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Thursday, April 30, 2009

Where's the Bar?

Countless other pundits have weighed in on the results of the first one hundred days of the Obama Administration, what those results mean for Obama's long term political capital and even the usefulness of the 100 day milestone itself which compares every President's trajectory with that of FDR's first term. Have the first 100 days of the Obama Administration been successful? Who knows? A more crucial question has to be answered first.

Where's the bar?

With an appropriately fuzzy goal, proponents can always claim success or rationalize falling short due to extenuating circumstances. Opponents can always incorrectly claim "I told you so" even when the right solution is chosen if something unrelated to the original debate intervenes and derails progress. For people to see the right solution was chosen or the wrong solution avoided, a clear, quantifiable goal has to be established BEFORE making a change and a reasonable explanation of the linkage between the change and the result has to be provided to justify support or opposition.

Since the financial meltdown began in earnest in March of 2008, the only goals provided for any multi-billion dollar program or bailout or geopolitical strategy change have been overly generic "avoid a worldwide depression" or "avoid a nuclear terrorist attack" goals. These types of overly broad, cataclysmic goals do nothing to help the public and politicians understand tradeoffs between goals and the compromises needed in a world of limited resources and tax dollars. As anyone in business will tell you, most products and business ideas fail -- the key is to quickly recognize the failures, stop digging and move on to the next idea to find the winner.

Given the variety, complexity and criticality of the problems facing the United States, everyone involved in the process is going to have to do a better job of establishing criteria for measuring success or failure. If you're a supporter of whatever it is the Obama Administration plans on doing on all these fronts, you have to recognize not all of the plans will work on their first, second or even third incarnation. If you're an opponent, you'll need to provide enough detail into WHY you're right and Obama is wrong in order to point to the failure early enough when a course correction will still do any good.

Stop and think about what's on the United States' plate right now:

Iraq -- We're trying to wind down our combat presence, leave a stable social and political environment and focus our military efforts elsewhere. If violence re-escalates, where's the bar for sticking with the current plan, slowing down withdrawal, or cutting our losses and speeding up the withdrawal?

Afghanistan -- We're trying to ramp up forces in Afghanistan to re-contain the Taliban and re-establish a more moderate political environment so we can eventually get out of Afghanistan as well. What's the timeframe for sticking with the current troop levels and plan versus escalating under some new approach or cutting losses?

Pakistan -- Our failure to corral and defeat the Taliban in Afghanistan has allowed them to take over provinces within Pakistan and seriously threaten the stability of a government that has multiple working nuclear bombs and has actively proliferated that bomb technology to numerous countries. Where's the bar for standing pat and letting the Pakistani military fend off collapse versus actively engaging with them against the Taliban?

Automakers -- Chrysler Motors was forced into bankruptcy on April 30, 2009 and GM is highly likely to do the same within 30 days. Hedge funds controlling 30 percent of Chrysler's $6.9 billion in debt felt they could net more for their junk bonds by triggering a bankruptcy that would trigger payouts on credit default swaps on that debt than accepting 28.9 cents on the dollar under the umbrella debt restructuring deal accepted by a majority of creditors. (#1) Where's the bar for deciding between paying on the TARP bailout side versus the direct cash side versus withholding all funds and then spiking unemployment another 3-4 percent?

Banks -- Stocks of financial firms soared in March and April of 2009. Despite "better than expected" earnings and grumblings from some TARP recipients about wanting to pay back their "loans" to get out from under the government's thumb, the risks to the system have by no means been eliminated. Virtually all of the unexpected earnings by major banks was due to investment gains as the Federal Reserve dumped over $1.2 trillion dollars into the market via bulk purchases of bonds and Treasuries. (#2) Despite that not-so-subliminal support, an April 28 story in The Wall Street Journal indicated Citi and Bank of America may actually require more capital from new stock issues or cash from the government. (#3) Both banks passed the Treasury Department's "stress test" (?), yet the Treasury notified each that the test results indicated their capital reserves were not sufficient and they needed to raise more capital (???), yet there's NO NEED TO PANIC (????????).

