Many of us first encountered the word “covenant” in the Old Testament story of the bond forged between God and Abraham and his descendants. In the context of faith, “covenant” conveys a mutual commitment of the most intimate sort.
Later in life, we encounter “covenant” in its more secular context when we take out a mortgage to buy a home, establish a line of credit to launch or grow a business, or in other realms in which we accept the status of borrower or lender. In such relationships, the covenants have come to mean the formal terms of the relationship, the metrics to which parties are to be held accountable, the conditions to which both parties are bound, and the consequences for violating those terms.
Perhaps more important than these formal agreements have long been the informal covenants between lenders and borrowers, that is, the societal expectations that supersede those drawn up by legal compact.
Think about the word “bond” for a moment. We use it to describe a security now, but what is it really? When investors buy bonds, they really are loaning money to a country (United States Treasury), a company (General Electric), or municipality (Los Angeles Public Schools). They also might be loaning money to a pool of credit card holders, a pool of mortgage holders, a pool of churches, or other borrowers. This use of the term “bond” is no accident, for the security represents a literal binding between lender and borrower, the forging of a relationship of mutual trust, confidence, and respect that provides assurance to both parties.
Over time, social convention has defined that bond or relationship between borrowers and lenders: A lender will not change the terms of the loan outside of parameters agreed upon in advance; a borrower will repay the lender in a timely fashion as promised; the lender will receive the rights commensurate with the lender’s position in the capital structure (secured, unsecured, senior, junior, etc.); the borrower will conduct itself with due care and loyalty to the lender at least until the borrower has fulfilled is obligations. In this social framework, the lender-borrower relationship remains built on the premise that loans are bonds and that covenants are sacred. But is that framework still operating?
Modern securities markets are such that lenders and borrowers rarely know each other. In the vast majority of cases, the lender knows neither why the borrower wants or needs the money nor how the money will be used. Instead, many lenders rely on a credit rating, yield, and maturity to ascertain whether the borrower is worthy. Likewise, the borrower rarely knows the lender. A municipality raises funds from thousands of faceless lenders located across the municipality and many living outside of it. The corporation borrows money from lenders seeking yield and some level of safety but who may have no other investment in the success of the corporation.
This evolution of the borrower-lender relationship from a true bond to one that is largely detached from a sense of mutual obligation is causing some intriguing and troubling events. In Harrisburg, capital of Pennsylvania, Mayor Linda Thompson is faced with a choice of maintaining city services or paying the city’s lenders (aka bondholders). For her, the choice is clear: do not cut services. According to the Wall Street Journal (“Harrisburg Surrender,” 9/8/10), Ms. Thompson said, "To disrupt [services] because we can't make a bond payment would just be unconscionable. And as a leader I couldn't do it," To her credit, she also is concerned about scaring off bond investors, recognizing that to do so would impact a critical source of financing.
A similar tough choice is faced by Michael Thomas, a leader of the Pequot tribe in Connecticut, owners of one of the world’s largest casinos at Foxwoods: Pay dividends to tribal members from Foxwoods’ revenues versus pay bondholders who have lent money to build Foxwoods. (WSJ, “Tribe’s Roll of Dice Rattles Lenders,” 9/17/10) The Pequot and other Indian tribes are in a privileged position for now because as sovereign nations, they can’t be forced into bankruptcy, and even if they declared it, their lenders would not be allowed to operate casinos on reservations. That said, the casino business will suffer greatly if by stiffing current lenders, the pool of future lenders dries up.
