Getting More For Doing Less: Bank Board Directors

Executive compensation is an art rather than a science. It is not as if numbers are fed into a computer and the correct compensation pops out. More discretion is involved than meets the eye. “Since the financial crisis,” The New York Times reported in 2013, “compensation for the directors of [America’s] biggest banks has continued to rise even as the banks themselves, facing difficult markets and regulatory pressures, are reining in bonuses and pay.” [1] Just five years after the financial crisis, it is interesting how the banks' respective managements decided to spend the TARP money from Congress and even more money from the Federal Reserve Bank. Also of note, board and upper management compensations seemed to be going in different directions in spite of both being presumably tied to the same firm performance. Even a performance-incentive approach tied to firm-performance can accommodate a lot of latitude, such that banks differ in how much they pay their respective boards. The discretion permits inside collusion and even outlandish demands by "celebrity" members whose advice does not necessarily come up to celebrity status.  

At $488,709 in 2011, Goldman Sachs had the highest director-pay of any American bank. Some of the bank’s 13 directors made more than $500,000 because they had extra board responsibilities. As the directors were paid in stock, 2012 promised to be an even better year for the board members. Compensation experts have stated that banks must pay premium dollar to pay such figures for what is essentially part-time work in order to get the best advice. However, JPMorgan, the largest American bank, gave its directors “only” an average of $278,194 in 2011. Bank of America paid its directors $275,000 each. Equilar reported that the average compensation for a director at one of the six largest American banks in 2011 was $328,655. This compares with $232,142 at almost 500 publicly-traded companies, according to Spencer Stuart, in spite of the fact that regulations had narrowed the responsibilities of bank boards.

One would think that compensation would reflect changes in the number of tasks even more than macro indicators of bank performance. “I get you have to pay up for sophisticated board, but what is that complexity worth?” said Timothy M. Ghriskey, co-founder of the Solaris Group, a financial services shareholder that voted in 2011 to reject a pay plan for top executives at Citigroup. “Does it take $200,000 or $500,000? The discrepancy between a board like JPMorgan and Goldman is confusing.”[2] I submit that it is confusing only from a rationalistic standpoint. 

The differential indicates that the matter is far more subjective than meets the eye. Collusion between upper management and its board may be happening. So when a compensation expert claims that a certain level is necessary, the claim can be questioned rather than taken at face value. In fact, the false-necessity may be a subterfuge used by insiders seeking to enrich each other. You scratch my back, and I’ll scratch yours. The dispersed stockholders are left with less.

In short, it can be doubted whether the director compensation levels at banks are necessary or even in the stockholders’ interest. The excess probably reflects the difficulty facing stockholders in holding the insiders accountable. Accordingly, one consequence of corporate governance reform may be reining in the pay for what is really a part-time job with fewer and fewer responsibilities. If very wealthy or renown board members demand a premium, it is not justified in terms of corporate governance unless the advice is more valuable. 

See Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.

