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Austerity Program for Banks

Stories in both the New York Times and Wall Street Journal said that European leaders are determined to stand behind any banks which fail their stress tests or are brought low by their holdings of Greek debt. The same leaders have not quite resolved how to deal with Greek debt despite Greece agreeing to an austerity program. Both bankers and national leaders insist that Greece and other countries (including the US) need a dose of public austerity so that they can both pay their debts and continue essential services.

So let's remix.

Countries should insist that banks which are being bailed out with public money, including low or no interest loans from central banks, need an austerity program of their own. How else can they both raise capital and still make loans?

The bank austerity program

  1. No employee of a bailed out bank can be paid more than the highest paid civil servant of the country the bank is located in.
  2. No employee of a bailed out bank may get a severance payment more generous than the best severance payment given a civil servant.
  3. No employee of a bailed out bank may have benefits better than the best benefits given to civil servants.
  4. These condition will remain in effect for any particular bank for two years after all bailouts, including interest rate concessions and guarantees, have been paid back at interest rates which are based on the risk to the government which made the loans or made the guarantees.
  5. Forget about changing employees to consultants, playing games with equity, or any pre-existing golden parachutes.

FAQ on the bank austerity program

Q. How will bankers live on civil servant salaries?

A. We all know that civil servants are overpaid.

Q. Won't bank management quit?

A. :-} Remember this only affects the management of banks which need to be bailed out. The rest can still pay management whatever they want tppay them..

Q. How will you get anybody to run the bailed out banks at these wages?

A. Well, there are the laid-off civil servants. May be better to have people with private sector experience, though. Plenty of them available on the job market, too.

Q. But they won't be qualified?

A. Are the current managers "qualified"? If so, why do the banks need bailouts?

Q. Won't bank executives refuse to apply for bailouts if they know they will have to change their lifestyles?

A. If the bank doesn't need a bailout, not applying is a good thing. If the bank does need a bailout and management refuses to apply, that's a dream lawsuit for breach of fiduciary duty. Better not cut lawyers salaries yet (except those who work for bailed out banks).

Q. Will the bankers riot in the streets?

A. And burn their limousines and break their bank windows? A pin-striped riot would be fun to watch, though.

Q. Won't all the bankers go to countries which pay them better?

A. Such as? And who's going to bail them out there?

Q. Won't this cost jobs?

A. Are you kidding? For every $10,000,000 a bank doesn't pay its CEO, it can make $100,000,000 in loans to job creating enterprises.

Q. Why wasn't a bank austerity program imposed before?

A. See campaign contributions.

Related posts

Trotters in the Public Trough

The Demopublican Duopoly is Due for a Fall

Bad News for Investment Banks; Good News for the Rest of Us

Election Analysis: It Was TARP that Boiled the Tea

We've Been T*RPed


Too-Big-To-Fail Goldman Buys Facebook Share

As a former founder and CEO of a public company, I understand why Facebook founder Mark Zuckerberg wants to raise money without taking his company public. During the dot.com bubble ten years ago, many companies, including mine, went public too soon – most before they were profitable, some before they even had revenue. Nevertheless, the announced deal between Goldman Sachs, Russian investor Digital Sky Technologies, and Facebook is disturbing both because Goldman was one of the banks considered too big to fail by the Federal Reserve and because the federal regulations on how many investors a company can have before going public is being used, as regulation often is, to favor big banks and big companies.

The details of the deal as described in a New York Times article by Susanne Craig and Andrew Ross Sorkin: "Facebook has raised $500 million from Goldman Sachs and a Russian investor in a transaction that values the company at $50 billion, according to people involved in the transaction. As part of its deal with Facebook, Goldman is expected to raise as much as $1.5 billion from investors for Facebook."

Further according to The Times article: "On Sunday night, a number of Goldman clients received an email from their Goldman broker, offering them the opportunity to invest in an unnamed 'private company that is considering a transaction to raise additional capital.' Another person briefed on the deal said that Goldman clients would have to pony up a minimum of $2 million to invest and would be prohibited from selling their shares until 2013."

