The Madoff
affair
Dumb money
and dull diligence
Like mould, Madoffs flourish in the darkness
WRITING about
one of the great swindles of the 1930s, J.K. Galbraith pointed to three
traits of any financial community that he believed put it at risk of fraud.
There was the tendency, he wrote in 1961, to confuse good manners and good
tailoring with integrity and intelligence. There was the sometimes "disastrous
interdependence" between the honest man and the crook. And there was
the "dangerous cliché that in the financial world everything
depends on confidence. One could better argue the importance of unremitting
suspicion."
The case of
Bernard Madoff, a New York financier who has allegedly confessed to running
a pyramid scheme that destroyed up to $50 billion of his clients' money,
has all three traits (see article). The former chairman of NASDAQ was as
well known to insiders on Wall Street as he was in the posh Palm Beach Country
Club in Florida, where he was a pillar of Jewish philanthropy. His clients
were fiercely loyal; they had to be or he would cut them out of his hallowed
investment circle and month-after-month returns of metronomic regularity.
And he thrived in an era of cheap credit, when greed and gullibility became
far more powerful than fear and suspicion.
What marks
Mr Madoff's case out, however, is the calibre of investor he suckered. It
is not the first time that wealthy people have been swindled out of huge
sums of money, nor will it be the last. But never have so many big financial
institutions—the oxymoronic "smart money"—been so bilked
by an individual. It is here that investors, as well as the authorities,
should tighten the thumbscrews and demand more transparency.
Oxymorons
Tragicomically,
a handful of global banks that had fared well during the financial meltdown
of the past 18 months are on the list of those caught out. HSBC, a British
bank, Santander of Spain, and BNP Paribas of France: all bear a share of
losses that add up to $33 billion, according to a Bloomberg tally. So were
the suave private bankers of Switzerland and Singapore.
It is, however,
the reputation of the big funds of hedge funds—some belonging to the
banks, others at firms like Britain's Man Group and America's Tremont Capital
Management—that have been most damaged. They charge whopping fees,
say 1.5% of assets, largely on the basis of their ability to pick out clever
people to manage their clients' money. Their business has flourished partly
because the hedge-fund industry is so opaque: if investors could dig out
more information for themselves, they would not have to pay others to penetrate
the veil for them. They are also the largest investors in hedge funds, accounting
for about half the investment in the industry, or $800 billion at the end
of last year.
Yet for all
their insights and access, some of them missed red flags billowing over
Mr Madoff's business, such as the way he kept custody over his clients'
accounts, handled the trades himself and employed an obscure accounting
firm. They ignored warnings from lesser mortals, such as one in 2001 from
MAR/Hedge, a diligent trade journal. They never wondered why, though the
sums he managed were vast, he rarely caused a ripple in the markets. Their
argument that enlightened self-interest is a reason to leave the hedge-fund
industry largely unscrutinised and unregulated looks ever harder to sustain.
The investors
were not the only dullards. The regulators, too, were taken for a ride.
The Securities and Exchange Commission (SEC), Wall Street's regulator in
chief, overlooked Mr Madoff's investment-advisory business, even though
it had assets under management of $17.1 billion at the start of 2008. The
outgoing head of the SEC has admitted the commission made a hash of the
Madoff case, failing to act on warnings made nearly a decade ago.
Not even the
best of regulators (and the SEC is not that) can be sure of stopping a determined
fraudster. The authorities can, however, help investors make better judgments
by requiring more disclosure from hedge funds and other high-fee asset managers.
It would have been particularly useful to know how much of their clients'
money they were investing in inscrutable people and illiquid assets—even
if, at the time, few investors may have cared.
The industry
has made a fetish of keeping its clients—and competitors—in the
dark about its holdings. But the credit crunch has revealed how few original
ideas most of them held. Like sheep, many of them flocked to borrow money
to enhance returns, parlaying this as genius. Some also turned to money
managers like Mr Madoff, where they were mercilessly fleeced. Let the light
shine in.