1. Susanne Craig, “At Banks, Board Pay Soars Amid Cutbacks,” The New York Times, April 1, 2013.
2. Ibid.

The Banks’ Consultants: Guarding the Hen House

Leaving it to consultants hired by mortgage servicers to right the wrongs that the services inflicted on foreclosed homeowners was the unhappy consequence of bank regulators giving ambiguous guidance and failing to install viable oversight mechanisms. According to the Government Accounting Office, “regulators risked not achieving the intended goals of identifying as many harmed borrowers as possible.” Even if the reviews had been completed, there was on guarantee that wronged mortgage borrowers would have received any compensation. On the other side of the ledger, the banks had received billions from the U.S. Treasury with no strings attached. Whether intentional or not, the banking regulators put too much stock in the consultants, who, after all, had been hired by the mortgage servicers."
The report confirms that the Independent Foreclosure Review process was poorly designed and executed," Rep. Maxine Waters (D-Calif.) said. The "report confirms what I had long suspected -– that the OCC’s oversight of the supposedly independent consultants hired by the servicers was severely deficient. The report should serve as a wake-up call.” By referring to the consultants as supposedly independent, Rep. Waters implies in her statement that the flawed review process put the consultants in the position of being able to exploit a conflict of interest.
On the one hand, the flawed oversight means that the consultants were the ones to protect the public interest. The public had to rely on them to correct the wrongs in the interest of the foreclosed. We can label this the consultants’ “public interest” role. The consultants’ other role  was in working for the servicers. As Benjamin Lawsky, the superintendent of New York's Financial Services Department, pointed out, "The monitors are hired by the banks, they're embedded physically at the banks, they are paid by the banks and they depend on the banks for future business." This is the consultants' other role, which can compromise the first role. 
In a conflict of interest, one role can circumvent another, more legitimate role. Even if the conflict is not exploited with the more legitimate role taking the hit, a person or institution in such a position can be reckoned as unethical, according to some scholars. Other scholars argue that only the actual exploitation of the more legitimate role by the other is unethical.
In my view, if exploitation can be seen as a possibility in the relation between two roles, the relation itself is unethical. Put another way, it is unethical to put a person or organization in such a position, even if actual exploitation does not occur. In my view, to create or perpetuate the condition wherein a person or organization can exploit a conflict of interest is unethical.
It follows that the government has a moral responsibility to eliminate the conflicting roles even if they are not being exploited. Furthermore, the person or organization having two such conflicting roles  as can be counted as a conflict of interest is also ethically obliged to pick one role or the other. Often this is not convenient from a short-term financial standpoint, so business practitioners tend to look the other way, rationalized that since no actual exploitation of the conflict of interest has occurred, there are no ethical issues. They are wrong. The mortgage servicers should never have hired consultants to monitor the servicers. This circle itself is problematic, ethically speaking.
The regulators rather than the consultants should have been the key enforcers, and thus protectors of the public interest. The regulators can be faulted not only for their lack of competence, but also ethically in having allowed the conflict of interest to exist.  A business should not be allowed by the regulators to guard the hen house. To permit this to happen is unethical even if no hens are eaten.  


For more on institutional conflicts of interest, see my book, Institutional Conflicts of Interest: Business & Public Policy, available at Amazon.

Sources:

Ben Hallman and Eleazar Melendez, “GAO Foreclosure Report Finds Bank Regulators Failed to Provide ‘Key Oversight’,” The Huffington Post, April 3, 2013.

 Dan Fitzpatrick, "'A Dose of Healthy Competition' For Banking Regulators," The Wall Street Journal, April 18, 2013.

Institutional Conflicts of Interest: Business and Public Policy

Typically people react emotionally much more severely to an exploited conflict of interest when a person gains a personal benefit such as through a bribe. If company, or even an office or department thereof, stands to benefit inordinately, American society typically looks the other way on the institutional conflict of interest rather than taking it apart. This may just be human nature. However, the troubling institutional arrangements within an organization or between them may be tolerated because of the erroneous assumption that conflicts of interest are unethical only when they are exploited. Accordingly, the book provides a solid grasp of the structure and essence of the conflict of interest in order to make the case that it is inherently unethical. Examples of institutional conflicts of interest readily come from business, with particular attention to corporate governance and the financial sector, as well as from how business and government relate, such as through regulation The reader should come away with a sense of just how pervasive and ethically problematic institutional conflict of interests are. 

The book, Institutional Conflicts of Interest: Business and Public Policy, is available in print and as an ebook at Amazon.com

Essays on the Financial Crisis

The financial crisis that peaked in the United States during the fall of 2008 is an excellent case study of what can go wrong with leadership and corporate governance in business, financial ethics, government regulation directed both to the firm level and that of the financial system itself, and legal accountability for the culprits. The collection of essays begins with a series of essays on Lehman Brothers, with particular attention on its last CEO, Richard Fuld. Given the fraud surrounding subprime-mortgage bonds at numerous banks, the second part of the book looks at why legal accountability was so elusive in the United States. Weaknesses in the financial regulation, with particular attention to whether agencies had been captured by their respective regulated firms, comprises the third part. The fourth part examines the culpability of the Federal Reserve Bank, which had perhaps been too close to its regulated banks to anticipate the crisis. The book concludes with essays on why business ethics had been so very weak. The careful reader will take from the book a sense that the financial system remained vulnerable even after government attempts to reduce the systemic risks of a big bank going under. 

