Pearlstein on Corporate Disclosure

Steven Pearlstein
Washington Post Columnist
Wednesday, August 5, 2009; 11:00 AM

Washington Post business columnist Steven Pearlstein was online Wednesday, August 5 at 11 a.m. ET to discuss corporate disclosure.

Pearlstein won a Pulitzer Prize in 2008 and is co-moderator of the On Leadership discussion site.

Read today's column: Are We Finally Breaking the Vicious Cycle of Corporate Deceit?.

A transcript follows.


Washington, D.C.: How is JER Investment Trust going to survive? I recently heard that Joe Robert had successful surgery and is back at the top, but he recently relinquished responsibilities and now has top executives leaving.

Steven Pearlstein: I haven't checked in with Joe in a number of months. I should.


Richmond, Va.: Mr. Pearlstein: I sure don't agree much with you, but I am sure most Americans can rally around this point: More clear information that is timely and "uncooked" is key to getting us to a new place. The questions I have is this: I read yesterday about new accounting rules that have been approved so banks can "adjust" their balance sheets to include asset listings previous disallowed. Is this accurate and do you feel it is a good change? Bank Balances Shift With Rule Changes

Steven Pearlstein: I think the change has been very helpful in resolving what was a very dangerous financial crisis. Certain assets were just being priced in a ridiculous way by the markets, which had been overcome with fear and suspicion, and the market price did not reflect in any way the long term value of these assets. So giving banks a bit more flexibility to value them in another way was a good thing. I am sure the outside auditors remained pretty careful in not allowing banks to ignore the realities of bad credit, and it may turn out that banks will have to bring down these values on their books over the next year if the market prices do not improve. But it was a good step to smooth out the adjustment process. Sophisticated investors understand what is going on and not only seem to have accepted it but have been getting back into bank stocks. Credit rating agencies have also not balked.


Fort Worth, Texas: Hi Steven, A little off-topic, but thought you might like a general economy question. Personally, I'm a little skeptical that the most recent GDP number isn't a little inflated. How much of the only 1% decrease can be attributed to a) loosening of mark-to-market in April, b) Fed and Treasury throwing money at financial institutions, c) the Stimulus and generally throwing money at state and local governments?

With consumer spending still receding (when adjusted for the higher price of gas spending decreased) I'm still not convinced that we're doing anything besides priming another bubble to pop. Your thoughts?

Steven Pearlstein: Nothing to do with mark to market and a lot to do with government stimulus spending -- at least 3 percentage points worth, in fact. I don't think we're priming another bubble -- we're doing what we need to do to prevent a very bad economic downturn. If the Fed doesn't sop up the liquidity at the right time, that could be bubble inducing. But they are keenly aware of that challenge.

My own concerns is that the markets have gotten ahead of themselves and that there is a real possibility of another dip down in growth early next year. It is also likely the economy will be pretty flat for at least another year or two, since there is a lot of adjustment still to be made in household and government balance sheets.


Columbia, Md.: Steve, I share your hope that things might, just might, change. But, looking at the amount of the fine, what is to stop BofA or the others from doing it again? The punishment must fit the crime; otherwise nothing will stop these people. BofA paying $50M is nothing compared to all the bonuses paid out - the $50M is not coming out the pockets of the C-level officers either. On a much smaller scale, here is an example from long ago: We found a UPS truck blocking an alley behind our then house in D.C. No one could come in or out. After about 10 minutes or so the driver came back and found a $10 ticket on his windshield. He tore it in front of us and said "Cost of doing business"...$50M is a very small cost of doing business for BofA.

