Saturday, January 31, 2009

Executive Compensation - Supplement

There's been a great deal of justified criticism in recent weeks about annual bonuses totaling a reported $18.4 billion paid or promised largely to investment bankers on Wall Street for their performance in 2008. This was at the same time as their employers are reporting huge financial losses, many of them have applied for and received substantial federal bailout moneys, tens of thousands of primarily lower paid and mid-level employees in their industry are receiving pink slips, and the country is in the worst economic recession since the Great Depression in the early 1930's.

Particularly newsworthy was the imprudent and inappropriate decision by former Merrill Lynch CEO John Thain and its board of directors to approve between $3-4 billion in bonuses to a large pool of their investment bankers at a board meeting on December 8th, when they knew, or should have known, that Merrill Lynch would be reporting a loss exceeding an incredible $15 billion for the 4th quarter alone! Furthermore, they decided to speed up the payments to later in December, rather than the customary January period, because, I think, they feared the possibility of Bank of America's CEO Ken Lewis and the bank's board downsizing the bonuses after their merger deal became official on December 31st. However, and it may have been another factor, Thain's reported rationale for the speeding up was that he wanted his senior executives to allocate the bonus pool to the respective beneficiaries before the merger and many of them left for other employers.

Additionally, the reported rationale from Mr. Thain and his supporters in paying the bonuses was the fear of losing many of their best performers, who no doubt would be quite unhappy if no bonus were paid. Critics, including myself, maintain that there couldn't have been that many top performers last year if the firm lost as much money as they did. And where would they go, since almost all the better firms in the industry are laying off people, not hiring?

On Thursday President Obama blasted Wall Street executives and board members for their actions in paying the bonuses, calling it the "height of irresponsibility" and "shameful." I think he was right to do so, even if the actions were legal. And I say that as a former investment banker who spent ten years in the industry. But to be fair to Mr. Thain, though originally apparently seeking a $10 million bonus for himself, I understand neither he nor the top four other executives at Merrill Lynch, were actually paid any bonus.

In my experience, bonuses to investment bankers are typically paid based on performance against pre-agreed personal objectives, especially involving revenue generation, and the level of individual contributions to the firm's financial results. However, limited bonuses were paid to anyone if the firm didn't achieve satisfactory overall financial results as measured against stated corporate objectives. By this standard, certainly, the bonuses, though much smaller than for performances in 2007, seem quite excessive and definitely inappropriate.

Given the public and media uproar on this subject, and understandings about limiting executive compensation for companies receiving federal bailout moneys, congressional investigators have called on the banks to justify their actions. In addition, New York Attorney General Andrew Cuomo has instituted his own investigation to determine if some of the executives have violated their fiduciary duties to shareholders, creditors and other employees. Apparently he has already subpoenaed Mr. Thain and Bank of America's Chief Administrative Officer J. Steele Alphin to testify. I'm fairly certain he will press hard for some meaningful convictions or similar outcomes, depending on the evidence he can come up with, particularly if this covers clear and unwarranted harm to shareholders, creditors or other employees.

What's going to be the end result? As I discussed in my post published last August, there will be even more pressure by the Congress, the media, the regulators, rating agencies and a great many shareholders for the boards of directors and CEO's of these firms to be more careful and a little more rigid and disciplined in how salary compensation levels are established and what policies will apply to incentive compensation, also often referred to as bonuses. I also would not be at all surprised if a number of additional CEO's and board members of these banking firms retire or are forced to resign.

Saturday, January 24, 2009

Israel and Hamas' Conflict - Supplement I

I'm pleased there is at least a temporary cease fire in Gaza, as I indicated in my post of January 6th was badly and urgently needed. I'm also pleased that Hillary Clinton has been confirmed by the Senate as President Obama's new Secretary of State and that Mr. Obama has appointed former U. S. Senator George Mitchell as his special envoy for the Middle East, with particular focus on Israel and the Palestinian territories. Most of my readers will remember that Mr. Mitchell, a 76 year old Arab American, was a key player in securing the successful Belfast Peace Agreement, signed in 1998, that finally brought peace to Northern Ireland.