Now step back from the list above and think about these problems from a different perspective. In normal times, any ONE of these issues would have merited weeks or months of debate and would have been viewed as the great problem of our day. Kinda makes you nostalgic doesn't it? At this point, many of these problems are actually DIRECTLY related. How?

Taking too long to leave Iraq will short-change our staffing in Afghanistan, jeopardizing our chances of stabilizing that country and increase deficits, spooking Treasury borrowers and further impairing our economy. Leaving Iraq too soon allows the chaos to return to Iraq, drawing us back in for an even more expensive return engagement or destabilizing the middle east and spiking oil to $120 per barrel again.

Failure to stabilize Afghanistan heightens the pressure the Taliban is putting on Pakistan, placing actual working nuclear weapons in serious jeopardy of falling under the control of militant Islamic fundamentalists. Over-escalating our effort in Afghanistan traps us in another expensive war of occupation, continues to wear out our military families and continues deficit spending that further destabilizes the economy, employment and credit markets.

Continuing to place billion dollar band-aids on GM, Chrysler and Ford may defer a spike in unemployment that could cripple many local communities but masks the moment of truth these firms require to fundamentally re-orient their product lines. How many quarters of $5 billion dollar bridge loans should be made before they are forced to sink or swim alone? In a battle between idiotic auto executives and speculative, sleazy hedge funds who bought automaker bonds in the past ten years, who do you choose or when do you decide to choose neither?

Continuing to bail out the largest financial firms each time they find bigger losses does… ….does….Well, it does NOTHING. Nothing helpful anyway. Bank executives see no incentive to review the true value of their own portfolios, write them down to realistic values and allow markets to stabilize and return liquidity. Even if the American economy instantly adapted to a lower level of credit utilization, the current lending climate cannot support that reduced level because of doubts about true valuations for homes, property and income stability. The longer this credit paralysis exists, the more nervous international investors will be about US dollar denominated assets, the less willing they will be to use US dollars for trade and the lower the demand for US treasuries will become. Once demand for US dollars and Treasuries begins waning, American's $11.1 trillion dollar national debt will begin dragging us to the bottom of the lake.

As bleak as all of this sounds, there is one bright spot. Nearly every other industrialized economy is just as screwed up as the United States is, only they don't have nearly the track record of innovation and productivity that can help begin eating away at the debt and generating growth in better directions. However, finding the right combination of solutions will require quick identification of the wrong solutions and a clear-cut framework for prioritizing the limited resources for the best overall result. Throwing everything at every problem won't work.

Then again, given the track record of our politicians and the mindboggling danger posed by any ONE of the multitude of problems we face, maybe we should just pose the question a different way.

Where's the bar?


#1) http://www.nytimes.com/2009/04/29/business/29auto.html

#2) http://www.washingtonpost.com/wp-dyn/content/article/2009/03/18/AR2009031802283.html

#3) http://online.wsj.com/article/SB124088901025362487.html

Sunday, April 19, 2009

Open Secrets - Then and Now

The May 2009 issue of The Atlantic has a joint book review written by Benjamin Schwartz covering a series of books published recently about Nazi Germany:

The Third Reich at War -- Richard J Evans
Life and Death in the Third Reich -- Peter Fritzsche
Germany and the Second World War – Volume IX: German Wartime Society 1939-1945 -- (various)
Hitler, The Germans and the Final Solution --Ian Kershaw

Schwartz’s piece, entitled Hitler’s Co-Conspirators (#1) addresses a common theme covered in all of these books that has not drawn much focus in prior historical summaries of Nazi Germany – how could millions of Germans citizens NOT know what was happening?

As the authors of these books found and as Schwartz summarizes, the answer is very simple. Hundreds of thousands, if not most, Germans DID understand exactly what the Nazi regime was doing. Soldiers wrote home about mass shootings. The German tendency towards methodical efficiency meant thousands of mid-level bureaucrats saw reports of killing squads and mass murders. Towards the end of the war, a principle motivating factor for German troops to continue the slog was the fear of possible treatment of Germany by the Allies should Germany lose when the full scope of the Final Solution became apparent. Here is a quote from the Evans book repeated in The Atlantic piece:

Railway timetable clerks, engine drivers and train drivers and other staff on stations and in goods yards could all identify the trains and knew where they were going. Policemen rounding up the Jews or dealing with their files or their property knew as well. Housing officials who reassigned the Jews’ dwellings to Germans, administrators who dealt with the Jews’ property—the list was almost endless … The mass murder of the Jews thus became a kind of open secret in Germany from the end of 1942 at the very latest.

