"Investors - The Forgotten Class"

Sydney M. Williams

Thought of the Day

“Investors – The Forgotten Class”

February 22, 2011

Matt Taibbi, in the March 3, 2011 issue of Rolling Stone asks a fundamental and unanswered question: “Why isn’t Wall Street in Jail?” A good question, but I would add a second, “Why are not some of our lawmakers also doing time in the pokey?” The country suffered a near death experience in the fall of 2008, yet Washington and Wall Street continue to operate as though very little has changed. For example, the CDS market, which bankrupted AIG and has cost the American people billions, still functions with no limits. As Mr. Taibbi writes, none of those on Wall Street who bore responsibility for the near collapse have been imprisoned.

It is not that the U.S. is shy about jailing miscreants. According to the Bureau of Justice Statistics, 7.2 million Americans, at year end 2009, were on probation, in jail or in prison. At 3.1% of the population, that represents the highest documented incarceration rate in the world. Fines have been paid, but they do not nearly compensate for the losses incurred by shareholders; nor do those fines adequately reflect the fact that taxpayers have been tapped for the misdeeds of a small but select group of CEOs, who used public companies for their own purposes.

The Press, in their quiet acquiescence, has been too often too silent on this matter. On Friday, Ben Protess writing in the New York Times declared that the $22.5 million dollar fine levied against former Countrywide Credit CEO, Angelo Mozilo, and the forfeiture of $45 million in ill-gotten gains was “a fitting outcome for a corporate executive who deliberately disregarded his duties to investors.” What Mr. Protess neglects to mention is that in the single year preceding the Company’s collapse Mr. Mozilo took $143 million and investors lost $36 billion, or 90% of their investment. Why should Mr. Mozilo be left a rich man?

Washington and Wall Street have always had a symbiotic relationship that crosses Party lines. Democratic Chuck Schumer has always been considered Wall Street’s favorite Senator. In 2008, after unions, Goldman Sachs was Barack Obama’s single largest financial contributor. Representative Barney Frank and Senator Chris Dodd were, financially, far too closely affiliated with Fannie Mae and Freddie Mac, taking in funds raised by the two GSEs and, in return, providing them cover to over-leverage and engage in transactions unrelated to their charter. As bonuses were determined by earnings, there was an enormous temptation to cheat. Between 1998 and 2003, Franklin Raines, former CEO of Fannie Mae was paid $90 million. According to a report issued by the Office of Federal Housing Oversight Office (OFHEO) in 2006, $52 million of that compensation was based on earnings from faulty accounting, yet he was only fined $24.7 million. With shareholders having lost about $60 billion in market cap (reflecting a 97% decline in the stock) and taxpayers forking over $150 billion (thus far), the fine seems piddling relative to the magnitude of the crime. Why should Mr. Raines be left a rich man?

Richard Fuld, who skippered the good ship Lehman Brothers onto the shoals in 2008, was paid $484 million between 2000 and 2007. After the bankruptcy, his net worth was, according to his own testimony, about $350 million, indicating that he was smarter than his shareholders. He even managed to sell his $13 million house on Jupiter Island, in November 2008, to his wife for $100.00. In February of 2007, Lehman stock was valued at $60 billion. By October 2008, it was worth nothing. Again, shareholders were left holding an empty bag, while the captain of the ship remains exceedingly rich. Mr. Fuld is yet to be charged. Why should be Mr. Fuld remain rich?

Mr. Fuld was far from unique among Wall Street CEOs. How can one forget Lloyd Blankfein, CEO of Goldman Sachs, claiming that his firm was doing “God’s work”? He did so while making billions for himself and his partners, but little for his shareholders, as the stock is lower today than four years ago. Regulators and Wall Street professionals regularly exchange jobs, suggesting the ties are nepotistic, not independent.

Toward the end of his article, Matt Taibbi writes: “All of this paints a disturbing picture of a closed and corrupt system, a timeless circle of friends that virtually guarantees a collegial approach to the policing of high finance.”

The capital markets are critical to our well being. It is very possible that populism will emerge in reaction to the corruptness of the system. Politicians who financially benefitted from their ties to Wall Street will be quick to swing the other way, as the winds shift. Despite their rhetoric to the contrary, too many of these people have no interest in any future beyond the next election. Debt and obligations, particularly from entitlements, threaten to overwhelm our nation. It is convenient to find scapegoats and Wall Street, having sinned, stands out as a target. The problem for our markets is that politicians do not seem to differentiate between investors and those who led these firms. About half of all Americans have exposure to stocks, through pension funds, 401k plans and thousands of mutual funds. The decline in defined benefit retirement plans (today, almost exclusively the domain of public pension funds) and the rapidly approaching bankruptcy of Social Security point to the necessity of people having to become more self reliant, in terms of retirement. That will require a vibrant, open and tax-advantaged stock market.

Wall Street has become increasingly dependent on trading strategies, as can be seen by the rapid growth of algorithmic high frequency trading platforms, a subject about which I have often written. Simultaneously, long term investment strategies have declined in popularity. Sarbanes-Oxley, perhaps well intentioned, has had the effect of reducing the number of publically traded companies. The effect has been to limit opportunities for investors (and for employment) at a time when both are needed. Money, seeking returns, has been forced overseas and into debt markets.

Thus, the on-going debate in Washington, Wisconsin, New Jersey and New York is welcome, as they are integral to the problems we face. Governors Chris Christie and Scott Walker have done us a favor, in putting on the table subjects no one wanted to address, including benefit plans for public employees that are unavailable to private workers and are threatening society. On this day, the real birthday of our first President, it is worth being reminded that George Washington was acutely aware of a similar problem. Ron Chernow, in his biography, Washington: A Life, writes that Washington had often expressed the view that “citizen’s had to feel before they saw – that is, they couldn’t react to abstract problems, only tangible ones.” We now have tangible problems and they include the plight of investors who have been given short shrift by too many politicians and by too many CEOs who have used assets owned by shareholders as their personal piggy banks.