Rule Yourself

Should Occupy Wall Street 'exact a cost on society?'

2011-11-18T06:21:00.001-08:00

I read an online comment, yesterday, advocating that theOccupy Wall Street movement disrupt freight-rail services, or even breakwindows if necessary, in order to gain greater attention from society at large.The writer argued that marches are ineffective and that the movement’s tactics todate allow too many people to ignore it and go about their lives. He suggestedthat without greater attention from society at large, the movement wouldfounder, and concluded that the movement must “exact a cost on society” if itis to be successful.

The writer’s frustration with the slow pace of change andlack of material, widespread support for Occupy Wall Street is understandable. WhileI suspect that the movement is cheered by many millions of people from whatthey deem a safe distance (whether literally or figuratively), the numbers ofpeople actually putting their lives and reputations on the line are, thus far,only thousands. But, every movement has to start somewhere and with a relativelysmall group of people.

As a child I watched the antiwar and civil rights movementsof the 1960s and 1970s grow from similarly modest foundations to widespreadempathy, acceptance, and support. They, too, began with meetings, marches, slogans,and, yes, occupations of physical space. The press and many in society ignoredor derided them. After years of sustained effort, however, masses of peoplecame to accept their goals as noble and embraced their ideas.

Elements in the antiwar and civil rights movements dideventually employ violent or destructive tactics, but these came after brutalacts of repression by local, state, and federal officials. At various times andplaces protestors smashed windows, burned buildings, and blocked trains. Somerioted and looted businesses; a few threw bombs. People lost their lives onboth sides of the conflict.

The movement we know today as Occupy Wall Street may yetlead to comparable violence and destruction. Certainly we see that governmentofficials have either learned nothing or else forgotten the lessons of severaldecades ago. When New York mayor Michael Bloomberg sends thousands ofparamilitary forces to disrupt lawful protests with chemical weapons and batons,he is initiating the use of force, which is never moral or just and onlyinvites defensive violence from his victims.

Perversely, this kind of official repression only feeds andstrengthens the movement. The movement would grow anyway, aiming as it does atending gross and intolerable injustices, but repressive actions suchBloomberg’s accelerate the process. When people see gun-bearing,baton-brandishing, helmeted police pepper-spraying defenseless young girls anddragging kids through the streets, most are repulsed. Those who cheer thethuggish police antics are either ignorant of their own interests ormalevolent; many of these are undoubtedly sponsors or beneficiaries of thefascist (“crony capitalist”) regime that the Occupy Wall Street movement seeksto end.

If Occupy Wall Street is to maintain its moral authority, itmust remain non-violent. That is not to say that its members should allowthemselves to be beaten like dogs or shot dead in the streets, but only thatthey must never initiate the use of force themselves. And, if force must be usedin legitimate self-defense or defense of innocent others, it must beproportionate to and calibrated solely to remove to remove the proximatethreat.

The suggestion that the Occupy Wall Street movement must‘exact a cost on society’ in order to bring about a better society is illogicaland would be self-destructive if followed. Were participants in the movement toadopt that tactic, they would lower themselves to the level of the blood-soakedsavages currently occupying city halls, state houses, and government buildingsin District of Columbia, who shrug off the deaths of innocents in the War onDrugs or “shock and awe” slaughters of brown-skinned people half a world awayas “collateral damage.”

The fascists among us have created enough victims already.Occupy Wall Street must stop the carnage, not create more of it.

U.S. Treasury market a sinking ship

2011-04-26T11:30:00.000-07:00

We separate the concepts of Federal Reserve Notes ("U.S. dollars") and U.S. Treasury bills, notes, and bonds ("Treasury securities") at our peril. Both are government liabilities (debts) and must be understood as such. "Dollars" are certificated, non-interest-bearing, face-amount notes, whereas U.S. Treasury securities are either book-entry discount notes ("bills") or book-entry, interest-bearing notes ("notes" and "bonds").

Technically, the U.S. central bank (the "Fed") issues dollars, while the U.S. Bureau of Public Debt issues Treasury securities, but this is really a distinction without meaningful difference. Both are backed by the full faith and credit of the U.S. government. Both are issued and redeemed by the Fed. To "redeem" Treasury securities is merely to exchange one form of government liability for another. That is, no one can redeem Treasury securities for anything other than another liability of the U.S. government.

