Tuesday, March 22, 2011

Inside Job: A Hollywood Analysis Of The Financial Crises.

The financial crises wrecked trillions in share holder wealth, brought the largest economy of the world to its knees, caused a global crises of proportions unseen since the Great Depression, rendered millions unemployed, devastated the pensions of many and so much misery. At the epicenter of this mega quake, runs the easiest narrative, are a bunch of CEO's in a small street on an island. You have Wall Street CEO's as villains, working class unemployed, law breakers, whistle blowers, arrogant government agencies, economists peddling philosophies conducive to lining their pockets and if with all these elements one could not cook a cocktail that begets Oscar what is Hollywood worth? So we got 'Inside Job', Oscar winner for documentary in 2010.

First, "Inside Job" does get it right on several issues. They present an accurate, albeit simplified, picture of the securitization process of mortgages. Wall Street drinking high on mathematical wizardry and exotic products, that bewildered even the veterans of the trade, went high on adrenaline and certainly became reckless in pursuit of profits and outsize bonuses. The incestuous ratings agency world which rated many of these exotic products as AAA (like a government bond). Ivy League economists on the board of companies and doing consulting for Hedge funds promoted "de-regulation" as mantra in classrooms and think tanks. Wall Street abounded in terms like Derivatives, dark pool trading, flash trading, SIV (Structured investment vehicles), CDO's (Collateralized Debt Obligations), CDS (Credit Default Swaps), OTC (Over the Counter), market makers and so much more.

Wall Street culture of focusing on quarterly reports, investor returns and of course the much maligned multi-million dollar bonuses were all factors in cooking this stew. Yes the Cassandra's like Brooksley Born who wanted to regulate the OTC and derivatives market in the late 90's were snubbed and silenced. When Raghuram Rajan presented a paper on the perils that awaited the financial industry he was roundly snubbed by his peers that included the high and mighty.

Harvard and Columbia economists consulted, for a fee, to hedge funds, were board members of companies like AIG etc. The voice over in the documentary wondered that its no surprise that these economists with forbidding credentials provided the intellectual mainstay for 'deregulation' and for incessantly promoting a "free market is the cure-all" approach. On this point I strongly agree with the criticism. Its pathetic to watch a Harvard economist grunt and grunt and grunt as to this glaring conflict of interest. He had no answer. Martin Feldstein, a Harvard economist and John Bates medal winner, was on the board of AIG, when asked how he felt about how AIG imploded thanks to exotic insurances that simply had no economic rationale, he just glares.

The ratings agencies are a law unto themselves given that only three are there (Standard and Poors, Moodys, Fitch). They routinely rated many of the complex investments as 'investment grade'. Ratings agencies are invited by investment banks and paid to rate the structured investment. This setup naturally presents a conflict of interest.

So far so good but then this is Hollywood. A case in point is Raghuram Rajan's appearance in the documentary. I've read Rajan's bestseller "Fault lines" that presents the financial crises as the result of a multiplicity of factors way beyond the simplistic narrative that is being peddled. Rajan faults a wide array of reasons and asserts that those reasons still exist, despite the gargantuan regulation that was steam rolled into congress. The documentary uses Rajan only to present as yet another Cassandra who was shunned. They fail to engage or present the other causes Rajan highlights. I guess that did not fit with the narrative of "CEO's are villains".

Barney Frank , democrat and powerful Chairman of 'House Financial Services Comittee', appears helpfully and upbraids Wall Street. Sure he is correct. But pray why no mention of his role in preventing overhaul of Fannie and Freddie, the GSE (Government sponsored enterprises). Fannie Mae and Freddie Mac, called Fannie and Freddie, were setup to bundle home loans and be the last stop in the mortgage market. Both were raided by, mostly democrat, politicians to further their own agendas of promoting home ownership amongst the poor. Rajan highlights how politicians used the mantra of owning a home, the 'American dream', and the GSE's as tools for social policy thus playing no small role in the financial crises. Weeks before Lehman was buried the GSE's were effectively nationalized. The documentary was  dishonestly and eerily silent on Fannie and Freddie and politicians. By the way one reason why any reform of GSE's was not done by democrats was because the President who proposed it was 'George W Bush'.