So what's not to like about the deal? Don't we want private sector investment? Risk taking?

Too Big To Fail

The deal reportedly values Facebook at $50 billion. Could be too much; but that's certainly a risk that Goldman and its wealthier clients are equipped to take, isn't it? Sure… except if we are expected to bail them out again if their investments go sour. Nothing substantive has changed since the last bailout , when the Federal Reserve gave Goldman 52 separate infusions with a high balance owed of $18 billion (all of which has been paid back). Goldman is, if anything, an even bigger and more important part of the entire financial structure. It's not that this one deal could even dent Goldman; still, they are playing a heads we win, tails you bail us out game. They get a privileged seat at the investment table; and, if they don't play their cards right, they get lent new table stakes by the Fed at concessionary rates, while the smaller players are forced to fold for lack of capital.

We don't want the government regulating what risks Goldman and its clients take; that a sure way to freeze and politicize the risk taking and private investment we need. That means we either have to change the law so that the Fed cannot repeat the kind of bailout it did last time around – and investors know this and can act accordingly – or we need a preemptive round of financial trust busting leaving no entities standing that are too big to fail.

Access to Public Markets

In an over-reaction to the dot.com bust, a law known as Sarbanes-Oxley was passed requiring much greater disclosure by publicly-traded companies. A consequence of this, whether intended or not, is that small companies can no longer afford the accounting required to be public. It is also true that the transparency required of a public company may be a bad idea for a startup which has good reason to keep its successes and failures secret from competitors and imitators. Moreover, quarterly reporting with an emphasis on short term results is not a great way to run any company and can easily be a fatal distraction to a company which needs to focus on long term value.

The SEC allows a company to have up to 499 investors without being public (state law varies). A secondary market in the shares of private companies has grown up including online exchanges like SecondMarket, which says it has "More than 30,000 participants, including global financial institutions, hedge funds, private equity firms, corporations and high net worth individuals". This is a largely unregulated market in which participants invest at their own risk. An investor can decide whether she wants to invest in a company which is not making public disclosure of its results and is not regulated by the SEC.

But the restriction that company have less than 500 investors is leading to the formation of investor pools which act as a single investor. Certainly this is legit when the investment pool, a VC firm or a pension fund, has many investments; but what if the pool was formed just to skirt the rule on having too many investors in a single private company? According to Bloomberg, the SEC is investigating this practice. It seems from the little information available, that this is exactly what Goldman is doing in the case of Facebook to allow its favored accounts to buy shares.

I'm not convinced more regulation by the SEC is a help to anyone; the illusion of oversight is dangerous to investors. Remember Enron and Bernie Madoff – remember the underreporting of underfunded pension plans, particularly in the public sector, and all those publicly-traded banks which were suddenly insolvent. An honest caveat emptor might be more helpful. The simplest thing may just be to lift the arbitrary limit on the number of investors a company can have without being forced to be "public".

There certainly shouldn't be one rule for Goldman and its clients and another rule for everyone else. Small companies need access to risk equity (not a guarantee of funding, just access) to allow them to compete with companies big enough to make their own deal with Goldman.

See Socialist Senator Sanders Saves Capitalism for more on the bailout of Goldman.

See Public Company – Deciding To Do It for the price a small company makes pays to go public.

See AT&T: Lesson From the Crypt #1: Don't Manage for Quarterly Results for why neither large nor small companies should manage for quarterly results.

My novel, hackoff.com: an historic murder mystery set in the Internet bubble and rubble has plenty of hair-raising stories about investment banks during the dot.com era as well as the story of a fictional company that went public too soon.

