Blind Men Bluffed, and Won. We Lost.

In every economic boom and bust, there are winners and losers. Never before in American history, or any other history, have the winners won so much.

The big winners were in the financial industry. They profited enormously from the expansion of the money supply from August 1982 until March 2000. They rose in the corporate ranks during this period.

The stock market boom ended in March 2000. But the Federal Reserve continued to inflate, beginning in June. The federal funds rate was at 6.25% in June 2000. The FED forced it down to 1% by June 2003.

With this next wave of monetary inflation by the FED, the really big money began to be made by the financial industry. Profits became astronomical. So did CEO compensation.

Cracks in the system began to be apparent in mid-2007. In August, the credit markets suddenly seized up internationally. There had been little warning. This was as a result of the reduction of monetary inflation by the Federal Reserve, which had begun in February 2006, when Ben Bernanke replaced Alan Greenspan as the chairman of the Board of Governors.

It was clear to me by late 2006 that there was going to be an economic crisis. The expansion of money had lowered interest rates too far, and the semi-stabilization of the monetary base would inevitably produce a recession when rates rise, as they did. The recession took longer to arrive than what I had thought. I had expected it to arrive in 2007. It arrived in 2008. I had believed that real estate prices had peaked sometime in late 2005, and that prediction turned out to be true.

The wizards of finance got a wake-up call in August 2007. Nevertheless, they did not take it seriously. Within a month, stock prices resumed their upward move. They peaked at the end of October.

On November 5, I told my subscribers it was time to short the S&P 500. I told them that the end of the era had begun. When the S&P 500 fell from 1550 to 1500, I believed that this was the end of the line. Really, the end of the line had taken place in March 2000, when I issued by warning in “Remnant Review” that it was time to sell the NASDAQ. I was convinced then that stocks would not recover in this decade. If we discount the rate of price inflation since 2000, my expectation has proven to be correct. The S&P 500 index briefly exceeded the March 2000 figure — 1550 vs. 1529 — in late October, but price inflation of 20% had eroded the value of that later index.

But the wizards of finance did not believe this. They continued to receive their huge salaries and stock option bonuses. We have never seen a period in American history that matched the increase in executive pay that we saw from 2001 to 2007. It is mind-boggling.


In 1976, the total compensation for the average CEO in the United States was about 36 times the compensation of the average worker in their companies. This moved up steadily until 1993. In 1993, the average CEO was paid 131 times what the average worker was paid. At that point, the Securities and Exchange Commission issued a new rule. The new rule specified that companies release figures on what their CEOs were paid. The belief of the SEC bureaucrats was this: as soon as the disparity was visible to shareholders, CEOs would not continue to receive these high salaries and bonus packages. As with almost everything the government does, the result was exactly the opposite. Compensation for CEOs began to shoot upward. It became a matter of pride of a company that it paid its CEO more than some other company paid its CEO. By 2007, the average CEO made 369 times what the average worker made. This story appears in Prof. Dan Ariely’s book, Predictably Irrational (2008), pp. 16—18.

Nevertheless, most Americans paid no attention. The annual issue of “Forbes” in which executive pay is revealed to the public is probably the most popular issue of “Forbes.” Everybody wants to see who is being paid what. There were very few calls for reform of the system. The public perceived that it was not a matter of any concern to the Federal government. It was a matter of concern to the shareholders.

Today, however, there is outrage concerning the compensation packages that were given to the CEOs who led their companies into bankruptcy, merger, or government bailout. There are several of them who have received considerable attention. I intend to give them even more attention. But the reality is this: the reason why these men were given such outrageously high compensation is because the Federal Reserve System had pumped in so much money, and financial services had become wildly profitable because of this subsidy. CEOs began to be paid enormous amounts of money to supervise ever more arcane and complicated systems of debt-based finance that were cooked up by their high-paid economists. The Federal Reserve System was subsidizing financial services by providing fiat money at interest rates that were lower than the free market would have established, had there been no fiat money. The CEOs in the financial services industry saw their opportunities, and they took them.

In retrospect, these people have turned out to be blithering idiots. They are singled out by the financial media and the general media as being overpaid, blind, greedy, and destroyers of capital. They were all of these things. But why did they get away with this now? Why did the markets seem to validate what they were doing?

Warren Buffett identified derivatives as weapons of mass destruction. He was right. But he was ignored on this point for years.

What I find interesting is that the media keep blaming the securities regulatory agencies for having failed to call this process what it was, and to take steps to stop it. What we do not see is a detailed discussion of Federal Reserve policy under Alan Greenspan. Greenspan was hailed as a genius, the Maestro, the greatest Federal Reserve chairman of all time. Yet it was Greenspan, as no other Federal Reserve chairman before him, who was the architect of this gigantic failure of the financial markets. It was the Federal Reserve System, far more than the regulatory agencies that supervise stocks and bonds, that caused the boom, which has now turned into a bust. But the Federal Reserve System remains sacrosanct in the media. To call it into question now is to call into question the financial markets since 1914. To call it into question, and to identify it for what it is — the enforcement arm of the commercial banking cartel — would be to identify the heart of modern state capitalism. State capitalists own the media, and we are not about to get this story regarding the Federal Reserve System. Instead, we get stories of CEOs who made fortunes, received large severance pay, and walked away multi-multimillionaires. This makes for great news bites, and it also makes for exceedingly bad policies passed by Congress and enforced by the regulatory agencies from this time on.

The winners in this process I call the bluffers. To them I attach the phrase blind man’s bluff. They bluffed. They won personally, but their companies are destroyed or tottering. The shareholders lost. But that was the fault of the shareholders. To blame the government at this late date is silly. The shareholders did not complain for as long as they appeared to be getting rich from the rise in the value of their shares. It was only when share prices collapsed that shareholders became incensed.

