THIS Will Get Their Attention

UBS, pronounced oops. Last month UBS Financial Services bought back auction-rate securities valued at $37 million that had been previously sold to 17 Massachusetts cities and towns (see May 8 post, "Pain in the ARS"). At the time the firm declared the matter "resolved." Now UBS is being prodded to do the same for individual investors, who have been unable to unload their ARS since the market froze in February. All told, over $200 billion of investment capital is trapped in these illiquid securities.

The Massachusetts Securities Division will file civil fraud charges today, alleging that UBS misrepresented ARS as cash-like investments with iron-clad protection of principal. Even worse, UBS continued to market the securities to small investors even as the firm was warning larger institutional clients of potential risk. Such two-tiered treatment of customers seldom goes over well with regulators.

Passive investors who thought they were safe started to smell the coffee in May, when their monthly statements from UBS began showing ARS as "fixed income" positions, not "cash." This meant that their securities could fluctuate in value, just like bonds. Sure enough, UBS has begun marking down the value of some of these investments on customer statements. "Your future," purrs the marketing jingle, now discounted at your friendly neighborhood broker.

Banc of America and Merrill Lynch are also in the crosshairs of Massachusetts regulators. Any money firm that spells "bank" with a "c" is guilty until proven innocent. As for Merrill, its rap sheet is as long as the Nile. I had a brokerage account with Merrill's Boston office back in the late '70s and early '80s and got personal attention from a customer rep named Don Martineau. He got me into Prime Computer before the stock took off, and that's how I paid for my honeymoon. Years later, though, long after I had moved to Maine, Martineau was convicted of bilking clients of millions and did some time. The "kulture," it appears, has not changed.


[update, 1:45 p.m.--]
Remember those preferred stock offerings that Merrill, Lehman, and Citigroup issued this spring to fortify their balance sheets? Those shares are now trading at 9.5% yields, which means (1) the share prices have declined since and (2) any new deals would have to be priced with double-digit yields. The day is coming when deals cannot get done at any price, and that is when the sugar will really hit the fan.

[update, July 24--]
New York Attorney General Andrew Cuomo announced today that he is joining the posse going after UBS for pushing auction-rate securites. "Not only is UBS guilty of committing a flagrant breach of trust between the bank and its customers, its top executives jumped ship as soon as the securities market started to collapse, leaving thousands of customers holding the bag," said Cuomo in a press release. Cuomo is seeking to compel UBS to buy back the ARS at face value, plus penalty. His lawsuit is the latest of two dozen against brokerages in nine states alleging marketing fraud.

Bad Money

Obama? McCain? It won't matter, according to Kevin Phillips, author of the new book Bad Money. The wheels are already in motion, and there is little the next President can do to prevent the coming train wreck. "This books," writes Phillips in his preface, "is about the insecurity of America's future as the leading world economic power, given a debt-gorged and negligent financial sector, and the vulnerability caused by the nation's expensive dependence on imported oil." To make sure you get the point, Phillips adds an ominous subtitle--Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism.

It is tempting to blame it all on the Bush II Administration, but let's be clear. These problems have been building for two decades, and simply escorting Dubya into retirement will not solve them. Since Alan Greenspan was appointed Chairman of the Federal Reserve Board in 1987, total debt in the U.S. has quadrupled to more than $40 trillion. That debt overhang is three times the country's annual Gross Domestic Product, a multiple surpassing the prior record set following the stock market crash of 1929.

Much is made of the Dubya Deficits, but government borrowing (federal, state, and local obligations added together) is less than one-third of the total private-sector issuance (financial, corporate, and mortgage). "In reality, public debt wasn't the big ballooner," points out Phillips, "private debt was." The risk to any society, as debt metastasizes, is that resources are allocated away from production and toward the useless pursuit of paper profits. Financial services in the U.S. now account for more than 20% of GDP, while manufacturing has shrunk to 12% (it was almost 30% the year I was born). The hollowing out of American manufacturing will make it that much harder to work off our debt.

"Money is 'bad,'" writes Phillips," when a leading world economic power passing its zenith...lets itself luxuriate in finance at the expense of harvesting, manufacturing, or transporting things." Phillips makes no predictions about how severe or prolonged the looming downturn will be, but he is pretty sure that down is where we are headed. For a reality check, let's check some headlines. How about this morning's? Citigroup Inc. today will begin laying off 10% of its investment banking staff, bringing its total headcount reduction for 2008 to over 15,000. And the American Federation of State, County and Municipal Employees, a public employees union, says about 45,000 government layoffs have been announced this year due to budget shortfalls.

And it's only Monday.

Quick Hits: Seeking Scapegoats

The massive deleveraging taking place in our economy, for all its impact, lacks suspense. When the dominoes start falling, the eventual result is known beforehand. That is why I can leave town for a week, dabble at farming in the Berkshires in the June sunshine, return home, learn of top executives at Lehman Brothers walking the plank during my absence, and not be surprised. I offered in my June 4 post that Dick Fuld's tenure as CEO was at risk. Turns out that the CFO and COO took the fall instead.

I fail to see how guys like Fuld can, or should, escape. These corporate execs get paid obscene amounts of money and should be held accountable when things go awry. Their compensation and severance packages should be heavily taxed (hear that, John McCain?). As they say on the farm, manure is a good thing only if it is spread around. Piled in one place, it stinks. The same thing goes for money.