Why We Can Succeed

After Governor Douglas' press conference last week, there was the usual scrum of reporters and administration officials in the hallway of the fifth floor of the Pavilion Building in Montpelier. The Governor had just said that Vermont cannot and must not sit around waiting for another Stimulus Bill (which would be a bad idea nationally) but can and must address its own structural problems in order to succeed in the post-bubble, post-recession (and post-stimulus) economy. In fact, he said, we are working towards a much more effective state government and have seen some early bipartisan support for some of the tough stuff we must do. Vermonters, he said, realize there's a problem, know there's no painless way out, and expect and will support action.

The reporters were, as reporters should be, skeptical. Is this just one more reorganization of government? If so, why do we think that it will be any more helpful than past reorganizations? Anyway, what are the specifics of the things we intend to do? What are these changes? What does a much more effective state government look like?

We administration officials didn't give the reporters the specifics they'd like to have – and I'm not going to do that here. Plans are not done; legislators not briefed; specific legislative proposals not written; and we have to propose a budget to deal with a anticipated gap of $150 million or more in fiscal year 2011 while figuring out how to permanently make state government more effective at lower cost to match revenues which will remain lower than in bubble years (and were being outstripped by expenses even then).

"So," a reporter asked me, "what is your role as Chief Technology Officer?" That is a question I can answer and helps answer why I believe we CAN succeed.

Part of my responsibility is to assure that we're using technology broadly-writ to make state government not only more efficient but also more effective. With a vast wave of retirements coming up in the state work force, there's an obvious opportunity to do the same work with less workers if we provide those workers the proper tools. But that's not enough; we want the work to be qualitatively better in terms of outcomes. Just for example: it's a good thing in itself if we can deliver needed benefits to needy beneficiaries with less overhead and fewer mistakes (efficiency); but it's even better if those benefits help more of the beneficiaries become independent (effectiveness).

Turns out that technology can be a big part of gaining both efficiency and effectiveness. Things are very different technically then when prior attempts at change fizzled or partially fizzled. We now have examples of how industries like airlines have used the web to dramatically change customer service both to reduce service costs AND to empower customers. Some readers may remember when you went to a travel agency to get paper tickets which were written by hand before you could fly anywhere.

Here's what's changed:

  1. The web exists and most people know how to use it to get service (but not all, of course).
  2. Even in Vermont broadband adoption is growing rapidly.
  3. The SmartGrid project by Vermont utilities and the VELCO fiber build (almost $200 million between them) will bring high-capacity data-carrying fiber into every corner of Vermont. This "backbone" capacity is necessary to get all our institutions online with very high bandwidth and to take us closer to meeting our residential availability goals even though the fiber itself won't stretch all the way to every home.
  4. We plan to up the goal from 100% broadband availability to 100% adoption (the Governor has proposed that over $3 million of remaining stimulus money be used for this rather than as a short-term bandaid). This assures that government services delivered electronically will be accessible to almost all Vermonters.
  5. The cost of computing resources continues to follow Moore's law down (50% reduction in cost for the same capability every 18 months) so that many computing and communication dependent projects have gone from impossibly expensive to very affordable just in the last five years.
  6. We can now afford to gather the data we can't afford to govern without (but, as of now, don't have). 

So, from my nerd's POV, the realm of the possible is greatly expanded, especially if we don't let ourselves be bound by current organizational constraints. We not only have the means to quickly implement 21st century government in Vermont, we are ready for change and all its attendant discomforts, confusion, and fears. 

  1. No alternatives to much more effective government other than a drastic cut in benefits to those who can't afford a drastic cut, raising taxes which will quickly get us less income as taxpayer flight accelerates, or the fantasy of more and more "stimulus" forever from a federal government whose credit is running out.
  2. A much better realization from at least some lawmakers of the situation we're in. The Governor talked in his press conference about the very real cooperation and good thinking coming from Joint Fiscal Chairman Michael Obuchowski and others.
  3. The acceptance (subject to ratification) of a paycut by state employees. That makes them part of the solution rather than part of the problem. We now owe it to them to give them better tools (technology, again).

It's going to be a very tough year in the legislature and in the state; but I'm optimistic that we'll be able to focus on the right issues, make the right choices, and do more than just "recover".

