Friday, March 26, 2010


One would imagine that the great financial crisis would precipitate meaningful banking and financial reform but I doubt that will be the case. As long as the financial institutions are too big or so well inter-connected to the financial system that their failure may precipitate a chain reaction that threatens the world financial system, the government will protect them from failure. The rescue of AIG turned out to be essentially a bailout of the investment banks. When executives, especially CEOs, suffer no serious financial consequences when their actions bankrupt or put their companies in deep financial distress, it encourages risky and unethical behaviour. Such perverse incentives need to be discouraged. The Board of Directors is supposed to protect shareholders but more often than not, directors are just patsies for the CEOs.

In a damning 2,200 page report, written by bankruptcy examiner Anton Valukas on Lehman Brothers, he wrote of one episode on March 20, 2007, where the chief administrative officer, Lana Franks Harber of Lehman’s Mortgage Capital division, e-mailed a colleague to summarize her discussion with Lehman President Joseph Gregory with regard to her presentation to the Board of Directors: “Board is not sophisticated around subprime market -- Joe doesn’t want too much detail. He wants to candidly talk about the risks to Lehman but be optimistic and constructive - talk about the opportunities that this market creates and how we are uniquely positioned to take advantage of them.” (italics emphasis added). The report then states, "Consistent with this direction, the Board presentation emphasized that Lehman's management considered the crisis an opportunity to pursue a countercyclical strategy.... Management informed the Board that the down cycle in subprime presented substantial opportunities for Lehman."

More than once, under a bankruptcy restructuring, I have seen the very CEOs who ran the company into the ground getting 5% of the recapitalized company without putting up any of their own money. In most occupations, there are penalties for egregious failure but the CEOs of public financial companies are in a league of their own. Many get paid obscene amounts of money for risky and reckless behaviour. There is a joke on Wall Street: "Today, President Obama announced a salary cap of $500,000 for executives at banks and companies that have received taxpayer bailout money. And the CEOs asked: ‘Well, that’s $500,000 a week, right?’”.
From the Chou Funds 2009 AR.