Financial Services Industry

Proxy battles tend to get settled — well, by proxy. More to the point, that is, by the proxy services that recommend how shareholders should vote on contentious issues. Since many large institutional investors simply vote their shares in line with proxy-service recommendations, big proxy operators like RiskMetrics/ISS can wield disproportionate influence.

Which is why it’s fascinating to see Proxy Governance — last mentioned around these parts for its role advising Yahoo shareholders to oust three members of the board — take on ISS and accuse it of abusing its “monopolistic power.” Its main complaint: ISS is conflicted because it sells consulting services to the same companies whose proxy materials ISS evaluates. Peter Galuszka has the details over at his BNET blog The Corner Office.

(FYI, RiskMetrics/ISS took the opposite position in the Yahoo vote, and recommended supporting the existing board.)

Folks who read finance blogs may well have heard of Peter Schiff, a stockbroker who has gotten a lot of airtime on and off. But when he goes on CNBC, the anchors tend to make fun of him and make him look bad. That’s because Schiff is a big bear, when financial pundits (and certainly the financial chat-show hosts) are expected to be bullish come what may.

Since I was one of the first journalists to write about Schiff (although certainly not THE first) and much later became a client of his firm Euro-Pacific Capital — but also mostly because he tends to make a lot of sense and does not run with the herd — I have a soft spot for Schiff. But even if I did not, I hope I’d see that his treatment at the hands of outlets like CNBC and Fox Business News has been a travesty.

Schiff essentially called the financial crisis before almost anyone. Here is the item I wrote about him for Forbes. Soon after that item appeared, Schiff became a regular on financial networks, but mostly so the bullish commentators like the buffoonish Larry Kudlow could use him like a piñata.

Suffice it to say that Schiff’s views on the dollar and the real estate market have proven correct — though he does tend to get excited and overstate his points. The odd thing is that once he started looking good, the chat-show bookers stopped calling. His fall from media grace is exemplified by a smackdown in Forbes published in March, which accused him of — shock! — using his media profile to attract clients.

More recently, Schiff has been interviewed by Barron’s, quoted in the Times Week in Review and appeared on the very mainstream CBS Sunday Morning show. The June 30 Barron’s piece is a detailed showcasing of Schiff’s view that the U.S. economy is drowning in debt and will, therefore, decline. (Regular doses of Schiff can be had on his firm’s website.)

I guess now it’s finally OK to be a pessimist on the markets. Does that mean the upswing is near?

For most folks (and I include myself in this) the agonies of Fannie Mae and Freddie Mac, now being salved in Washington, are a tad abstract. But the story comes home when people say that the Fan-Fred woes will limit homebuyers’ ability to get mortgages. Already, some say, the crisis has increased mortgage rates.

But is that really true? A story in the New York Times includes a chart from HSH Associates, which tracks mortgage rates around the country. The chart has several prominent features, but in total the data can be read to minimize the importance of Fannie and Freddie.

First, while rates have been rising in recent weeks, they are still lower than they were when they spiked in mid-2006 and again in mid-2007. Rates move for many reasons, and there’s no reason to assume that panic about the secondary buyers of mortgages is currently the most important one. Second, there is a widening spread between conforming mortgage rates and jumbo rates. Fannie and Freddie have nothing to do with jumbo mortgages, so one would assume — all other things being equal — that the conforming rates should be rising faster. Also, HSH itself reports that last week, when the Fan-Fred panic was going great guns, rates were stable.

The larger point is that while these “mortgage giants” play a role in housing and mortgages, it’s a limited one, and they are not the prime movers.

The Congressional Budget Office’s assessment of the cost of a bailout of Freddie Mac and Fannie Mae is refreshingly honest, but disconcertingly uncertain. The price could be zero, the price could be $100 billion, but the best-guess expected cost is $25 billion.

Here is how the CBO puts it in a letter summarizing its report:

… there is a significant chance — probably better than 50 percent –that the proposed new Treasury authority would not be used before it expired at the end of December 2009. If the proposal is enacted, private markets might be sufficiently reassured to provide the GSEs with adequate capital to continue operations without any infusion of funds from the Treasury; during that time, it is possible that expectations about the duration and depth of the housing market downturn may brighten. Under that scenario, the temporary authority would not be used and thus would involve no budgetary cost.

On the other hand:

Taking into account the probability of various possible outcomes, CBO estimates that the expected value of the federal budgetary cost from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.

Finally: the CBO analysis suggests there is “almost a 5 percent chance that the added losses would total more than $100 billion.”