There’s the key phrase. An open secret.

Here is the key point of Schwartz’s commentary on these books and their conclusions about mass psychology, fear and unspeakable criminality:

As the social historians of the Reich probe more deeply, it’s increasingly clear that although knowledge of the Final Solution prompted action by only a heroic few, that knowledge—and Germans’ accompanying quiescence—nevertheless loomed large in the mind, and in many cases the soul, of the nation. This was deliberate on the part of the regime. In their public pronouncements Hitler, Goebbels, and Alfred Rosenberg married the bluntest language about an exterminationist policy toward the Jews with a complete absence of detail regarding implementation of that policy. Or the regime would wink at the population, as in a famous speech Goebbels made in 1943: when describing Nazi plans for the Jews, he said “exter—” and then theatrically corrected himself with the word exclusion. By establishing the murder of the Jews as an open secret—open enough that awareness of it pervaded society but secret enough that it couldn’t be protested or even openly discussed—the Nazis devilishly nudged the nation into complicity, and further bound the population to its leaders.

Read that paragraph a couple of times, slowly and carefully.

Sound familiar?


America has maintained many notable “open secrets” of its own over the past years.

Remember Dick Cheney’s appearance on Meet the Press on September 16, 2001 after the September 11 attacks? Here’s the first reference to working on the “dark side”: (#2)

VICE PRES. CHENEY: I’m going to be careful here, Tim, because I — clearly it would be inappropriate for me to talk about operational matters, specific options or the kinds of activities we might undertake going forward. We do, indeed, though, have, obviously, the world’s finest military. They’ve got a broad range of capabilities. And they may well be given missions in connection with this overall task and strategy.
We also have to work, though, sort of the dark side, if you will. We’ve got to spend time in the shadows in the intelligence world. A lot of what needs to be done here will have to be done quietly, without any discussion, using sources and methods that are available to our intelligence agencies, if we’re going to be successful. That’s the world these folks operate in, and so it’s going to be vital for us to use any means at our disposal, basically, to achieve our objective.
MR. RUSSERT: There have been restrictions placed on the United States intelligence gathering, reluctance to use unsavory characters, those who violated human rights, to assist in intelligence gathering. Will we lift some of those restrictions?
VICE PRES. CHENEY: Oh, I think so. I think the — one of the by-products, if you will, of this tragic set of circumstances is that we’ll see a very thorough sort of reassessment of how we operate and the kinds of people we deal with. There’s — if you’re going to deal only with sort of officially approved, certified good guys, you’re not going to find out what the bad guys are doing. You need to be able to penetrate these organizations. You need to have on the payroll some very unsavory characters if, in fact, you’re going to be able to learn all that needs to be learned in order to forestall these kinds of activities. It is a mean, nasty, dangerous dirty business out there, and we have to operate in that arena. I’m convinced we can do it; we can do it successfully. But we need to make certain that we have not tied the hands, if you will, of our intelligence communities in terms of accomplishing their mission.

TRANSLATION: I’m going to be careful here (you true patriots know I can’t say the truth so read between the lines here…), we’re going to have to work on the dark side (what could be “darker” than war?), if you will, without discussion, to use any means at our disposal (what means are there beyond bombing and killing people?). It is a mean, nasty, dangerous dirty business out there and we have to operate in that area. But we need to make certain that we have not tied the hands, if you will, of our intelligence communities. (No translation required).

Was there any doubt what was being conveyed with those comments?

Remember Cheney’s appearance on Meet the Press on September 8, 2002 prior to the October debates over a war resolution for Iraq? Here’s his mock restrained comment on the link between Saddam Hussein and the September 11, 2001 attacks: (#3)

Mr. RUSSERT: But no direct link?
VICE PRES. CHENEY: I can’t-I’ll leave it right where it’s at. I don’t want to go beyond that. I’ve tried to be cautious and restrained in my comments, and I hope that everybody will recognize that.

