Just what the doctor ordered: corporate accountability

It appears, at least at some companies, that the bailout plan has caused some boards of directors to more closely securitize the actions of their CEOs. In a recent business week article, it was noted how GM’s new board has placed increased expectations on its recently installed CEO, Frederick A. "Fritz" Henderson. The old board gave a substantial amount of deference to former CEO Rick Wagoner. Because of GM’s excessive cost, Wagoner was more focused on cutting cost rather than building market share and increasing profit. In essence, the board and the CEO were solely focused on keeping GM afloat.

Under the new regime, this is not enough. In fact, Henderson has already come under fire by the board, as the board has “said that GM’s revised recovery plan filed on Apr. 27 isn't quite good enough.” “That plan, which cut four brands, downsized the company and its dealer network, and led the way into bankruptcy to clean up the balance sheet, only keeps GM above water. It doesn't show growth. Some directors were concerned GM wouldn't push to grow beyond the sales and market share laid out in the plan, say two sources familiar with the discussion.” The current board is chiefly concerned with paying the bailout money back and making GM a profitable going concern; however, in order “for taxpayers to break even, GM will have to eventually issue new stock and the company's value will need to reach $69 billion, more than it has ever been valued.”

To maintain this type of accountability, two things mush happen, boards must put more pressure on their officers to perform, and the law must put pressure on boards to remain focused on this goal. In regards to the first consideration, because of the current market conditions, it is likely that boards will continue to put this type pressure on their CEO’s; however, as the economy improves, it is less certain whether this will continue. As to the second consideration, to ensure that boards remain accountable, there must be a better system for watching the watch dogs (the board). Under the current legal framework, the officers are kept in check by the board. The officers have the greatest level of accountability under the current frame work considering that business judgment protection generally does not extend to them. As such, with the current market conditions, increased board oversight, and lack of business judgment protection, CEOs will be under an increased pressure to perform and they will finally have to prove that they are worthy of their exorbitant salaries. Conversely, the law does not put the same level of pressure on the board. Since the board’s decisions are protected by the business judgment rule, they have less accountability than the officers. This is extremely problematic considering that the board is the critical lynchpin in increasing corporate accountability and responsibility. Without greater levels of board oversight or a less deferential business judgment standard, history is bound to repeat itself.

The Subprime Mortgage Crisis: Debunking Myth and Reality?

Recently, Yuliya Demyanyk, a Senior Research Economist, at the Cleveland Federal Reserve Bank issued a very interesting Economic Commentary entitled “Ten Myths about Subprime Mortgages.” Demyanyk contends that many of the popular explanations for the subprime crisis were in reality myths. Further, Demyanyk takes the position that empirical research proves that the causes of the subprime crisis are multifaceted and complicated; going far beyond mortgage rate resets, declining underwriting standards, or declining home values that we typically are quick to point a finger towards.

In addressing and debunking the ten myths she perceives about the subprime mortgage crisis, Demyanyk makes the following observations:

* Subprime mortgages went to all kinds of borrowers, not just borrowers with damaged or impaired credit.

* Subprime mortgages did not promote homeownership.

* Declining home prices and values did not cause the crisis. Declining home prices served to reveal the quality of subprime mortgages that had been deteriorating for years.

* Declining underwriting standards did not trigger the subprime crisis. Yes, standards were declining, but not to a level to account for the enormous rise in mortgage defaults.

* Borrowers did not use their homes as ATM’s to extract cash from home equity loans and lines of credit. Data shows that mortgages originated for refinance performed better than mortgages originated solely to buy a home.

* Mortgage rate resets did not solely cause the subprime crisis. Fixed rate mortgages showed all the signs of distress that adjustable-rate mortgages showed.

* Subprime borrowers with hybrid mortgages were not offered low “teaser rates.”

* The subprime mortgage crisis was not totally unexpected.

* The subprime crisis in the United States is not totally unique; it follows a classic cycle of boom-and-bust that has been observed historically in many countries.

Demyanyk’s Economic Commentary makes for an interesting read to better understand the complicated causes of the subprime mortgage crisis. I tend to agree with some of Demyanyk’s assertions. On the other hand, I tend to disagree with some of Demyanyk’s assertions. Again, Demyanyk’s Economic Commentary is an insightful and thoughtful piece. Do you agree or disagree with Demyanyk’s perspective? I look forward to hearing what you think about the causes of the subprime mortgage crisis.

