Why George Soros Hates Lloyd Blankfein

While the Congress and the White House debate the best way to wean the U.S. financial industry from the government teat, George Soros is actively promoting the wholesale castration of the banking industry. Not that many bankers aren't deserving of such treatment. It's just ironic that George Soros would be urging such regulation of the financial markets. In a recent interview with the Financial Times, George Soros went so far as to urge a government cap on executive compensation at financial institutions receiving government aid, so that the risk-takers who are earning the greatest bonuses will be inclined to jump ship and go to work for the hedge funds, such as Soros Fund Management, where George Soros believes their abilities are better suited.

Clearly, I can understand Soros' jealously and frustration. In previous posts I have expressed deep dismay at actions by the Treasury and the Fed, as well as Congress' absurd TARP legislation. Financial institutions who have access to the Fed Window can borrow almost unlimited sums for free, and use them to purchase government bonds at 3%, which is literally giving banks a license to print profits. Hedge funds, like Soros Fund Management, have to raise money the old-fashioned way, by seeking out investors, and must pay over-market returns in a volatile and risky environment. The resentment in the hedge fund world must be tangible.

However, is increased regulation of the banking industry, including unprecedented moves such as regulating executive compensation, the correct response? Absolutely not. Any institution that provides a service that is so central to the function of the Republic that they have been designated as "too big to fail" should be nationalized and the service should be provided by a government agency. If the government is not willing to nationalize the biggest banks, then they should remove support and permit them to sink or swim on their own.

Existing regulations, such as minimum capital requirements and leverage limits on FDIC insured deposits, should be enforced and the legal authority of the FDIC to seize troubled institutions should be bolstered, but the government should not socialize the banking industry through excessive regulation. Doing so would guarantee that credit remains available only to those who least need it, and that innovation and risk-taking are squelched.

As much as we hate watching Lloyd Blankfein and his ilk suck the government dry, it is the government itself that got into this position, and it is the goverment itself that must get out, but not at the expense of free market capitalism and the American Way.

NATURAL SELECTION

The recent discovery of a remarkably well-preserved, mummified baby mammoth reminded me of the gargantuan banks, insurance companies, and auto companies that are slowly dragging the balance sheet of the U.S. Government toward the bottom of the sea.

I am reminded how the mammoths, once the largest land mammals to walk the earth, are no more. There is debate as to what brought about the end of the reign of the woolly mammoth, but one fact is clear: whatever stresses befell this massive animal, the species could not flee or adapt quickly enough and perished in its entirety.

What parallels exist between the extinction of the mammoth and the taxpayer support of Citigroup? For one, Citigroup is a bank that is doomed to failure by its over-burdened corporate structure that permits far too many inefficiencies to creep in at all levels. Secondly, the massive size of Citi, and the sheer weight of its balance sheet, makes it impossible for the company to rapidly adjust to the finanical tsunami by, for example, merging with another bank, or spinning off business units, and thereby effectively getting to higher ground.

Not only is it preferable to let outsized banks like Citigroup collapse under their own weight, it is absolutely necessary in order to preserve the ecological balance for all other banks and financial institutions. While Citi is kept on life support, it continues, like a zombie mammoth, to trample the shoots of smaller, more agile banks that are looking to advance their own business models. The taxpayer funding of these privately-held banks is also setting a precedent of government intervention into private enterprise that will encourage the same kind of consolidation and risk-taking that led to this crisis.

In order to restore balance in the system, the public must begin immediately to extricate itself from the process of nationalization of the financial sector and refuse to re-engage, no matter how scary it gets. At the same time, we must formally establish a hands-off policy with regard to the success or failure of any individual private business enterprise, backed by the force of law if necessary. At the end of the day, the core constitutional obligation of the federal government is to protect us from famine, war and natural disaster. Restoring the central government to its core function, and allowing the free market to heal itself, will preserve the innovation and diversity that is the hallmark of U.S. enterprise.

AMERICAN OLIGARCHS

In the Comment section of today's Financial Times, Martin Wolf wrote about analogies drawn by former IMF Chief Economist Simon Johnson between Russia and the United States. The parallels stem from the outsized political authority wielded by, and public attention paid to, the largest U.S. financial institutions, which he compares to the Russian Oligarchs.

