Business Law Prof Blog

What Ex-GM CEO Wagoner Should Have Said to Obama: "You Do Not Have the Authority to Fire Me"

When President Obama and his senior economic advisers decided that GM CEO Wagoner should be fired and this was communicated to Wagoner he responded incorrectly.  He should have said: " You are not my board and you cannot fire me.  I am going to stay until the board fires me."  Consider what a simple refusal would have done -- reasserted the separate roles of public and private industry. Then if and hen Obama had followed up with calls to the GM board, telling them to fire Wagnoer, the board should say: "We will take you advice into account but you do not bind the board, our primary allegiance is to our shareholder and, if insolvent, to our unsecured creditors."  In other words, Wagoner should have grown some cajonies.  And when the President asked Wagoner as he has asked his successor Henderson, to hire adminsitration embedded employees, Wagoner and or Henderson should have said no.  

On the merits of Wagoner's job performance, the board should have fired him because his "reorganization plan" was a joke.  Wagoner, in fashioning a plan, should have laid out significant haircuts to wages and debt repayments, even if the groups had refused to assent, and told the government to condition any bailout grant on their agreement.  If the groups then refused, GM declares Chapter 11.

Geithner's Plan: They're All Fannie Now

Geithner's new ambitious plan hinges on one assumption -- some financial institutions are too big to fail. Once one buys into that assumption, government intervention becomes inevitable.  The banks that are too big to fail have the implicit backing of the United States government and the United States government must take steps to make sure that those banks do not misuse the implicit guarantee.  We therefore need a bigger, badder regulatory agency, more regulatory powers, and a right to take over financial institutions that are insolvent.  Inevitability, the regulation must go global, as the institutions must be stopped from moving offshore to do what they cannot do here.  The alternative, now dismissed, is that no financial institutions are too big to fail and that those financial institutions that make bad bets will cost those who own them and run them their investments and salary.  This system is the one we, more or less, used to have.  Once we leave it, we cannot go back.  This is a one way ratchet to global government financial regulation.

AIG: And Worse

Now there is news that AIGs successful subsidiary businesses, real insurance companies, are suffering from the pasting taken by the holding company executives over bonuses.  Moreover, competitors in the insurance business are complaining that the insurance company subs, too retain business, are aggressively offering lower rates "subsidized by the government."  And, by the way, Senator Dodd's wife was on the board of one of the subs.

Geithner's Toxic Asset Plan: Can It Be Gamed??

I hope Geithner has stopped all the ways to game his proposal.  I am not hedge fund guy, paid millions to game the markets, but I suggest the following.  A hedge fund makes an investment of $7 in a bank's toxic assets and, under the program,the government matches the investment with another $7 and with a loan for $86.  The fund then hedges its risk with a default swap, written by the selling bank itself perhaps for a small fee (added to the purchase price), for a $7 loss if the investment (on resale or collection) does not pay back the loan with interest and $14.  The result?  All upside to the fund, all downside to the government with the largely free use of government money. The incentive for the fund?  Take huge risks on the worst bank assetsin order to make a killing with government money.  Will the government stop the hedges?  Not if it wants private money to get in the program.  No wonder the financial stocks are soaring: another opportunity to play the government for a sucker.

Sweden: A Raw Capitalist Compared to the US

We have been lectured by China on monetary prudence and now we are doing something that Sweden will not due, bail out car companies.  Sweden refused to bail out Saab.  "Let the markets decide," Sweden announced.

Government Prints Money

We used to laugh at small country dictators who, once having ruined their country's economy and having borrowed beyond their country's capacity to pay, decide to inflate their currency.  Their inflated currency worked for a short period of time, allowing debt repayments with cheap cash, and then created hyperinflation.  The United States, through the IMF, used to lecture these small country dictators on the inappropriateness of the tactic -- advocating reduced government spending and balanced government budgets.  Now, we are the violators.  The government is buying billions of its own debt (Treasuries and Fannie and Freddie debt) from banks and crediting the banks with cash through the banks accounts with banks in the Federal Reserve System.  It is the equivalent of printing money; it increases the supply of money in circulation and, unless reversed, will lead to hyperinflation.  The government believes they can time the credit markets -- increase the money in circulation and then, when inflation appears, decrease funds in time to stem inflation.  It is a dangerous gamble, too dangerous. 