Fiat Deal Values Chrysler at Less Than Zero

Fiat won't accept a 35% stake in Chrysler unless the US adds another $3 billion to the $4 billion we've already "lent" to the "US" automaker, according to a story in the Wall Street Journal. Fiat isn't going to put any money of its own in, of course; no one in their right mind would. Cerberus Capital Management, currently owner of 80.1% of Chrysler isn't putting money in; Daimler, owns the rest but values it at zero.

So, without our putting additional money in, the owners can't even give away shares in the company; that means its current value must be somewhere south of zero. Since that's the case, please remind me why we're planning to put more money in?

We are in the process of treating Chrysler Financial, also owned by Cerberus, like a bank so we can shovel money in there so that people can buy Chryslers. If there were no Chrysler, we wouldn't have to worry about Chrysler Financial. We've also bailed out GM. We have a better hope of getting a return on that investment if Chrysler isn't taking sales from them. And we've bailed out GMAC "to help GM". We've even added money to the GM bailout so it can put more into GMAC. GMAC's majority owner is Cerberus – must be a coincidence.

Ford has so far avoided bailouts. They won't be able to do that forever if we keep bailing out their competitors.

The New York Times says the Fiat deal (they didn't report that it's contingent on more bailout money) "will bring Chrysler what it needs to be a viable player in the evolving United States market, with its fuel-efficient engine technology and the engineering that goes into its small cars." The deal allows Chrysler to make Fiat models in its US plants. The Times goes on to say "The Fiat brand suffered from a reputation for poor quality among American consumers. Fiat models still score below average in J. D. Power customer-satisfaction surveys in some European markets."

The real value of the Fiat deal is that it gives us a way to see what Chrysler is worth today AFTER we have already put $4 billion in: less than nothing. The best result of this announcement is if we act on the valuation, swallow our losses, move on, and let Chrysler fade away.

Past Performance Is Not an Indication of Future Results

You don't need to invest in a Ponzi scheme to lose all your money; most arbitrage strategies will get you sooner or later.

Let's say there's this absolutely fair and honest and even profitable investment. You, of course, do some diligence and find that the investment has returned .6% per month on the average every month for the past four years since it was founded – sometimes .55%, sometimes .65% - but variance you can live with. Moreover, you absolutely know (don't ask me how but you know) that it's not a Ponzi scheme.

You prudently invest a bit and, sure enough, for the next two years you get this nice return between .55% and .65% per month. The return isn't great but it beats the money you've been losing in the stock market. You're going to retire in five years and you figure that, if you put all your liquid assets into this and let them compound until you retire, you'll be able to live comfortably on the interest plus your pension and social security and even sleep at night. Why take any more risk?

What you don't know is that the investment strategy, which earns these consistent returns in good years and bad, has a half percent chance of losing all the fund's capital in any given month. Usually, of course, that doesn't happen. Statistically, it'll happen every seventeen years or so with an 50-50 chance that it'll happen in any eight year period although the occurrences are random. Bad luck, it happens just before you retire.

Were you defrauded? Only if someone said there was no chance of losing your capital. But probably the prospectus said that capital is at risk and past performance is not indicative of future results (right under where the past performance is displayed). If you do the math, you'll find that an investment with a 99.5% chance of returning .6% each month and a .5% chance of losing the principal (returning minus 100%) has a positive expected value - about .1% per month. That's the MEAN return but you've been looking at the MEDIAN return. We get fooled by the usual.

The investment described above is better than most hedge funds because it has a positive expected value – the real return on whatever the underlying investments are is greater than whatever management fees are being charged. In most cases hedge funds are like lotteries in that the expected return for all participants over time is less than zero because there are fees coming out of the pot. We usually loose when we play a lottery so, unless we have a gambling addiction, we don't get sucked in or tempted to bet our retirement on a single ticket. With many hedge funds we win most of the time (the usual return) but, when we lose, we lose most or all of our investment. The only hedge funds which are around to invest in are the ones which haven't yet lost all of their investors' money; they have positive track records or they'd be gone (as many are). Our brains are wired to think that past performance is THE indicator of future results no matter what it says in the prospectus.

