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When things go dramatically wrong, the starting point for making improvements is self-assessment and an
honest acknowledgement of the causes of problems. If the problems are great enough, changes will be forced
on the companies. The alternative is bankruptcy.

The financial upheaval we’re currently going through has exposed glaring deficiencies in American
management. If this doesn’t prompt changes in management of these companies (and in government
management of the economy and regulation), nothing will.

Those of us who are old enough remember growing up with Mad Magazine and its main character, Alfred E.
Newman (“What, me worry?”). One of its staples was a segment called “Scenes We’d Like to See.” The
authors would take a cliché about American life and make a parody of it. Their approach was to take a clichéd
character in a clichéd setting and have the character say something atypically honest.

Parodies of eleven events follow in this newsletter. After each of the examples, select the behavior(s) displayed:
arrogance, bad judgment, greed, gross negligence, hubris, lack of ethics, outright stupidity, self-dealing,
shamelessness, sense of entitlement. More than one behavior may apply.

At the end, cast your vote for the top management outrage of this economic cycle. Remember,
these are talented people who have used their talent to screw up big time. We expect that the choice will be
difficult.

So here goes. Scenes we’d like to see.

1. The Management of Freddie Mac

In 2004 William Syron, Freddie Mac’s president, was advised by his chief risk manager that the quality of loans
that Freddie Mac was guaranteeing through its securitization program was deteriorating. He was advised by his
capital compliance officer that the portfolio should shrink and additional capital should be raised as a cushion
against credit losses. Syron responded by refusing to raise capital and expanding the loan portfolio by 17%.

In 2008 the company was shut out of the credit markets and was put into government conservatorship. This is
the equivalent of reorganization under bankruptcy for a government sponsored enterprise.

Scene we’d like to see

In congressional testimony:

Congressman: “Mr. Syron, why did you ignore the warnings of your chief risk manager and capital
compliance office, and expand your company’s portfolio, lending to marginal credit risks and operating
your company with 30-1 leverage?”

William Syron: “I did it to get paid lots of money. My shareholders wanted me to use obscene leverage
to goose profits. I used the Congressional mandate to support housing as cover for unsound financial
practices. Hell, no one ever got paid outrageous compensation by running a financial institution in a
sound manner.”

What ought to happen

  • Fannie Mae and Freddie Mac should be recapitalized, split up into small pieces, and sold off to the
    private sector.
  • They should operate without government guarantees of their debt.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

2. The Government Bailout of American Insurance Group (AIG)

AIG was one of the key sellers of credit default insurance. They had a 177-person derivatives group that by
itself sunk a company with over a worldwide presence and 120,000 employees.

When AIG’s losses were disclosed and its credit rating downgraded, they had to post bond for large amounts of
money to ensure payment under the credit default insurance policies. The company was essentially nationalized
when the government injected over $100 billion of capital to preclude cross defaults among its counter parties.

Scene we’d like to see

Wall Street Journal reporter: “Mr. Sullivan, There is an old saying in the investment banking business.
If you don’t know who the fool is at the table, then it’s probably you. Aren’t the managers at AIG the real
fools in this financial crisis?”

AIG President Martin Sullivan: “Wrong-o moosebreath. The real fool is the US taxpayer. We’ve got
everyone convinced that we are essential to the health of the world economy.”

Wall Street Journal Reporter: “Mr. Sullivan, what oversight did AIG’s board exercise over the
company’s credit default insurance operation?”

Martin Sullivan: “None. We paid them board fees to act dumb, ask no questions, and do lunch.”

What ought to happen

  • Credit default insurance should be limited to parties with an insurable interest (i.e. the bondholders).
  • Issuers of credit default insurance should be subject to federal regulation and be required to maintain
    minimum capital levels.
  • Company directors should get a clue about their oversight responsibilities.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

3. Treasury Secretary Paulson Speaking with Clarity about the Financial Crisis as a 100-year Event

Risk managers try to assign probabilities to unpleasant events. The one that everyone is familiar with is the
100-year flood. Yes, we may live on a flood plain, but it will happen only once every 100 years.

