Thursday, 17 December 2009

That Giant Sucking Sound ...

is New York City inhaling another finance blogger. That's right, first it was Mike over at Rortybomb, and now I've got a semi-full U-Haul truck parked in the frigid cold, waiting for the trip tomorrow morning. All day I've been playing that moving game of Tetris, slotting in boxes, furniture and odds and ends (guitars, keyboard, studio photography light poles) in available spaces in a cavernous truck.

For my readership of 10 to 15 -- you know who you are -- my blogging may be a bit less frequent after I start this new job. It's not that I lack ideas; the rub is simply that blogs suck up time. Maybe I'll try blogging shorter (a la Greg Mankiw, who sometimes just links to stuff he finds interesting, with no comment). I dunno; that's not really my style. But ...

I really, really wanted to do a long entry this week on the maddening futility of regulating banks using capital ratios. The problem is that Basel-type thinking (capital weightings for certain classes of assets) is just so, I don't know, 19th century. Modern financiers will always be a step ahead, using new products to innovate around the rules, so that you have to wonder, "Is this just a failed approach?"

But what in its place? Do we just let banks gamble recklessly, with even less supervision? That seems foolish since the fact that regulators were asleep at the switch during this financial crisis was a huge problem.

I think there may be a better way. I would consider ditching capital ratio requirements altogether (radical idea), but in return, make it easier to prosecute and strip of their wealth Wall Street CEOs and traders who end up running an institution into the ground. What if there were no capital requirements, but someone said, "You bankrupt this company through reckless behavior or negligent oversight and we'll take every penny you have, possibly throw you in jail, cut off your pinky and thumb (okay, I'm exaggerating to make the point), and ensure you never work in the finance industry ever again."

How high do you think the capital ratios would be in that scenario? Say 15, 20 percent, as opposed to the current 8 percent minimum today? Hard to say, but when there are aggressive clawbacks and serious prosecutions, I'm not sure you need a lot of rules about needing this much capital for this kind of asset and this much for the other. What we have now unfortunately is a broken system -- a dense framework of rules that encourages the banks to go diving for loopholes, following the advice of a platoon of securities lawyers.

Wednesday, 16 December 2009

An Economist of Our Time

Few people stand up to a close scrutiny. Paul Samuelson, who died on Sunday at the age of 94, fell apart at first glance. The man was a mountebank, a particularly offensive mix of knave and fool whose crowning as “Titan of Economics”, as the Wall Street Journal put it, said volumes about the society which did the crowning.

He neither understood nor followed the age-old advice that Clint Eastwood’s Inspector Callahan disdainfully summarized: “A man’s got to know his limitations”. In that, he was a fool. He knowingly and methodically downplayed, dismissed and covered up the contradictions that came into his ken, especially the ones which sprang from his “theories”. For that, he was a knave.

He was a “popularizer”; he stripped the “complexities” from the ideas to make them more palatable to the masses. He explained, according to the New York Times obituary, “what Marx could have meant by a labor theory of value”. (Marx meant what he said!)

He dabbled in everything and left behind “voluminous” writings. To the Times, they are the evidence of his “astonishing array of scientific theorems and conclusions”. What they are is a circular canon of superficiality; they show how one may write million of words on a subject and not advance it one iota forward. His Economics is a case in point. It sold millions of copies. It was a veritable cash cow for the Titan over a half a century. And it reads like a Danielle Steel novel, only with more inconsistencies. It is a hillbilly tune to the grand symphonies of the classical economics.

Here is a sample of the Times’ description of Samuelson’s contribution to economics, beginning with his much touted Neoclassical Synthesis.
Mr. Samuelson wedded Keynesian thought to conventional economics. He developed what he called Neoclassical Synthesis. The neoclassical economists in the late 19th century showed how forces of supply and demand generate equilibrium in the market for apples, shoes and all other consumer goods and services. The standard analysis had held that market economies, left to their own devices, gravitated naturally towards full employment.

Economists clung to this theory even in the wake of the Depression of the 1930s. But the need to explain the market collapse, as well as unemployment rates that soared to 25 percent, gave rise to a contrary strain of thought associated with Keynes.

Mr. Samuelson’s resulting “synthesis” amounted to the notion that economist could use the neoclassical apparatus to analyze economies operating near full employment, but switch over to Keynesian analysis when the economy turned sour.