It is obvious that it's in almost everyone's best interest, especially the great majority of the Israeli and Palestinian peoples, that a fair and long lasting peace agreement be achieved, but it is difficult to be very confident about the prospects. Many conservative Israelis are understandably extremely uncomfortable with the concessions they expect will be required of them with respect to Jewish settlements, the sharing of Jerusalem, potential return of Palestinian refugees, and trusting Hamas militants and their supporters, including Iran, Syria, and Hezbollah in Lebanon. All Israelis and their allies, including the U. S. and the European Union, cannot accept any agreement that leaves intact Hamas' oft stated refusal to accept Israel's right to exist and commitment, shared by the Iranian government, to destroying Israel.

The bulk of the Palestinian people deserve and urgently need a good peace agreement, especially those who live in the West Bank, those who live in Gaza and didn't support Hamas in the last election, and the hundreds of thousands who live as de facto refugees in other parts of the Middle East, in Europe and the U. S. It should be very clear to objective Gazans that Hamas' policies have been very harmful to their interests. However, as long as Hamas remains in power in Gaza, and continues to be supported by radical Islamists and many other Islamic Arabs who are unhappy with the West's bias toward supporting Israel, achieving peace will be a major challenge.

The Palestinians have legitimate reasons to be uneasy about trusting the West to be fair in trying to broker a fair peace agreement and in Israel' s trustworthiness. Since 1948, when Israel was established from the British Mandate of Palestine, the U. S. and several countries now part of the European Union have been key players in providing foreign aid and selling modern weapons and related technology to Israel. For many years Israel tolerated, and to some extent encouraged, Gaza's Islamic militants, leading to the founding of Hamas, as a counterweight to the more moderate, secular nationalists of the PLO and its dominant faction, Fatah, led by Yasser Arafat. Most Palestinians and other Arabs feel strongly that Israel's recent 22 day offensive was highly disproportionate to the actions of Hamas' missile attacks in the southern part of Israel. Much of this feeling is based on the fact that more than 1,200 Palestinians were killed, the majority probably innocent civilians, while only 13 Israelis lost their lives.

I presume that Mr. Mitchell in his new position, working under both Secretary of State Clinton and President Obama, will cooperate closely with former British prime minister Tony Blair, special envoy for the Middle East since 2007 on behalf of the United Nations, European Union, Russia and the U. S. To succeed they will need serious support from several major Middle East Islamic neighbors, including Egypt, Turkey, Saudi Arabia, Jordan, and Iraq. It would also be very useful to have some support from Iran, but obviously that cannot be expected.

I expect a good peace agreement with a two-state solution will be one of the highest foreign policy priorities of the Obama Administration, the UN, as well as the EU. The first step should be a formal extended cease-fire agreement of at least a year to allow Mr. Mitchell and Mr. Blair to meet all the big players and design an effective strategy for peace agreement. Two of Mr. Mitchell's most important strengths, aside from diplomatic and negotiation skills, are patience and perseverance. He will definitely need a lot of that, plus a good measure of luck.

Wednesday, January 21, 2009

Income Tax Reform

While surprisingly there was little discussion of it in last year's presidential campaigns, our current system of federal income taxation is ridiculous and badly needs to be reformed. The system is unnecessarily complex, too expensive, compliance is difficult to effectively monitor, and its complexity and loopholes unfairly favors the wealthy and other upper income individuals and larger businesses who can much better afford high-priced tax attorneys and accountants.