In a speech at Simi California on 11/20/98, Paulson argued against overly strict regulation, stating, “There is no
playbook for dealing with a once or twice in a hundred year event.”

Paulson did not mention that he was the Chief Executive at Goldman Sachs and successfully lobbied to
eliminate the leverage limits on investment banks. He also did not mention meeting the current Goldman CEO
prior to approving government assistance to AIG, something that eliminated huge counter party risk at Goldman
(supposedly on the order of $20 billion).

Scene we’d like to see

At a news conference:

Reporter: “Why weren’t American financial institutions better prepared for disruptions in the credit
markets that seem to occur at least once a decade?”

Secretary Paulson: “Not to worry. We knew that operating an investment banks with 30-1 leverage
was reckless. All we really smart guys working there knew they were playing with shareholders’ money.
We knew that if we blew through that, there would be government assistance.”

Reporter: “You asked for the power to disburse $700 billion of government funds with no oversight or
judicial review. A good portion of the funds disbursed to date went for the indirect benefit of a company
(Goldman) in which you continue to own stock. Aren’t you in a conflict of interest situation?”

Secretary Paulson: “Naaaaaa. What’s good for Goldman is good for the country. Did someone say
investment banker banana republic?”

Reporter: “Don’t football coaches prepare a playbook in advance of the game? Wouldn’t adequate
regulation of these companies be the equivalent?”

Secretary Paulson: “That is so boring. I get an adrenaline rush from being a crisis manager and
shooting from the hip.”

What ought to happen

  • Investment banks should have increased capital requirements.
  • Employees at these companies should have a large portion of their compensation paid in company
    stock, so if they want to take on risk, they have long-term exposure to it (not just until the year-end when
    bonuses are paid).
  • Treasury Secretaries should be precluded from disbursing government funds for their own benefit.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

4. Trump Lawsuit Against Deutsche Bank

Donald Trump is the developer of a condominium project in downtown Chicago. Like many others, the
project has become financially stressed. Mr. Trump sued the primary lender (Deutsche Bank) over its refusal to
renegotiate the terms of the loan. The Trump lawsuit states that contract provision should be modified because
the financial crisis amounts to a force majure (act of god).

Scene we’d like to see

In a trial deposition:

Deutsche Bank attorney: “Mr. Trump, what makes this financial crisis an act of god?”

The Donald: “God schmod. I’ve been pulling the chains of my creditors for over 30 years. It’s a
religion with me. Why stop now? I’m playing to the members of the religious right on the jury.”

What ought to happen

  • Judge’s ruling: “Bankruptcies occur on a daily basis in this country when developers operating with no
    capital get into trouble. This is no force majure. Donald, you’re fired.”
  • Banks should insist on more equity in these deals before lending.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

5. Securities and Exchange Commission Chairman Christopher Cox Presiding Over the Elimination of the Leverage Limits on Investment Banks, and then Looking the Other Way as They Levered 30-1.

Prior to 2004 the investment banks (Goldman, Merrill, Morgan Stanley, and Lehman) were limited to 12-1
leverage, meaning that they could have $12 of assets on their balance sheets for every dollar of stockholder’s
equity. In 2004 the SEC removed these limits and allowed these companies to self-regulate.

A fractional banking system funded with commercial paper and demand deposits is inherently a risky affair.
The thought here was that since the investment banks employed the most skilled risk managers, they would act
in their own best interests and manage their businesses prudently.

Another factor supporting deregulation was that the investment banks were not funded with demand deposits.
Since the government did not insure the lenders of capital to the investment banks, the transactions were
between informed parties (sometimes called consenting adults).

Well, greed trumped risk management, and the system started to unravel when there was a run on Lehman
Brothers. This would have led to a chain of financial sector bankruptcies had the Federal Reserve not stepped in.

Scene we’d like to see

More congressional testimony:

Congressman: “Chairman Cox, do you think it was wise to let investment banks lever up and then
operate with no regulatory supervision?”

Chairman Cox: “This is the new economy. Who needs capital? If my buddies at the investment banks
get in a pickle, they can just borrow from the Fed.”

Congressman: “What about systemic risk and moral hazard?”

Chairman Cox: “Regulation is so old school.”

