Interesting Article

Ruth Faces Living Off a Scant $2.5 Million

by Brett Arends
Monday, June 29, 2009

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How tough is it living off $2.5 million? Ruth Madoff is about to find out.

Bernie Madoff's wife has been left with a lump sum in that amount from her settlement with the Justice Department.

The first thing to note is that the cash doesn't come completely free and clear. She may still face claims from the Securities & Exchange Commission, the Securities Investor Protection Corporation, and the trustees liquidating her husband's business and estate. It is also unclear how much Social Security she will have to live on as well.

When you cast aside the sort of smoke and mirrors used by her husband, a conservative investment portfolio may only earn about 3% a year over inflation. At that rate, and if Mrs. Madoff wants to make sure she doesn't outlive her money, her $2.5 million settlement should give her an annual income of maybe $125,000 a year. That would make the money last all the way to age 100.

That's a pretty good income. It's a lot more than many of her husband's ruined victims will have. But it will hardly support her past lifestyle. Mr. and Mrs. Madoff, according to court papers, owned homes in Manhattan, Montauk, N.Y., and Palm Beach, Fla., along with millions of dollars in furniture, art, furs, and the like.

Sounds like she's going to have to do, on a bigger scale, what a lot of Americans are doing right now: Downsize.

If Ruth Madoff spends a third of her $125,000 a year on accommodation, that will come to about $3,500 a month -- enough perhaps for a (modest) two bedroom in Manhattan, but nothing glamorous. It will rent more in Florida. Especially if she moves inland from Palm Beach -- to somewhere like Sunrise.

The good news? There's an Ikea nearby. And lots of factory outlets. And in Florida she will be able to survive without her $36,000 Russian sable coat.

As for cars: Mrs Madoff has to give up her Mercedes-Benz E class and CLK. But a brand new Mercedes SmartCar only costs about $14,000.

As for investments: Mrs Madoff is 68. She will need income to live on for maybe 30 years or more. She's going to have to generate income to live on, and enough growth to keep up with inflation. That's going to mean a conservative mix of stocks and bonds.

Among bonds, Treasurys look expensive. Even inflation protected Treasurys, so-called TIPS, are starting to look fully priced. And Mrs. Madoff would do well to avoid very long-term bonds. They are at risk from inflation.

There are better opportunities in corporate debt, from investment grade to high yield. She might also look at tax-exempt municipals -- she can earn at least 3.5% tax-free without taking on too much inflation risk. She might even consider emerging market government bonds.

If she wants stocks paying good income as well, Mrs. Madoff should be able to earn yields of about 4.5% a year right now without taking too much risk. Closed-end funds -- special mutual funds that trade like regular shares -- can be a great way to get equity income. That's because the funds themselves can sell at a big discount, which means you get more income for each dollar invested.

The irony, of course, is that Mrs Madoff really needs right now a financial adviser she can trust to handle her money.

Jamie Dimon: The Future of Our Financial System

By Jamie Dimon, Chairman and CEO, J.P. Morgan

The extent of the damage and the magnitude of the systemic problems make it clear that our rules and regulations must be completely overhauled. Such changes to the regulatory system could have huge implications on the long-term health, and strategies, of our business.

While unprecedented actions have been taken by both the Federal Reserve and the Treasury, my hope is that new policies are grounded in a thorough analysis of what happened and what we need to do about it. Political agendas or simplistic views will not serve us well.

Often we hear the debate around the need for more or less regulation. What we need is better and more forward-looking regulation. Someone has famously said that a crisis should not go to waste. But what is also true is that it shouldn't take a crisis to solve our problems. During a crisis, people panic. This can make it harder, not easier, to do the right thing. From our perspective, certain improvements would make a big difference. We would like to share with you some of our suggestions.

A. The need for a systemic regulator with much broader authority

We agree with our leaders in government that we should move ahead quickly to establish a systemic regulator. In the short term, this would allow us to focus attention on correction some underlying weaknesses in our system and filling the gaps in regulation that contributed to the current situation. It also is clear that U.S. policy must be coordinated with the proper set of international regulators. When the crisis emerged, the actions of individual countries had a critical impact on numerous other countries. International coordination is essential in resolving this kind of crisis.

There should be procedures in place to deal with systemically important institutions - failure is fine as long as it's orderly and controlled and doesn't cause systemic failure

Size is not the issue; rather it is when institutions are too interconnected that an uncontrolled failure has the potential to bring the whole system down. What we need is a resolution process that allows failure without causing damage to the whole system. In the case of Bear Stearns or Lehman - both investment banks - regulators did not have this protocol They do have it, however, for commercial banks. Even more important, regulators are going to need a resolution process for large, global corporations that operate in many jurisdictions around the world.

The first goal should be to regulate financial institutions so they don't fail. If they do fail, a proper resolution process would ensure that action is swift, appropriate and consistent. The lack of consistency alone caused great confusion in the marketplace. For example, when some of the recent failures took place, there was inconsistent treatment among capital-holders (preferred stock and debt holders were treated very differently in different circumstances). It would have been better if the regulators had a resolution process that defined, a priori, what forms of aid companies would get and what the impact would be on capital-holders. The FDIC resolution process for banks provides a very good example of how a well-functioning process works.

Various liquidity and "lender of last resort" facilities, like some of those put into place during this crisis, also could be in place on an a priori basis. These controls would reduce risk and maximize confidence.

Regulation needs to be administered by product and economic substance, not by legal entity

We have experienced the unintended consequences of redundant regulation; i.e., different agencies regulating the same product in the mortgage business, in the derivatives business and in lending overall. If, on the other hand, similar products were overseen by a single regulator, that regulator would have much deeper knowledge of the products and full information that extends across institutions. The "regulatory competition" that could have caused a race to the bottom would be eliminated.

Hedge funds, private equity funds and off-balance sheet vehicles must be included in our regulatory apparatus without compromising their freedoms and positive attributes

Certain vehicles like hedge funds and private equity funds need to be regulated but only to protect the system against risk. These vehicles do not need to be heavily regulated like a deposit-gathering bank. We should consider requiring hedge funds over a certain size (say, $1 billion of equity) to register, provide quarterly audited reports, disclose total leverage and certain risk attributes - like volatility and investment categories - and outline operational procedure. They also could be requited to show their regulators (not their competitors) any concentrated "trades" that could cause excessive systemic risk. This all could be done without compromising flexibility or disclosing confidential positions while allowing these vehicles to move capital - as freely and aggressively - as they see fit.

The systemic regulator needs the ability to anticipate risk and do something about it if necessary

There, undoubtedly, are financial products in the market today that - if unchecked - could have a destabilizing effect. A systemic regulator, had it been closely watching the mortgage industry, might have identified the unregulated mortgage business as a critical point of failure. This regulator also might have been able to limit the leverage of Fannie and Freddie once they were deemed to pose major systemic risks. Such a regulator might have been in the position to recognize the one-sided credit derivative exposures of AIG and the monoline insurers and do something about it.

A systemic regulator also should be on the lookout for new or potential structural risks in our capital markets, such as the structural flaw that grew in money market funds.

B. The need to simplify our regulatory system

Everyone agrees that the existing system is fragmented and overly complex. We have too many regulators and too many regulatory gaps. No one agency has access to all the relevant information. Responsibility often is highly diffused. This problem could be relatively easy to fix but only if we have the political will to fix it.

