Is Hagel qualified?

For now, Senate Republicans have blocked the nomination of former Sen. Chuck Hagel, a decorated Vietnam War combat veteran, to become defense secretary. Last week, the Senate came up two votes short of the 60 needed to move his nomination forward. Senators are expected to reconsider the nomination when they return from a break Monday.

The recent vote followed Hagel’s stumbling performance at his Senate Armed Services Committee confirmation hearing last month. It was a halting and poorly informed appearance that included mistaking a key U.S. policy on Iran and admitting, “There are a lot of things I don’t know about.”

Republicans’ stated reasons for holding up their former colleague’s nomination range from outstanding questions about the Obama administration’s handling oflast September’s deadly U.S. consulate attack in Benghazi, Libya, to Hagel’s tepid support for Israel. This being Washington, the confirmation hearings were also used to settle old scores.

But one question that didn’t arise is whether Hagel is qualified to be CEO of a $700 billion defense enterprise.

The new defense secretary will face immediate challenges, none of them bigger than how to transform the enterprise without harming America’s national security and economic recovery. For example,  despite a two-month reprieve from sequestration, defense is bracing for budget cuts of up to $500 billion. This follows the $487 billion already cut from its projected spending over the next ten years as a result of the Budget Control Act of 2011. These reductions are a first step toward reining in the Pentagon, which is responsible for about 20 percent of all federal spending.

Defense spending has increased by about 46 percent since 200 1. If the Pentagon were a nation, it would be among the world’s 20 biggest economies.

Which brings us to the now-famous sequester. Unless a deal is reached to cut the deficit by $1.2 trillion over the next 10 years, spending cuts that fall equally on defense and domestic programs will be triggered.

Financial issues are not the only challenge facing the new CEO. There are the core global issues of dealing with Iran, North Korea, the Middle East and terrorism.

Still, no questions have been raised about the nominee having the required management experience and proven track record to serve as CEO and manage a multibillion-dollar enterprise.

Ah, management. Presumably the most essential requirement for organizational success.

During the second half of the 20th century, it became increasingly apparent that the challenges of managing large organizations had grown so complex that only those with the right mix of skills and experience could effectively meet them. Managerial success depends on configuring and coordinating multiple activities to create value for all the stakeholders. No one person has all the qualities of the ideal manager and leader, but how does Hagel score? Does he bring the requisite combination of managerial experiences and personal leadership characteristics to the position? How does he stack up against successful CEOs who have run multibillion-dollar enterprises under difficult circumstances?

Jack Welch turned sclerotic giant General Electric into a heads-up growth company. Lou Gerstner became CEO when everybody was writing IBM off as a leftover from another era and made it a cutting­ edge leader in information technology. Jamie Dimon of JP Morgan Chase showed that a financial conglomerate could really get its act together. All are strategic leaders and managers who transformed and revitalized their enterprises.

Given the Pentagon’s budgetary and strategic challenges, the Senate and the American public should be asking tough questions about the nominee’s managerial and leadership abilities. Sure, Mr. Hagel served his country honorably, but that doesn’t mean he is qualified to serve as the military’s CEO any more than driving a car qualifies you for the pole position at Indianapolis.

originally published: February 23, 2013

Why the fed’s case against Standard & Poor’s matters to you

Federal prosecutors filed civil fraud charges against Standard & Poor’s for alleged wrongdoing in rating mortgage bonds. This is the first federal enforcement action against a major credit rating agency over alleged illegal behavior tied to the 2008 financial crisis.

For the uninitiated, Wall Street investment banking firms long ago woke up to the fact that their credibility as sellers of financial securities to private investors could be significantly enhanced if these securities were “rated for safety” by so-called independent and objective third parties.

This was especially true for debt securities like bonds, whose likely buyers were perceived as very conservative. Since the market for bonds and other debt securities is far larger than the market for common stocks, development of a third-party rating system for them became a priority for Wall Street.

Three private firms emerged as the most trusted “rating agencies” for debt securities: Moody’s Investors Services Inc., McGraw-Hill subsidiary Standard & Poor’s, and Fitch Inc.

These firms assign “investment ratings” to debt securities based on their analysis of relevant financial data about the issuers. They charge fees to the sellers for rating the debt securities.

The financial community accepted this approach for providing debt securities buyers with “objective” information about their relative safety and these rating systems became a popular shorthand way to categorize the securities. Investment banks routinely used favorable ratings as marketing tools.

