THREE REASONS WHY I WILL NOT VOTE FOR SARAH PALIN
PROTECTING DICK CHENEY'S WRINKLED OLD ASS FROM EVILDOERS WILL ALSO HELP PROTECT YOU FROM IDENTITY THEFT

Bailout: Will Paulson's fund manager compensation plan be wrong from day one?

You can tell Treasury Secretary Henry Paulson comes from Wall Street. The former Chairman and Chief Executive Officer of Goldman Sachs is said to be struggling over a compensation plan for appointed managers of the individual segments of the bailout buyback fund.

The problem of compensation should not be as problematical as Paulson thinks.

This is a government program, run by government employees using government money. So what part of “government” does the Treasury Secretary not understand?

For easy reference, here are the government pay grades from GS-1 to GS-15.  Anything else should be determined by the Congress or Administration in a totally transparent manner.

Capture10-4-2008-1.29.16 PM

The fund managers, as government employees, get paid like, well, government employees. Perhaps the equivalent of the President of the United States – no more, no less.

It is anticipated that the actual fund managers will be hired as “consultants” and thus be able to sidestep governmental salaries. But if this is true, doesn’t this represent a conflict of interest; especially since their loyalty could be to their own firm rather than the taxpayers? Firms which may have participated and benefited in the current crisis? With the “name” consultants having an equity interest in a firm that will benefit from their decisions? Or be “consultants in name only” with the real work being done by others? There are many questions and when big money is involved, big schemes to secure a beneficial advantage emerge.

It is not their money that these managers will be spending. And the performance of the managed funds will be determined more by the vagaries of the market and the desirability of the funds underlying assets. The prime determinant of the  fund’s profitability will revolve around the initial price paid for the assets and what the market sees as value. Therefore, I see very little effort expended in managing the fund – especially since the heavy lifting will be done by staff members and computer systems.

Of course, you can bet that the bailout staff will be top heavy with attorneys and the odd economist advisor for the hyper-technical tasks of unwinding any existing asset encumbrances and valuing derivatives that can only be valued with complex computer models – and whose real value is not a computer-generated entry – but a function of what someone is really willing to pay for the asset. In this vein, we should be employing auctioneers rather than fund managers.

The danger of a bureaucracy …

The danger in the bailout mechanism is that the government and others will try to complicate the procedure with rules, regulations, guidelines into a complex system that is virtually impenetrable by those outside the process. If history of large governmental operations is an example, everything will be conditioned on building the biggest bureaucracy with competing factions and arcane internal rules.

If the Treasury Secretary were serious about building a competent management structure, perhaps he should look at Ginnie Mae who runs a profitable billion-dollar government mortgage operation  with under 100 employees.

My greatest fear …

My greatest fear is that the citizens of the United States will be defrauded by the government’s need to artificially manufacture a given result: that is to artificially value the assets now held on the balance sheets of financial institutions so that they don’t appear to be the insolvent train wrecks suggested by a fairly valued balance sheet. To accomplish this, the Treasury Secretary will, in my opinion, fraudulently value assets at greater than fire-sale pricing and that a few of these overvalued transactions will then be used by the financial institutions to re-value their remaining portfolios. Thus creating the fiction that the assets are worth much more than their true value. The secondary danger is that even after this re-valuing of assets, there will be significant losses due to the use of borrowed funds to highly leverage the original asset purchases.

How do you unwind leverage?

Since I know of no way of unwinding leveraged positions without a corresponding increase in value – some how, some way, these assets must be worth much more than their true value to compensate for the cost of borrowed capital – or at least the cost of the total debt service on the borrowing. More than any other factor, it is the use of leverage which turned solid companies from survivors to losers. A firm with $1,000 in equity capital used their balance sheet to purchase $30,000 or more in toxic assets. When the underlying value of the toxic assets declined a mere 30%, the resulting $9,000 loss exceeded the core capital by $8,000 and the company become instantly insolvent and a candidate for chapter 7 bankruptcy.

Will fictional accounting techniques continue?

