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  • The Continuing Debate on AIG

    The House of Representatives is debating a 90 percent tax on executive bonus payments made to companies receiving bailout funds. Anything they pass will still have to get through the Senate and past the President’s desk. They are “upset about something they already did,” according to Dan Lungren (R-CA). Congress ignored the opportunity to deal with this back when you and me and 100,000 other voters were telling them not to pass the bailout legislation.

    Executive compensation schemes at American International Group (AIG) have been under investigation by the New York State Attorney General, Andrew Cuomo since last fall. He is ramping up the investigation now, given the news over the weekend of new bonus disbursements, to determine if the bonus contracts are unenforceable for fraud under New York law. AIG agreed with Cuomo last October not to use their own “deferred compensation pool” to pay bonuses – and then bargained with executives to make the payments anyway! AIG execs got contracts in early 2008 that guaranteed their bonuses – information that former Treasury Secretary Paulson and current Treasury Secretary Geithner (former President of the New York Federal Reserve Bank) had when they initiated the original bailout.

    It’s pretty amazing 1) that taxpayers are bailing out a company that’s under criminal investigation; 2) that Treasury didn’t negotiate compensation schemes before they wrote the first check (like they do with auto workers?); and 3) that the bonuses are a bigger story than the fact that more than one-third of the bailout money was shipped overseas.

  • Compensation Confidential

    The salary of the chief executive of a large corporation is not
    a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.
    John Kenneth Galbraith

    What would Galbraith have said about the AIG bonuses?

    When AIG CEO Edward Liddy said the bonus payouts helped retain “the best and the brightest,” he revived a theme that has been common throughout the modern era of executive compensation: an arithmetic correlation between money and talent. Lost on Mr. Liddy, and indeed on much of Wall Street, was the fact that the term was used by David Halberstam to characterize the intellectuals who led us to war and failure in Vietnam. Sweet irony.

    I have been silent witness to the growth of executive compensation entitlement syndrome for the last ten years as a sometime ghostwriter for a prominent company in the field, which shall remain nameless (they pay infinitely more than newgeography.com, and may want to hire me again). This week seems the appropriate moment to share the lessons I learned about the behavioral underpinnings of today’s financial industry bonus crisis.

    1) The seeds of each new scandal in executive pay are sown in the wake of the last one. Remember stock options? They came into vogue in the early 1990s when executives awarded themselves bonuses for laying off vast numbers of workers, rationalizing that they had raised profit margins and deserved a payoff. Congress decided that compensation in excess of $1 million would not be tax deductible to the corporation unless it was geared to performance. As we have learned over and over, performance can be cut to order conveniently when options or other incentives vest. This is what one economist called “the invisible hand of Alexander Portnoy, not that of Adam Smith.” When I began working in executive compensation, CEOs chose which options to cash based on which vintages from a multiyear portfolio were in the money at a particular time.

    And if the resulting tax bill was too high? The stockholders would pick up the tab. Even Apple was caught backdating options for Steve Jobs. Regulators were — and are — perpetually one barn door behind the horses. Who knows what well-intended remedies will be born of the current crisis?

    2) CEOs are as peer conscious as any high school clique, but better paid. Executive comp consultants refer to the Lake Woebegone Effect. To wit, if your pay isn’t above average, or well above average, the board is admitting to the world that you are sub-par…and we wouldn’t want that, would we? So comp committees and their consultants have to find schemes whereby CEO pay keeps rising, perks keep rising, and the water level in Lake Woebegone goes up accordingly until it overflows its banks. If a CEO at a competitor in your industry category is in the 75th percentile, you have to be in the 80th or 90th. World-class management, like a designer accessory, is a function of the price tag.

    3) CEOs are risk averse. They want their money upfront, to justify the risk of taking the new job and the headaches that go with it. Once seated, management finds ways of locking in wealth. The turnover in these jobs is massive. Five years after the Mergers & Acquisitions boom of 1989-91, fewer than half of CEOs who had received sizable recruitment bonuses were still in place (figures courtesy of The Wiley Book of Business Quotations).

