[AGL] Fw: naked capitalism: Nails in populism's coffin lid...

[Frances Morey]

Why is it that I feel so powerless in the face of capitalistic fascism? 
Best,
Frances

--- On Sat, 5/16/09, naked capitalism <blogger at nakedcapitalism.com> wrote:

From: naked capitalism <blogger at nakedcapitalism.com>
Subject: naked capitalism
To: frances_morey at yahoo.com
Date: Saturday, May 16, 2009, 6:05 AM





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naked capitalism 





Links 5/16/09 
Posted: 16 May 2009 12:36 AM PDT


Deserted Mexican hotels offer flu-free guarantees to lure visitors Financial Times

Home of Slumdog Millionaire child actor destroyed by Mumbai authorities WSWS (hat tip reader Elaine)

The Thirst For Risk Tyler Durden

Economic Recovery Still Months Away: Roubini, Rogoff CNBC

Ready, Shoot, Aim Menzie Chinn, Econbrowser

The Worst Is Yet to Come Jesse

Credit Card Defaults Reach Record Highs in April CNBC

Volcanism in Saudi Arabia Paul Kedrosky

U.S. money manager takes aim at subprime servicer Reuters

FDIC “Clarifies” Bair Comments about Bank CEOs Rolfe Winkler

China Power Production Fell 3.9% in Early May, Securities Says Bloomberg (hat tip reader Michael)

The IMF is hurting poor countries Mark Weisbrot, Guardian

America’s phobia of banks Simon Schama, Financial Times


Antidote du jour. These are pictures of Jacob, via Dennis:




        


Guest Post: Is the System Still Rigged? 
Posted: 15 May 2009 10:31 PM PDT


Submitted by Leo Kolivakis, publisher of Pension Pulse.


A past colleague of mine wrote an excellent article in the Montreal Gazette. Consultant Luc Vallée, the former chief economist at the Caisse de dépôt, thinks the system is still rigged:



The end of April marked the first 100 days in office of U.S. President Barack Obama; elected on the promise of change. Change we could believe in.
I believe that he meant it. However, by now, he met all these nice Wall St. types; powerful, quite smart, extremely charming and actually very convincing guys. Like President Obama, they want to re-establish trust in the system but they also want the system to keep working in their favour.
So how did the new president perform so far on reforming the financial sector? The approval of the markets during the last few weeks certainly suggests that he has done quite well. But let's take a closer look at things.
In raising the rhetoric against free trade and bonuses, Obama definitively tried to side with the average guy. But that sort of populism won't do it. Free trade was the backbone of global prosperity for the last few decades. Stopping it would put us on a destructive path. Moreover, bonuses are, unfortunately, legal contracts. However tempting it may be, nullifying these contracts certainly would be a trust buster. And who knows what might happen if America starts going down that path?
There are a lot of very tempting things that I refrain from doing in my life because I know they would come back to haunt me later. I choose, instead, to go see a hockey game if I need some release for my frustrations. I call this happiness by design! So far, the president has resisted his initial populist impulse but has not yet proposed viable alternatives.
Take the case of executive compensation. The problem is not with the bonuses themselves, but rather why and how some of these bonuses were awarded in the first place.
Indeed, I have nothing against flexible or performance-based compensation. It may actually be a very effective way to increase the flexibility of the U.S. economy and to help reduce unemployment in times of crises. The problem lies with the system of governance that awarded the bonuses and hence created their perverse structure. Many of those payment schemes would never have seen the day had they been designed by people held accountable for their actions. Making executives and directors personally liable for unpaid bonuses would certainly help focus their attention.
Obviously, when individuals have the power to design their own incentive reward system, abuses can be expected; all the while claiming that it is all in the shareholders' interest. The privatization of gains and the socialization of losses suit many people just fine if they stand to gain more as bonus recipients than they stand to lose as taxpayers; perhaps not very ethical but human nonetheless. That is precisely why we have the separation of powers in so many of our institutions: to avoid such conflicts of interest.
Similar dynamics led U.S. banks to overlook the opportunity to recapitalize themselves more aggressively last year when there was still time to save the financial system and the economy. It was socially optimal to do so, but the optimal private decision for a banker was to avoid dilution and gamble that the system would survive or be saved.
By doing nothing, at least bankers stood a chance to avoid dilution if the system endured. Obviously, if all bankers had raised enough fresh capital, they would have increased the likelihood that the financial system would survive. However, each individual banker elected instead to do nothing as their individual private gain would have been maximized if "others" behaved responsibly. Obviously, every selfish banker, able to make the same reasoning, waited. In any case, they figured that, in the eventuality of a disaster, the government would come up with the money. And the money did eventually come. One must admit that the system does appear to be rigged in favour of the few and that it undermines the welfare of its citizens.
What should we then think of the latest plan proposed by Treasury Secretary Timothy Geithner to save the financial system? Private equity and hedge funds are to buy toxic assets from banks using government subsidies. Isn't that the left hand selling assets to the right hand? The left hand gets to clean its balance sheet and gains access to fresh capital while the right hand stands to make a killing if the plan succeeds; while leaving the taxpayers to clean up if it does not. I get the feeling that both hands belong to the same banker's body while the only taxpayers' involvement is to finance the scheme and clean up the mess.
What else could be done? Reduce outstanding mortgages for those who need it the most, improve financial information and draft regulation that aims to get rid of conflicts of interests and sets the right incentives for executives. In other words, democratize finance! Wouldn't that be a change we could really believe in?Democratize finance? For that we need the unemployment rate to double from these levels and a social revolution. I doubt either will happen anytime soon but who knows, 2009 isn't over yet and 2010 might bring some nasty surprises.