Steven Pearlstein: Actually, I think it was $33 million. It's not a lot of money for Bank of America, but it is a big fine absent a finding of fraud. And its not the size of the fine that matters so much. Companies really don't like getting cited by the SEC for snookering their own shareholders. It will send a message to other companies and their securities lawyers. But it needs to be followed up with other enforcement actions. I look forward to the SEC chairman who basically starts sending every quarterly filing back for revision with instructions to start telling shareholders in a straightforward manner what is really going on in the business. My concern with Mary Schapiro is that she would never be radical enough to do that -- to risk upsetting lots of people all at once. But I can tell you that investors would really cheer her on if she did this. The kind of press releases I quoted from General Growth are very typical, and they ought to be censured as the misleading propoganda that they are. The system will adjust pretty quickly, if only someone would raise the bar.


Chapel Hill, N.C.: As someone who worked for ten years at an investment bank, I believe high frequency trading is one of the more insidious practices that banks and traders have invented. The banks are causing volatility and profiting from it thereby making volatility endogenous. The next step is for banks to sell volatility to each other - which will lead to hedging and making the market completely opaque. This bodes very ill for the small investor. If I was a day trader, I would be very nervous right now.

Steven Pearlstein: That was very well put -- and very wise.


Ashland, Mo.: A frequent refrain for company misconduct is that "Wall Street made me do it." Would it be helpful to return to the notion that insurance companies should be mutual companies and financial firms should be partnerships and prohibit the corporate entity, which encourages short-term excessive risks by limiting responsibility for losses?

Steven Pearlstein: Short answer: yes.


Washington, D.C.: How thrilled are you that Cash For Clunkers worked? I'm amazed to see that dunderhead Ray LaHood claiming credit for his former congressional buddies for this concept when the idea actually came from the Federal Republic of Germany. Ach du lieber.

Steven Pearlstein: It's a lousy precedent, there are all sorts of reasons to criticize it, but I think it was a smart, one-time thing to do. Psychology is important in trying to change the economic dynamic, and break the vicious cycle. If we can spend a billion here and a billion there to reverse the cycle, even at the risk of setting a bad precedent, then sometimes you have to do that.


College Park, Md.: Steve,

Thanks for another great article. I think this is a big issue not just between management and investors, but also between companies and their customers. For instance, it seems like health insurance companies will frequently reject claims that they know to be valid because they know it is a hassle for the customer to resubmit and fight with them. Because they are big and organized and their customers are not organized, they don't need to use good faith in the performance of the contract. This would seem to be another area where the regulators ought to crack down on the company and make sure that they honor their contracts.

In the case of management lies to the investors, fining the company does not seem to be a good solution. The investors lose twice, both from the false information and from the fine. Is there some way for the government or the investors to hold management directly accountable through fines and/or firing?

Steven Pearlstein: Yes, if you can prove it was outright fraud, you can punish the executives. I think in this case the government was probably reluctant to get into that because of all the ancillary issues -- did the Fed and the Treasury put pressure on Bank of America to close the deal and keep quiet about things like bonuses for fear of roiling the markets at a very delicate time? In general, it is better to go after both the company and the individuals, including the lawyers, who in my opinion are a big part of the disclosure problem. There needs to be more sanctions against the lawyers and the law firms that enable and encourage the opaque, misleading communication.


Arlington, Va.: How does fining a corporation for lying to its investors help end corporate deceit? The investors are the ones who pay the fine, not management. The stockholders are losing on both ends; once when they are being told the lies, and once when they are fined because management lied to them. The same thing often happens with class action suits against corporations. The only remedy the stockholder has is to sell the stock, which promotes a short-term investor strategy rather than a more sensible buy and hold long-run strategy.

Steven Pearlstein: Again, that's a valid complaint. But its not the money that is the key punishment. Its being called out. You should also know that the court order also puts the company on probation for a number of years, which makes it easier for the SEC to come down on them hard if they do it again.


New York, N.Y.: Steve, With all due respect (as I love your columns), you've got to be kidding!!! Wall Street is set to pay record bonuses one year after it nearly caused the world to melt down, and you think the corporate culture has begun to change? PUH-LEEZE. Although I'm generally a person who believes in the free markets, I've come to believe that the culture and pay system on Wall Street are incorrigible and intractable. I've got two potential solutions, both of which are hardly great: 1) Raise the marginal tax rate of anyone earning over $1M to 50%. 2) Lobby the big institutional investors not to touch stocks such as Goldman, Morgan, etc. with a twenty foot pole because an increasing stock price will only encourage more stupid risk-taking.