To summarize: Theory A worked under Condition A, but not Condition B. Theory B worked under Condition B and not Condition A. Paul Samuelson came along and “wedded” the two together to create Theory AB. He suggested using part A under condition A and part B under condition B. This, he called “Neoclassical synthesis” – or “Can’t We Just Get Along?” (He probably got the idea from quantum mechanics, where the light is shown to be both wave and particle at the same time).
His speeches and his voluminous writing had a lucidity and bite not usually found in academic technicians. He tried to give his economic pronouncements a “snap at the end”, he said, “like Mark Twain”. When women began complaining about career and salary inequalities, he said in their defense, “Women are men without money.”
So the “Titan of Economics” wanted his comments to have bite, just like Mark Twain! How could have one explained to him that Mark Twain’s comments had a bite because he was conscious of the larger social inequalities. On this topic, he would have probably said: Women are black men.
Mr. Samuelson also formulated the theory of public goods – that is, goods that can be provided effectively only through collective, or government, action. National defense is one such public good. It is nonexclusive; the Navy, for example, exists to protect every citizen. It also eliminates rivalry among its many consumers; that is, the amount of security that any one citizen derives from the Navy subtracts nothing from the amount of security that any other citizen derives.

The features of public goods, Mr. Samuelson taught, stand in direct contrast to those ordinary goods, like apples. An apple eaten by one consumer is not available to any other. Public goods, he concluded, cannot be sold in private markets because individuals have no incentive to pay for them voluntarily. Instead they hope to get a free ride from the decisions of others to make the public goods available.
Here, Samuelson compares the U.S. Navy with an apple and “concludes” that no one would voluntarily buy a nuclear attack submarine, no matter how bad the crime situation got in the neighborhood. From this, he draws the further conclusion that the government has to force everyone to pay for the navy. (Notice how he chooses the safely remote Navy and ignores police, a more logical and intuitive example of the “public good”. Some might have questioned the “nonexclusivity” of the police force from their experience.)

Mr. Saber, now, really. You must be exaggerating; having fun at the expense of the dearly departed. There had to be some value to Samuelson’s work. More than half a century of prizes, awards, citations, recognitions; his book being translated to more than twenty languages and now all these posthumous praises. Surely you are not suggesting that all that is due to chicanery and the man fooled most of the people all his life. You, yourself call him an economist of our time. Even with the hint of disapproval that it is there, he had to do something to deserve the designation. No?

Samuelson influenced our world in two ways. Both were destructive. Both set back the cause of science and gave a black eye to civilization.

One is his “introduction” of mathematics to economics and, later, finance. A single sentence in the Times obituary – in code, as usual – captured this sinister deed:
Mr. Samuelson was credited with transforming his discipline from one that ruminates about economic issues to one that solves problems, answering questions about cause and effect with mathematical rigor and clarity.

Here, “mathematical rigor and clarity” means calculation. It is referring to Paul Samuelson taking economics, which was a social and philosophical discipline concerned with discovering the laws of the dynamics of social change, and bringing it down to the service of the businessmen, putting it to use for the calculation of profit and loss. It was the opportunistic seizing of an opportunity by an opportunist. And it was a serious blow. If the war of ideas were fought like wars, Samuelson would be shot for treason. I wrote about this in Vol. 1:
Pursuing mathematical finance along the lines of Portfolio Selection was advantageous in other ways too. It provided a respite from the contentious ideological disputes in economics between the Left and Right that in the era of McCarthyism were beginning to assume an ever sharper, and potentially career-ruining, tone. Research in mathematical finance had no downside risk. It was socially safe, it provided a perfectly respectable line of research and, with luck, it could lead to new discoveries and from there, to fame and fortune.

But, taking the Times’ descriptions, how does one solve problems and answer questions about cause and effect without ruminating about the issues? This question did not concern Samuelson. He was not interested in the larger social issues that resulted from the business decisions. His work on linear programming is the Exhibit A in this regard. From Vol. 1:
Linear programming epitomized the “objective” science. It seemed to be the embodiment of Friedman’s assertion that “positive economics is in principle independent of any particular ethical position.” The solutions it offered were arrived at mathematically and were indisputable. There was only one best way of scheduling oil tankers between a given number of ports if the profits were to be maximized or costs minimized. Democrats and Republicans, capitalists and communists, oil producers and tanker owners, all had to agree on it.