Let's look at the latest attempt to "democratize finance". The vilification of credit-card companies—not entirely undeserved—has reached fever pitch. On Thursday, President Obama gave a speech in Albequerque, N.M. and shared some of his thoughts in an effort to help push through a bill, currently in front of Congress, that would overhaul the way the credit-card industry interacts with its customers, including the interest rates and fees it charges:

"You should not have to worry that when you sign up for a credit card, you're signing away all your rights," the President said. "You shouldn't need a magnifying glass or a law degree to read the fine print." (Read "The Real Problem with Credit Cards: The Cardholders.")
The industry, naturally, is crying foul. Having the flexibility to change interest rates and charge all sorts of fees lets card issuers free up more credit for more people, they argue: folks with lower prospects for repayment pay higher interest rates, while good, credit-worthy customers don't have to pay as much. Plus, they say, now is the exact wrong time to re-legislate the lending process. Thanks to the credit crunch and soaring default rates, card issuers are already reeling in credit limits and accepting fewer new applications. "There are two ways of managing risk—for a particular borrower and across a portfolio," Ken Clayton of the American Bankers Association recently explained. "If risk-based pricing changes, lenders will have no choice but to contract credit."
That sort of thinking, while valid, misses the larger picture. If one brackets the equally-as-legitimate notion that Americans probably should have less access to credit-card borrowing and simply dissects the bill before Congress, one starts to see that the proposed changes aren't really about dictating what a card company can or can't charge people who borrow money. There's a way to do that—impose interest rate caps, as many states' usury laws do. That isn't what Congress is on track to do. Instead, the new law, which would build on regulations issued by the Federal Reserve and other agencies at the end of last year, would, above all else, inject transparency and fairness into credit-card contracts.
That goal is easily seen in the legislation's key feature: limitations on how card companies treat customers' existing balances. When you sign up for a credit card, you agree to pay a certain interest rate on the balance you carry—you enter into a legal agreement to that end—but historically your card company has been able to change that rate for all sorts of reasons. Maybe you charge up a greater chunk of your credit limit than normal. Maybe you're late on a payment to some other company. In recent years, the difference between the interest rate folks sign up for and the average penalty rate imposed later on has skyrocketed, from 8.1-percentage points more in 2000 to 16.9 points more in 2008, according to the Center for Responsible Lending. (Read a brief history of credit cards.)
Tellingly, the proposed law doesn't try to tweak those figures. If you go from being a good credit risk to a bad one, credit card companies can still take steps to make sure they continue to be adequately compensated. When you go to buy new things, they can charge you 30% a year if they want to. The thing they wouldn't be allowed to do under the new law is go back and change the terms of your original agreement—that is, hike your interest rate on existing balances—except in a very few situations, such as you egregiously failing to pay your bill (for 60 days or more in the version of the bill before the Senate). 
The approach therefore isn't to smack down credit-card companies for high interest rates, but to hold everyone to the original agreement about how much credit will cost. "Virtually no other contract in this country allows a business to change the terms of an agreement once a purchase has been made," says Travis Plunkett of the Consumer Federation of America. "That's the main issue." (One Senator did suggest an interest-rate cap, but that was shot down.)
Other provisions of the law are similarly set up. A card company can still change the terms of your contract. It just has to give you 45 days notice. It's still possible for an issuer to assess a charge when you go over your credit limit. But you'll have to have indicated that you want to be able to go over your credit limit in the first place, instead of having your card denied. Companies can still set minimum required payments however they see fit. But they'll be required to tell you how long it would take to pay off your balance if you stick to that minimum amount each month.
A few of the changes would be more heavy-handed. Those phone-payment fees would be prohibited outright (unless a customer asks for expedited service—a genuine additional cost which the card company would be allowed to pass along). It could also be substantially harder to market or sell credit cards to young people (either those under 18 or 21).
But for the most part, the bill before Congress isn't about changing the game on card companies. It's about creating a fairer set of rules to play by.
Interestingly, some think cap or limit on fees will cause credit card companies to limit their exposure particularly to minority and inner-city areas, since those with low incomes are at higher risk for default.

Others are not convinced that that the bill could cut access to credit for millions of Americans but worry that once new credit-card rules take effect next year, card companies might cut off consumer credit even more.
I happen to think that banks, credit card comopanies, hedge funds, and private equity funds have been raping people with fees for such a long time that it's time we reintroduce laws prohibiting usury.
Go back to read my comment on banking with hedge funds and bailing out alternative investments. Public pension funds investing in hedge funds that then turn around and charge desperate businesses outrageous fees to extend them a loan during a credit crisis. Not only is this risky, it's a scandal and it should be illegal for public pension funds to invest in these type of "asset-based lenders".
Earlier this week I listened to Charlie Rose interviewing Elizabeth Warren, Naomi Klein and William Greider. If you didn't listen to these interviews, take the time to watch the entire show.
There is a crisis of leadership and while millions worry about losing their pensions, including retired autoworkers here in Canada, nobody is hatching a survival plan for retirement plans. 
Finally, I don't know or care if the world's power elite is meeting Athens. I have been reading Charlie Skelton's Bilderberg files, mostly for amusement, but my thoughts are that any attempt to stop rigging the system and truly democratize finance will have to come from the bottom-up, not the top-down.

