Friday, November 21, 2008

Quebec Inc. in Dire Straits?

Why do strange things always happen on Friday afternoon? In the latest edition of freaky Friday, we saw some interesting announcements.

First, Wall Street rejoiced on news that president-elect Obama was likely to nominate New York Fed president Timothy Geithner for Treasury Secretary:

Wall Street put a stop to a terrifying decline and stormed higher Friday as President-elect Barack Obama appeared ready to tap the chief of the New York Federal Reserve as the next treasury secretary and hand him the herculean task of righting the U.S. financial system.

The Dow Jones industrial average, which had broken even for the day until news of the nomination leaked about an hour before the close, raced upward and finished 494 points higher, a rally of more than 6 1/2 percent.

The outbreak of buying pushed the Dow above 8,000 -- a figure that would have seemed like a nightmare three months ago but on Friday was a relief for Americans who have watched their investments and retirement savings drain away with alarming speed.

In the two previous days, the Dow had lost a staggering 873 points, more than 10 percent of its value, and the broader Standard & Poor's 500 index had sunk to its lowest level since 1997.

The turnaround came when word reached Wall Street that Obama was likely to nominate New York Fed president Timothy Geithner, 47, for treasury secretary. Geithner would assume top responsibility for tackling what threatens to be the deepest recession in a generation.

Financial markets despise uncertainty, and investors were looking for a clear message from Obama on who will make up his economic brain trust. Wall Street had been voicing increasing frustration with Henry Paulson, the current treasury secretary, over his erratic handling of the federal financial rescue system.

"Something needed to be done on the economy," said Ben Halliburton, chief investment officer at Tradition Capital Management. "The fact that they've got the team together, maybe that is going to shorten the period of indecision."

Elsewhere, the government continued its efforts to shore up the financial system. The Federal Deposit Insurance Corp. also said it would guarantee up to $1.4 trillion in U.S. bank debt for more than three years as part of the government's financial rescue plan.

The decision is aimed at breaking the logjam of bank-to-bank lending. The health of the economy depends on the free flow of credit, and credit markets cinched up again as the market plunged earlier this week.

The benchmark Standard & Poor's 500 index jumped 47.59, or 6.32 percent, to 800.03, and the Nasdaq composite advanced 68.23, or 5.18 percent, to 1,384.35.

The Russell 2000 index of smaller companies rose 21.23, or 5.51 percent, to 406.54.

Advancing issues outnumbered decliners by about 2 to 1 on the New York Stock Exchange, where consolidated volume came to 9.27 billion shares, up from the 8.96 billion shares that exchanged hands on Thursday. This makes Friday's volume the heaviest since the 11.20 billion seen on Oct. 10.

The Friday afternoon rally managed to prevent the week from being one of the few most dismal in Wall Street history. Corporate mainstays running the gamut from Gap Inc. to Alcoa Inc. and Walt Disney Co. to Microsoft Corp. surged by double-digit amounts.

But it did not erase heavy losses for the week. The Dow finished down about 5 percent for the five days, and other major averages suffered, too -- 8 percent for the S&P 500, nearly 9 percent for the Nasdaq.

The Dow finished at 8,046, and the S&P just a hair over 800.

But the S&P is still down 46 percent so far this year, the most since 1931. And there was still plenty to be concerned about. Citigroup stock took another huge hit -- down 20 percent of what's left of its value, to close at $3.77 -- as pressure built on the bank to sell part or all of itself.

I told you yesterday, this market is looking for a catalyst to rally, and today they got it. There will be profit taking, but this rally will have some legs going into year-end. When you see this type of volume after a major selloff, you know the bulls are trying to make a go of it.

I also think that Tim Geithner is leagues ahead of Hank Paulson in understanding the complexities of the financial markets. Paulson is getting an "F-minus" grade for his mediocre performance by former regulator William Black:

"All of his policies made [the crisis] worse," says Black, citing Paulson's:

  • Pushing for more deregulation of the securities and mortgage businesses.
  • Failure to recognize the liquidity crisis in credit markets sooner.
  • Failure to act to stop foreclosures sooner.
  • Opposition to the government taking equity stakes in financial institutions, until very late in the crisis.

"And he gets the worst grade because as head of Treasury he's also in charge of banking and thrift regulation," Black continues, noting he "destroyed" rather than beefed up supervision. "I hope you like the consequences."

Black, author of "The Best Way to Rob a Bank Is to Own One," says there's ample reasons why the financial markets have lost confidence in the Secretary.

He also notes Paulson steered Goldman Sachs into subprime and alt-A mortgage securities before becoming Treasury Secretary in 2006. Goldman began shorting those instruments shortly after Paulson's departure, he notes.

The current crisis is "not a hundred-year flood, that suggests it's an act of God caused by random forces," Black says. "This was one cause by bad policies, the same policies that have caused prior crises."