AIG: And Worse

We now find out that AIG was incompetent in unwinding its problems with government money. And for these its experts get bonuses??  AIG was unwinding its credit default swap positionswith government money by buying the assets that were underlying the positions.  This, in theory, makes sense.  Rather than pay increased collateral for the increased risk of default by AIG on the contracts, AIG buys the debt instruments insured by the credit default swap from the counterparty and cancels the swap contract.  The problem?? AIG overpaid for the underlying assets; paying par value for assets that have discounted value due to increased credit risk.  The counterparty then pockets the gain from the overpayment and taxpayers take the hit. Taxpayers break even only if the can resell the assets at par value when markets recover.  Even if the counterparty does not own the underlying assets it will go out and buy cheap and sell them dear to AIG that pays with government money.  To make a long story short: AIG is playing the sucker in these unwinding strategies with taxpayer money.  Can it get worse??

AIG: It Gets Worse

The scramble of politicians in response to populist outrage over the AIG bonuses gives one a sense of what it was like on the Titanic when it startedd to started to go down.  Hostile folks are milling outside the AIG building looking at armed guards, AIG personal are resigning and not coming to work, and AIG and politician e-mail boxes are overflowing with venom.   Politicians and pundits are panicked and saying very, very silly things:  AIG employees should commit sucide; the government should tax 100% of the bonuses;  the government as shareholder should claw back the bonuses.    Traditional corporate law has answers:  The CEO of AIG< Liddy, can break the contracts, wait for lawsuits, if any, make his defenses on the circumstances of the individual contracts, and settle those suits that have merit.  If Liddy does not do so he (and the board of directors) can be sued by shareholders (for waste or breach of fiduciary duty) or removed by shareholders (or both).  The government's AIG shares are owned by a trust with trustee appointed by Geithner.  If they refuse to act the government has to sue or remove them (from breach of a trustees duty to a beneficiary or for a breach of the trust agreement).  If Liddy's defense is that Geithner passed on the contracts and ratified them (as a representative of a controlling shareholder) then Giethner should be removed by our political process.  The President should fire him and if the President does not he should be accountable at the next election.  It is not complicated.

The contractual defenses are an array of traditional long-shot defenses--duress, fraud, unconscionability, impracticality, force majeur -- to set aside the deal and contract interpretation doctrines to recall payments that are not owed due to unsatisfied conditions or other terms.  The "sanctity of contracts" worry of Sorkin of the New York Times is a laugher.  Where was he when high paid ball players refuse to show up to work unless contract terms in place on salary where not increased due to a good past season??  Contracts are enforced by reputation and by law.  AIG is not worried about its reputation any more; it has none -- good business still are and still will be if AIG breaches.  In court AIG has defenses and will settle based on the costs to plaintiffs of suing and the likely of AIG prevailing on a long-shot defense -- normal stuff.  Contracts, Mr. Sorkin, will survive just fine thank you. 

AIG Bonuses

AIG executives are claiming from $165 million to $450 million, depending on who you believe, in contractually stipulated bonuses after the company lost $60 billion last quarter, the largest quarterly loss by a private corporation in modern history.  The government has loaned or otherwise granted AIG with $170 billion in cash and has executed value guarantees for another several hundred billion dollars of toxic assets.  Needlesstosay, the press is all over the story and politicians are outraged, outraged.  The truth of the matter is that the government is using AIG to funnel money government money to other banks, both international and domestic, that the government could not, politically and/or legally, otherwise fund.  Why should United States taxpayers bailout out French, British, German, Swiss, and UAE banks??  Why should taxpayers give money to Goldman Sachs or Merrill Lynch??  The entire AIG bailout is tawdry and dirty.  The government should have refused any funds and forced the AIG holding company into bankruptcy, which would have led to AIG spinning off its profitable insurance subsidiaries.   