The documentary focuses, for several reels, on how wall street traders used escort women and frequented strip clubs. This, I found, is the most distasteful character assassination. Its takes a certain chutzpah for a Hollywood documentary to fault an entire industry for what a few indulge in. By the way the strip clubs are strictly legal entities to which anyone can go to.

In what could be the height of hypocrisy, Elliot Spitzer, who thinks of himself as crusader against Wall Street makes an appearance and bemoans how the courts would not be more aggressive in pursuing criminal cases against the CEO's. After all when billions are lost there HAS to be a crime behind it. The documentary time and again bemoans that no CEO is behind bars on a criminal charge and how often cases are settled by paying a penalty. As Spitzer fades into the background the documentary helpfully notes that he was made to step down for a simple infraction of law without mentioning what it was. Spitzer was bust in a prostitution raid. Spitzer had broken banking laws of structuring payments to high priced escort girls while he was Governor of New York. He had to step down because he was holding a political office and his position became politically untenable to hold. As Governor he had burnt his bridges with his opposition by his steam rolling, sometimes legally questionable, tactics. Today he is a high priced anchor on CNN. We call that an "American story of redemption".

That no bank CEO is behind bars is something the director cannot fathom or tolerate. Short of accusing the legal system as being in the pocket of Wall Street he indulges in casting aspersions as to why no criminal charges are filed against, for instance, Angelo Mozilo the CEO of Countrywide, the largest sub prime lender that went belly up. Then of course no vilification of Wall Street is complete without tarring Goldman Sachs.

Goldman Sachs was sued by the SEC in the most sham manner that smacked of witch hunting. The country was practically crying for the blood of Goldman Sachs. SEC sued Goldman over a fund that went bust costing investors of a hedge fund tens of millions. "Goldman bet against investment they sold", "Goldman structured the investment to fail so they could make money while their clients lost", etc etc screamed headlines. Even 'Wall Street Journal' did not do justice to explaining what is a very complex structure. I can understand populist magazine like 'Time' indulging in Goldman bashing. WSJ exists only to educate readers on finance. Its beyond the scope of this blog to explain why the case finally fell through. Goldman, as its CEO testified in congress, did NOTHING wrong. In fact many industry insiders bet that Goldman would walk away and that this was a politically motivated case by the SEC.

Compensation is another favorite stick to beat Wall Street CEO's. It does not matter that Tom Hanks, Tom Cruise, Julia Roberts, all A-listers, draw minimum $20 million per movie. Entertainers like David Letterman (philanderer too), Jay Leno etc sign contracts that are worth tens of millions of dollars. Sportspersons and Rock stars sign contracts with outlandish payments. Thats ok. When a Wall Street CEO who signs on papers that make him legally liable for billions of dollars gets a 50 million pay day its all hell break loose. Lets take this compensation question at depth.

It is a wall street tradition that a significant portion of compensation is called 'bonus'. From the lowly IT person to the highest echelons its the bonus that most eagerly look forward to. Financial industry is heavy on bonuses because its the financial industry and most importantly because the work load and tension is indeed not comparable to most other industry segments. Ask an IT person supporting a trading desk application. His/her job is far more tense than an equivalent job elsewhere and very saliently here when an application goes down the monetary quantification is immediate. So its no wonder that IT people prefer to work in banks. If its so for just IT people when we are talking about a trader who is bringing in business worth tens or hundreds of millions of dollars then its natural that they rake it in during bonus time. Also lets face not just New York City even New York state depend on those bonuses being spent. If comparisons are made with what unionized workers make versus traders that argument is not even worth having.

Golden parachutes are another pet stick to beat CEO's with. Stanley O' Neal, CEO of Merrill Lynch, departed Merrill with $160 million after helping sink a storied company. Shameful. Bob Nardelli departed Home Depot with $200 million after Home Depot stock languished for years. Despicable. But wait. Their successors were not so lucky. Wall Street, stung by the criticism and shareholder revolt, is re-drawing compensation provisions with 'claw back' clauses, significant portions of bonuses of CEO's are now given as deferred stocks contingent on performance. Conan O'brien, late night comedian, had his show canned for dismal ratings. He walked away with $30 million, no outcry only sympathy. Tom Cruise is still A-lister after his last movie plainly bombed. I am sure Matt Damon, the narrator in the documentary, would love to have his salary regulated by somebody sitting in DC.