But while mathematics is abstract, it is always applied in the context of given social conditions. And precisely because mathematics is abstract, upon application it assumes the characteristics of the context to which it is applied. If the context is the Battle of Britain, the mathematics of linear programming shows the best way of organizing fighter planes. If the context is the profitability of commercial airlines, it still shows the best arrangement, which is establishing “hubs” and cutting service to low traffic destinations. Both solutions are mathematically correct. In the latter case, because the purpose behind the application of the method has changed–and that purpose is determine by social conditions–the solution leads to a different kind of consequences: medium-sized and small communities become further isolated.
It mattered little that Samuelson’s knowledge of mathematics was, like his knowledge of economics and finance, shallow. In Vol. 2 of Speculative Capital, you may recall, I examined a densely mathematical passage he wrote on warrants pricing. I was taken aback by flagrant flaws in calculation and reasoning and, especially the way Samuelson handled a contradiction that his own formulation had created; he simply dismissed it as “prosaic”. I wrote: “The passage, after it ceases to be funny, remains difficult to believe”.

What mattered is that Samuelson “delivered” the goods, the goods being the nations’ best and brightest to the service of finance. “When today’s associate professor of security analysis is asked, ’Young man, if you’re so smart, why ain’t you rich?’, he replies by laughing all the way to the bank or to his appointment as a high paid consultant to Wall Street”, he wrote in the introduction to Merton’s Continuous-Time Finance. That was the new goal of economics: training highly paid consultant to Wall Street. Looking back at what took place in the business schools and economics departments in the past 30 years, we must, in fairness, acknowledge Samuelson’s service.
When economists “sit down with a piece of paper to calculate or analyze something, you would have to say that no one was more important in providing the tools they use and the ideas that they employ than Paul Samuelson,” said Robert M. Solow, a fellow Nobel laureate and colleague of Mr. Samuelson’s at M.I.T.
Exactly. That is the secret of Samuelson’s fame and success: genuflection in the direction of the businessman. What a falling off was there.

Still, this retrogression pales next to the effects of Samuelson’s other deed, whose impact went further and deeper in the society. I do not suppose the man who emptied economics of social elements noticed or appreciated the irony.

Prior to Samuelson – and Friedman – writing and speaking about economics had been in the form of discourse, which is “proceeding from one judgment to another in logical sequence”, according to its dictionary definition. All classical economists were schooled in logic and philosophy. They could disagree with each other – and they often and vehemently did – but each side could answer and refute the opposing arguments point by point. Because there was a logical relation between the points of a case, in this way one could, if he had the logic on his side, refute the core thought of his opponent.

Samuelson, and his partner in crime, Milton Friedman, changed that. The change was violent and disorienting. It had a similar effect on the intellectual terrain that the introduction of the machine gun had brought to the battlefields of WWI. Whilst previously cavalry had charged the enemy lines, now two men behind a machine gun could hold the line against a thousand charging cavalrymen.

Samuelson and Friedman had no core theory, no central point, no logical anchor, only an “astonishing array of scientific theorems and conclusions”, which meant that they could not be nailed down to any particular position; they switched the subject and sides at will. And they were “formidable debaters”, according to the New York Times, precisely because the substitution of the spoken word for the written word created the ideal environment for their style of polemics. They uttered rapid-fire sequence of nonsensical assertions, peppered with false statistics that they knew no one could check.

With the rat-a-tat of their drivel, they killed discourse. They made discussion, and even conversation, impossible. What do you do with a man who goes on and on about the contrast between the U.S. Navy and an apple and cannot be thrown into a madhouse because of his Nobel Prize and M.I.T. tenure?

In this way, the Tweedle Dee and Tweedle Dum of economic scene invented the aggressive in-yourfaceness of unreason that we see today in talk radio hosts, Rush Limbaughs and the public figures. That is the main legacy of Samuelson with which we will have to live for years to come.

The Times obituary mentioned that Samuelson had trained and mentored many “brilliant” economists who went on to occupy important positions in academia, government and the private industry. Looking around at the social and economic landscape, I must say that I could have surmised that on my own.

The Trojan War
is over now; I don’t recall who won it.
The Greeks, no doubt, for only they would leave
so many dead so far from their own homeland.

Tuesday, 15 December 2009

Dimon, in the Giving Xmas Spirit, Gives Obama the Bird?

Just had to link to this naked capitalism post by Tim Duncan:
Bankers Support Regulation? Au Contraire?

Only hours after Obama met with Wall Street "fat cat" CEO bankers (about half of whom opted to be patched in by conference call -- how's that for signaling?), JPMorgan put out this media release on its Web site.