Predatory Lending and the Racial Wealth Gap

Disparities in wealth between white Americans and people of color have grown in the last thirty years in spite of dramatically increasing levels of educational attainment on the part of African Americans and Latinos. For every dollar the median white family owns, the median Latino family owns twelve cents. For every dollar the median white family owns, the median Black family owns ten cents. Many have written about and discussed the fact that African Americans and Latinos have less wealth than white Americans. But, to the extent this wealth gap is discussed, it has been without the benefit of context. It is time to add context so that we understand at least one of the underlying causes of the racial wealth disparity. The predatory lending that occurred during this decade provides the context that illustrates the type of structural and institutional racism that impedes the economic advancement of people of color.

Predatory lending and mortgages should be distinguished from subprime lending. Subprime mortgages and loans extended to low-income borrowers have enabled many to purchase homes and other consumer goods that would otherwise be out of reach. The interest rates of subprime loans are higher than the rates on prime loans to account for the risk that lenders would not be repaid when a borrower’s income is low or her credit history is weak. Predatory lending, however, involves excessive and unnecessary fees. Predatory lenders steer borrowers into expensive loans even when they qualify for more affordable credit.

Local, state and federal investigations across the nation have revealed that real estate professionals targeted people of color for predatory loans. Even middle and upper income African Americans and Latinos were led into subprime loans and mortgages even though they qualified for prime loans with much lower interest rates. In 2006, the National Community Reinvestment Coalition reported that in more than 70% of the neighborhoods it investigated, middle and upper income people of color were twice as likely as middle and upper income whites to receive high cost loans. The high rate of foreclosure caused by predatory mortgage lending has drained almost $200 billion from African American and Latino households.

Some of the lenders that engaged in predatory lending were public companies. And, we should also understand the relationship between predatory lenders and the financial institutions that did business with them. The relationship between Wall Street firms such as Lehman Brothers, Bear Stearns, and Merrill Lynch, on one hand, and predatory mortgage lenders and brokers, on the other, involved two aspects. First, Wall Street firms provided large loans to nonbank mortgage lenders that enabled them to make the predatory loans to prospective homeowners. Second, nonbank lenders were funded when they sold mortgages to major financial institutions as part of a securitization process in which investors purchased interests in pooled mortgages. In other words, the mortgage lenders and brokers who engaged in fraudulent and predatory lending could not have been in business without the help of Wall Street’s financial institutions.

Many of the predatory lenders and the financial institutions that did business with them have failed. But, it is important to understand the role of these companies in draining billions of dollars in wealth from communities of color. Understanding their role is essential to comprehending one of the most salient causes of the widening wealth gap between white Americans and Americans of color. Articulating the fact that there is a racial wealth gap without discussing the reasons it exists implies that the gap is attributable only to some deficiency in the financial acuity of people of color.

Symposium in Central Ohio: The Financial Crisis: New Administration Initiatives and How Practitioners Should Advise Clients as a Result

On Friday, October 16, 2009, Capital University Law School Graduate Law Programs will present a conference on “The Financial Crisis: New Administration Initiatives and How Practitioners Should Advise Clients as a Result.” The goals of the conference are to educate the audience on the corporate governance issues that arose from the recent financial crisis in the financial industry, and to instruct the audience on financial transaction options that distressed companies may use in the current recessive and turbulent economic environment. Speakers and panelists include nationally recognized practicing attorneys, business financial advisors and academics.

The conference’s morning portion will focus on the financial crisis and the governance of private and publicly held for profit and nonprofit corporations. The morning will begin with a presentation and discussion of directors’ and senior executives’ respective duties and responsibilities. Then the focus will shift to the financial crisis and whether the crisis resulted from a failure in corporate leadership or from a confluence of low probability, market-driven events. The next segment will address potential federal legislation that may impact board governance. The presentation will shift to examine beliefs underlying corporate governance (e.g., “pay-for-performance requires equity-based compensation,” “managers must think like owners”) and to challenge whether these and other beliefs lead to corporate governance practices that are in the best interests of the corporation.

The conference’s afternoon portion will address financial transactions for distressed companies, including bankruptcy, restructuring and raising capital. This portion will touch on the responsibilities of management of distressed companies as well as offer practical advice on the restructuring tools available for distressed companies. In addition, one segment will provide insights and pointers on how corporations may proceed smoothly through the business bankruptcy process. The afternoon will conclude with a presentation highlighting the new Department of Justice antitrust enforcement policy and its impact on business combinations designed to help financially troubled business organizations.

Additional details regarding the program will be forthcoming here in the near future.

North American Leaders Summit Raise Concerns Regarding Trade, Public Health, and Human Rights

President Barack Obama and Canadian Prime Minister Stephen Harper joined President Felipe Calderon in Guadalajara, Mexico for the annual North American Leaders Summit to discuss increased cooperation amongst, and the future of the three North American nations under the auspices of the North American Free Trade Agreement (NAFTA) which was enacted in 1994 presumably to relieve trade barriers between the United States, Canada and Mexico.

