Chairmans Corner

BLOOMBERG In the Loop: Surviving in the Amazon Market (VIDEO)

Thu, 17 May 2012 15:36:00 GMT

Huffingtonpost: Conflicts: No Ambiguity

Wed, 04 Apr 2012 15:10:00 GMT

The most surprising facts about Greg Smith's denunciation of Goldman Sachs' ethos and its disdain of its clients is that he had the audacity to write what is common knowledge, and the New York Times printed it. Media, academic and elected officials have jumped on the article to reinforce their previously held views on everything from the state of capitalism to the collapse of morality.

The article shows nothing more than the failure of Goldman's Board and management. And that eventually bad business practices will tarnish a great reputation.

In full disclosure, for 50 years I have competed against Goldman Sachs. During these decades, Goldman and most of its peers transitioned from private partnerships to limited liability public companies with access to virtually unlimited capital. Capital was the catalyst for ventures more lucrative than advising clients, such as proprietary investing in private equity, real estate, commodities and securities.

Finance may be complex, but life is simple. If you are a principal dealing with another principal on the other side of a trade and you are involved in any way with a counter party, you have a conflict. At the least, you are obligated to disclose fully your conflict. The preferred position is to avoid the conflict or even the appearance.

Lloyd Blankfein defined Goldman's position clearly. In his most recent edition of The Partnership: The Making of Goldman Sachs, Charles Ellis lets Lloyd Blankfein define Goldman's view of conflicts.

The crucial differentiating advantage of Goldman Sachs would be one that outsiders might find surprising: Its complex variety of many businesses was sure to have lots of conflicts. Goldman Sachs, Blankfein said, should embrace the challenge of those conflicts. Like market risk, the risk of conflicts would keep most competitors away -- but by engaging actively with clients, Goldman Sachs would understand these conflicts better and could manage them better. Blankfein (who spends a significant part of his time managing real or perceived conflicts) said, "If major clients -- governments, institutional investors, corporations, and wealthy families -- believe they can trust our judgment, we can invite them to partner with us and share in their success."

Blankfein's concept of the relationship between an advisor and its clients is dangerous and alien to the tenets of trust and fiduciary obligations. It is difficult to envision a situation where competing with your client is good for the client. It has never occurred in my experience.

Imagine a lawyer managing conflicts with clients or a doctor managing a conflict with a patient. The Courts and government regulators have continually found such conduct wanting. As recently as February in the Kinder Morgan merger with El Paso Corp., Delaware Chancery Court chastised Goldman for a series of undisclosed conflicts.

Irony is a word without definition -- unlike conflict. But like pornography, in the words of Justice Potter Stewart, "I know it when I see it."

How ironic it is that Goldman, the firm that advises governments, boards of directors, senior managements and the world's wealthiest cannot advise itself on appropriate behavior. Where is the Board oversight?

How ironic that Goldman's corporate clients operating their own Boards under scrutiny of Institutional Shareholder Services and Sarbanes-Oxley legislation would tolerate a conflicted relationship with its advisor that it would not tolerate for a moment within its own organization.

How is it that the nation's pre-eminent business schools provide their finest graduates who may intellectually understand the term fiduciary responsibility but seem incapable to apply it in practice?

It is ironic that mainstream media -- so critical of every aspect of corporate behavior -- ignored the Goldman situation until it was poked in its averted eye, first by Rolling Stone and now by Greg Smith.

Finally, how ironic is it that I, a competitor, should feel that the health and reputation of the financial system requires Goldman to confront these practices and re-set its culture.

The financial system is fragile. It is just beginning to rebuild its capital base at a huge cost to the nation. As a result of the financial crisis, we now have an oligopolistic financial system with "banks too big to fail." Goldman Sachs is in that select group. Ironically, Goldman and other such banks are semi-government entities -- some form of "ward" of the State. Politically, however, from Occupy Wall Street to Main Street, banks are the object of derision. The banking community needs distinguished leaders and practices beyond reproach because, like a sprawling utility, Wall Street supplies the credit and liquidity propelling America's economic growth. Wall Street is a jobs issue and not only in the financial centers.

It is late in the process but it "ain't over!" Businesses succeed because they put the customer first. Gus Levy -- the famed Goldman partner -- admonished his partners 60 years ago to be "long-term" greedy. I never liked the term but understood the concept. Simply stated... we will get rich by being sure we hold back a bit and be sure to serve our clients first. There is no irony in that.