In fact there are an infinity of arbitrage strategies which USUALLY have small positive returns; but, when they fail, they fail spectacularly. I think the promoters of funds based on these strategies even believe themselves that these are good investments. Maybe some are. But, unless there's an underlying investment in something that creates value, the expected return over time is less than zero after the fees come out. Since the returns are positive the vast majority of the time, the infrequent blowups are huge to keep the statistical books balanced.

Remember, this caution is about NON Ponzi schemes. It doesn't take a crook to part you from your money.

Nassim Nicholas Taleb explains these things much better than I do.

Deflation May Be the New Normal

Deflation has been the rule in high tech ever since I first programmed a multi-million dollar IBM 7090 forty-seven years ago which had less computing power than my current $100 watch. We high-techies have learned that we have to double the usefulness of what we sell every eighteen months if we want to charge the same number of consumer dollars for our products. In most cases we haven't been able to keep up with the relentless progression of Moore's law (the amount of computing power you can get for a dollar doubles every eighteen months) and prices have fallen.

Maybe we should all learn to live with deflation.

It wasn't that long ago that it cost dollars per minute to call coast-to-coast in the US. Today there is no incremental cost for us to use video Skype with grandson Jack on the left coast. His other grandparents in Ireland pay the same amount. Cell phone rates are kept up monopolies and cartels but will soon crash. Most people can get basic (pretty basic) DSL broadband access for what dialup used to cost. Broadband prices are even lower for even more in much of the rest of the world.

Suddenly it looks like the rest of the economy may be going the way of high tech. Oil and housing prices are back to 2004 levels (even as I write this, gas is back up a few cents, though). Most other commodities including agricultural goods have crashed as well. Industrial products like steel and fiber are available at bargain prices. The IRS reimbursement rate for mileage went down on New Year's Day. Even wages are actually down given less overtime, smaller bonuses, less 401(k) match, smaller medical benefits, and actual givebacks by unions seeking to save jobs. Despite a recent bounce, the stock market is where it was ten years ago.

Interest rates paint the same picture. Some people are accepting negative rates on very short-term treasury notes. Are they dumb? Not if deflation is going to continue because the purchasing power of their investment is increasing as long as most of the principal is safeguarded. In fact getting six percent interest in a time of five percent inflation is a much worse deal; you have to pay taxes on the six percent which means you're probably losing purchasing power. If you get no interest in a year when there's five percent deflation, you've got a real gain in purchasing power and you don't even have to pay any taxes on the gain. No wonder governments hate deflation.

Deflation is hell on debtors whose debts get harder and harder to repay. Deflation is great for savers who gain (tax free) by postponing consumption. Do we really want to go back to being an economy of debtors? Inflation is miserable for the retired and others living on a fixed income; deflation is a pay raise to everyone receiving social security (although a problem for the indebted treasury).

One fear in times of deflation is lack of retail spending because prices will always be lower soon. We in high tech know that is nonsense. Every one who ever bought a computer or an MP3 player knew that she'd be able to get the same item for less six months later; but still we buy electronic items. You don't wait until next year to eat because beef prices may be down; you don't even postpone phone calls a few months in hopes that prices'll fall. In inflationary times you fill your gas tank when it's half empty; in deflationary times you let it run nearly dry; but you still need the same number of gallons to drive the same number of miles.

Come on, Tom, you say, you don't really think energy and housing prices can go down long term, do you? I do actually although chances are that governments will print so much money that we'll have inflation again. After all, it's conventional wisdom that we need inflation and that we can't live with deflation. Inflation's a "painless" way to pay government and private debt and lets government collect taxes on nominal income which is actually just inflation reimbursement (some interest and some capital gains).