The book: Essays on the Financial Crisis

Bribery at Barclays: Can an Unethical Culture Be Changed?

Amid the financial crisis in 2008, Barclays raised $15 billion from Qatar and other investors. The infusion of capital saved the European bank from needing a government bailout. Unfortunately, the bank may not have disclosed the $390 million paid to the Qatari government for “advisory services” as part of the fund-raising, and the $3 billion loan facility that Barclays made available to that government.[1] The bank, along with three of its executives at the time were charged in 2017 with conspiracy to commit fraud by false representation, and providing unlawful financial assistance—in other words, paying a bribe to avoid needing an E.U. or state-level bailout. According to Amanda Staveley, a European financier, Barclays improperly favored the Qataris in the fund-raising. The relationship between the bank and the Qatari government rings of “mutual back-scratching.” Admittedly, any business deal involves both parties benefiting, and in much of the world bribery is de facto necessary cost of doing business. Nevertheless, Barclays may have had an organizational culture similar to that of Wells Fargo in which anything goes in pursuit of profit.

The full essay is at "Bribery at Barclays."

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1. Chad Bray, “Former Barclays Executives Appear in Court Over Qatar Deal,” The New York Times, July 3, 2017.

How to Regain Reputational Capital: The Case of Wells Fargo

How does a firm rebound from the toll taken in reputational capital from a track-record of unethical practices? Paying $175 million to settle accusations without admitting any wrongdoing, such as Wells Fargo did in 2012, does not suffice, but neither does merely admitting culpability without real change going forward. The case of Wells Fargo may provide an explanation for how reputation recovers.

The full essay is in Cases of Unethical Business, available in print and as an ebook at Amazon.com.  

Fraud in Selling Sub-Prime Mortgage-Based Bonds: Beyond Accountability

“In December 2011, the S.E.C. publicized its civil securities fraud charges against top executives from Fannie Mae and Freddie Mac for understating their exposure to subprime mortgages, which resulted in the government taking them over.”[1] Robert Khuzami, then the head of the S.E.C.’s enforcement division, said at the time that “all individuals, regardless of their rank or position, will be held accountable for perpetuating half-truths or misrepresentations about matters materially important to the interest of our country’s investors.”[2] Pursuing even senior ranks has the air of fairness economically as well as in terms of the dictum, no one is above the law. So much for words; how about the accompanying deeds?

The full essay is at "Essays on the Financial Crisis."

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[1] Peter Henning, “Prosecution of Financial Crisis Fraud Ends With a Whimper,” The New York Times, August 29, 2016.

[2] Ibid.

[

SEC Investigating a Hedge-Fund Priest: Christianity’s Pro-Wealth Paradigm Lapsing into Greed?

It is against U.S. securities law to knowingly make false statements or publish false information about a company you are shorting (selling stock now and buying the shares later, hence betting the stock price will go down). In other words, you can’t try to drive the company’s stock price down you are shorting so you can profit from the trade. Besides being illegal, the practice is unethical. Just go to Kant for that! The guy was fanatical against lying.

You wouldn’t expect to read, therefore, that the SEC is investigating a Greek Orthodox priest who sidelines as a hedge-fund manager for trashing commercial reputations in order to make money off shorting stock.  BloombergBusiness reported on March 18, 2016 that the SEC was “examining whether the Reverend Emmanuel Lemelson of Massachusetts made false statements about companies he was shorting.”.”[1] He reportedly referred to his trading skills as a “gift from God.”[2] Such a claim is on a slippery slope, theologically speaking.