When we say that the dollar is the world's "reserve currency," we misspeak. The world's reserve currency is the *combination* of dollars and Treasury securities. People hold reserves in dollar form only to the extent needed for immediate expenditures or because they find it impractical to hold reserves in the form of Treasury securities. Otherwise they hold reserves in bill, note, or bond form or because they find it impractical to hold reserves in dollar form. Holders of reserves in dollar form receive no interest thereby. Holders of reserves in the form of Treasury securities earn interest, though at the cost of liquidity. Even the interest payments are nothing more than additional liabilities of the U.S. government.

Whether held in the form of dollars or Treasury securities, the sole purpose of holding reserves (including interest received on those reserves) is for the future purchase of other goods or services. A "price" is nothing more than a ratio between the good or service in question and the reserve currency in dollar form. To accept the U.S. as issuer of the world's reserve currency is to accept implicitly that the U.S. government will manage responsibly the dollar price of goods and services, both now and into the foreseeable future.

It should thus be obvious that arguments to the effect that Treasury securities are free of default risk because the Fed can print unlimited quantities of dollars with which to redeem them are spurious. No one relies on a reserve currency because it can be created in unlimited supply or debased at will. Quite the contrary: the implicit bargain between the holder and issuer of the reserve currency is that the issuer will behave responsibly and thereby protect the interests of the holder with respect to the purchase of future goods and services. Once holders begin to doubt the intentions of the reserve-currency issuer, they will begin to seek substitute currencies they calculate will better protect their future interests, or liquidate their reserves in favor of other assets, causing the dollar prices of those assets to rise.

The dollar prices of Treasury securities reflect in part the demand for U.S.-issued reserves and in part differences between supply of and demand for reserves in dollar form and reserves in security form. Thus, dollar prices for Treasury securities can easily transmit a false signal to reserve holders - disastrously so. To the extent they focus on the dollar prices of Treasury securities to the exclusion of the dollar prices of other goods and services, they may miss what is in fact a massive redemption of the reserve currency in favor of other assets.

When a large ship is sinking, fleeing from lower to upper decks is generally a good strategy and may forestall death, but cannot save the ship. Ultimately, if passengers recognize the danger and can do so, they have to abandon ship in order to save themselves, because when all is said and done, upper and lower decks alike will be under water. Those seeking a safe haven in Treasury securities will not escape the failure of the U.S. as issuer of the world's reserve currency. Sooner or later, most will realize that holding Treasury securities is a disastrous strategy and that reliance on any fiat currency is folly. When that happens, prices of U.S. Treasury securities will fall far below their par values and issuance of new securities will become impossible. Only vultures, seeking to buy U.S. debt for pennies on the dollar in the hope of an eventual windfall, will remain.

For the time being, the U.S. Treasury market is best conceived as a battleground. The Fed is fighting to preserve the reserve status of Federal Reserve Notes and U.S. Treasury securities in the face of incontrovertible evidence that people the world over are seeking substitutes. The Fed knows that if Treasury prices break lower, the battle is lost. So it is intervening directly in the market in an effort to maintain an appearance of normalcy. How long the Fed will fight this battle I do not know, but I would guess that within two to five years, the Treasury market will see substantially higher yields.

Low-flying jets cause Jersey City office evacuations

2009-04-27T07:45:00.000-07:00

My office in Jersey City was just evacuated for what turned out to be a false alarm: a low-flying 747, trailed by a fighter, on a 'planned' photography outing over New York harbor:

How stupid is the federal government? It does something like this without warning the public in advance?

We could see people milling about outside of office towers all around ours in Jersey City.

FDIC skirts law, projects no losses from Public-Private Investment Program

2009-04-07T04:47:00.000-07:00

Andrew Ross Sorkin deserves an award for "'No-Risk' Insurance at F.D.I.C."

