Lessons From Crash and Resurrection
Why would I open an e-pitch from Harvard Business Publishing?
Because four days earlier it was reported that, in the fiscal year that ended June 30, Harvard University's endowment had earned an 8.6% return that took the value of the foundation from $34.9 billion to $36.9 billion. On Friday, it was announced that Yale did a paltry 4.5%.
Management of the Harvard endowment fund was overseen by Robert S. Kaplan, former VP of Goldman Sachs and a management practice professor at the Harvard Business School.
Given the outrageous shenanigans that went on in the markets over the past year, professor Kaplan appears to be the only sane, responsible and honest person devoted to making money for his clients (in this case one client, Harvard) and actually succeeding.
I am berserk. After reading this, you might also be berserk.
The Culprits--A Perfect Storm Created
How many times has this cranky e-zine mentioned the eight key copy drivers--the emotional hot buttons that make people act--fear, greed, guilt, anger, exclusivity, salvation, flattery and patriotism?
The first two--fear and greed--have fueled the boom-'n'-bust hysteria that overheated the markets, then dumped ice water all over everybody. My brother-in-law--former CFO of a major conglomerate and a savvy investor--called what has happened "Armageddon." What happened? Who and what are the culprits?
1. Derivatives: Financial instruments where the value is based on an underlying security or asset. An example of how a derivative comes into being: A consumer takes out a mortgage loan to buy a home. The lender assembles a batch of these mortgage loans, creates a fund and sells pieces of the fund to investors. When the homebuyers default, everybody loses--the mortgage holder, the fund's investors and the homeowner who loses the house. Other derivatives: options, swaps, forward contracts and futures. The definitions of these words are gibberish--houses of cards. The only people who have a lesser understanding of derivatives than the rapacious sales sharks in financial institutions are those they've conned into buying them and the politicians who are supposed to regulate them.
2. Phil Gramm: One of the most dangerous, devious and dark figures in the financial world is former Texas Sen. Phil Gramm, who was chairman of the Senate banking committee. An example of Phil Gramm's duplicity was described by syndicated columnist Froma Harrop:
Another Gramm contribution was the "Enron loophole," which prevented federal oversight of Enron's electronic energy trading. Such favors proved very expensive to consumers but profitable to the Gramms. Enron CEO Ken Lay chaired Gramm's 1992 re-election campaign, and wife Wendy Gramm spent years on the Enron board, earning as much as $1.8 million, according to Public Citizen, a consumer advocate.
Phil Gramm--John McCain's economics mentor and former McCain campaign co-chairman--has been in the pockets of financial industry lobbyists for years and is a fierce opponent of government oversight and regulations of the financial markets. On Dec. 15, 2000, just before Congress took off for Christmas vacation, Gramm slipped a 262-page amendment into the appropriations bill. It "forbade federal agencies to regulate financial derivatives that greased the skids for passing along risky mortgage-backed securities to investors," wrote Harrop. The appropriations bill was approved with no one in Congress reading the Gramm amendment, let alone understanding the ramifications. And, says Harrop, "that, my friends, is why everything's falling apart."
3. The Securities and Exchange Commission (SEC): "The Securities and Exchange Commission can blame itself for the current crisis," wrote Julie Satow in The New York Sun. "That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns and Merrill Lynch. The SEC allowed five firms--the three that have collapsed plus Goldman Sachs and Morgan Stanley--to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults."
4. The Uptick Rule: You can bet the stock of a company will go down by selling short--that's sell that stock even though you don't own it. If the price does go down, you then buy it at the new lower price and make money. Conversely, if you guess wrong and the stock goes up, you have to buy it at the new higher price and you lose. The Securities and Exchange Act of 1938 decreed that a trader can only sell short on an uptick--an increase in price on the last transaction. Otherwise bear traders could short, short, short with impunity and drive prices down. On July 6, 2007, the SEC commissioners voted to repeal the uptick rule.