The priest who may have lapsed off the plank of Christianity's pro-wealth paradigm onto outright greed hidden under rationalizations as to means and ends. Is Christianity itself at risk for having gone so far into this worldly realm? The again, the Medieval Roman Church was very worldly as a political power.

When the story broke, I had just days earlier finished revising my second book on Christian attitudes toward profit-seeking and wealth in relation to greed. Lemelson’s “gift from God” language reminds me of the pro-wealth writings during the Italian Renaissance two centuries before the Calvinist work-ethic of industriousness. The Italian theologians of the fifteenth century tended to lighten up on profit-seeking and wealth. Cosimo de Medici got a pass from Pope Eugene IV in spite of a fortune based on usury (lending at interest). One priest, Fancini, went so far as to claim that humans are gods on Earth, given the dominion we have over its resources. Far from the camel who could not get through the eye of the proverbial needle, a Christian during the Renaissance (and after) knew he had to be rich in order to exercise the Christian virtue of munificence. Whereas liberality pertains to typical gifts, munificence involves donating money to build a cathedral, for instance. Being able to make a lot of money was a “gift of God” that would enable the successful Christian to give philanthropically on a scale worthy of God’s majesty.

Of course, the pro-wealth paradigm in Christianity is vulnerable to lapsing into love of gain (i.e., greed). Luther’s extremely anti-wealth stance can be interpreted as an effort to put on the brakes before the by-then dominant pro-wealth attitude in Christianity hit the skids and flipped over into greed. Luther did not succeed. Nor did Calvin or the Puritans, though they were more accommodating to the dominant perspective. The result was a clear line to the Prosperity Gospel—the notion that God rewards true believers with not just salvation, but material wealth as well. This idea came from the Old Testament, wherein God promises Israel that material wealth would come if His People hold to the covenant.

In my book, God’s Gold, I search for a theological undercurrent below the graduate shift from anti-wealth to pro-wealth dominance. I discount the impact of the commercializing context. With regard to the hedge-fund priest, I would be hesitant simply to say he was a manifestation of a pro-business American culture. This may be so, more significant, I submit, are the rationalizations presumably going on in the guy’s head. Bearing false-witness (i.e., lying) to harm others is difficult to view as a gift from God. Even as a means to a salubrious end, the juxtaposition of a gift from God and lying without concern for others’ welfare is odd at best.

In the book, I come to a discussion of how the human brain functions in the domain of religion. If we are vulnerable to certain “short-circuiting” cognitively and yet we have a religious instinct, are we not as a species in a double-bind? Put another way, if Lemelson can neither cognitively nor perceptually recognize his own rationalization, is his urge to be religious compromised? I don’t think so; rather, other aspects of the brain, or mind, may obstruct or circumvent it as it manifests itself. I do think these short-comings can be made transparent, and thereby reduced at least somewhat in severity, or swollenness, but denial is indeed a formidable and intractable obstacle. I suppose the dominance in Christianity since the Renaissance of the pro-wealth paradigm (i.e., profit-seeking and wealth decoupled from the stain of greed) renders the “mind-games” that much more harmful in terms of rationalizing some rather un-Christian behavior toward others. For one thing, in order to make money in order to serve God better can enable some pretty nasty means-ends justifications.  In this way, Christianity itself is now more vulnerable than the religion was when being wealthy and Christian were presumed to be mutually exclusive (i.e., greed was assumed to be tightly stapled to virtually any wealth). Ironically, the theology may be partially to blame, in so far as anthropomorphism unwittingly lifts the religious status of money and property.[3]

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1. Matt Robinson, “Hedge Fund Priest’s Trades Probed by Wall Street Cop,” BloombergBusiness, March 18, 2016.

2. Ibid.

3. The secret to that sauce is in chapter 12 of the book, God’s Gold. I got so into the writing of that chapter in revising it that in retrospect the chapters on the historical shift seemed a bit like a very long preface.

American Consumers Using Gas-Savings to Reduce Debt: Frugality or Responsibility?