During this year’s summit, President Obama commented on the strong trading partnership among the three North American nations and that he intends to expand commerce between the three nations. Canada is America's top trading partner. China is America’s second top trading partner and Mexico is America’s third top trading partner. Given President Obama's intent to increase commerce between the three North American nations, the Buy American provision in the $787 billion economic stimulus package, which require many of the public works projects paid for by the U.S. economic stimulus plan to use materials made in the United States, has drawn criticism from Canadian Prime Minister Harper. However, President Obama stated that every effort will be made to implement the Buy American provision in a manner consistent with U.S. international obligations, while minimizing disruption to trade. As a result, Congress has made changes to the bill to include various exceptions. To date there has been no statistically significant change in trade between U.S. and Canada. The three leaders agreed to a shared recovery, to reform the international financial institutions, and to lay the foundation for future growth between the three North American nations.

With regard to public health, the three North American nations agreed to a "joint, responsible and transparent" response to the swine flu threat. President Obama noted that although, the Canadian health care system is fundamentally different from the U.S. system. He expects that "more sensible and reasoned arguments will emerge" regarding the U.S. national healthcare program.

Despite the lofty trading terms in NAFTA, NAFTA has drawn much criticism including, the loss of American jobs to Mexican workers, the collapse of small American and Mexican farmers, and a significant increase of illegal immigration from Mexico to the United States. Additionally, trade disputes have also arisen with Mexico alleging that the U.S. violated a NAFTA accord when the U.S. canceled a program allowing some Mexican trucks to operate in the U.S. Mexico responded by imposing retaliatory tariffs of $2.4 billion on U.S. goods back in March.

Not everyone was pleased with the North American Leaders Summit, approximately 400 people marched outside of the meeting place for the summit to protest the negative effects of free trade and to demand benefits for retired Mexican laborers who worked in the U.S. The protesters also demanded immigration reform in the U.S. and that Mexican laborers who work under the World War II guest-worker program receive the money withheld from their paychecks.

Human rights concerns in Mexico persist, particularly at the state level where violence surrounds local elections and misuse of the judicial system. However, President Calderon stated that the Mexican government has an "absolute and categorical" commitment to human rights.

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law
St. Thomas University School of Law

Corporate CEOs are the New Potentates

Friedrich Hayek stated the following with regard to the rule of law in 1961: “By ‘law’ we mean the general rules that apply equally to everybody… As a true law should not name any particulars, so it should especially not single out any specific persons or group of persons... the rules must apply to those who lay them down and those who apply – that is, to the government as well as the governed – and that nobody has the power to grant exceptions.” Aristotle and Plato cast the rule of law in terms of legal autonomy—meaning that government is the servant of law, not that law is the servant of the government. Indeed, the difference between the rule of law versus rule by law amounts to the abuse of power wherein law is reduced to a mere instrumentality of oppression, unfair advantage, and the arrogation of legal immunity.

In the US, our legal system has devolved from a rule of law system to a rule by law system. I posit that this transition is the direct outcome of rising inequality, with a very high concentration of resources at the very top of the income distribution. When a small percentage of the population accumulates vast resources then they will naturally seek to influence the law with money to entrench themselves and insulate themselves from competition and even basic accountability. Note from the chart above, that the income share of the top 0.01 percent of our population has soared in recent decades, eclipsing even the 1928-1929 high by a significant amount.

This spike in inequality at the very high end coincided with an assault on the rule of law in the corporate arena. In 1986-1988 corporate elites abolished the duty of care for corporate directors. In 1995 and 1998 those same elites insulated themselves from liability for securities fraud. In 1999 they freed themselves to become too big to fail by repealing the Glass-Steagall Act, the last remaining legal cap on the size of banks. Now they have secured government guarantees for their bonus payments and golden parachute payments. All of these legal indulgences directly contributed to the subprime fiasco.

It makes sense that elites would immunize themselves from corporate laws that imposed accountability or constrained their accumulation of power. First, it is clear that a significant number of the families in the top 0.01 percent of the income distribution are CEO families from the data on executive compensation, above. Second, in addition to their own prodigious resources they can also muster the lobbying efforts of the corporation, as well as the wealth of other senior officers within the corporation. Thus, corporate wealth services the political goals of management not the shareholders. Third, CEOs are a small group of 500 or 1000 individuals (depending on how you count) which means they can act collectively with little cost of free-riders.

The picture is fairly grim. It runs from inequality to executive compensation to an assault on the rule of law. Moreover, since this is a bi-partisan dynamic it is unlikely that either party is likely to roll back the immunities, subsidies and exceptions to accountability corporate executives have garnered. The financial sector lavishly supported both Obama as well as McCain. The law now quite clearly serves the interests of the CEOs.