Ms. Thompson and Mr. Thomas are not alone in this dilemma. Municipal borrowing (states and cities) has grown from $1 Trillion in 1990 to $2.4 Trillion in 2010, an increase of 140% over 20 years. Not evident in these numbers is the concurrent sharp increase in unfunded or underfunded pension and health care obligations municipalities have accepted. These commitments paired with a sharp decline in tax revenues have converged to confront municipalities with multi-horned dilemmas of epic proportions: Pay underfunded pensions versus support public education versus build infrastructure versus support unemployed citizens versus pay secured lenders versus maintain vital emergency services versus raise taxes versus encourage new business investment versus get reelected versus…
An early sign of the current economic crisis occurred when banks stopped lending to each other following BNP Paribas’s announcement that it could not adequately value the loans on its books. The overnight interbank lending rate spiked and the crisis of confidence began. Soon after, investment banks stopped supporting the auction rate market, another marketplace where lenders and borrowers met to support each other’s interests. The municipal bond market experienced its greatest shock since the 1860s. These events occurred in late 2007 and early 2008, well before the escalated fears of municipal defaults, declining tax revenues, and unfunded pension obligations, and before the failures or near failures of Bear Stearns, Washington Mutual, Lehman Brothers, AIG, Merrill Lynch, General Motors, Wachovia, Goldman Sachs…you get the idea.
So where are we today? We all operate with an investment marketplace driven by computer algorithms and high frequency trading, an investment industry populated with countless exchanges, traders, product engineers, and money managers, a regulatory framework with agencies possessing complex mandates without rationalizing guidance to address conflicts like those described above, and a global pool of millions of borrowers and lenders striving to make the most effective decisions for themselves every day.
Despite these complexities and technological innovations, at the end of the day, we have borrowers and lenders who desire confidence in the larger system and in their relationships with each other. For all of our wizardry, those who lend and borrow want to have the assurance that comes from relationships built on a shared commitment to each other.
America is at a crossroads in so many ways, and the most difficult of our collective economic decisions still lie ahead of us. Before we further diminish the sanctity of the relationship between borrower and lender, we need to recognize how doing so irrevocably impacts our culture. This is not a time to say that our social contracts do not matter because they force difficult choices; this is a time to make difficult choices precisely because our social contracts are what bind us.
Friday, September 24, 2010
Thursday, September 9, 2010
Beware the Financial-Industrial Complex
Three days before the end of his term as President, Dwight D. Eisenhower—Republican, architect of D-Day, and senior military officer for the United States in the closing years of WWII—gave the American people his parting thanks and a stern warning about the growing interdependence of the Federal government and what he described as the “military industrial complex.” He said in part:
“This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.
In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”
While we lack the bully pulpit and gravitas of a departing president, we would like to issue a similar warning about our society’s changing relationship with financial services. We ask you to reread Eisenhower’s passage above, substituting “financial” wherever you see a reference to “military.” It would start, “This conjunction of an immense financial establishment and a large finance industry is new in the American experience. The total influence—economic, political, even spiritual—is felt in every city, every State house, every office of the Federal government…” And so on.
Is this overstating matters? Consider that the financial services industry spent over $5 billion on campaign contributions and lobbyists in the decade leading up to the financial crisis, that by 2007, nearly 3,000 lobbyists represented the industry in Washington, and that the cost of bailout, stimulus, TARP and other recent programs stands at over $3 trillion. From 1998-2008, campaign contributions from the financial sector rose by 185% to $443 million while lobby expenditures grew by 117% to $455 million. Meanwhile, the Standard and Poor 500 fell by 13%.
It is important for all Americans to acknowledge that the political contributions and policy missteps (deliberate or well-intentioned) occurred under both Democratic and Republican leadership reflecting the near-even split in political contributions from banks, securities firms and insurance companies. (See: “Sold Out” http://www.wallstreetwatch.org/) This is not one party’s problem.
People could give in to cynicism, chuckle at the irony of financial reform being named after Barney Frank and Chris Dodd, stare in amazement at political candidates who claim to represent the “regular folks” yet are funded by those who exploit their ignorance of finance, shake their heads when government officials promote annuity sales as the basis for retirement planning, and marvel that so little has changed structurally in how investments are crafted, regulated and sold. But that would be a weak response, a concession not worthy of those who are aware of these problems and can potentially influence their successful resolution.