C. The need to regulate the mortgage business - including commercial mortgages - in its entirety

Many of the same gaps in regulation that helped lead us into this mess still exist today - for example, in the mortgage business. Mortgages are the largest financial product in the United States, and while we do not want to squelch innovation, the entire mortgage business clearly needs to be regulated. This is not the first time that mortgages and real estate have led this country and many of its financial institutions into deep trouble. Proper regulation would go a long way toward standardizing products, testing new ones, improving customer disclosure and clarifying responsibility.

D. The need to fix securitization

We believe that securitization still is a highly effective way to finance assets. But some securitizations, particularly mortgage securitizations, had an enormous flaw built into them: No one is responsible for the actual quality of the underwriting. Even mortgage servicing contracts were not standardized such that if something went wrong, the customer would get consistent resolution. We cannot rely on market discipline (i.e., eliminating bad practices) alone to fix this problem.

We have heard several reasonable suggestions on how the originator, packager and seller of securitizations could be approximately incentivized to ensure good underwriting. For example, requiring the relevant parties to keep part of the securitizations, much like we do with syndicated loans today, would help manage resolution if something were to go wrong and could go a long way to re-establish market confidence and proper accountability.

E. The need to fix Basel II - leading to higher capital ratios but a more stable system

As discussed earlier, Basel II has many flaws - it has taken too long to implement, it responds slowly to market changes and it is applied unevenly across global borders. Perhaps its worst failing is that, in its current construct, Basel II does not include liquidity, which allowed commercial and investment to buy liquid or illiquid assets and fund them short. While this practice did not appear quite so dangerous in benign times, it created huge issues for many financial institutions during the market crisis. Basel II also has relied too heavily on rating agencies and, by its nature, has been highly pro-cyclical in its capital requirement for assets. It would be easy to make these capital requirements less pro-cyclical and require Basel II to recognize the risk of short-term funding, particularly that of wholesale funding. Finally, Basel II should be applied consistently, reviewed continuously and updated regularly. The world changes quickly.

F. The need to get accounting under control

We at JPMorgan Chase are strong believers in good, conservative accounting. Accounting should always reflect true underlying economics, which actually is how we run the company. However, accounting practices are not widely understood, are changed too frequently and are too susceptible to interpretation and manipulation. Sometimes, they even inadvertently determine U.S. government policy.

We generally like fair value accounting

For assets that are bought and sold, fair value accounting creates the best discipline. Fair value accounting (often referred to as mark-to-market accounting) already provides for some flexibility if recent prices are under highly distressed conditions. In such cases, good judgment and sound fundamental cash flow-type evaluations can be employed to value certain assets. However, in our opinion, the application of fair value accounting for certain categories needs to be reconsidered. For example:

• We now have to mark to market our private equity investments by using potentially artificial benchmarks. These investments, by their nature, are very illiquid and are intentionally held for several years. To mark them to market, proxies made up of comparable companies are used, and appropriate discounts and judgment are applied. Essentially, we write these investments up when markets are good and write them down when markets are bad. But I am fairly confident that this approach is not always right. In many instances, cost is the best proxy for fair value. We would rather describe our investments to our shareholders, tell them when we think these investments might be worth more and, certainly, write them down on our financial statements when they have become impaired.
• A new mark-to-market rule addresses "debit valuation adjustments." Essentially, we now have to mark to market credit spreads on certain JPMorgan Chase bonds that we issue. For example, when bond spreads widen on JPMorgan Chase debt, we actually can book a gain. Of course, when these spreads narrow, we book a loss. The theory is interesting, but, in practice, it is absurd. Taken to the extreme, if a company is on its way to bankruptcy, it will be booking huge profits on its own outstanding debt, right up until it actually declares bankruptcy - at which point it doesn't matter.
• It is becoming increasingly more difficult to compare mark-to-market values of certain instruments across different companies. While it's too involved to go into detail here, different companies may account for similar mark-to-market assets differently. This needs to be addressed by ensuring that companies adhere to consistent valuation principles while applying the rules.
• Fair value accounting does not and should not apply to all assets. Investments or certain illiquid assets that are intended to be held for the longer term (like real estate or plant and equipment) or loans and certain assets that are shorter terms (like receivables or inventory) all could actually to marked to market. There are, in fact, markets for some of these assets, and others could be calculated based on reasonable assumptions; for example, a farm would be worth more when corn prices go up, and a semiconductor plant would be worth less when semiconductor prices go down. However, if we marked these assets in this way, they would have wildly different prices depending on the health of the economy or the swings in prices for their output. While accounting should recognize the real impairment in the value of assets, marking the aforementioned assets to market every day would be a waste of time. Under this scenario, it would be quite hard for companies to invest in anything illiquid or to make long-term investments.

New accounting rules that have the potential to inadvertently affect how the capital markets function or change fundamental long-term U.S. government policies should be made thoughtfully, deliberately and with broad input

For example, we all believe that companies should have fully funded pension plans; i.e., the actual assets in the plan should be enough to meet a fair estimate of the liabilities. Years ago, if this wasn't the case, companies were allowed to maintain a "deficit" and fund it over several years. That deficit was not recorded on the financial statement of the company.

A change in accounting rules dictated that the deficit should not just be a footnote in the financial statements but that it should be reflected directly in the equity account of the corporation. Clearly, in very bad markets, these deficits grow dramatically, thus depleting the increasingly precious capital that companies have. (This is just another example of a pro-cyclical force). When companies realized they were getting enormous volatility in their capital account, they began to curtail or eliminate their pension plans in favor of 401(K) plans (where the individuals bears all the investment risk). This was a rational, precautionary step. But it, in effect, transferred the risk from the company to the individual. No longer did the large corporations assume the risk of providing a steady income stream to retired employee. Instead, the risk was passed to the individuals - many of whom could not afford it.

This is a perfect example of how accounting inadvertently sets policy. And, in my opinion, this was probably the wrong policy for the country. There would have been many ways to be true to the economic purpose of accounting without making a detrimental policy change. There are countless other example, and we hope regulators and accountants will eventually find better ways to apply accounting principles.

G. The need for appropriate counter-cyclical policies

During this crisis, it became evident that our system created enormous pro-cyclical tendencies. In fact, I can't think of one counter-cyclical policy at all (other than emergency actions taken by the government). Accounting policies such as mark-to-market and loan loss reserving are pro-cyclical. Basel II capital requirements are pro-cyclical. Regulatory and legal requirements are pro-cyclical. Repo and short-term financing are pro-cyclical. The one pro-cyclical tendency we probably can never correct is that of the market itself (i.e., the cost of capital goes way up in a downturn or investors refuse to finance less liquid assets). I have heard many good ideas about how to create some counter-cyclical policies and will focus on three here.

Loan loss reserving can easily be made counter-cyclical

I find it absurd that loan loss reserves tend to be at their lowest point precisely when things are about to get worse. As things get worst and charge-offs rise dramatically, one must dramatically increase loan loss reserves, thus depleting capital rapidly. This problem would be solved if banks were allowed to estimate credit losses over the life of their loan portfolios. Reserves should be maintained to absorb those losses. This would enable banks to increase reserves when losses are low and utilize reserves when losses are high. Transparency would be fully preserved because investors and regulators would still see actual charge-offs and nonperformers. This would require a rational explanation about the appropriateness of the lifetime loss estimates. It also would have the positive effect of constantly reminding CEOs, management teams and investors that bad times, in fact, do happen - and that they should be prepared for such events.