This variety of possible outcomes reflects the fact that no one can know the number of future mortgage defaults on Fannie- and Freddie-backed mortgages. Unlike banks, whose write-downs are for a number certain (which does not mean they know exactly how much they’ll lose), the CBO can waver and wander. That makes it sound like no one really know what’s going on, which just may be the truth.

Citigroup’s announcement today that Michael Klein is leaving the company surely makes one wonder whether there is a reason for Citigroup. Klein, oft referred to as one of the bank’s “most senior executives” though he is all of 44, is leaving “to pursue other opportunities.” He should have a few. His bio on the Belfer Center for Science and International Affairs, a unit of Harvard’s Kennedy School, says Klein is:

a member of the Board of IHS Inc., General Motors Acceptance Corporation, LLC, the Chairman’s Committee and Board of the London Investment Bankers Association, The Trans-Atlantic Business Dialogue, The Investment Advisory Board of the Prime Minister of Turkey, the Advisory Board for the National Football League, the board of the British American Business institute and the Mount Sinai Medical Center Board of Trustees.

But Klein is not done. He is also:

a member of the Dean’s Council of the Woodrow Wilson Business School of Princeton and a member of the Belfer Center International Council at Harvard. He is also actively involved in several charitable endeavors focused primarily upon educational development and equal opportunities for young people.

Phew! It’s a good thing he’ll no longer have to spend any of his spare moments toiling for Citi.

But if Klein is done with Citi, his departure begs the question whether Citi should be done with itself.

Back in 2002, Salomon Brothers announced that Klein would be co-head of global investment banking and Panfilo Tarantelli would be head of European investment banking at Schroder Salomon Smith Barney. Since then, Salomon and Schroder have been absorbed into Citi. Michael Carpenter, Klein’s boss at the time, was let loose in the aftermath of a scandal in 2006. Carpenter was replaced by Chuck Prince. Prince is now also gone; I’m not sure what happened to Tarantelli.

And Citigroup itself, a conglomerate that pieced together Salomon (investment banking), Travelers (insurance) and Citibank (banking) can’t find anyone from any of its constituent parts good enough to run the whole show. CEO Vikram Pandit spent most of his career at Morgan Stanley.

One of the striking things in Citigroup’s earnings announcement was its sale of “legacy assets.” Legacy assets? What’re those?

It turns out that Citi has been using the term since about May of this year. While “legacy assets” pops up on a New York Times item from 2000 (talking about telecoms), the only other uses in the newspaper all relate to Citi in 2008. According to Bloomberg’s David Wilson, some other bankers have also started using the term recently –- something in the air at the country club, perhaps.

As far as I can tell, a legacy asset is something you owned until very recently, having just sold it. You could call them former assets or sold assets. But the term also implies that these are assets acquired by some former CEO, who never should have bought them or built them in the first place.

Citi says: “Total assets declined by $99 billion since first quarter 2008; approximately two-thirds from legacy assets.” I suppose that means it sold $66 billion in assets and just flat out lost $33 billion.

It’s a handy phrase. But an odd one. A legacy is usually (not always) something helpful. George Bush’s dad went to Yale. That made him a legacy, which is nice. As president, Bush may be burnishing his legacy, which usually means a positive image. Of course, it’s also possible to have a negative legacy.

The way Citi and current boss Vikram Pandit uses the term strikes me as false and wrong. First of all, nearly all the bank’s assets are legacy assets in that Pandit did not acquire them. Second, aren’t the legacy assets responsible for most of the revenues as well? Still, I doubt you’ll hear Pandit say that 98 percent of earnings came from legacy businesses. No, the au courant CEO knows that the good assets that the bank still owns are not “legacies” — they’re his.

Federal regulators appear to be on a bit of a lawless streak, making up new rules as they go in responding to the crises du jour.

The trend began back in March as the Federal Reserve and the Treasury Department joined in arranging a fire-sale buyout of Bear Stearns. At that time, the Fed suddenly and without warning changed its decades old practice of opening its discount window only to commercial banks.

But the move to “emergency” rulemaking accelerated last month when Treasury Secretary Hank Paulson demanded “additional emergency authority” to limit temporary disruptions.

Now the SEC is getting into the act as well with its “emergency order” restricting short trading — not in general, but specifically in the shares in Fannie Mae and Freddie Mac, both of whom are protectorates of the federal government anyway. The SEC’s supposed target is “unlawful manipulation,” which is illegal already (first by definition — it’s unlawful — and second by the fact of it being manipulation).