    Earlier in this decade, I interviewed a dozen or so CEOs for a Wall Street publication, which deemed them exemplars for a new economic age. Two years later almost all of them were on a list of CEOs who had been indicted or were otherwise disgraced. Of course, the pay levels that justify the risk of failure look a lot like the rewards for success to the rest of us. The bigger scandal comes when the initial contract ink is dry, and they start to manage the company in a way that makes the shareholders feel like they deserve to earn their enormous compensation. That’s when they take risks, as AIG did when the bosses saw the company’s Triple-A credit rating sitting on a shelf and decided to put it on the street in the form of Structured Products.

    What they failed to do was something the barbershop down the street from me, in its capacity as a “number hole”, always remembered to do. If the action was too heavy on a number, they’d lay it off on another bookie…er, banker. Who will hedge the hedgers now that AIG is circling the bowl?

    4) CEOs hate their jobs, mostly. That’s why you have to pay them extra for doing the jobs they are already paid to do, only better. Look, I wouldn’t want to do it either. Corporate jobs are good when business is good and soul-destroying the rest of the time. That was true at my level and I’m sure it’s true at the top, too.

    Come to think of it, even when things were apparently going well, I saw the body language; I heard the mental gymnastics, the ethical contradictions, and the hairsplitting. When you have what comp consultants call “line of sight” for the whole company, you see that it’s a rare event when everything is going well. You make your numbers by selling assets and hope that the problems stay out of the newspapers. But when things are rotten, and they have been rotten for a long time, it’s no wonder that CEOs take everything they can: apartments, jets, club dues, sports tickets, million-dollar furnishings, a piece of the M&A action, stock buybacks, and $440,000 spa weekends complete with manicures and hair styling. They’re like hookers going through a john’s wallet while he’s in the shower. And successful or not, they feel they’ve earned it.

    To be sure, they buy back their humanity with good works, a form of plenary indulgence, as I learned first hand the last time my mother was sent to the emergency room. En route, on the car radio I had listened to the Senate Banking Committee questioning Lehman Brothers chairman Richard S. Fuld. When I arrived, I noticed a plaque on the wall of my mother’s ER cubicle. The space had been donated by Mr. and Mrs. Richard S. Fuld.

    This is the curse of the managerial class, particularly the financial managerial class, and one of the sorry phenomena of our current situation is that everything is financial. Everything is worth what the financial chieftains say it’s worth for as long as they can get away with it. They don’t love the product, the process, or the people. They love the pay package, the perks, and the power. They love the action. When Bear Stearns was melting down, its CEO was incommunicado at a bridge tournament. Isn’t that a bit like a busman’s holiday? What happened to their brains? They hold their breath and search for the greater fool. The best and the brightest, indeed.

    Henry Ehrlich is author of Writing Effective Speeches and The Wiley Book of Business Quotations. He is currently working primarily with companies that are trying to fix the health care mess. Piece of cake.

    Photo by David Shankbone

  • Economic Resilience in Rural America?

    This week Reuters is hosting a Food and Agriculture Summit in Chicago. On Tuesday presenters, including leading agribusiness executives and business economists, reported that despite the challenging global economic climate, the U.S. rural economy has weathered the recession better than most sectors due to steady demand for agricultural products, stable land prices and healthy credit lines for farmers”.

    Jim Borel, a VP at DuPont Co stated that “fundamentally, food demand is there,” as “people need to eat,” which “helps to stabilize things.” According to Reuters such claims were echoed by other participants, including Mark Palmquist, CEO of CHS Inc, who noted that the world keeps “adding mouths to feed,” and that “food demand… tends to be pretty insensitive to what the global economy is doing.”

    While there appears to be some anticipation of stability at large agribusiness corporations, such optimism may be tempered among farmers, who have seen commodity prices drop by 50% or more over the past year. Such drops will create a more difficult business environment for producers. However, there is some hope that the strong prices received by farmers over the past couple of years will make them better able to, as one agricultural official in Wisconsin stated recently, “ride it out for somewhat longer than otherwise would have been the case”.