Oh wait the bailouts. The much maligned "TARP" bailouts. Obama, as candidate, used to scream 'wall street is being bailed out while main street is languishing'. Here is a less known nugget on TARP. The US government was laughing its way to the bank when the banks that it loaned money (some like JP Morgan and Goldman were forced to take it) repaid with punitive interest in short order. Even the AIG bailout is turning out profitable. Often some smug politician would say that Goldman, apart from the $25 billion it was forced to take, benefited immensely from AIG bailout. The implication being that if AIG had sunk Goldman would have followed suit. Andrew Ross Sorkin, author of bestseller 'Too big to fail', in a column put a stop to that saying recently analyzed records showed that Goldman was indeed well covered for an AIG bankruptcy. But the urban myth persists that Goldman siphoned AIG bailout money and would have sunk otherwise. As a result of TARP money being repaid FDIC made record profits last year.

Now for some brief notes. Ask any American on the road which President they blame most for the crises the answer will be 'Bush'. But guess in whose presidency were banks de-regulated? Guess who was the President when Brooksley Born was silenced? Bill Clinton. While Born looks like a prophet in hindsight lets remember that hindsight is always 20/20. In the Clinton era America was drunk high on its economic fundamentals having buried communism. 'How high is high' used to be the mantra. During his impeachment Clinton was touring Russia. Clinton would call back home and ask "how is the Dow today". As long as the economy kept soaring he was untouchable. By the way Clinton did finally accept that he committed perjury. He was pardoned with a slap on his wrist by taking away his license to practice law. Talk about suing for crimes by CEO's!!!!

The documentary makes it sound as if Alan Greenspan and Larry Summers benefited from preventing regulation of derivatives as Born suggested. Alan Greenspan did not own a penny in stocks until he remitted office. Not even in blind trusts, such was his probity.. Regulation is at best a necessary evil and at worst a job killer. There is always a creative push and pull between the desire to regulate a commercial activity and the industry captains who profit from keeping it unregulated. Neither should become a run away truck. The dot com bust gave rise to Sarbanes Oxley and completely altered the landscape of the accounting industry. The current Dodd-Frank regulation will undergo several evolutionary changes and the financial industry will also change from within and without. Regulation is not a panacea for all ills. We can only regulate what we understand and what we know might come. Financial innovation is outstripping the ability of government agencies to understand and regulate.

I dont see a problem with economists advising hedge funds and promoting economic principles that they apply in the market. I'd have a problem if economist practiced capitalism in private life and taught socialism to students or vice versa. The association of economists is addressing better disclosure norms. Likewise this canard of Government Sachs, implying that the US government is run by Goldman Sachs personnel is stupidity. Who would I have as US treasury secretary, somebody who has experience running a billion dollar corporation or some academic who only dabbles in theories? Often the documentary succeeds in insinuating covertly. There is not a shred of evidence that anybody from Goldman Sachs profited from their decisions as government executives. Snide remark that Paulson profited from tax write offs when he had to sell his Goldman Sachs shares when he became US secretary of treasury is a cheap technique. Such sops are required to attract talent from outside corporate world and this is necessary because they HAVE to sell their stocks prior to taking over such positions. Who would have wanted Paulson's job in September 2008 when the world came crashing down? Lets thank the man for saving the world.

The ratings industry is undergoing a sea change. The fact that they are paid by companies asking for their products to be rated makes it appear an 'inside job'. Reality is more complicated. As much as terms like casino capitalism abound the US model of capitalism does have its redeeming features without which America would not be where its today.

I'd rather live in chaotic America than live in Ukraine as farmer when what I sow is decided in Moscow. Also I am still waiting to see a Hollywood documentary on how Unions ran down the car manufacturers, how Unions wrecked the state of California, how Unions and pension burdens are decimating countries. Would that not be some documentary to make????

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