Everything
you didn't want to know about Ford. There's more to what's wrong
with the auto makers than their employees' high wages. Stupidity is a good
part of it. This piece from Bloomberg, though long, is really good. I've
bolded the amazing parts.
Ford Errant
Forecast Hits Investors Missing Profits (Update1)
Dec. 22 (Bloomberg)
-- In one of his first acts after joining Ford Motor Co. as chief executive
officer in September 2006, Alan R. Mulally set up weekly meetings with his
Asian- Pacific, European, and North and South American regional bosses -
- people who rarely gathered in the fragmented company. They came together
in person and on video screens in a large conference room at headquarters
in Dearborn, Michigan.
Mulally told
them to present reports during the meetings using green, yellow or red labels
to show whether they were hitting their plans. Even though Ford was about
to post the worst annual loss -- $12.6 billion -- in its history, every
manager used only green labels in more than a month of meetings.
Finally in
November of that same year, Mark Fields, who leads the North and South American
units, flashed a red label because of a production delay with the new Edge
wagon.
"A red
basically says you're off plan," Fields says. "There was kind
of dead silence. I was sitting next to Alan. Then Alan starts clapping.
What he was communicating was it's okay to be transparent."
Mulally, the
first outsider to lead the iconic 105-year-old automaker, began a bumper-to-bumper
overhaul in 2006. Not only was Ford addicted to profits from large gas-guzzling
vehicles that consumers were shunning. It operated as four separate companies,
duplicating parts and labor costs while the global operations of its Asian
rivals hummed in unison.
Two years
into his work in progress, the CEO now faces his biggest test -- to endure
the pounding of a global recession that made Chrysler LLC and General Motors
Corp. wards of the state -- until 2010. That's when Mulally's transformation
of Ford into a leaner global manufacturer of fuel-efficient cars should
finally bear fruit.
"Did
Ford wait too long?" asks John Casesa, a former Merrill Lynch auto
analyst who's now a partner at consulting firm Casesa Shapiro Group in New
York. "The answer is yes. To Mulally's credit, he's been on the right
path. I hope it's not too little, too late."
Hope is one
thing that's hardwired into Mulally's personality. Just weeks after taking
the reins at Ford, he predicted that the company would be profitable by
2009 -- a forecast he pulled in 2008.
The global
credit crisis hasn't shaken his faith. In September 2008, with U.S. auto
sales plunging 27 percent, Mulally, 63, displayed in his office an almost
boyish enthusiasm. He called Ford's first-quarter profit in 2008 "fabulous"
and the design of the 2010 subcompact Fiesta "neat."
Mulally then
took a reporter's legal pad to explain why the company won't go down after
losing $24 billion since 2005. He methodically drew a grid showing Ford's
finance, manufacturing and human resources functions and its four regions.
The CEO wrote the words "working together" across it to stress
the meaning of his One Ford plan.
"When
we came together, we decided on One Ford," Mulally says. "We're
going to operate as a global company. That's a new strategy. We were going
to focus on the Ford brand. Huge, huge strategic decision. We were going
to have a full complement of cars, utilities and trucks. Huge issue. The
U.S. plan was to concentrate on the trucks and SUVs. That's the new Ford."
Two months
later in November, with the decline in auto sales accelerating to 37 percent,
Mulally and the CEOs of Chrysler and GM -- Robert Nardelli and Rick Wagoner
-- took their private jets to Washington to beg for a bailout. While Ford
was seeking a credit line in case it needed it, Chrysler and GM demanded
cash fast to survive the year. To lawmakers, the CEOs' imperious behavior
exemplified all that was wrong with Detroit.
After countless
restructurings since the 1973 oil shock -- Ford alone has been through six
major revamps -- the automakers still didn't make many fuel-efficient cars,
still didn't match Toyota Motor Corp. and Honda Motor Co. in quality, and
still hadn't pared down their plethora of duplicate brands: Ford's Mercury
Milan and Lincoln MKZ are essentially the same car.
