It's time for old Saint Nicholas to tally up the year's naughty and nice. When Saint Nick gets to Wall Street, he can probably get away with using just one of the lists this year - and save on overhead by buying coal futures for next year as well. We'll look briefly at the naughtiest of the naughty for 2009. (If you don't know how the recession began, read on to learn more in The 2007-08 Financial Crisis In Review.)
- The Federal Reserve and the Treasury
In dealing with an "unprecedented" financial disaster, the Fed and the Treasury have set some disturbing precedents. One is a lack of disclosure over what actions were being taken and why. Some of those actions seem to undermine the base of the system they were struggling to save, such as the alleged strong arming of Bank of America CEO Ken Lewis into completing a deal to buy Merrill despite Lewis' concerns over Merrill's balance sheet and the overall impact on B of A shareholders.
In addition to some questionable actions taken in the heat of the moment, the Fed and the Treasury are continuing to play with fire in the form of inflation. Although the massive treasury purchases by the Fed have been scaled back, the low interest rates and loose money are weakening the dollar and may become the catalyst for yet another asset bubble if the reins aren't tightened soon. (Find out what tools the Fed has at its disposal to fight the good fight in The Federal Reserve's Fight Against Recession.)
- Bernie Madoff
After ruining Christmas for many in 2008, Madoff will be spending Christmas 2009 and every other one after in jail. His massive Ponzi scheme was more of a psychological blow to the financial world than a monetary one. Despite defrauding clients, including charitable foundations, of billions, the overall market chaos of the last three years has erased trillions in wealth, making Madoff's crime seem smaller than it otherwise would.
That said, his scheme enraged an already angry public and fueled a populist backlash against other Wall Street players. The reverberations of this rage can still be felt in the stance of politicians towards Wall Street and the anti-business bend in some of the proposed legislation.
- Canadian Ponzi
Any Ponzi scheme would look tiny when compared to Bernie Madoff's fraud, but Canadian Gary Sorenson could be the mastermind behind the largest Canadian investment scam. Midway through 2009 the RCMP claimed to have uncovered a C$100 million and possibly as high as C$400 million investment fraud. Allegedly Gary Sorenson was part of a team based in Calgary, Alberta that faked earnings by taking on new clients. Sorenson turned himself in in late September of 2009
In a traditional Ponzi scheme the fund manager would claim higher returns than the fund actually received. Any withdrawals are paid with new money going into the fund. In the Calgary case, investor funds were said to be invested in shell companies around the world. If this turns out to be true, the money was not invested in these companies and instead gets funneled to other unknown locations.
- The House
This year was filled with calls for businesses to work together with politics to solve the financial crises and end the recession. Oddly enough, it was also filled with calls for the blood of business. This Jekyll and Hyde approach is inevitable when politicians have to balance their constituents' desire for revenge, the needs of the country and the political opportunity that crises create.
The bonus tax of 90% was one of the saddest moments in U.S. finance. Attempting to break contract law and singling out certain taxpayers goes against the financial values that made America a world power. (How did America's strong economy tumble so quickly? Find out in The Fall Of The Market In The Fall Of 2008.)
Legislating according to popular outrage is undoubtedly dangerous - look no further to the reactions towards "Buy American" clauses by our largest trading partners for an example - but using a crisis to push through expensive social reforms may prove worse. Perhaps universal healthcare and an expanded social state will lead to significant savings and minor tax increases. But it will likely require more magic than your average Christmas miracle because every historical expansion of social entitlements has led to tax increases and ballooning costs.
- Too Big To Fail Companies
This category includes banks, carmakers and everyone else suddenly protected by the taxpayer for their "systemic importance." In the end, many of these "too big to fail" companies are going to end up paying a high price for their salvation. It won't be a simple lump of coal, but a financial overhaul dictated by politics. Capitalism works best when wrong decisions, whether they're internal or influenced by outside forces, have quick consequences. Using taxpayer funds to ease, evade and erase the consequences will create new and unforeseen consequences in the future.
As taxpayers, we want to see these companies carefully monitored by the government to protect our investment and ensure there is no possibility of a repeat. As investors, however, government intervention in the financial system is always a cause for worry. Remember, the former GM bondholders were taxpayers too.
Making a List, Checking it Twice
We're coming to the end of two or three, depending on how you measure it, difficult years in a row. There has been enough naughtiness to snuff the Christmas cheer from even the hardiest spirit. But there have also been bright spots. Ford has yet to tap into the automotive welfare fund and there are politicians and business people fighting for fiscal responsibility as well as opposing the permanent melding of government and business. Hopefully these bright spots will continue to grow and shed some light over what might otherwise be a dreary New Year.