        


Thought Police II: Media Airbrushing (Including Removal of Article With Negative Comments on TARP) 
Posted: 15 May 2009 01:17 PM PDT


We asked readers to clue us in to when the media posted stories where the headline spun the underlying report. Remember, many people read only the headline of certain news items, and even if they read the entire article, it might not dispel the impression conveyed by the headline.

Sighting of the day, from reader Michael D: "Industrial Output in U.S. Falls at Slower Pace as Recession's Grip Eases" from Bloomberg, which is the headline on the news summary page. The story itself has the somewhat more evenhanded headline "U.S. Economy: Industrial Production Contracts at Slower Pace." Michael deemed the story itself to be putting the best face possible on the data. For instance:

Output at U.S. factories, mines and utilities decreased 0.5 percent last month, less than forecast, after dropping 1.7 percent in March, Federal Reserve figures showed today in Washington. The New York Fed’s Empire state manufacturing index rose to minus 4.6, also beating economists’ estimates.

Today’s figures signal that manufacturing is bottoming out after companies slashed their stockpiles of unsold goods the most on record in the first three months of the year. Continued weakness in consumer spending means demand is too low for firms to raise prices: government figures today showed the consumer price index was unchanged in April after a March drop.

“This is another signal that suggests the biggest pocket of weakness in the overall economy was the fourth quarter and the first quarter,” said John Herrmann, chief economist at Herrmann Forecasting in Summit, New Jersey, referring to the manufacturing reports. “Weakness is dissipating and the economy is poised to grow in the second half.”
A second sighting comes from Tyler Durden. We posted last night on a Telegraph story, in which one Michael Patterson, head of a private equity firm that used TARP funds to buy a Michigan bank, said some less than positive things about it at an conference.

If you go to the link to the story now, guess what? The Telegraph has yanked it.

Tyler Durden had the presence of mind to put up the entire piece on his blog. Patterson has been issuing requests for retraction, claiming "factual errors" and the Telly complied. Patterson has had his "representatives" which I assume means attorneys, send a copy of the letter that Patterson sent to the Telegraph effectively disclaiming the entire content of the artice. . Durden has said he is willing to correct any factual errors (as opposed to deep sixing the entire story). 

Patterson spoke at the Qatar Investment Forum. He has no reason to expect confidentiality; the remarks were made in a public forum with no restrictions placed on the attendees. Durden is soliciting input from fellow panelists and attendees as to what Patterson really said.

Update 4:00 PM. I am in contact with the Telegraph and Tyler Durden to understand what steps they are taking and what I can learn from that.

        


Thought Police I: More Analysis of NPR Trying to Discredit Elizabeth Warren 
Posted: 15 May 2009 07:21 PM PDT


The Columbia Journalism Review takes apart an interview by Adam Davidson of NPR's Planet Money, which we linked to earlier this week and caused some consternation among readers who listened to the program. Davidson took a combative stance towards Warren, painted her as out to get the banking industry and out of step with mainstream America (really? most Americans are as disgusted with the practices of credit card companies as she is). He also interrupted her repeatedly. 

CJR also makes a broader point: the media has been trying to marginalize Warren in a completely different fashion, by simply refusing to cover her.

The CJR points out that no banking industry executive would have been treated this way, and it's 100% correct. What it fails to note that it isn't just becoming standard practice to question liberals merely for being liberal, suggesting that a diversity of views is a bad thing. And frankly, women are easier to take on. It's socially acceptable to interrupt them, which can throw off one's line of thought. In court, it's a tactic of counsel to raise a lot objections to throw off opposing counsel. Even the mild mannered Charlie Rose at point in an interview Naomi Klein questioned he at points in a way that he seldom does (making faces and interrupting her) but threw softballs to financial industry stalwarts like Timothy Geithner and Morgan Stanely CEO John Mack. In a interview with Elizabeth Warren, he was did not challenge her but did set some snares that she did not walk into.


>From the Columbia Journalism Review (hat tip reader Doug):


A couple of times in the last few months I’ve taken the press to task for ignoring the Congressional Oversight Panel and its report on the TARP. I’ve talked to reporters in the biz since and got the impression that many of them don’t really take it seriously because its chairwoman Elizabeth Warren is a liberal who, they say, pushes her agenda.

So it’s worth listening to this entire Planet Money podcast from NPR, where Adam Davidson badgers Warren for more than an hour to justify her existence, so to speak.

If you want a peek inside business-press mentality, and why certain stories get reported and others don’t, you can do worse than start here. It sees Warren as an outlier whose views, based on decades of research, are suspicious. It would never, ever have badgered a former bank exec, say, like this if one had been chairman of the panel. Davidson, like the reporters I referenced above, has been talking to too many bankers and insiders who sneer at someone not inside their bubble. Perhaps he’s trying to prove his objective journalist bona fides at “liberal” NPR by taking it to a liberal.

Warren isn’t legitimate in the eyes of the press, so it just pretty much ignores her—even though she and her co-panelists were selected by Congress to oversee whether the Treasury is spending the $700 billion we gave it in a way that’s best for the economy.