The steep drop in the price of oil in July 2015 was a concern for traders. Drillers and other energy companies comprise a significant portion of the S&P 500 index. “The upside to falling oil is that all the money that drivers are saving at the gas pump should mean more spending by them at stores — and a faster-growing U.S. economy. But Americans are choosing to pay off debt instead of going shopping.”[1] Is this a bad thing? In reckoning it as such, Wall Street analysts are missing the big picture, even financially.

Gasoline at a station in January 2015. (ABC News)

To go on a shopping spree when in significant consumer debt is, I submit, foolish and perhaps even reckless. The mentality erroneously treats debt as permanent rather than something to be paid back. In this respect, the U.S. Government has been a terrible role model, as Bill Clinton dedicated only half of the surpluses in the late 1990s to paying down the debt. After his presidency, the wars and occupations in Iraq and Afghanistan added more than $4 trillion to the government’s debt.

To urge consumers in debt to spend what they save on gas implies the same mentality. Tim Courtney at Exencial Wealth Advisors, for example, says "Household finances are growing more healthy ... but you want to see a pick-up in spending, too."[2] I submit that such additional spending at the expense of reducing debt is detrimental to a person’s financial position. Not only is the debt not reduced, but also the habit of spending while ignoring the debt is reinforced. Consumers regaining their pre-debt position is good for Wall Street, moreover, because the financially solid position puts the consumers in a better position to spend beyond the short term.

Even so, using discretionary income to reduce household debt is said to be frugality. The following passage from The Associated Press is a case in point, and even makes explicit the interests behind the perspective. “The new frugality helps explain why the biggest long-term driver of stock prices — corporate earnings — have been so disappointing lately. In the second quarter [of 2015], companies in the S&P 500 grew earnings per share just 0.07 percent from a year ago, according to research firm S&P Capital IQ.”[3] That which is behind disappointment can be expected to be treated harshly rhetorically. Hence, responsible efforts to reduce debt is “frugality,” which has the negative connotation of cheapness.

I submit that debtless consumers are worth more societally than are continuously increasing corporate earnings (and consumer debt). The Associated Press could have reported that consumers were being responsible while over-reaching corporate expectations were taking a hit. How the media decide to report a story does indeed have an impact not only on consumers and company managers, but also the society as a whole—even in how it votes. In the case of the U.S., especially relative to the E.U., business interests can be said to have a disproportionate influence societally.

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[1] Bernard Condon and Ken Sweet, “Why Stocks Are Tumbling 6 Years into the Bull Market,” The Associated Press, August 23, 2015.

[2] Ibid.

[3] Ibid.

Banks Guilty of Colluding to Set Euro-Dollar Exchange-Rate Basis: Toward a Competitive Market

In May 2015, Citicorp, JPMorgan Chase, Barclays, and the Royal Bank of Scotland both acknowledged colluding to set the “fix” rate in foreign exchange markets, and agreed both to change their internal cultures and pay criminal fines of over $2.5 billion.[1] The U.S. Attorney General, Loretta Lynch, stated that her department would “vigorously prosecute all those who tilt the economic system in their favor; who subvert our marketplaces; and who enrich themselves at the expense of American customers.”[2] I submit that this does not go far enough, given the size and power of the banks and the condition of the sector.

Private gain at the expense of the public good is an old story. Corporations give to Congressional campaigns at least in part in hopes of being able to bend federal lawmakers to insert and approve a loophole that would keep the good of the whole from constraining quite so much the particular private interests. To be viable in the long term, a republic—even a republic of republics—must privilege the public good over potentially overweening private interests; otherwise, the implicit message can only be that anything goes—provided a company’s head knows where to send the dollars.

