Attention MBS Shoppers!

Gosh, I sure hope the bailout happens, because Warren Buffett says it'll be lots of fun. “I would love to have 700-billion at Treasury rates to be able to buy fixed-income securities now that they're in distress," he said. "There's a lot of money to be made.”

Yes, he actually used the word “love,” and then gushed enviously: "If I could borrow 700 billion on the government's terms and buy these assets I'd be doing it myself. But unfortunately I'm tapped out.”

Aw, Warren, don't feel bad. When I get my new CDOs, I'll be happy to trade them to you for some Berkshire Hathaway stock.

Having fought off the cynical thought that Mr. Buffett is playing Tom Sawyer and you and I will soon be whitewashing a fence somewhere in Omaha, I'm eager to start shopping at MBS-Mart! But that still leaves the pesky issue of how much Mr. Paulson should pay at the checkout counter.

Mr. Buffett weighed in on that one, too: ”I basically like a market, or something very close to a market-related price. And there are ways to determine that and I don't think that Uncle Sam should be in the business of paying somebody a whole lot more than it's worth in the market today.”

But what will happen to market prices when the market notices a 700 billion-pound gorilla lurching around with cash hanging out of its pockets, mumbling something about hold-to-maturity values? Perhaps, with this bailout plan, we have met the market and it is us.

*****

Some not-so-bad news: According to my friends at the witty-yet-eggheady Liscio Report, we can sort of afford this bailout.

Some not-so-good news: I just remembered this post I did for footnoted a couple of months ago about Wall Street valuations.

Image source: Unfocused Content

Gone With the Wind

My patience reached a breaking point with yesterday’s news that “headwinds” have helped 4th-quarter profits at Yahoo! (YHOO) drop by 23%.

I've been tracking the Headwinds Cliché Index for the past few months, after tripping over the H word again and again on my regular strolls through Proxyland. A search for “headwinds” in SEC filings this month yielded 161 hits, nearly triple the number of times it appeared in January of 2007.

Not being a CEO, I don't know whether "headwinds" refers to boating or to flying and frankly, my dear, I don’t give a damn which one it is. Whatever its origin, this overblown metaphor seems to serve as an all-purpose excuse for pretty much anything that’s going wrong anywhere, financially speaking. The filings speak of “macroeconomic headwinds,” “credit headwinds,” “market headwinds,” and even “delinquency headwinds.” Fund managers seem especially fond of the word, often bragging about how they've "prevailed" in the face of these fierce countercurrents.

I’m not saying there’s anything wrong with a company using this word to capture the state of economic pushback that looks to be the real state of our union right now. I am saying, however, that I’m sick to death of it. Come on, people, there are 10,000 writers on strike - grab a few, buy them some beers and see if they can't come up with something better. Failing that, crack open a thesaurus and get your maelstrom on.

Upside Down

I love the concept of time travel. Let’s head back to 1981, when Ronald Reagan pushed through those huge tax cuts that were the beating heart of Reaganomics (and now are the beating heart of Romneyomics, Giulianiomics, Huckabeeomics and so forth).

Reagan revived the concept of tax-favored incentive stock options that year. The darn things had been used in the fifties and sixties, but got tossed out of the tax code in the late seventies because - you’ll be shocked - some had abused them. But compensation experts assured Congress that sprinkling CEOs with stock option fairy dust would motivate them to make bigger profits for shareholders.

We’ve been told this for the last twenty-five years, and companies still earnestly repeat it in their CD&As. That doesn’t mean it’s right. In a 950-company study published last week, economists Gerard Sanders and Donald Hambrick concluded that what stock options do is tempt CEOs to take extreme risks. And in the case of CEOs getting more than half their pay in options, these bets led to big losses significantly more often than they led to big gains.

Why would this happen? Sanders and Hambrick suspect that “option-loaded CEOs are riveted on upside possibilities, with little concern for downside,” and take chances they wouldn’t take if they owned the stock outright. This follows from the structure of stock options, which are basically win-no lose.

You can poke some minor holes in their argument, as Graef Crystal did in this Bloomberg piece. Still, the fact remains that when companies ask shareholders to approve option plans, they wax poetic about the upside incentives, and that’s where the analysis ends.

This week brought other news about managerial behavior. A study mentioned in Time Magazine tied CEO decisionmaking to a non-monetary factor: birth order. The study’s author, an industrial psychologist, says firstborn chief executives are better at "incremental improvements," while those who come later in the birth order are more adept at "transformational change.”

So listen up, compensation designers. Human behavior is complex. If you keep pretending you understand it, we’ll zap you back to the 1980s, where there are no cellphones or iPods, and you can forget about beeping open your car door.

Frank, Incensed

Go ahead, say the government should do more to control executive compensation. Congratulations: You are officially (a) a liberal extremist, (b) brain-damaged from upside-down yoga positions and too much ginseng tea (a hippie liberal extremist) and (c) an unbeliever when it comes to the benevolent powers guiding the free market (a godless liberal extremist).

If, however, you are Barney Frank, the openly gay liberal Congressman from Massachusetts, you are already all of these and more, so what the heck? Since to your delight you are suddenly the Chairman of the House Financial Services Committee, you can actually make people nervous when you threaten legislative action on excessive compensation.

We are neither shocked nor awed, unfortunately, by Mr. Frank’s liberal extremist proposal. New compensation information in company annual reports, separate and different from proxy disclosures, will just make things more confusing. The bill would institute shareholder approval of a company's overall "compensation plan," but NASDAQ and NYSE companies already get shareholders' OK for equity-based comp plans and it hasn't done any good. We're fond of Mr. Frank's notion that execs who screw up should pay back some of the big bucks, but we’re not sure Congress can use the SEC to make that happen. The Senate's efforts don't seem particularly inspired either.