What's the evidence? Its virtually endless, but for starters President Obama's bright and experienced nominee for Treasury Secretary, Tim Geithner, who will oversee the Internal Revenue Service, made some embarrassing mistakes with his tax returns and has taken heat from this in recent testimony on his nomination in the Congress. The tax code, including associated regulations, now runs more than 60,000 pages, 500 changes having been made last year alone. This compares with 400 pages when the federal income tax was introduced in 1913.
The IRS offers more than 400 different forms and more than 100 instruction booklets to explain how to complete them.

The IRS' national taxpayer advocate has estimated that the complexity of the tax code results in taxpayers spending roughly $193 billion annually complying with filing requirements, equivalent to 14% of all income taxes collected! Reportedly, about 60% of taxpayers feel it's necessary to pay a professional, generally a tax attorney or accountant, to handle their tax returns. Another 22% of Americans apparently purchase tax return preparation software, like TurboTax. That means that only 18% of Americans are comfortable preparing their own returns.

According to an article written by a credible business executive in 1998, individuals spent an estimated total of 1.7 billion hours annually preparing tax returns and business owners spent an additional 3.4 billion hours. That was 10 years ago when the tax code was shorter in length and somewhat simpler. No doubt the hours spent in more recent years are much greater.

The clear conclusion by almost everyone, including most members of Congress, but probably excluding tax attorneys and accountants who specialize in making a good living by preparing tax returns for their clients, and who lobby for something close to the status quo, is that serious tax reform, especially much greater simplicity, is greatly needed. Why, then, has there been so little meaningful and effective action? It's a fair question. I think the answer is the fact that there have been so many other issues deemed to be priorities, partisanship and gridlock in the Congress, legitimate differences of opinion about how to tackle the issue, and the lobbying by the attorneys and accountants. Another factor is probably that there has been relatively little political pressure from voters and the media to act.

A number of general proposals have been brought up, including a flat tax of 20-21% and a so-called "fair tax" under which the income taxes would be abolished and instead we would have a federal sales tax of about 23%. A problem with the flat tax is that it would be likely to increase taxes for the poor and middle class and reduce taxes paid by upper income and wealthy Americans. A problem with the "fair tax" is that state and local taxes would come on top of the federal sales or consumption tax.

Whatever the final solution, the bottom line is we need to reform the tax system in a way that makes tax return preparation and filing much simpler, less time-consuming and less costly, but the new system must be fair and sustainable, with compliance much easier to monitor. Furthermore, the system needs to be able to generate adequate tax revenues to cover the legitimate needs of an efficient federal government with a fully balanced budget.

Many individuals should be able make do with a one page form and most individuals should be able to use a return of no more than two or three pages that they can complete themselves. I would think that the preferred solution will involve abolishment of our current tax code and the associated regulations as well as the IRS as we now know it, with its roughly 100,000 employees and annual budget of around $10 billion.

Sunday, January 18, 2009

The Barack Obama Presidency

As most of the world knows, on Tuesday, January 20th, Barack Obama will be sworn in as our 44th and first Afro-American President and Joe Biden will be sworn in as our new Vice President. George Bush will presumably retire to his new home in Dallas, Texas, and Dick Cheney will apparently move back to his home near Casper, Wyoming.

Both Democrats and Republicans acknowledge that Mr. Obama, originally considered a long-shot to win, ran one of the most effective major political campaigns in recent memory. It's noteworthy that his nominee for Secretary of State, Senator Hillary Clinton, no doubt would have been the country's first female President had Mr. Obama not been a candidate, had he not run such a strong campaign, or if Mrs. Clinton had been able to manage a somewhat stronger campaign herself.

President Obama's presidency from the first day faces perhaps the most complex and difficult number of challenges of any president since Franklin Delano Roosevelt was elected in 1932, having to lead the country out of the Great Depression and later with the horrors of World War II. The widely accepted biggest challenge for Mr. Obama, similar to Mr. Roosevelt, is, of course, to turn the U. S. economy around, especially by further stabilizing the financial markets, restoring confidence, and promoting measures in both the private and government sectors to create and preserve millions of needed jobs. It will be a great challenge for several major reasons, including the facts that we are facing a mountain of national debt, a huge federal budget deficit, deep economic recessions in almost all our main trading partners, and retrenching by the majority of our largest companies, hinding employment gains and important corporate investment spending.

