Tuesday, July 29, 2008

Back to blogging

Vacation is winding down so I will get back to blogging. It has been a great summer with trips to relief trips to Missouri (helping after tornadoes) and Iowa (gutting homes after flooding), as well as a vacation to Barcelona.

But I am back and let the blogging begin again!

Wednesday, July 02, 2008

The capital role of finance in history - Money Matters - livemint.com

Finance and history have been linked for centuries. Here is an interesting look at some long run trends and later in the article what the history says may happen if the US loses its preeminent position.

The capital role of finance in history - Money Matters - livemint.com:
"Almost a hundred years ago in 1910, Austria-born economist Rudolf Hilferding wrote a book called Finance Capital....In his book, Hilferding described the emergence of a new type of capitalism dominated by the banks. He believed that the power of the old manufacturing interests had waned, pushed aside by a whole new breed of powerful bankers who controlled the pursestrings of the economy....“Through this relationship,” he argued, “capital assumes the form of finance capital, its supreme and most abstract expression.”"

Not too big to fail?

Bloomberg.com: Worldwide:
"`We need to create a resolution process that ensures the financial system can withstand the failure of a large complex financial firm,'' Paulson said in the speech excerpts distributed by the Treasury to reporters traveling with him in London.

The Treasury chief noted while there is a resolution mechanism for commercial banks, there is no such process for securities firms. Federal Deposit Insurance Corp. Chairman Sheila Bair has also urged that an agency be given power to take over and liquidate investment banks in an orderly manner. The FDIC has that power over lenders whose deposits it insures."

Let me confess that teaching Financial Institutions and Markets is not my favorite (although much better than its counterpart Money and Banking). That said, there are times that I wish I were still doing it. This is one of those times since the class room discussion over this would be very interesting. FTR I agree. I think large firms should be allowed to fail and if the current system is such that the cost of failure is too high, lowering it (either by allowing a more orderly liquidation or other means) is a worthy endeavor.

Grasso now and then. A look back to 2003.

Bloomberg.com: U.S.:
"Richard Grasso, the former New York Stock Exchange chairman who became a poster child for Wall Street excess, won a court ruling that allows him to keep his entire $190 million pay package.

A state appeals court in Manhattan today dismissed the remaining claims against him for excessive pay, and Attorney General Andrew Cuomo announced he won't appeal further"
And so it is over. At least we can hope it is. In writing this I went back to my the old (now defunct) Financeprofessor Newsletter (September 25, 2003) to see the story as it was originally written back in 2003 when it broke. Here it is in its entirety:

How much is too much? A look at the controversy surrounding Grasso’s
pay Short view: it is not just the pay!

What started as a fairly minor story about a large pay plan really took
on a life of its own as the uproar over the pay package for the NYSE’s
Dick Grasso is arguably the biggest corporate and institutions story in
several months. Grasso originally was set to receive a $186+ million
pay package. The payment almost immediately drew criticism from all
corners. As the criticism grew, Grasso gave back about $48 million of
the pay, but this did not appease his critics who now included board
members, NYSE employees, and shareholder groups including California
State Pension plan, North Carolina’s State Pension fund, and the NY
State Pension plan. On top of this criticism were numerous newspaper
editorials calling for Grasso’s resignation.

On Wednesday Grasso called a special board meeting. During this phone
meeting and in the face of mounting criticism, (in the press, from the
SEC, and from various stakeholder groups mount), Grasso tendered his
resignation to the board. Somewhat to Grasso’s chagrin, the resignation
was accepted by the board of directors.

Grasso had worked for the NYSE since 1969 (he began at $82 a week!) and
had been president since 1995. Looking back at Grasso’s reign one finds
that he oversaw the NYSE during some of its most fast changing times.
While the NYSE did lose market share on his watch, things were much
better than many had feared for the NYSE. Facing competition from both
new and existing markets, Grasso helped differentiate the exchange as a
place that strived to protect investors while also offering the best
possible execution of trades. However, Grasso is probably most known
for his rallying of his “troops” following the events of September 11,

However, there were some puzzling actions (such as remaining on boards
of firms on NYSE while in the role of regulator and president of the
exchange) and failing to adequately improve the corporate governance on
the NYSE. This was problematic as how could the NYSE call for improved
governance for the firms that list on the exchange if the exchange
itself did not have its house in order. Additionally, few would argue
that Grasso’s pay was not at least quite generous. In his first full
year as president, he was paid an estimated 50% more than his
predecessor. Moreover this pay grew quickly to over $30 million by 2001
(or at least it appears that way, it is hard to say as the NYSE is
famous for its secrecy and this pay does not include any bonuses or the
like). Ironically (and maybe coincidentally) Grasso’s predecessor was
William Donaldson. Yes the same William Donaldson who is now the head
of the SEC and has publicly spoken out against the pay plan. (It should
be noted that Donaldson’s pay package while presumably lower in value,
was at least as secretive as Grasso’s).