  • Digging into AIG bonuses and other aid recipients

    On Sunday March 15, 2009, American International Group, Inc. revealed the identities of some of the beneficiaries of about half of the nearly $180 billion the US government has committed ($173 billion actually paid out so far) to support the ailing international financial giant. As we now know, AIG sold credit default swaps (CDS) that paid off if the market value of some bonds fell. (I use the term “bond” here generally to refer to the alphabet soup of CDO, CLO, MBS, etc. – all of which are debt that is sold to the public.) Most CDS only pay off if the borrower fails to make payments – something that hasn’t happened in the case where AIG is making payments. The geniuses at AIG – and we know they are geniuses because they earned $165 million in bonuses for the effort – took on completely unknown risks for, apparently, insufficient premiums, resulting in the need for an emergency $85 billion loan last September from the Federal Reserve Bank of New York (courtesy of my buddy Tim Geithner) to “avoid severe financial disruptions”… as if that worked!

    Whatever. So, now AIG is letting us know who got our money: $22.4 billion for payouts on the CDS and $27.1 billion to buy the bonds underlying the CDS (so some of the CDS could be cancelled). That’s about $50 billion so far for derivatives – no one knows how much more they’ll need. Here’s a summary by the country where the recipients are based:

    Country

    CDS
    Payout

    US

    $16.0

    France

    $13.3

    German

    $8.1

    Switzerland

    $3.3

    UK

    $2.0

    Canada

    $1.1

    Netherlands

    $0.8

    Scotland

    $0.5

    Spain

    $0.3

    Denmark

    $0.2

    Numbers in billions. $4.1 billion paid to “other” not included here. Numbers won’t total to $49.5 billion due to rounding.

    There was also $12.1 billion paid to US municipalities (states, cities, school districts, etc.) – where states invested, for example, bond proceeds prior to expenditure. In those cases, the municipalities invested in assets with guaranteed rates of return (another genius idea at AIG!). The bigger numbers belong to the states that had recent large bond issues – for example, $1.02 billion to California which has yet to distribute a dime of the bond money raised for stem cell research (due to on-going litigation).

    AIG took $2.5 billion for their own business needs – like the bonuses? The $165 million bonuses were just for the London-office that specialized in selling those very special CDS. Total bonuses paid were $450 million for all the geniuses at AIG – the AIG who made $6.2 billion in 2007 and lost $37.6 billion in the first 9 months of 2008!

    The most interesting bit, perhaps, are payments of $43.7 billion to securities lenders – those stock and bond holders who lend out their shares to enable short sellers. This means that AIG borrowed stocks so they could short sell them – make an investment that paid off only if the prices fell. (If you don’t know what short selling is, here’s a five minute video that explains it in a light-hearted way.) Bottom line – it gave AIG incentives to push down market prices. And their announcements and actions at the end of 2008 certainly achieved that goal. Way to go, geniuses!

  • Restoring the Real New Orleans

    Like so many others, I have long been a visitor to New Orleans. In my case, the first visit was 1979, when we studied the city to influence the design of the new town of Seaside. I have been back often – for New Orleans is one of the best places to learn architecture and urbanism in the United States. My emphasis on design might seem unusual, but it shouldn’t be, for the design of New Orleans possesses a unique quality and character comparable to the music and the cuisine that receives most of the attention.

    During those visits, sadly, I did not get to know the people – not really. The New Orleanians I met were doing their jobs but not necessarily being themselves. Such is the experience of the tourist.

    This all changed when Katrina brought me back in the role of planner. Engaging the planning process brought me face to face with the reality.

    Apart from the misconceptions of the tourist, I had also been predisposed by the media to think of New Orleans in a certain way: as a charming, but lackadaisical and fundamentally misgoverned place long subjected to unwarranted devastation, with a great deal of anger and resentment as a result. That is indeed what I found at first; but as I engaged in the planning process I came to realize that this anger was relative. It was much less, for example, than the bitterness that one encounters in the typical California city with nothing more than traffic gripes. The people of New Orleans have an underlying sweetness, a sense of humor, and irony, and graciousness that is never far below the surface. These were not hard people.

    Pondering this one day, I had an additional insight. I remember specifically when on a street in the Marigny I came upon a colorful little house framed by banana trees. I thought, “This is Cuba,” (I am Cuban). I realized in that instant that New Orleans is not really an American city, but rather a Caribbean one.