The JPMorgan statement of Dec. 14 appears to be guarded support for financial regulation. In other words "yes, let's have some of course, but slowly, slowly ... carefully, carefully."
The details matter, and the stakes are simply too high and the consequences too far-reaching to do this hastily and poorly. While we agree with many of the proposals, we share concerns with others that some regulatory proposals could restrict lending by banks, which will hinder economic growth and job creation.
Duncan's analysis:
This press release so quickly after the meeting at the White House today would seem to have no apparent purpose other than to make it clear to the other bankers and lobbyists that nothing has changed with regard to the industry’s passive-aggressive battle against the CFPA. It also appears to be a rather harsh metaphoric middle-finger to the White House given that it is posted less than 24 hours after the President personally asked for Mr. Dimon’s support.
Why did I find this amusing? Well, because of my April blog post, JPMorgan Flips Geithner the Bird. At that time, Dimon was saying basically, "Hell no, we're not going to offer up any assets for PPIP (Geithner's plan to relieve banks of toxic assets)."

Since the Geithner Plan was rolled out with all due fanfare, and awaited with baited breath, the Dimon comment was actually pretty explosive, though it got scant coverage. The subtext of Dimon's remarks was clear: "Screw you. Take your PPIP and stick it up your nether regions." And PPIP has been dying a slow death all year long, as other banks decided to shy away from the program as well.

So has JPMorgan (or Dimon, more specifically) now metaphorically flipped off Geithner and Obama too? If so, that would be arrogance seasoned with plenty of chutzpah.

Joe Lieberman, Mighty Force of Nature

It looks like uber-nebbish Joe Lieberman gets to exact his will on the nation on health-care reform. Amazing. So this is democracy. One guy can hold hostage the most important health care legislation in decades.

I was listening to Lieberman on TV last night. He sounds like a Jewish Steven Wright. I keep waiting for the punchline. ("I'd kill for a Nobel Peace Prize ... but seriously folks, about health care ...") Lieberman has a flat, uninflected, depressive aspect that apparently the people of Connecticut find irresistible.

Hell hath no fury like a former Democrat scorned.

Sunday, 13 December 2009

The U.S. Treasury Reaps Big Profits

The news that the U.S. Treasury had “reaped” $936 million from the sale of JPMorgan warrants was everywhere over the weekend. Google “treasury + $936 million” and see for yourself.

Credit the U.S. Treasury with the P.R. job. Its announcement said that JPMorgan’s warrants provided “an additional return to the American taxpayer from Treasury’s investment in the company”.

Additional return. Investment. American Taxpayer. Only Apple Pie and Motherhood were missing from the formal communiqué.

If the “return to U.S. taxpayer” had any meaning, or if the sum involved even matched what Maddoff “investors” are going to get back from the IRS, I would go through the trouble of showing in numbers what this “return” entailed; I know a thing or two about warrants and options.

Still, you can form an informed opinion about the matter from the concluding sentence of the FT article that reported the happy news on its front page:
The Treasury said the price was well above what JPMorgan had offered to buy back the warrants, adding that the auction had been oversubscribed.

The price was well above what JPMorgan had offered. That is called lowballing.

The auction had been oversubscribed. There was nary a word about the buyers, but you could bet your top dollar that they were all professional traders and fund managers. And they were falling over one another to buy the warrants, which is why the auction was oversubscribed.

Bravo, Secretary Geithner – playing one scene of excellent dissembling and letting it look like perfect honor.

A Brief Commentary On a Picture

According to the New York Times, this is how Prof. Sidney Plotkin of Vassar “dramatizes the pressure a president faces in a falling economy”. Click here to see how.

The paper said that Prof. Plotkin shines “a Marxist light” on the economic crisis, though Marx is an “uninvited guest,” the professor was quick to add.

What does he know about his uninvited guest?

Marx wrote: “In the analysis of economic forms … neither microscopes nor chemical reagents are of use. The force of abstraction must replace both”.

Prof. Plotkin has substituted dramatization for abstraction. He no doubt thinks that this shows his enthusiasm. And he may well be enthusiastic. But there is a deeper rationale behind his theatrics which makes them appeal to his students and administrators.