TRANSLATION: I don’t want to go beyond that (implying there is a “beyond” when there wasn’t), I’ve tried to be cautious and restrained in my comments (famed protector of state secrets that I am except when they help my cause) and I hope everyone will recognize that (and read between the lines to absorb what I’m trying to imply while not actually saying it so I can be convicted later).

Of course, open secrets aren’t just limited to genocide, terrorism, torture and war. How many thousands of people were employed in the financial and real estate sectors who knew of the trillions in fraud being perpetrated?

* how many thousands of loan officers approved no-document loans for hundreds of thousands of dollars?
* how many thousands of real estate agents encouraged people to buy homes they couldn’t afford as long as their commission was paid at closing?
* how many thousands of appraisals for properties were written on a drive-by basis or site unseen?
* how many county tax assessors said nothing as appraisals on dilapidated properties jumped ten or twenty percent on flip after flip as long as the next sucker paid the property tax on time?
* how many thousands of accountants working for banks and insurance companies knew their firms could not cover their CDS bets?
* how many thousands of stock brokers ignored their fiduciary duty to their clients by convincing them to buy crappy stocks their own internal analysts categorized as dogs?
* how many executives approved securitization and CDS strategies for their firms they didn’t understand for fear of being caught short in earnings compared to their competitors or for fear of losing millions in bonuses?

The key point about open secrets is the willful suspension of disbelief and mass psychology involved aren’t used to merely trick millions into buying Snickers bars when they should have been buying Milky Ways – harmless mis-directions in the overall scheme of human activity. They produce a culture and society in which unimaginable harm is produced and unspeakable crimes can be (and often are) committed. Americans need to start thinking very seriously about the broken mechanisms in our government, media, society and ourselves that allow these kinds of “open secrets” to remain unaddressed for years / decades. No guns have been held to our heads to ignore the realities in front of us and look away. Willful ignorance is the primary enabler and it’s entirely avoidable.


#1) http://www.theatlantic.com/doc/200905/nazi-germany

#2) http://www.emperors-clothes.com/9-11backups/nbcmp.htm

#3) http://www.mtholyoke.edu/acad/intrel/bush/meet.htm

Wednesday, April 08, 2009

Yellow Ribbons, Pink Slips and Extortion

I admit it. After the resignation of Donald Rumsfeld as Defense Secretary in November of 2006, I was not in favor of the nomination of Robert Gates to replace him. (#1) The concerns at the time were:

1) he's an intelligence guy, not a "big iron" and weapons systems kind of guy and might be tempted to do his old job rather than his new job
2) he had prior work involving illicit arms sales to Iran, Iraq and Nicaragua
3) he was a trusted member of the inner circle of "Daddy's fixers" surrounding GWB, which means his ideas are still very much like those that got us into the war in the first place
4) as an insider, his selection made it more clear the Bush Administration was suffocating from within because of the toxic environment they created in the first six years

I'm still not a fan of Gates' work under item 2 and still think item 4 held true but Robert Gates has proven to be not only the best leader President Bush appointed to the Cabinet but one of the most effective Defense Secretaries ever. Gates demonstrated superior leadership virtually from Day One by immediately reorienting the Pentagon's lackadaisical approach to correcting shoddy facilities and shoddy care given to returning veterans. After appalling conditions at Walter Reed Medical Center came to light in February of 2007, Gates pressured the Secretary of the Army to can the head of Walter Reed. That was done but the when it was found the replacement had been aware of the poor conditions from a prior stint as commander of the facility in 2003 and had taken no actions at that time, Gates IMMEDIATELY fired the Secretary of the Army, pressured the new replacement out of the Army and appointed a widely respected General and doctor over the Walter Reed facility. In a matter of days. Talk about sending clear messages.