This interview is really cringeworthy stuff from Davidson, who comes out looking pretty bad (which makes it all the more admirable that NPR runs the entire tape). Warren takes this fight going away.

I don’t have a complete transcript of the show but I typed up some of it.
The article continues here.

        


Guest post: A populist interpretation of the latest Boom-Bust cycle 
Posted: 15 May 2009 09:09 AM PDT



Submitted by Edward Harrison of the site Credit Writedowns.
As with my most recent post here on Naked Capitalism about Larry Summers, I want to write a thought piece here, as much for discussion’s sake as for its analysis. Now, the core of what you are about to read is something I put together and posted on Credit Writedowns in March of ‘08. At the time, I was struggling with the dichotomy between the perceived increase in wealth in the United States and the obviously poor macro statistics on debt, leverage and earnings for the middle class. This piece was the product of that struggle.
I should warn you that it is at odds with some of what you will see me write here since I am basically a libertarian and the piece is very populist. When I wrote the piece, I can’t say I was 100% behind this interpretation of events. Nevertheless, as time has passed during this financial crisis, many events have validated this view in my eyes (the dichotomy between the bank/insurance company bailouts and the auto bailouts being a prime example). Therefore, I would be curious to read your responses.
As to the data that reinforces this view, you can find more at the following posts:

Chart of the day: real hourly earnings (Jun 2008)
Charts of the day: US macro disequilibria (Oct 2008)
I intend to follow this post with one titled “De-regulation as crony capitalism” or something to that effect, because the theme underneath this post is that Special Interests which favor elites are always present in any society, at any time regardless of the form of government. This was true in Egypt, Rome and Greece. It was true in the Soviet Union and it is certainly true in the United States. Therefore, it is axiomatic that de-regulation favors elites through crony capitalism, which is basically what we have seen over the past few decades. This is not the invisible hand of Adam Smith on display and makes the case for some minimal level of regulatory oversight.
One last comment: this post also is in line with my view that the United States has been in relative decline for some time, probably since World War II. The U.S. reached its apex as an economic and military power when large parts of Europe and Asia lay in ashes in 1945. In the intervening time, the U.S. has not recognized its relative decline. This has led to imperial over-stretch and a redistribution from the middle class to elites (This view is in line with Kennedy’s “The Rise and Fall of the Great Powers’ and deserves another separate post as well).
Below is the post. Feel free to comment whether you agree or disagree. Enjoy.
In an earlier post, I said that populism was the problem, not the solution. I reject populist methods of tariffs and protectionism because they are self-defeating economic poison. However, in this brief post, I do want to give voice to a populist interpretation of the last 35 years of U.S. economic history. This is a story of unequal re-distribution of wealth from the less fortunate to the more fortunate. This is a story of the United States in which the rich get richer at the expense of everybody else. At the conclusion, ask yourself: is this true and, if so, what should we do about it?
The Theory of Kleptocracy 
First, let's use a theory from Guns, Germs, and Steel by Jared Diamond as the center-piece for this little theory. In Chapter 14, entitled "From Egalitarianism to Kleptocracy," Diamond postulates that more stratified societies are by definition less egalitarian, but more efficient and are, thus, able to eradicate or conquer more egalitarian, less stratified societies. Thus, all 'advanced' societies with high levels of GDP are complex and hierarchical.
The problem is: these more stratified, more complex societies are in essence Kleptocracies, where those in power re-distribute societal wealth to themselves. Those at the bottom of the society's pyramid accept this unequal, non-egalitarian state of affairs because they too benefit from their society's relative advancement. It's a case of a rising tide lifting all boats.
Diamond says the Kleptocrats maintain power using 4 different methods:

"1. Disarm the populace, and arm the elite." 
"2. Make the masses happy by redistributing much of the tribute received, in popular ways." 
"3. Use the monopoly of force to promote happiness, by maintaining public order and curbing violence. This is potentially a big and underappreciated advantage of centralized societies over noncentralized ones." 
"4. The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy."
Kleptocracy in America? 
The obvious corollary of this theory is that most successful modern societies are, in fact, kleptocracies. The key is to use the four methods to gain popular support in order to re-distribute as much wealth to the ruling class as the populace will support. If the ruling class takes too much, it will be overthrown and replaced by a new ruling class (which in turn will re-distribute wealth to itself using the same four methods).
While this angle seems cynical, it is a a line of argument that has great internal consistency.
So, is the United States a kleptocracy? Of course it is! Is that bad? Well, it obviously depends on who you are in society. But, it also depends on whether the kleptocracy is efficient and fair over the long term. Let me explain this last statement a bit more.
Efficiency and Fairness 
Because any heavily stratified society is by its very nature non-egalitarian, there always exists the potential for disenchantment amongst the masses. The U.S. is no exception. In order to prevent this disenchantment from leading to revolt, the ruling class must appear to strive for efficiency and fairness.
According to dictionary.com, efficiency means "accomplishment of or ability to accomplish a job with a minimum expenditure of time and effort." So, for the US, it means the ability to increase productivity at a rate which makes the U.S. wealthier on a per capita basis now and in the future. And remember, it is the perception of efficiency, not actual efficiency which is important.
To be fair is to be "free from bias, dishonesty, or injustice." For the United States, this means maintaining the perception that most every person has the opportunity to succeed while few, if any, have unobstructed paths to guaranteed success.
Is the U.S. efficient and fair? 
That's the $64,000 question, isn't it. My populist take: no, the United States is neither efficient nor fair.
The United States has been living beyond its means for some time. Since the 1960s, we have run up a massive federal debt and current account deficit, while debt levels have doubled on a percentage of GDP basis. Our present levels of consumption are simply not justified by our current levels of productivity, if we want to maintain our present standard of living in the future.
Were we not the world's major military superpower with the world's reserve currency and the world's largest economy, we would have succumbed to our profligacy years ago. Paul Kennedy has a great book on "The Rise and Fall of the Great Powers." By contrast, many developing countries have gone bankrupt in the last 30 years from Argentina to Zimbabwe. Yet, we are in worse shape than were they, if one looks at the signposts which represent our macroeconomic health: debt-to-GDP levels, current account deficit as a percent of GDP, Government budget deficit, savings rate, etc.
The fact is our day of reckoning is upon us. We will soon realize that our massive debt and an outsized credit bubble have not only saddled us with debt, but it has also misallocated capital so that we are less productive than we believed. We have built miles and miles of telecom dark fibre when we could have invested in schools. We have built massive numbers of new homes, when we could have repaired our bridges and roads. The last 35 years have been an illusion of extreme productivity and wealth because we have artificially pulled forward demand by misallocating resources in order to consume today, what could have been consumed tomorrow. In essence, we are consuming today, while unwittingly making it more difficult to consume tomorrow because we believe we are wealthier than we truly are.
And as for fairness, Real Weekly Earnings peaked over 35 years ago in September 1972! Using the CPI to adjust wages to today's dollars, the average worker made $738.48 per week in September 1972. In January 2008, that figure was $598.18.
(Note: these figures are expressed in Jan 2008 dollars. I use the CPI Index to calculate real dollars, which is based on 1982-1984 dollars. But, I then multiply this figure by 2.1108, which represents the BLS's index factor for Jan 2008).
So, we are getting poorer. And we have been for over 35 years. Only during the end of the Clinton Administration was there an appreciable upswing in real weekly wages over this time period. Don't believe me? See the raw data yourself, here and run the numbers.
In the meantime, CEOs are earning hundreds of millions of dollars, even when they are forced to leave because of poor management which cost their firms billions. In 2005, the average CEO earned 262 times what an average worker gets. In 1965, that figure was 24 times (see story).
Conclusions 
There it is: the U.S. ruling class is not living up to its role in either efficiency or fairness. We are getting poorer.
That is why people are so angry. That is why the poll numbers for the President and Congress are so low [remember, I wrote this in March 2008]. And that is why so many people are suffering from the housing bubble.
The question you should ask yourself is this: Why has it taken the citizens of the U.S. so long to figure all this out? Answer: Even though the gulf between rich and poor was widening and the rich were getting richer, we thought we too were getting richer as well. We thought that we too were profiting from all of this "productivity." In the 1980s, we came out of a steep double dip recession and stagflation and we won the cold war. This inflated our sense of well-being. In the 1990s, there was the tech bubble to inflate our assets. In this decade, there was the housing bubble. So, we thought we were getting rich too. We didn't mind that the ruling class was benefiting disproportionately as long as we too appeared to be benefiting.
But, what was really happening is we were loading up on debt. We were not benefiting at all
And now that there are no more cold wars we can win quickly, no more tech stocks, no more double digit house price increases, and no more asset bubbles to hide the naked truth -- now we realize that we were getting poorer all the time -- just as it felt to us. The ruling class have used the four methods to maintain popular support that I enumerated before in order to give the appearance of equity and efficiency. All the while, the rich were milking the system for all they could.
I advise anyone who finds this populist line of argument compelling to read Jared Diamond's Pulitzer Prize-winning book. Chapter 14 is especially rich. Once you realize that we the American people have been duped for the last generation, you will be angry. And this is why we need a major change in Washington. The politics and policies of the past just will not do.

        


Guest Post: Pension Probe Tip of Private Equity's Woes 
Posted: 15 May 2009 04:59 AM PDT


Submitted by Leo Kolivakis, publisher of Pension Pulse.


BusinessWeek reports that former federal pensions chief faces criminal probe:



The former head of the federal pension insurer inappropriately interfered in a contracting process that ultimately led to the hiring of Goldman Sachs (GS), JPMorgan Chase (JPM), and Blackrock to manage billions of dollars in assets and earn $100 million or more in fees, a federal watchdog concludes in a draft report distributed on May 14. BusinessWeek has learned that a criminal investigation into some of the allegations raised in the report has been requested by a group of senators and will begin shortly. 
The report calls into question the process used to award contracts for managing some $2.5 billion in assets at Pension Benefit Guaranty Corp. The report's author, PBGC Inspector General Rebecca Anne Batts, who will also handle the criminal probe, recommends that the Cabinet secretaries who oversee the agency consider whether the contracts should be revoked. The PBGC's acting director said the agency would decide whether to revoke the contracts. 
Among other things, the report says Charles E.F. Millard, who stepped down on Jan. 20, improperly contacted some of the firms potentially bidding on the contracts and later sought and received job-hunting help from an unnamed executive of Goldman Sachs after the company had been awarded a contract to manage up to $700 million. The report also says Millard was warned not to engage in much or all of the activity it calls into question. The inspector general's inquiry was already under way before Millard's departure. Millard said earlier this month that he has been doing some consulting work while exploring different job opportunities. 
All of this comes at a challenging time for the PBGC, which could become the steward of one of the large pension plans at bankrupt or struggling companies in the auto industry and elsewhere. Now, more scrutiny is sure to come. Representative George Miller (D-Calif.), chairman of the House Labor Committee, which released the draft report, announced that the committee will launch an investigation of its own, calling the questions over Millard's conduct "very serious." Herb Kohl (D-Wis.), chairman of the U.S. Senate's Special Committee on Aging, also announced a hearing, to be held on May 20, looking into the allegations and into broader concerns about the PBGC. Senator Charles Grassley (R-Iowa) said in a statement that he and three fellow senators—Edward M. Kennedy (D-Mass.), Max Baucus (D-Mont.), and Michael Enzi (R-Wyo.)—also support further investigation. A spokeswoman for Kohl's office said Millard had received a subpoena to appear at the hearing. 
In a brief e-mailed statement, Millard's attorney, Stanley Brand, said Millard's efforts to improve the PBGC's financial health were "carried out in a transparent and ethical manner." 
The report says it didn't find evidence of criminal activity by bidders for the contracts, though the scope of the inquiry so far has remained internal. Spokeswomen for Goldman, JPMorgan, and Blackrock declined to comment.

A controversial switch from bonds to riskier assetsThe PBGC's board—Labor Secretary Hilda Solis, Treasury Secretary Timothy Geithner, and Commerce Secretary Gary Locke—has asked the agency's interim director to determine whether the contracts in question should be reevaluated. 
The PBGC insures defined-benefit pension plans—traditional pensions that pay retirees a set monthly amount for life—and as of Sept. 30 managed nearly $50 billion in assets for plans that have been abandoned by the companies that originally sponsored them, usually after bankruptcy or insolvency. 
At the heart of the inspector general's inquiry is a controversial decision made in early 2008 to gradually shift billions of dollars from bonds, which make up the bulk of the agency's assets, into stocks, real estate, and private equity investments. The goal, supporters say, was to improve returns and therefore the odds that the agency's gap between its assets and its potential obligations—about $11 billion, currently—would close, avoiding the need for a government bailout at some point down the road. Critics called the move hasty and ill-informed and said it would subject the agency's assets to too much additional investment risk. 
Although the shift was approved in February 2008, a PBGC spokesman said no assets have been moved yet under the "strategic partnership" contracts to farm out asset management. 
"We will work with our board to decide whether these contracts should be terminated and whether strategic partnerships fit into the board's investment approach going forward," said Vince Snowbarger, the PBGC's acting director, in a written statement. Future PBGC directors won't be allowed to be directly involved in procurement, he added. 
In addition to the contract Goldman Sachs was awarded to manage up to $700 billion, Blackrock and JPMorgan each received contracts to manage up to $900 million in real estate and private equity assets, the report said. 
"government sachs"
Goldman's supporting role in the inspector general's report once again highlights that company's often cozy connections with the halls of government power. Those ties have earned the firm the nickname "Government Sachs," from the fact that Henry Paulson, President George W. Bush's last Treasury secretary, once ran Goldman, to the close ties between Goldman and AIG (AIG), and the bank's receipt of $12.9 billion of AIG's bailout money. Meanwhile, President Barack Obama received nearly $1 million in campaign contributions from Goldman employees, second only to University of California workers. 
The PBGC report documents 29 emails between Millard's PBGC account and a Goldman pal, including the extensive assistance by the banker in Millard's job search. That assistance ranged from making introductions to passing along Millard's résumé, biography, and press clippings to CEOs at other financial firms. 
Millard called the allegation of impropriety "ridiculous" and said he had a "deep personal relationship" with the Goldman executive. In a written response from Millard that is attached to the report, the former director insists: "I always acted in the interests of the agency." 
In a letter Millard sent Batts, dated Apr. 28, Millard defends his position on the PBGC panels as an attempt to get things done at an agency that in the past hadn't always moved quickly. And some of his defenders imply there may be a political motivation to Batt's report since Millard is an active Republican. Batts notes that her inquiry began long before the November 2008 election and says she has seen no evidence of partisanship. 
The investigation, begun on Sept. 17, 2008, as a simple review of the PBGC's implementation of its new investment policy. But within a few weeks it had broadened into a look at Millard's behavior after Batts was approached by an unnamed whistleblower with specific allegations. By Oct. 31, when the PBGC was to issue the contracts with Goldman, JPMorgan, and Blackrock, Batts suggested holding off, but Millard wouldn't, Batts said in a telephone interview. 
unprecedented dual role for PBGC chief
According to the inspector general's report, a whistleblower accused Millard of contacting executives at firms bidding for PBGC business "in order to enhance his future employment prospects." The inspector general's subsequent investigation found 29 emails documenting the extensive efforts the unnamed Goldman executive made on Millard's behalf. The draft report notes that some PBGC employees involved in the investment portfolio "believed that the former Director made some decisions based on his relationship with certain industry members and not on the merits themselves." 
Because Millard didn't record details of his calls, visits, and emails, "we could not determine whether [his] communications with Wall Street firms had any impact on his decisions," the report says. However, Millard's actions "made PBGC vulnerable to allegations of bias, improper influence, or abuse of position." 
Many of the questions around Millard's conduct stem from his "unprecedented" role on the committee that evaluated bidders and awarded contracts; ordinarily, PBGC directors haven't served in that capacity. Batts says she told Millard that serving on the committee was "unwise," but he continued when told there was nothing expressly illegal about it. 
Members of the committee aren't supposed to contact bidders during a "blackout" period, when they are being evaluated—something Millard was told several times, the report says. Yet Millard made phone calls to 8 of the 16 firms bidding on the contracts, including all four finalists and the three firms that were ultimately chosen, Batts wrote in the report. At least nine calls were made from or received at Millard's phone to Goldman Sachs during the three-month blackout period, most to an executive directly involved in the bidding process, Batts wrote. Another six calls were made to or from a key Blackrock official, and at least 10 calls to or from a managing director at JPMorgan. 
The report says Millard's explanations for the contacts changed over time, and it suggests that several of those explanations didn't hold up. Batts called the contacts a violation of PBGC policy and federal acquisition regulations. Millard's "improper actions raise serious questions about the integrity of the process by which the winners…were selected," Batts wrote.These allegations are serious. Mr. Millard had a fiduciary obligation to invest this money in the best interests of PBGC's stakeholders and beneficiaries. Any hint of impropriety will seriously undermine his defense.