By checking facts with securities lawyers he exposes the dubious legal reasoning behind the FDIC's loan-guarantor role in the Public-Private Investment Program:

"Nobody is paying any attention to how they’re pulling this off," said a prominent securities lawyer who has done work for the government. Not surprisingly, he, along with others I asked to review the program, declined to be quoted by name. "They may not be breaking the letter of the law, but they’re sure disregarding its spirit."

The F.D.I.C. is insuring the program, called the Public-Private Investment Program, by using a special provision in its charter that allows it to take extraordinary steps when an "emergency determination by secretary of the Treasury" is made to mitigate "systemic risk."

Simple enough, but that language seems to bump up against another, perhaps more important provision. That provision clearly limits its ability to borrow, guarantee or take on obligations of more than $30 billion.

The exact legalistic language says that it "may not issue or incur any obligation" over that limit.

Sorkin also allows FDIC head Sheila Bair to prove to the world that she still believes in Santa Clause and the Tooth Fairy:

So how much does the F.D.I.C. think it might lose?

"We project no losses," Sheila Bair, the chairwoman, told me in an interview. Zero? Really? "Our accountants have signed off on no net losses," she said. (Well, that’s one way to stay under the borrowing cap.)

As Sorkin explains, the FDIC's position is essentially that it is incapable of losing money because it can always assess financial institutions to make up for any losses.

But by definition, wouldn't losses be the justification for any such assessments? So doesn't that mean that the FDIC really is capable of losing money?

Alice has nothing on Sheila in Wonderland.

The "I win-you lose" partnership

2009-04-01T12:39:00.000-07:00

In "Obama's Ersatz Capitalism" economist Joseph Stiglitz shreds Tim Geithner's Public-Private Investment Program.

Shooting the messenger: bank analysts pay price for being right

2009-03-30T05:33:00.000-07:00

Chinese walls and paeans to analyst independence are for other industries, apparently.

Mark DeCambre of the New York Post reports that snubs, cold shoulders, legal action, and muzzles are the rewards for prominent securities analysts who spoke the truth about bank financial performance.

Public pension fiasco: fun with mortality tables

2009-03-03T12:42:00.000-08:00

Bloomberg reports that the "Hidden Pension Fiasco May Foment Another $1 Trillion Bailout." Its account of the games played by public actuaries are astounding. I especially loved this bit about the Puerto Rico system:

Gaitan says the retirement system’s underfunding may actually be an additional $1 billion or more than the fund reports, because the board relies on outdated mortality tables based on 1960s statistics to compute its future obligations. The shorter life spans in those outdated tables reduce the apparent size of the fund’s liabilities.

Bank "stress test" a mockery of the term

2009-03-02T07:30:00.000-08:00

Dealbook pours cold water on the notion that the proposed stress tests of large banks will answer any meaningful questions:

The government will be stress-testing the banks under two economic scenarios to determine how much capital they might need: a baseline scenario and a “more adverse” scenario. The more-adverse scenario assumes that the economy will shrink 3.3 percent this year, followed by growth of 0.5 percent in 2010. It also assumes that unemployment rises as high as 8.9 percent in 2009 and 10.3 percent in 2010.

Is that pessimistic enough? The government sees the downturn bottoming out in the second quarter of this year — making it long as recessions go, but nowhere near as bad as what the nation experienced during the Great Depression.

In 1930, the first full year of the Great Depression, United States gross domestic product declined 9 percent. Gross domestic product then fell by another 6 percent in 1931, followed by a 13 percent drop in 1932.

The administration repeatedly invokes the Great Depression in seeking to rally popular support for its economic spending programs. Some economists may find it puzzling why it doesn’t use a more Depression-like set of assumptions in its “more adverse” stress tests.

These stress tests are public theater, nothing more.

Elbow room on the NYSE trading floor

2009-03-02T07:02:00.000-08:00

Serena Ng and Geoffrey Rogow of The Wall Street Journal report that the NYSE will implement rebates for order flow and faster technology in response to market-share losses to BATS and other venues.

According to their report, the population of the NYSE trading floor has declined from 5,000 to 1,200 over the past five years. The floor will become more crowded today when 370 options traders from the American Stock Exchange join the fray.