Here is an excerpt from the manuscript of Vol. 4 of Speculative Capital. We pick up where the product is produced and must now be sold, i.e. converted into money. Without this conversion, the production process will come to a halt:
Given this centrality of sales and its practically limitless sub-specialties in a Capitalist society– in the U.S., one would find hiring ads for “nuclear waste salesman” – it is natural that the subject is deeply embedded – intertwined, really – with the culture. Often, it is the driver and creator of the culture, especially in the “Anglo-Saxon” U.S. and U.K., where the businessman’s influence goes further than it would in other nations. The culture in these countries could be said to be the culture of a salesman, as it is shaped by the habits, sensibilities, tastes and priorities of a salesman. This point can best be seen by a look at Dale Carnegie’s How to Win Friends and Influence People.

The book’s title is precise. It telegraphs the content, so attention must be paid. Carnegie wants to win friends. Why? Because he wants to influence them. But the purpose of this influence is not bringing new friends to the righteous path. Carnegie is not an Islamic zealot practicing the Prevention of Vice and the Propagation of Virtues. He wants to influence people in order to sell to them. Friendship is a strategy, a mere means, towards that end. Note the word “win” – not finding friends or making friends but winning friends. The purpose is exploitation, after which “friends” become what they always were: people. It is a singularly cold-blooded and cynical title.

A straight line connects Dale Carnegie to the modern financier, Michael Milken who, responding to a minion’s comment that the rate they were charging a friend was too much answered: “Who are we going to make money off of if not our friends?”

I am not overstating the role of this depression-era salesman. Dale Carnegie did not invent the ways of salesmanship. He merely categorized them – arranged them around a central theme and in doing so, gave them cohesion and focus. His is the authentic voice of a salesman the way braying is the voice of a donkey.

Look at his chapter titles: Three Ways of Handling People; Six Ways to Make People Like You; Twelve Ways of Winning People to Your Way of Thinking; How to Change People Without Giving Offense or Arousing Resentment (in 9 steps, ending with “Making People Glad to Do What You Want”). Little wonder, then, that his book became the manifesto for a country whose “chief business” President Coolidge had declared was “business”.

What Carnegie began has grown into a multi-billion a year “self-improvement” and “interpersonal skills” business. Millions of people have taken courses on dressing, speaking, walking, even sitting – that would be “your silent presence” – to hone in their selling skills.

The graduates have then gone on to quietly instill the culture with the values that they learned and internalized in the classrooms. In this way, the modus operandi of the salesmen has turned into the cultural trait of the society. When the modus operandi changes, the culture changes.

One main change in the past 40 years has been the intensified competition due to the falling rates of profit. That has made selling a far more stressful occupation than it was in the heydays of the U.S. industrial power. The salesman is under constant pressure to be more “productive”, meaning that he has to sell more in less time.

The ensuing stress has darkened his mood. The passive Willy Loman has given way to the obscenities-spewing, conniving and downright criminal salesmen of Mamet’s Glengarry Glen Ross.

In practical terms, efficiency squeeze has necessitated harsher sales tactics. One is that the prospective buyer has to be evaluated quickly: is he/she going to buy or not? There is no time to be wasted on those “just looking”. This could only be done visually, checking the prospective buyer’s car, clothes, shoes – in short, any outward signs of material wealth. Hence, the elevation of the visual and “first impression” above all else. Rorschach test is the “psychological” test of this culture in which the salesman constantly and quickly “sizes up” his prey ...

In this way, the reliance on the visual becomes the norm. The “visual art” rises.
Prof. Plotkin’s understanding of economics is shaped by the salesmen, in the same way that Black, Scholes and Merton’s understanding of options was shaped by the traders. Those who have read Vol. 3 know the price one pays for blindly following these agents of circulating capital.

Saturday, 12 December 2009

Is the SIV Accounting Fraud Nearing an End?

Anyone who's read this blog for a while will know that one thing I absolutely can't wrap my head around is the Great SIV Loophole, and why it was never addressed until the "structured investment vehicles" exploded messily.

Here's how everything worked before the financial crisis/meltdown/blowup: A bank -- let's call it "Smitigroup" -- creates an off-balance sheet vehicle; let's give it a sexy name like "Xena." Here's what lil ol' Xena does: it borrows money by issuing short-term securities, then in effect lends money by buying longer-term securities. Now, if you're a Joe Blow reader who's wondering, "Exactly why does, ahem, Smitigroup, want to do this?," let's look at what's going on.

You make the short-term borrowing at say 2.8 percent, then you buy longer-term products at say 3.5 percent. Notice the "spread" between the two. Borrow a million for $28,000, buy a longer-dated asset (like, say, a security backed by mortgages from some fast-appreciating neighborhood of homes in south Florida) that pays $35,000 a year, and you're pocketing a cool $7,000 annually from the difference.

