IT’S JUST TOO HARD TO BELIEVE

The testimony of former Citigroup officials before Congress should be an eye-opener for shareholders in all companies. These brilliant (?) men testified that they didn’t see the risks in the subprime mortgage market. Further, former CEO Prince testified that “Citigroup could have lost market share or key employees if it veered away from the sorts of bets that so many banks and securities firms were making at the time”. This is preposterous coming from men who knew or should have known better.

If the officials did not see the risks in the subprime mortgage market, then they must have been completely out of touch with the business practices raging at the time. Even a beginner in the real estate brokerage business must have realized that they were selling homes to people who couldn’t afford them even though they may have believed that continued price appreciation would make it all ok. Many experienced practitioners and observers of the real estate market recognized, as early as 2005, that some very questionable practices were rampant. Buyers were speculating on a continued rise in housing prices and were not the intended end user of the home purchased. They were buying to sell at a profit. Lenders were making loans with very low “teaser” rates of interest and knew that when the rate adjusted the borrower might have a difficult time making the payments. Lenders began making “no-doc” loans which meant that underwriting standards were being compromised. Mortgage brokers were having a field day with all of the refinancing activity that provided homeowners an opportunity to use their home as a “piggy bank”. And, at the end of the chain, Wall Street packaged good and bad loans into mortgage backed securities or CDO’s for sale to investors with a great assist from the rating agencies. Experienced practitioners recognized that all of this was a prescription for a disaster and that it wasn’t a matter of whether the market would tank but rather was only a question of when. It is impossible to believe that highly experienced, overpaid, supposedly brilliant bankers did not see all this coming. The answer is more probably contained in the testimony of Mr. Prince.

Unquestionably, the banks were earning substantial profits through their participation in this wild mortgage market and the testimony of Mr. Prince that “Citigroup might have lost market share or key employees if it veered away from these sorts of bets…” is probably closer to the underlying truth. These bankers must have recognized the risk but they were making so much money doing the deals that they closed their eyes to the risks. Unquestionably, they feared that if they gave up the activity their key employees, who were making big bonuses because of the activity, would have moved on to another employer where the activity continued. But, that is no good reason to “bet the farm”, which is what these bankers did.

Shareholders should be vigilant; particularly the large shareholders with enough stock to exercise influence, in demanding that their paid managers and directors act prudently and avoid taking risks just because their competitors are doing so. CEO’s and directors have a primary obligation to protect the shareholder investment. Institutions like Citigroup and Bank of America (among others) failed to do just that. Yet, toady, during Annual Report Season, looking at executive compensation suggests that our corporations haven’t learned too much from the past mistakes. Executives are still grossly overpaid for sub-standard performance

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