Eisenhower, too, could easily have succumbed to cynicism in his farewell message; however, his next paragraph admonished Americans to be more vigilant. He stated that,
“We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together.”
So let’s imagine for a moment that we share a similar goal with regards to the relationship between American society and financial services. What would it take for us to more effectively “compel the proper meshing of the huge (machinery of finance) with our peaceful methods and goals, so that security and liberty may prosper together?”
While the question deserves a more comprehensive review of cultural, regulatory, and operational changes, there are some low-hanging fruit that are ripe for the picking that do not necessarily require Washington’s acquiescence.
· Create much clearer and more restrictive policies regarding how past and present senior officers and directors of major banks, broker-dealers, and insurers can serve in positions of authority or influence at the Federal Reserve Bank, in the US Department of the Treasury, the OCC, FDIC, SEC, and other regulatory agencies or offices, state or federal. Obviously, these policies would need to flow both ways. The argument that their “talent” is invaluable has been sufficiently disproven by those who have crossed over previously and failed massively in their economic judgment if not their political adroitness. If enough voters express enough frustration when conflicted appointments are made, fewer will be made.
· Stem the consolidation of financial power in a few financial institutions that have become increasingly dependent on government largess to support their operations. Antitrust or banking regulators could carry this out; in the meantime, consumers decide where to conduct business.
· Support community banks and credit unions that are imbedded in the local community, are more likely to return profits to the community, support FDIC, and are of a more human scale.
· Eliminate the conflicted relationships between broker-dealers and money managers that materially increase costs to investors in a manner that lacks transparency. Rather than waiting for the SEC to take action, consumers can refuse to do business with conflicted professionals.
· Create a fiduciary standard for anyone involved in the manufacture, promotion, or distribution of financial products. That is, require that every financial professional in the supply chain of investment product creation and distribution demonstrates the highest ethical standards and always prioritizes the loyalty and care due to the end client, be it a retired couple, a pension plan, or a municipality. This does not mean that every investment must work perfectly, but that every investment product must be crafted and marketed with the intent of benefitting the end investor—even insurance products. We demand similar accountability in most other industries; finance is largely exempt.
· Reward politicians who refuse to accept money from financial corporations that do business in manner that is conflicted with the best interests of their customers.
Eisenhower’s words of warning resonated and surprised because he had tremendous credibility when it came to military matters. He was an insider. He had seen the evolution of the US military from 1941 to 1961 and—right or wrong—he did not like what he saw.
Financial Services lacks such a powerful figurehead. There is no one voice that can stand up in Washington DC with the credibility of an Eisenhower to warn against the corruption of finance and government. Because of that vacuum, it becomes all the more important that citizens, consumers, and voters of all persuasions express their sentiment in their actions to the best degree they can.
Pogo once said, “We have met the enemy and he is us.” What Pogo forgot to mention is that, “We have met our allies, and they are us, too.”
“This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.
In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”
While we lack the bully pulpit and gravitas of a departing president, we would like to issue a similar warning about our society’s changing relationship with financial services. We ask you to reread Eisenhower’s passage above, substituting “financial” wherever you see a reference to “military.” It would start, “This conjunction of an immense financial establishment and a large finance industry is new in the American experience. The total influence—economic, political, even spiritual—is felt in every city, every State house, every office of the Federal government…” And so on.
Is this overstating matters? Consider that the financial services industry spent over $5 billion on campaign contributions and lobbyists in the decade leading up to the financial crisis, that by 2007, nearly 3,000 lobbyists represented the industry in Washington, and that the cost of bailout, stimulus, TARP and other recent programs stands at over $3 trillion. From 1998-2008, campaign contributions from the financial sector rose by 185% to $443 million while lobby expenditures grew by 117% to $455 million. Meanwhile, the Standard and Poor 500 fell by 13%.