In using “a private electronic chatroom to manipulate the spot market’s exchange rate between euros and dollars using coded language to conceal their collusion,” the banks, or “The Cartel” as they referred to their group, “acted as partners—rather than competitors—in an effort to push the exchange rate in directions favorable to their banks but detrimental to many others.”[3] In other words, the banks acted as price-makers rather than price-takers; the market could not, therefore, be considered competitive. I submit that Lynch did not go far enough in settling for an acknowledgement of wrong-doing, promised change of internal cultures, and a fine; they do necessarily result in a competitive marketplace. Lynch said that the “penalty all these banks will now pay is fitting considering the long-running and egregious nature of their anticompetitive conduct” as well as “the pervasive harm done.”[4] Perhaps this so in terms of the size of the fine, but in giving the public confidence that the market would from then on be competitive. If firms in an industry are large enough that four of them colluding can set a price or rate, then the industry is oligarchic. To move it to a competitive basis, governmental action breaking up the largest firms (including in terms of ownership) is necessary. The justification lies in the value of the public good when economic liberty and property rights threaten to compromise the good of the whole.

To be sure, the U.S. Government would only be able to break up Citicorp and JPMorgan. Lest it be claimed that the resulting smaller firms would have less wherewithal to compete with Barclays and the Royal Bank of Scotland (as well as other banks), shedding less profitable divisions and focusing on developing a specialty-area can result in higher profits (i.e., from the sale of premium goods). Had lawmakers and President Obama given the U.S. Government the authority to break up financial institutions that have an unacceptable level of system risk (i.e, that a bank’s collapse could paralyze the entire financial system given the impact of high volatility on the market mechanism adjusting for risk), breaking up the largest American banks would not only make the sector more competitive, but also reduce the banks’ respective systemic risks. Were a crisis and ensuing short-sellers’ run on the banks occur, holding more dollars in reserves might not buy a bank much more time. It did not take long for Lehman Brothers to run through its cash once the short-sellers set in.

In short, the U.S. Attorney General could have taken a more systemic view and a related pro-active approach oriented beyond holding the banks accountable by including measures that would have provided the public with more confidence that the sector would be more competitive in the future.

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1. Loretta Lynch, “Attorney General Lynch Delivers Remarks at a Press Conference on Foreign Exchange Spot Market Manipulation,” The U.S. Department of Justice, May 20-, 2015.

2. Ibid.

3 Ibid.

4. Ibid. Lynch said that the banks’ concerted actions “inflated the banks’ profits while harming countless consumers, investors and institutions around the globe—from pension funds to major corporations, and including the banks’ own customers—who placed their faith in the market and relied on it to produce a competitive exchange rate.” Ibid.

Stockholder Activism at DuPont: A Conflict of Interest for Management

In American corporate governance law, the business judgment rule gives management expertise the benefit of the doubt over stockholder proposals. Compared with executive skill, they look rather populist and thus potentially irrational in nature. Nevertheless, with the rule chaffing up against the property-rights foundation of corporate capitalism, the managerial prerogative can be said to be dubious. Indeed, a strict private-property basis justifies displacing the default profit-maximization mission for a given corporation. Alternatively, stockholders may want to use their concentrated, collective wealth for other purposes, such as to alleviate hunger. Once enough profit has been made for the business to be sustained for another year or two, any additional surplus would be spent on food pantries, for example, rather than going out as dividends or being retained by the corporation. Because managerial skill is premised on the profit-maximization goal and its associated strategies, corporate executives intrinsically resist alternatives proposed by stockholders. The managers face a conflict of interest in providing their recommendation for stockholders. Even when the proposal assumes profit-maximization but differs from a current strategy (i.e., adopted by management), a conflict of interest exists should the management seek to provide a recommendation for the stockholders.


The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Is Dark Trading Ethical?

Dark trading” has a subterranean connotation, as if it were done by slithering snakes in the river Styx. In actuality, the term refers to trading in stocks that is done on computers that are less public than the exchanges. That is to say, the bid-and-ask quotations on a given computer network are known only to participants on it, and not to the traders on the public exchanges. Ethically, the public-private dichotomy is relevant. I submit that it reflects a wider trend in American society.

The full essay is in Cases of Unethical Business, available in print and as an ebook at Amazon.com.  