Gates has also done well at the task of leading the Pentagon organizationally while allowing career military personnel to lead at the purely military strategic and tactical levels. There's no better proof of this balance and its benefits than the recent budget proposal provided to Congress by the Pentagon. Key highlights of the new budget plan include: (#2)

* cancelling purchase of a replacement for Marine One
* an end to the F-22 fighter program, a 16-year old design superseded by the JSF
* a halt to the vehicle portion of the Future Combat Systems program (roughly $87 billion)
* increasing the budget for intelligence, surveillance and reconnaissance by $2 billion
* adding 2800 personnel to Special Operations
* replacement of 11,000 contractors with 9,000 permanent employees in the Pentagon's procurement organization

Even ignoring the current financial meltdown that demands budget reductions, these changes prove beyond a shadow of a doubt that Gates GETS IT. He understands the nature of the wars we have been fighting, understands we can't afford to have it all and understands that we can't use many of the toys favored by Pentagon desk jockeys, defense contractors and corrupt politicians.

Put quite bluntly, the new 2010 Pentagon budget proposal is the near perfect crystallization of the financial and moral choice America must make between merely claiming to "support our troops" and crassly protecting local parochial and political interests in the name of "jobs". You can't have it both ways. You can't claim to support the troops by insisting on the building of aircraft carriers we can't use to protect jobs in Virginia and Connecticut. You can't claim to support the troops by insisting on the development of lightweight, fuel efficient troop transports loaded with electronics that can't protect troops from roadside bombs to protect jobs at Boeing, SAIC, BAE Systems and General Dynamics.

The final 2010 budget level and specific contents are far from finalized but the political debate in the coming months could best be described as the ultimate choice between yellow ribbons and pink slips with vast amounts of hidden political extortion between defense contractors, politicians and constituents over who feels the pain the most or least.

Robert Gates has laid out an effective budget for critical military needs in a desperate financial climate and has framed the rational for spending priorities so effectively that any argument against the plan will expose members of both parties for the charlatans and hypocrites they are if they choose to fight it wrapped in the flag claiming to protect our troops and our jobs. For this alone, Robert Gates deserves a hearty thank you from taxpayers.


I had planned on posting all of the above based solely upon the terms of the latest Defense Department budget proposal and the difficult choices between truly productive support of our troops and political protection of jobs for favored states and defense contractors.

The trade-offs between true security and jobs takes on an entirely different dimension in light of the investigation broadcast April 7, 2009 on the PBS show Frontline concerning systemic international bribery paid by huge corporations to corrupt government officials.

The Frontline show, entitled Black Money (#3), examined cases involving Germany's Siemens and Britain's BEA dating back as far as 1990. Thirty minutes into the program is a STUNNING series of findings involving an investigation by Britain's Serious Fraud Office (a "major case squad" within the equivalent of their DoJ) into payments to Saudi Arabia's Prince Bandar made by BAE. The SFO had collected significant amounts of evidence about illegal payments made by BAE and was beginning to apply pressure to officers of BAE and thus to Bandar and the Saudi government.

In the weeks following the July 2005 terrorist bombings in London, the SFO was within weeks of pursuing action in its case against BAE. In that tense, post-attack climate, Prince Bandar himself hand-delivered a personal letter from Crown Prince Sultan of Saudi Arabia to Tony Blair at 10 Downing Street that threatened a halt to any Saudi cooperation in the war on terror if Britain pursued any continued investigation of the BAE payments -- essentially stating the investigators would have blood on their hands for any attacks that might occur after they continue their criminal investigation and the Saudis halt cooperation on terrorism. Tony Blair shortly thereafter held a meeting with all of the heads involved with the BAE investigation, relayed the same message, and the British investigation has gone exactly nowhere since.

At present, the only country moving forward with any investigation is the United States but even that has a twist. Former FBI director Louie Freeh is now representing Prince Bandar who is now arguing the US has no role in investigating potential bribery payments, even though BAE is the fifth largest defense contractor for the United States Department of Defense.

Let's review, shall we?