The NYSE will also try to narrow the performance gap between its technology and that of its rivals. From the Journal:

In coming weeks and months, NYSE plans to roll out technology to reduce trading times and narrow the gap with its rivals, who up till recently have been able to execute trades in less than a fifth of the time. By streamlining and upgrading its systems, NYSE has so far reduced latency, or the time it takes to execute an order, by about 28% to 62 milliseconds from 86 milliseconds in the past three months. Later this quarter or early next, NYSE expects to further drop latency into the single-digit milliseconds, closer to some of its peers.

Where is Europe's contribution to AIG rescue?

2009-03-02T04:36:00.000-08:00

Reuters reports an AIG failure would still be disastrous for global markets and provides a litany of excuses for the latest bailout of the firm imposed on U.S. taxpayers. According to the Reuters report:

"The government really does not have the option of letting AIG totally blow up," said Robert Haines, senior insurance analyst at CreditSights,

AIG's foray into the roughly $28.5 trillion credit default swap market left it heavily exposed to losses on toxic mortgage assets that it had guaranteed against default.

AIG, through a financial products unit, sold more than $450 billion of protection on securities to U.S. and European banks. With government support, some of those derivatives have been unwound, but the company still has about $300 billion of this exposure, according to Credit Sights.

Haines said that European banks in particular, counterparties on many of AIG's outstanding derivative contracts, "would be hammered if the U.S. walked away."

Donn Vickrey, an analyst with Gradient Analytics, who has closely followed the financial deterioration at AIG said while "European banks are about two-third of the problem ... it would be a domino effect across the globe.

"The ensuing panic would be disastrous," he said.

If European banks have two-thirds of the remaining exposure to AIG financial guarantees, why are U.S. taxpayers footing the entire bill? AIG has operations in more than 100 countries. As I understand it, the subsidiary that did the serious damage is British, not American. Have U.S. politicians made any attempt to extract help from other central banks and national treasuries?

Bank nationalization will fail, too

2009-02-23T09:37:00.000-08:00

No good will come from government ownership or control of banks ("nationalization"). Banking is a business. Government is an instrument of blunt force. Were government to own or control banks, it would not be able to tolerate an outcome which is essential to the health of any market: failure. Government managers would careen from strategy to strategy, with each change in direction requiring more taxpayer support and greater restriction on any competition that might derail their plans. Nationalization of banks will exacerbate, not ameliorate, the current catastrophe in financial markets.

Nationalization fails to address the root causes of the banking disaster: speculation by banks with FDIC-guaranteed deposits and corporate ownership forms that misalign the interests of bank managers with those of shareholders and creditors.

As for FDIC's deposit guarantee, we have learned nothing from the thrift debacle of the 1980s or those who have objected at every step in the implementation and subsequent expansion of government deposit guarantees. Even the warnings of government economists about the moral hazards implicit in FDIC guarantees have been ignored.

Similarly, with disastrous consequences we have ignored the warnings of countless economists and legal theorists that banking is incompatible with corporate and other limited-liability-ownership forms. For good reason corporate banking was illegal in the United States until the middle of the 19th century. It is no accident that the only solvent bank in the United States is Brown Brothers Harriman & Co. - a general partnership.

The combination of government-guaranteed deposits and corporate banking was a recipe for the present disaster, as many said it would be.

Government managers can do no better than current bank management with the putrid practice of funding illiquid or otherwise risky investments with demand deposits backed by the full faith and credit of the U.S. government. Government managers cannot predict the future any better than private managers but may be worse at such predictions.

If taxpayers are to be the ultimate guarantors of bank deposits, then such bank deposits should only be invested in government bonds on a matched-duration basis. No other investment strategy will insure bank solvency. Of necessity, the returns on such deposits will be low. Those seeking higher returns should be free to speculate in banks of their choosing, but without a government guarantee as to the outcome of such speculation.

Aguirre blows whistle on regulation

2009-02-08T05:46:00.000-08:00

Hayek and other real economists demonstrated long ago that government regulation of the economy is a farce, a primary aim of which is to protect large, established firms from competition by entrepreneurs. Matter Renner of Truthout provides a perfect illustration of the thesis in his interview with former SEC investigator Gary Aguirre, the man fired for wanting to issue a subpoena to John Mack during an insider-trading investigation of Pequot Capital Management.