But there was another announcement that caught my attention this afternoon. In mid afternoon, Andrew Willis of the Globe & Mail published that the Caisse de dépôt et placement du Québec may be about to drop a bombshell into a provincial election campaign:

Canada's largest fund manager called a news conference for Friday at 4 p.m. EST to “provide an update on its situation.”

No one thinks the Caisse will announce good news. There is talk in Quebec that the $155-billion fund has lost anywhere up to 30 per cent of its assets in the market meltdown, and will need government help to fulfill its pension promise.

The Caisse is providing this update at the mid-point of an election campaign that hinges on economic leadership - Quebeckers are scheduled to vote on Dec. 8.

Opposition politicians having been pushing for more disclosure from the fund. The CPP Investment Board discloses performance quarterly, while the Caisse and most other Canadian pension funds report results once an year.

The Caisse will be speaking at the end of a week that's been chock-a-block with changes. On Thursday, the fund revealed that newly named CEO Richard Guay is in the midst of a four-week sick leave. Mr. Guay got the top job in September - he was previously chief investment officer.

On Thursday, the fund also let go 10 investment professionals and shut down a $5-billion portion of its international equity portfolios that is managed out of Montreal.

The Caisse is also dealing with a messy, 15-month freeze in its $13-billion portfolio of asset-backed commercial paper. While that debt is expected to trade in coming weeks, as the Montreal Accord restructuring finishes up, the ABCP will likely command only 70 cents on the dollar, at best.

Pierre Brunet, chairman of the board at the Caisse, and Fernand Perreault, acting CEO and executive vice-president, real estate, will conduct Friday's briefing.
So everyone was waiting to hear what will happen at the press conference. As it turns out, not much happened.

The Caisse won't reveal its financial data until next year and they moved to defuse rumors:

With the health of the provincial pension fund and its new president suddenly a smouldering election issue, executives of the Caisse de Dépôt et Placement du Québec moved to defuse it.

At a hastily-convened afternoon press conference that he denied was at the request of the Liberal government, chairman of the board Pierre Brunet reiterated the Caisse would not divulge preliminary, partial results quantifying the extent of recent losses from the global stock-market meltdown, rumoured to be as high as $30 billion.

To do so would be to depart from its clearly-defined, independant code of governance, for no worthwhile purpose, he said. "It's not in the interests of the Caisse or its depositors to take actions outside the rules it's always had."

Brunet said Richard Guay, named in September to succeed Henri-Paul Rousseau as chief executive of the Caisse, was expected back on the job Dec. 10 after going on medical leave last week because of "fatigue."

From the time Guay was confirmed for the top job, equity markets around the world have been in freefall.

Guay has the confidence of the board and "has done an exceptional job," said Brunet, adding that he didn't think the one-month medical leave justified the play it's received in the media.

Interim president Fernand Perreault said there was no truth to rumours the Caisse was experiencing liquidity problems.

It had $20 billion in liquidity, he said, sufficient to meet all its obligations, and it's still collecting more than it pays out in benefits.

The Caisse had net assets under management of $155.4 billion at the end of 2007. After four years of double-digit gains, returns in 2007 were a 5.6 per cent.

This clearly will be a more difficult year, but it has to weighed in the context of the Caisse's investing horizon, which is 10 years, Brunet said. "Only at the end of the cycle will the precise impact by measurable."

On the campaign trail, Premier Jean Charest insisted he did not order the Caisse to hold the press conference.

"It's their initiative," he said. "I'm not the political master of what is happening at the Caisse, so I don't order their communications. The Caisse is independent and should remain independent."

Premier Charest may not have "ordered" this press conference but I am pretty sure he wants this monkey off his back going into the December 8 elections.

The problem is that it isn't a monkey - it's more like an eight hundred pound gorilla.

The Caisse has always been dragged into politics. Admittedly, under the leadership of Henri-Paul Rousseau, political influence was kept at bay. Mr. Rousseau, however, left the Caisse this past summer before the full fury of the storm hit.

(His timing to exit "Quebec Inc." and join Power Inc. was almost perfect, wouldn't you say?)

That left Richard Guay with the monumental task of cleaning up a huge mess - a mess that he also played a part of over the last few years.

Mr. Guay has the worst job you can possibly imagine. I still feel he is the only hope they have to clean that place up, but he has to deal with tremendous internal and external pressure. That is part of the job that is totally thankless and ruthless. If the Caisse posts huge losses this year - which I can guarantee you they will - then he gets all the blame.

Think about it, you can be a totally incompetent president & CEO (and I know a few of those), come in at the bottom of a bear market, and enjoy the ride up. The media will be praising you for delivering outstanding results, but all you really did was deliver beta.

Now, politicians from the opposition smell blood and they are demanding that the Caisse posts its returns.

I am all for transparency, but where were these same politicians over the years and why weren't they demanding transparency back then? Why didn't they pass laws so that the Caisse posts its quarterly results? Why didn't they demand that independent performance and operational audits for each and every internal and external investment activity at the Caisse be performed at least once a year and be made public?

I will tell you why: because politicians and regulators fell asleep at the wheel and instead of being proactive, they are now running around trying to cover their asses or to score political points.