    Looking through the lens of the Caribbean, New Orleans is not among the most haphazard, poorest or misgoverned American cities, but rather the most organized, wealthiest, cleanest, and competently governed of the Caribbean cities. This insight was fundamental because from that moment I understood New Orleans and began to truly sympathize. Like everyone, I found government in this city to be a bit random; but if New Orleans were to be governed as efficiently as, say, Minneapolis, it would be a different place – and not one that I could care for. Let me work with the government the way it is.

    It is the human flaw that makes New Orleans the most humane of American cities. (New Orleans came to feel so much like Cuba that I was driven to buy a house in the Marigny as a surrogate for my inaccessible Santiago de Cuba.)

    When understood as Caribbean, New Orleans’ culture seems ever more precious – and more vulnerable to the effects of Katrina. Anxiety about cultural loss is not new. There has been a great deal of anguish regarding the diminishment of the black population, and how without it New Orleans could not regain itself.

    But I fear that the city’s situation is far more dire and less controllable. Even if the majority of the population does return to reinhabit its neighborhoods, it will not mean that New Orleans – or at least the culture of New Orleans – will be back. The reason is not political, but technical. You see, the lost housing of New Orleans is quite special. Entering the damaged and abandoned houses you can still see what they were like before the hurricane. These houses were exceedingly inexpensive to live in. They were houses that were hand built by people’s parents and grandparents, or by small builders paid in cash or by barter.

    Most of these simple, and surprisingly pleasant, houses were paid off. They had to be, because they do not meet any sort of code, and are therefore not mortgageable by current standards.

    I think that it was possible to sustain the culture unique to New Orleans because housing costs were minimal. These houses liberated people from debt. One did not have to work a great deal to get by. There was the possibility of leisure.

    There was time to create the fabulously complex Creole dishes that simmer forever; there was time to rehearse music, to play it live rather than from recordings, and time to listen to it. There was time to make costumes and to parade; there was time to party and to tell stories; there was time to spend all day marking the passing of friends. One way to leisure time lies in a light financial burden. With a little work, a little help from the government, and a little help from family and friends – life could be good! This is a typically Caribbean social contract: not one to be dismissed as laziness or poverty, but as a way of life.

    This ease, so misunderstood in the national scrutiny following the hurricane, is the Caribbean way. It is a lifestyle choice and there is nothing intrinsically wrong with it. In fact, it is the envy of some of us who work all our lives to attain the condition of leisure only after retirement.

    This is the way of living that may now disappear. Even with the Federal funds for new housing, there is little chance that new or renovated houses will be owned without debt. It is too expensive to build now.

    If nothing else, the higher standards of the new International Building Code are superb, but also very expensive. There must be an alternative or there will be very few “paid off” houses. Everyone will have a mortgage, which will need to be sustained by hard work – and this will undermine the culture of New Orleans.

    What can be done? Somehow the building culture that created the original New Orleans must be reinstated. The hurdle of drawings, permitting, contractors, inspections – the professionalism of it all – eliminates grassroots ‘bottom up’ rebuilding.

    Somehow there must be a process whereupon people can build simple, functional houses for themselves, either by themselves, or by barter with professionals.

    There must be free house designs that can be built in small stages, and that do not require an architect, complicated permits, or inspections. There must be common sense technical standards. Without this, there will be the pall of debt for everyone. And debt in the Caribbean doesn’t mean owing money, it means destroying a culture that arises from lower costs and leisure.

    To start, I would recommend an experimental “opt-out zone.” Create areas where one “contracts out” of the current American system, which consists of the nanny-state raising standards so expensive and complicated that only the nanny-state can provide affordable housing. The state thus creates a problem and then offers the only solution.

    However it may sound, this proposal is not so odd. Until recently, this was the way that built America from the Atlantic to the Pacific.
    For three centuries Americans built for themselves. They built well enough – so long as it was theirs. Individual responsibility could be trusted.

    We must return to this as an option.

    Of course, this is not for everybody. There are plenty of people in New Orleans who work in conventional ways at conventional times. But the culture of this city does not flow from them; they may provide the backbone of New Orleans, but not its heart.

    See the attached file for a polemical draft for legislation that activates the thesis of the above essay.

