Bailing Out Corporate America

Bailing Out Corporate America
(by: Rene Velez Sept 24th, 2008)

I have been wanting to contribute my own thoughts on the recent events of bailing out corporate America. But first I have to get some things off my chest. This is truly embarrassing but not a surprise. The level of greed in this country has reached a new level. Not to be undone is the level of in-competency our government has shown and the absolute inability of regulatory agencies to function for the public good.

Recent events show clearly how management is willing to push the numbers of corporate America to prop up earnings under a business model that is little more than a house of cards. While at the same time meeting the objectives, however unfounded, and in this case insane, that lead to lucrative executive compensation packages and golden parachutes. Clearly, not only should these executives not receive what amounts to excess compensatory packages, but I would investigate and prosecute the executives and the board, who demonstrated reckless abandon for what is now economic terrorism.

Sarbanes Oxley, has done nothing as there is no mechanism to measure and to judge the magnitude of a failed business model in light of poor management. In the case of AIG the $85 billion bailout figure will surely cost more. To think this is an insurance company, an actuarial business, who can calculate that you could extend your life expectancy another 5 years by eating a brand muffin every morning. Yet despite sophisticated mathematical models that predict probability they fell drastically short, in fact claim they were totally unaware of, predicting their eventual demise and collapse.

To think that no one dared to think that the real estate market could tank from oversupply, despite warning signs that were everywhere. To think that no one dared to question a home that increase in value 55% in two years might suddenly fall in value. To think the government truly did not know that income levels for the average American were far behind the appreciated prices of housing, To think that no one thought that the shear volume of collateralized securities could suddenly tank due to a market correction in the real estate and the credit markets. That no one in the mortgage community ever stopped to think what would happen to all those “No Document” loans that were issued with no income verification and virtually no credit worthiness.
The reality is that the securitization of mortgages transfers the risk of performance of those loans, in this case, directly to the stock market. In effect the mortgage business became a game of musical chairs, where many were left without a chair. Whatever happened to the traditional banking and mortgage model where money was earned the old fashion way? What happened to the five “C” of credit? Credit Worthiness, Collateral, Character of Borrower, Credit Risk, Cash Flow to Repay? It seems that lending model is too difficult! Why bother when you can make a mint on volume transactions and a ready market to transfer risk. The old theory of the free market has gone astray, and we should hold regulators accountable for not seeing it. Our federal government is to blame as well. The shear size of this newly created market, together with unprecedented real estate values was a clear indicator for all. A free and self correcting market was thought to allocate capital from the capital markets based on ascertainable facts based on the five “C’s” of credit. Capital is best placed where the likelihood for success and repayment were deemed to be the best. This did not work in this fiasco. Simply put, capital simply followed those who could place it the fastest and they in turn made money from packaging and issuing securitized instruments as fast as they could. The fundamental basis for proper allocation of capital was totally ignored. This neo mortgage securitization model of the mellenium was ripe for a wall street collapse. A collapse that is being compared to the calamity of the great depression.

Although a government bailout is difficult to swallow, I must admit that at some level it must be done. I have heard many say, to hell with wall street let them suffer and pay the price. The truth is that this is not about wall street loosing a lot of golden eggs, but more so the shear magnitude of the problem indicates that the golden goose is in critical condition. In this case it is the same golden goose that provides the golden eggs for all of us. So we must have government intervention to save us all. However, we must be very careful. Bernanke and Paulson both have deceived the public by not coming out sooner with the bad news. It is difficult to discern if this was negligence, incompetence or complacency. Either way they should have been sounding the alarms many months if not a year or so ago. So, we should not be so ready to react simply because now they are sounding the alarm. Some have made this quick and irrational response to a crisis similar to how we made the mistake of invading Iraq. This crisis is with us now and will be despite any government intervention so I would venture on taking some time to think through how all this works out.

The Positive Correction

The truth be told, after a significant market correction, mortgage backed securities will flush through our economy. Let us not forget, despite overvalued properties and the cost of non performing loans, these securities are collateralized and some tangible value is still there. So the bottom may not be as grim as it could be. In fact if these non performing and securities are repackaged and properly analyzed, purchased at a significant discount and held by our government, taxpayers could stand to make a profit. All this while injecting liquidity into the financial system. The question is whether our government can in effect make that work efficiently. Having said that we should look for private equity funds as well as foreign markets to invest in this venture. We should leverage our global economy so we all benefit from this process and not absorb U.S. taxpayer funds.