Some institutional buyers of debt securities (like insurance companies with streams of premium income to invest) announced that they would only buy securities rated “A” or better. Government and private sector regulators often set minimum ratings for the securities firms they regulated (such as commercial banks) were permitted to buy.

During the run-up to the financial crisis, this business was quite profitable. From 2005 to 2007, Moody’s had a return on capital of 140 percent, the highest among all publicly traded corporations listed in the S&P 500 Index. Its operating profit margin was 53.6 percent. And the firm’s revenues from rating corporate bonds grew by 187 percent. In short, the rating agencies made out like proverbial bandits.

So it doesn’t take much imagination to picture how the relationship might have played out on a typical day in 2007 as the mortgage backed securities and derivative products boom was approaching its climax. Wall Street investment banks delivered risk-profile reports for their latest deals that included mathematical risk models.

Except the formulas and equations behind those models were proprietary, meaning that rating agencies’ reliance on them amounted to little more than “trust me.” The agencies happily made that leap of faith, which benefited their bottom lines to the detriment of those who purchased the securities.

In addition to consistently churning out strong ratings for highly questionable debt securities, they also regularly increased the fees they charged for doing so.

If you conclude that the interaction between big banks and the rating agencies was more like a criminal enterprise than an arms-length relationship between a commercial enterprise and an independent , objective third party, you’re not alone. Federal prosecutors feel the same way.

Now where do all the purchasers of those now-worthless debt securities go to get their money back?

originally published: February 19, 2013

Congress has come to a fork in the country’s fiscal road

Here’s a safe prediction for 2013: The folks in D.C. will continue the policies of extend and pretend, endlessly kicking the can into the high grass, lurching from crisis to crisis and showdown to showdown without addressing the causes of our fiscal woes, as pundits complain about how uncertainty is undermining economic recovery.

The New Year could have begun with America falling off the “fiscal cliff’ if lawmakers had not reached an agreement at the last possible moment. But the deal left unresolved the issue of raising the current debt ceiling of $16.394 trillion. House Republicans would not agree to raise it without drastic spending cuts to get the national debt and deficits under control.

Those same House Republicans then gathered at their annual legislative retreat, where they decided to retreat from their resolute debt ceiling position and agreed to allow government borrowing to continue until May 19, long enough for the House and the Senate to pass a budget for the next fiscal year.

The House bill does not raise the federal debt ceiling; it simply allows the government to borrow as necessary to meet its obligations until May 19 and requires that the House and Senate pass a budget by April 15. If either body fails to meet the budget deadline, lawmakers’ salaries would be held in escrow until their chamber passes a budget.

The legislation is a strategic move by House Republicans to avoid a fight over the debt ceiling and shift the political debate to areas where they believe they have greater political leverage. The goal is to draw the Democratic Senate into taking action to cut deficits by requiring the Senate to pass a budget  resolution for the first time since 2009. Yes, the Senate Budget Committee has failed to produce a budget, which it is required to do by law, in each of the last three years , during which time the nation has added more than $1 trillion annually to the deficit.

The next real showdown will come over sequestration, $110 billion in automatic spending cuts that would take effect March 1. The sequester calls for roughly $55 billion each in ¬∑budget cuts to defense and non-defense spending. These forced spending cuts were delayed until March as part of the American Taxpayer Relief Act of 2012, the New Year’s deal that avoided the full-on “fiscal cliff.”

Pentagon advocates warn that the cuts will hit the defense budget hardest. But when you spend over $700 billion annually on defense, what you need most isn’t allies but an enemy.

Meanwhile, the government’s ability to fund itself (the continuing resolution) runs out March 27. Republicans have made it clear that they are willing to let the government shut down to force deep spending cuts and/or changes to Medicare and Social Security that would address the long-term deficit Issue.

It is against this backdrop that Congress and the White House will take up the deficit issue next month. Once again they are putting off the difficult decisions needed to get the country’s fiscal house in order, deal with persistent unemployment, and stagnant and declining wages.

The most fun you can have with the budget deficit is to lay bets on the mythic narratives each party will spin, explaining why they kicked the can down the road once again. This brings to mind a quote from Woody Allen: “More than any other time in history, mankind faces a crossroad. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have the wisdom to choose correctly.”

originally published: February 2, 2013