    Andrés Duany is a principal at Duany Plater-Zyberk & Company (DPZ). DPZ is recognized as a leader of the New Urbanism, a movement that seeks to end suburban sprawl and urban disinvestment. In the years since the firm designed Seaside, Florida, in 1980, DPZ has completed plans for close to 300 new towns, regional plans, codes, and community revitalization projects.

    Duany is the author of The New Civic Art and Suburban Nation. He is a founder of the Congress for the New Urbanism. Established in 1993 with the mission of reforming urban growth patterns, the Congress has been characterized by The New York Times as “the most important collective architectural movement in the United States in the past fifty years.”

  • Andres Duany

  • How Elite Environmentalists Impoverish Blue-Collar Americans

    The great Central Valley of California has never been an easy place. Dry and almost uninhabitable by nature, the state’s engineering marvels brought water down from the north and the high Sierra, turning semi-desert into some of the richest farmland in the world.

    Yet today, amid drought conditions, large parcels of the valley – particularly on its west side – are returning to desert; and in the process, an entire economy based on large-scale, high-tech agriculture is being brought to its knees. You can see this reality in the increasingly impoverished rural towns scattered along this region, places like Mendota and Avenal, Coalinga and Lost Hills.

    In some towns, unemployment is now running close to 40%. Overall, the water-related farming cutbacks could affect up to 300,000 acres and could cost up to 80,000 jobs.

    However, the depression conditions in the great valley reflect more than a mere water shortage. They are the direct result of conscious actions by environmental activists to usher in a new era of scarcity.

    To some extent, such efforts reflect some real limits imposed by the growth of population. Constructive long-term changes in the conservation and utilization of all basic resources – energy, water and land – are not only necessary, but also inevitable.

    Yet the new scarcity does not simply advocate humane ways to deal with shortages, but seeks to exacerbate them intentionally. This reflects a doomsday streak in the contemporary environmental ethos – greatly enhanced by the concern over climate change – that believes greater scarcity of all basic commodities, from land and water to energy, might help reduce the much detested “footprint” of our species.

    One key element of this agenda has to do with reducing access to critical resources like water beyond those required to support existing uses. To be sure, two years of below-average precipitation helped create central California’s current water shortage. Planting crops such as cotton, which needs lots of water, may also have contributed to the problem.

    However, this only explains part of the problem, which increasingly has to do not with vicissitudes of nature but conscious political action. In prior dry periods, the state has managed its water resources to supply farmers and other users as effectively as possible. Today, in response to seemingly endless litigation to protect certain fish in the Delta region west of Sacramento or to “revitalize” valley streams, enormous amounts of water have been allowed to flow untapped into San Francisco Bay.

    This distinction was entirely missing in national coverage of the drought. A recent New York Times article, for example, barely acknowledged the role played by environmentalists whose move to block additional water supplies from the Delta have turned a below-average year – moisture content in the Sierra is about 90% of normal – into something of an epochal agricultural and human disaster.

    “This is still a pretty decent drought but nothing unusual,” suggests Tim Quinn, executive director of the Association of California Water Agencies, which represents both urban and agricultural interests. “We were prepared, as usual, for the drought, but they have taken all the tools away from us.”

    Many environmentalists justify their efforts to curtail water availability for California’s farmers and towns by citing various doomsday global warming projections. Energy Secretary Steven Chu, for example, recently opined that as the state’s climate inevitably shifts to a hot-weather, low-precipitation pattern, water scarcity will create “a scenario where there is no more agriculture in California.” If agriculture is doomed anyway, why not kill the industry now and use the water for fish or other pet “green” projects?

    This represents a remarkable reversal in the spirit that only a few decades ago drove the development of California. Anyone who has lived for any period in the state knows that aridity represents our greatest natural challenge. California seems always either at the edge of drought, coming out of one, or about to enter a dry spell. Since 1920, the state has experienced crippling six-year droughts during 1929 to 1934 and 1987 to 1994, as well as severe shortfalls of a lesser span on several occasions.

    Recognizing the need for a reliable water supply despite the certainty of significant dry years, Californians responded by building one of the most highly advanced water delivery systems in the world. The result was a network of federal and state dams, pumps and aqueducts emblematic of the “can-do” spirit motivating old Progressives, like Edmund Brown in Sacramento and New Dealers in the nation’s capitol.