These institutions, deemed "too big to fail", are literally sapping the public dry on the belief that what is good for Wall Street is good for Main Street. And, like the oligarchs in Russia, while these companies and their shareholders represent a tiny percentage of the population of businesses in need of rescue, they are benefiting from almost all the stimulus money.

How could this distinctly undemocratic policy arise in a social democracy such as the United States? In short, because of the corrupting effects of money on the political system. In 2002, the financial sector booked 41% of all corporate profits in America, more than double the long-term average, and a lot of this money flowed to the political parties. By 2008, many politicians had been elected, and many bureaucrats appointed, in no small part as a result of contributions from members of the financial sector.

So, when it started to become apparent that the outsized financial profits had been made on the backs of ridiculously outsized bets that were quickly coming home to roost, the heads of the major banks were able to rally President Bush and his Treasury Secretary, former Goldman CEO Hank Paulson, to sell a terrifying scenario to Congress and the Fed of a financial domino effect in which the major banks and the global credit markets collapse, leading to runs on banks, a deflationary spiral, and general chaos.

Whether this scenario was accurate or not is anybody's guess (I personally do not believe in the "too big to fail" thesis and would not have voted to approve TARP), but trillions of dollars in public money have been spent and it is not clear that bank balance sheets and credit markets are showing any lasting signs of improvement.

The good news is that the ability of the financial sector to wield the same public policy authority is set to wane: relative wages in the financial sector fell from a 1933 peak of over 1.6 (the ratio of financial wages to non-farm private wages) to near parity in 1980. As of last year, the ratio was over 1.7, so if history is a guide we can expect non-financial wages (and political authority) to grow relative to financial wages for many decades to come.

The bad news, of course, is that the U.S. dollar and to the spending ability of the U.S. taxpayer have been dealt a lasting and awful blow.

LAWMAKERS LEFT SCRATCHING THEIR HEADS OVER HOW TAXPAYERS GOT STUCK HOLDING THE BAG

Maryland Congressman Elijah E. Cummings (pictured above) has been one of the lawmakers on the forefront in expressing dismay that institutions that received taxpayer dollars and guarantees might have used the money to DO WHAT THESE COMPANIES HAD COMMITTED TO DO BEFORE TARP FUNDS WERE AUTHORIZED.

Some of these companies, such as AIG, faced receivership absent taxpayer cash injections, which would have annulled some or all of the contracts it held with employees and the holders of insurance contracts. However, as long as they have the money, they are legally obligated to pay up, which is exactly why TARP was a bad idea in the first place and hasn't served to improve credit spreads in any event. AIG was doomed to fail because of bad management that made bad bets on risky instruments. Injecting fresh money into AIG without first declaring the institution insolvent and forcing wholesale restructuring is complete idiocy, but that is exactly what we did and is exactly what we are now griping about.

Which makes me wonder how bright legislators, such as Representative Cummings (who voted in favor of TARP twice), really are, and how safe our national patrimony is in their hands.

PAULSON'S PALS & YOUR TAX DOLLARS AT WORK

In case you were wondering why the U.S. taxpayer now effectively owns what was the largest privately-held insurance company in the world, it is worthwhile to remember where ex-Treasury Secretary Hank Paulson, former CEO of Goldman Sachs, came from. Turns out that AIG had insured a lot of the commercial paper that Goldman Sachs was holding, and that current Goldman CEO Lloyd Blankfein (pictured above doing his best to resemble the covetous Gollum from Lord of the Rings) was conveniently on the advisory board that recommended the bail-out of AIG. Since then, Goldman has received at least $6 billion of taxpayer dollars in the form of insurance payments, money that they would not have received, mind you, if AIG had been forced to reorganize.

The best data that I have indicates that the U.S. taxpayer poured $150B into AIG (that's about $1,500 per U.S. taxpayer invested in one, effectively bankrupt, company), and holds an 80% stake in the company. If I had wanted to buy 80% of AIG on the stock market yesterday, it would have cost me $753 million (about $8 per taxpayer).

Do the U.S. taxpayers have a right to be angry about this? Hell Yes. AIG has paid out over $50B in insurance claims to institutions such as Goldman Sachs, Deutsche Bank, Merrill Lynch, and others, and small business owners STILL can't get an increase in their credit line so they can weather this economic storm. More egregious even still, AIG went ahead with planned bonuses promised earlier to the very executives who ran the small division whose outsize losses torpedoes AIG. What, was AIG management afraid that these execs would mutiny and sue the company if they weren't paid their bonuses? Doubtful. More likely is that this is a continuation of the cozy politics that have marked the entire bailout process, all at taxpayer expense.