The long list of other big challenges include dealing with our wars in Iraq and Afghanistan, the world-wide war on terror, the violent conflict between Israel and Hamas, supported by Iran and Hezbollah in Lebanon, serious tensions between India and Pakistan, the needs to reform and strengthen Social Security and Medicare, securing a greater degree of energy independence, and finding bipartisan solutions to the weaknesses in our present healthcare system. That's just a partial listing. The challenges are reflective of the simple fact that as a country we're in a tight jam without enough money and resources to cover serious needs. To get out of this predicament we will no doubt need to tighten our belts quite a bit more and make sacrifices that will have at least a temporary adverse impact on our quality of life.

Popular political commentator Bill O'Reilly recently stated boldly that President Obama will be reelected in four years if he only is able to get the economy turned satisfactorily around and the country suffers no terrorist attacks. While those would be judged as major achievements, I doubt that would be sufficient for reelection, and I'm fairly certain Mr. Obama is not concerned or even thinking about that at this stage. He has an incredible amount of difficult work to do and most probably he will take it one day, one week, one month, one year at a time.

Fortunately, he is a very bright and articulate politician, who has assembled, for the most part, a very experienced and strong team of advisors and cabinet members. We can be thankful for that. Hopefully he will deserve and obtain broad bipartisan support from the Congress, the media, and the great majority of the American people. While he has has been frequently branded by the far right and many other conservatives as a leftist, socialist and a typical liberal, I'm increasingly confident that he will govern as a very pragmatic moderate centrist on most issues, even though when it comes to healthcare, for example, he will likely, as is well known, be governing somewhat left of center.

It will take some time to turn the economy around, perhaps as long as 12-18 months, and to make good progress on many of his other big challenges, but I'm cautiously optimistic that he will be reasonably successful overall. Especially during the first several months, he will help himself and the country by scheduling weekly press conferences in which he explains what he is doing and why, and is very open to questions from the press corps. Meanwhile, the business sector, the state, county and city governments, and we as individuals need to do what we can within our own control to move ourselves in a positive direction and help Mr. Obama and his administration to succeed, thereby benefiting us all.

Friday, January 9, 2009

The Massive Bernard Madoff Fraud Case

As most people who read newspapers know by now, Bernard Madoff, the 70 year old New York based money manager, was arrested on December 11th of running a giant illegal so-called Ponzi scheme under which old investors are provided above average manipulated returns funded by moneys from unwary new investors, rather than from actual returns from their investments. He has confessed to fraudulently losing over a long period of time, possibly since he started his business in 1960, up to an incredible $50 billion of money entrusted to him by family members, close friends, major banks, and other substantial financial market players. As I understand it, he is currently free on a $10 million personal recognizance bond, but is under 24 hour house arrest in his New York penthouse.

There is increasing pressure from several well-known investors, including major Hollywood celebrities, like Jeffrey Katzenberg, CEO of Dreamworks Animation, to put him in jail, especially after word got out that federal prosecutors actually found $173 million in checks signed by Madoff when they searched his office on the day he was arrested. The checks, about to be mailed out, were apparently made out to family members and close friends who had invested with him in an effort to keep those funds away from the prosecutors and other creditors. Madoff's attorneys apparently have argued that their client didn't violate any of his bail terms and didn't know the asset freeze imposed applied to the $173 million. Incredible!

What a crook! He definitely belongs in jail, though he no doubt has some negotiating leverage with the prosecutors because he reportedly is the only one who knows exactly what happened to all the money entrusted to him, what's left and where it is deposited or invested. It is likely his attorneys won't hesitate to employ that leverage in talking to the U. S. Attorneys examining and prosecuting the highly publicized and unusual case in New York.