Rinse. Wash. Repeat. (As they say.)

Now, if you're financially savvy, you may be thinking, "Hey, that sounds kind of like what my bank does." And bingo -- you'd be right. Your bank basically "borrows" short term from its depositors (paying them a small amount for their funds) then lends long term (home and business loans). But there is a difference: the structured investment vehicle is more like an invisible bank; it doesn't show up on regulatory radar.

So let's return to that riveting question: Why does Smitigroup want to create an SIV? Well, one reason obviously: the potential profit. But why create the SIV off-balance sheet?

Yes, why oh why? Because Smitigroup operates under capital constraints and other regulations. It must have a certain amount of underlying capital to be able to expand its traditional banking operations. But here's the neat thing about its SIV: Smitigroup waves a magic wand and Xena takes shape and starts operating at arm's length from its creator, so that the business doesn't eat into Smitigroup's capital base. Meanwhile Xena funnels profits back to Smitigroup.

Hey! What's not to like?

But then, you have a liquidity seize up -- those long-term assets Xena is holding become worth less, no one wants to buy its short-term securities, and Xena begins to circle the bathtub drain at an increasingly frenetic clip. So, no problem for Smitigroup right? Smiti won't be on the hook.

Wrong. Suddenly you see the tractor beams appear. Smiti hoovers up Xena, moving the vehicle's operations onto its own books. So much for the fiction that Xena was "independent"!

This is the absurd crap -- sorry, crap is the most polite term I can think of -- that was allowed to persist in the financial industry. Now though, that may be changing, Floyd Norris of the NYT reports in a meandering column:
The issue is a couple of new accounting rules that are forcing banks to put back on their balance sheets some strange creations that bad accounting rules had allowed them to shunt aside in the past.
Strange creations indeed! But as weird as these SIVs were, there was an even odder beast out there:
Bank holding companies have been allowed to issue something called “trust preferred securities.” The beauty of those securities was that they were really debt that the holding companies could call capital. Having that “capital” meant the bank could take on more debt. A system that lets a bank borrow more money because it has already borrowed money — rather than because it has sold stock — is hardly a wise one.
Got that? As a bank, I'm supposed to hold capital against my assets (mostly loans). The more loans I make, the more the capital ratio shrinks toward my regulatory minimum. But a "trust preferred security" turns that equation upside down. As I make more loans, my capital ratio grows. Ain't bank accounting grand!

Broadly, such tricks fall under the rubric of "capital arbitrage." Ah, if only we could have seen these capital arbitrage tricks at the time. But zee banks, zey are so clever! It would take a man of almost unimaginable perspicacity and intelligence, a man possessing perhaps clairvoyance even, to divine the gravity of the game that was afoot ...

Or maybe not:
In Spain, some smaller banks are in trouble from real estate loans, but the big banks seem to have emerged in good shape. One reason is that Spanish regulators were not fooled by things like SIVs, and insisted that if any bank wanted to create one, it could, but would have to hold reserves anyway. Since there was no business reason — other than capital arbitrage — for a SIV, those banks shied away.
Oh well. But at least the Financial Accounting Standards Board is finally getting around to sewing this loophole shut:
The FASB, in an attempt to save face and a degree of integrity, has pushed back on Wall Street by passing FAS 166 and 167 which would require investments in off-balance sheet vehicles to be brought on-balance sheet. The implementation of FAS 166 and 167 is imminent and would require financial institutions to set aside increased capital against selected assets.
This seems like a no brainer, a slam dunk. But the banks are squealing, predictably, because they have been hiding operations off balance sheet for a while and are worried about the impact of bringing them back onto the books.

The fact that we're even having this discussion is ridiculous. We need a better regulatory regime. I think capital-based requirements in a rule-based system (See Basel, incarnations I and II, e.g.) may be an obsolete approach, especially in an information-rich age of high-speed computers and financial innovation galore. The banks, with an army of lawyers in tow, will always twist and limbo their way around the requirements.

There is a better way. I'll look at that later this week.

Friday, 11 December 2009

Matt Taibbi's Latest Must-Read: Obama's Big Sellout

The Rolling Stone writer takes on President Obama in his latest Wall Street slamdown. Everyone should read it, whether or not you agree with him, or care for his freewheeling, expletive-heavy, cynical style. I think Taibbi does channel well the pissed-off liberal-intellectual zeitgeist of disgust with Wall Street excesses.

