2008-10-03 / Columnists

From the Editor's Desk

Do We Really Want The Business Model Running (Or Ruining) Our Public Institutions? Part I: The Root Of The Problem
Commentary By Howard Schwach

When Michael Bloomberg ran for Mayor nearly eight years ago, his campaign was largely built on his success as a business leader and millionaire. There was a feeling that using a business model on our public institutions would be a good thing.

Now, eight years later, the business world lies discredited and in ruins and it is clear that the business people did it to themselves through a policy that greed is good, that all that counts is the bottom line and that anything that gets in the way of the profit motive is, by definition, bad.

Now that the largest financial firms in the nation have proved that they had no idea what they were doing and that greed drove every decision they made, perhaps it is time to rethink the idea that bringing the business model to our public institutions would somehow make them better.

To understand why the profit motive undercuts public institutions, you have to take a closer look at what has been happening, not in the sweeping generalizations, but in little specifics that show, better than anything else, how the business model and corporate greed are inextricably tied together.

Witness the story of one Lehman Brothers trader as told in a recent New York magazine story.

"The trader had come to Lehman only a year ago, after being recruited from a rival firm. He'd studied physics as a grad student and then came to Wall Street as the tech bubble and the aggressive gentrification of the Giuliani years remade Manhattan into a banker's playground, a place where a $2 million salary could seem like the norm.

"Like many on Wall Street, the trader's career was moving along briskly. By 2006, he had settled into a new $2 million home in Connecticut, with a pool, and kept a pied-a-terre in Manhattan. With two young children, he had private school tuition to cover. The trader estimated that he was two years away from making enough money to retire and never have to work again."

How did the trader do it? By packaging securities backed by mortgages that any person in his or her right mind had to know were going to fail some day.

In fact, this week, an email from a high level official in his company surfaced that asked the question, "How are we all going to get out of here before this house of cards collapses?"

Another company on the cusp of collapse before the government propped it up is AIG, the giant that insured those phony securities that were packaged by the Lehman traders.

"AIG once sported the tag line on its website, "The biggest risk is not taking one."

That slogan served as a dare and may well be the emblem of this entire sordid affair.

It told people that they had to up the ante, that if their assets were safe, they probably were not making as much money as they could if they kicked it up a notch or two.

That is what business people do. Push the envelope, even if it is not strictly kosher, because the bottom line is the amount of money you can make for the firm, earnings that translate into million dollar bonuses twice a year.

Take a look at Bear Stearns, and its Alt-A Trust 2006-07, what the New York Times called "a $1.3 billion drop in the sea of risky loans."

As the credit bubble grew to massive proportions and everybody who wanted to buy a home was granted a mortgage whether they could pay for it or not, Bear Sterns, then one of the largest mortgage traders on Wall Street, bought 2,871 mortgages from lenders like the Countrywide Financial Corporation. Those mortgages, with average cost of $450,000 were the kind of loans referred to on the street as "liar loans," because they were made without the usual credit and salary checks.

You want the mortgage, hey, you got it.

Don't have a job, don't worry.

Can't afford the monthly charge, don't worry.

Sterns bundled the loans into 37 different kinds of bonds, ranked by risk, for sale to investment banks, hedge funds and insurance companies.

About 25 percent of those loans are now in default and many others will become default in the coming year.

The mortgage loans were worthless when they were made, they were worthless when they were packaged and they were worthless when they were sold, and I'll bet that everybody who took part in the charade knew that they were worthless and would one day collapse under their own weight.

At the same time they were buying the packages, hedge funds were "shorting" the securities, betting that they would fail.

Hedge funds have made a fortune this year betting that the economy would tank after they helped it to do so.

Those bonds, called depravities, were, by law, outside the supervision of the Security and Exchange Commission or anybody else. The businessmen demanded that of Congress and our legislators complied without a whimper.

That's the business model. Make money on misfortune, even if you have to forge that misfortune yourself.

On Friday, the chairman of the SEC stated that the voluntary supervision program for Wall Street firms had contributed to the meltdown.

He admitted, in essence, that the business world is incapable of policing itself.

Even with the present problems, the greed doesn't end. Washington Mutual Bank chairman Alan Fishman has been on the job for three weeks. His bank failed and he will walk away with more than $18 million in salary, bonuses and severance pay.

Lehman Brothers CEO Richard Fuld will rake in more than $65 million when the failed company's assets are finally sold, experts say.

Greed - the great motivator.

"The last six months have made it abundantly clear that voluntary regulation does not work," he said.

He ain't just whistling Dixie.

Which brings us back to the business model vis a vis the public sector.

More on that in this space next week.

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