Gordon Gekko Goes to Washington

In the 1987 Academy Award winning film, Wall Street, Gordon Gekko (Michael Douglass) tells the shareholders of Teldar Paper that, “Greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA.”

In the midst of an unfathomable collapse in our banking system, on the heels of the worst week in history of the Dow Jones Industrial Average, at a time when you’re more likely to find stilettos in a nunnery than a commercial loan...let’s revisit the words of Mr. Gekko and agree that greed, when unchecked, is bad.

Very bad indeed.

For the record, I’m not against corporations. Quite the contrary. Corporations hire people, and they pay huge chunks of change in payroll taxes. And in my book, offering someone a job is one of the most influential and essential things you can do for a person.

A good job -- purposeful employment -- can resurrect a life.

That point notwithstanding, let’s not sugar coat the debacle on Wall Street. It was driven by greed. And now, the taxpayers, you and me, will dish out a few dimes of life support (about seven trillion of them) to prop up Wall Streets voracious misfires.

Let the good dimes roll.

As part of the $700 billion initial bailout (I say initial because there’s more to come, in one form or another), Treasury Secretary Paulson infused $250 billion into eight of the largest banks in the world in exchange for debt and preferred shares of equity. Eight banks, which now envelope the stalwart investment players on Wall Street – are now controlled, in part, by the U.S. Government.

Don’t confuse the act with socialism. With one or two exceptions, these titans of Wall Street had no choice. That had to have the cash. Why? The investment houses of Wall St. made $60 trillion of uncollateralized sidebets on credit default swap (CDS) derivative contracts. And in the end, they couldn’t make good on their debts.

For frame of reference, there are approximately $1 trillion in outstanding sub-prime mortgage loans. Said another way: 1/60th of the outstanding obligations on credit-default swaps.

These swaps are labeled as insurance contracts, and technically they are, providing downside risk protection against potential defaults on bonds – whether the bonds are tied to large blocks of mortgages, credit cards, corporations, or municipalities. In reality, these CDS contracts have evolved into mammoth bets as to how bonds will perform. Bets that due to their labeling –- over the counter insurance products as opposed to regulated financial instruments -- require no collateral.

In other words, investment banks were able to sell and take on billions and billions in exposure, without needing to park $1 of collateral in a bank.

Worse, these CDS contracts are so complex, so leveraged, so chopped up in terms of who owns what, it makes accurate accounting of the contracts about as easy to measure as a gamma ray from Orion’s belt.

Berkshire Hathaway Chairman and famed investor, Warren Buffet, warned of the danger of these complex derivative contracts in the late 1990s, calling them “weapons of financial mass destruction.” Buffet even sold one of his portfolio companies, American Re, which was a large underwriter of derivates after assuming losses exceeding $470 million. Buffet didn’t sell because of the losses; he sold because “I couldn’t even figure out what we owned.”

If only others had followed suit.

But really, if you were a manager at a mutual or hedge fund, why would you listen to Buffet? You are paid a 2% management fee + 20% of the profits of the fund. In other words, if your fund loses money or performs at a mediocre rate, you get paid well. If it performs well in the short run, you get paid incredibly well.

And initially these swaps proved very profitable. Profitable for fund managers and profitable for brokers of the contracts, who more times than not sold a portion or all of the swaps downstream to other investors at a profit (see former reference to accounting nightmares via Orion’s Belt).

As an investment manager or broker, what’s not to like? It's the power of now invoked to the nth degree: cash in while you can. If the bonds tied to the swaps start defaulting and/or your fund goes belly up later, you will already have enough cash stockpiled from your 2 + 20% days for a lifetime (or three) in the Cayman’s.

Parody, between the retail investor and investment managers and executives, has never been part of the game. Never more noticeable than now.

It’s the foremost Gekkoian principle: greed always looks out for number one.

Looking back at the sum of the parts amidst the current meltdown -- the lack of regulation, the focus of near-term earnings to appease Wall Street, the exorbitant bonuses for executive and fund managers -- it seems eerily plausible that the investment banks on Wall Street would bet the house (literally), wanting more.

But you can only double down on black so many times. Eventually, the roulette wheel will read red.

And it did.

Bear Sterns was the first investment bank to buckle, now a part of JP Morgan. Merrill Lynch: acquired by Bank of America. Morgan Stanley, forced to take in $9B from Mitsubishi Bank. Goldman Sachs nabbed $5B from Warren Buffet, and like Morgan Stanley, became a depository bank. And then there’s Lehman Brothers.

Lehman had outstanding debts and derivate exposure so enormous, the market brought no suitors. They couldn’t raise capital; their market value, in the end, was zero. One of the most recognized names on Wall Street forced to close up shop – last week an auction on their outstanding bonds yielded owners less than ten cents on the dollar.

I also watched in disgust last week as Martin Sullivan testified before Congress. Sullivan, the former CEO of the world’s largest insurer, AIG, convinced the Board of AIG to change their company’s administrative guidelines and approve $40 million in bonuses for top executives in 2007. $40M in bonuses in a quarter when AIG posted $5 billion in losses. The same company which has since taken in $120 billion of taxpayer money.

AIG: today’s poster child, “your taxpayer dollars at work.”

In the same breath I want to laud the man who followed in Sullivan’s footsteps, Robert Willumstad, who held the top job at AIG for a mere three months before the government stepped in. When Uncle Sam bailed out AIG, they removed Willumstad from the helm.

Willumstad was due $22M in severance when he was ousted. He turned down the cash, referencing the fact that he was not given the chance to execute his turnout around plan. Willumstad said he was undeserving of the severance, especially considering AIG’s financial plight.

If only we could duplicate Willumstad. We need (thousands) more like him around Wall Street. I won’t hold my breath.

Instead, I will fasten my seatbelt and hope that, in the end, when we emerge from this recession, we end up with a better, more stable, financial system. The system is the key, needing appropriate checks and balances.

Greed will always try to one-up it.

When the dust settles, and that could be years from now, I do think our financial system will have improved immeasurably. Unfortunately, millions of people will have lost sizable portions of their pension and retirement savings in the process.

If I were in that boat, I would probably be irate.

Thankfully, I'm at the opposite end, with little-to-no money tied up in the market. Not that my days are disassociated with this debacle: my generation will pay for the current day’s gluttony, not in one form or another, but at every imaginable turn.

Americans loves a good ride, whether a .com coaster or a bungee-like mortgage boom. In the end, it’s uncanny how often history rises from the ages and whispers, “yea masses of short-term memory, greed has bested you again.”

History, that subtle voice in the distance, has always been the greatest light onto tomorrow. Some lessons we are forced to learn over, and over, and over again.

Revisit the Congressional floor in 1874 as Robert Brown Elliot, a black congressman from South Carolina remarks on the fall of the Confederacy: “The progress of events has swept away that pseudo-government which rested on greed, pride, and tyranny.”

130 odd years later, another reconstruction is upon us: our nation's pseudo-financial system is about to have its stomach stapled. History changing Hamilton’s America forever.

When the surgery is over, let’s just hope the system which provoked our insatiable, former self...is unrecognizable.