His main points are:

1. Everyone who's senior level on Obama's economic/Treasury team once worked for Robert Rubin, came from Citigroup, came from Goldman Sachs, or some combination of all three. It's rather sobering as he ticks off the names, one by one -- and ties them back to Rubin/Citi/Goldman. And we wonder why we get so much Samethink out of this White House on economic issues?

2. Banking lobbyists right now are busily gutting legislation that would add consumer protections for financial products and force stricter regulation and transparency for derivatives trading. They are of course abetted by our "elected" representatives, who probably should be required to wear logo-plastered jumpsuits, a la racecar drivers, to show which special interests (which major insurers, banks etc.) they really take their marching orders from.

3. Americans on the whole are too dumb to care that the financial sector is hardly being reformed at all, despite the fact financier misdeeds brought us last fall to the brink of Credit Armageddon.

What disappointed me about Taibbi's article was that he catalogs a familiar litany of crimes but doesn't try to answer the underlying question of his piece: Why did Obama sell out? What happened to "Change We Can Believe In?" Is Obama really just another empty suit politician? Did we, American voters, just get duped again?

Here are the possible explanations I have for why Obama sold out. Pick the one, or ones, you like or feel free to add your own in the comments section:

Obama really was a fraud, just like so many other politicians, willing to say whatever he had to to get elected. He has no principles.

Obama talks a good game -- he is a master rhetorician -- but his cojones are about the size of sesame seeds. He does believe in change, but in practice, he all too quickly defaults to dull compromise.

Obama remains very aware of his "blackness," and is so worried about seeming radical to White America that he tacked hard the other way, to the safety of the Wall Street moguls.

Obama to this day doesn't really understand how badly his team screwed up and how much they gave away to the banking interests; economics is his weak suit and he simply isn't very interested in it, preferring on that long flight to Pakistan to read the Urdu poets instead. And he really thinks that, over the long view of history, his team will be lauded for its courage and wisdom in how it tackled the financial mess, and not disparaged for failing to deal directly with so many problems that caused it.

The banking lobby basically does own our capital: they own the Senate, the House, and the White House too. Of course that includes owning Obama, who felt the sting when Wall Street moneybaggers began to tighten their pocketbooks and said they weren't going to donate as much funds to Democrats because of his constant bashing of their industry.

Wednesday, 9 December 2009

More Proof that "IBG" Thinking Motivated Bankers

Well, the electronic ink was barely dry on my previous entry when I noticed, somewhat belatedly, this piece by Lucian Bebchuk et al in the Financial Times: Bankers Had Cashed in Before the Music Stopped.

Yesterday I blogged that OPM ("Other People's Money") and IBG ("I'll Be Gone") were meta-reasons for the financial crisis. Of course that didn't quite square with part of the accepted storyline of the collapse: namely, as Bebchuk notes, "according to the standard narrative, the meltdown of Bear Stearns and Lehman Brothers largely wiped out the wealth of their top executives."

In which case, IBG thinking ("I'll Be Gone when this stinker of a product/strategy blows sky high") would have afflicted the junior traders, but not the senior leaders, it would appear. And, accordingly, one would expect a furious flurry of pay reform taking place now as angry CEOs, their wallets and their stock portfolios scorched once, vow to never let such an orgy of risk-taking ever occur again.

Except ... except ... the top brass apparently made out like bandits too. They were IBG beneficiaries, if not quite direct practitioners. From Bebchuk:
In 2000-07, the top five executives at Bear and Lehman pocketed cash bonuses exceeding $300m and $150m respectively (adjusted to 2009 dollars). Although the financial results on which bonus payments were based were sharply reversed in 2008, pay arrangements allowed executives to keep past bonuses.
So you have those traders practicing IBG, and those supervising them who are incentivized to turn a blind eye to IBG.

Which leads us to the number of the day.

Chances of Wall Street spontaneously reforming compensation practices: approximately 0.

Tuesday, 8 December 2009

The Two Abbreviations that Explain the Financial Collapse

I was traveling this weekend -- back! -- and last night it occurred to me that if you want to understand why this financial crisis occurred, you can look hard at two often bandied-about abbreviations. Forget about low interest rates, regulatory lapses, securitizations, risky derivatives etc. etc. Those are reasons, but these are meta-reasons. These are the reasons that create the environment for the reasons. These abbreviations are easy to understand, but have deep, wide-ranging implications.

1. OPM ("Other People's Money)
What does it mean to make bets with other people's money? I think the answer is obvious. When I'm betting my house on an outcome, you can be assured that my thinking moves down a different decision tree than when I'm betting your house.