Renner begins the interview by asking Aguirre about Madoff, but soon turns the subject to the SEC more broadly. Aguirre skillfully demonstrates the function of the revolving door between the SEC and Wall Street law firms and departments.

At the conclusion of the fascinating conversation, Renner asks Aguirre whether there are "other Madoffs out there." Aguirre's response:

We have to look back in history. Yes, I do. I believe there are other Madoffs out there. I don't think that the banks are finished collapsing and imploding, and I think we will also see more evidence of market abuse and insider trading. The way it works is when markets are going up, none of this comes to light. But when you have the markets begin to go into free fall and people begin losing money, it becomes hard to conceal the fraud. That's what happened in Madoff's case. In 1929, when the market crashed and the Senate Banking Committee surveyed the rubble, they discovered all kinds of fraud by Wall Street elite.

I'm not sure that all of the dirt has come to light at this point. I think one reason for that is because [Treasury Secretary Henry] Paulson, a representative of Wall Street, has been pumping money into the system. We're transferring trillions of dollars from taxpayer's pockets to Wall Street to try to stem the downward cycle that we are in and perhaps to some extent we have. But that may help conceal the extent of the fraud. It is when the veneer is completely stripped away; that's when you discover the fraud. To the extent that we are pouring trillions into the capital markets, we may delay, postpone or even prevent the full extent of the fraud from surfacing. But I think it is out there and I don't think the downward cycle has ended yet. As long as it continues, we'll discover more.

Oh, goodie: The Ascendant State

2009-01-30T04:05:00.000-08:00

James Raft of Reuters reports on the mood at Davos:

Now the state is in the ascendant, both as an "investor" and regulator and as an economic force. There is talk everywhere of stimulative government spending, and although it is intended to be temporary while the economy recovers, you get the feeling that the shift in the balance between state and private enterprise might outlast the downturn.

Blaming the system

2009-01-25T04:37:00.000-08:00

I have many questions about the current financial debacle, but of one thing I am absolutely certain:

Human beings allowed and perpetrated it.

Understandably, certain individuals who were paid large sums of money and prestige, given fancy titles and offices, and vested with the power and responsibility to prevent the calamity, now wish to evade their responsibility and shift the blame for what has transpired. Take Treasury Secretary nominee Timmy Geithner, for example, as quoted in The New York Times:

"I believe that our regulatory system failed to adapt to the emergence of new risks," Mr. Geithner said in a written response to questions that was made public on Friday by Senator Carl Levin, Democrat of Michigan. "The current financial crisis has exposed a number of serious deficiencies in our federal regulatory system." [Emphasis added.]

I see. People are not to blame. The system failed!

Timmy sits before a Senate committee considering, at least in theory, whether he is a fit steward for the people's money, after presiding - as a steward for the people's money - over a long-running financial disaster of epic proportions, and is allowed to blame a disembodied system rather than real human beings for what happened. Does a single United States Senator hold him to account for this evasion?

Of course, not.

All sentient beings should be able to recognize that neither alien invaders nor machines nor bricks nor disembodied systems had anything to do with the meltdown of the financial markets. Human beings did this all by themselves.

I am not in the habit of making guarantees, but will guarantee this: new regulations will not solve the current crisis or prevent future ones, and rewarding those responsible for the present failure with continued responsibility of like kind will only perpetuate the disaster.

New York AG investigating Merrill bonuses?

2009-01-23T05:38:00.000-08:00

This snippet caught my eye in today's New York Times report on John Thain's resignation:

But despite the mounting losses, Merrill Lynch rushed to pay annual bonuses to its employees before its deal with Bank of America closed on Jan. 1. Those payments are now under investigation by the attorney general of New York, a person briefed on the investigation said Thursday.

Much can and deserves to be said about Thain's conduct at Merrill. His alleged office decorating spree in the face of layoffs of thousands of employees and need for taxpayer support is astounding on its own, but the accelerated bonuses are reckless, at best.