Stewart Squares Off On Cramer

Like a sucker I stayed up to watch the Jon Stewart/Jim Cramer smack down on the Comedy Channel.  Steward, angry at the refusal of Santelli to come to his show after Santelli's outburst against Obama's mortgage bailout, had run clips of CNBC stock analysts before Sept. 2008 that had predicted incorrectly the subsequent swoon in the stock market.  Cramer's show Mad Money was featured in one of the many clips; he said positive things about Bear Stearns that, one week later, was essentially insolvent in a forced sale to JP Morgan.  Cramer responded that Stewart was just a comedian that that his clip was out of context.  Stewart, his back up, told Cramer "F..k You" and played more Cramer clips on Bear Stearns that showed Cramer had, seven weeks before the collapse, told folks to buy the stock.  The gleeful press reported the dust-up and Cramer offered to come on Steward's show.  Comedy Central played up the interview as a rumble and it turned out to be a smack-down.  Cramer had no clips of Stewart, or himself for that matter, and Stewart came loaded with more clips.  Stewart had found a 2006 interview of Cramer, well known to those who follow Cramer, in which he had bragged about beating the system as a stock picker when he had run a hedge fund in the 90s.  Stewart had two effective attacks:  1) CNBC's financial pundits called the crisis incorrectly and, therefore, aided the fraudsters by giving them a forum for lying to the public; and 2) Cramer was a clown (throwing chairs, books and plastic bulls and bears and punching sound effect buttons) participating in a swindle -- good people were losing their life savings in their pension plans (told to invest and hold) so that the fraudsters could loot and get away with millions in questionable trades (in other words, it was "not a game").  Cramer's three responses were lost in the on-onslaught: 1) They lied to me too; 2) Reporters do not call CEO and CFO guests liars without very good evidence; and 3) I made some good calls too (his call on the Today Show to get five years of cash out of the markets in Oct. 08).  Stewart chastised him for knowingly playing gullible and for not protecting his viewers -- "Whose side are you on?"  It was no contest and Cramer left with a meek offer to do better.  [Note that the great Warren Buffett's company has lost a boatload of investor money after Sept 2008 and suffered recently a downgrade in its credit rating by Fitch and Buffett has the ear of the President and most of the press. Why is he ethically better than Cramer?] 

I have a like-dislike relationship with Cramer.  I like his candor on the air:  1) He has courage and takes personal positions (not "others say") on complex questions and risks making mistakes.  Periodically this show recalls his winning and losing calls from the past several weeks (what other show does that??).  2) He knows insider trading strategies that you may hear only from him in a timely fashion ("hedge funds are dumping good stocks today, driving down their prices, not because the stocks are bad but because the funds need to raise cash"). 3) He does have a "wall of shame" for poor CE Os that other pundits would not touch.  And, most importantly 4) he does educate folks about the folly of chasing the markets, the number one problem for amateur investors (selling in down markets and buying in up markets) and he offers another strategy (buy in layers on the way down and sell in layers on the way up).  When to pull the trigger??? he tries to you what he is doing and would do if he still ran a hedge fund.  If he did nothing else, 4) would justify his show.  On the other hand, I do not like:  1)His long only strategy (when to buy and when to sell what you hold).  Short selling, although risky, is, as we now know, a very, very important part of the trading game. He attacks shorts, although he was one (and Stewart skewered him personally for this).  2) His uneven attack on regulators (he went after Lockhart, the Fannie and Freddie regulator for not loosening the market further; he went after Bernanke for not lowering interest rates faster) and looks to be too supportive of only the fixed income (bond) market traders. And 3) his support for day trading, an inherently losing strategy for the majority of his viewers.

In other words, Stewart has made a mistake -- he has gone after one of the more candid guys for not being candid enough.  I worry about whether Cramer will pull back and be less cutting edge, not push forward.  Stewart should pick better targets; those who really are shills for the markets.  And, by the way, had Cramer had his staff edit clips of Stewart's poor political calls (Stewart is a political junky) -- I do not watch Stewart often yet can reminder several gaffes easily --Stewart's political calls can be made to look questionable as well.  But Cramer is not a political hack and did not pull the knee jerk political hack counter-attack of a Matthews that answers a social question by pushing back with personal attack (On whether single motherhood is a social problem:  "but Palin's child has an out of wedlock baby..."). 

TALF Program Lacks Investors

The Government's $1T TALF program is stalled.  Recall that the government is offering to loan $1T at below market rates to investment funds (hedge funds) if the funds buy AAA asset backed securities.  How could a fund turn down cheap money?  The loan comes with a requirement that the hedge funds open their books to any government agency that comes a calling.  Moreover, the funds could be liable for a representation that they are "solid."  In other words, the funds will not participate in the government's voluntary program because the conditions are too onerous.  This comes on the heels of news that several banks are paying back TARP funds in order to free themselves from a growing list of government conditions, even though they could otherwise use the funds.  The conditions include -- mortgage modification requirements, foreclosure and eviction delays, executive pay caps, limits on sales meetings and exectivev retreats, shareholder vote on exective pay and others.  The list threatens to grow everytime some company holds a meeting in Los Vegas. The government is finding its public/private partnership programs tough going.

G-20 Nations Expect More United States Cash

We now hear that Germany, Japan, and France, among others (China) will not stimulate their economies by floating more debt and spending the borrowed money in "stimulus" payments.  Only the United States, and to a much lesser extent the United Kingdom, are anxious to incur debt and spend the funds.  But keep in mind that the United States, in bailouting AIG, our banks, and our auto companies, is funnelling money to Europe, Japan, China, and UAE countries.  In other words, the countries are, like the private investors in our markets, waiting out our government to see how much money it will send their way on its own. 