    The state’s water conveyance facilities opened vast new tracts of land to agriculture. Some of the world’s largest expanses of almonds, pistachios, pomegranates, grapes and cotton covered once-arid land. This expansion created steady demand for advanced farming technologies as well as low-paid labor, much of it undocumented. Reflecting this dichotomy, wealth and poverty grew hand in hand throughout the Central Valley.

    Today, environmentalists cite – as yet another reason to dehydrate California farmlands – the prevalence of immigrant labor in the Central Valley. Lloyd Carter, a major state environmental activist, recently suggested that cutting farm production would actually be beneficial since most farm workers are “not even American citizens for starters” and raise children that “turn to lives of crime,” “go on welfare” and “get into drug trafficking and … join gangs.” These comments cost Carter his association with certain environmental groups, but not his day job – deputy attorney general under former governor and supreme green jihadi Jerry Brown.

    Unfortunately, Carter’s comments reflect what many environmentalists will tell you in private. As a Valley resident himself, Carter may have great empathy for his region’s poor and working class, but it’s hardly a priority among the core of the green movement, which is based in places like San Francisco or Santa Monica. This reflects not so much racism as a disconnect with the productive industries – agriculture, energy and manufacturing – that tend to cluster on the other side of the coastal range.

    The growing economic problems in Central Valley cities like Fresno, where unemployment is near 15%, represents little more than an abstraction to a new cadre of wealthy “progressives” who merely pass through the area on their way to Yosemite and other Sierra resorts.

    “We are getting the sense some people want us to die,” notes native son Tim Stearns, a professor of entrepreneurship at California State University at Fresno. “It’s kind of like they like the status quo and what happens in the Central Valley doesn’t matter. These are just a bunch of crummy towns to them.”

    This split has engendered what is likely a quixotic secession campaign led by farmers in the interior counties, but such drives to divide the Golden State have risen and failed many times before. Yet clearly, there exists a growing divide between producer and consumer economies, and this is coming to the fore not only in California, and on issues well beyond water.

    It is critical to understand that anti-growth politics diverges from the old conservationist ethos in radical ways. No longer is it enough to talk about growing intelligently or using technology to meet long-term problems. Instead, scarcity politics seeks to slow and even reverse material progress through what President Obama’s science adviser, John Holdren, calls “de-development.”

    “De-development” – that is, the retreat from economic growth – includes some sensible notions about conservation but takes them to unreasonable, socially devastating and politically unpalatable extremes. The agenda, for example, includes an opposition to population growth, limits on material consumption and a radical redistribution of wealth both nationally and to the developing world.

    In much the same way as seen in California’s water crisis, many of the administration’s “green” energy policies pose a direct threat to blue-collar workers employed in extracting and processing fossil fuels. The resultant high energy prices caused by the proposed “cap and trade” system – essentially a system for creating scarcity – also will cost middle-class consumers, blue-collar workers, truckers and manufacturers. These constituencies could well face the kind of water policy-related decline that is destroying farming communities throughout central California.

    Yet at the same time, such policies make the well-to-do and trustafarians in San Francisco and Malibu – for whom higher energy prices are barely a concern – feel better about themselves. In what passes for progressive politics today, narcissism usually takes priority over reality.

    In the new scarcity politics, access to land also may be sharply limited. New land regulation, ostensibly for climate-change reasons – already in place in California and being discussed as well in Washington state – could force almost all new development to follow a high-density, multi-family pattern. Over time, single-family homes – the preference of a vast majority of Americans – will become once again, as they were in the past, the privilege only of the upper classes in some metropolitan regions.

    By embracing the politics of scarcity, the Obama administration seems committed to imposing a regime that could slow any sustained recovery from the current recession. Although these ideas might appear plausible at a Harvard Law Review bull session, their real consequences for millions of Americans could prove very ugly indeed.

    This article originally appeared at Forbes.

    Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

  • Buffett Update: Downgrade from Oracle to Seer?