1) Saudi Arabia, a supposed ally of the United States in the "war on terror",
2) within DAYS of a Islamic terrorist bombing of a United States ally,
3) hand-delivered a written letter directly to the head of state of that ally,
4) threatening to halt any cooperation on terrorist investigations current and future,
5) unless said ally ceased all criminal investigations of a British firm involved with bribe payments to Prince Bandar and other Saudi royal family members

Does anyone think Saudi Arabia has the ****s to extort the United States like it did Britain?

Does anyone think the United States would cave like Tony Blair did?

Does anyone still think these are purely hypothetical questions?


#1) http://watchingtheherd.blogspot.com/2006/12/bush-ignores-everyone-surprises-no-one.html

#2) http://thehill.com/leading-the-news/gates-forecasts-change-for-obama-pentagon-budget-2009-04-06.html

#3) http://www.pbs.org/wgbh/pages/frontline/blackmoney/

Sunday, April 05, 2009

(Another) American Psycho

The April 13, 2009 edition of Fortune has a fascinating (in the train wreck sense) article on New York attorney Marc Dreier and the multi-million dollar fraud he perpetrated for more than a decade. The article, entitled The Imposter (#1) summarizes more than a decade of alleged legal malpractice, investment fraud and frivolous lawsuits on behalf of a New York real estate developer. As the author puts it, the story of Dreier's fraud reads like another version of the movie Catch Me If You Can -- the story of someone seemingly addicted to living on the edge and perpetrating their fraud in the spotlight, rather than minimizing their risk.

The more interesting aspect of the Dreier story involves the number of alarm bells Dreier's very public conduct set off in the minds of nearly everyone that dealt with him. Not just in the last few months as the end of his fraud drew near, but for YEARS. A few quotes from the article:

At Fulbright, Dreier was a "lone wolf" who "didn't quite fit in with the other partners," according to someone who worked with him then. "Marc wasn't the kind of guy to stop and say, 'Let's run this past a committee.'"
"He is a thoroughly vile human being," says Kevin L. Smith, an attorney at Manhattan's Stroock & Stroock & Lavan, who litigated against Dreier for many years. "This is really a bad guy."
Kalikow's lawyers brought the phony legal-notice stunt to the attention of U.S. bankruptcy judge Burton Lifland, who had presided over the original Kalikow bankruptcy. At a hearing in June 2004, Lifland suggested that Solow's and Dreier's conduct had been "sleazy," and then read aloud a series of synonyms from a thesaurus: "tacky, shabby, base, low, malicious, petty, nasty, unsavory." In October 2004 he ordered Solow and Dreier to pay $335,000 in sanctions for having violated Kalikow's rights. But today - more than four years later - the fine has still not been paid, since, tellingly, Solow and Dreier are still appealing it.

So how many similar narratives are waiting to be uncovered as the next house of cards collapses and the rats within scurry for cover? It's hard to guess but the more important question might involve what has happened to our legal and accounting professions where people like Dreier can not only exist but thrive? Dreier wasn't leading a silent, double life of fraud behind a "pillar of the community" public persona. This guy was DESPISED by nearly anyone that ever dealt with him. What does it say that someone with this track record could attract clients searching for legal or financial help?

The best part of the article is a perfect analogy made in the conclusion:

There is an unfortunate optical illusion - a variant on the Doppler effect - that besets all frauds. It's unfortunate, because it has the effect of exacerbating the pecuniary losses that fraud victims endure, by unfairly leaving them, like many rape victims, irrationally ashamed of themselves.

The Doppler principle we posit holds that as a victim approaches a swindler, he sees nothing but green lights. But as soon as he realizes that his money is gone, he spins around and beholds, as if by magic, bright red flags as far as the eye can see.


#1) http://money.cnn.com/2009/03/31/news/newsmakers/parloff_dreier.fortune/index.htm

Friday, April 03, 2009

Corporations, Credit and Criminality

One of the questions asked most frequently by Americans about the financial crisis boils down to this: With over $11.1 trillion in US wealth destroyed (#1), how is it possible that Bernard Madoff seems to be the only individual yet to be sent to jail? Is it even possible for TRILLIONS of dollars in wealth to be destroyed only by incorrect but innocent mistakes and misguided optimism and greed? Millions or billions, maybe but TRILLIONS?

The short answer is NO.

