Monday, November 22, 2010

Intifada is the Arabic word for “a shaking off” or a “rebellion.” One might ask what behavior would foment a rebellion. The Poster children for stirring an Intifada are ample: The first man down the runway is Guy Hands who first tipped his hand on his priorities by moving offshore, away from his family, to reduce his income taxes. Now, in a far more revealing act, he sued Citigroup alleging that he selected his bid price for EMI, based not upon analysis of the business, but because an investment banker suggested he pay more. Later, it was rumored that similar advice by the banker had Mr. Hands on the verge of changing his surname to Mr. Arms. Fortunately, the jury had the sense to reject the notion that a man spending billions of dollars is not responsible for his own decisions. Equally interesting is the absence of incredulity by the financial press or by fund investors that billion dollar decisions are the product of gossip, not of diligence, leaving investors on Terra Infirma.

Next on the runway is the ubiquitous Steven Rattner. Despite multiple charges laid at his feet by the SEC and the NYS Attorney General for his role in a pension bribery/kickback scheme, he is decidedly high-key, appearing in interviews and on other promotional stages for his book, Overhaul, a near pun on the pair of orange “overalls” the partial immunity the Attorney General granted helped him avoid. While GM goes public the Attorney General is looking to put Steven into the stocks. On the same day he agreed to pay the SEC $6 MM to settle fraud charges, he was sued by the Attorney General for $26 MM for providing kickbacks. He responds to the Attorney General “This episode is the first time in 35 years of business anyone has questioned my ethics or integrity.” Did he mean 35 minutes? While he takes credit for the turnaround at GM in his book he does not touch on the public policy implications of the White House hiring a person under multiple investigations for such a visible post.

Third on the runway is the invisible investor. Much has been heard in the last year about the investor’s concern about the contract with private equity. Yet no investor policy has emerged banning business with firms that have admitted paying bribes. The fines paid by firms appear to have acted as price discovery for the “bribery risk” as investors have reacted with a yawn or by banning legitimate agents from their doors. Similar to prisoners who find religion once convicted, some of the violators are now self declared leaders in setting new ethical standards for the PE industry.

The GM rescue is reaching the next stage with its new IPO. Certainly having a viable domestic auto manufacturer in the U.S. is an appealing notion. It is equally appealing to look at what was required to arrive at this point and who lost in that exchange. First, the largest and perhaps most complex bankruptcy in U.S. history was declared. It led to thousands of layoffs. Normally, the bankruptcy laws would have required years to complete this case. However, since the government was now the “owner” the law was applied when the government needed it, while federal employees “strong-armed” creditors into taking their offer and did not let them pursue alternatives. The two large GM pension plans, the union plan and the salaried workers’ plan, entered the bankruptcy woefully underfunded. The government decided to fully fund the union plan and let the pensions of the salaried workers decline by over 50%. When it emerged from bankruptcy, a period when tax loss carry-forwards, of which GM had billions, are normally severely limited the government granted GM a special waiver allowing them to avoid $45.4 billion in income taxes on future profits (twenty years worth is estimated) splashing cold water on the idea that restoring a healthy GM meant restoring a tax paying GM. Ironically, any profitable Toyota dealer will pay more in annual tax than will GM when earning billions of pretax dollars each quarter.

We have previously mentioned the vast underfunding of municipal pension liabilities. Tenth grade world history classes study the slow realization by the eighteenth century French population of the massive debt incurred by its leaders and the subsequent revolution to which it contributed. A post-shadowing of this was seen in France’s recent decision to cut costs by raising its retirement age. Riots ensued. A similar decision in the UK to raise college tuition has led to small scale property destruction. San Francisco tried to pass a law to require its employees to contribute to their health insurance which led to demonstrations. Each of these are canaries in the retirement benefits coal mine. In addition to the pension shortfall, another trillion dollar shortfall in health benefit funding is anticipated. Recent decisions like Honeywell’s to report pension assets on a mark to market basis rather than on a five year “smoothing” basis should be applied to all domestic pensions to place a bright light on the gap with their liabilities. Equal attention should be paid to overly optimistic future rate of return assumptions. The bold ideas put forward by the Bowles-Simpson debt reduction committee deserve serious attention by a Congress that should be banned from a microphone until they have agreed upon a serious solution.

In contrast to all the dour news with respect to the PE and investment world the past quarter witnessed one of the great acts of human achievement, cooperation and spirit in the rescue of the Chilean miners. When the first miner, Florencio Avalos, emerged from his fantastic voyage to the surface millions of people, transfixed by their televisions, let out their breath and shed tears of joy for the stunning results it foretold. This miraculous result was achieved through the combination of government, private and individual efforts to create a clear plan to reach a clear goal. We hope our legislators can follow this example as they address the pension funding crisis.

I’m Rob Morris and I approved this blog.

Hello Muddah, Hello Faddah Does PE Need An Intifada?