    A day or so after he was on CNBC, Warren Buffett went on Bloomberg Television and told them that he’ll continue to sell derivatives contracts. He’s getting deeper into investments that he has called “financial weapons of mass destruction.” Apparently he’s betting that there will not be a crash (which would require a payout) in corporate junk bonds, muni bonds or stock markets in the UK, Europe and Japan. Here’s the punch line: his stock is up 17.2% since he started talking!

    Berkshire Hathaway shares peaked last year at $147,000 each when Buffett was buying energy companies. The price is so very high because they have a policy of never paying dividends. Therefore, all the company’s earnings are put back into investments. If you tried to use a standard finance model to determine the appropriate price for these shares, the answer would be “infinity” because you can’t divide by $0 dividends. Anyway, two months after the peak, the shares were in the tank – relatively speaking – at $77,500 per share. By the end of the week before his TV appearances, the shares were even lower, at $72,400. The day of the CNBC interview: Berkshire Hathaway shares closed at $84,844 – a cool 17.2% gain. Remember, this is the man who said he is fearful when people are greedy and greedy when people are fearful.

    On March 12, Berkshire Hathaway lost its triple-A credit rating from Fitch Ratings because of potential losses from those derivatives. Not that we should believe everything Fitch says – Fitch is among the credit rating agencies that gave triple-A ratings to subprime mortgage bonds, and look what happened to those investments! For what it’s worth, Fitch gives Berkshire a “negative” outlook, meaning another cut is possible within a couple of years. The two other big ratings agencies, Moody’s Investors Service and Standard & Poor’s, still rate Berkshire triple-A.

  • We Need a New Oracle

    Warren Buffett was on CNBC for three hours on March 9, 2009, dishing out his wisdom. All this fanfare despite having lost $24 billion in value last year, and handing the title of Richest Man in the World over to Bill Gates. Buffett made multiple references to “war” in describing the current financial crisis.

    There are several problems with Buffett’s comparison of the current state of the economy to war, as pointed out in this story in the Omaha World-Herald, which ran the day after the interview. What we are seeing is less like war – in which an outside enemy attacks you – and more like arson, except the people who burned down the house are now collecting the insurance too!

    Warren Buffett – the widely revered Oracle of Omaha, where I live – is one of those who built the boom in the capital markets and are benefiting from the bust. No surprise then that Buffett whose primary business vehicle is Berkshire Hathaway, a financial holding company, supports the bailout of financial institutions. Their business includes, among others, property and casualty insurance and a financial holding company. When Senator Ben Nelson (D-NE) told me that he talked with Warren before voting for the first bailout package, I button-holed him after lunch and gave him an ear full.

    Of course Buffett was in favor of the bailout – his companies directly benefited as did the investments made by his companies. He put $5 billion into Goldman Sachs preferred stock with a 10% dividend – a substantially better rate of return than the US government got on our $10 billion bailout, er, I mean “investment.” Berkshire Hathaway was the largest shareholder in American Express Co. when they received $3.4 billion from Uncle Sam.

    Buffett appeared on CNBC a year ago (March 3, 2008). At that time he was forthcoming about the risks Berkshire Hathaway was taking. He told CNBC at the time that he had “written 206 transactions in the last three weeks” which were default swaps on municipal bonds – the financing used by cities and states to fund everything from building schools to general obligations.

    Buffett bragged that “the municipality has to quit paying” before any losses would have to be covered. This gives him incentive for another payout from Uncle Sam in addition to the Wall Street bailout – he also has incentive to support the stimulus package. If the cities and states default on their debt, then Buffett (Berkshire Hathaway companies) would be on the hook to make good on the full value of the bonds. At that point in March 2008, after just 3 weeks of investing, Buffett said he made $69 million in premiums for guaranteeing payment on $2 billion of municipal bonds. The primary insurer received about $20 million, an amount significantly less but that carries more risk. If that doesn’t seem to make sense, then you understand – the pricing of risk and premiums did not make sense. This systematic irrationality was also a contributing factor to the current financial mess.

    The scheme of buying and selling bond payment guarantees is very much dependent on rising asset prices (and no recession), just like any Ponzi scheme. Describing his investment strategy in March 2008, Buffett clearly said that what he and the other insurers in this market are “hoping for is new money.” He even admitted that getting new money was preventing he and others in the market from having to “totally face(d) up to the mistakes that they’ve made.”