At a hearing
of the U.S. House Financial Services Committee on Nov. 19, Representative
Peter Roskam, a Republican from Illinois, asked Mulally if he would forgo
his compensation. The CEO's enthusiastic embrace of restructuring didn't
extend to his own pay. Mulally, who made $49.9 million in 2006 and '07,
seemed oblivious to the public outrage over excessive CEO pay when he answered
no.
"I think
I'm okay where I am," Mulally said.
The CEOs flew
home empty-handed. Two weeks later, the repentant bosses drove their hybrids
for a return visit to Washington, armed with detailed restructuring plans
and pledges to work for $1 a year and sell the company jets. Senate Republicans
such as Richard Shelby of Alabama, home to nonunion plants owned by Toyota
and Honda, rejected a House bailout measure because it didn't slash United
Auto Workers wages and benefits.
The Bush administration's
rescue of Chrysler and GM on Dec. 19 with $13.4 billion in emergency loans
mimicked the outline of the House bill. In exchange for loans from the Treasury's
$700 billion bailout fund, the two automakers must demonstrate plans for
profitability by March 31 or repay the money and face bankruptcy. The deal,
which requires the automakers to make labor costs competitive with their
Asian rivals in the U.S. by the end of 2009, should enable GM and Chrysler
to wring concessions from the United Auto Workers. ...
Mulally, in
another show of confidence in himself and his company, opted out of the
Paulson plan. Ford borrowed $23.4 billion in 2006 and says it would need
government help only if the recession deepens. Mulally says his restructuring
should start paying dividends in 2010 with the debut of his first fuel efficient
"world cars" -- single models that are sold worldwide -- and the
unprecedented drop of labor expenses.
The CEO brokered
a UAW contract in 2007 that puts Ford's retiree health-care costs in a union
trust starting in 2010. The company's labor costs including wages and benefits
will drop to $58 an hour from $71 today, narrowing the gap with Toyota and
Honda. Japanese automakers, who offer fewer benefits, pay U.S. workers about
$49 an hour. With these changes, Mulally says, Ford will reach a milestone
in two years.
"We expect
our automobile business to be profitable in 2011," the CEO told the
Senate Banking Committee in December.
Investors
don't share the chief's bullishness. Ford's stock dropped only 7 percent
from Sept. 5, 2006, when the company disclosed Mulally's hiring, to May
21, 2008. The CEO's retraction the following day of his profit forecast
was a turning point for investors. Since then, Ford shares have tumbled
67 percent to $2.59, and hit a 26-year low of $1.26 on Nov. 19. GM shares
plummeted 82 percent during the same period and Toyota's decreased 45 percent.
Moody's Investors
Service today lowered its rating on $26 billion in Ford debt two grades
to Caa3, or nine levels below investment quality.
Brian Johnson,
a Chicago-based analyst at Barclays Capital, warned in November that Ford
wouldn't have enough cash to operate by the second half of 2009 without
a government bailout or drawing down its credit line.
"It's
unrealistic of Alan to expect Ford to survive, let alone profit, when they're
experiencing a 30-plus percent decline in sales," says Sean Egan, president
of Egan-Jones Ratings Co. in Haverford, Pennsylvania, which rates Ford's
debt a D, its lowest level. "Without a bankruptcy filing and a complete
reorganization, Ford is not going to be profitable, period."
Mulally is
dealing with the consequences of a litany of missteps and missed opportunities
by his predecessors. Ford never learned the lesson from the Arab oil embargo
in 1973 about the dangers of relying on only large vehicles for profits.
With gasoline prices soaring in 1975, Congress forced automakers to improve
the overall fuel economy of their fleets. From then on, Ford says, it made
cheap small cars in the U.S. simply to comply with the law and rarely if
ever made a profit on them.
Even as compact-car
specialists Toyota and Honda began putting up plants in the U.S. in the
1980s, setting the stage for their conquest of the market, Ford kept building
bigger vehicles with bigger profit margins. With its eight-cylinder F-Series
pickup truck already the best-selling vehicle in the U.S., the company introduced
the six-cylinder Taurus in 1985, a sedan that would become the top-selling
car in America seven years later.