Corporate Behavior in the Face of Reform

Treasury Secretary Timothy Geithner has been aggressively peddling the Obama Administration’s plan to reform the financial industry in recent weeks. We as a nation, have a habit of experiencing an economic crisis and then passing reform after the fact in order to try to protect against its recurrence. Interestingly, we often fail to heed the calls for common sense reform or regulation prior to a devastating meltdown (I wrote a law review article warning against unregulated over-the-counter trading of derivatives back when Greenspan was telling Congress that large institutional investors would never leverage themselves to the point of financial failure), waiting instead to clean up the carnage after the fact. In fact, as criticized on this Corporate Justice Blog, often the carnage clean up rescues the malfeasors (recently in the form of government bailout and continuing excessive executive compensation) and leaves taxpayer citizens (the innocent party) shouldering the burden of the economic crisis.

To wit, the Securities Act of 1933 and the Securities Exchange Act of 1934 were both enacted in wake of the Great Depression. Sarbanes-Oxley was enacted in the wake of the Enron, WorldCom, Tyco scandals. Today, the momentum to pass regulatory reform is strong in wake of the devastating market crisis that we continue to feel and attempt to overcome. Still, the broken models that have proved ineffective continue to be used as the baseline for these reform efforts.

In response to the subprime mortgage meltdown, the Obama administration’s reform effort will seek regulatory control that includes (1) broadening the Federal Reserve’s authority to assess risks and overleveraged positions taken by financial firms and taking action to divert failure and (2) the creation of a consumer watchdog type of agency that would oversee mortgages, credit cards and other financial products. So, with Wall Street reform on the table, leaving aside the value or quality of the suggested reforms, what response can we expect from Wall Street and the financial industry in the face of these proposed reforms?

If history is any indicator, the response driven by corporate interests will be forceful and coordinated in an effort to defeat any new regulation or to significantly weaken it if the force of majority is too strong for reform (see Sarbanes Oxley, etc.).

As a point of comparison, Corporate behavior in recent weeks in response to health care reform and climate change legislation has been breathtaking in its audacity and truly underhanded in its application:


Corporate interests in the health care industry have undertaken a strategy of near mob mentality in coordinating efforts to hijack Congressional town hall meetings through astro turf lobbying firm “marching orders” designed to squelch conversation and open debate. As Congresspersons use the recess to openly debate and honestly describe the efforts to reform U.S. health care, a group of citizens will show up with the express purpose to shout down any attempts at an open conversation about changing a health care industry that works extraordinarily well for insurance companies (and their investors) but that is broken for large segments of American society.

Corporate interests in the energy industry hired lobbying firms that have recently forged letters from civil rights groups in an effort to defeat environmental reform. Several Congresspersons received letters ostensibly from the NAACP and a Hispanic Civil Rights organization pressing the representative to vote against climate change legislation, only to later learn that these letters were forgeries sent from a Capital Hill lobbying firm hired by industry corporations to defeat reform.

Corporate justice? With corporations in the insurance and energy industries using scorched earth tactics to defeat reform? The mountaintop (of reaching corporate justice) seems to be extraordinarily steep.

Enron’s Aftermath: This Is Not Just Business News

In this economic downturn, Americans are clear that the business community has a huge impact on the welfare of the entire nation. In part, because our government has rescued private companies with taxpayers’ money, the intersection of Wall Street and Main Street is clearly visible. News stories about corporate governance failures, violations of securities laws and corporate criminality are no longer confined to the business section or financial media. Because average Americans have been asked to save the private sector, business news has become mainstream.

The Savings and Loans debacle of the 1980s was one of the first mainstream business stories. The 1990s “dotcom” bubble and its bursting were reported on the front pages of newspapers and described on television and radio programs that typically devoted little time to business news. And of course, the recent economic downturn and the private sector excesses that contributed to it are reported in all of the major news outlets used by average Americans who are outsiders when it comes to business.

Business news became front page news at the beginning of this decade with the bank failures of important companies such as Enron, WorldCom, Tyco, and Adelphia. The disgraced leaders of these firms became public icons of corporate greed and hubris. Ken Lay, Jeffrey Skilling and Andy Fastow of Enron were tried and convicted. Bernard Ebbers of WorldCom, Adelphia’s John Rigas, and Tyco's Kozlowski were sent to prison. All of this was reported by the mainstream media, resurrecting the confidence of the American public.