You know things are crazy when the President of the Czech Republic, Vaclav Klaus says:  "Coming from...a former communist country where I spent most of my life, I almost don't believe my eyes to see how much you believe in government and how much you don't believe in the market.  This for me is a shocking experience. And I have to say that very loudly." 

Merck Buys Schering-Plough

Is anyone in Justice investigating the anti-trust implications of all these huge deals in the drug industry.  Moreover, the Merck deal seems to depend on whether a reverse triangular merger can beat a control change clause in a Schering-Plough agreement with Johnson & Johnson.  This is either a very badly drafted control change clause of a loser of a position.

Dow Agrees to Buy Rohm & Haas

Dow Chemical, on the eve of a trial, has reversed course and agreed once again to go forward with a deal to buy Rohm & Haas.  Dow had balked at closing the deal after credit rating companies threatened to downgrade the company's debt to below investment grade if the deal had closed on the original terms. The surprise is the new money in the deal.  Large shareholders of Rohm & Haas that include funds run by Warren Buffett and John Paulson have agreed to buy $3 billion in preferred shares in Dow to finance the deal.  It is good money after bad.  Dow shares dropped 11% on the announcement of the new deal.  I was one of the few commentators that thought Dow had a shot, although a long shot, at prevailing in court.

Our President, the Stock Tout

The President on Tuesday told citizens of the world that stocks in the United States were a bargain.  He said and I quote "the P/E ratio, the profit to earnings ratios are low."  He was, I think, referring to P/E ratios used by everyone that stand for "prices to earnings."  It was a breathtaking error born of ignorance.  He is, by his own admission, not well-informed about market mechanics and has consistently, for over two years, disparaged capital markets and capital market traders and financiers.  Moreover, since his tepid endorsement the market has dropped significantly. His statement is reminiscent of the famous claims by President Hoover in 1930 and President Roosevelt in 1935 that the market declines were over.  Presidents ought to stay out of the market prediction business, especially when they know little and do not care to figure it out correctly in light of their other aims and goals.

Lessons on Markets from the Chinese

China announced a $560B stimulus plan and our market went up 200 points on the Dow.  When President Obama passed a $780 B plan our market dropped like a rock.  We need, apparently, to take some lessons on capitalism from the Chinese.

The Fed's TALF Program: Another Surprise in the Details

The Fed announced the details of its new $1T TALF lending program yesterday.  It was another unpleasant surprise.  The Fed is acting as a prime broker (investment banker) for private investment funds (hedge funds), in essence, for free.  Here is how it works.  The Fed loans money to hedge funds who use the money to leverage purchases of the AAA tranche of asset backed securities from SPV pools of assets.  The backing will encourage other investors to buy other tranches, will give SPVs money to buy income producing assets (loans) from originators who will then be encouraged to place loans with consumers who will then buy on credit from American manufacturers. Several problems: 1) Who will buy the "junk" tranches? 2) Consumers are credit wary. 3) The Fed is, very quietly, backing securitization, leverage, and hedge funds, three of the primary targets of Congress and the media. Moreover, hedge funds will make a killing in profits and not share them with the Fed.  4) Obama, in his budge bill, is attempting to impose higher taxes on hedge fund manager's share of the profits ("carried interest"), however.  Good golly Miss Molly.

New AIG Bailout: A Complex Mess

AIG has lost $61B in the 4th Quarter and the government has responded with another bailout plan. The new plan does two things: First, it corrects a horrible first plan and, second, it dumps in more cash.  The new problem is that the new plan is a complex mess.  The plan lowers the interest rate AIG must pay on the government's line of credit, offers lines of credit to a variety of AIG subs, and gives up cumulative dividends on the preferred stock the government holds. In exchange the government takes a substantial ownership interest in two of AIGs more profitable subs (and continues to hold a potential 77.9% ownership interest in AIG itself with outstanding warrants).  The ownership interest is held in a "trust" with trustees appointed by the Treasury.  The government exchanges its Series D Preferred for two new issues of preferred, Series E and Series F and new out of the money warrants ($2.50 strike price).   Why the complexity??  To hide the true extent of the bailout (for how much cash are we in??) and to hide the true extent of AIG's problems (will this hold??).  In many ways, the AIG bailout is the government's worst of its worst efforts.  And it will get worse yet.