Ford squandered
its profits from the late '80s on European luxury brands in an attempt to
spiff up its middlebrow image and diversify its fleet. It purchased a controlling
interest in Aston Martin in 1987 for an undisclosed price and acquired Jaguar
two years later for $2.5 billion. In 1990, Ford introduced the Explorer,
a boxy vehicle that got 15 miles to the gallon in city driving and that
ignited the market for SUVs.
The Explorer
was a cash cow, enabling Ford in the '90s to snap up Volvo for $6.4 billion
and Land Rover for $2.73 billion. As the company slashed investments in
refreshing its own branded cars, the Asians moved in: Toyota's Camry and
Honda's Accord surpassed the Taurus as the top-selling U.S. cars in 1997.
Ford's $4.79
billion loss in 2001 after seven straight years of profit was a wake-up
call for the Ford family, which controls the company. Chairman William Clay
Ford Jr., who had held various executive jobs in the company, ousted CEO
Jacques Nasser and took his job at age 44. After cutting 23,000 jobs in
2002, he chased fuel-efficiency by bringing out a $27,000 hybrid version
of the Escape SUV. To make the hybrid, Ford licensed technology from Toyota.
The U.S. automaker
began hemorrhaging money again in 2005 as Explorer sales fell 29 percent
from the prior year. The CEO said in early 2006 that Ford would slice off
another 30,000 jobs during the next six years. The automaker's U.S. market
share had sunk to 17.5 percent in 2006 from 25.7 percent in 1995. Bill Ford
needed help and began to pursue Mulally, then a vice president at Boeing
Co., the No. 2 commercial aircraft maker.
The son of
a mailman, Mulally grew up in Lawrence, Kansas, in the 1950s, then a small
town of about 23,000. President John F. Kennedy's famous speech in May 1961
about landing a man on the moon spurred Mulally to study aeronautical and
astronautical engineering at the University of Kansas in Lawrence in the
hopes of becoming an astronaut.
"It was
so exciting because it was so important," says Mulally.
While in college,
he was evaluated by NASA , which discovered that he was slightly colorblind
and thus ineligible for spaceflight. Mulally received a bachelor's degree
in 1968 and a master's the following year.
He took an
engineering job at Boeing in 1969 and steadily earned promotions to the
top of the commercial aircraft unit in 1998. The Sept. 11, 2001, terrorist
attacks in the U.S. made people afraid to fly and spurred air carriers to
slash orders, driving down profit in Mulally's unit to $707 million by 2003.
He cut jobs by more than 50 percent while making his factories more efficient
and halved the average time for building a 737 aircraft to 11 days by 2006.
That year, Mulally's do-more-with-less approach paid off, with his unit
posting operating earnings of $2.7 billion.
Mulally says
he initially rejected Ford's job offer because it was hard to leave Boeing
after 37 years. Joining the automaker would also mean working for the Ford
family, which has often demanded a say in major management decisions. The
Fords control 40 percent of voting power through 70.9 million Class B shares,
a structure set up when the company went public in 1956. Two family members,
Bill Ford and his cousin Edsel Ford II, 59, sit on the board.
"The
family is in a position to second-guess everything," says Gerald Meyers,
a professor at the University of Michigan Business School and the former
CEO of American Motors Corp. "You always have to think of it in terms
of what will the Fords think. Anytime you have the possibility of being
second-guessed, you come to be over cautious."
In 1978, CEO
Henry Ford II stripped his president, Lee Iacocca, of some of his power.
They clashed, and Iacocca was fired. Twelve years later, after Bill and
Edsel Ford publicly complained that CEO Donald Petersen had relegated them
to minor assignments on the board, the chief resigned.
Mulally, who
signed a five-year contract to lead the automaker in September 2006, says
he worked closely with Bill Ford to develop his strategy. The new CEO added
to his predecessor's cuts, slashing at least another 25,000 jobs in North
America.
