The Corporation: A Portrait of Dysfunction

February 9, 2009

Good morning. We actually started the month of February with a solid advance, with the SPY up $4.15 (or 5%) on the week. This still leaves the SPY down around 3.6% for the year, but still a real advance cutting the losses for the year roughly in half. The VIX was down from 44.84 to 43.36 (3%) for the week, moving in the expected direction for an up week, but still hanging historically very high. This market advance coincided with (notice I did not say “was caused by”) the advance through Congress of the so-called stimulus package, which was passed entirely by Democrats in the House, but is enjoying “some” bi-partisan negotiation and support in the Senate. The House/Senate negotiations to unify the two very different bills will certainly be interesting this week.

Does one good week mean all the trouble is behind us? I would give that a definite maybe. Some of you have probably noticed that we did put some money to work in a couple of areas last week. We did a couple of longer-term spreads in the XLF, or banking index, and we did some investing in the XLE (oil index). The XLF is currently trading at a very low level, for reasons that are well known, but a conservative position looking to take advantage of the continued high volatility and possibly even a modest advance seems to be a good idea. The companies making up the XLE (mostly big oil) have shown so far their continued ability to profit, even with oil at this level, so an increase in our exposure in this area seems warranted, again looking to take advantage of the high volatility in the call options.

What about the financial news swirling around us? There is still a tremendous debate going on regarding what to do with the banking system going forward. I did not receive any telephone calls from the administration regarding my solution of last week that the banks should just be able to operate with reduced capital levels for a while. We continued to see and read about continued calls for a so-called bad bank, some sort of Resolution Trust, some plan to buy loans, etc. from everyone who could grab a microphone. The problem I have with most of those “pundits,” Bill Gross and his merry band of self-servers in particular, is the bold self-serving tone of their “advice.” It would certainly be a good idea (for you) if the Government was so foolish as to move these assets to a third party at ridiculously low prices (like the Resolution Trust) and you were one of those “managing” the movement of those properties to others.

We also had huge debate this past week regarding the role of Government in deciding salaries, bonuses, money spent on sales meetings, whether people should have off site meetings, almost to the point of whether people could order Stoli or have to go with well vodka for the martini (now that is going too far!). The conservatives are outraged! Government has no business telling our fine business captains (many of whom are now in hock to the government up to their eyeballs) what and how much they can spend money on! The new President even weighed in that corporate leaders were seriously out of whack from main street America regarding compensation, etc. The backlash from all business people, not just the conservatives, towards the President and the overstepping Congress (with maybe the exception of those getting other people’s money) is surely growing. As for Main Street, the question is easy “How could these people be worth all that and still have to borrow money from me?”

Does anyone really believe that the government has any business, in the long run, setting wages, bonuses, limits for sales meetings, etc? No, no, and no. You can accuse someone of being ultra liberal, and even that person does not think government belongs in this role. The question is how did we get to the point where this ludicrous idea (I might go with the part about some rules for people you just lent money to) is even being debated? We are here because the first line of defense in watching, governing, regulating (you pick the term) the modern Corporation, the Board of Directors, has been compromised to the point of being broken. The Corporation is one of the finest inventions of modern times, without which most of the advances of our modern society would not have been possible. It has allowed capital to be accumulated and maintained without regard to individual life spans, and “supposedly” gave investors the confidence that their investment was being watched by a group (The Board) that had their well being in mind, and was the ultimate decision maker, power, and moral compass in the organization. Does anyone think that is the case in most modern Corporations, that the Board actually controls the direction, risk, and overall morals of the place? The behavior, not of just a select few, of the management of literally dozens of large Corporations in regard to risk taken with shareholder money, unabashed shamelessness in regards to undeserved compensation, etc. right in front of the watchful eyes of these “august” Board members is deplorable. The Government is stepping in (probably not wisely) simply because there is a leadership vacuum, both in basic morality and in lack of courage to step up and be counted on the part of these people supposed to be in charge. How did they become so emasculated? Why were they so eager to submit to any number of fast-talking, self-serving, snake oil salesmen? I have some thoughts, and would welcome yours.

I will give one example. Last Friday CNBC had as a guest a fellow named Thomas Patrick, former Vice-Chairman of Merrill Lynch. It was one of the most damning interviews of how a serious company with a long history can be brought down by hubris right in front of a Board that somehow lacked any spine. Mr. Patrick related that in 2003 he and another high ranking executive were forced out by then Chairman Stanley O’Neal, mainly for disagreements regarding risk in some of the new mortgage instruments the firm was rapidly accumulating. Some time later, in 2006, another couple of high-ranking people (people responsible for managing risk) were ousted for the same reason, I assume most of this playing out right in front of the Board’s eyes. He then related during the interview that in the next six months Merrill went from $6 billion of exposure to mortgage type assets to $94 billion, effectively committing suicide. Finally, when it became obvious to all the folly of this direction, Mr. O’Neal was asked to leave with over $100 million dollars of comfort. Shareholders had no ability to throw these people out, none had the conscience (remember that word?) to resign, and most probably feel themselves capable of sitting on other Board’s. The same could be said for Citi’s group still feeling that paying Robert Ruben $15 M a year was a good value. In one word, incredible!

I would submit that the issue is not what government is doing, but whether the Corporation as we know it is mortally wounded. Do we (meaning shareholders and concerned citizens) have any chance of finding individuals, or even getting some input into the locating process, that are capable and willing to do the job of Board member? We need some people able to resist the “comfort” of having their head up the behind of the Chairman. We need people that realize that they are the “boss” of the Chairman, a novel concept for most, especially since the Chairman probably selected them. If we can’t fix this, if there is no adult supervision of these places going forward, no one will want to invest. Don’t think for a second that a significant part of the market’s severe sell-off is not due to the average investor feeling he or she cannot trust these Corporations to take care of his or her investment dollars. Can you blame them?

Why have these Boards become so dysfunctional, if not outright intimidated? I think we have a topic for next week, maybe I will even hear from a few of as to your opinion on how real people can become so spineless in certain settings.

I certainly would welcome comments on this and other articles. Let’s at least start asking the right questions, surely necessary before we find any real answers.