Elsewhere, the Carlyle Group has agreed to pay $20 million in a settlement with the New York attorney general, Andrew M. Cuomo, and make broad changes in its practices as part of his office’s continuing pension corruption inquiry:


Mr. Cuomo hopes to use the settlement with Carlyle, one of the largest and most politically connected private equity firms, as a template for broader reform in how hedge funds and private equity firms intersect with public pensions.
His office has developed a series of guidelines that include a broad ban on firms using any kind of intermediary to provide even an introduction to officials at public pensions. 
The guidelines also bar firms and their executives, and even family members of executives, from making campaign contributions within two years of doing business with pension funds. Carlyle will also have to disclose contributions to any politicians in a state in which it does pension business. 
“This is a revolutionary agreement,” Mr. Cuomo said during a teleconference on Thursday. “I believe it totally changes the way people operate, it ends pay-to-play, it bans the selling of access, it puts the political power brokers out of business.”
While the agreement is sweeping in nature, it only applies to Carlyle’s nationwide business; Mr. Cuomo will need Congressional legislation or new federal regulation to make it broadly apply across Wall Street. 
“Our ultimate goal is to get that code enacted, meaning, by either state law, state regulation, or in this case, federal law, federal regulation,” Mr. Cuomo said. 
Christopher Ullman, a spokesman for Carlyle, said: “We are pleased to announce today that we have reached a successful resolution with the attorney general and strongly support his efforts to implement reforms that usher in a new era of transparency and accountability into the pension fund investment process.”
Carlyle also said it was suing Hank Morris, once a top aide to New York State’s former comptroller, Alan G. Hevesi, and a firm he worked for, Searle & Company, seeking more than $15 million.
Last month, The New York Times reported that state and federal investigators were reviewing whether Carlyle made millions of dollars in improper payments to intermediaries in exchange for investments from the state pension fund. While payments to intermediaries, known as placement agents, are typically legal, they are not if they are simply disguising bribes or kickbacks. 
Mr. Cuomo’s office and the Securities and Exchange Commission have been conducting parallel investigations focused on the millions of dollars that friends, relatives and aides of Mr. Hevesi gained by selling access to New York State’s $122 billion pension fund. The inquiries have uncovered what investigators describe as a wide network of corruption from California to New York, in which billions of dollars of investments from public pension funds were handed out in exchange for kickbacks or other questionable payments. 
“If Boss Tweed were alive today, he would be a placement agent,” Mr. Cuomo said. 
Mr. Morris and David Loglisci, another former top aide to Mr. Hevesi, have been indicted on a variety of corruption-related fraud charges, and Raymond B. Harding, the former vice chairman of the state’s Liberal Party, has also been charged in the case.
Saul Meyer, a top consultant to pension funds around the country, has also been charged with a fraud-related felony, and his firm, Aldus Equity, has been charged by the S.E.C. with a number of securities violations.
Two investment executives, Barrett Wissman and Julio Ramirez, Jr., have pleaded guilty in the Cuomo inquiry. 
The Carlyle deals are among the most complex described in court filings. One deal involved an energy investment fund run by Carlyle and another firm, Riverstone Holdings. As part of the arrangement, the firms paid $10 million to Searle, nearly half of which was secretly funneled to Mr. Morris, according to an S.E.C. complaint.
David Leuschen, a top Riverstone executive, also invested $100,000 in “Chooch,” a movie produced by Mr. Loglisci. 
Riverstone’s activities are still being scrutinized by regulators; the company has denied any wrongdoing.
“Most of the objectionable activities were by Riverstone,” Mr. Cuomo said. 
Apart from pension probe, these aren't easy times for private equity. Earlier this week, the FT reported that investors desperate to sell their stakes in private equity funds face the specter of being trapped in their holdings indefinitely due to a sharp fall in activity in the secondary market.