What ought to happen

  • Only individuals who believe in regulation should be appointed to these positions.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

6. Investment Banker Risk Management

Here is the scorecard on our investment banks since the credit market problems started in 2007.

Bear Stearns faced a run by lenders and counter parties. Without a forced sale to JP Morgan it would have gone
bankrupt. Lehman faced similar run and was allowed to fail. The reaction to the Lehman bankruptcy would
have brought down Merrill, so a forced sale was arranged.

The two survivors, Goldman Sachs and Morgan Stanley, had to raise equity capital on unfavorable terms and
convert to regulated bank holding companies as a condition of accessing credit lines from the Federal Reserve.

*Blankfein’s figure is for 2007 as he was CEO for only part of 2006. Compensation is
listed for 2006 because that was the last full year before the sector started to unravel.

These are called asymmetric returns for management. When risky bets work out there is huge payday. When
they don’t, the government picks up the tab. This is like having deposit insurance without paying the fees.

Scene we’d like to see

Yet more congressional testimony:

Congressman: “I would like to understand more about your risk management systems.”

CEO’s: “Simple. It’s the taxpayer’s risk and our reward.”

What ought to happen

  • Institutional investors (the ones who ought to know) should get an idea that investing capital in a
    business where the employees don’t invest but take the bulk of the profits is a dubious proposition.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

7. Minding the Store

James Cayne is an American Contract Bridge League Life Master, having amassed 12,887 master points. There
are only 300 individuals living or deceased who have earned 10,000 or more. Stanley Neal is an avid golfer and
has a handicap under 10.

During the period when their companies were under fire in the summer of 2007, Neal of Merrill Lynch and
Cayne of Bear Stearns were reported taking time off to pursue their outside interests. Cayne was playing at
the ACBL’s North American Bridge Championship and Neal played over 20 rounds of golf in August and
September.

Scene we’d like to see

At shareholders’ meetings:

Irate stockholder: “I thought we paid you guys obscene compensation for minding the store.”

Neal: “I didn’t understand those derivatives even when I was in the office.”

Cayne: “Responsibility to shareholders shouldn’t get in the way of a good bridge tournament.”

What ought to happen

  • In retirement Neal should be required to play at public golf courses where it takes 7 hours to complete
    a round.
  • In retirement Cayne should be required to play bridge with the newcomers group.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

8. Chrysler Bonuses Might be Paid with Bailout Money

The Detroit Free Press reported that when Cerberus Capital Management bought the company, Chrysler agreed
to pay retention bonuses to management totaling $30 million in February and August 2009. Observers have
noted that federal aid to the automaker could wind up being used to pay these bonuses.

Scene we’d like to see

Yet more congressional testimony:

Congressman: “President Nardelli, do you think it’s right to pay bonuses to management when you
don’t even have the money to pay your suppliers?”

Robert Nardelli: “Why should we be subject to the principles of economics? From an auto executive’s
perspective, a dollar borrowed is a dollar earned.”

What ought to happen

  • There should be no federal aid to Chrysler unless the bonuses are cancelled.
  • Before getting a dime of taxpayer money, these executives and the head of the United Auto Workers
    should be locked in a room until they can come up with a new way of running these companies on a
    sound basis.
  • Require business executives to receive a substantial portion of their compensation in restricted stock
    with a minimum 5-to 10-year holding period.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

9. Greenspan Confessional

CNBC business show host Larry Kudlow has been an insufferable proponent of low interest rates. One could
argue that he never met an interest rate that was low enough. Federal Reserve Board Chairman Alan Greenspan
set off the housing bubble by maintaining a low Federal Funds rate.

Scene we’d like to see

Kudlow interviewing Greenspan on CNBC:

Kudlow: “Alan, I guess you really messed up this time. 20% of the homeowners have no equity, and the
foreigners won’t put any more money into the mortgage market without explicit government guarantees.
Those interest rates you engineered were too low, even for me. What do you have to say for yourself?”

Greenspan: “It was all for the cause of monetary stimulus. Anyway, I got all my ideas for management
of the business cycle from your show on CNBC. I think you should take credit where credit is due.”