Repo and short-term financing can easily be made counter-cyclical

All banks now have access to the standard financing facilities for securities and loans via the Federal Reserve (i.e., the Fed will lend a specific amount of money against specific assets). A suggestion is this: If an institution provides financing to clients in excess of what the Fed would lend to the bank for the same securities, it would have to be disclosed to risk committees and the company's Board of Directors. The Fed then would have two major tools to reduce leverage and in a way that is counter-cyclical - it could charge higher capital costs to a bank when the bank is lending more than the Fed would lend or the Fed could reduce the amount it would lend to the banks. Market players would still be free to provide credit and leverage as they see fit.

Banks should have the ability to implement counter-cyclical capital raising with rapid rights offerings

Banks and possibly other companies would be aided by having the ability to effect rights offerings at a moment's notice. Regulations should facilitate such offerings - with the proper disclosure - in a matter of days rather than weeks. This would allow a company to raise capital and repair a balance sheet that might have been stretched by unanticipated market events and to do so in a manner that is fair and does not dilute the company's existing shareholder base.

H. The need for policies in health care, pensions, energy and the environment, infrastructure and education that will serve us well over time

Beyond the financial crisis, there are several important issues that will dictate whether or not the United States will continue to thrive over the next century. We believe our nation can and should be able to provide health care coverage for all. It is the right thing to do, it will help us build a stronger nation, and, if done properly and efficiently, we believe it ultimately will be cheaper than the current course we are on. On energy, we now have experienced our third major crisis, and we, as a nation, still have not executed a sensible long-term energy policy. Again, we believe that done right, an energy policy could be economically efficient, create great innovation, reduce geopolitical tensions and improve our environment. Similarly, we need to improve our nation's infrastructure and develop an education system that befits our heritage.

We can't fall into the trap of institutional sclerosis - now is the time to act. In the past, this nation has shown the fortitude to work together to accomplish great things, and we need to do that again. For our part, JPMorgan Chase are doing everything we can to be helpful to our leaders on all these issues.

Jamie Dimon: Fundamentals Causes and Contribution to the Financial Crisis

By Jamie Dimon, Chairman and CEO of J.P. Morgan

After Lehman's collapse, the global financial system went into cardiac arrest. There is much debate over whether Lehman's crash caused it - but looking back, I believe the cumulative trauma of all the aforementioned events and some large flaws in the financial system are what caused the meltdown. If it hadn't been Lehman, something else would have been the straw that broke the camel's back.

The causes of the financial crisis will be written about, analyzed and subject to historical revisions for decades. Any view that I express at this moment will likely be proved incomplete or possible incorrect over time. However, I still feel compelled to attempt to do so because regulation will be written soon, in the next year or so, that will have an enormous impact on our country and our company. If we are to deal properly with this crisis moving forward, we must be brutally honest and have a full understanding of what caused it in the first place. The strength of the United States lies not in its ability to avoid problems but in our ability to face problems, to reform and to change. So it is in that spirit that I share my views.

Albert Einstein once said, "Make everything as simple as possible, but not simpler." Simplistic answers or blanket accusations will lead us astray. Any plan for the future must be based on a clear and comprehensive understanding of the key underlying causes of - and multiple contributors - to the crisis, which include the following:

• The burst of a major housing bubble
• Excessive leverage pervaded the system
• The dramatic growth of structural risks and the unanticipated damage they caused
• Regulatory lapses and mistakes
• The pro-cyclical nature of virtually all policies, actions and events
• The impact of huge trade and financing imbalances on interest rates, consumption and speculation

Each main cause had multiple contributing factors. As I wrote about these causes, it became clear to me that each main cause and the related contributors could easily be rearranged and still be fairly accurate.

It was also surprising to realize that many of the main causes, in fact, were known and discussed abundantly before the crisis. However, no one predicted that all of these issues would come together in the way that they did and create the largest financial and economic crisis of our lifetime.

Even the more conservative of us, and I consider myself to be among them, looked at the past major crisis (the 1974, 1982, and 1990 recessions; the 1987 and 2001 market crashes) or some mix of them as the worst-case events for which we needed to be prepared. We even knew that the next one would be different - but we missed the ferocity and magnitude that was lurking beneath. It also is possible that had this crisis played out differently, the massive and multiply vicious cycles of asset price reductions, a declining economy and a housing price collapse all might have played out differently - either more benignly or more violently.

It is crucial to understand that the capital markets today are fundamentally different than they were after the World War II. This is not your grandfather's economy. The role of banks in the capital markets has changed considerably. And this change is not well-understood - in fact, it is fraught with misconceptions. Traditional banks now provide only 20% of total lending in the economy (approximately $14 trillion of the total credit provided by all financial intermediaries). Right after World War II, that number was almost 60%. The other lending has been provided by what many call the "shadow banking" system. "Shadow" implies nefarious and in the dark, but only part of this shadow banking system was in the dark (i.e., SIVs and conduits) - the rest was right in front of us. Money market funds, which had grown to $4 trillion of assets, directly lend to corporations by buying commercial paper (they owned $700 billion of commercial paper). Bond funds, which had grown to approximately $2 trillion, also were direct buyers of corporate credit and securitizations. Securitizations, which came in many forms (including CDOs, collateralized loan obligations and commercial mortgage-backed securities), either directly or indirectly bought consumer and commercial loans. Asset securitizations simply were a conduit by which investment and commercial banks passed the loans onto the ultimate buyers.

In the two weeks after the Lehman bankruptcy, money market and bond funds withdrew approximately $700 billion from the credit markets. They did this because investors (i.e., individuals and institutions) withdrew money from these funds. At the same time, bank lending actually went up as corporations needed to increasingly rely on their banks for lending. With this as a backdrop, let's revisit the main causes of this crisis in more detail.

A. The burst of a major housing bubble

U.S. home prices have been appreciating for almost 10 years - essentially doubling over that time. While some appreciation is normal, the large appreciation, in this case, and the ultimate damage it caused were compounded by the factors discussed below.

New and poorly underwritten mortgage products (i.e., option ARMs, subprime mortgages) helped fuel asset appreciation, excessive speculation and far higher credit losses

As the housing bubble grew, increasingly aggressive underwriting standards helped drive housing price appreciation and market speculation to unprecedented levels. Poor underwriting standards (including little or no verification of income and loan-to-value ratios as high as 100%) and poorly designed new products (like option ARMs) contributed directly to the bubble and its disastrous aftermath.

Mortgage securitization had two major flaws

In many securitizations, no one along the chain, from originator to distributor, had ultimate responsibility for the results of the underwriting. In addition, the poorly constructed tranches of securitizations that comprised these transactions effectively converted a large portion of poorly underwritten loans into Triple A-rated securities. Clearly, the rating agencies also played a key role in this flawed process. These securitizations ended up in many forms; the one most discussed is CDOs. Essentially, these just added a lot more fuel to the fire.

While most people are honorable, excess speculation and dishonesty were far greater than ever seen before, on the part of both brokers and consumers

The combination of no-money-down mortgages, speculation on home prices, and some dishonest brokers and consumers who out-and-out lied will cause damage for years to come. This, in no way, absolves the poor underwriting judgements made by us and other institutions, and it certainly doesn't absolve anyone who mis-sold loans to consumers.

B. Excessive leverage pervaded the system

Over many years, consumers were adding to their leverage (mostly as a function of the housing bubble), some commercial banks increased theirs, most of the U.S. investment banks dramatically increased theirs and many foreign banks had the most leverage of all. In addition, increasing leverage appeared in:

• Hedge funds, many using high leverage, grew dramatically over time. Some of that leverage was the result of global banks and investment banks lending them too much money.
• Private equity firms were increasingly leveraging up their buyouts. Again, some banks and the capital markets lent them too much money.
• Some banks (and other entities) added to their leverage by using off-balance sheet arbitrage vehicles, like SIVs and leveraged puts.
• Nonbank entities, including mortgage banks, CDO managers, consumer and consumer finance companies, and even some bond funds, all increased their leverage over time.
• Even pension plans and universities added to their leverage, often in effect, by making large "forward-commitments." Basically, the whole world was at the party, high on leverage - and enjoying it while it lasted.