Thain could not have thought he would get away it. Why did he do it? His reputation is now tarnished. He may even face civil or criminal liability. It would be fascinating to know what calculations he made.

Notes from the Chairman: Bono on Sinatra, and courage

2009-01-11T05:58:00.000-08:00

I am a big fan of U2 and Bono's work for peace and to end hunger, but his essay in today's New York Times - subject Sinatra, but theme something even more profound - blew me away. An excerpt:

Is this knotted fist of a voice a clue to the next year? In the mist of uncertainty in your business life, your love life, your life life, why is Sinatra’s voice such a foghorn — such confidence in nervous times allowing you romance but knocking your rose-tinted glasses off your nose, if you get too carried away.

"What were they thinking?" A clue...

2009-01-05T04:46:00.000-08:00

Many have asked of the alleged Madoff victims, particularly of those who entrusted their life savings to the man, "What were they thinking?"

Access International Advisors co-founder Patrick Littaye provides a clue to at least some of the thinking in an interview with Bloomberg's Alan Katz:

Littaye met Madoff in 1985 when a private banking client asked the Frenchman to check whether a put option the bank had ordered had been secured, and he confirmed the transaction with Madoff. After that, Littaye said, he was impressed with Madoff’s ability to forecast the short-term direction of stocks based on order flows he saw as a market maker.[Emphasis added.]

This is the first explicit acknowledgment that I have seen that investors believed Madoff was using information gathered from his market-making business to generate profits in his investment-advisory business. Such a practice may well be illegal.

The law has an "unclean hands" doctrine. To the extent investors placed funds with Madoff because they believed he was cheating and sought to profit from same, a judge would likely limit their recovery of assets accordigly.

SEC mea culpa on Madoff: pretext for federal bailout?

2008-12-19T06:31:00.000-08:00

I don't trust Chris Cox's sudden bout of candor about the SEC's failure to prevent or at least mitigate the alleged Madoff fraud. Cox unexpectedly admits:

The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action.

This smells to me like the beginnings of a public campaign for a bailout of Madoff's victims. Almost never do regulatory agencies admit error, much less what amounts to negligence. I would think that Cox's admission would help counsel for plaintiffs overcome a sovereign immunity defense.

The lone con-man theory

2008-12-16T19:19:00.000-08:00

The lone con-man theory - the idea that Bernard Madoff acted alone - is impossible to believe.

Was his brother, Peter - general counsel for the firm - a total idiot? No. If he didn't know something was up, he is at best guilty of criminal negligence in the due diligence department.

Madoff case requires independent prosecutor

2008-12-14T08:19:00.000-08:00

With Bloomberg reporting that the SEC failed in Madoff's case to perform its customary, first-year audit, the need for independent counsel to review the actions (or inactions) of regulators becomes obvious. Neither the SEC nor FINRA can properly investigate themselves. Both must be held to account for the Madoff fraud, if facts are as they now appear.

Seemingly all of the following red flags and practices that are always carved out for heightened regulatory scrutiny were dismissed or ignored by SEC and FINRA in Madoff's case:

1) Direction of order flow by an investment advisor through an affiliated broker-dealer.

2) An exclusive custody arrangement for assets of an investment advisory firm with a broker-dealer under common ownership and control with the advisory firm.

3) The exercise of limited or full discretion over a brokerage account by a registered representative or supervisory principal.

In addition, we have Madoff's role as a regulator himself, his donations to Senator Schumer, and his management of funds for Senator Lautenberg, all begging independent inquiry.

The religion of regulation

2008-12-13T08:44:00.000-08:00

Many analysts blame insufficient government oversight for the present financial crisis and demand additional regulation in order to prevent future crises.

Their belief in the powers of regulation is religious in nature. Evidence suggests that regulation fails at its stated purpose of protecting the innocent from the rapacious. At best, regulation lulls the innocent into a false sense of security and causes them to feel relieved of the duty of due diligence.

Regulation, then, is a false god. It makes people feel better but does them no good. To the extent they depend on this false god and support it with the fruits of their labor, they are harmed by their belief.

