What a remarkable day! We never thought we’d see the likes of it.
First, Ben Bernanke appeared in the U.S. Senate, with former Fed governor Paul Volcker by his side, and announced an incredible turnaround in Fed policy. Yes, he said, he and his fellow Fed governors were very concerned about weakness in the financial sector. And yes, they were very sympathetic to all those people who had high mortgage payments to make and all those people who had bought shares in Bear Stearns and other high-flying investment firms. But he went on to say that the Fed’s primary mission was not to protect people from the consequences of their own mistakes; it was to protect the nation’s money and its credit.
Bernanke went on to hint strongly that there would be no further rate cuts. Instead, Fed policy has turned back to its more traditional role of fighting inflation, he said. The Fed has become serious about stabilizing the value of the dollar.
“We can no longer ignore the economic consequences of price increases in fundamental resources, such as oil, wheat and iron ore,” he said. “These price increases not only cause suffering on the part of average citizens who now pay an average of $3.23 for a gallon of gas. They also cause huge distortions and malinvestments in the whole world economy.”
While he was still speaking, prices of stocks began to fall – in anticipation of higher interest rates – with the Dow closing down 535 points. The dollar rose against all foreign currencies; the euro dropped back to $1.30. A shop owner in Paris was heard to say that he actually liked Americans. Commodities fell, and the price of gold dropped to $750 an ounce.
That was just the beginning. At 11AM a group of corporate executives, present and former – including Stan O’Neal, Richard Fuld, Ray Irani, John Mack, Barry Diller and William Foley – appeared at a press conference in New York. The spokesman for the group startled reporters when he announced the group’s intention to return a considerable part of its earnings to the shareholders for whom they worked.
“We’ve thought long and hard about this,” said Mr. Fuld. “And we’ve come to realize that these salaries are just absurdly high. None of us can think of anything we’ve done anytime in the last ten years to warrant a salary of even half of what we get paid – much less the $38 million Stan got or the $322 million Ray got. Speaking for myself, I spent practically all of last year attending meetings, parties, and ceremonies – and frankly I can’t recall what any of them was about. None of them needed me. And I’ll tell you something else, when I attend those board meetings, half the time I don’t even know what the accountants and lawyers are [there] talking about. We got together this morning and asked each other how those CDSs work, for example. None of us had any idea. And apparently, believe it or not, between us, we’ve got billions of them on our books.”
As we’ve been saying here at Markets and Money , executive salaries are preposterous. But we never thought we’d see the day when executives would admit it.
But the day wasn’t over.
Hedge funds have had the worst quarter since they’ve been keeping records. Fifty of them went broke last year. About 8,000 more to go, by our estimate.
What is remarkable is the hedgies response. According to the American Hedge Fund Association, managers are reversing their typical “2 and 20” compensation package, to make up for their lost income. Instead of charging 2% of capital and 20% of performance (usually over a benchmark), they’re charging 20% of capital and a 2% performance fee.
An article in the Financial Times demonstrated recently how the previous fee structure worked. Managers were encouraged to take risks, knowing that “heads I win, tails I lose someone else’s money.” Taking a big chunk of the gains, while not participating in the losses, gradually transfers ownership of the capital from the investor to the manager. This new system of fees merely speeds up the process.
Finally, Alan Greenspan himself stepped up to the microphones yesterday.
“I think it is time for me to apologize,” said the former head man at the Fed. “This crisis in the financial markets; it’s really my fault. It was on my watch that the bubble in residential real estate developed. It was while I was at the Fed, too, that the huge parallel banking system grew to its monstrous size – with trillions of dollars worth of CDSs, SIVs, MBSs, and all the other crazy alphabet derivatives, that are causing so much trouble.
“I knew all along that the only real money is money backed by gold. And I knew that there would be Hell to pay when people got carried away with the cheap paper-dollar credit that I was helping to make available. I remember that I said at the time that the growth in sophisticated investment vehicles helped spread out the risk. And I also told homebuyers that they should take advantage of those ARMS that they now regret.
“I am truly sorry for what I have done.”
What a day!
Markets and Money