C. The dramatic growth of structural risks and the unanticipated damage they caused

I believe there are four structural risks or imbalances that grew and coalesced to cause a "run on the bank." But this was not a traditional bank run - it was a run on our capital markets, the likes of which we had never experienced. After Lehman's bankruptcy, many parts of our capital markets system stopped providing any capital to the market at all, If the crisis had unfolded differently, then perhaps the events that followed would not have occurred. Surely no one deliberately built a system with these fundamental flaws and imbalances. Clearer heads will understand that much of this was not malfeasance - our world had changed a lot and in ways that we didn't understand the full potential risk. But when the panic started, it was too much for the system to bear.

Many structures increasingly allowed short-term financing to support illiquid assets

In essence, too much longer-term, non-investment grade product was converted into shorter-term Triple A-rated product. Some banks, hedge funds, SIVs, and CDOs were using short-term financing to support illiquid, long-term assets. When the markets froze, these entities were unable to get short-term financing. As a result, they were forced to sell these illiquid assets. One of the functions of banking and the capital markets is to intermediate between the needs of investors and issuers. This triggers a normal conversion, either directly or indirectly (through securitizations) of longer-term, illiquid assets held by the issuers, who need to finance the business into the shorter-term, higher-grade product that most investors want. Clearly, over time, this imbalance had grown too large and unsupportable.

Money market funds had a small structural risk, which became a critical point of failure

Money market funds promise to pay back 100% to the investor on demand. Many money market funds invested in 30 to 180 day commercial paper or asset-backed securities that under typical circumstances could be sold back at par. In normal times, investors demanded their money in fairly predictable ways, and funds were able to meet their demands. Over time, money market funds grew dramatically to exceed $4 trillion. After Lehman collapsed, one money fund in particular, which held a lot of Lehman paper, was unable to meet the withdrawal demands. As word of that situation spread, investors in many funds responded by demanding their money. In a two-week period, investors pulled $500 billion from many money funds, which were forced to sell assets aggressively. To raise liquidity, these money funds essentially were forced to sell assets. As investors moved away from credit funds and into government funds, the banks simply were unable to make up the difference. This became one more huge rupture in the dike.

Repo financing terms got too loose, and too many illiquid assets were repo'ed

Over time, in those markets where financial companies financed their liquid assets, financial terms had become too lax. For example, to buy non-agency mortgage securities, financial institutions only had to put up 2%-5% versus a more traditional 15%-25%. The repo markets also had begun to finance fairly esoteric securities, and when things got scary, they simply stopped doing so. In the two weeks after Lehman's bankruptcy, more than $200 billion was removed from this type of financing, by both investors and banks. Once again, financial institutions had to liquidate securities to pay back short-term borrowing - thus, another rupture in the dike.

Investors acted wisely to protect themselves, but the system couldn't handle them all doing it at the same time

Individual investors, corporations, pension pans, bond and loan funds, money market funds and others - all acted in their own self-interest, and all individually acted wisely. But collectively, they caused enormous flows out of the banking and credit system. Regardless of whether the funds came out of a bank, a money fund, or a bond or loan fund, the fact remains that the cumulative result was a severe shortage of necessary credit that was removed from the system. Clearly things had changed. In the past, regulators had focused on preventing a systemic collapsed of the main intermediaries in the financial system; i.e., the banks. In this new world, however, we need to discuss how to protect ourselves not only from runs on banks but also from runs on other critical vehicles in the capital and financial markets.

D. Regulatory lapses and mistakes

With great hesitation, I would like to point out that mistakes also were made by the regulatory system. That said, I do not blame the regulators for what happened. In each and every circumstances, the responsibility for a company's actions rests with us, the CEO and the company's management. Just because regulators let you do something, it does not mean you should do it. But regulators have a responsibility, too. And if we are ever to get this right, it is important to examine what the regulators could have done better. In many instances, good regulation could have prevented some of the problems. And had some of these problems not happened, perhaps things would not have gotten this bad.

Unregulated or lightly regulated parts of the market contributed to the crisis

I've already discussed some of the flaws with money market funds and hedge funds - the latter were not regulated, and the former were lightly regulated. In addition, there are two large segments, among others, that - had they been regulated - could have helped the system avoid some problems.

• Much of the mortgage business was largely unregulated. While the banks in this business were regulated, most mortgage brokers essentially were not. In fact, no major commercial bank that was regulated by the OCC wrote ARMs (possibly the worst mortgage product). A very good argument could be made that the lower standards of the unregulated parts of the business put a lot of pressure on those players in the regulated part of the business to reduce their standards so they could compete. In this case, bad regulation trumped good regulation.
• Insurance regulators essentially missed the large and growing one-sided credit insurance and credit derivative bets being made by AIG and the monoline insurers. This allowed these companies to take huge one-sided bets, in some case, by insuring various complex mortgage securities.

Basel II, which was adopted by global banks and U.S. investment banks, allowed too much leverage

It is quite clear now that the second of the Accords by the Basel Committee on Banking Supervision (known as Basel II), published in 2004, was highly flawed. It was applied differently in different jurisdictions, allowed too much leverage, had an over-reliance on published credit ratings and failed to account for how a company was being funded (i.e., it allowed too much short-term wholesale funding). In 2004, the five independent U.S. investment banks adopted Basel II under the jurisdiction of the Securities and Exchange Commission (this was not allowed by the banks regulated by the Federal Reserve or the OCC, which remained under Basel I). The investment banks jettisoned prior conservative net capital requirements and greatly increased their leverage under Basel II. And the rest is history.

Perhaps the largest regulatory failure of all time was the inadequate regulation of Fannie Mae and Freddie Mac

The extraordinary growth and high leverage of Fannie Mae and Freddie Mac were well-known. Many talked about these issues, including their use of derivatives. Surprisingly, they had their own regulator, which clearly was not up to the task. These government-sponsored entities had grown to become larger than the Federal Reserve. Both had dramatically increased their leverage over the last 20 years. And, amazingly, a situation was allowed to exist where the very fundamental premise of their credit was implicit, not explicit. This should never happen again. Their collapse caused damage to the mortgage markets and the financial system. And, had the Treasury not stepped in, it would have caused damage to the credit of the United States itself.

Too many regulators - with overlapping responsibilities and inadequate authorities - were ill-equipped to handle the crisis

Our current regulatory system is poorly organized and archaic. Overlapping responsibilities have led to a diffusion of responsibilities and an unproductive competition among regulators, which probably accelerated a race to the bottom. Many regulators also did not have the appropriate statutory authority (through no fault of their own) to deal with some of the problems they were about to face. One large, glaring example revealed by the collapse of Bear Stearns and Lehman was the lack of a resolution process in place to deal with failure of investment banks. If commercial banks fail, the FDIC can take them over. This was not the case with investment banks. In addition, a resolution process needs to be in place for large, global financial companies that operate in many jurisdictions and use many different regulatory licenses.