5. Naked Short Selling: If you sell short--selling stocks you don't own--theoretically you're required to locate the number of stocks you want to sell and "borrow" them. Selling stocks you don't own without borrowing is called naked short selling--frowned on by the SEC but heretofore not enforced. "What I do know is that many fellow traders, who, like me, prefer to trade short, are raking in the profits," wrote equinetrader.blogspot on Aug. 15, 2007. "The past few days have been a dartboard in the market. Shoot and short. The goal this past week has been to find any kind of upward momentum in the market--then short it, and keep shorting it. Short Apple, short RIM, short financials, short Nike for heavens sake. Just short it." New York Attorney General Andrew Cuomo said that short sellers "are like looters after a hurricane."
These five elements created a perfect financial storm that came close to destroying America and the world economy.
Finally, this past Friday, the SEC banned short selling for 799 financial company stocks--a case of locking the barn door after the horses were stolen.
"The fifth major federal bailout this year--after Bear Stearns, Fannie Mae, Freddie Mac and the American International Group--is now in the works," said The New York Times editorial board this past Saturday. "Taxpayers have every right to be alarmed and angry. The latest plan is not necessarily a bad one, and officials had to move quickly to prevent credit markets from seizing up. But make no mistake, this crisis could have been avoided if regulators had enforced rules and officials had dared to question risky lending and other dubious practices."
Two headlines yesterday add fuel to the fire in my gut. See the hyperlinks below:
"U.S. weighs bailout of foreign banks, too"
--International Herald Tribune, Sept. 22, 2008
"Big Financiers Start Lobbying for Wider Aid"
--The New York Times, Sept. 22, 2008
The Customer Comes Last
The name of this e-zine is "Business Common Sense."
Common sense dictates that while politicians, bankers, regulators, traders, consumers and the media are all pointing fingers at each other, the underlying problem is a sick culture where tens of thousands of sleazy executives in the financial world--and the dirty sales people who did their bidding--created giant business models based on screwing customers, clients, their own companies and their country. Two examples:
* Subprime mortgages. No need to rehash this one. Not only were consumers encouraged to lie about their incomes and net worth to get in on the real estate boom, but when it turned out they couldn't make their monthly payments, those consumers were left to twist in the wind. When my wife, Peggy, and I bought our house in center city Philly, we kept receiving letters from this and that finance company announcing that it was now the mortgage holder and payments should go here rather than there. I never understood it. Peggy, who runs the finances, paid off the mortgage early. We want nothing to do with these creeps.
* Auction-rate securities. These are financial instruments that were widely touted as being just as safe and just as liquid as money market funds, but paying slightly higher interest. Neither consumers, businesses nor the sharks that sold them understood them. Check out the two links below: "Lehman screws over its rich clients" and "Goldman screws over its rich clients." As Liz Rappaport wrote in The Wall Street Journal of July 25, 2008:
The state of New York on Thursday joined a widening array of prosecutors and customers accusing Wall Street firms of wrongdoing in efforts to hold together the $330 billion auction-rate securities market before it collapsed in February. State Attorney General Andrew Cuomo filed civil fraud charges against UBS AG, accusing the firm of a "multibillion-dollar consumer and securities fraud," and demanding that the firm pay back its profits from the business, make investors whole and pay damages.
UBS AG? Gee ... ugh ... isn't UBS where Phil Gramm ended up after he left the Senate in 2002? "Senator Gramm's experience gained from more than 35 years in academia and government make him uniquely suited to assist our clients to meet the challenges presented by today's business environment," UBS Warburg CEO John Costas crowed in a release on Oct. 7, 2002.
"This is a mental recession," Phil Gramm said on CNN on July 9, 2008. "We've never been more dominant. We never had more natural advantages than we have today. We sort of become a nation of whiners. You hear this constant whining, complaining ..."
Watch Phil Gramm call us "a nation of whiners":
Gramm is rumored to be John McCain's choice for Secretary of the Treasury.