Allegedly his two adult sons, who served as senior executives in other parts of Madoff's business and worked on a different floor in his building, knew nothing at all about their father's activities with this fraudulent scheme. It's rather hard to believe that was actually the case, but I suppose it's possible.

This case definitely will put another big dent in the reputation and credibility of U. S. financial markets and our significantly damaged financial services industry. It is unclear whether more government regulation, such as that now being considered, could have prevented this scandal. However, it ought to lead to much more due diligence and care, and exercise of more common sense, by investors seeking investment advice and asset managers for their investment funds. Madoff's clients should have known that steady, double digit investment returns in good and bad markets was not realistic, especially if the planned investments would not involve above average risk. They should also have known that it wasn't prudent to invest all, or a substantial percentage, of their investable funds with one money manager or in one category of investments. These are very basic, quasi no-brainer investment principles. Live and learn.

Tuesday, January 6, 2009

Israel and Hamas' Military Conflict

It is very unfortunate and tragic that Israel in recent days found it necessary to bomb and invade the small and very poor Hamas controlled Palestinian territory of Gaza, demolishing dozens of buildings and unintentionally killing and wounding hundreds of largely innocent civilians, including quite a few children. However, it's difficult to credibly blame the Israeli government, given the hundreds, if not thousands, of missiles recently fired by Hamas militants into and around towns and other residential communities in southern Israel, killing a number of innocent civilians and wounding dozens of others. Retaliation is entirely understandable, and also Article 51 of the United Nations charter reserves the right to every nation to engage in self-defense against armed attacks.

Critics of Israeli actions should keep in mind that it was Hamas who allowed the six month cease-fire agreement to lapse last month and who initiated the latest round of missile attacks. This is the same Hamas who, like Iran's current radical government, which reportedly is supplying Hamas with weapons and financial backing, does not recognize Israel's right to exist and, incredibly, has vowed to destroy the country! That noted, the Palestinian people do have some legitimate complaints and concerns about Israeli actions going back several decades that definitely ought to be addressed.

Obviously this fighting, especially if it escalates and goes on for too much longer, is not good for the Palestinians, Hamas, Israel, the entire Middle East region, the U. S., or the world at large. A cease fire is urgently needed first and a fair, durable, and lasting peace agreement is needed thereafter . Two key questions are how this can be best achieved, and what should be the role of the U. S. Acknowledging I'm not an expert on this very emotional and complicated subject, I'll still relatively briefly provide my "common man," pragmatic viewpoints.

The initial urgent step must be reestablishment of a firm cease fire agreement of six to twelve months to be monitored by either United Nations troops, European Union troops, or a contingent of troops from moderate regional powers such as Turkey or Egypt. Almost everyone agrees with that. The U. S. is in the best position to pressure Israel to agree to this, although the European Union certainly could also contribute. Hamas can best be pressured by Iran, but it's doubtful that Iran will want to play that role, in part because the longer the conflict continues, the easier it will be for both Hamas and Iran to fan the flames of anti-Israel and anti-U. S. rhetoric in the Arab and Muslim worlds.

Additionally, the conflict is serving to deflect world-wide attention to Iran's controversial nuclear power and weapons build-up plans. A quick cease-fire and early peace agreement would therefore probably be detrimental to Iran's strategic interests. The primary alternative governments to pressure Hamas, aside from their countrymen in the West Bank, would likely include those of Syria, Egypt and Turkey, as well as Jordan. I'm not confident pressure from the United Nations' Secretary-General or Security Council would be as effective.

Israel will surely agree to an early cease-fire with strong pressure from the U. S., particularly if they believe they have significantly weakened Hamas and their capacity to fire more missiles into southern Israel. It is less certain with Hamas, who are much less predictable and rational, but with meaningful political pressure from one or more of the above regional governments and their own citizens, it's very probable they will comply. Recognition of their militants' casualties and substantial infrastructure damage, as well as very limited realistic options, should also induce Hamas' leaders to sign up.