E. The pro-cyclical nature of virtually all policies, actions and events

In a crisis, pro-cyclical policies make things worse. I cannot think of one single policy that acted as a counterbalance to all of the pro-cyclical forces. Although regulation can go only so far in minimizing the impact of pro-cyclical forces in times of crisis, we still must be aware of the impact they have. For example:

• Loan loss reserving causes reserves to be at their lowest level right when things take a turn for the worse. Therefore, as a crisis unfolds, a bank not only faces higher charge-offs but also has to add to its level of reserves, depleting precious capital.
• Although we are proponents of fair value accounting in trading books (a lot of the mark-to-market losses that people complained about will end up being real losses), we also recognize that market levels resulting from large levels of forced liquidations may not reflect underlying values. Certain applications of fair value accounting can contribute to a downward spiral where losses deplete capital, and lower capital causes people to respond by selling more, at increasingly lower values.
• The rating agencies made mistakes (like the rest of us) that clearly helped fuel a CDO and mortgage debacle. They also, in the midst of a crisis, continually downgraded credits. Lower ratings, in turn, required many financial institutions to raise more capital, thus adding to the vicious cycle.
• In bad times, the market itself demands both an increase in capital and more conservative lending. We may not be able to change this phenomenon, but there are steps we can take to ensure that the system is better prepared for it.
• Financial arrangements allow the most leverage in good times, but they force a dramatic reduction in leverage in bad times.
• As capital markets volatility increases, Basel II capital calculations and many risk management tools, like Value-at-Risk, demand that more capital be held to own securities or loans.

F. The impact of huge trade and financing imbalances on interest rates, consumption and speculation

I suspect when analysts and economists study the fundamental causes of this crisis, they will point to enormous U.S. trade deficit as one of the main underlying culprits. Over an eight-year period, the United States ran a trade deficit of $3 trillion. This means that Americans bought $3 trillion more than they sold overseas. Dollars were used to pay for the goods. Foreign countries took these dollars and purchased, for the most part, U.S. Treasuries and mortgage-backed securities. It also is likely that this process kept U.S. interest rates very low, even beyond Federal Reserve policy, for an extended period of time. It is likely that this excess demand also kept risk premiums (i.e., credit spreads) at an all-time low for an extended period of time. Low interest rates and risk premiums probably fueled excessive leverage and speculation. Excess consumption could be finance cheaply. And adding fuel to the fire, in the summer of 2008, the United States had its third energy crisis - further imbalancing capital flows.

There have been times when large imbalances - such as those in trade - sort themselves out without causing massive global disruption. However, it is bad planning and wishful thinking to assume that this will always be the case. These imbalances shouldn't be allowed to get that large - they create too much potential risk.

Many other factors may have added to this storm - an expensive war in Iraq, short-selling, high energy prices, and irrational pressure on corporations, money managers and hedge funds to show increasingly better returns. It also is clear that excessive, poorly designed and short-term oriented compensation practices added to the problem by rewarding a lot of bad behavior.

The modern financial world has had its first major financial crisis. So far, many major actors are gone: many of the mortgage brokers, numerous hedge funds, Wachovia, WaMu, Bear Stearns, Lehman and many others. Some of the survivors are struggling, particularly as we face a truly global, massive recession - and it still is not over.

Robert Wilmers: Regaining Confidence

By Robert Wilmers, Chairman & CEO, M&T Bank

My focus, above, has been, as it must be, on M&T own situation. But no discussion of an individual bank's results nor strategy can ignore the extraordinary time in which we find ourselves, a time in which there has developed a crisis of confidence in the financial services industry. It is a crisis which has already prompted unprecedented forms of government intervention but calls for more - much more - action to ensure the long-term health of our capital markets. Regulatory reform will simply not be sufficient nor effective if its focus is confined to historically "covered" financial institutions such as banks. Put simply, nothing we do to "fix" our banks will be enough to allow investor and consumer confidence to return. That is so because, over the course of the past three decades, there has been nothing less than a sea-change in the world of lending, a change which has helped create the sorts of risk - and need for regulatory reform - we face today. Indeed, despite the well-publicized problems of specific banks, the so-called financial meltdown we've experienced over the past two years was owed much more to the investments of what can be call a new, shadow banking system - a system which has actually outstripped traditional banking as a source of credit and yet has been beyond the reach of the regulatory system's standards for safety and soundness. At the same time, it influenced the business approach of traditional banks. Yet regulatory has remained stuck in the past as the world has changed around it.

Consider the fact that, in 1978, commercial banks and thrifts held 71% of all private, non-governmental U.S. loans. Since then, the amount of credit extended not by banks but by other parts of the private sector has grown more than three and a half times as much as that provided by the banking system. Indeed, as of the end of the third quarter of 2008, commercial bank loans accounted for just $6.9 trillion of the estimated $20.3 trillion in private U.S. financial sector loans outstanding. This reflects the fact that throughout the 1980s and 1990s, a new idea about lending took hold and grew. Securitized credit outstanding grew nearly 50-fold from 1980 to 2000 - compared to a mere 3.7 times for commercial bank loans over the same period. Its essential idea: that loans could be sliced, diced and packaged in large groups, to serve as the basis of debt to be sold in the securities markets. This new approach began with mortgage-banked securities, but grew to include a variety of assets. The concept was little short of revolutionary. It meant that bank deposits would no longer be the only - or even the chief - funding source for credit. Instead, loans of all sorts would effectively be financed by the capital markets - and packed and sold by Wall Street. In the watershed year of 1998, bank lending was, for the first time, surpassed by what some call synthetic products sold in the capital markets.

Who was responsible for this huge new universe of lending? The answer to this question is crucial in understanding what form new financial services industry regulation must take. The key actors were a vastly increased number of investment firms far outside the purview of federal or state regulators. The number of unique, identifiable hedge funds increased from fewer than 50 in the early 1980s to 22,650 in 2007. In that same period, their assets under management grew from less than $1 billion to $2.1 trillion. The securitized debt in which they were investing proved, we found out too late, to be laced with risky mortgages, bundled into securities which rating agencies - with their own financial incentives to do so - gave their highest seal of approval.

This is simply not clearly understood by the public - which continues to think of banks as the primary source of credit - and has not been well-explained by political leaders. Thus, regulators have continued to fix their gaze - indeed, to micro-manage - traditional financial institutions such as banks, even as the ground has shifted beneath the entire industry. Banks found themselves on an unlevel playing field compared to others under no obligation to make clear the extent to their debt nor its relationship to their liquid assets. Notwithstanding the need to deal with immediate problems, we must not, in the wake of our financial crisis, fail to review and update the rules of the game. Just as the Depression of the 1930s led to the establishment of the Securities and Exchange Commission and the Federal Deposit Insurance Corporation, so must this current crisis spur regulatory innovation. It is no special pleading on the part of a bank chief executive to assert we must restore the balance of regulatory oversight between commercial banks and other parts of the financial services industry. We should do so not in order to be fair to banks but because the nation's problems won't be solved unless solutions are directed at the entire financial system, not just one-third of it.

So it is that we need a new generation of regulation to extend the time-honored principles of safety, soundness and transparency to what has become a virtual casino of lending. All the players must be included. Investment banks, hedge funds, and other investment vehicles - who are the ones who sparked the securitization boom - must be overseen. The rating agencies which enabled the lending casino to operate by certifying as top quality what turned out to be high-risk bonds, must operate under a new business model: they must be paid by those who might purchase bonds, not by those issuing them. They, too, must be regulated. Complex derivatives, such as credit-default swaps - which ostensibly provided insurance for high-risk investments - must be brought out of the shadows, into a public clearinghouse, such that markets can know their magnitude and extent. (The market for credit-default swaps is estimated to have grown from $500 billion in 1998 to $54.6 trillion in 2008.) At the same time that huge flows of capital must come under a broader regulatory regime, so too, must all players. The activity of U.S. mortgage brokers, for instance - whose number increased from 9,000 in 1988 to 54,000 in 2005, played a key role in the subprime debacle and must have some sort of supervision.