Steven Pearlstein: Don't misunderstand me -- I DON'T think the culture has change much at all. This was just one small initial step in the right direction. The culture hasn't changed as it relates to disclosure, it hasn't changed as it relates to compensation and it hasn't changed as it relates to Wall Street firms taking advantage of their customers.


Falls Church, Va.: In the case of BofA, it seems worth noting that the bank had the U.S. Government as a co-conspirator in saying or doing anything necessary to make the Merrill deal happen.

Steven Pearlstein: The government, I'm sure, was complicit.


Princeton, N.J.: Since I am 71 years old and stand slightly to the right of Leon Trotsky, all I can say is, "What else is new?"

Steven Pearlstein: Didn't know you were that old, Len.


Mt. Lebanon, Pa.: On C-SPAN this morning, Treasury official Barr two-stepped around the issue: are the credit rating agencies legally accountable to the findings (ratings) they issue? He hid under the rubric of I'm not a Constitutional scholar so I can't speak on the first amendment.

And this is what the best and brightest have now come to? Shades of Brown Brothers, Harriman, and Benjamin Strong!

I'm a professional engineer. I make a mistake, get someone hurt, or killed, or cost a client a lot of money through incompetence or deceit, I can at the least, lose my license to practice engineering.

How come no licenses are required to practice financial hocus pocus for Series 7 graduates?

You know, something society could take away too, yes: correct errant, unprofessional, duck-and-cover behavior.

Without severe penalties for early stupidity and malfeasance, there's no point talking about breaking or even abating corporate deceit.

Sometimes it all starts at the foundations. Trust me, any decent and responsible engineer can tell you that.

Thanks much. HLB

Steven Pearlstein: You are right to be outraged about the performance of the ratings agencies -- they share a very big part of the blame for the bubble and the ensuing financial crisis. But Michael is aware that there is a serious issue about punishing the ratings agencies for their published recommendations. Investors did not pay them -- the issuers did--and its not clear that under the law they have a fiduciary duty. They voiced an opinion about this bond and that security. What people did with that was their business.

That's the argument, anyway. I personally don't buy it. I think as a matter of common law they can be held liable for their lousy ratings IF, and only if, it can be shown that they were reckless or negligent or knowingly put out bad ratings to win clients and fees. I'm not a lawyer, constitutional or any other version, but I do sense this will require some judge to make new law.


Bethesda, Md.: What is the prospect for real regulatory reform and not just cosmetic surgery this year? Do you think Congress will have the will to resist the Wall Street lobby or not?

Steven Pearlstein: Frankly, I'm not sure. It is possible they will do a watered down version. It is possible they will do nothing. It is possible they will do a slightly revised version of the administration plan. My guess is the first.


Annandale, Va.: Wouldn't eliminating complicated derivatives and other confusing products help to decrease corporate deceit??

Steven Pearlstein: No, I don't think that gets to the heart of it. They lie and mislead and cover up lots of simple things, such as : We bought this company for $2 billion two years ago, put another $1 billion into it and it was such a disaster we just sold it for $500 million. You will never, ever see a company say that. And it happens all the time.


Boston, Mass.: Hasn't BOA had some recent "retiring" of members of their Board of Directors? Coincidence?

Steven Pearlstein: It's no coincidence. The regulators have essentially and quietly told them they have to make major changes and they are in the process of doing that in an orderly manner. The chief executive this week put in motion a succession process that will probably see him leave earlier than expected. The board changes are part of that process.


Bethesda, Md.: What about the idea of having an ombudsman assigned to big corporations to keep them reporting honestly?