A swath of pension funds, insurance companies, endowments and family offices that flocked to the asset class in recent years are believed to be under pressure to exit, particularly as many stakes include legal obligations to make additional commitments they may not be able to fund.
Industry estimates suggest that $100bn-$130bn of the $2,200bn (£1,462bn, €1,632bn) committed to private equity is expected to be offered for sale in the next two years.
Yet the volume of deals closed in the secondary market slumped to $2bn in the first quarter of 2009, according to Greenpark Capital, a specialist secondary investor, suggesting full-year dealflow may not even match the $20bn recorded in 2008. 
“In a year where people are considering selling a volume that is far greater than has ever been put up for sale before, the concern is that we will struggle to get to $10bn this year in terms of deals closed,” said Marleen Groen, co-founder and chief executive of Greenpark. “There will be a lot of frustrated sellers.”
Elaine Small, partner at Paul Capital, another secondaries house, said: “There is probably 10 times as much supply as available money in the market from secondary funds.”
Prices in the secondary market have fallen dramatically, with deals this year being struck at an average of 37 per cent of face value, compared with 85 per cent in the first half of 2008 and a peak of 108 per cent in 2006, according to Cogent Partners, a US advisory house. There are reports of investors having to pay buyers to take stakes off their hands. 
Hanspeter Bader, head of private equity at Switzerland’s Unigestion, said pricing was poor for stakes that contain significant undrawn capital obligations.
“It could be that you have to give it away for free. We have seen some transactions of that nature. I have anecdotally heard of a fund where the buyer got money to buy it,” he said.
Ms Groen added: “The only way sellers can get out of some of the large positions is by paying a buyer to take it to compensate them for the undrawn capital and the quality of the existing investments.”
However, she believed an increasing number of investors would instead choose, or be forced, to default on their commitments, particularly if private equity funds need to make capital calls to retain control of their portfolio companies, even though defaulters risk losing the bulk of their investments as well as being sued and blackballed by the industry.
“We will see defaulting limited partners. If they don’t want to be in private equity again they can and they probably will.”
The secondaries market is estimated to have sufficient capacity to absorb about $30bn of deals over the next two years. However, the logjam is largely being driven by a wide gap in valuations between buyers and sellers. 
Because private equity funds are believed to have been slow in writing down the value of their assets to reflect the deteriorating economic backdrop and lower valuations in public equity markets, would-be sellers are facing the “sticker shock” of having to accept valuations well below net asset value. 
Market participants believe dealflow will pick up when the valuations of private equity funds catch up with reality later in the year.
The FT also reports that private equity faces investor exodus:

The private equity industry is poised for an unprecedented rush to the door by investors as more than a 10th of them plan to sell fund interests in the next two years, according to research published on Tuesday. 
When investors commit money to a private equity fund, it is locked in for at least 10 years and drawn down as needed by the fund manager to finance investments.
During the credit bubble, when private equity deals ballooned, investors increased their commitments to the industry dramatically, expecting them to be financed by the flow of cash back from earlier deals. 
Now that cash has dried up, they are being forced to turn to the opaque and unstructured secondary market to raise capital and escape from the unfunded commitments they cannot afford to meet. 
Tuesday’s research from Preqin, which surveyed 568 institutional investors, also found that almost half of them were interested in buying secondhand private equity holdings from other investors in earlier funds.
As investors focus on buying secondhand assets, it is likely to mean that it will take longer before private equity groups can raise new funds from their investors. 
“If you have an investment that you like in a private equity fund and someone says you can have some more for half the price, then that is a sensible thing to do,” said Brenlen Jinkens, managing director of Cogent Partners, the secondary market adviser. 
Preqin said 11 per cent of institutions (excluding funds of funds, which are already regular users of the secondary market) planned to sell fund interests.
It forecast that $75bn- $100bn of private equity assets could change hands, half in the next year. 
The research found that 48 per cent of active private equity investors, including pension funds, endowments, insurers and sovereign wealth funds, had indicated an interest in buying on the secondary market in the next two years.
“Why go into a primary fund when you can get secondaries more cheaply?” asked Andrew Sealey, managing partner of Campbell Lutyens, a private equity adviser.
However, specialist secondary investors said there had been very little activity so far this year, even after private equity groups published their year-end valuations, which some had expected to trigger a rush of activity.
Peter Wilson, managing director of HarbourVest’s secondary arm, said: “Buyers are anticipating a drop in forward earnings. 
“Sellers are optimistic because of the rally in stock markets. The two forces are pulling in opposite directions.”
Instead of being the exclusive preserve of specialist secondary funds, he said more secondhand assets were being bought by traditional investors.
“They look at the big discounts and see a way to reduce their initial cost of entry into a fund,” he said. 
Michael Granoff, chief executive of Pomona Capital, a $6bn private equity fund of funds, said: “A big problem buyers have today is that it is very hard to figure out what these assets are worth, not just today, but what they will be worth tomorrow.” 
He forecast that activity was likely to pick up when private equity deal flow recovered, triggering calls for investors to meet undrawn capital commitments.
“Probably capital calls will come before distributions for most private equity investors – so that could increase the pressure to sell,” said Mr Granoff. “I think the market will clear gradually.”
The private equity and commercial real estate markets will face their worst crisis ever. Deflation will wreak havoc on their asset values and I expect a long, tough slug ahead. 
As pension funds shoveled billions of dollars into these asset classes over the last five years, I expect they will also suffer more material losses in the next few years.

What was Mr. Millard thinking when he thought of shifting the PBGC's assets into private equity? What are pension funds thinking shoveling more assets into private equity right now? Have they completely lost their marbles?

        



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