We are neither fond of regulation nor quick to call for more of it. But it is neither consistent nor wise to subject banks to regulation that can only be called intrusive and excessive while the rest of the financial services sector operates in a Wild West environment. There is simply no justification for the exclusion from regulation of any major pools of capital which, if poorly managed, could threaten the smooth functioning of the financial system as a whole.

Apart from the extension of regulatory oversight to what has become a vast shadow banking system, so, too, must we bring common sense to accounting as it affects all financial institutions. This must include, first and foremost, the re-examination of the appropriateness of so-called mark-to-market accounting for balance sheet purposes, in periods of illiquid markets, The ability to reasonably determine the fair value of certain assets in times of economic uncertainty is, at best, severely limited - when those that previously made markets in such assets, for all practical purposes, have gone fishing. No serious observer, however, believes that the long-term value of securities which continue to perform is as low as mark-to-market rules would dictate.

The fact that we must "mark to market" current securities which were highly rated when we bought them, with the intention of holding them for the long haul and which, indeed, continue to pay returns forces us to maintain additional capital. Moreover, marking to market leads to a false picture of our health, as measured by the tangible common equity ratio. It is worth nothing that if such requirements were imposed on the loans we make each day to our customers the entire commercial banking system would have already collapsed, for a loan made today, to even the highest-rated borrower, can only be sold at a considerable discount to its face value, in today's dislocated markets. Such irrational rule making inhibits us from doing exactly what government asserts is the use to which it wants public funds it has injected into the banking system to be dedicated: lending. We will not, however, lend for the sake of lending, especially to those with poor credit histories. We know all too well the consequences of so-called well-capitalized institutions extending credit to borrowers without ability to repay. That's how we got into this mess in the first place.

It is important, moreover, to keep in mind that mark-to-market accounting has not, historically, been standard practice. Indeed, for more than 60 years after the Depression era, the Securities and Exchange Commission resisted adopting such "fair value" accounting, out of concern that such numbers were more subjective than reliable. Having seen its effects, we need not be adverse to reform out of fear that such change would undermine accounting integrity.

Similarly, it is past time to adjust the approach to loan loss reserve requirements imposed by the Securities and Exchange Commission - and which led the banking industry to enter a recession with the level of reserves close to an all-time low. Concern about such phenomena as earnings-smoothing, which preoccupied regulators earlier in the decade, are far removed from our present situation. Indeed, the idea that we should worry about banks putting too much into their loss reserves is hard to understand today. Regulators must recognize that loan loss provision is a matter of judgment; there is simply no way to assess a portfolio of loans and be able to know - with scientific precision - which loans will perform and which will not. Sound judgment will likely lead to a conservative approach - but it is just an approach which regulators have discouraged because of an exaggerated fear of earnings manipulation. It is worth keeping in mind that loan loss reserves are clearly disclosed - such that investors can make up their own minds about the judgment of management. Armchair quarterbacking by regulators has been ill-advised, never more so than now.

In light of the problems associated with mark-to-market-accounting and the formulaic approach to loan loss reserves - not to mention the regulatory failure which allowed a now-infamous $50 billion investment "Ponzi" scheme to go undetected - the time would seem right for a thorough review of the policies and procedure of the SEC. Regulators should take stock of their own performance - and, in that context, it is well worth nothing the concentration of problems which surfaced in the past year in institutions overseen by the Office of Thrift Supervision (OTS). A handful of major thrift institutions regulated by the OTS accounted for the lion's share of payments to depositors which had to be made by the FDIC. Indeed, just four large thrifts accounted for $355.6 billion or 95.6% by assets of the failures in 2008.

This poor quality of oversight has led to sharply-increased-premiums for FDIC member banks such as M&T; we anticipate paying an additional $37 million in such premiums in 2009 over and above those we paid in 2008. It is worth considering whether to abolish the OTS and fold its duties into the portfolio of another, more effective agency.

At the same time we consider long-term regulatory changes, we continue to be confronted by an immediate crisis. It is crucial to make sure that the extraordinary steps being taken to address that crisis do not actually make things worse. The record to date is not altogether reassuring. Consider the Troubled Asset Relief Program, or TARP, the so-called bank "bailout" through which the federal government has injected capital, in exchange for preferred shares in 364 commercial banks and thrifts, including M&T, whose FDIC-insured institutions hold two-thirds of all bank and thrift assets. TARP funs had brought with them to lend at a time when there is limited loan demand - and when we have already added $2.4 billion to our loans in the past year. Indeed, we have not been alone in doing so. For the 12-month period ending September 30, 2008, total loans held by U.S. commercial banks increased by $562 billion. In contrast, over the same period, credit provided by issuers of asset-backed securities, major players in the "shadow" banking industry, fell - by some $320 billion. It may appear that banks are not lending - but that impression is the result of near-collapse of what I have called the shadow banking industry.

It is, in other words, exactly wrong for public officials and the press to complain that the injection of government funds - through the TARP - has not solved our credit crisis because banks are not doing their part.

But when the public complains about banks and the TARP program, it may really be making a broader point. The emergency program was sold as a way to help the little guy - and the large number of homeowners who are in trouble are seeing precious little relief. Finding a way to provide that relief will not be easy, in substantial part due to the complex structure of mortgage-backed securities, on the one hand, and the way mortgages are serviced by independent institutions, on the other - not to mention the financial meltdown which has hit middle America. It's an imposingly complex problem whose solution will demand changes in rules, regulations and even laws - and both creativity and competence in the government approach to helping those in distress.

It's good to see the new Administration working hard, and with imagination, on the problem. As officials do so, however, we hope they keep in mind that the banking industry whose help they will need includes more than just a handful of large institutions. A quasi-oligopoly has emerged among commercial banks - indeed, the top four banks now have a larger percentage of total assets (52%) than all others combined. That's both impressive and distressing. And indeed, these four, together with two other institutions which were granted a fast track to bank holding company status, have received $165 billion or 54% of all TARP funds. Including three other, non-bank institutions that participated, the total increases to $229.8 billion or 75.3% of TARP funds distributed to date. It is these same few institutions or those that they acquired in the past year, or those that have gone bankrupt during the same period, that totally dominated the shadow banking market through their leadership and creativity. It is also their compensation policies that have sullied the reputation of the other 8,341 banks and thrifts in the U.S. that have done the right thing, day in, day out, in their communities. Indeed, one has to raise the question whether allowing the creation of a banking oligopoly is prudent public policy, particularly as it is logical to assume that by dint of size these same institutions would provide leadership to the industry. If past is prelude, one must question whether they will provide the moral tone that leadership demands and what our society expect of its banks.

The goal of public policy in this time of crisis must not be to preserve specific financial institutions - but to restore health to the financial services industry as a whole. We are optimistic that the team assembled by the new Administration in Washington can do just that. We all shape the hope that a thoughtful approach, one which recognizes the changes that have occurred over the past two decades and that revisits the structure and regulation of our financial system, will help restore confidence in our markets It is such confidence on which M&T - and all America - will depend.

Warren Buffett's Live Lunch Interview on CNBC with Becky Quick

Warren Buffett appeared live on CNBC with Becky Quick today, Wednesday, June 24, 2009.

Buffett told us the economy is in a "shambles" with no signs of a recoveryanytime soon. He also criticized Apple for not disclosing earlier that CEO Steve Jobs had received a liver transplant.

Here's the video.