References:

•Charles D. Ellis, The Partnership: The Making of Goldman Sachs (London: The Penguin Press, Edition 2009) 669-670

•Jacobellis v. Ohio 378 U.S. 184 (1964)

BLOOMBERG Inside Track: Peter Solomon on Bank Structure, Management (VIDEO)

Thu, 19 Jan 2012 15:37:00 GMT

BLOOMBERG Inside Track: What are US Corporations doing with their Cash? (VIDEO)

Tue, 29 Nov 2011 16:09:00 GMT

Balance of Outrage

Thu, 01 Dec 2011 13:14:00 GMT

The spreading protests of “Occupy Wall Street” may become a significant political force. What began as a rag tag band of middle class college age youths agitating against capitalism is galvanizing Main Street’s feelings of helplessness. With 14 million officially unemployed and another 5 million probably no longer seeking work; with wages for workers stuck at 1973 levels and a 7 percent decline in the real medium income of families since 2000; with growth so anemic that we cannot lower unemployment rates; with a Washington train wreck impotent to provide policy leadership; and with public employment projected to be reduced due to city, state and federal cuts….with all these alone…the mood of the country is justifiably grim.

Pundits and politicians have tended to dismiss the protests as outbursts from college-types who can’t find a job. Movements can become radical even if they start with the middle class. In the 1960s, it wasn’t the underclass that provoked cultural and political change. The leaders of the “movement” were bred in such fancy institutions as Bryn Mawr College, Columbia and Berkeley. It was kids who looked like their parents with the exception of unruly hair.

Today’s protesters lack organizing power and money. Facebook and Twitter might enable a revolt in Egypt, but by themselves they are not sufficient to sustain a national movement in this country. Establishment forces are more modern and pervasive.

The increasing disparity between the rich and poor, the have and the have-nots, has the most potential to unsettle our comfortable democracy and shake up the political establishment. Over the past decades of Republican and Democratic leadership, the gaps have widened on income, employment opportunities, education, healthcare, even who serves in the military. It isn’t a question of class warfare, although that is how those opposed to President Obama characterize his philosophy. No policies set out to cause such sharp distinctions. The gap has grown from a series of policy choices and global shifts. Such disparities cannot be in the longer term interests of any group – whether the Tea Party or Progressive.

The protests will spread, not solely because they ignite smoldering resentment, but because they will get the necessary money and organizational abilities. Already, public and private unions are increasingly interspersed with the protestors. The unions will turn the protests into a political movement.

A coalition makes political sense. Private unions, now representing less than 10% of the American workforce, need a cause. Public unions have gone through the economic changes faring relatively well. Employment has continued and workers’ wages, health benefits and pensions are better than workers in the private sector – unionized or not. Times are changing with deficit reduction headlining city, state and federal agendas.

What will the protests accomplish and how will they affect the political environment? There will be a limited effect on the presidential race unless a credible third party candidate emerges. According to media reports, Mayor Bloomberg – the most financeable candidate – has looked at a race but is not going forward. No other politician is stirring.

With the usual caveats, President Obama’s re-election looks doubtful. I was a close observer of President Carter’s 1980 re-election campaign. While historians often reach the wrong conclusions from apparently similar earlier events, we can learn something from the 1980 election. The American electorate had essentially concluded that President Carter was not an effective leader. He might have gotten lucky and the Iranian hostages might have been released, but even freed hostages probably would not have changed the electorate’s assessment. A question in that election was whether the older governor and former actor from Los Angeles would be an amiable and effective campaigner. Unfortunately for President Carter, Ronald Reagan was both.

The Republican candidate will win unless he scares the electorate. The nation seeks hope and the Obama Administration, regrettably, seems to offer none. We know in economic terms there is nothing which will reduce employment significantly prior to the election. This isn’t a political statement; it is economic analysis. We now know, and even the President has said, that we are not better off than when he took office.

Short-term, the greatest effect the protests can have is on Congress and the 2012 Congressional elections. “Occupy Wall Street”, with its vigor and youth and a just cause, has the potential to create a counter-weight to the Tea Party. Sustained and organized protests may intimidate incumbents and encourage challengers. Our hope is that the balance created by this movement will center political debate, encourage compromise and goad both parties towards responsible solutions to our nation’s problems.

Peter J. Solomon

Iraq and Afghanistan: Impressions by Peter J. Solomon

Wed, 23 Nov 2011 17:48:00 GMT

Earlier this month, I spent a week with a delegation from the Council on Foreign Relations and under the auspices of the Central Command meeting with military and civilian leaders in Iraq and Afghanistan, including General David Petraeus. We travelled by C-130 aircraft, Chinook and Blackhawk helicopters and armored vans.

We visited Baghdad and Tikrit in Iraq and Kabul, Bagram and Kandahar bases, several forward bases in Kandahar province as well as a hospital and the Parwan Detection Facility holding insurgents. Our trip terminated in the city of Bishkek in Kyrgyzstan. We were briefed by more “stars” than in the Big Dipper.

It was a strenuous and enlightening week. One does not become an expert in a week. I did, however, get a better understanding of the terrain, political and economic influences, military capabilities, leadership and strategic considerations. The deadly nature of these enterprises is constantly reinforced. Our cargo on the C-130 to Kandahar was blood.

General Petraeus, in his recent testimony to Congress, said that one has to be cautious about Afghanistan. Iraq is clearer but not without continued ambiguity. My comments are a distillation of what we heard and the conclusions I drew. I will not quote any specific Generals or member of any government. Some of what we were told is classified. A great deal is not.

One opening comment: I was enormously impressed by the US military, both regular and Reserves. The military is proficient in PowerPoint presentations and "spin”. More importantly, they are dedicated, motivated and professional. American business leaders and public officials would benefit from the poise, leadership and motivational training the military displays.

Iraq:
It is not worth debating the reasons we are in Iraq, whether the invasion was wise or the shift of resources to Iraq in 2003 was smart. We now have 50,000 troops in Iraq, an additional 17,000 men and women in support from the State Department and other agencies, and about 50,000 contractors, many of whom supply internal security on US facilities – such as our Embassy.(i)

The US military commitment to Iraq ends on December 31, 2011. The State Department will then be responsible for reconstruction, operating from four compounds throughout the country. It is clear to me that the complete withdrawal of US troops would be a mistake. I believe the US military agrees with this statement but it is above its pay grade to say so. No matter how competent the State Department is, the magnitude of the challenge is too great. The scale will overcome its capacity and lead to poor results.

A look at the issues. Iraq’s infrastructure was destroyed and the work on reconstruction has barely begun. There is limited electricity. No power plants were built in the last 3 years. The country needs 12 million megawatts. It has 7. Oil production will be up to 3 million barrels daily by year-end and there is abundant natural gas. Its potential oil output of 10 million barrels daily is limited by pipeline, refining and export terminal capacity.

Iraq has foreign reserves but it lacks a private sector economy. The two legs of its economic stool are oil and religious tourism. 40% of Iraqis work for the Government. Saddam Hussein and the State owned all industry. Worse, L. Paul Bremer, among his disruptive decisions as Provisional Administrator of Iraq during 2003-04, fired all the managers of the State-run infrastructure because most belonged to the Ba’ath Party. There are no managers to rebuild the public utilities or private industry.

There is continued violence. We were scheduled to fly North to Kirkuk. Sandstorms and violence between the Kurds and Sunnis, severe enough to require the attention of General Lloyd Austin and Ambassador James Jeffrey, kept us in Tikrit. An IED (improvised explosive device) attack, the first roadside bomb since 2009, on “Route Irish”, the route downtown from Baghdad airport to the Green Zone, illustrated the underlying tension.

Political leadership remains shaky. The good news is that Iraq does have the semblance of a democracy. The counterpoint is illustrated by vacancies in two key posts - the Ministers of Defense and Oil. The citizens reflecting the Arab “street” have begun to protest the lack of services, putting deserved pressure on the Government. The Government, responding to more immediate priorities, cancelled its purchase of about $1 billion worth of F-16s.

Given these observations, it would seem more prudent to keep a nominal force of perhaps 10,000 troops in Iraq. It would also be logical to station them near the Gulf, to, among other objectives, help protect the oil terminals. The military believes that we have sufficient personnel resources to accommodate this deployment.

The Iraqi Government must request us to stay. While this might be delicate politically, the Iraqis have no ability to defend themselves against external threats. Iraq’s 500,000 army and 300,000 police will focus on internal security but it has neither a navy nor an adequate air force. The US could be asked to continue to train the new Iraqi air force and navy.

Iraq is poised between a rich and tentative democracy and a failed state with oil. Leaving now and relying on non-military resources alone seems short-sighted.

A final word: In a shower room in Tikrit, I asked a Sergeant what he thought of his time in Iraq. “I hope it was all worthwhile,” he said. What more is there to say.

Afghanistan:
Some of the conclusions are clear. Many are not. We are clearly killing and capturing more insurgents and clearing provinces. The surge is working as it did in Iraq. We are re-integrating former insurgents into Afghanistan society. One estimate is that 5% of the members of the Shuras - the town councils - shot at us at one time. We have trained a lot of the Afghanistan National Army (ANA) and the Afghanistan National Police (ANP). The ANA is able to lead operations now, though the attrition rates remain unacceptable. We are working with the Shuras to promote democracy and conflict resolution. We are uncovering corruption. Finally, President Obama and the coalition have extended our presence in Afghanistan until the end of 2014 so there is more time to achieve results.

That said, we have been at war 100 days longer than the Soviets. Our troops are getting injured daily and dying. We are spending over $100 billion annually, including $12 billion training and arming the army and police. The country’s GNP is about $25 billion. Our military estimates that there are 25,000 Taliban with about 4,000 at most hard core. The leadership stays in Pakistan. The older Taliban are getting killed and there is a debate about whether the newer and younger Taliban leadership is more radical. The Pakistan border remains porous. The Central Government under President Karzai is notoriously corrupt and unresponsive. We are fighting not only the Taliban but the Haqqani Network(ii), Lashkar-e-Toiba (LeT)(iii) and al-Qaeda. Of the four, al-Qaeda – the reason we invaded in 2001 – seems the least relevant now in terms of continued presence in Afghanistan.

From what I can tell from briefings by our Commanders in the field using biometrics, many forms of intelligence, our technology in terms of advanced weaponry and our troops, we are making military progress. We have cleared a number of provinces and long-term Taliban strongholds like Kandahar City with 850,000 people. We have abundant aerial surveillance including blimps, towers, predators, and a more advanced drone which provide vivid intelligence. As an aside, one wonders why we don’t use this technology on the Mexican border.

Afghanistan is not secure, however. We expect heavy fighting in Helmand and Kandahar as we try to hold on to these areas during the summer fighting season. The Pakistan border allows insurgents to come and go. Three identified ammonia nitrate plants near Pakistan’s border provide explosive material used in IEDs. The situation is reminiscent of Cambodia and the Parrot’s Beak.

The Taliban is increasing its attacks on principally civilian locations which our generals believe show desperation but are deadly. There is potential for a Tet-like offensive (Vietnam 1968) this summer. There are intelligence reports of 400 suicide bombers. The base commanders are alert to such attacks. Three weeks ago, the British intercepted a shipment of newer, more sophisticated rockets being smuggled from

Iran.
A note about our casualties and the type of war being fought. Because of superb and fast medical attention and improved body armor, fewer of our casualties are dying. However, because of IEDs and RPGs (rocket propelled grenades) and the manner in which they impact Humvees and even our newer, sturdier MRAPs (mine resistant ambush protected vehicles), our personnel suffer more severe injuries. For example, there are many more life-changing limb and head wounds. I think we are underestimating these losses and their physical and psychological impact on our troops’ lives.

Balancing the above observations and reaching a conclusion of “now what” is excruciating. Our goals, as stated by every commander, are to "win"; to create a "stable and secure” Afghanistan; to eliminate corruption and to promote democracy. The burden is on the military with assistance from civilian agencies to attain these goals. It puts the military in the midst of nation building – a political process. We are more accustomed to our military having such a role in Reconstruction, the Philippines in 1898 and post WWII Japan. Insurgencies are these types of wars, according to our current doctrine.

What does "win" mean? Surely, we are not going to destroy the entire insurgency or eliminate the Haqqani Network. We will never occupy the entire country. What do “secure” and “stable” mean?

Is it a reasonable goal to eliminate corruption? In developed countries, such as our own, we are constantly uncovering corruption among public officials. Corruption is a way of life in Afghanistan.
It is the lack of definitions which is so troubling.

A second issue is how does peace occur? Who starts the process and under what circumstances? Who negotiates with whom? It is clear that, in addition to the Taliban, Pakistan has a major role in the process. I don’t have sufficient knowledge of Pakistan’s views on what type of Afghanistan it prefers. I have been told that Pakistan’s preference is a failed Afghanistan state so it can maintain control and thwart India’s influence. Since Afghanistan won’t be a failed state assuming the US stays the course, what is Pakistan’s next best choice?

Third, we are in the process of nation building to the nth degree. We have nonmilitary, US government employees and NGOs through the Country. They are risking their lives to create a democracy in a country which ranks at the bottom of all nations in almost every category, such as literacy, (28 % literacy overall) and in per capita income. We are encouraging farmers to substitute wheat, vegetables and fruits like pomegranates for poppies. We have a form of the Peace Corps but one aligned with the military and with a lot more money. None of these efforts seem practical or achievable without coalition military presence. Will all these labors pay off by 2014 so we can rely on the ANA, ANP and the Afghanistan Government?

We are doing our best to be sensitive to the culture and avoid harming civilians. In deference to Islam, no liquor or beer is served on our bases in Iraq or Afghanistan. Rules of engagement are designed to minimize collateral damage. On one video recording the targeting of an insurgent, for example, after a bomb was released, an unidentified person entered the target area on a bike. Unable to get a positive identification, the F-15 crew moved the bomb several hundred yards to the left and away from the target where it exploded without injuring the target or the biker.(iv)

I went to Iraq thinking it was the wrong war and nothing I saw changed my mind. In Afghanistan, I am encouraged by the effectiveness of our military effort. We are not the Soviets. We are trying and seem to be succeeding in influencing Afghanistanis towards our goals.

I also understand the geography better. Afghanistan is the territorial nexus between countries of strategic interest to the US – Iran, Pakistan, India, China and former Soviet countries, such as Kyrgyzstan and Uzbekistan. This territory may not be able to be conquered but it cannot be ignored. The stability of Pakistan is the primary concern and the relationship of India and Pakistan. The Taliban itself is not the strategic threat to us despite its brutality and abuse of women’s rights. al-Qaeda can go elsewhere. There is always a failed state or two. The Haqqani Network and LeT will remain lethal. Our military believes that by the end of the next 12 months at the latest or, perhaps, by the end of the summer season, the Taliban will know that it cannot beat us. We are hopeful that, as a result, a segment of the Taliban will move towards peace. It will be a long and difficult summer. There is no doubt about the intensity of fighting. No one knows when the Taliban or which subset will consider compromise. I am not sanguine concerning the prospects of peace. A year from now will be the time for the Obama Administration and NATO to conduct another policy review.

i A number of the contractors are security guards from Peru and Uganda.
ii An independent insurgent criminal group in Afghanistan and Pakistan aligned with the Taliban.
iii A militant Islamic terrorist organization with headquarters in Pakistan which organized the attack in Mumbai.
iv The targeted insurgent was killed subsequently by strafing. I couldn’t help but think that the ability to react so quickly was attributable as much to time playing video games as military training.

Embracing Conflicts: A Bad Business Strategy, by Peter J. Solomon

Mon, 27 Feb 2012 14:41:00 GMT

Goldman Sachs may or may not be guilty of fraud as alleged by the Securities and Exchange Commission. The legal issue centers on whether Goldman had to disclose that a prominent institutional investor had selected mortgages to be sold to other institutional investors. "Disclosure" is the central issue in this case.

There is a much more basic business issue raised by the case; namely, when a firm represents itself and other parties simultaneously, to whom do they have a fiduciary responsibility?

For most of my 50 years on Wall Street, it was assumed that your firm could only represent one party in a transaction. This was not only good business practice but legal advisors cautioned against conflicts of interest and the courts dealt harshly with a participant who tried to wear two hats.

As Wall Street firms expanded and moved into proprietary investments, leveraged or not, short and long-term, debt or equity, departments arose to resolve not only conflicts within the firms but also conflicts with their clients. Jargon was created, such as Chinese Walls and Clean Teams, to camouflage what is dubious behavior – representing competing interests under the same roof – one of which increasingly is the firm itself.

Ambiguity and self-interest have become the standards in the diversified firms, replacing loyalty and trust.

Charlie Ellis, in the updated version of his history of Goldman Sachs, interviewed the current CEO extensively. Ellis writes:

"The crucial differentiating advantage of Goldman Sachs would be one that outsiders might find surprising: Its complex variety of many businesses was sure to have lots of conflicts. Goldman Sachs, Blankfein said, should embrace the challenge of those conflicts. Like market risk, the risk of conflicts would keep most competitors away – but by engaging actively with clients, Goldman Sachs would understand these conflicts better and could manage them better".

Ellis goes on to quote Blankfein directly:

"If major clients – governments, institutional investors, corporations, and wealthy families – believe they can trust our [Goldman Sachs] judgment, we can invite them to partner with us and share their success."

There are a number of points worth noting. First, managing conflicts or competing with your clients may be good business for a securities firm but how can it be better for the client?

Second, from a client's perspective, when and how fully does he receive the disclosure that his agent is actually competing with him, and when and how is he able to evaluate fully that information? Over a decade ago, it was conclusively demonstrated that financial firms could not resolve conflicts between clients using securities research and the firms' drive to obtain underwriting business. The internal barriers were scaled whenever management wanted. Citigroup, for one, was forced to hive off its research. Safeguards were enacted to increase transparency and limit potential conflicts in securities research.

Third, from a management point of view, how do you monitor the conduct of your employees to be sure they are informing their clients sufficiently? In the present Goldman Sachs case, a 31 year old vice president apparently had enough independent authority to make this judgment.

When I left Lehman Brothers over 21 years ago, I noted this problem and quipped "I didn't want my reputation or net worth dependent on people I didn't know, trading securities I didn't fully understand in places I rarely visited." That was over two decades ago and the now mightier firms tout the extent of their reach in much larger global markets. Even the best managed firm cannot police conflicts with their clients.

Fourth, what happened to the concept of fiduciary responsibility and loyalty to your clients as opposed to your firm's interests? Without sounding like Little Mary Sunshine, the enduring firms, such as JP Morgan and Goldman, were built on relationships with clients – corporate and personal – nurtured over decades.

There is a legal issue as well best expressed by then Judge Benjamin Cardozo of the Court of Appeals of New York in 1928. In the case of Meinhard v. Salmon, Judge Cardozo opined,

“…copartners owe to one another…. the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.”

Since 1928, hundreds of cases have defined the relationship between agents and their clients. In thinking about the conduct of financial firms, the words of Cardozo resound.

Fifth, an argument is frequently made that in the capital markets, a securities firm simply runs the casino, likened to a craps table in Las Vegas. There is nothing neutral, however, about proprietary trading or investments which often compete with clients.

As we debate restructuring the financial markets, no legislation nor regulatory reform would rekindle more trust in the markets than a recognition by the managements of these behemoths that competing with your clients is a bad business practice, will hurt one's franchise and undermine the integrity of the markets.

Peter J. Solomon

IDD: A Call to Action by Peter J. Solomon

Tue, 29 Nov 2011 21:10:00 GMT

The debate over the bureaucratic location and independence of a Consumer Financial Protection Agency as part of the financial reform bill raises legitimate concerns about the relationship of consumer advocacy to the “safety” and “soundness” of the credit system.

Consumers, however, were certainly abused, and the existing regulatory structure failed to protect them. Opponents of an independent agency fail to overcome the fact that consumer interests buried within another bureaucracy have been inadequately represented.

Given this history, President Obama should continue his post-health-care-reform assertiveness and not settle for the Senate’s version. He should insist on a truly independent agency.

First, let me reiterate. There is sufficient regulation to protect the consumer. But protection did not occur.

Does one really think that the Federal Reserve (where Sen. Chris Dodd proposes the agency be housed) will suddenly reverse years of neglect and become the prosecutor of bad practices when its primary jobs are monetary policy and the “safety and soundness” of our financial system? Even the Consumer Advisory Council of the Fed favors an independent agency, saying the central bank failed to protect consumers.

If not the Fed, what other agency does the Congress have in mind?

Second, the argument that a new independent agency will enlarge the federal bureaucracy misses an obvious point — namely, that each agency from the Department of Housing and Urban Affairs to the National Credit Union Administration already has a consumer affairs division. Their employees number in the thousands. Rep. Barney Frank’s proposed legislation calls for consolidation of these bureaucrats into the consumer agency.

Third, it is not only Main Street that needs protection. Sophisticated investors cannot penetrate the fog of bank practices.

Two banking friends related examples of bizarre banking practices. When changing his bank credit card, one was told that it would cost $15 to overnight the card. When he asked why he should pay such a fee when it was in the bank’s interest to get the card to him ASAP, the bank representative immediately waived the charge. A second friend tried to prepay a credit balance to stay within his limits. The bank told him it could not be done without talking to a representative and that this would cost $20. The charge was also immediately waived when the customer complained.

These are examples from sophisticated investors. Think now of the Main Street consumers who can’t understand a word on their credit agreement.

Recently, I lunched with a dean of securities law, and he reiterated the common complaint about the inability of even a skilled attorney to understand the gobbledygook of today’s bank credit agreements. Why, then, has this argument generated so much heat and become a pivotal partisan issue? There is a valid argument that the agency must have some regard for the issues of “safety” and “soundness.”

There is a fear that rules promulgated by an independent agency would force financial intermediaries to issue credit cards or mortgages to uncreditworthy people or to take actions that would undermine the financial system.

It is hard to argue that a new, independent agency would function any worse or, in fact, do more harm to the credit system than the financial industry has already done to itself and the country.

Fourth, the advocates of an independent consumer financial protection agency scare the financial industry in the same way Ralph Nader scared the consumer products establishment.

I understand this point. Characterizing the argument as a fight between “families” and “banks” is class warfare and adds little beyond hysteria to the cause.

Change, regrettably, requires some level of hysteria, but the president’s good judgment in advocating the agency will be reinforced by supporting a dedicated, intelligent regulator and not, inevitably, the proponent with the loudest voice.

Finally, safeguards can be put in place. “Safety” and “soundness” are important concepts.

The regulations issued by the agency should be subject to review by the central bank with the Fed having a limited time to object to them.

The monitors of the agency might include members of the Federal Deposit Insurance Corp., the Fed, insurance regulators and others who are responsible for oversight of the financial system. A process requiring public hearings on significant proposals could be required.

It is time to get financial reform done. More jabber is a loser for both parties. Republicans look as though they are kowtowing to financial lobbyists. On the other hand, Dodd and the administration look indecisive. Frank and the House look smarter.

The financial system is lapsing into its pre-Lehman-crisis mode. Financial reform and, with it, an independent consumer agency are needed — and now.

Peter J. Solomon is the founder and chairman of Peter J. Solomon Co. LP, an investment banking firm. In the 1980s he was vice chairman of Lehman Brothers.

REUTERS: Not Enough Attention or Fiduciary Responsibility (VIDEO)

Thu, 17 Nov 2011 18:29:00 GMT

Peter J. Solomon is interviewed

THE DIGITAL AGE: Did the Banks Sell Greece a Digital Time Bomb? (VIDEO)

Tue, 29 Nov 2011 21:30:00 GMT

Financial Crisis Inquiry Commission Hearing: Testimony of Peter J. Solomon

Tue, 03 Jan 2012 19:38:00 GMT

Thank you for asking me to appear before the Commission. Before I begin, I want to commend the leadership of the House and Senate for creating this bi-partisan Commission to examine the causes of the current financial and economic crisis in the United States.

When I entered Wall Street in the early 1960s, securities firms and commercial banks had not changed much since the 1930s. Stock ownership was not widespread. Public pension funds and endowments did not invest broadly. The average daily volume on the NYSE was about the same as 40 years earlier. There wasn't a large public bond market. The business of commercial banks was lending. The securities firms were usually private partnerships. Investment funds and trading were separate from banks and securities firms.

I have been afforded the opportunity over 50 years to observe the dramatic changes in the financial world from a number of perspectives. My career at Lehman Brothers spanned 29 years. I rose to Vice Chairman of the firm in the 1980s and was the Co-Chairman of the Investment Banking and Chairman of the Merchant Banking divisions. I have held financial positions in the public sector as Deputy Mayor of the City of New York during the financial crisis of the late 1970s and as Counselor to the Secretary of the Treasury in the Carter Administration. I have been active on corporate, not-for-profit and foundation boards where I have been involved in investment decisions.

For the past 21 years, I have been the Chairman of the Peter J. Solomon Company, a private independent investment bank and member of the FINRA. Our firm is a throw-back to the era of the early 1960s when investment banks functioned as agents and fiduciaries advising their corporate clients on strategic and financial matters such as mergers and the raising of debt and equity capital. Unlike today’s diversified banks, we do not act as principals or take proprietary positions. We do not trade and we do not lend.

For a moment, let me set the scene of the 1960s investment bank. The important partners of Lehman Brothers sat in one large room on the 3rd floor of Number One William Street – the Firm’s headquarters. The partners congregated there, not because they were eager to socialize. An open room enabled the partners to overhear, interact and monitor the activities and particularly the commitments of their partners. Each partner could commit the entire assets of the partnership.