Jefferey Skilling’s conviction was confirmed by a federal appeals court, the Fifth Circuit, but his sentence was vacated. It is not surprising that Skilling appealed his conviction. Appeals are routine. Skilling’s sentence was vacated, and a hearing date, July 30th, was set for his re-sentencing. (His re-sentencing, however, was postponed.) None of this surprises me either. But I am surprised that these details have been largely confined to the business media. Most Americans would want to know that one of the key architects of Enron’s downfall may get less jail time. And many of these Americans do not follow business news.

What Role for Institutional Investors?

In my first post on this site, I mentioned that I had planned to write about institutional shareholder roles in corporate governance post-financial markets meltdown. Instead, another topic presented itself (i.e., the SIGTARP quarterly report). On August 1, at an American Bar Association Business Law Section Corporate Governance Committee presentation during the ABA Annual Meeting, a task force on the delineation of shareholder and board roles presented its final report.

The task force report, which is highly readable and balanced, praises shareholders and boards, noting that “shareholders and boards have become increasingly engaged in their roles, and generally this increased engagement has been a positive development.” Also, it gives kudos to institutional investors for actively using their voices and votes. Furthermore, the report praises boards for becoming “more actively engag[ed] in discussions with shareholders on a variety of governance related topics.” For example, “Pfizer, UnitedHealth and Home Depot . . . initiated meetings with large institutional investors to discuss issues ranging from executive compensation to board composition.” The report recognizes “[w]hile the data is not definitive, there is evidence that focus by large, long-term shareholders and greater activation by independent boards is associated with better corporate performance.”

I am particularly interested in the increase in meetings between corporate boards, executives and investors. The report indicates that some corporate executives are willing to discuss issues that are the subject of shareholder proposals during proxy season, such as “nomination of directors, compensation matters, social and environmental issues,” and the like. Might corporate executives be willing to discuss with institutional investors corporate risk management policies, internal control procedures and monitoring of internal auditors, and other hot topics on the border between corporate governance and corporate operations?

The report is available here.

The World Bank and IMF Forgave Ayiti's Billion Dollar Debt as Ayiti Struggles to Reform Public Programs and Policies

A few weeks ago the boards of the World Bank and IMF decided to approve Ayiti’s (Haiti)$1.2 billion debt relief under the enhanced HIPC (Heavily Indebted Poor Countries) Initiative and the Multilateral Debt Relief Initiative (MDRI). The interest payment on Ayiti’s loan had grown to approximately $20 million per month, which is a staggering payment for a poor island-nation with approximately $4.1 billion in GDP and $1,300 per capita.

Ayiti’s debt was relieved because Ayiti had reached the completion point under the enhanced HIPC Initiative. For Ayiti to reach the completion point, Ayiti had to make several reforms despite suffering through a series of humanitarian crises and enduring the devastating impact of four hurricanes, drastic increases in food and energy costs and challenging political conditions. A number of political leaders and organizations urged for the cancellation of Ayiti’s debt. US organizations including Jubilee USA Network, Institute for Justice and Democracy in Ayiti, TransAfrica Forum, the Quixote Center, Center for Economic and Policy Research, the Episcopal Church, and Partners in Health worked together to build the political will in the U.S. for Ayiti’s debt cancellation, in partnership with colleagues in Ayiti, throughout the Americas, across Europe and around the world. Ayiti is now under the MDRI for further debt relief from International Development Association (IDA) the Inter-American Development Bank (IADB). MDRI relief would save Ayiti US$972.7 million in debt service of which US$486.7 million owed to IDA and US$486 million to the IADB.

Several of the reforms that Ayiti has made and will continue to make as part of the debt forgiveness program, include: implementing a national poverty reduction strategy; strengthening public expenditure management; producing audited government accounts; ensuring commitment to an asset declaration law, which requires a country not to nationalize foreign assets; adopting a law on public procurement; strengthening tax and customs administration; improving debt management and financial reporting; establishing a financing mechanism to allow over 50,000 additional children to attend public school; allocating over 20 percent of recurrent spending to education; implementing a national teacher training program; approving an HIV/AIDS prevention and treatment plan; and, improving immunization rates for children under the age of eighteen.

Despite the extensive list of reforms, Ayiti’s public health law and public health program are not included as reform iniatives althougth they are in dire need of renovation. I recently joined a group of approximately 60 doctors, nurses, administrators and educators on a week-long medical relief mission to Les Cayes, Ayiti to provide medical services to residents in one of the poorest areas in Ayiti. Medical doctors came from as far as China, New York, Philadelphia, New Jersey and Florida to volunteer their services. The mission was organized by Gaskov Clergé Foundation which was developed to promote, health, sports, education and science in Ayiti. I was the only lawyer in attendance, and my involvement was originally limited to providing strategic support to the board by interviewing various parties and taking footage of the medical mission for an upcoming documentary. However, within a few hours of arriving in Ayiti, my role expanded as the need from the community extended beyond the group’s initial expectation. As word spread within the community that “doctors from America had arrived,” people came from neighboring provinces to seek free medical services. The week was intense. Each day the doctors consulted with 300-600 patients, and 2-3 surgeries were performed at the national hospital with limited surgical resources. My cutting-edge interviewing skills gave way to my language skills. I placed the camera aside, to a large extent, to fufill the more fundamental need of serving as an interpretator for the non-French speaking doctors and conducting direct patient medical history inquiries of patients who primarily spoke French and Creole.

