Wednesday, January 23, 2008

Who is to blame: why capitalists are capitalist;s worst enemies

Who's to Blame?

Why capitalists are capitalism's most dangerous enemy.

By Robert J. Samuelson
Newsweek Web Exclusive
Updated: 11:17 AM ET Jan 23, 2008

Amid the mayhem in the world's financial markets, it is becoming clear that capitalism's most dangerous enemies are capitalists. No one can have watched the subprime mortgage debacle without noticing the absurd contrast between the magnitude of the failure and the lavish rewards heaped on those who presided over it. At Merrill Lynch and Citigroup, large losses on subprime securities cost chief executives their jobs—and they left with multimillion-dollar pay packages. Stanley O'Neal, the ex-head of Merrill, received an estimated $161 million.

Everyday Americans will conclude (rightly) that this brand of capitalism is rigged in favor of the privileged few. It will be said in their defense that these packages reflected years of service, often highly successful. So? It's not as if these CEOs weren't compensated in all those years. If you leave your company a shambles—with losses to be absorbed by lower-level employees, some of whom will be fired, and shareholders—do you deserve a gold-plated sendoff? Still, the more serious problem transcends the high pay itself and goes to the wider consequences for the economy.

Wall Street's pay practices perversely encourage extreme risk-taking, which can destabilize the economy. Subprime mortgage losses may simply be chapter one. Now there are signs of problems involving securities known as "credit default swaps." Never mind the details. Concentrate on the possible fallout. If banks and investment houses sustain more losses, the nation's credit system will be further wounded, and so will the economy. The Federal Reserve cut its key overnight interest rate yesterday from 4.25 percent to 3.5 percent—a huge move—in part to shore up this wobbly credit system.

By "Wall Street" I mean all the commercial banks, investment banks, mutual funds, hedge funds and the like that comprise the financial sector—but particularly investment banks. Pay is eye-popping. In 2007, Lloyd Blankfein, chief executive of Goldman Sachs, received compensation estimated at $68 million. But pay is also heavily skewed toward annual "bonuses" based on the profits that traders and bankers generate. I asked Johnson Associates, a compensation consulting firm, for typical Wall Street pay packages. The results describe "managing directors" based in New York with 10 or 15 years' experience. Most would be in their 40s.

Here are estimates for 2007:

Investment banker: $2.1 million, consisting of $275,000 in base pay plus $1.2 million in cash bonus and $625,000 in long-term bonus. (An investment banker helps firms raise capital by selling new stocks and bonds and also advises on mergers and acquisitions.)

Bond trader: $1.5 million, with $240,000 in base pay, $975,000 in cash bonus and $310,000 in long-term bonus.

Hedge fund manager: $1.8 million, split between a salary of $265,000 and $1.5 million bonus.

Just why investment bankers and traders outearn, say, doctors or computer engineers is a question I've never heard convincingly answered. Are they smarter? Unlikely. Do they contribute more to the economy? Questionable. True, Wall Street often performs a vital function. It channels savings into productive investments. It helps provide access to capital and credit. In 2006, U.S. companies raised nearly $4 trillion through new stocks and bonds. Many financial innovations, including mortgage-backed securities, have benefited individuals and companies.

But Wall Street also frequently misallocates capital and credit. The "tech bubble" of the late 1990s was one episode. Now we have subprime mortgages. Why? Well, the herd mentality of financial crazes has a long history. But compensation practices skewed so heavily toward bonuses based on annual profits make matters worse.

"People self-select for careers. On Wall Street they self-select for the money," says pay consultant Alan Johnson. "Wall Street is a sales business—they sell bonds, securities, transactions, ideas … They're not paid to be long-term, philosophical, reflective." The pressure is to do the next merger, sell more stocks and bonds, do more trading—whatever boosts current profits and bonuses, the long-term consequences be damned.

"These are my MBA students, not just mine but MBAs from Harvard, Stanford, Pennsylvania," says economist Allan Meltzer of Carnegie-Mellon University. "They were buying and selling this garbage [subprime mortgage securities]. Are they so stupid? They got compensated for doing it. If they didn't do it they'd lose their jobs."

To be fair, the real-estate bubble had many causes, including low interest rates, the political popularity of homeownership and the (mistaken) belief that housing prices could never fall. This may explain why, so far, the backlash against Wall Street has been muted.

But if the subprime failure turns out to be a preamble to a larger financial breakdown flowing from the creation of new securities that offered short-term trading possibilities but whose long-run risks were underestimated, then the mood could turn uglier. Indeed, many Americans may conclude that capitalism has run amok.


Study: 935 False Statements Led to War

by Douglas K. Daniel

WASHINGTON — A study by two nonprofit journalism organizations found that President Bush and top administration officials issued hundreds of false statements about the national security threat from Iraq in the two years following the 2001 terrorist attacks.

The study concluded that the statements "were part of an orchestrated campaign that effectively galvanized public opinion and, in the process, led the nation to war under decidedly false pretenses."

The study was posted Tuesday on the Web site of the Center for Public Integrity, which worked with the Fund for Independence in Journalism.

White House spokesman Scott Stanzel did not comment on the merits of the study Tuesday night but reiterated the administration's position that the world community viewed Iraq's leader, Saddam Hussein, as a threat.

"The actions taken in 2003 were based on the collective judgment of intelligence agencies around the world," Stanzel said.

The study counted 935 false statements in the two-year period. It found that in speeches, briefings, interviews and other venues, Bush and administration officials stated unequivocally on at least 532 occasions that Iraq had weapons of mass destruction or was trying to produce or obtain them or had links to al-Qaida or both.

"It is now beyond dispute that Iraq did not possess any weapons of mass destruction or have meaningful ties to al-Qaida," according to Charles Lewis and Mark Reading-Smith of the Fund for Independence in Journalism staff members, writing an overview of the study. "In short, the Bush administration led the nation to war on the basis of erroneous information that it methodically propagated and that culminated in military action against Iraq on March 19, 2003."

Named in the study along with Bush were top officials of the administration during the period studied: Vice President Dick Cheney, national security adviser Condoleezza Rice, Defense Secretary Donald H. Rumsfeld, Secretary of State Colin Powell, Deputy Defense Secretary Paul Wolfowitz and White House press secretaries Ari Fleischer and Scott McClellan.

Bush led with 259 false statements, 231 about weapons of mass destruction in Iraq and 28 about Iraq's links to al-Qaida, the study found. That was second only to Powell's 244 false statements about weapons of mass destruction in Iraq and 10 about Iraq and al-Qaida.

The center said the study was based on a database created with public statements over the two years beginning on Sept. 11, 2001, and information from more than 25 government reports, books, articles, speeches and interviews.

"The cumulative effect of these false statements _ amplified by thousands of news stories and broadcasts _ was massive, with the media coverage creating an almost impenetrable din for several critical months in the run-up to war," the study concluded.

"Some journalists _ indeed, even some entire news organizations _ have since acknowledged that their coverage during those prewar months was far too deferential and uncritical. These mea culpas notwithstanding, much of the wall-to-wall media coverage provided additional, 'independent' validation of the Bush administration's false statements about Iraq," it said.


On the Net:

Center For Public Integrity:

Fund For Independence in Journalism: