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Nov 30, 2009 Too Much Weekly: A Meltdown Myth Demolished

Click here to read the Too Much weekly edition, as emailed to readers on November 30, 2009.

This Week in Too Much

We’re getting close, only a few weeks away, from Wall Street’s annual bonus announcements. This year’s numbers figure to be the most stunning ever. So be prepared to feel outraged. Better yet, be prepared to express your outrage.

Need to warm up for that expressing? This week’s Too Much may help. Our lead story looks at a new analysis, released last week, that explores how the ten top execs at Bear Stearns and Lehman Brothers — the two biggest Wall Street giants that collapsed last year — have actually fared, financially speaking.

Also this week: We swing into the holiday spirit and contemplate who’s really benefiting — and who’s not — from the charitable donations the wealthiest among us are making.

Greed at a Glance

Mathias ButtetThe world’s hottest new luxury watch doesn’t just tell time. The “La Clef du Temps” imagines it. Plunk down $380,000 for a La Clef and you get a timepiece that lets you choose between “real,” “fast,” and “slow” time. In slow, the hours pass at half their normal pace. In fast time, double. But if you want to pick up a La Clef, fast better be your byword. The Swiss company behind the timepiece — the Confrérie Horlogère, or Watchmakers’ Brotherhood — is only placing 24 La Clefs on the global market. The company already has the sales patter down dead-on. Gushes company founder Mathias Buttet: “True luxury and wealth in this day and age lie in the freedom to manage one’s time as one wishes.”

Marketers to the mega rich — like Mathias Buttet — are seeing plenty of opportunity in the current global recession. With fewer people able to afford luxury, as Reuters recently noted, savvy purveyors of luxury are enhancing that “aura of exclusiveness essential to a high-end retailer” by letting inventory run low and avoiding fire sales. Upscale retailers, says mall developer William Taubman, are working “to train the customer that luxury equals exclusivity and that they cannot assume they can wait” and buy an item “on sale.” At the Saks flagship store in Manhattan, the strategy seems to be working. The $2,520 Marni shearling vest has sold out, and, the week before Thanksgiving, the store only had one Brioni leather bomber jacket left — at $5,295 . . .

Earlier this fall, Xerox announced plans to pay $63 per share — about 33 percent over market price — to take over the Dallas-based Affiliated Computer Services, an outsourcing company. The Xerox share price has since dived 12 percent, but the chairman of ACS, Darwin Deason, is still smiling. Last week, after a Xerox filing with federal regulators, the reason why became somewhat clearer. Deason will pocket $41.3 million in severance from the takeover deal — and $17.4 million more to cover the taxes on his severance. On top of that, reports, Deason will collect $800 million when the ACS stock sale to Xerox finalizes. Deason, after the initial sale announcement, told reporters he “could not be more optimistic about the future.” Xerox workers have a bit less reason to feel cheery. To make the deal “pay,” Xerox will have to realize “cost savings” of between $300 to $400 million a year. That’s “corporate speak,” notes business journalist Sam Gustin, “for layoffs.”

Timothy Durham, the Indianapolis-based leveraged-buyout king, has made no secret of his life’s ambition. He wants to die as “the richest man on earth.” The FBI last week put a little crimp in Durham’s plans. On Tuesday, agents raided Durham’s majestic offices on the top floor of Indiana’s tallest skyscraper — and also seized documents at his Ohio-based financial services company. The FBI won’t give a reason for the raid. But an investing buddy of Durham’s has already been indicted for scheming to inflate the stock of a Durham takeover target. CNBC last year profiled Durham for a Rise of the Super Rich special. The show spotlighted his collection of 70 classic luxury cars. Durham also owns a manse outside Indianapolis, two other homes in Los Angeles and South Florida, and a private jet that speeds him from one to the other . . .

Higher taxes on the rich, friends of the rich like to argue, always backfire. Rather than pay higher taxes, the argument goes, the rich will merely exit any jurisdiction foolish enough to hike taxes on them. Maryland did up taxes on the rich two years ago, from 5.5 to 6.25 percent on income over $1 million. Earlier this year, preliminary figures indicated that the number of Marylanders reporting million-dollar incomes had fallen, and apologists for the awesomely affluent at the Wall Street Journal immediately claimed that millionaires were exiting the state to avoid the higher tax. Last week, Maryland’s comptroller released final figures for 2008 millionaire filings. They show no mass exodus. In every year this decade, the comptroller notes, at least 5.3 percent of taxpayers who filed million-dollar returns the previous year did not file taxes in Maryland. Last year, after the millionaire tax increase, this total moved to 7.7 percent, not much over the 6.4 percent of year 2000 millionaires who didn’t file in 2001. This tiny increase didn’t stop one state senator, David Brinkley, from insisting that Maryland millionaires were fleeing the state en masse. Brinkley, a financial planner by trade, told the Baltimore Sun he had even “advised one millionaire client to move to Florida.” Brinkley didn’t say whether the client took his advice.

Quote of the Week

“In today’s marketplace, the super-rich have become richer in large part by destroying jobs. They amass staggering wealth by gambling, and fraud, and they depend very dearly on government policies (especially very low taxes on so-called ‘capital gains’) to protect what they have and allow them to grab more.”
Edward Ericson Jr., Baltimore City Paper, November 24, 2009

Stat of the Week

How unequal have the rewards in college sports become? At the college football powerhouses Florida, Alabama, and Louisiana State, notes former Philadelphia Inquirer reporter Gilbert Gaul, “the head coaches all get more than $3.7 million a year in salary and other income.” That total equals more than “the combined value of all the scholarships awarded to their players.”

In Focus

A Wall Street Meltdown Myth Bites the Dust

Great minds have been searching, ever since last fall’s financial sector meltdown, for an antidote to the wildly excessive Wall Street paydays that made that meltdown inevitable. That search, after over a year, still hasn’t generated anything close to meaningful Wall Street pay reform.

And that has to be puzzling many, if not most, average Americans. The problem on Wall Street, after all, doesn’t seem to be all that complicated. Neither does the solution. Wall Streeters did terrible things — they gutted the pensions and savings of millions — because they were rushing to hit massive pay jackpots. To prevent that greedy rushing in the future, we ought to limit those jackpots.

And Congress could do that — by not letting any banker getting bailout dollars make more than the President of the United States. Or by denying government subsidies or tax deductions to firms that pay their top execs over 25 or 50 or 100 times what their workers make. Or by taxing big bonuses at 90 percent.

Various bills that take these approaches have actually been sitting in Congress, all this year. Why aren’t these bills going anywhere? America’s big banks, predictably enough, oppose them. But so do many of Wall Street’s mainstream critics. Both these camps have been bending over backwards to steer Congress away from the notion that rewards on Wall Street need serious downsizing.

The banks, by and large, simply deny that these rewards have had any significant impact on how the movers and shakers of high finance behave. In the end, they argue, “the market” will always punish power suits who take reckless risks — and the power-suits know it.

And if those power-suits didn’t know it before last year’s financial meltdown, the apologists continue, they know it now, thanks to last year’s nosedives at Bear Stearns and Lehman Brothers.

These nosedives left top execs at Bear Stearns and Lehman holding millions of shares of worthless stock. The Lehman collapse wiped nearly a billion dollars — $931 million, to be exact — off the personal net worth of Lehman CEO Richard Fuld. Bear Stearns CEO James Cayne saw the total value of his personal stock holdings drop by $900 million.

In effect, apologists for Wall Street’s compensation status quo argue, the market system worked. The truly reckless paid a price for their recklessness. So leave that system alone.

Wall Street’s mainstream critics don’t want to leave that system alone. They believe “the market,” left to its own devices, does not adequately discipline the reckless. We need reforms, they believe, that tie executive rewards to “performance” that boosts “long-term shareholder value.”

With such reforms in place, their argument goes, Wall Streeters would have no incentive to take reckless risks — and lawmakers would have no reason to mess with capping the rewards that go to Wall Streeters.

Last week, the most eminent among Wall Street’s mainstream critics — Harvard Law’s Lucian Bebchuk — released a report that takes on Wall Street’s hardline defenders and their claim that the reckless, thanks to the market, have truly suffered for their sins.

This new report powerfully demolishes that hardline claim. But the report, read closely, may just as powerfully undermine the mainstream case against caps.

Bebchuk’s new paper revolves around what really happened, on the executive pay front, at Bear Stearns and Lehman. Top execs at these two banks, Bebchuk and his two Harvard co-authors show, did not lose their shirts when the banks crashed. In fact, the top execs at both Bear and Lehman left the crash scene in fine financial fiddle. Spectacularly fine fiddle.

Between 2000 and 2008, the top five executives at Bear Stearns and the top five execs at Lehman together pocketed just under $2.5 billion. About half a billion of that came from annual cash bonuses. They picked up the rest selling off the shares of bank stock they had received as “performance” incentives.

But what about those $900 million “losses” that the CEOs of Bear Stearns and Lehman suffered? Those losses existed only on paper. They represented the difference between the pre- and post-crash value of the Bear and Lehman stock the two CEOs had left in their portfolios when their banks tumbled over the cliff.

In real cash, the two CEOs — despite their epic failures — came out way ahead. For his labors between 2000 and 2008, CEO Cayne of Bear Stearns ended up $388 million to the richer. CEO Fuld of Lehman walked away with $541 million.

So what do mainstream reformers propose, to prevent a repeat of the Bear Stearns and Lehman fiascos? These mainstreamers want execs to get more of their “incentive” pay in stock and less in bonus cash — and have to wait a number of years before they can cash out their stock incentive awards.

If these executives took more pay in stock, the mainstreamers hold, they and their shareholders would share the same self-interest. So “aligned” with shareholders, the executives wouldn’t do anything to jeopardize “long-term shareholder value.” We would all be safe from recklessness.

But these reforms, New York Times analyst Louise Strong points out, had already been put in place at Bear and Lehman — before the two firms crashed.

“Both firms required executives to wait several years before selling their stock,” her report on Bebchuk’s new paper notes. “Both firms paid heavily in stock.”

These requirements, in practical terms, did nothing to discourage short-term recklessness, mainly because Bear Stearns and Lehman awarded massive stock incentives to their executives year in and year out.

Execs at Bear and Lehman did have to wait five years before they could cash out the stock incentives they received in any one year. But after their first five years on the job, they ended up with stock awards they could cash out every year. That gave them plenty of incentive to play risky games that could recklessly jack up their short-term share price.

Bebchuk, in his new paper, acknowledges as much. Having executives wait five years before they cash out, he notes, isn’t go to stop long-serving executives “from placing a significant weight on short-term prices.”

A better approach, Bebchuk suggests, might be the Goldman Sachs policy that requires executives to hold 75 percent of the incentive stock they receive until they retire. But Goldman Sachs execs get the bulk of their windfalls from annual cash bonuses, not stock awards, and annual cash bonuses give execs just as much incentive to think short-term as annual stock awards.

That’s why bolder mainstreamers — like Bebchuk — also want firms to be able to “claw back” bonus awards based on short-term gains that later evaporate.

But clawbacks have their limitations. You can easily, for instance, claw back a single year’s bonus based on a specific accounting fraud. But you can’t so easily claw back the long-term damage that a greedy rush for quick profits — and big bonuses — can do to innocent bystanders.

And top executives can do this damage while appearing to enhance “long-term shareholder value.” The execs at Bear Stearns and Lehman did just that. Year after year, for the better part of a decade, they enhanced shareholder value. Between 2000 and 2007, they quadrupled their bank share prices.

The bottom line: We need more protection from Wall Street greed than the “long-term shareholder value” reform standard can provide us. Americans on Main Street understand that. Why can’t Wall Street’s mainstream reformers?

In Review

Charity, Wealth, and Your Old Underwear

Wendy Gerzog, From the Greedy to the Needy. Oregon Law Review, 2009.

The rich, as we all know, don’t contribute to charity purely out of the goodness of their hearts. They contribute, in many cases, only because they get tax breaks for contributing. Why does the government offer these tax breaks? The tax breaks, holds the standard rationale for them, advance the public good — through the good works that charities go on to perform with the contributions that tax breaks make possible.

But sneaky people, as we also all know, can subvert this noble intent. They can manipulate charitable contributions to advance their own personal gain.

Congress, over the years, has taken notice — and moved to limit these manipulations. But these limits, University of Baltimore law school analyst Wendy Gerzog shows in this sobering new paper, have done far more to curb average-income cheats than rich ones.

Just a few years ago, for instance, a good number of middle-income Americans were regularly exaggerating the value of the non-cash gifts they were making to charity, claiming deductions for donating worthless old property that ranged from junky cars to old socks and underwear.

Legislation enacted three years ago has shut down many of these loopholes.

But many more loopholes remain, and the most substantial of these, Gerzog relates, benefit wealthy taxpayers. In her new paper, she walks us through these loopholes, explaining, along the way, how the affluent can set up charitable transactions where gains for the affluent taxpayer — and revenue losses for the federal government — “far” exceed any benefit to charity.

One example: Current laws against insider corporate stock trading do not apply to charitable deductions. CEOs who know their share price will soon be sinking, once they publicly announce some disappointing piece of corporate news, often “donate” huge chunks of their personal stash of company stock to their own private family foundations, just before that stock sinks drastically in value.

The donations give the CEOs tax deductions worth many times more the real market value of their stock.

Another example: the “charitable lead trust,” a device that helps wealthy donors pass vast sums, free from gift and estate taxes, to family members.

An individual “who deposits $1 million in a 20-year charitable lead trust and stipulates that the charity is to receive $70,000 in income annually, with the remainder going to his sons and daughters” can easily, Gerzog shows, end up passing over $2 million, tax free, to heirs — and deny the government nearly $1.25 million in revenue the IRS would have otherwise collected.

Gerzog proposes a number of reforms that could limit the situations where “the government has sustained a significant revenue loss that cannot be justified by the rationales for the charitable deduction.”

But the grand concentrations of private wealth we see today don’t just confer enormous charitable tax deductions. They confer enormous political power. That’s why you can’t claim a deduction any more for donating your old underwear — and why the rich, with help from their tax lawyers, can still manipulate charitable contributions to help themselves get ever richer.

New Wisdom on Wealth

Peter Phillips, The Higher Education Fiscal Crisis Protects the Wealthy, Media Monitors Network, November 24, 2009. A sociologist sees today’s deep budget cuts in postsecondary ed as the end product of tax policies that have handed the nation’s richest billions in tax breaks.

Paul Krugman, Taxing the Speculators, New York Times, November 26, 2009. Why the Obama administration needs to free its mind from Wall Street’s thrall.

Robert Skidelsky, Will we ever have enough wealth? The Straits Times, November 28, 2009. A noted political economist examines why, beyond a certain point, the accumulation of wealth offers only substitute pleasures for the real losses to human relations that it exacts.

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