How was Wall Street betting with "Other People's Money"? Largely, this came about because of a shift in ownership models. The old wingtipped investment bankers worked at firms owned by partners. The oft-repeated joke about partners is that they live poor, but die rich. Their wealth is tied up in the worth of the firm. Under this type of model, you can bet that Wall Street CEOs over the past decade would have known exactly what types of risky wagers their traders were making each day. But they didn't.

Because they were using "Other People's Money."

"Other People's Money" is what you get from the new ownership model: becoming a public company. You sell shares to a vast swathe of investors, everyone from Aunt Edna to Fireman Joe's Pension Fund, to raise capital. And so when your company starts trading for itself in credit default swaps or liquidity puts, you as CEO don't risk losing your house if the bets go bad. You risk losing Aunt Edna's house. (Note: even with CEO "incentives" that try to align your pay with performance, you still tend to capture the upside of your company's gains and escape most of the pain of the losses.)

Big difference. And a slew of Wall Street banks went public in the 1980s and 1990s (Goldman was late to the party, making the jump in 1999).

Yves Smith at naked capitalism and the always incisive (and often acerbic) business journalist Michael Lewis have noted repeatedly the significance of changed ownership models, re: this financial crisis. And they're right: This constitutes a huge meta-reason for the meltdown. On top of all this, once you really start to leverage up other people's money, the danger of excessive risk-taking compounds fast.

2. IBG (I'll Be Gone)
If you were to use this in a sentence, it would sound something like: "IBG (I'll Be Gone) by the time that trading strategy blows up." The prevalence of short-term thinking -- trying to make the numbers for quarterly earnings reports to satisfy investors and analysts (that's a consequence of playing with "OPM;" you're always performing for the stockholders), trying to hit yearly targets for that fat bonus -- it all tends to focus the mind on the end of the money-seeking nose, and not much farther out.

"I'll Be Gone" actually represents the convergence of two bad trends: one, this short-term thinking that reflects in part the stunting of our attention spans, and two, the abdication of personal responsibility ("Hey, my trades went south? So they went south ... that's life, seeya.").

So think about it: if you've got a financial industry with a belief system centered around "get mine, get out, and use other people's money to do it" ... well, why are you surprised that a lot of big reckless bets were made and everyone got out with their bags of gold and no one's being prosecuted?

Tuesday, 1 December 2009

The Fed: Ivory Tower Economists or Just Clueless Bagholders?

The Fed as bagholder ... it hadn't occurred to me until I read this piece on naked capitalism called "The Fed, Treasury and AIG" (the title has the disarming ring of a child's nursery rhyme). Author: Richard Alford, former Fed economist. He defends the Fed's behavior related to the AIG rescue -- he sounds a bit querulous at times, but it's a thankless mission he's on -- and then he hooks a sharp left turn toward the end of his essay and launches a flurry of pointed and interesting questions:
Why didn’t Treasury announce a more detailed proposal including a Fed role limited to bridge financing? Why didn’t the Fed require it as a condition for supplying “liquidity” to the capital-impaired AIG? Why didn’t the Fed require a commitment from Treasury to assume AIG assets it acquired subject to legislation being enacted? Why didn’t the Fed leave the responsibility for management of AIG with Treasury? Why did the Fed permit itself to be used as an off-balance sheet slush fund by Treasury? Why did the Fed permit itself to be put in a position wherein it would have to pay out public monies on behalf of a capital impaired-institution? Why did the Fed turn itself in to a political punching bag?
Indeed. Why, why, why? Perhaps Bernanke's a leading academic economist, but he certainly lacks a Phd. in "cover your ass"-ology. He's the Gomer you get to sign all the room service bills during one of those crazy guys-go-wild weekends at some luxury hotel. He's the kid you hand the freshly lit stink bomb to, then say, "Listen, Ben, we have to duck outside for just a minute, but you just hold this thing, don't let it go, and we'll be right back. Promise." And earnest Ben says, "Sure, Hank. Sure, Tim."

Yup, Ben Bernanke's confirmation as Fed chairman is now in danger because it looks like he got played as a patsy. Bernanke let the Fed be drawn outside of its proper sphere of influence. It appears he got pushed and he didn't bother to push back.

If there's a lesson to be abstracted from this I'd say: any agency clueless enough to be duped by a bunch of Treasury bureaucrats, who were in turn duped by the Wall Street pros, shouldn't be christened "super regulator" of our entire financial system.