It is important for all Americans to acknowledge that the political contributions and policy missteps (deliberate or well-intentioned) occurred under both Democratic and Republican leadership reflecting the near-even split in political contributions from banks, securities firms and insurance companies. (See: “Sold Out” http://www.wallstreetwatch.org/) This is not one party’s problem.
People could give in to cynicism, chuckle at the irony of financial reform being named after Barney Frank and Chris Dodd, stare in amazement at political candidates who claim to represent the “regular folks” yet are funded by those who exploit their ignorance of finance, shake their heads when government officials promote annuity sales as the basis for retirement planning, and marvel that so little has changed structurally in how investments are crafted, regulated and sold. But that would be a weak response, a concession not worthy of those who are aware of these problems and can potentially influence their successful resolution.
Eisenhower, too, could easily have succumbed to cynicism in his farewell message; however, his next paragraph admonished Americans to be more vigilant. He stated that,
“We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together.”
So let’s imagine for a moment that we share a similar goal with regards to the relationship between American society and financial services. What would it take for us to more effectively “compel the proper meshing of the huge (machinery of finance) with our peaceful methods and goals, so that security and liberty may prosper together?”
While the question deserves a more comprehensive review of cultural, regulatory, and operational changes, there are some low-hanging fruit that are ripe for the picking that do not necessarily require Washington’s acquiescence.
· Create much clearer and more restrictive policies regarding how past and present senior officers and directors of major banks, broker-dealers, and insurers can serve in positions of authority or influence at the Federal Reserve Bank, in the US Department of the Treasury, the OCC, FDIC, SEC, and other regulatory agencies or offices, state or federal. Obviously, these policies would need to flow both ways. The argument that their “talent” is invaluable has been sufficiently disproven by those who have crossed over previously and failed massively in their economic judgment if not their political adroitness. If enough voters express enough frustration when conflicted appointments are made, fewer will be made.
· Stem the consolidation of financial power in a few financial institutions that have become increasingly dependent on government largess to support their operations. Antitrust or banking regulators could carry this out; in the meantime, consumers decide where to conduct business.
· Support community banks and credit unions that are imbedded in the local community, are more likely to return profits to the community, support FDIC, and are of a more human scale.
· Eliminate the conflicted relationships between broker-dealers and money managers that materially increase costs to investors in a manner that lacks transparency. Rather than waiting for the SEC to take action, consumers can refuse to do business with conflicted professionals.
· Create a fiduciary standard for anyone involved in the manufacture, promotion, or distribution of financial products. That is, require that every financial professional in the supply chain of investment product creation and distribution demonstrates the highest ethical standards and always prioritizes the loyalty and care due to the end client, be it a retired couple, a pension plan, or a municipality. This does not mean that every investment must work perfectly, but that every investment product must be crafted and marketed with the intent of benefitting the end investor—even insurance products. We demand similar accountability in most other industries; finance is largely exempt.
· Reward politicians who refuse to accept money from financial corporations that do business in manner that is conflicted with the best interests of their customers.
Eisenhower’s words of warning resonated and surprised because he had tremendous credibility when it came to military matters. He was an insider. He had seen the evolution of the US military from 1941 to 1961 and—right or wrong—he did not like what he saw.
Financial Services lacks such a powerful figurehead. There is no one voice that can stand up in Washington DC with the credibility of an Eisenhower to warn against the corruption of finance and government. Because of that vacuum, it becomes all the more important that citizens, consumers, and voters of all persuasions express their sentiment in their actions to the best degree they can.
Pogo once said, “We have met the enemy and he is us.” What Pogo forgot to mention is that, “We have met our allies, and they are us, too.”
Thursday, September 2, 2010
My Kingdom for a Treasurer!
In a literary reference often overlooked by high school English teachers, Shakespeare’s King Richard called out “A Treasurer! A Treasurer! My Kingdom for a Treasurer!” just moments before he lost his horse. Alas, he had neither reliable Treasurer nor brave horse and thus lost his kingdom. Let’s hope we do better.