Steven Pearlstein: You'd think that is what the board of directors would do. The fact that they don't is a good sign that they really work for the management, not the shareholders. So that leaves it to the SEC, which is really set up as a law enforcement agency and isn't really very good at changing cultures and ways of doing business without getting into very legalistic enforcement actions. What I'd like the SEC bureau that handles this to do is to issue guidelines on what is considered full and frank disclosure and tell companies that starting next quarter, they need to follow the guidelines or the SEC will keep sending back their filings until they meet the standard -- and giving public notice of those that fail to comply.


I am sure the outside auditors remained pretty careful : You're referring here to whom? The outside auditors that missed the cheating, lying, and fraud in the derivatives bubble? Or some new class of independent, honor-bound auditing type of professional most of us haven't met yet.. not on TV, anyway?

And they likely aren't being turned out by schools of accounting still teaching the old method: You have to go along to get along.

Thanks. Skeptic

Steven Pearlstein: There is lots of blame to go around on the financial crisis, but the auditors are pretty far down on my list. Other than the off balance sheet chicanery, I don't think they were very complicit.


Yes, exactly the issue: "If the Fed doesn't sop up the liquidity at the right time, that could be bubble inducing. But they are keenly aware of that challenge."

Who's to say that down the road when adult supervision is required, the U.S. and world economies won't be saddled with another Alan Greenspan and his 7 votes (D.C.) to 5 -regional Fed banks?

After all, we've seen this movie before. We could have another Alan running things again one day. And as a famous hoohah once said: History first repeats as tragedy, then as farce.

We don't need another farcical Fed chairman. Ever.

Good one today.

- The first Marx brother, Karl.

Steven Pearlstein: Obviously, for our system to work we need good people to fill key roles. You can't design a financial system that is immune to the incompetence of regulators and policy makers.


Cash For Clunkers: Was it Jon Stewart who said that this was a federal subsidy to companies the U.S. government already owned?

Can one subsidize oneself? And, if so, is this a Noble Prize winning kind of New Age bootstrapping device?

We do live in amazing times.

Steven Pearlstein: It's a good laugh line, but its really not a good critique of the problem.


which makes it easier for the SEC to come down on them hard : Which assumes the SEC isn't asleep at the doughnut shop to begin with.

An assumption which wasn't at all true during the George Walker Bush years.

Please check your assumptions at the door - it's how we got into this mess to begin with.

Steven Pearlstein: I will if you will. You're assuming they are all venal or incompetent.


Chicago, Ill.: Hey Steven, You have argued that the CFTC is right to rein in "speculators" in the commodity markets because of the increasing volume of transactions in the futures market that seem to be driving the spot price. The part I don't understand is why would that necessarily drive the price higher? After all, one can speculate long or short and every buyer must have a seller or else the market won't clear at the elevated price. What am I missing? Why did the speculators let the price fall from 150 to 30 last winter?

Steven Pearlstein: What you are missing is the fact that futures prices actually do affect the actual transaction prices, and that based on the behavior of futures market, people who really produce the commodity or use the commodity alter their behavior because of it. So, to use a common analogy, the better in the stands really does affect the players on the field.


Washington, D.C.: You missed Mt. Lebanon, Pa's point. Here in the District you have to have a license to braid hair, and if you do it poorly enough the city can take away your right to malpractice you trade. USDA can take away, for life, an individual's right to trade in fresh fruits and vegetables if they don't follow rules related to contract terms and payments. Do you think licensing individuals in the financial sector backed up with the threat of loss of professional income would help change some of the less desirable aspects of corporate culture?

Steven Pearlstein: I'm not sure ratings agencies are licensed, although they do enjoy some sort of special status from the SEC. I suppose the SEC could hold hearings to determine if that status should be withdrawn for any of them. The problem is you'd have to withdraw the status for all of them, in which case the system might not operate very well for a while. And, again, are you going to go after the entire firm or individual analysts within the firm? If the former, then all you will do is get the same people working under a new corporate name.