"Bill
Ford Jr. was so relieved when he came in," says David Lewis, a University
of Michigan business professor who's written six books on Ford. "Releasing
people, cutting jobs, cutting plants, really cutting into the fabric of
Ford -- he couldn't bear himself to do some of the hard things that needed
to be done."
In addition
to gutting Ford, Mulally set a new course for its remaining employees. In
his first week, he moved to end the Balkanization that was most acute between
Ford's North American and European regions. Before Mulally, regional chiefs
met no more than once a year.
"Probably
the biggest shock for everybody was when I called everybody together,"
Mulally says. "They said, 'This is great, why don't we get together
next year?' I said, 'Why don't we get together next week?' We were up against
competition using all of its global assets, and we were this very regional
operation. 'How is this going to work guys?'"
The company's
prior attempt to stitch itself together was undone by turf wars between
regions. In 1995, Ford created five vehicle design centers worldwide and
centralized decision making in Dearborn. But bosses and engineers in the
U.S. and Europe didn't cooperate enough and produced lemons like the first-
generation Focus, says Dennis Virag, president of Automotive Consulting
Group in Ann Arbor, Michigan.
After its
U.S. release in 1999, the car was recalled for faulty panels, cruise control
and rear wheels, and the North American unit had to re-engineer it. Ford
quit trying to operate as a global company and reverted back to regional
control in 1999.
"That's
one of the big problems with Ford," says Virag. "They always had
this division between Europe and North America."
Mulally says
his weekly meetings force regional managers to cooperate and be accountable.
"Together
we look at one set of data on one screen," he wrote in an e-mail to
all employees during his second month at Ford in October. "We talk
to each other with candor and respect. We will all participate, and we will
all support each others' efforts."
In December,
the CEO appointed North American executive Derrick Kuzak, 57, to a new position
of worldwide product development head.
"A lot
of what we're doing is bringing North America into One Ford," Kuzak
says. "It drives investment efficiency. You have to do more with less.
You're getting more out of engineers."
The same month
that Mulally appointed Kuzak, he flew to Japan to meet with Toyota Chairman
Fujio Cho. A student of Toyota's famously efficient global manufacturing
process since his days at Boeing, Mulally keeps a book on the subject --
"The Machine That Changed the World" -- in his office. While the
Japanese company has mastered the production of world cars such as the Corolla
and Camry that are sold globally, Ford still does it backward: Its regions
waste money making slightly different versions of the same model for sale
in those areas.
In the U.S.,
the $16,000 Focus is produced near Detroit at one of Ford's busiest factories.
Inside, robots weld body panels to frames before workers install engines,
transmissions, seats and instrument panels. Almost all of these parts are
made exclusively for the U.S. model; in Europe and Asia, the Focus is built
mostly with different parts.
Ford's move
to world cars requires the kind of top-to-bottom changes in manufacturing
that have tripped up the company before. Since 2000, Ford has spent at least
$5 billion to make its North American plants flexible so they could, like
Honda's factories, change the type of vehicle they produce in a matter of
days rather than a year. The problem for Ford is that its SUVs and cars
are built so differently that one plant can't quickly switch between the
two.
In 2005, the
company shelled out $300 million to rebuild a truck plant in Wayne, Michigan,
so it could easily flip-flop between different SUV models. Now that sales
of these large vehicles have plummeted, Ford is spending millions more and
at least 13 months to retool the same factory to make smaller cars.
Honda, which
makes all of its vehicles basically the same way, is now pressing its advantage.
At a plant in Ontario, Canada, Honda says, it needed only two months to
ramp up production of the subcompact Civic while stopping output of Ridgeline
pickup trucks.
At a Ford
plant in Dearborn, Bob Bradley, 46, is at work preparing dies -- stamps
used to make vehicle body parts -- for world cars. In his 13 years working
in several Ford factories in the Detroit area, Bradley has seen their assembly
lines decay.