The full answer requires thinking through the relationships between corporations, credit and criminality. More importantly, answering the question doesn't accomplish anything unless it drives changes in public policy.


A corporation is a legal entity that allows a collection of people to act as a single entity under the law and act like any real individual to enter into contracts, own property, pay taxes, etc. Over the past century or so, the laws of most industrialized countries have evolved to grant two crucial benefits to corporations -- limited financial liability of individual stockholders and a perpetual existence of the corporate entity beyond the life of any of its stockholders, directors or employees.

Limited liability creates a layer of indirection between claims against the corporation and its assets and the assets of individual shareholders of the corporation. With limited liability, shareholders can never lose more than the equity they invest, regardless of the size of claims against the corporation itself. Without that protection, far fewer investors would be willing to provide capital to the average business, much less gigantic multinational companies which can incur hundreds of billions in liabilities.

Perpetual life allows companies to continue operating indefinitely without having to "cash out" the assets of the company to new owners periodically like a sole proprietorship. That type of forced reorganization typically limits the size of a company due to the difficulty of finding individuals who are both financially capable of investing in the reconstituted firm AND participating in its daily operation. By eliminating the periodic re-organization and re-capitalization to new owners / operators, perpetual life allows corporations to continue aggregating market share, brand recognition and assets.

The legal fiction of a corporate entity creates complex issues in situations when corporations become involved in criminal acts. Like any human entity, the legal entity of a corporation can be sued, can lose tort cases and can face criminal charges for actions taken by the firm. In practice however, criminal charges may result in financial penalties being applied or regulatory limits being imposed upon the firm but more frequently involve an attempt to identify and prosecute wrongdoing on the part of individual employees. Very seldom (never?) is a "death sentence" applied to a corporation by directly terminating its charter and forcing it out of business.

More about corporate death sentences will be discussed shortly.


America's Founding Fathers, notoriously famous "smart guys", worried about the operation of banks and the use of money and their effect on the country. In fact, they worried and wrote a great deal about banks and money. Perhaps John Adams summarized their concerns most effectively:

All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulation.

They clearly understood the temptation and danger represented by the ability to incur long-term, trans-generational debt coupled with the ability to issue credit in the form of fiat money, even in an eighteenth century world that limited documents to quill and pen or hand-cranked printing presses and limited communication to the speed of a horse or sailing ship. Given the communication and computing tools at our disposal today, the concerns of the Founding Fathers over the ability of the tools at their disposal to produce bubbles and crashes seem almost quaint in comparison. They had no possible way to imagine the size and power wielded by modern corporations or the computerized ability we have to exchange BILLIONS of stock shares, commodities, bonds and other financial contracts on a daily basis. A great deal of information is flowing around the world amidst those billions of transactions but a great deal of mis-information also flows with it and mis-information is the lifeblood of the frauds and pyramid schemes that produce bubbles and crashes.

You may have seen this in a hundred blogs and commentaries at this point but the single most important thing to understand about credit is the origin of the very word itself -- from the Latin credere for "to trust or believe." Credit is literally an illusion. It can be useful when the relationship between borrower and lender is direct and the ability and willingness of the borrower to repay a debt is verified and when the lender has not recursively turned the promise of future payments into additional paper assets for additional loans. When these conditions aren't present and computers are used to generate BILLIONS of transactions every day and abstract those data streams down to nice Excel charts "proving" everyone's investments will grow at 7.3 percent uninterrupted, disaster is virtually assured. The combination of multi-national companies manufacturing credit at the speed of light with limited liability for insiders who benefit disproportionately from the inflation of credit is an irresistible temptation and danger.


Financial markets aggregate billions of individual decisions and opinions about value and risk into numbers which then drive billions more individual decisions in a never-ending feedback loop. Can the market as a whole or major players within the market be blamed or held to be criminally liable when expectations of future values fail to come true? Clearly not. However, when players in the market create products directly BASED upon such uncertainty and claim to protect parties from losses from the uncertainty and are mathematically unable to make good on those claims, they are perpetrating a criminal fraud. When databases, web servers and emails are used to transmit information to customers touting the ability of a firm to provide insurance against such risks, collect payments for such insurance policies and provide statements about the "worth" of such contracts which cannot be fulfilled with the capital available to the firm, wire fraud is being perpetrated.