Bel Air, Md.: This is slightly off the topic.

Wasn't Tim Geithner's "expletive laced tirade" a display of immaturity, and incompetence?

Why would the people on the receiving end of such a tirade put up with it? Can you imagine if someone made a recording of it? (I am sure somebody did!)

Steven Pearlstein: It probably wasn't a smart move, given that somebody was bound to leak it. What I would have done is shown up at the hearing and rebutted their arguments point for point and highlighted the fact that they were just protecting their turf or shilling for the special interests they are supposed to regulate. He could have embarrased them in public rather than embarassed himself in private.


Wokingham, U.K.: Is the most important lesson of the banking crisis that when the system reached crisis point everyone rushed not to reform it but to rescue it?

Steven Pearlstein: No. You have to rescue it before you reform it.


Are there two Pearlsteins out here?: Steve.

You write a great column. A financial meisterwordsmith. Cogent, thoughtful, right on the button.

Then you get on these online sessions and you talk like you've been hired by the Treasury Department to act as their internet Joe Isuzu.

Are you twins? Or is a doppleganger doing these stints with us U.S. citizen types?

Maybe our built-in BS detectors are just what you need once a week. You know, to keep you on the straight and level.

Which is why Wall Street financial types are prohibited from flying large commercial aircraft. They lose their way when their heads are forced onto an even keel.


Steven Pearlstein: Not sure what it is you are referring to, towing the Treasury line and such. I can assure you they don't think me a reliable ally over there.


Baltimore, Md.: Dear Mr. Pearlstein, I enjoy your columns and chats--thanks. It seems that among other problems, a good portion of the financial crisis stems from out-of-whack compensation schemes that lavishly reward short-term thinking or behavior that is relatively unproductive or unhealthy for the general economy. I have heard much comment on this topic but little in the way of concrete ideas to alter the incentive system towards rewarding more "productive" behavior. Could you comment on what, if any, changes are likely to occur that might address this problem?


Steven Pearlstein: Compensation is a factor in causing the crisis, and it is the factor that makes the rest of us the angriest. But I'm not sure it is really the root of the entire problem, as too many people believe. In the case of General Growth, for example, nobody lost more money than the executives and board members of the company, so they had the most incentive not to get over their heads in debt. But they did anyway. You can't over-estimate the role of self-deception and rationalization that provided the foundation for the bubble.


Washington, D.C.: How much of the current "the bad news isn't as bad as it was, so things must be turning around" media frenzy do you believe? It seems to me that at the beginning of a hearty downturn everybody from the local store back to the copper mine tries to cut inventory so that the apparent downturn is worse than underlying one, therefore an improvement in the apparent downturn doesn't indicate that there is any change in the underlying downturn, which could in fact still be getting worse.

Steven Pearlstein: Perhaps a simpler way to put it is that companies have turned profitable again by cutting their costs, even as their revenues remain flat. That's not the basis for a sustainable recovery. Demand is still weak.


Anchorage, Alaska: Slap on wrist to BOA, which leads to comment from Pearlstein: "Yeah, but the SEC has issued them a warning. We're going to be looking at you closely from now on. Boy, you're in a heap of trouble."

Words to that effect.

It reminds me of a spoof of the old Leave it to Beaver show. For some inexplicable Kafkaesque reason which escapes me now, the Beaver has been turned into a hamster or a gerbil.

When Wally sees him munching on his seeds, he says: "Wait till Dad sees you. You're really going to get it this time, Beave."

- Was it $50M or $33M? Either way, it's what? Their dry cleaning bill for the executive dining rooms for one year?

Steven Pearlstein: So what would you have done? Slapped them with a billion dollar fine? How does that help the shareholders? The logical next step would be to punish the individuals, but as I said, this case has too many other complications to it. Better to find a cleaner case for that.


Steven Pearlstein: That's all the time we have for today, folks. "See" you next week.


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