And it isn't just the politicians outside the Caisse who are doing this. There are plenty of cover your ass politicians within the Caisse who to my dismay are still lurking around there. These people are the cancer of this organization and they should have been fired a long time ago.

This week they fired the international managers to index international investments but they kept other internal managers who racked up huge losses this year. The question is why?

Having worked at the Caisse, I can tell you why: politics permeates this organization in a pathological way. Instead of hiring, promoting and retaining the best and the brightest, they often promote and retain people for "internal" political reasons.

(I would love to know what percentage of the Caisse's employees are of diverse ethnic backgrounds and how many of them are promoted to senior investment positions. I know one or two but there should be a hell of a lot more.)

Moreover, instead of helping Montreal's financial community thrive, the Caisse has been actively moving its business to New York and London. Why can't they support Montreal outfits so that this city's financial community can flourish once again?

In 1993, businessman Pierre Arbour published a book, Quebec Inc. and the Temptation of State Capitalism, where he railed against Quebec's politicized economy:

Quebec's foray into the management of its economy has cost the province billions of dollars. That is the conclusion of a book by a Quebec businessman who was once deeply involved in the government's control of businesses through a provincially-run pension fund called the Caisse de Depot et Placement, known as ``the Caisse.''

Pierre Arbour's ``Quebec Inc. and the Temptation of State Capitalism'' caused a stir in Quebec when it was published in French last year (1992). The book has now been translated into English. The Caisse is a sacred cow to many Quebec nationalists because of its size - $41 billion (Canadian; US$30.2 billion) in assets - and the political motivation behind many of its investments.

``This influence of the state on the Caisse de Depot had begun soon after the election of the Parti Qucois (PQ) in November 1976 and the nomination of Jacques Parizeau as finance minister of the province,'' Mr. Arbour writes.

His book details how Mr. Parizeau, who is now leader of the PQ, packed the Caisse with political appointees, including a top civil servant, Jean Campeau, who was named manager in 1980.

The book lists a series of financial misadventures by Campeau and the Caisse:

  • In trying to keep the Steinberg grocery chain in Quebec, the Caisse lost $448 million, according to Arbour. The Caisse lent money to a Quebec-based entrepreneur to keep the chain out of the hands of an Ontario grocery chain. The company eventually went bankrupt.
  • The Caisse's investment in a mining and forestry corporation called Brascade-Noranda cost the pension fund $858 million.
  • Taking control of Domtar, a pulp and paper firm, cost $117 million.

The politicians and managers of the fund say they believed they were helping Quebec's economy become self-sufficient while offering more opportunities to French-speaking businesspeople. Parizeau has defended the Caisse's strategies and says he would do the same thing again.

Arbour says that political intervention has meant that Quebeckers don't have as much money in their pension fund as they should.

``If the Caisse hadn't made so many bad, politically motivated investments in the 1980s, it would be one of the best performers on the continent,'' asserts Arbour, who was a member of the Caisse's board of directors and worked there from 1967 to 1979.

The Caisse manages all the money collected by the government for state-run pensions, especially the old-age security plan that is funded by payroll deductions. It was founded by the government in 1965, when Quebec was five years into the so-called Quiet Revolution, the awakening of French Canada.

The political slogan of the day was ``Maitre Chez Nous'' - master of our own house. It was a period that saw the nationalization of Quebec's electricity companies into the state-owned Hydro Quebec utility. It also spawned the Caisse.

It has since expanded beyond administering the pension fund to managing the money from a state-run auto-insurance fund and even a provincially operated fund to protect consumers who lose money to travel agents.

Arbour is not alone in his criticism that the Caisse should stick to making money from investments. ``There's too much political interference and patronage at the Caisse,'' said Leo-Paul Lauzon, an accounting professor at the University of Quebec at Montreal.

Arbour's book ends by criticizing ``linguistic interventionism,'' the passing of language laws which the author says forced at least a quarter of a million English-speaking Quebeckers to leave the province from 1966 to 1986, mainly for other parts of Canada.

In my opinion, a lot has changed since then. Under Mr. Rousseau, the Caisse did refocus on making money and he made sure that politcal interference was kept at bay.

But under his watch, they made huge commitments in the asset-backed commercial paper market and other risky investments, completely underestimating the risk of these investments. Those costly mistakes continue to haunt the Caisse till this day.

Let me end by stating that the Caisse and other large public pension funds in Canada are in need of major governance reforms. There needs to be laws passed mandating annual independent performance and operational audits audits on all the large public pension funds and the results need to be public so taxpayers can scrutinize their investment activity.

But I will tell you straight away, as far as the Caisse is concerned, politicians should wait until after the Quebec elections to call for reforms.

It's time they stop politicizing the Caisse and start reforming it so that it can truly become a global investment powerhouse with governance rules that lead the world.

Out of every crisis, there is an opportunity. Let's hope that the Caisse comes out of this crisis a much better pension fund.

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