Warren Buffett Gives Advice to Girl Scouts at Dairy Queen

Surrounded by a group of Girl Scouts in his hometown of Omaha, Neb., Buffett offered this tip for college students:

“The biggest suggestion I have is to avoid credit cards. Interest rates are very high on credit cards. Sometimes they are 18 percent. Sometimes they are 20 percent. If I borrowed money at 18 or 20 percent, I’d be broke… So if I had one piece of advice for young people generally it would be to just avoid credit cards.”

And what advice does Buffett have for a new investor?

“I would do a lot of reading before I invested. In other words I would prepare for it. I wouldn’t jump in the water until I know how to swim… I read every book the Omaha Public Library had about investing by the time I was 11.

On qualities Buffett looks for in employees?

“The biggest thing I look for is if they have a passion for whatever they are going to do.

Ingredients for greatness

What makes Tiger Woods great? What made Warren Buffett the world's best investor? Each was a natural who came into the world with a gift for doing exactly what he ended up doing. Buffett was known to say, he was "wired at birth to allocate capital." It's a one-in-a-million-thing. You've got it or you don't. But well folks, it is not as simple. For one thing, you do not possess a natural gift for a certain job, because targeted natural gifts don't exist. No one is a born CEO, investor or chess grandmaster. You can only achieve greatness through an enormous amount of hard work over many years, at times, both demanding and painful. Buffett, for instance, is famed for his discipline and the hours he spends studying annual reports, reading 5 newspapers a day, and reading lots of books. The good news is that your lack of a natural gift is irrelevant - talent has little to do with greatness. You can make yourself into any number of things that you have a passion for and be great in it.

Scientific experts are producing remarkably consistent findings across a wide array of fields. Talent doesn't mean intelligence, motivation or personality traits. It's an innate ability to do some specific activity especially well. How can some people able to go on improving? The truth may lies by what is uncovered by scientists' observations on great performers across a diverse field.

NO SUBSTITUTE FOR HARD WORK

The first major conclusion is that nobody is great without work. It is nice to believe that if you find the field where you're naturally gifted, you'll be great from day one, but it doesn't happen. There's no evidence of high-performance without experience or practice.

Evidence shows that even the most accomplished people need around 10 years of hard work before becoming world-class.

The ten-year rule is a rough estimate, and most researchers regard it as a minimum, not an average. In many fields, like music, literature, elite performers need 20 or 30 years experience before hitting their zenith.

So greatness is not presented on a platter. It requires a lot of hard work but yet that isn't enough since many people who work hard for decades cannot even sniff greatness. What's missing?

PRACTICE MAKES PERFECT

The best people in any field are those who devote the most hours to what the researchers call "deliberate practice." It's an activity that's explicitly intended to improve performance, that reaches for objectives just beyond one level's of competence, provides feedback on results and involves high levels of repetition.

For example, simply hitting a bucket of balls is not deliberate practice, which is why most golfers don't get better. Hitting an eight-iron 300 times with a goal of leaving the ball within 20 feet of the pin 80 percent of the time, continually observing results and making appropriate adjustment, and doing that for hours every day - that's deliberate practice.

Do it regularly - like you would bath every day - not sporadically.

For most people, work is hard enough without pushing even harder. Those extra steps are so difficult and painful they almost never get done. That's the way it must be. If great performance were easy, it wouldn't be rare. Which leads to the deepest question about greatness. While experts understand an enormous amount about the behavior that produces great performance, they understand very little about where that behavior comes from. Some people are much more motivated than others but why - something yet to be answer.

David Novak, CEO and Chairman of YUM! Brands, says, "If it can happen to me, it can happen to you. I believe that you are only as good as you think you are, and that only you can hold your back, that positive thinking is self-fulfilling, and that you become what you think you can become. That in a nutshell is what will inspire you to know your stuff, give you real substance, and love what you do, which have always been the keys to success."

So the reality is that we are not hostage to some naturally granted level of talent. We can make ourselves what we will. Strangely, that idea is not well embraced or popular. People hate abandoning the notion that would coast to fame and riches if they found their talent. But that view is tragically constraining, because when they hit life's inevitable bumps in the road, they conclude that they just aren't gifted and give up.

Maybe we can't expect most people to achieve greatness. It's just too demanding. But greatness isn't reserved for a preordained few. It is available to you and about everyone.

The ten commandments for business failure by Don Keough

Don Keough is a director of Berkshire Hathaway and chairman of Allen & Co, a New York investment firm. He is a retired president of the Coca Cola Company. 

Applying the basic wisdom of what the rustic said (in the prior post), figure out where I will die and ensure I walk around it and avoid it at all cost. Learn from others' failures. So here are the 10 commandments for guaranteed business failures as prescribed by Don Keough.

• 1) Quit taking risk. He who is overly cautious accomplish little. Of course, risk should only be taken on a calculated basis. It's the management's major task to prudently risk a company's present assets in order to ensure its future existence. 

• 2) Be inflexible. People who are inflexible are so set in their ways, so sure that they have the formula for success that they simply cannot see any other way of doing things (they cannot question and destruct their own well-loved ideas). Inflexibility is a crippling disease. A case in point involving a brilliant and legendary businessman, Henry Ford. Ford did not become the nation's richest man by inventing the automobile, or mass production. What made him a genius was his instinctive sense of mass marketing. He saw better than anyone at the time that if he could drive the cost down, the automobile could be transformed from a plaything of the rich into transportation for the masses. So to do that, he took two risks: 1) he kept reducing the profit per car in order to increase sales volume; 2) when the average wage for an automobile assembly-line worker was less than $2.50 a day, he announced in 1914 that he would pay his workers the unheard of wage of $5 a day. Ford had this idea that his workers could also be his customers - people who would both produce and consume the product. In paying $5 a day, overnight Ford increased the size of his market by paying his workers enough money to actually buy the product they were making. Yet in a few years, this genius who had been so visionary became so inflexible that he nearly ruined the company. He reportedly said, regarding the Model T, "They can have it in any color they want, as long as it is black." For a long time, that was just fine. But then people began to get tired of black. America was also roaring into the 1920s with bigger, faster, fancier, brightly painted automobiles. And Ford kept insisting that the Model T remain unchanged since 1908. He insisted that was what America wanted and needed and he was not going to change his mind. Inevitably, upstarts like Chevrolet and Dodge began to erode Ford's market and seriously challenge the company's dominant leadership. At last, more rational minds prevailed and Ford admitted the need to produce better vehicle. In 1928, he launched successful the Model A. But Ford's inflexibility had brought the company to the brink of disaster and cost it a competitive edge it has never regained. The story of failure of each company and industry is different. Some are more straightforward than others. It's obvious when you look back that in the early part of the 20th century that ice companies, no matter how they resisted, would have to find something else to do because they were going to be replaced by electric refrigeration. It is not quite obvious how the majority of more than 3000 bicycle companies just disappeared while others morphed into the automobile business, and even, as the Wright Brothers demonstrated, into the airframe business. Clearly some folks were more flexible than others. 