A few observations became immediately apparent. First, poverty in Ayiti is not at all analogous to poverty in the United States. Poverty in Ayiti is brutal. The concept of health insurance, public funding for hospitals, or effective medical equipment are non-existent, therefore resident do not receive basic medical care. Second, the majority of illnesses that the doctors treated were preventable, if patients had public health information regarding the importance of washing their hands, using clean water to bathe, and drinking parasite-free water because preventive medicine is not accessible. Third, what Americans consider as "basic" necesities to maintain health such as clean water, annual medical check ups, dependable medical equipment and supplies, is not basic provisions provided by the govenment for the residents of Ayiti. Clean water and public health education is a national concern. Things that are viewed as “basic” to Americans are life-giving and extremely precious to residents of developing countries. As Ayiti struggles to reform its macro-economic policies, developed countries such as the United States should continue to encourage the government of Ayiti not to overlook the importance of public health education and the need to provide “basic” preventive care to the poorest of the poor.

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law
St. Thomas University School of Law

Call for Papers - The Fall of the Economy and How New York City Can Rise to the Challenge

On Friday March 5, 2010, the St. John’s Journal of Civil Rights and Economic Development will host a symposium on the recent economic downturn and its effect on New York City at St. John’s University in Queens, New York.

Date: Friday, March 5, 2010

Location: St. John's University School of Law Moot Court

The symposium will consist of academics who have conducted research in all areas related to this downturn as well as community leaders and organizers who have dealt first hand with the individuals affected. The goal of this symposium will be to expose the pitfalls that lead to the recession and to determine an approach to avoid a similar situation in the future. Further, through discussion and debate, this symposium will connect all classes and ethnicities in an effort to work together to build a stronger city for the future.

Call for Papers
We invite you to participate in this symposium by sending a short 250-500 word essay by August 12, 2009 on your research and your desired involvement in this discussion. After review, panelists will be invited to speak and potentially asked to submit a paper for publication in the Journal.

Please download the attached call for papers for a more in-depth explanation of the symposium and the paper submission process.

Related Studies
Job Losses Show Wider Racial Gap in New York
By Patrick McGeehan and Mathew R. Warren

Contact Information
Adam Dressler
Research & Symposium Director
St. John’s Journal of Civil Rights and Economic Development
adam.dressler07@stjohns.edu

The Wages of Sin: Ruth Madoff and Bernie's Money Trail

Last week I posted a piece on the Corporate Justice Blog about affinity fraud and the Bernie Madoff scandal. Well, the drama surrounding Bernie Madoff does not cease. A couple of days ago, Ruth Madoff, the wife of Bernie Madoff, was a major item in the news.

As it turns out, Irving Picard, theTrustee appointed to liquidate Bernie's business assets filed suit against Ruth Madoff to recapture and recoup upwards of $45 billion transferred to Ruth Madoff, or companies she controlled, for her own personal benefit. In his Bankruptcy Court filing, Mr. Picard detailed 111 alleged fraudulent transactions and conveyances to Ruth Madoff.

As part of his 150 year sentence, Bernie Madoff forfeited most of his personal assets. The government did not contest Ruth Madoff's claim to $2.5 million. Ruth Madoff continues to enjoy substantial advantage and a relatively lavish lifestyle compared to the individuals and charities that were defrauded by Bernie Madoff, her husband.

The sins of the father are often the sins of the son/daugther. Are the sins of the husband the sins of the wife? This remains to be seen. Will Ruth Madoff have to atone for Bernie's sins? We shall see. Will we ever sort out the Bernie Madoff money trail? We'll find out. I'll keep you posted.

Beware the Zombie Banks!

Zombie banks seem to be killing our economy, just as financier George Soros predicted. Zombie banks do not lend money because they are worried about remaining solvent and staying in business (so they may continue to pay outrageous bonuses and golden parachute payments to their inept CEOs and senior officers). Zombie banks are widely viewed as the root cause of the now 20 year old Japanese contraction. Rather than lending money on reasonable terms zombie banks use government subsidies to soak borrowers and drive out competition. Further, zombie banks squeeze out profits from healthy competitors through the advantages of government subsidies and thereby cause industry-wide stagnation and job losses.