All this on-the-fly regulating smacks of a banana republic. Normally in a functioning democracy, lawmakers and federal agencies craft rules through a deliberative process, and those rules apply prospectively across the board. When the government acts through orders rather than legislation or established administrative procedurees to identify emergencies and bogey men, and then seeks to outlaw their practices with hastily drafted decrees — well, that’s when the market makers, who depend on freedom and the established rule of law, should start to worry.

It’s not protection, but something closer to the opposite.

Merrill Lynch’s sale of its 20 percent stake in Bloomberg for $4.5 billion — in a widely leaked deal expected to be announced Thursday — places a value of $22.5 billion or more on the New York Mayor’s privately held firm.

The Times notes that Michael Bloomberg could well be worth more than five times Merrill’s holding because Merrill is a distressed seller whose CEO said Merrill’s shares were worth more like $5 billion to $6 billion. (Of course, it’s probably wise to take Merrill’s ability to value assets these days with a grain of salt — that’s why it’s in distress, after all.)

If the company is worth $22.5 billion, that means the mayor is worth $16.2 billion — just in Bloomberg shares — plus whatever else he holds. Good news for Mayor Mike.

But it’s a bit of a black eye for Forbes and its Forbes 400, a list that is the cornerstone of Forbes as a magazine and publishing company. Forbes puts Bloomberg’s net worth at $11.5 billion, making him the 25th richest American. If he is really worth $16.2 billion, he’d jump into 16th place, ahead of Steve Ballmer and just behind a flock of Walton heirs (assuming the magazine is right about the others’ fortunes). He’d also be perhaps the richest New Yorker, vying with oil and gas billionaire David Koch, who just gave $100 million to Lincoln Center.

So if Forbes is off by 41 percent or more for one of the most visible billionaires in the world, how can anyone believe its numbers are remotely accurate? Good thing no one should care. Knowing how a man makes money may be useful. Knowing how much he’s got is gossip.

Erin Callan, deposed last month as CFO of Lehman Brothers, has moved over to Credit Suisse. Her position is a brand new one: global head of Credit Suisse’s hedge fund business. Before she moved to the management suite at Lehman she advised hedge funds there and is best known for her “involvement” in the IPO of the private-equity fund Fortress.

This is an excellent example of failing up. At Lehman, Callan’s main duty was shoring up investor confidence in the venerable investment bank. The result was the opposite: Lehman’s shares have tanked and rumors of its possible demise linger.

But here’s the funny part: Fortress, since its IPO, has also tanked. The share price topped $30 in Fortress’s first week of trading in February 2007. Now it’s around $9. Compared to Lehman, that’s good. Otherwise: bad. And for this, Paul Calello, CEO of CS, points to Callan’s “proven track record.”

Not sure what the proof is. Maybe she attracted clients the way she attracted cameras while at Lehman — she was the rare banker whose personal shopper was in the news . Or maybe Calello figures that anyone who can get investors to pay $30 for Fortress must be pretty good

As the banking/housing crisis has progressed, there has been much talk about “predatory” loans. What’s a predatory loan? There is no universal definition. But the term seems to involve loans that the borrower is eager to take, but will be unable to repay. In other words, it’s a loan that is less likely to be paid back.

Normally, the lender would be the victim in such a scenario. But we are taught to believe that the lender is no victim, but a predator. This obviously makes no sense. But new regulations, such as those approved by the Federal Reserve yesterday, are best sold when they are said to protect consumer victims or prey.

Here is a summary of the new rules by the AP.

• Bar lenders from making loans without proof of a borrower’s income.
• Require lenders to make sure risky borrowers set aside money to pay for taxes and insurance.
• Restrict lenders from penalizing risky borrowers who pay loans off early. Such “prepayment” penalties are banned if the payment can change during the initial four years of the mortgage. In other cases, a penalty cannot be imposed in the first two years of the mortgage.
• Prohibit lenders from making a loan without considering a borrower’s ability to repay a home loan from sources other than the home’s value.

In fact the new Fed rules simply enshrine traditional banking practices that any prudent bank would impose on itself — that is if it cared about being paid back. But at the heart of the banking crisis is the fact that many banks (and even more mortgage brokers) did not care at all about being paid back. Their business was collecting fees up front — and some of the so-called predation does involve heavy fees. As for the loans themselves, they could be sold in the secondary market.

Traditionally, it was harder to sell subprime loans in the secondary market. But in recent years, the mortgage securitizers have found ways to package most anything. The people who bought these securities (or the banks that got stuck with them) bore the brunt of the defaults, which were rather predictable given the lending practices.

So the Fed is really just protecting the buyers of mortgage securities going forward. The preyed-upon consumers will only be hurt in that the high-risk (to the banks) loans will not be made, or made much less frequently.