In the coming months, voters around the country will select governors, senators, and congressmen. We will vote on controversial amendments and propositions. Further “down ballot” most of us will find elections for school boards, judges, university regents, attorneys general, and the little known and even lesser understood office of municipal treasurer.
Treasurers of municipal districts (states, cities, counties, etc.) are an underappreciated lot. Given their intense responsibilities, they also are under-scrutinized by voters and the media, and in too many cases under-qualified or under-resourced. Cynics might argue that the Treasurer’s office is nothing more than a political stepping stone to the greater glories of mayoralty or governorship or a chance to pocket some spare change from vendors of various stripes.
However, we believe that electing someone to serve as caretaker of the community’s purse is one of the most vital decisions voters can make and one worthy of the most thoughtful consideration. Syntrinsic has crafted a generic job posting for Municipal Treasurer in an effort to capture a sense of the arduous and often thankless task faced by the keepers of the purse strings.
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For Immediate Posting: Municipal Treasurer
The Municipality of [Insert locale here] seeks a Treasurer who possesses the judgment of King Solomon, the courage of King Arthur, the compassion of Mother Theresa, and the communication skills and media savvy of Oprah Winfrey.
Responsibilities
The following responsibilities are to be completed in full, without exception, every day, even during election cycles, with limited staff, without undue influence caused by partisanship, media hype, special interest pressure, kickbacks, traveling salesmen, or CNBC:
· Renegotiate unrealistic pension obligations made by previous administrations. Do so without causing taxpayer revolt, regional strikes, or municipal bankruptcy. Honor the sanctity of contracts while modifying them.
· Unwind illiquid derivative contracts with obscure counterparties without negatively impacting the balance sheet or attracting the attention of credit rating agencies, the press, voters, regulators, or former municipal employees whose jobs were cut to pay for the failed investments.
· Vet the fiscal health and ethical business practices of all financial institutions with whom the municipality does business, including custodians, bond issuers, credit providers, money fund issuers, bond traders, investment banks, broker-dealers, consultants, insurance underwriters, banks Pension Plan platforms, money managers, research providers, technology vendors, and other assorted financial partners.
· Assist in evaluating how the municipality can take on greater regulatory oversight for financial institutions and finance professionals within your jurisdiction, given changes in the national regulatory landscape.
· Improve education by cutting education spending. Stimulate the economy by raising taxes on businesses. Encourage employment by increasing the cost of hiring new employees. Identify other contradictions and address them with grace and composure.
· Predict the future.
Skills
Eligible candidates should be able to demonstrate the following skills and traits:
· Fearlessness
· A wonkish delight in policy balanced by a disdain for wonkishness
· Healthy skepticism
· Hope and faith
· The ability to make impossible choices
· The ability to make sure that no one blames you for the impossible choices you have made so that you can stay in office and make more of them
· The ability to travel to distant regions, meet new people, and persuade them to entrust you with their money
· Offend and inconvenience no one
· Persuade most everyone to share the burden and feel good about it
· Stay out of the press, but keep citizens informed
· Be transparent, but don’t cause a panic
· Make wise long-term decisions without the next election distracting you
· Raise money. (For yourself. It costs a lot to be a Treasurer these days.)
Final Consideration
For those uncertain if they might be suitable candidates, we have found that effective municipal Treasurers often have backgrounds as alchemists, nuclear weapons inspectors, HazMat crew chiefs, and Supreme Court justices. Mortals need not apply.
Please forward cover letter, resume, and glitzy promotional video to the address below. We will review your materials as soon as we can afford to rehire our elections staff. They were laid-off after one of our structured notes failed to protect the municipality’s principal. The lawyers tell us that the prospectus had said that might happen but…well, you know.
Attention: Candidates for Treasurer, State of Distress, One Long Road, Capital City, USA
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