    By now, Bernie Madoff has shown you how a Ponzi Scheme falls apart in a down market. In the 2008 interview, Buffett gave us a preview of what keeps him awake at night. Cities and states don’t go broke very often, but when they do “it could be contagious.” Luckily for Buffett, the Congress – “the best Congress that money can buy”, according to Sen. Kennedy – voted to send “stimulus” money to the cities and states.

    In fact, Buffett wouldn’t have to pay on any of those bonds unless the primary bond insurer went broke, too. That primary bond insurer is Ambac Financial Group, Inc. Ambac is the first to pay in the event of default on the municipal bonds that Buffett is guaranteeing. If any of the bonds go bad, Ambac has to pay the bondholders. If Ambac got into financial trouble Buffett said he would “be out trying to help them raise money” – otherwise Berkshire Hathaway would have to pay off the bonds. Now, in March 2009, Buffett talks about the economy going over a cliff while Ambac teeters on the edge of junk bond status. When it falls, it could take Berkshire Hathaway with it. The table below shows what happened to Ambac’s credit rating between Buffett’s two appearances on CNBC.


    Timeline of Ambac Credit Rating Slide

    Date Event
    3/3/2008 Buffett appears on CNBC discussing investment scheme relative to Ambac
    3/12/2008 Moody’s confirms Ambac’s Aaa rating; changes outlook to negative
    4/24/2008 Moody’s reiterates negative outlook on Ambac’s Aaa rating following earnings announcement
    5/13/2008 Moody’s says worsening second lien RMBS could impact financial guarantor ratings
    6/4/2008 Moody’s reviews Ambac’s Aaa rating for possible downgrade
    6/19/2008 Moody’s downgrades Ambac to Aa3; outlook is negative
    9/18/2008 Moody’s places ratings of Ambac on review for possible downgrade
    11/5/2008 Moody’s downgrades Ambac to Baa1; outlook is developing
    3/3/2009 Moody’s reviews Ambac’s ratings for possible downgrade
    3/9/2009 Buffett appears on CNBC; no discussion of Ambac

    Acting selfish and self-serving is what got us into this mess in the first place. We’ve been witness to bloated executive compensation in the face of lousy corporate performance. We’ve seen mega-billionaires living lavish lifestyles for years on the proceeds of Ponzi schemes and fraud. Maybe it’s time for a new Oracle, in Omaha or elsewhere, because this one has been giving us bad advice.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Blagojevich Misdoings Could Have National Fallout

    Former Illinois Governor Rod Blagojevich’s arrest, impeachment and removal from office assured his place as another famous name in our state’s corruption hall of disrepute. But it turns out the selling of President Obama’s Senate Seat was only a minor part of Blagojevich’s misdoings – and some of this could have greater national political fall-out than is commonly imagined.

    As the Justice Department looks at Blagojevich’s machinations, the scope is likely to widen. Operation Board Games, the formal name of Justice Department’s investigation of Blagojevich, is about more than just Blago’s seat-selling or about Democratic Party political fundraiser Tony Rezko shaking down individuals for campaign contributions.

    Perhaps the most fertile ground for the investigation centers on the awarding of a gambling license in the Chicago suburb of Rosemont, as The Chicago Tribune reported in 2005. Because of the negative attention drawn to placing a casino located in the Chicago Mob-linked suburb of Rosemont, Blagojevich needed to make the situation look more respectable.

    So who was brought in to try and make Rosemont look acceptable? None other than Eric Holder, the current newly installed Attorney General. Rosemont didn’t get the casino because of pressure applied by former FBI agent Jim Wagner on the Illinois Gaming board. Wagner is the guy who publicly raised the question of Eric Holder’s connection with Blagojevich.

    And there’s more to come:

    A day before his arrest, former Gov. Rod Blagojevich was hit with a sweeping federal subpoena seeking eight years of calendars, correspondence, e-mails, logs, notes and other records involving everyone from his wife to Chicago Tribune owner Sam Zell

    The “everyone” includes Valerie Jarrett and David Axerod, individuals who are very close to President Obama.Tony Rezko appears to be a link between Rod Blagojevich and Barack Obama. All of this could get pretty messy before it’s all done.