• 3) Isolate yourself. There're just a few things you need to do to create your own executive bubble. Start with your surroundings. Build your own bubble. Get yourself a great big office in some remote corner of the most remote executive floor and then shut the door. Never walk around the HQ office and talk to people. Don't bother to learn of your employee's name. Always lunch with only a few close members of your immediate staff in the executive dining room. Put a big sign: "Don't make the boss mad. Bring me no bad news." Create a climate of fear. With power comes responsibility, and power includes hiring and firing. Just scream and throw tantrums. Dress down people who make istakes in front of other people. Be rude. Act like a 2-year old child. To completely isolate yourself further, put yourself first in everything. When there's credit to be taken, take all of it. When there is blame to be taken, take none of it. If the spotlight of public attention turns toward your company, leap into that light and leave your employees and associates and everyone else who might have a helping hand way off in the wings. After you have hogged the limelight, in the unlikely event that you harbor some feelings of guilt, you can assuage some of those feelings by sending your hardest workers a nice X'mas card or something. Hogging the limelight does not guarantee failure but it does make great success very difficult. Among most truly successful people, they possess a self-effacing quality - an avoidance of the spotlight. If you read Warren Buffett's annual letters, you can't help but uncover that he lavished praise and credit on someone else. Strangely enough, it is when things go wrong that Warren comes on centre stage to assume responsibility. 

• 4) Assume Infallibility. Never admit a problem or a mistake. If something seems to be heading in the wrong direction, cover up, or better yet, wait until you have a full-blown crisis, then blame it on some external force - or blame it on someone else. Customers are frequently troublesome. You can always blame whatever goes wrong on them. Annual reports, particularly those to shareholders, is often a place you see CEOs shifting the blame to something or someone else. When a company had a disastrous year, the Chairman's letter is frequently an artful exercise in fingerpointing at any number of causes ranging from unforeseen currency fluctuations, to the unusually active hurricane season. You have certainly read, many times possibly, that "mistakes were made." Timbers were caving in, dust is in the air, and the person in charge of it all blithely asserts, "mistakes were made." Implied, of course, is, "But not by me." That's what sets Warren Buffett apart in his legendary annual letters. If in a particular year, performance is not quite up to previous years or what might have been expected, he is quick to say "It wasn't good and it was my fault." Despite his virtually unequalled record for profitably allocating capital, he lays no claim to infallibility. In his 1996 letter to shareholders, for example, Warren noted the problems with Berkshire's investment in USAir and commented, "In another context, a friend once asked me: 'If you're so rich, why aren't you smart?' After reviewing my sorry performance with USAir, you may conclude he had a point."

• 5) Play the game close to the foul line. If you play close to the foul line, you are not likely to inspire much trust on the part of your customers or employees and you will fail. Success is more permanent when you achieve it without destroying your principles as Walter Cronkite said. Trust is one quality Don wanted, not being loved or feared. Kmart and Wal-Mart were founded in the same year (1962). Yet Kmart filed for bankruptcy in 2002. Kmart had pursued a dangerous path, along the way, there were rumors and allegations of corruption and self-dealing on the part of executives. Indeed, a senior real estate executive with the firm was convicted of bribery. The truth is they played close to the line and in some cases, the court said they crossed it. One of the reasons corruption became more wide-spread, was because our whole social environment became less civil and more tolerant of bad behavior. In 1969, a famous experiment was conducted by Philip Zimbardo, a Stanford psychologist.  Two cars with no license plate and the hoods up were abandoned - one in the Bronx, New York and the other in Palo Alto, California. In the Bronx, the car was stripped and trashed in a matter of minutes. In Palo Alto, something quite different happened. For more than a week, the car sat there unmolested. But one day the psychologist himself took a sledgehammer and began smashing the car. Soon, passerby were taking turns with the hammer and within a few hours, the car was demolished. This experiment led to the "broken window" theory of crime - the idea that if a broken window is left unrepaired in a building, soon vandals will break the rest of the windows. According to the theory, it says "No one cares. Break a window and nothing happens to you. Break more. It's ok." To a degree, the business environment was suffering a similar fate. Little cracks in the body of ethics were being ignored. Another reason why corruption became more widespread is that we began to spend an inordinate amount of time catering to our valued friends who help to make "the market" - the Wall Street analysts.

• 6) Don't take time to think. 

• 7) Put all your faith in experts and outside consultants.

• 8) Love your bureaucracy. If you want to get nothing done, make that administrative concerns take precedence over all others. Leaders of complex organization walk a thin line. There must be rules and routines in every business to maintain the proper rhythm in everything. Over time, however, it seems that inevitably the rules and routines become more important than the ends they were designed to serve. The rules and routines become rigid, obsolete rituals and obstacles to the positive energy of the system. The bureaucrats who control these rituals guard them with their lives because any change undermines their own power or authority. Gradually, the bureaucrats simply can and often do become a major impediment to progress of any kind and guarantee failure. And they do look busy! They churn out internal reports and memos. They cover their backsides with trails of thousands of emails and memos in the file. They go home at night complaining of how hard they work and in reality no single productive event has taken place all day. In such enterprise, failure is guaranteed. In the cattle business, it was clear if you kept the right mix of male and female animals you would end up with a lot more animals. Bureaucracies multiply in the same way and here is how it works: You put a manager in place and within 18 months, he or she has an assistant. The assistant becomes a junior manager and guess what? Another assistant. The beat goes on. There are layers upon layers of people yet when the customer calls, nobody's home. They are all in meetings. These meetings generate more paperwork, more emails, more calls, more meetings. In fact, most often there are even meetings to plan meetings. Meetings are the religious services of a great bureaucracy and the bureaucrats are fervently religious.

• 9) Send mixed messages. Jack Welch had indicated that when he took over GE, the company was a jumble of mixed messages, with many longtime units on the brink of failure. At the Coca Cola Company in the 1970s, there were a number of situations where communication was, at best, misleading, especially to its employees and bottlers, but also to its retail customers. Like a parent who tells the child, "Clean your plate or no dessert!" The parent said it but didn't mean it. The child got dessert anyway. 

• 10) Be afraid of the future. Most people find it sensibly to be prudently cautious regarding the future. It is not a crime to be cautious but when caution becomes the overriding modus operandi in a business, it can precipitate failure. You see it in football. Near the end of the game, the team with the lead begins playing it safe, cautiously protecting their lead. They quit taking the same kind of risks that gave them the lead in the first place. And too often they lose in the final minutes of the game. To quit taking risk is a serious risk!

• Bonus commandment - Lose your passion for work and life. Nothing great in the world has been accomplished without passion. The old saying goes, "Tell me what you love and I'll tell you who you are." Love has been around a long time. The word comes from the ancient Vedic, or Hindu, word of the Sanskrit "lurb," meaning desire. A major component of happiness in the business world is finding something you love doing, whatever it might be, and then finding a way to do it. To have success you have to have a high level of unadulterated desire to get up and go to work. It's not that work has to be fun. That's a misconception promoted by some of the more giddy human resources people who like to talk about team spirit. Work, real work, is often very hard, exhausting at times. Rallying the troops is not telling people to have more fun. It's telling them to work harder because they are capable of doing better. They deserve for their own self-satisfaction to perform at a higher level. The hard work itself is what makes you tap-dancing into the office. It's that passion to solve the problems of the day. If you really want to fail, lose that passion for whatever it is you are doing. Get that spring out of your way. Say to yourself, "That's good enough." Or "That's not my job." Or "I don't care." Or "I'm retiring soon anyway." We all know people who have done this. They are the grey-faced automatons found in every workplace - the people who seem to stew in their own misery, cursing the darkness rather than lighting a candle. Even if they manage to make a good living, they are not successful - in fact failures - because they set such low expectations for themselves and those around them. All truly successful people express love for what they do and care about it passionately. They display such passion in their work so much so that if you asked them they'll tell you they can't imagine doing anything else. They seem almost so crazily focused on what they do. In recent times, it is common that one's career is span over many jobs at many different companies. It makes the notion of passion antiquated. How can you be passionate about anything that is going to last only a few years, and then you are going to move on to something else? What's the point besides getting more pay?