Consider the Madoff case. If the allegations [PDF, 11 pages] against Mr. Madoff are true, he operated a massive fraud for many years (and thus spanning multiple accounting periods and audits) in the face of multiple regulators possessed of unlimited powers to detect and prosecute the fraud. These regulators failed to act even when warned of the potential fraud by a Certified Fraud Examiner:

"Madoff Securities is the world's largest Ponzi Scheme," Mr. [Harry] Markopolos, wrote in a letter to the U.S. Securities and Exchange Commission in 1999.

The regulatory failure is even more remarkable and inexplicable when one considers that this alleged fraud was effected through accounts at a brokerage firm under common ownership and control with Mr. Madoff's advisory business, over which he exercised discretion. Anyone with an iota of experience in managing a brokerage or investment advisory firm knows that this arrangement incorporates multiple red flags that would invite heightened regulatory scrutiny.

Not every missed or ignored the red flags raised by Madoff's business operation. Private enterprise Aksia LLC warned clients to stay away from Madoff on the basis of due diligence alone. Private enterprise Societe General nixed a deal because of red flags flying from the Madoff business and private investor Doug Kass spared a client exposure to the Madoff debacle because Madoff's stated returns did not compute.

Madoff was himself a regulator, whether as chairman of Nasdaq or governor for the New York region of the NASD (now FINRA). This raises the specter that cronyism explains, at least in part, the failure of authorities to protect the public.

The Madoff website proclaims in bold color the firm's membership in FINRA and SIPC. Investors took comfort in those credentials, such as they are, at their peril. To the extent investors relied on regulators rather than their own due diligence, they lost.

While the alleged, Madoff fraud may prove to be a $50 billion or larger instance of criminal incompetence by regulators, it pales in comparison with their failures to properly supervise the so-called bulge bracket on Wall Street. Whether at Lehman or Goldman, AIG or Bear Stearns, Citi or Merrill, at no point in time did regulators lack the power or the means to question or constrain the risks these firms were taking. The idea that credit default swaps are "unregulated" is a lie advanced and promoted by the disciples of regulation. No aspect of any bank or brokerage firm is beyond the reach of regulators. The American people are now on the hook for trillions of dollars in losses because too many of them worshiped at the alter of regulation.

Fraud, theft, and trespass are crimes by common law, each of an economic nature. They constitute sufficient boundaries for the operation of financial firms - no further "regulation" is necessary and all further regulation is harmful. Substantially everyone is touched by and must interact with financial firms - a body of potential victims too massive for third-party protection. People must look out for themselves. Private enterprise provides the only reasonable, reliable third-party means of investor protection, whether through due-diligence services or insurance arrangements.

After the Madoff case, no one has any excuse for believing in the efficacy of regulation.

Who are the real beneficiaries of the auto bailout?

2008-12-10T14:03:00.000-08:00

The idea that U.S. taxpayers should bailout GM, Chrysler, and Ford is ridiculous.

The only sensible course of action for these companies is bankruptcy. No other course offers them the opportunity to reorganize their affairs legally and fairly.

The choice is not between a bailout on the one hand and no American auto industry on the other - that is a false dichotomy. Fundamentally, these companies are perfectly capable of producing marketable, competitive, innovative products. Perhaps not all three would survive a bankruptcy proceeding, but at least two would, and these two would sell millions of cars per year, profitably.

Suggestions that the bailout is in the national-defense interest of the United States are equally silly. America has a deep bench of politically-entrenched, fabulously-wealthy defense contractors - including the "Big Three" automakers - that is perfectly capable of building tanks and whatever other vehicles the empire needs.

Sure, there are union pressures, but these, too, are overblown as a motive force for the bailout. Some of the jobs will disappear in a bankruptcy scenario, but most will not. Many who lose their jobs will find employment elsewhere, even in the same industry.

No, the real beneficiaries of this bailout are the people who own the debt and equity securities issued by automakers and their suppliers, and the banks who have lent money to them and their franchisees. In other words, the same cast of characters who have already benefited from Wall Street bailout will be saved, at least temporarily, by this one. No other group has the political clout to get members of the House and Senate to vote for something that most of their constituents oppose.