Wall Street’s Maker-Taker Rebate: An Inherent Conflict of Interest

On June 14, 2014, the U.S. Senate Investigations Committee held a hearing on “High-Speed Stock Transactions and Insider Trading.” The issue at hand concerned the payments that wholesale brokers and exchanges make to brokers for going through the brokers and exchanges, respectively. An academic study had found that the broker or exchange that pays the most is not typically the most efficient, and thus in the best interest of the investor. Essentially, the payments give rise to a conflict of interest for the retail broker, who is supposed to put the client’s financial interest first, before his or her own. Is greater disclosure, such as Sen. Levin suggested, sufficient? I contend that a conflict of interest that is inherently unethical warrants removal rather than countervailing measures.   
 

Investors assume that exchanges such as the New York Stock Exchange are not tilting the game-board. Empirical evidence indicates that this assumption does not hold up. (Image Source: Reuters)

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Justice as Fairness: Writing Down Greek Debt

In 2012, 80% of Greece’s private creditors agreed to “voluntarily” convert their Greek debt into debt of a bit less than half the face-value (plus a lower interest rate). With such a proportion having agreed to the swap without triggering credit default swap insurance payouts, Greece could get the E.U. to agree to force the remaining 20% to involuntary write-downs. That would trigger the credit default swaps, at least in theory.

The full essay is at "Justice as Fairness: Greek Debt."

Long Term Capital Management: An Institutional Conflict of Interest

By 1997, “after three years of strong profits for LTCM, the opportunities were drying up. There was too much money chasing the same investments. . . . In early 1998, LTMC decided to give a large portion of its capital back to its original investors because profitable opportunities were so hard to find. At the end of 1997, LTCM had nearly $7.5 billion under management, compared to $1 billion when it started, and it now returned $2.7 billion of that to investors. The partners also figured that they could, if necessary, simply leverage their portfolio further to compensate for the loss of capital, which would compound their personal gains. Greed was at the heart of what turned out to be a disastrous decision. . . . Unable to reproduce the returns of the first three years, LTCM took increasingly more risk, abandoning its purer arbitrage for the kinds of ‘directional’ investments Soros made and LTCM had so long disdained—such as trying to forecast interest rate and currency movements. More and more of these trades were unhedged.”[1] Furthermore, “LTCM’s risk models—VAR and related statistical tools . . . –were misleading.”[2] For example, diversification was little protection if there was a run on the banks. When Russia defaulted on August 17, 1997, LTCM’s hedges against its Russian investments were worthless. Furthermore, because all fixed income assets fell sharply in value, “diversification, it turned out, did not matter. The finely calculated relationships on which LTCM was built and which the firm always believed would hold started to come apart. VAR could  not account for such an unlikely but sweeping event—an event in which everyone wanted out at the same time and almost all investments fell significantly in price. The use of VAR itself precipitated much of the selling. Commercial banks under the jurisdiction of the Basel Agreements, which . . . set capital requirements based on the level of VAR (the lower the VAR, the lower the capital required), were forced to sell assets to raise capital.”[3] LTCM lost $1.9 billion that August. Eventually, fourteen banks, organized by the Fed, put together loans of more than $3.5 billion to purchase 90 percent of the firm.” LTCM “did manage to sell down assets in an orderly fashion and by early 2000 it was essentially out of business”[4] 


The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

1. Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (New York: Alfred A. Knoff, 2011), 277-81.

2. Ibid.

3. Ibid.

4. Ibid.

Amid Record Bonuses Goldman Sachs Enabled Greek Debt

The person who has the gold makes the rules.  I suspect this is the operating mantra at Goldman Sachs even after the bank’s near-death experience (when Solomon Bros stock was taking a hit, Blankfein knew his bank could be next).  As it turns out, the bank was involved in enabling Greece to stealthily spend beyond its means. Just after Greece had been admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means. Additionally, in late November, 2009— three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in Athens with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.[1]

The full essay is in Cases of Unethical Business, available in print and as an ebook at Amazon.com.  

1. Louise Story, Landon Thomas, Jr., and Nelson D. Schartz, “Wall St. Helped to Mask Debt Fueling Europe’s Crisis,” The New York Times, February 13, 2010.