The bailouts began in September 2008. The general public chimed in. How could these men have made so much money? The answer is simple: Federal Reserve inflation caused an economic boom in financial services.

These men were blind because they had been blinded. As early as 1912, Ludwig von Mises identified this process. He said that it is central bank policy to distort interest rates by creating new fiat money. This distortion leads entrepreneurs into making uneconomic allocations of capital. The blindness that afflicts entrepreneurs is caused by central bank policy. They are blind as a group, they prosper as a group, and they fail as a group, because they have been blinded as a group. In September 2008, the blindness was exposed for what it was. What was not exposed was the cause of their blindness.

If you want to see what CEOs have made, you can read the 2008 report in Forbes. The alphabetical list is here.


In early March, a week before the Bear Stearns bust and forced sale, three former CEOs appeared before a Congressional committee. They had been subpoenaed. They were Angelo Mozilo, former CEO of Countrywide Financial, Charles Prince of Citibank, and Stanley O’Neal of Merrill Lynch.

The day before, the committee had released a report that their combined compensation, 2002—2006, was $460 million. This did not count 2007, which was an even bigger bonanza for them. This was reported in a March 7 story on CNN/Money.

Their compensation was tied directly to the performance of the company, via stock and options that the executives have held over time. Prince, O’Neal and Mozilo argued that their pay was buoyed by impressive profits the companies delivered in the years leading up to the mortgage crisis. They also said that they have lost millions since as their companies have seen the price of their stock plummet in recent months.

The Congressmen were not sympathetic.

But also in focus were the cozy relationships between the directors responsible for determining pay and compensation consultants who get hired by directors to advise on executive pay, which was the centerpiece of an earlier hearing sponsored by the committee in December. Lawmakers have argued that these consultants are merely getting paid to tell the board and CEO what it wants to hear.

The pay consultants have been described by Buffett as the firm of “Ratchet, Ratchet, and Bingo.” Yet the fact remains that the CEOs’ companies went along with this. Shareholders could have sold at any time.

I recommended that they sell on November 5, 2007.

The article continued.

In December, Goldman Sachs (GS, Fortune 500) Chairman and CEO Lloyd Blankfein took home nearly $68 million in restricted stock, options and cash, making it the largest bonus ever given to a Wall Street CEO.

Chrysler Chairman and CEO Robert Nardelli made headlines when he was forced out of Home Depot (HD, Fortune 500) in January of last year and left with $210 million in cash, stock options and retirement benefits.


The story of Franklin Delano Raines was the first one to penetrate public consciousness when he left Fannie in 2004 under a cloud because of accounting irregularities. He later paid the government $24 million, $15 million of which was worthless stock options.

The most recent occupant at Fannie was Dan Mudd, son of Roger Mudd, and great-great something or other of Samuel Mudd, who treated John Wilkes Booth when he escaped from Washington. Dr. Mudd went to prison for this. Ever since, the phrase “his name is Mudd” has been handed down from generation to generation.

Dan’s name is still Mudd, but he will not go to prison. He walked away with $9.9 million for his leadership.

Richard Syron of Freddie did much better: $14.1 million.

These men were in charge of the biggest joint failure in American history, a loss so huge that no one can calculate it yet. If 20% of the $5 trillion portfolio is bad, this will require a trillion dollar bailout by the government.


Richard Fuld ran Lehman Brothers Holdings . . . into a brick wall. He refused to sell in the crisis. He refused to admit defeat. On September 15, Lehman declared bankruptcy when a $70 billion bailout attempt failed when Barclays said no. Recently Barclays bought remnants of Lehman for pennies on the dollar. Fuld took home almost $170 million in 2005 to 2007.

Lehman’s filing wiped out as much as $13.7 billion in company stock held by employees, who owned 30 percent of the shares when the stock peaked at $85.80 last year. Lehman encouraged stock ownership and has said about 20,000 of its 26,000 workers got at least some equity in 2007.

But the market got its revenge. Fuld at one point was worth $1.2 billion in stock. He recently sold 2.8 million shares for $500,000.

Then there was Bear Stearns. Same story, different numbers.

After Bear Stearns collapsed in March, its acquirer, JPMorgan Chase & Co., offered employees it kept shares in the combined bank equal to their 2007 pay. Workers owned a third of Bear Stearns, and they saw the value of the stake drop to $393 million at the sale price of $10 a share. That compared with $6.7 billion at the $171.51 peak last year. Former Bear Stearns CEO James “Jimmy” Cayne sold a holding once worth $1 billion for $61 million in March.

Lesson: when the CEO says you should invest in the shares of the company that employs you, think “Enron,” “Bear Stearns,” and “Lehman.”


These guys were all pikers. Why? Because they did not know when to sell. You’ve got to know when to hold ’em, know when to fold ’em, know when to walk away, know when to run.

Henry Paulson knew when to walk away.

He had been the CEO of Goldman Sachs until he accepted the call to become Secretary of the Treasury.

Maybe you did not know the following. When you become Secretary of the Treasury, you must divest yourself of stock holdings. Not to do so would be a conflict of interest. Make sense?

But how could anyone be lured into this office who is a big player? Think of the capital gains taxes! So, the government passed a law that exempts Federal appointees from taxes if they sell their holdings before they take office.

Paulson sold his shares. I would call this very good timing. Because he had a reason for selling, the sale did not depress the share price. He got out. None of the others did.

He owned half a billion dollars in Goldman Sachs shares.

Nice work if you can get it. If you can get it, tell me how.


The taxpayers now get to bail out Fannie and Freddie. The Big 3 American auto companies will get $25 billion. AIG will get its $85 billion.

It will never happen again. Next time, it will be different. Congress will make sure of this.

October 1, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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