs are being treated differently from their rank and file. No, Mr. Frank, we don’t take back lawfully earned income from people when they exit a firm. No, Mr. Baucus, the shareholders don’t appreciate a hidden tax increase as a result of misguided attempts to have them pay their senior officers like civil servants.
I have to admit I’m desperately searching for a good explanation about what went wrong this past month. The problem is complex, and the root(s) of it are, I’m guessing, rather subtler than most people think. But there is one explanation–the most common one out there–that I’m certain is useless: greed.
Blaming the financial crisis on greed is like blaming a raging fire on oxygen. Greed is a pervasive aspect of humanity, visible on both sides of every trade, at every level of society, except perhaps for the guy sleeping in a box near a steaming grate, although I bet he would hungrily grab a better box or squat a warmer grate if he could find it.
I also don’t buy the idea of mass stupidity, complacency, or irrationality. The more likely explanation is perfectly sensible, rational behavior of thousands or millions of people under perverse incentives. The most fruitful line of inquiry is likely to be: What were the incentives? How did they arise? Who did they affect? Why did they manifest the way they did now?
Or, we can shortcut rational inquiry and go for the cheap morality tale and the inevitable witch hunt that follows.
Posted by Marc Hodak on September 20, 2008 under Invisible trade-offs | Comments are off for this article
Everyone heard yesterday morning about the Federal government basically agreeing to bail out the (remaining) financial firms. Everyone got a glimpse of the breathtaking cost of this bailout to the taxpayers. We also heard concern about “moral hazard” as a secondary effect, though that concept is hard for the average person to really get, especially the idea that this secondary effect may be even more economically costly than the nominal cost of the bailout.
What slipped by with nary a peep was the news later that day that GM drew down the remaining $3.5 billion of its credit facility.
To me, this looks a lot like your second kid, seeing the promise that you made to pay off the debt of your first kid, suddenly decide to tap out his own credit.
The Bush administration knew that one of the dangers of bailing out the financial sector is that other sectors were sure to pile on. Detroit was a logical choice. Especially in an election year where Michigan is a swing state. Can Ford be far behind? And Michigan is not the only swing state this close election…
On Thursday, September 18, 1873, the Panic of 1873 reached crisis proportions at 11:00am on Wall Street, when H.C. Fahnstock, the New York partner of Jay Cooke (one of the leading gold market participants), announced that Cooke’s office was closed. Cooke, in his Philadelphia office, admitted it was true, and the most prominent banker in the country was suddenly bankrupt.
Robert Sobel, writing like Stephen King in Panic on Wall Street, said the “coal-black steed named Panic” quickly “thundered riderless down Wall Street,” where “a monstrous yell went up and seemed to literally shake the building in which all these mad brokers were for the moment confined.” Along with Jay Cooke, 37 other banks and two brokerage houses closed their doors on this date alone. In the ensuing days, the losses increased and the NYSE was forced to close down for over a week. With the situation growing dire, the secretary of the Treasury decided to infuse the economy with $26 million in paper money and the market eventually re-opened.
Jay Cooke failed over trying to construct a second Transcontinental Railroad, but demand could not support a second line. He was merely a symbol of gross over-speculation in land and securities, followed by the issuance of too much paper money, resulting in higher inflation. (Sound familiar?) The Panic of 1873 started with a bang, as over 5000 businesses failed in the last quarter of 1873, but the Panic lingered long, as another 5,000 failed over the next five years.
Panics hit America every 17 years, on average, for about a century, from 1819 to 1920 (in 1819, 1837, 1857, 1873, 1894, 1907 and 1920). The word “panic” aroused such a negative reaction (in 1894 and 1907) that Herbert Hoover invented a less threatening word for the 1929 event–connoting a small pothole in the road. Hoover called the 1929 panic “merely a depression.”