No doubt one of the first changes that we will see is improved
transparency. At a time when investors and regulators are demanding
more disclosure and transparency, the NYSE is a bastion for information
asymmetries and a lack of transparency. This can be demonstrated by
showing what happened once the Grasso story broke. First no one knew
how the pay was set or why it was so high. Then, like sharks with blood
in the water, reporters were quick to find more examples of “excess” and
apparent conflicts of interest that occurred on Grasso’s watch.

For instance the NY Times reported that this plan was “six times as
generous as those at major financial services companies.” And MSNBC
uncovered that charities who were associated with board NYSE board
members received significant donations from the NYSE. These payments
may not be problematic, but without disclosure, it seems like they are
hiding something which is not a good thing.

However, in the end, Grasso may still have a last laugh. If he can
prove that he was dismissed without good cause (an unlikely event), then
his forced resignation could trigger an additional $57 million payment
for dismissal “without cause.”

So who will be the next president? Not many people are stepping up in
line. For now John Reed, the former chairman of Citigroup, is serving
as interim president. His pay? $1.00


If indeed this type of pay plan is a problem and an indicator of more
serious governance problems at the exchange, then reforms are needed or
the next president will be the same. (As Fool.com points out this is a
nice definition of fungibility). While the exact shape of the reforms
for the NYSE are unknown, it is easily within the realm of possibility
that the NYSE may be forced to give up its role as a regulator.
Additional changes may be to limit conflicts of interest by not having
NYSE board member from firms who trade on the NYSE. In the short term,
the next in line of fire will almost assuredly be the board of Directors
who approved the pay plan. Stay tuned.


Many of the large pension funds that pushed for Grasso’s resignation are
now pushing for more lasting reforms. CALSTRS (Calpers’ sister fund)
took the lead but shortly many others joined in pushing for a breakup of
market function and regulation functions.


Longer term the NYSE is also facing many operational decisions. Not
least of which is how it is going to continue to compete with the
multitude of electronic trading platforms. As many have pointed out
specialists do provide important services, but this service is most
valuable in market downturns, and whether investors will pay for this or
not is still up for debate.

In an attempt to determine how widespread the large pay plans are, the
SEC (Donaldson) is asking that all of the financial markets disclose
their executive pay. Seeing what each is paid will be interesting.. In
the background are those markets that are already publicly traded and
hence already disclose their executive pay. For instance the Chicago
Merc’s James McNutty’s pay while lower than Grasso’s, is still pretty
high by most standards and above most of his peers when options are
included. Thus, the question arises as to whether more disclosure would
in fact dramatically lower the pay.

Additional sources used:

What others are saying:
“Each troubling detail of the package: its basis on cash; the lack of
comparability with CEO's of other major financial institutions (let
alone the heads of quasi-regulatory agencies); the apparent dozing on
the job by the NYSE compensation committee; not to mention the size of
it, is so appalling as to be almost comical. The type of mathematical
and moral calculus that structured the compensation package, and
Grasso's twisted logic in explaining it, is more in keeping with the
leadership of the Enron's and WorldCom's of the world, than it should be
with the executive of the world's most prestigious stock exchange”

Tuesday, July 01, 2008

Financier Starts Sentence in Prostitution Case - NYTimes.com

It has not been a good year for Jeff Epstein. A billionaire money advisor who owned his own island in the Caribbean as well as a large townhouse in NY, Epstein used to be known for his secrecy, smart friends, dislike of suits and ties, and yoga. That has changed in the past year. In fact, it has changed in a big way! Read on:

Financier Starts Sentence in Prostitution Case - NYTimes.com:
"On Monday morning, he turned himself in and began serving 18 months for soliciting prostitution....It is a stunning downfall for Mr. Epstein...a tabloid monument to an age of hyperwealth. Mr. Epstein owns a Boeing 727 and the largest town house in Manhattan. He has paid for college educations for personal employees and students from Rwanda, and spent millions on a project to develop a thinking and feeling computer and on music intended to alleviate depression.

But Mr. Epstein also paid women, some of them under age, to give him massages that ended with a sexual favor, the authorities say."

In addition to these charges, he was also recently was identified as a major investor in Bear Stearns' (where he used to work) hedge funds that collapsed last year:

From NY Times DealBook:
"The New York Post reported Monday that he was the “Major Investor No. 1″ described in a recently unsealed indictment as one of the three largest investors in two Bear Stearns hedge funds that collapsed. A spokesman for Mr. Epstein confirmed to the Post that he was the investor, who wasn’t identified in the indictment but was said to have had $57 million tied up in the funds shortly before they imploded early last summer.....The indictment said that in April 2007, the investor — whom we now know to be Mr. Epstein — told Mr. Cioffi he was thinking about pulling his money out of the fund. The funds had a bruising February and both funds lost money in March of that year."
So he was at least right on wanting to pull his money out of the fund.

For more on the charges see the Wikipedia entry.