A fair, durable and lasting peace agreement will be much more challenging. The Palestinian people, while very angry now with Israel's bombing and invasion should, when the dust settles and some months have gone by, be so unhappy with the performance of Hamas' leadership, that they will increasingly come to accept the fact that they would be better off with the more moderate Fatah leadership in the West Bank led currently by President Mahmoud Abbas. I cannot believe that a majority of the Palestinian people, even those living in Gaza, would prefer to continue supporting a highly militant Hamas organization with continued fighting and resultant further devastation of their land, and no realistic chance to ever defeat Israel. If they have a clear option of living in peace, with no more threats of Israeli attacks, an internationally backed, fair peace agreement, and promises of substantial economic aid from both the West and their well-heeled Muslim neighbors, I think they would definitely go this route. It's possible even a significantly weakened Hamas would still try to prevent the Palestinians in Gaza from having this peaceful choice, but international pressure should be able to overcome that potential threat.

Both sides would need to make substantive concessions in order to achieve a fair, durable and lasting agreement that both the Israelis and Palestinians, as well as most of their supporting countries (excluding Iran) could be convinced to sign. There is no need to go into all of them here. However, the Palestinian government in both Gaza and the West Bank must acknowledge Israel's right to exist in peace and security without any military threats from its neighbors or other countries in the Middle East. If somehow Hamas remains in power in Gaza, their leaders must make it clear that they fully agree with this point, though that would be a drastic change in their current political posture toward Israel. As long as Hamas is in power and would reasonably still be considered a potential threat to Israel, any agreement would also need to incorporate a provision that no import of any offensive weapons or weapon components be allowed into Gaza.

The Israeli government must also make some meaningful accommodations to the Palestinians. While perhaps only symbolic and of little practical significance, Israel should seriously consider acknowledging some responsibility for disadvantaging Palestinians since 1948, when with United Nations support Israel declared its independence after the British Mandate to govern Palestine had expired.

One of the major practical accommodations Israel should agree to in the peace agreement is removing the de facto economic blockade surrounding Gaza and make it easier for Palestinians to enter and leave the territory and to find employment in Israel. Others, of course, include reasonable and fair provisions with respect to restricting Israeli settlements in Gaza and the West Bank, the status of Jerusalem, adjusting the final borders, and the right of at least a modest number of Palestinian refugees to return to Israel or be compensated. As a reminder, I'm talking about the Palestinians who lived in what is now Israel, or their descendants, and fled or were forced to leave their homes and businesses in 1948 during the Arab-Israeli war and its aftermath.

The peace agreement must build upon the negotiations brokered by President Bill Clinton that took place at Camp David eight years ago and serve to expedite the long discussed independence for Palestine and full Arab recognition of Israel's right to exist in peace and security.

The U. S.' role under President-Elect Obama and his new Secretary of State Hillary Clinton must be to put appropriate pressure on Israel and to work diplomatically with our allies in the Middle East and fellow members of the Security Council to do what we can to achieve a fair and balanced agreement Israel and the Palestinians can live with and which has a good level of support from most of the countries in the region. Recognizing our longstanding, well-known bias favoring Israel, shared by most of the U. S. media, it's critical that our diplomatic initiatives be perceived as pragmatic, objective and balanced, being as fair as possible toward the Palestinian side.

Getting a temporary cease-fire in place within the next week or so will be relatively easy. Getting a satisfactory result with a signed peace agreement that endures will no doubt be very difficult. Major challenges will be dealing with the deep emotional scars from decades of conflict and anticipated resistance from Islamic radicals led by Iran, Hamas in Gaza, and Hezbollah in Lebanon. Negotiations between Syria and Israel, perhaps brokered by Turkey and encouraged by the U. S., with respect to the longstanding dispute on the future of the Golan Heights, could be an important component in achieving a peace agreement with limiting the resistance from the Islamic radicals.