The price of energy in terms of how much human time is needed to earn an amount of inhuman energy has gone steadily down through history. Think what 200 horsepower would have cost when you needed 200 horses to get it. Monetary inflation has hidden some of that deflation in energy cost. Long term, when we have more nuclear, wind, and solar sources and have either convinced ourselves that CO2 is the harmless gas it used to be or learned to sequester the CO2 from burning coal, the price of energy will continue to fall.

Moore's law is finding its way into more and more products and services. First computing started on the deflationary path along with every toy or tool with computing in it; communications followed soon after; transportation'll come next as smart cars increasingly run on electricity from a smart grid with all kinds of diversified smart inputs. Cheaper houses are easy to envision; cheaper real estate unlikely until population growth stops and people stop emerging from poverty, hopefully because they've all emerged.

When we've had to, we've used adjustment formulae for inflation. We can do the same thing with deflation although the politics are admittedly tough. Can you imagine Congress passing an annual cost-of-living DECREASE formula for social security or annual deflators in union contracts? On the other hand, if we didn't let inflation run rampant, we wouldn't need the sudden deflationary pain of recessions and depressions to put things back in balance.

This post is so far from conventional economic wisdom – and from most of our experience – that it makes even me nervous. It could be that inflation'll come surging back from the flood of money governments are now printing once we start circulating and recirculating that money again. It may be that we need inflation. But we've lived with deflation in high tech and the results haven't been all that bad. We do live in a time of abundance compared to the scarcities of the past.

UPDATE: According to the Wall Street Journal, reporting on the just released minutes of the December Federal Reserve Board meeting: ""Some members saw significant risks that inflation could decline and persist for a time at uncomfortably low levels," the Fed said." But whom will that low inflation be uncomfortable for?

The Cost of Zero Percent Financing

If we’ve learned anything in the last year, it’s that we don’t get anything for nothing. If it’s good, it probably won’t stay good. If it’s too good to be true, it’s probably a trap. So what about zero financing? Now that we’ve bailed out both GM and GMAC, the latter is offering zero percent financing on the former’s cars – and presumably with our money. Should we  snap it up?

Probably not but maybe. At the bottom of the post, if you’re on my website, you’ll see a handy dandy calculator to use in evaluating the deals a dealer offers you. If you’re reading this post in a  feedreader or an email, the calculator probably won’t show up but you can still access it at http://blog.tomevslin.com/zero-cost-calculator.html.

Obviously there’s a cost to zero percent financing. The dealer and/or the manufacturer pay the finance company the interest which you’re not paying. One way or the other, some or all of that amount gets tacked on to the price you pay for the car. Often there’s a cashback rebate you don’t get if you take advantage of the zero percent financing. You may also be able to negotiate a lower price for a car if the dealer is not making a contribution to paying down the interest rate.

For example, suppose you’re looking at a $30,000 car. You’re planning to make a $3000 down payment. The salesman says he’ll sell it you for twenty-nine thousand (such a deal!). If you don’t take the zero percent financing and pay cash (which you know you can borrow at the bank for  6.5% APR on a 48 month loan), you’ll get a $4000 cash rebate. Which is the better deal?

In this case you’d save $21.82 every month by applying the rebate to the down payment and taking the bank loan. The actual APR on the zero percent financing is 8.77% hidden in the rebate you’re not going to get.

On the other hand, if you were only offered a two thousand dollar rebate, you’d better off by $35.44/month if you do take the dealer financing which has an actual APR of only 4.05%. Of course if could get the saleswoman to reduce the after-rebate price to anything less than $25,923.53, you’d be better off using the bank financing. She just might do it (after the obligatory talk with the manager) depending on how much of the cost of the zero percentage loan the dealership is paying.

Here’s the calculator: an informed negotiator is a good negotiator. Good luck (if you don’t see the calculator below, look here).

Please supply either bank APR or cash price for car or both as well as all required fields.

Price at which dealer will sell car with 0% financing (required)
Price at which dealer will sell car for cash net of any rebates
Amount of down payment you intend to make (required)
Percentage APR of loan from bank
Loan duration in months (required)

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