What should and could we have done differently? First of all, we should have defeated TARP the second time. Fannie Mae and Freddie Mac, which operated with an implicit government guarantee from the get-go and were therefore compelled to buy up questionable alt-a mortgages, should have been made into full-fledged U.S. agencies where they could continue to operate as they have in the past. Additionally, Fannie and Freddie should have been given the authority to behave much like a commercial bank of last-resort. For example, if you owned a business and went to Bank of America to apply for a line of credit, but got denied, you should have been able to take your denial letter to Fannie or Freddie who would give you a second chance. If you could prove that you deserve the money and have the means to pay it back, they would give you the loan. The adminstration of the loan could have been farmed out to private companies for a fee, but the loan payments would go back to the government.

In the mean time, the major U.S. financial institutions should have been forced to bite the bullet. Some, like Lehman Brothers, would have collapsed outright, and others would find compelling reasons to merge. The resulting firestorm would have cleared up most of the dead wood. Those institutions, like the AIG financial products division, that took outsized risk would suffer the consequences, thereby tempering the enthusiasm of other risk-takers. Too big to fail is nonesense-- private risk, private pain.

Instead of funding TARP, the government should have increased the earned income tax credit, issued new stimulus checks, stood ready to extend unemployment benefits to laid-off workers, and engaged in some good, old-fashioned Keynsian stimulus (i.e. bridge rebuilding, job training, school repair and construction), while the system sweats out the contagion.

Why would this be better? Right now, all banks, whether they took undue risk or not, are trading far below their historic multiples (currently, U.S. banks are trading at 1/2 of book). In the scenario that I just spelled out, the strong banks would be picking over the carcasses of the weak and the dead. These banks would be acquiring assets on the cheap, and they would be in a position to be hugely profitable when economic growth returns. Now, by virtue of the massive investment of tax dollars, all banks are facing onerous regulation of their operations to prevent banks that are "too big to fail" from doing just that. Therefore, capital-raising, lending, leverage, and growth will all be severely curtailed in the years to come, which will effectively guarantee socialization in other parts of society. In other words, it is quite likely that we have killed western capitalism as we knew it, and the Wild West of entrepreneurial risk-taking that we saw prior to the collapse is no more.

Good riddance, you say? Keep in mind the extent to which government policies can influence the fortunes of the society at large. Do we remember the poverty and deprivation that were the norm in Eastern Europe prior to the fall of the Iron Curtain? How about the vastly different fates of North and South Koreans? All of which can be attributed to government policy, relative lack of freedom, and limitations on risk-taking.

U.S. NATIONAL DEBT CLOCK OVERWOUND?

The ridiculously large dollar amount above is an up-to-the-minute count of national debt that must be periodically refinanced by the U.S. Treasury (debt clock courtesy of Ed Hall).

U.S. 2009 gross domestic product was $14T, which means that our debt is more than the value of all of the goods and services that we produced in 2009, putting the U.S. behind only Japan of the large industrialized nations in debt as a percentage of GDP.

It will cost us, as a nation, about $500B in the 2009 fiscal year to meet the obligations of this debt.

Currently, the U.S. population is about 350M and the per capita share of our national debt is about $35,000. The per capita share of the annual interest payment on the debt is about $1,650.

However, not everyone generates tax revenue that the Treasury can use to help maintain the debt burden. Based on 2004 data, there are 131 million tax filers, of whom 43 million owed no tax. At current levels, our national debt is over $120,000 per taxpayer and the annual interest payments are $5,700 per taxpayer.

Of course, this $5,700 excludes expenses for things like social security, medicare, infrastructure, national defense, etc. (click here for a graph), which explains why the Congressional Budget Office forecasts budget deficits of over $430B in each of the next two years, or $1.4T between 2009 and 2013.

Based on the CBO predictions, the federal budget will not be in balance for any of the next ten years, and the total national debt in the year 2018 will be nearly $13T, or about $148,000 per taxpayer (again, using 2004 data), and the interest on that debt will cost each taxpayer about $7,000/year, assuming that the interest rate on Treasury debt does not exceed 4.7%.