So the bills need some work, but must we rule out legislative solutions altogether? Wall Street Journal editors and their ilk love to say prior efforts have backfired. Pointing to the 1993 law that used tax deductions to encourage "performance-based" compensation, they conclude that the whole run-up in stock options is - natch - Bill Clinton’s fault. Nicely done, free marketeers: preach the old "performance-based compensation is better for shareholders" gospel, then smack a guy for getting religion.

Yes, legislation doesn’t always accomplish its intended goals. But neither does "the market," a perennial ne’er-do-well when it comes to keeping compensation at reasonable levels. It would be nice if people listened to compensation expert Broc Romanek (probably not the kind of guy who guzzles vast quantities of ginseng tea); he noted the other day that "market forces do not set CEO pay" and tried very patiently to explain to everyone how things work in the real world. But we can’t turn conventional wisdom on its head unless, perhaps, we persuade it to take up yoga.

Railroaded

You know how dogs love rolling around in something smelly? I felt that way recently while reveling in the preposterousness of an employment contract between The Greenbrier Companies (GBX), which makes railroad cars, and its President/CEO William Furman. As I noted a couple of weeks ago, Furman's contract allows him to be canned without severance only if he’s convicted of a serious crime - and then only if the crime happens to interfere with his job performance.

In fairness to Furman, his contractual chutzpah no doubt derives from his superstar status. The company reported record profits for last year and analysts expect more happy news for 2007. In fact, Furman has been running Greenbrier since 1994 and my favorite magazine, Progressive Railroading, credits him with transforming the former "small rail-car leasing company" into a large and profitable operation.

So what's wrong with a successful CEO negotiating himself a one-sided contract? I can just hear those esteemed professors of "law and economics" (known here as the Wannabeconomists) ridiculing my concerns. If you understood the first thing about the beauty and majesty of economics, Miss Stupid, they’d say, you’d understand that Furman’s employment agreement has come into being through a kind of economic immaculate conception. The guy's performance gave him the bargaining power to insist on this contract. The contract's terms are disclosed to the market. The market is free, free, free, free, free. It's all good. Yes, Milton Friedman’s in heaven, all’s right with the world.

I’d love to join your cult, boys, but I can’t shake the feeling that Furman is getting away with something. Just because a CEO is such a matinee idol that he can persuade board members to OK an employment contract nonsensically slanted in his favor doesn’t mean he ought to do that. Such behavior falls short of the good faith and loyalty Furman owes to the company and its shareholders. He may not be violating any duties in a legal sense, since American corporate law gives managers an embarrassing amount of leeway, but what about ethics?

I’ll leave those questions to the experts, whoever they are. But us regular folks can at least agree Furman’s behavior is selfish and piggy.

Look at it this way. If that guy who plays Jack on Lost were a CEO at some firm, he could totally put me on the comp committee, hand me a pen, and have his way with me at contract negotiation time. “Anything to ‘attract and retain’ you, Jack,” I’d purr. We’d both walk out of the boardroom happy. But that wouldn’t make it a healthy relationship.

(Thanks for not mentioning that this is the second time I’ve concocted an excuse to post Jack’s photo.)

Smartypants

A long long time ago I heard this joke from my Econ 101 professor:

A physicist, a chemist, and an economist are stranded on an island with nothing to eat. A can of soup washes ashore.
The physicist says, "Let's smash it open with a rock."
The chemist says, "Let's build a fire and heat it.”
The economist says, "Why bother? Let's just assume we have a can opener.”

Not much for laughs, but economists think it's funny, which shows they understand their limitations. I have one economist friend who’s prone to blurting out things like, “I don’t know why anyone pays attention to our forecasts; we’re wrong most of the time.”

Enter the Wannabeconomists, a bunch of corporate law professors in an area of exalted legal scholarship known as “law and economics.” These guys believe in the rightness and majesty of economics and just wish people were smart enough to appreciate how the dismal science makes everything work beautifully in Proxyland, including CEO compensation.

Among my favorite Wannabeconomists are Larry Ribstein of University of Illinois College of Law (Ideoblog) and Stephen Bainbridge at UCLA Law School (ProfessorBainbridge.com). Neither has an economics degree, though Bainbridge has a master’s in chemistry and maybe doesn’t need a can opener anyway. Then there’s Geoffrey Manne at Lewis & Clark Law School (not an economist either, but he once taught Law & Literature), who blogs at Truth on the Market.

Ribstein (in a barrage of posts; here's one) and Manne are busy holding down the fort against what Ribstein calls "backdating alarmists." Girlishly giddy, as always, over the beauty of economic concepts, they insist the rest of us are getting our panties in a wad for nothing: This wasn’t about greed, but about retaining good employees; the behavior hasn’t really cost shareholders much; the stocks of backdating companies probably dropped only because the media made such a big fuss; there was no immoral intent because so many companies did it everyone probably thought it was OK; "it's likely the efficient market looked through the accounting;" and no one got overpaid. You get the idea. Oh, and, according to Manne, "THERE IS NO LIE" in options backdating. He put that in caps.

So they get in a blog-to-blog debate with another corporate law professor, Matt Bodie of Hofstra Law School, who attempts good-naturedly on PrawfsBlog to dispute the Wannabeconomists. His best moment is on the NO LIE thing: “Backdating is always a lie -- you are claiming something happened before it actually did. I am baffled that this basic conception can elude my esteemed interlocutors." Me too.

To back up Professor Bodie, here’s what backdater extraordinaire UnitedHealth Group, Inc. told its shareholders in last year's proxy statement: “Historically, the Committee has utilized executive stock options because a holder of an option benefits only if the Company’s stock price increases after the date of grant.”

Pants. On fire. Hot enough to blow open a soup can.