According to the FDIC, bank lending contracted by $116 billion in the fourth quarter of 2008 and $138.5 billion in the first quarter of 2009, as indicated in the chart above. The Wall Street Journal reports that lending fell an additional 2.8% in the second quarter of this year. This coincides with a newly revised GDP numbers that track the contraction in lending; for example, GDP contracted at a rate of 5.4% in the fourth quarter of 2008 and 6.4% in the first quarter of 2008. In the just completed second quarter, the contraction in GDP seems to be slowing, based largely on increased government expenditures now amounting to 20% of the economy.

This is some cause for optimism, but the economic problems posed by zombie banks are not likely to be resolved any time soon. The IMF now projects total toxic assets in the world financial system will reach $4 trillion, and banks have recognized less than half of these losses. Moreover, securitized credit in the US has fallen over 60%. Much of the recent optimism in the financial sector is also the result of changes in accounting rules that allow banks more discretion in valuing assets that previously had to be marked-to-market. Earlier this spring Paul Krugman suggested that we should prepare for a lost decade of zombie banking. Since then he thinks that the risks of a zombie economy have increased; I argue that the greater estimated losses and the use of accounting machinations to conceal deep financial wounds means that a zombie economy is a near certainty. The net result is gross injustice and perverse incentives that are economically corrosive.

I have previously suggested on this blog that a government regulator should have the power to order prudential divestitures to assure that no bank ever becomes too-big-to-fail again. Given the enormous costs of bail-outs generally, and financial bailouts in particular, however, I now suggest that the power to bailout financial firms rest with a separate, non-banking regulator. The non-banking regulator should have the power to organize government assistance for any firm (financial or not) the failure of which would present a severe economic disruption.

Even then the regulator should be required to find that rescuing the firm is highly likely to result in profits to the taxpayers and will result in a viable firm over the long run with substantial certainty. This regulator should be depoliticized, like the Fed, but have no significant ties to any one industry, financial or otherwise. It should be self-funded, through a tax on any economically significant public firm–like a users’ fee. Government assistance should come with severe restrictions with regard to compensation (bonuses and golden parachute arrangements should be dischargable by the bailout agency), and any individual who engages in reckless conduct leading to substantial government expenditures should be subject to fines (commensurate with the cost to the public fisc and the degree of their recklessness) and disbarment from serving as an officer or director of a publicly traded firm–meted out in an administrative proceeding. Criminal sanctions should be reserved for knowing misconduct leading to government assistance. The PSLRA should also be amended so that it does not apply to officers and directors of bailed-out firms. That way, securities fraudfeasors (currently protected by the PSLRA) would at least think twice before defrauding shareholders of an economically significant firm. Senior management of rescued firms should be terminated, unless their service is vital to the success of the firm.

Because creditors could not count on government bailouts under this regime they would not carelessly supply cheap capital to any large firm. The user fee would therefore likely result in a higher cost of capital for firms flirting with too-big-to-fail status. CEOs and directors would find government bailouts distinctively unpleasant. Incentives toward prudence would be restored. This proposal therefore would greatly contract the problems associated with too-big-to-fail.

The problem is not that the law cannot remedy the too-big-to-fail problem; the problem is that the financial sector may have too-much-political-power-to-reform.

Goldman and AIG: Two Strategies, Two Very Different Outcomes

Goldman Sachs (“Goldman”) continues to be a major player in the derivatives market. Unlike AIG, Goldman’s derivative strategy is much more conservative. AIG insured almost $430 billion in credit default swap (“CDS”) contracts; however, it took no offsetting positions against these contracts. As a result, AIG was able to make substantial profits from the premium payments it collected, since it did not pay any premiums to offset these contracts.

While AIG made substantial profits from this strategy, it proved to be one of the decisions that led to the current financial crisis. Conversely, Goldman’s derivative strategy has proven to be more efficient, especially under the current market conditions where competition in the derivatives market has “diminished and the spreads between buying and selling have widened.”
Goldman’s derivative strategy is very straight forward, for every CDS contract it insures, it attempts to secure an offsetting position in an amount equal to or greater than the CDS contract it protects. “A review of Goldman's 10-Q filing for the period ending March 31, 2009, shows that Goldman wrote credit derivative protection for others equal to $3.2 trillion or 12% of the $26 trillion notional value of these derivatives existing. Offsetting that $3.2 trillion position is $3.429 trillion in credit derivative protection in Goldman's name. This gives Goldman Sachs a cushion of $257 billion in notional CDS contracts as protection.” Through this strategy, Goldman makes a profit on the spread between the CDS contract it insures and the offsetting position it secures to cover the CDS contract. While the overall spread under this type of strategy is lower, it has proven to be highly efficient as well as profitable. In fact, “Forbes estimates that Goldman Sachs made about $1.8 billion in gross profits during the first quarter of 2009 from trading 12% of the total nominal amount of credit default swaps that exist. This profit would be the result of collecting only a 1.5 basis points spread on the $3.171 trillion CDS position. This estimate of $1.8 billion is before overhead, interest and taxes. Goldman reported total net profit of $1.8 billion for all of its activities during the first quarter.” Thus, a significant portion of Goldman’s profits from the period ending March 21, 2009 are from its derivative activities.