However, the CBO is basing these deficit estimates on a projected 5.2% annual growth in nominal GDP, estimates that currently appear to be absurdly rosy. For example, the International Monetary Fund predicts nominal GDP growth for 2008 and 2009 in the U.S. of less than 0.5%. Additionally, Goldman Sachs predicts U.S. GDP to drop 5% in the fourth quarter of 2008 and be flat to slightly down in 2009.

What this means is that, with GDP growth flat to non-existent, the U.S. government engaged in vigorous rounds of Keynsian economic stimulus, and unemployment headed toward 9%, we can expect the U.S. national debt to start climbing at a new, exponential rate. How long this trend can continue before the U.S Treasury starts having problems finding buyers for its debt is anyone's guess.

Finally, it is not clear that the trillions of dollars of stimulus spending and loan guarantees are included in the current debt estimate on which I am basing these calculations, so the actual debt numbers could be up to $7T higher!

P.S.

If the amount of the U.S. debt is distressing to you and you would like to do something about it, you can send a check to the U.S. Government which will be used to reduce the national debt:

Make your check payable to the Bureau of the Public Debt, and in the memo section, notate that it is a Gift to reduce the Debt Held by the Public. Mail your check to:

Attn Dept G
Bureau Of the Public Debt
P. O. Box 2188
Parkersburg, WV 26106-2188

THROW WAGONER OFF THE TRAIN

Kirk Kerkorian (pictured above) had amassed nearly a 10% position in GM, and earned a seat on the board, but GM management blocked Mr. Kerkorian's initiatives (such as a merger with Nissan/Renault) to such an extent that Mr. Kerkorian dumped the entire position at a loss nearly two years ago.

After decades of obstructing the sort of change that Detroit really needed, the management of GM is now in Washington, hat in hand, looking for enough cash to get them through the winter. All I can think is, "I wonder what Mr. Kerkorian would have to say about it?"

I imagine that the first thing he would say is, "Throw the bums out!", referring of course to GM management. The idea that all that GM needs is more cash is absurd. The writing was on the wall as far back as 1973, and again in 1979 when Jimmy Carter was pushing for the kinds of changes that GM is going to have to embrace if they are to prosper. We are talking NEARLY 30 YEARS OF OBFUSCATION AND OBSTRUCTION.

The miracle is that GM has survived this long, which can only be attributed to America's love of American cars, especially the Chevy brand.

However, this love has been long in decline, as Japanese, and now Korean, automakers have really gotten their finger on what the median U.S. car driver in looking for (I can't tell you exactly what it is, but I can tell you that GM doesn't make it).

What did Detroit do in the face of massive market-share loss in the all-important midsize sedan segment? They put all their energies into the next generation of the large-platform SUV segment which had been generating most of their profits. However, in the face of nearly $4 gasoline, and after more than a billion dollars in R&D, GM completely pulled the plug on this project (which, allegedly, was developing an even BIGGER family of SUV's than the current crop of Suburbans and Tahoes).

So, what can or should the U.S. public do in the face of an impending Chapter 11 filing by GM? Some say nothing at all, let GM be controlled by their creditors to reemerge a different company. However, I don't think that GM would emerge on the other side. I believe that the combined weight of market-share loss, loss of public confidence, legacy costs, labor unrest, and the credit crisis would doom GM to implode in absolutely horrendous fashion, bringing down with it a large swath of the U.S. manufacturing sector.

So, if this is true, we probably should craft a plan to inject capital into GM, but the new U.S. administration should have at least one seat on the board and the capital should come in the form of convertible preferred shares (assuming we as a nation are committed to maintaining a domestic auto industry). And, I'm sure the plan would be better received if it came with Rick Wagoner's head on a platter.

Update 12/2/2008

DRIVING FROM DETROIT TO DC? How much clearer can they make it that they just don't get it than by making the announcement that Rick Wagoner will drive a Malibu Hybrid from Detroit to D.C.? Who drives that distance for ONE DAY OF HEARINGS? What, is he going to DRIVE BACK TOO? A quick check on Expedia shows that, by booking as little as one week in advance, Rick could have flown non-stop from Detroit to Washington in coach on Northwest Airlines for $194, including taxes. Detroit to Washington, round-trip, is 1,048 miles; at $0.27/mile, driving will cost him $283.00, never mind the cost of his time. Rick Wagoner costs shareholders of GM $2,833/hour plus benefits, so his decision to spend an extra 14 hours driving is costing the company $39,662 vs. flying non-stop in coach.