"In order
to prop up profits, they were not investing in the facilities," he
says. "Our press lines were not in good shape."
Under Mulally's
One Ford plan, Bradley is converting standards for dies so they match the
ones used in Germany. He says workers support Mulally effort to improve
manufacturing because he's been consistent.
"He's
started to grow on people because he's proven himself little bit by little
bit," says Bradley. "It's not like he has one message one week
and a different message the next."
In 2010, the
redesigned Focus and subcompact Fiesta will be Mulally's first world cars
to roll off assembly lines in North America and Europe. At least 80 percent
of their parts will be identical. Other models will also share the Focus
platform, which includes the suspension and chassis. Ford will reduce the
number of platforms to 9 in 2012 from 25 in 2005. In all, world cars may
save Ford as much as $25 billion over four years, says Virag.
"You
don't need to re-engineer everything," he says. "You don't need
two sets of tools."
Six months
into his new job, in early 2007, Mulally traveled to the Consumer Reports
vehicle test center in Colchester, Connecticut, to work on another weakness
at Ford --the quality of its fleet. Accompanied by two engineers and a spokesman,
Mulally was the first Ford CEO to visit the center, whose rankings influence
the sales of vehicles.
The CEO and
his entourage watched David Champion, the senior director of the center,
examine Ford's 2007 Edge wagon, which sells for $26,000. As Champion pulled
the lever used to adjust the back of the seat, it broke off in his hand.
Immediately, Mulally began to pepper his employees with questions.
"'How
did we get to this point?'" the CEO asked, says Champion. "He
looked at them with a 'what the hell are we doing' look. It was an uncomfortable
time. He wants to understand how Ford has gone wrong and wants to fix it."
Under Mulally,
Ford began ordering its managers to examine warranty claims daily and send
information about defects to plants so they could be fixed. While the quality
of Ford's vehicles has improved, Champion says, they still don't match those
made by the Asian companies.
In the October
2008 issue of Consumer Reports, Toyota, Honda, Nissan Motor Co., Hyundai
Motor Co. and other Asian brands captured the top 10 slots in the quality
rankings. The U.S. automaker's Lincoln earned No. 11 while Mercury was No.
15 and Ford's namesake brand was ranked No. 17.
By early 2008,
Mulally had something to crow about -- his job cuts in the prior two years
helped Ford post a first-quarter profit. In March, he also agreed to sell
Jaguar and Land Rover for $2.4 billion -- less than Ford's purchase price
for Jaguar alone -- to Tata Motors Ltd. of India after shedding Aston Martin
to an investment group for $931 million a year earlier.
In the next
four months, as gas soared to $4 a gallon and credit markets froze, Ford's
truck and SUV sales evaporated. Mulally realized that his turnaround plan
wasn't moving fast enough.
In July --
on the same day Ford reported an $8.7 billion second-quarter deficit, the
worst quarterly loss in its history - - the company said it would accelerate
the production of fuel- efficient cars. The CEO says his weekly meetings
made it possible to rush four more small cars designed in Europe to the
U.S. market in 2010 and '11.
"We were
all watching the fuel prices," Mulally says. "Nobody knew at what
fuel price there would be a structural change on consumer behavior. What
if we got together once a year?"
Almost four
decades after the '70s oil crisis, Ford is set to finally offer a full mix
of better-quality compacts, sedans and trucks -- allowing it to adjust to
shifts in consumer demand as gas prices rise and fall.
But the company
may need a bailout to get to 2010, because for all Mulally has accomplished,
it's not enough, says Kevin Tynan, an auto analyst at New York-based Argus
Research Corp. Mulally should have produced smaller cars faster and pushed
for union concessions to take effect before 2010.
"He played
the cards he was dealt," Tynan says. "What you needed was someone
who would throw back the cards and say, 'This won't work.' You needed General
Patton, somebody who is not going to accept this is how things are done.
It was essentially a missed opportunity, maybe the last chance." ....
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