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August 26th, 2009

Perspicacity Vs. Purse Capacity

The mantle of wisdom is often assumed by the wealthiest person in the room as people errantly conclude the control of large sums of money is the product of conscious thought or inherent ability. Fortunately, we have Congress and the Administration to squash this notion. In the wake of months of debate about the domestic auto industry, driven to its death by bloated costs, weak product offerings, union intransigence and management myopia, two of the major producers were forced into bankruptcy and, in desperation, took many of the expected cost cutting actions expected. Yet, as the companies were poised to emerge from bankruptcy, a Congressional panel held hearings to encourage reopening unnecessary auto dealerships in their home districts. Cash for Clunkers, the alliterative tax program from which dealers withdrew due to lack of promised federal payments, is the clunker in the coal mine for future federal intervention into private enterprise. Despite ample evidence that the existence of regulation does very little to actively prevent large economic problems (See investment bank leverage, Bernie Madoff, pay-to-play bribes, sub-prime mortgage crisis) the divine belief in more regulation, rather than enforcing existing law or applying it justly, persists as the poultice for “systemic risk”, the domino theory of our decade. Bernanke’s reappointment offers the hope for some continued independent thoughtful consistency on policy.

Evidence of bribes being given by private equity firms to officials at various state pension funds and to pension officials’ henchmen has been widely published. Rather than enforce existing law against bribery with criminal charges, the SEC and various attorney generals have turned this into a risk pricing rate card. Data to date suggests that a little less than two years’ management fees, paid as a fine, on the ill gotten capital is the price of this risk. The regulatory response has been to ban placement agents, none of whom were involved in the scandal. In our twenty years of speaking to municipal funds we have never heard a direct hint of any untoward arrangement to gain capital. Registration of private firms is being advocated to monitor “systemic risk”. Setting aside the millions of dollars that will be diverted from investing in companies to create jobs and be spent instead on compliance, what is the proposed level of assets under management to require filing? $30 million. By that standard Yankee third baseman, Alex Rodriguez’s annual income poses systemic risk.

Desperate crisis management regulators lured Ed Liddy out of a lucrative retirement, to work as a public service for $1 per year to try to save taxpayers assets in AIG. He worked in close concert with the regulators to agree on contracts to retain management to squeeze profits from the various businesses at AIG. How do public officials pay back his donated effort? Congressional hearings treated Liddy like William Wallace at the end of Braveheart. Federal officials and the NYS Attorney General called for AIG to breach the employment contracts and devised laws to tax 100% of the contracted bonuses despite all the relevant agencies being in agreement over the contracts when they were signed. Home addresses of bonus recipients were published as a vigilante exercise. A similar emotion has extended to the banking sector regarding TARP recipients where large percentage bonus payments are rued by Washington. Shockingly, what have the banks done to “address” the problem? To reduce the percentage of compensation attributed to bonuses, they have substantially increased salaries, the fixed cost of bank operations and the cost of any salary severance payments required if the banks need to shrink. All of these consequences are contrary to the taxpayer’s interest if the banks do not improve their financial state. Dissent about public policy by officials is understandable, but abrogation of the government’s contractual obligations and shooting of helpful messengers, is not.

We have retained the services of one of the Administration’s economists; the one who provides the “jobs saved” figures. He has concluded that Olympus has saved 1200 IRR points in the second quarter and expects that figure to double by year’s end.

Citicorp continues as a financial reality show as yet another CFO has been voted off the island. They have now had three CFOs in the first half of the year. The most recent CFO was replaced at the government’s behest. One CFO left to spend “more time with his family”. It turns out his family is a private equity firm in Utah. Remarkably, Bank of America has begun to hire Citicorp executive refugees.

Economic news seems to be a mixture of spin, mysticism and actual facts. In a recent month Yale’s Richard Schiller enthusiastically analyzed home prices as showing a “striking improvement in the rate of decline.” If Churchill had told the British public the German buzz bombs had reduced their payloads similar euphoria would have resulted. $4,500 coupons were issued by the government to generate car sales resulting in artificial demand propping up auto sales. Unemployment levels approached 10% as record levels were reached in the federal deficit. Consumer demand continues to decline, aided by a higher savings rates coupled with pessimistic consumer sentiment and declining disposable income. Amidst the flotsam and jetsam left by the recent events we see the carcasses of the firms led by financial luminaries such as John Meriwether and Lenny Dykstra begging the question of whether investors, who continue to support these triumphs of hope over reality, deserve protection.

I’m Rob Morris and I approved this blog.

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