Lehman’s capital at the time of incorporation in 1970 was about $10 million. The wealth and, thus the liability, of the partners like Robert Lehman exceeded the Firm’s stated capital by multiples. Since they were personally liable as partners, they took risk very seriously.

The financial community changed dramatically beginning in the 1980s. Incorporation and public ownership by securities firms enabled them to compete with commercial banks. Innovations like junk bonds, for example, allowed securities firms to lend to non-investment-grade companies. All the firms accelerated the push into global markets, far-flung operations, mathematical modeling, proprietary dealings in debt and equity, and the growing use of leverage and derivatives to hedge risk.

As the Commission investigates the causes of the 2007-2009 crisis, it is important to remember that market crises occur periodically. To name a few, in the last 20 years the markets have been roiled by Asian, Russian and Mexican crises; the crash of ’87; the collapse of Long-Term Capital; the 2000 dot-com bubble collapse and Enron’s bankruptcy.

The question before the Commission is: What events or actions occurred within the capital markets or the environment which allowed this crisis to become a debacle?

First, every legislative and regulatory move in the last 20 years has been towards obliterating the distinctions between providers of financial services and freeing the capital markets. The shining example, of course, is the Gramm-Leach-Bliley Act of 1999 which removed the last vestiges of the Glass-Steagall barriers.

Second, financial institutions used the more lenient regulatory environment to build scale and to extend scope. Citigroup, Bank of America, JP Morgan and Lehman Brothers, for instance, acquired competitors and expanded their operations into new fields. Concentration created institutions “too big to fail”. Government regulation, in terms of oversight and coherence, did not keep pace with innovation, leverage and the expanded scope of the banks.

Third, access to new capital permitted the banks and securities firms to shift the nature of their businesses away from agency transactions and more towards proprietary trading that took positions in marketable and less liquid securities and assets such as commercial real estate. Combined with greater leverage, earnings volatility increased.

Fourth, scale, scope and innovation created an inter-dependency, most noticeably in Credit Default Swaps, disproportionate to the equity capital of all banks. Managements misjudged the capabilities of their elaborate risk management systems, like VAR, to keep their institutions solvent. Even for insiders, transparency diminished so much that firms were not prepared for the extraordinary – so-called BLACK SWAN – event.

Given these changes affecting the banking system, what fundamental issues might the Commission probe?

1. The lack of coherent regulation by agencies where the application of existing regulation could have provided more transparency and forestalled a meltdown. The Commission might examine the role of campaign contributions as they relate to Federal Government’s regulatory structure. The financial community has become increasingly active in Washington and is now one of the largest contributors to Federal political campaigns. Even today, one can see the detrimental effects of its lobbying on Government action to create transparent, accountable and efficient markets.

2. The Commission might consider whether the legal structure of banks contributed to undertaking excessive risk. The mixture of unlimited capital, limited liability and incentive compensation inevitably led to testing the levels of risk. It might be argued that public ownership and the compulsion to increase earnings per share propels employees towards greater risk. The experience of Lehman Brothers and Bear Stearns indicates that large stock ownership by employees was not by itself a barrier to imprudent risk.

3. It is time to examine whether it is appropriate to have proprietary trading and investments, essentially hedge fund activities, within the same bank as lending and other agency transactions. The Commission might explore how these proprietary activities affect the stability of the markets and whether Congress should limit the scope of banks.

Paul Volcker has suggested that financial firms might be categorized between activities with ongoing relationship businesses such as lending, and transactional interactions such as trading. He has proposed that these functions be separated.

A corollary question is whether it would be preferable from a public policy perspective and adequate from a capital markets point of view to require proprietary investing to be in private partnerships. Until it went public, Goldman Sachs, for example, remained a private partnership and was able to attract sufficient capital and weather a series of large losses.

In closing, my hope is that the Commission will determine whether the 21st Century model is consistent with the need for stable banks and capital markets sufficient to finance the world economy. The Commission has an opportunity to approach this challenge in a bi-partisan manner and produce unanimous recommendations. These conclusions can have a profound effect on legislation as did the recommendations of the 911 Commission. In doing so, the Commission will make a major contribution to the stability of the financial markets and we will have a chance to mitigate future crises.

Thank you.

Bloomberg TV - Economy and the Credit Crunch

Tue, 14 Feb 2012 15:39:00 GMT