This fictional accounting will be aided by accounting rules which might be selectively enforced. The first rule to fall by the wayside will be the scurrilous mark-to-market  rule which demands that toxic paper be valued at today’s market price. This rule will sink any company with derivatives in a declining market; and especially a market where no counterparty purchasers can be found. It is not known whether or not financial institutions will be forced to repatriate all of their off-balance sheet accounts which kept the increasing debt and losses from the public, counterparty and regulator scrutiny.

And what about those insurers?

The government, hence you and me, now own 80% of insurance giant AIG (American International Group). It is said that the multi-national insurer will sell off key assets to repay the government and then continue operating the resulting company. Considering the number of offshore entitites and other combinations and permutations of interlocking subsidiaries, it is believed that a strong core might emerge – a privately-owned profitable core which will have benefited from the bailout without providing a return to the taxpayer. This is a situation which will develop over the next few years and should be re-visited by the Harvard Business School as a case study in the off-shore deployment of assets to avoid the catastrophic impact of financial imprudent management actions.

And speaking of insurers …

I can’t help wondering if the government will exert claims on the insurers who were complicit in representing to the ratings agencies that the toxic assets were adequately insured against losses and which enabled the agencies to provide triple-A (AAA) ratings to the public and investors – indicating that the toxic securities were of “investment grade.” This qualified pension funds, retirement funds, mutual funds and financial institutions to use these funds as part of their core capital requirements or to meet specific “prudent” investment guidelines. Thus the toxicity traveled throughout a much wider financial body which did much to produce today’s systemic illness.   

Considering that many of these insurers were either off-shore or re-insured their risk with off-shore entitites, one might wonder if the government plans to swing a mighty hammer to break down the walls of off-shore asset sequestration in order to seize foreign-controlled assets which are related to insurance products used to “protect” toxic derivatives?

Trust works both ways …

I have great reservations that the same quality of government workers, who have built unauditable bureaucracies and managed to lose billions of dollars of taxpayer dollars somewhere in the system, are able to manage the bailout funds in a hyper-partisan political environment. Especially one that might be deeply affected by political programs and decisions put forth by House Financial Services Committee Chairman Barney Frank or his Senate  counterpart at the Senate Banking Committee, Christopher Dodd. Or having the securities rules enforced by Christopher Cox at the Securities and Exchange Commission. How can we trust the value of the securities when we can’t trust the ethics of those running the system?

Time is the enemy …

Considering the scare tactics used by the Administration, Wall Street, Congress and others to push the bailout bill through the system, one can only wonder what will happen in a few months when Secretary Paulson will be replaced on January 20, 2009 and a new Administration inaugurated. And, of course, we are also unsure of the composition of the incoming Congress. Therefore, there is pressure to push funds though the system at a rate which insures mistakes will be made. Mistakes which then can be overlooked and denied by the new Administration using the SODDI (Some other Dude Did It) excused used to shift blame to previous Administrations.

Bottom-line …

Treasury Secretary Paulson, the ultra-rich Eagle Scout from Wall Street may be completely trustworthy, but he can’t do it alone or supervise all of the individual components that may go into the mix. Therefore, it is necessary that he will keep the bailout mechanism simple, transparent and auditable.

Since the government is , in essence, allowing those who regulated and/or rigged the system to manage the bailout, we can only hope that the regulators, oversight committee and the law enforcement community will be smart enough, independent enough and tough enough to detect, deter and prosecute those who illegally benefit from an already dubious program.

-- steve

Quote of the Day: “There should be no yelling in the home unless there is a fire.” --David Oman McKay

A reminder from OneCitizenSpeaking.com: a large improvement can result from a small change…

The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane. -- Marcus Aurelius


“Nullius in verba.”-- take nobody's word for it!

“Beware of false knowledge; it is more dangerous than ignorance.”-- George Bernard Shaw

“Progressive, liberal, Socialist, Marxist, Democratic Socialist -- they are all COMMUNISTS.”

“The key to fighting the craziness of the progressives is to hold them responsible for their actions, not their intentions.” – OCS

"The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane." -- Marcus Aurelius

“A people that elect corrupt politicians, imposters, thieves, and traitors are not victims... but accomplices” -- George Orwell

“Fere libenter homines id quod volunt credunt." (The people gladly believe what they wish to.) ~Julius Caesar

“Describing the problem is quite different from knowing the solution. Except in politics." ~ OCS

Comments