These two stories beg the question of whether AIG’s board and its officers should suffer sanctions given that AIG’s actions seem more reckless in light of Goldman’s derivative strategy. More specifically, how could AIG’s board and its officers legitimately believe, in good faith, that their strategy created a bottomless pit of money?

whither executive compensation?

Bank Bonus Tab: $33 Billion
Nine Lenders That Got U.S. Aid Paid at Least $1 Million Each to 5,000 Employees

Splashed across the the Wall Street Journal on Friday (7.31.09) was the news that nearly $33 billion in executive and employee performance bonuses were paid out in 2008 by nine Wall Street banks that had accepted government bailout money through the TARP program. Despite near collapse and a necessary rescue from the government, nine investment banks still paid the executives and employees that presided over the catastrophic declines $32.6 billion in bonuses.

This news comes on the heels of reports on Thursday of last week (7.23.09) that Goldman Sachs, Morgan Stanley and JPMorgan Chase had set aside dozens of billions of dollars to pay their executives and other employees for 2009 performance. On the same day that Goldman Sachs announced that it would likely (if the pace of set asides continues this year) pay its executives an average of $775,000 in 2009, more than double that of 2008 and more than bonuses paid in 2007, a report on unemployment indicated that jobless claims increased more than expected, and the Federal Reserve expects the unemployment rate to top 10 percent by year-end.

As unemployment increases on Main Street, over on Wall Street, the song seems to remain the same. Executives and employees will receive significant performance bonuses in 2009 despite receiving government bailout funds and in many instances presiding over a near collapse of the banking industry. More shocking than the plans to compensate for 2009 is the New York Attorney General Andrew Cuomo report that $32.6 billion in bonuses were paid out in the wretched economic performance year of 2008. What gives?

Common sense seems to dictate that if performance is dismal, then bonuses should match that performance (meaning, very little should be paid in bonuses). Remember, that bonuses are paid to executives and employees in addition to salary. In the Sports context, in particular the National Football League, performance bonuses are negotiated in advance between an athlete and a professional club, and those bonuses are simply not paid if the negotiated performance is not met. Many bonuses in professional sports are team based, indicating that if a team reaches a certain level of success, then bonuses will be paid to a particular player. The NFL collective bargaining agreement even breaks bonuses down for purposes of the salary cap, into "likely to be earned" bonuses and "not likely to be earned" and those bonuses count differently toward a team's overall budget and cap number. In the NFL, bonuses are paid for successful performance and are in excess to an athlete's base salary.

Apparently on Wall Street, a much different conceptualization attaches to performance bonuses than in the world of professional sports. Nine investment banks received bailout funds rather than face collapse, and then turned around in that environment of "failure," and paid bonuses to its executives and employees that presided over that dismal performance, above and beyond salary, to the tune of $33 billion. In some ways, one could interpret this payout as taxpayers (through the TARP bailout) subsidizing the performance bonuses that were paid to executives that engaged in breathtaking risk and lost badly. As would be expected, Congress is inflamed. Edolphus Towns, the chairperson of the U.S. House of Representatives investigative panel called the payouts "shocking and appalling" and announced hearings.

Those that defend paying significant bonuses in the face of failed performance typically claim the following: (1) Wall Street must pay to keep talent at their firms; (2) that only a small group of executives or employees are typically responsible for losses and it is unfair to punish employees or executives in other areas of the business.

AG Cuomo stated: "The banks say they pay for performance. . . . Yet in 2008 there was no performance and they still continued to pay out huge sums of money."

I get the argument that individuals that were not responsible for the damning losses and egregious decision making should not be held responsible or "punished" for the "sins" of the few. Still, that argument fails to appreciate the broken executive compensation system in place on Wall Street. Over and over again, Wall Street executives have shown that they exist in a much different space than the rest of America. From the AIG "retreat" to a posh resort moments after receiving bailout funds to the $33 billion in bonus payouts for 2008 performance, those that run Wall Street seem incapable of recognizing Main Street and the human suffering that continues unabated for many based almost wholly on reckless and irresponsible leadership by Wall Street executives.

What to do about executive compensation?