Punishment

We must take corrective action to teach reckless management a lesson. Corporate America should not be let off the hook. I would be very disappointed, although not surprised, if those responsible were let off easy. Government officials and regulatory agencies deserve to be held to the same standard. No lucrative compensation packages. Seek damages from management and the board. Conviction if criminal intent was involved.

Regulation

We must learn from this, create a mechanism that prevents this from happening again. This mechanism must be designed so as not to be too costly or burdensome on our capital markets, Sarbanes Oxley, does not really work, did not work here and is too costly. We can not maintain a competitive capitalist economy and compete globally with these types of regulations. There are other ways to accomplish this. If only the accounting profession was more aggressive, innovative and dared to think out of the box. It’s time for the accounting profession to show what it can do rather than taking its cues from the corporate infrastructure and government beaurucrats.
Colleges and Universities need to institute more corporate governess and ethics courses. I know that to many this seems like trying to address a cancer by prescribing an aspirin. Yet what should be evident to all is that corporate America is lacking in the fundamental precepts of how to crate value and sustain shareholder worth through true and tried methods. We seem to have a whole culture of executives who’s greed and desire to obtain quick results together with the true stresses of managing large corporations have time again yielded severe consequences in the long term. The results of many of the major critical issues of today, have a fundamental tie to short term, shortsighted management and government.
We had an oil and energy crisis in 1974, we did not learn. We did not diversify energy sources. Our auto manufacturers did not compete effectively against the Japanese. We’ve known we have an immigration policy issue for many years, we have not fixed that. We have been talking about the environment and the effects of pollution for over 40 years, we have done nothing. Healthcare is not new either. Terrorism was in someone else’s back yard so we turned the other way.

Reinventing our Government

We need to create a system so that government works for the people. Currently it does not. Our political system is geared towards and for the benefit of those with the most economic power. Those who have the most lobbyists and are behind PAC’s are those that have a stronger voice then the ultimate voters. We simply can not wait any longer for the general public, to come up to speed on the issues in order to then create a force to move our political leaders. What we can do however to is to create a system of transparency in government by creating milestones to the issues that face our nation. Initially. The agenda is simple as we have at this moment in time quite a number of issues that need immediate attention. We need to create a timetable with specific and quantifiable performance measurement standards to move this country into the 21st century. Our system of government, our capital markets, our corporate governance and our position in a global economy are being managed based on industrial era concepts and models. This simply will not get us there. We need a JFK, man on the moon, style of timetable to kick this great nation into gear. Some of the critical areas:

(1) Energy independence by energy type and source diversification.
(2) Transportation sector innovation and technology.
(3) Global economic development and restructuring trade flows.
(4) Healthcare Reform. / National Healthcare System
(5) Social Security System Overhaul.
(6) Immigration Policy Enforcement and Repatriation.
(7) Federal Government Realignment based on Critical Path Initiatives
(8) Educational System Restructuring.

For those of you who have any doubts, China has become a formidable power because of some very simple factors:

(1) Focused National Initiatives (Timetable Effectiveness)
(2) Small, Unified and Nimble Power Structure. (Efficiency)
(3) Global Market Initiatives (Assimilation into large markets)
(4) Shear mass of population. (actual productivity / vritual)
I should note that although China has mostly unskilled labor, its workforce takes great national pride in the work they do. Reminds me of days past when Americans were more unified. We could learn from the Chinese.

The Bailout

Lets not create a bailout that leaves taxpayers holding debt. Lets create a profit sharing scenario that pays our federal government for the bailout. Forget free money. All bailout funds need to be repaid in some way shape or form.
We need to create a system to make sure what we buy, hold or acquire has determinable value and or risk. This should under no circumstances be a giveaway. The government should act like any white knight who does so with a profit motive and not just for the sake of keeping the company alive.


The Real Fiasco

The darkest side of all of this is that everyone involved is to blame. Consumers took out loans they knew they could not repay. Some homeowners became homeowners but did not have the resources or earning potential to acquire a home. A sad testament to the sheer demand for housing by the masses of the working poor. Yet businesses and institutions preyed on unknowledgeable consumers who were not educated enough of finance to make better decisions. A sad truth about the financial literacy of the people from the richest nation on earth. Our regulators failed to judge the magnitude of an unjustified new capital market through securitized mortgages. Insurers failed to recognize the magnitude of risk by taking large positions on real estate driven transactions. Our government, as usual, was asleep at the wheel and reactionary til the end. The only winners are those that timed their entry and exit at the right time, and with barely a contribution to the production of tangible wealth.