The next bar on this chart will be below 0.00%, i.e., negative returns:
Yep, if you had invested in the S&P 500 at an average cost of that index over the course of 1998–a year which included the Asian meltdown–the roller coaster ride you would have been on since then–with two years and 32 percent in gains left in the dot com boom, followed by the bust, followed by the strong gains until last year before this credit crunch–would have gotten you right back where you started.
Which is about 35 percent worse off than if you had left that money in a passbook savings account. Which represents very negative real returns.
I know the mantra is “it always comes back,” and I’m still committed to the market for my long-term funds because I believe there is a risk premium for holding equity. It’s times like these that create that premium, by reminding us exactly what the risk looks like. Something to keep in mind when I begin to near retirement.
Posted by Marc Hodak on September 13, 2008 under Practical definitions | Comments are off for this article
In this article, the LA Times headline helpfully explains that, “New rules would give FBI more freedom in U.S. operations.” That’s right, the editors there apparently consider giving government agents more leeway to spy upon, deceive, and coerce its citizens as a form of “freedom.” Did I miss something in my civics classes? Or is this just the intermediate step to Orwell’s definition?
I don’t know if Obama intended to call Sarah Palin a pig. I really don’t. But it can certainly be interpreted that way. Sure, the phrase “lipstick on a pig” is commonly used in Washington. Sure, McCain himself has even used it referring to Hillary’s health care proposal in 2007. But Hillary didn’t brand herself as the lipstick lady in 2007. Palin did two weeks ago. Everybody knows it. The media burned it into our consciousness. Before Nike, a teammate saying “Just do it,” was being supportive. After their ad campaign, he was being cliche. Same words, different time. That’s how marketing works. Obama knows this as well as anyone.
So Obama can complain all he wants about being unfairly tagged with a slur. Here’s what he’s pretending not to get. Let’s say Barack and Michele are drying dishes in the kitchen and he says something and Michele gets a look on her face. Barack doesn’t know where the look came from, but it’s not pretty. Barack says, “What’s wrong honey?” Michele says, “Did you just say I was a…” Doesn’t matter what she thought she heard. Doesn’t matter if he meant it. When it comes down to it, it doesn’t even matter if he really said it. All that matters is that she heard it. If you’re a guy, you’ve been there.
I don’t have much to say about the Republican convention other than Palin appeared to be the clear highlight. My basic problem with them all is that they propose to protect us from threats of all sorts, and to send me the bill for their protection. I have to count on them spending my money wisely. History shows little promise of that.
I don’t know how to put the graphs up here, but consider that the likelihood of the average American dying from heart disease is about 34%. You have about a 30% chance of dying from cancer. You have an almost 30% chance of dying from any other kind of disease, and about a 6 percent chance of dying in an accident. If the U.S. suffered the equivalent of a World Trade Center attack every single year, you would have a 0.2% chance of ever dying from terrorist activity.
Then consider that our government spends about 15 times as much money fighting terrorism as it does on all other threats to our health and safety put together.
Availability bias is the human tendency to ascribe a higher probability to events that come readily to mind. Over the last 8 years, many of us may have heard about or even witnessed the death of someone from disease or accident. But every one of us have seen or heard, with incessant repetition, about 9/11. The vivid sight of the plane crashing into the Twin Towers is burned into our national consciousness. 9/11 is a highly ‘available’ data point.
Our politicians have used that consciousness to organize a Dept. of Homeland Security and invade Iraq, the costs of which are approaching $500 billion. How many lives have been saved from all that fighting, over-the-top airport security, encroachment on our civil liberties, loss of respect among our allies, etc.?
The obverse of availability is peace of mind. We’ve paid dearly for it. But what would we have gotten by channeling a half a trillion dollars to medical research instead? Personally, I would much rather live with a greatly reduced fear of cancer than whatever solace I now get from having people check in at the security desk when entering my building–one of tens of thousands in Manhattan that have never been attacked.
I don’t blame our politicians. They’re doing what they do–grab money and power based on people’s fears. The media creates the fear, which is regrettable, but they too are doing what they do to sell stories.
Ultimately I blame our schools. Our system turns out analytical morons. We are all much poorer for it.
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