Kudlow: “Didn’t these credit default swaps contribute significantly to the financial crisis? It’s a matter
of public record that you repeatedly opposed regulation of derivatives. Do you feel some sense of
responsibility for what has happened?”

Greenspan: “Get real. You’re a free markets guy. The only sound principle of financial regulation is
not to stifle innovation. The only good regulation is no regulation.”

What ought to happen

  • Stop artificially suppressing interest rates to stimulate borrowing.
  • Stop micromanaging the economy.
  • Seriously regulate the derivatives market (i.e. forget self-regulation).
  • Greenspan should contribute royalites from his book “The Age of Turbulence” to the TARP Bailout Fund.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

10. Yet another stimulus package …

For the past 50 years households have monetized real estate to fund consumption. The percentage of fair
market value owned in 1957 was 83%. By 2005 this had dropped to 57%. With the current decline in housing,
the figure is estimated at 44.7% (Randall Forsyth, Barrons, 12/15/08). Debt service payments were 15% of
disposable income in 1979-1981. This figure grew to 18% by 2005.

Stimulus can take several forms.

  • The government can try to encourage borrowing for spending by suppressing interest rates.
  • The government can send money to households.
  • The government can spend money on public works projects. Eventually the money will be spent by
    the workers and will buoy consumer spending.

For some years we have been running a balance of payments deficit. When we dole out money to households,
we are borrowing from foreigners for consumption. When we engage in infrastructure spending the effect is
roughly the same, but occurs indirectly. We borrow money ostensibly for public works that we should have
been maintained anyway, and this allows us to temporarily maintain an unsustainable level of consumption.

Scene we’d like to see

Congressional testimony by Federal Reserve Chairman Ben Bernanke:

Congressman: “Chairman Bernanke, didn’t borrowing to supplement our consumption get us in this
mess in the first place?”

Ben Bernanke: “That’s not important. Unless we borrow, people will be unemployed.”

Congressman: “Aren’t you a junkie hooked on foreign credit.”

Ben Bernanke: “I am exercising my fifth amendment rights against self incrimination.”

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

11. Citigroup Multiple CEO’s

Since 1999 Citigroup has paid former US Treasury Secretary Bob Rubin a total of $115 million. When hired,
it was announced that he “will work with Mr. Reed and Mr. Weill, Chairmen and Co-CEO’s, in a newly
constituted three person office of the Chairman.” (Wall Street Journal, 12/3/08)

Later the CEO’s further described Rubin’s Job. “Bob will participate in strategic managerial and operational
matters of the Company, but will have no line responsibilities.” The article continued . . . . . To this day, he
appears unable to say what exactly he did for the $115 million that he took out of Citi. “I think I’ve been a very
constructive part of the Citigroup environment.” (Wall Street Journal, 12/3/08)

Talk about pay for performance…

Scene we’d like to see

Bob Rubin discussing his compensation with the Citigroup HR department:

HR staffer: “Tell me about your position as the third man on a three man executive team. Isn’t that like
being a third something of a woman’s anatomy?”

Bob Rubin: “I honestly felt that Citi was understaffed in the executive suite during this period.”

HR staffer: Don’t you think $10 million a year is a bit much for having no line management
responsibilities and, uh, doing lunch?

Bob Rubin: “No price is too high for constructive participation. If Citi is stupid enough to have three
CEO’s, then I feel obligated to accommodate the stupidity. Anyway, cost cutting is for the little people.”

What ought to happen

Citigroup should move its headquarters to North Dakota so they could engage in serious cost cutting.

Pick the behavior(s)

  • Arrogance
  • Hubris
  • Shamelessness
  • Bad judgment
  • Lack of ethics
  • Sense of entitlement
  • Greed
  • Outright stupidity
  • Gross negligence
  • Self-dealing

Vote for the top management outrage.

1. William Syron management of Freddie Mac
2. AIG playing the fool in the credit default insurance business
3. Henry Paulson financial crisis management
4. Donald Trump force majure lawsuit
5. Christopher Cox removing the leverage limits on investment banks
6. Investment banker risk management
7. CEO priorities
8. Paying Chrysler bonuses with bailout money
9. Greenspan confessional
10. Another stimulus package
11. Citigroup multiple CEO’s