If a crime has been committed, what are appropriate next steps?

First, there is likely an unlimited amount of evidence that can be collected from all of the major financial players who dabbled in mortgage backed securities and credit default swaps that would prove numerous employees of those firms did in fact know the numbers did not add up and they were facilitating a ponzi based fraud. Dispatching trained computer forensic experts from the FBI with subpoenas in hand to the data centers of every TARP recipient and blocking the destruction of email archives would be an excellent start.

If criminal wrongdoing is found within the megabanks or any giant corporation on the multi-billion dollar scale, the real question involves the appropriate penalty for the crime. In most billion dollar corporate fraud cases like Enron or Worldcom, the criminal pursuit quickly narrows down to a search for the biggest fish with a direct tie to the alleged crimes. Seeing Bernard Ebbers, Ken Lay or Jeff Skilling at the table hearing their guilty verdict might calm public opinion but does nothing to destroy the corrupt pond in which they operated.

What's missing in the debate over punishment of corporate fraud is recognition that as a artificial creation of the law for the public good, no corporation has any natural "right" to exist. Corporations are granted charters to operate in order to efficiently and legally increase economic activity, provide a good or service or play some charitable / philanthropic role for the society. When a corporation is found to be operating in a way which reflects systemic fraud throughout the corporation and / or inflicts material harm on the larger society it is supposed to be benefiting via its special chartered privileges, society not only has a right but an obligation to terminate that charter and halt the corporation's operation.

The argument against this is that usually ALL of the employees of the firm may not have played a role in the criminal activity. Since the structure of the firm is already established, why destroy the entire company and impact its employees and customers to punish a smaller subset of employees? This argument may make sense if the firm makes candy bars and is found guilty of systematically cheating customers of a tenth of an ounce of chocolate per bar over several years to reduce costs and boost profits. The only people "harmed" are the customer who purchased the candy bar, the harm itself doesn't permanently harm the customer or disrupt the larger economy and the harm doesn't have a feedback cycle that exponentially magnifies the harm over time. Just pay a fine and promise to never to it again.

The "pay a fine and promise to never do it again" approach is NOT a sufficient dis-incentive to firms specializing in banking, insurance and credit because of the unique combination of leverage and disproportionate rewards available in the financial sector. When one bank or insurance company holds hundreds of billions in assets, operates at a three percent reserve ratio and fraudulently creates hundreds of millions / billions in additional assets, the false expansion of credit produced by the fraud ripples throughout the larger economy and harms thousands more than the first customer who signed the first derivative contract that starts the cycle. The benefits of limited liability and perpetual life granted to a firm operating in the financial sector pose a uniquely dangerous risk to society when the firm abuses the leverage available in its business to commit fraud. The unique scale of damage created by such frauds merits a penalty equal to the damage -- the corporate death penalty:

* the orderly dissolution of the firm and its assets (much like an FDIC takeover)
* board members at the time of the crime are banned from serving on the board of any public firm
* pension, healthcare and severance pay for VP or Cxx executives of a convicted firm are nullified
* return of any bonuses paid to VP or Cxxx executives based upon results during the period of the fraud

How likely is it that more corporate death penalties will be imposed? Based upon testimony provided to Congress on April 2, 2009 by former AIG CEO Hank Greenberg, Congress doesn't appear to have a clue. Greenberg is still under investigation by the Securities and Exchange Commission for alleged fraud at AIG during his tenure at the firm that ended in 2005. Greenberg was not only invited by Congress to testify on the effectiveness of the AIG bailout so far ($185 billion and counting) but to outline his recommendations. His recommendation? By all means, keep the company operating as it stands right now rather than breaking it up. Spoken like a man who lost ninety six percent of his net worth --- and is still worth $28 million dollars. (#2)


#1) http://online.wsj.com/article/SB123687371369308675.html

#2) http://blogs.wsj.com/wealth/2008/09/17/hank-greenbergs-sudden-wealth-loss/