[update, June 27:]
Bloomberg News is reporting that CEO Fuld will forgo his bonus in 2008. Last year Fuld made $40 million, less than a million of which was his actual salary. The rest was his bonus. How's the guy going to carry on without it?

Who pays for fixing medical mistakes? Sadly, it is either the patient (the victim) or those who pay insurance premiums (the rest of us, which makes us victims as well). Massachusetts wants to change all that. Yesterday state officials, in concert with the state's largest private health insurer (Blue Cross and Blue Shield), announced that hospitals or doctors may no longer bill for the costs of extra care following any of 28 different types of screw-ups. The extra costs may range from hundreds of dollars per case for preventable bed sores to thousands for post-surgical infections.

This cost-containment measure is long overdue--and essential if affordable health coverage is to be extended to the entire population. Again, it is all about holding perpetrators accountable. Until recently practitioners got away with medical errors, which went largely unreported. Who knew, for instance, that more people die in the U.S. each year from faulty treatment or diagnosis than from cancer!

American healthcare, when you think of it, is more like Russian roulette. When seeking services, there is a sizable chance that you will end up infected, indebted, disabled and/or drug-dependent. For that, you pay the highest per capita healthcare costs in the world. Now excuse me while I go for my aerobic workout.

Hoop Heaven

First K.U., now the C's!

Back From the Berkshires

Friends on a Mission youth group

United Baptist Church of Peru
Monterey, MA
06-14-2008

More Gloss Than Grit

It's a mouthful, this so-called Evergreen Mountain Four Season Resort & Casino. Doesn't exactly roll off the tongue now, does it. The long name bespeaks the project's aim to be all things to all people: a creator of jobs, a magnet for tourists, an anchor for investment, a benefactor of state programs, a guarantor of student loans, a steward of the natural environment, and a liberator of honest Maine folk just looking for a little entertainment close to home. It is Seth Carey's very own economic stimulus package for Oxford County.

But Seth has retreated to the background. Instead, Pat LaMarche, one of Maine's most recognizable public figures, has come to the fore to champion the idea of casinos in Maine. Last evening she made her pitch in Rumford before three dozen people in the Town Hall auditorium. At stake is a referendum question on the November ballot that, if passed, would give the ever-green light to construction of a casino "somewhere in Oxford County." What's more, the venture would be protected from any and all competitors for ten years.

Saying that the project is in the "conceptual" stage might be generous. Lacking a business plan, Carey has been unable to secure a favorite-son endorsement from the River Valley Growth Council, which hosted last night's forum. LaMarche threw out a few figures--4,000 visitors a day, a thousand jobs, repatriation of a million Maine dollars now going to Foxwoods--and promised more by November 4 (Year Five total revenues? revenues per customer?). She estimated ripple-effect job creation at 40%; for every ten casino jobs, four more would be created in the local economy.

Representative John Patrick led a discussion about how the Maine Legislature would have the opportunity to massage the bill if it passes. Though Patrick supports the initiative, he admits that it might need some "fixing" by the Legal and Veterans' Affairs Committee, on which he has served. Alas, Patrick is termed out and will be running for County Commissioner, begging the question as to who will remain in the House to shepherd this thing through. Talk of "trusting the Legislature" to get it right brought involuntary twitches from more than a few in last night's gathering. Something about foxes and chickens...oh, never mind.

LaMarche's patter was a reprise of her radio-host shtick as she tried to cozy up to her audience with local trivia and home-spun aphorisms. Clearly she is being paid to lend credibility and buy time while Evergreen tries to get its act together. Which is exactly what Evergreen promises: entertainment.

Quick Hits: Lehman Ducks, Lame Duck

"The worst is behind us," said CEO Richard Fuld in April at the annual shareholders meeting of Lehman Brothers Holding Inc. Oh, yeah? Then why did the Wall Street Journal report yesterday that Lehman may be issuing more common stock to raise $4 billion--just two months after a preferred-stock offering? The report sent Lehman's stock down almost 10% in one day, bringing the cumulative decline to over 50% since January 1.

Late yesterday Lehman, the fourth largest U.S. securities firm, denied rumors that it was borrowing from the Federal Reserve. "We did not access the primary dealer facility today," insisted Treasurer Paolo Tonucci. That lending facility allows an investment bank temporarily to swap illiquid assets for U.S. Treasuries, buying time until either the assets resume trading or the bank raises new capital.

Lehman next reports quarterly earnings on June 16, and losses are expected. By month's end Fuld may be gone, following Wachovia's CEO (G. Kennedy Thompson was dismissed Monday) into early retirement.

I'm here to give you some important advice, said President George W. Bush to Furman University's graduating class on Saturday. "My advice to you is not to dig a financial hole that you can't get out of. Live within your means."

Words from the master. During the Bush II adminstration the federal debt has increased by two-thirds to $9.4 trillion, and outstanding debt to foreigners has doubled. The private sector has followed suit, with home mortgage debt doubling and domestic financial debt (engineered by the likes of Lehman Bros.) increasing by two-thirds. These are staggering numbers. Says former comptroller general David Walker, "we have gone from a point where we were projected to pay off all the federal debt and have fiscal sustainability for 40-plus years to a point where we have large and mounting debt burdens and the simulation model that is used by GAO to project fiscal sustainability crashes in about 40 years."

[For more on Walker's concerns, see my Feb. 25 post.]