The auto bailout is just another form of Wall Street bailout.

Gulf states may establish common currency

2008-12-02T05:40:00.000-08:00

Liz Mak of Asian Investor reports that leaders of Bahrain, Kuwait, Qatar, Saudi Arabia and United Arab Emirates met last week to plan the creation of a common, central bank and currency.

Her account also contained this nugget:

The sukuk market is witnessing stronger volatility after local Islamic scholars have spoken out against wide-spread incompliance of such products to the sharia laws. Sharia laws forbid Muslims from profiting from maysir (speculation), gharar (uncertainty) and riba (interest). These three qualities are considered to be haram (forbidden) in the Islamic region.

Goldman's market capitalization now less than bailout amount

2008-11-19T07:46:00.000-08:00

As I write this, the common stock of Goldman Sachs last traded at $61.17 (current chart), which equates to a market capitalization of $24.95 billion, according to Google Finance.

Goldman reportedly received $10 billion in direct taxpayer support from the Troubled Asset Relief Program ("TARP"), administered by former Goldman CEO Henry Paulson and, if reporting by The New York Times is correct, at least $20 billion in indirect taxpayer support via the government's bailout of AIG, now led by former Goldman director Ed Liddy.

Thus, Goldman may now be trading at more than a $5 billion discount to the amount of taxpayer support provided to keep it afloat.

Michael Lewis does it, again

2008-11-13T15:03:00.000-08:00

I have enjoyed everything I have read by Michael Lewis, but "The End" - his account of Wall Street's unraveling - ranks with Liar's Poker as a must-read.

FDIC insures GE Capital debt

2008-11-12T19:04:00.000-08:00

Every day brings a new outrage - or several of them - but the FDIC's decision to insure the debt of GE Capital ranks pretty high in the litany of despicable acts.

From Bloomberg's report on the matter:

General Electric Co. said the U.S. government agreed to insure as much as $139 billion in debt for lending arm GE Capital Corp., the second time in a month it has turned to a federal program designed to help companies during a global credit crunch.

Gee, is there any borrower in America that wouldn't like to have the full faith and credit of the United States government backing its obligations? What exactly has one of the wealthiest companies on earth done - or not done - to merit the explicit support of every man, woman, and child in America?

In perhaps the understatement of the week, GE's flack assures us that its shareholders will benefit from the generosity of the American people:

"Inclusion in this program will allow us to source our debt competitively with other participating financial institutions," [Russell] Wilkerson said. GE sent investors an e-mail about the program today and posted the letter on its Web site. "Our participation is a positive development for our investors."

When a person begs me for money on the street or in the subway, he unfailingly says "thank you" or "bless you" or something to that effect to acknowledge whatever change I could spare.

All we get from GE is a statement of the obvious.

In The Know: Should The Government Stop Dumping Money Into A Giant Hole?

2008-11-12T18:11:00.000-08:00

Finally: the perfect counterpoint to CNBC:

In The Know: Should The Government Stop Dumping Money Into A Giant Hole?

AIG bailout begs Congressional hearings

2008-11-11T19:50:00.000-08:00

Now that former Goldman Sachs CEO Henry Paulson has used his powers as Secretary of the Treasury to bailout September's $87 billion bailout of AIG - now led by former Goldman director Ed Liddy - with a new, $150 billion bailout, the time has come for Congress to ask a few simple questions in open hearings:

1) To whom is AIG obligated and by how much? Is it true that the original bailout spared Goldman Sachs a $20 billion loss?

2) What would happen to AIG's regulated insurance businesses if the parent were allowed to fail?

3) Have officials of foreign governments lobbied either the U.S. Department of Treasury or the Federal Reserve for taxpayer support of AIG?

4) Who are the largest holders of AIG equity and debt securities?

5) What did Ed Liddy know about the true financial condition of Goldman Sachs when he served on Goldman's board? Why did he resign as a Goldman director when he joined AIG? What was the perceived conflict of interest?

Scrutiny of Wall Street bonus plans

2008-11-06T04:40:00.000-08:00

New York attorney general Andrew Cuomo is investigating whether Wall Street's compensation practices were "illegal fraudulent conveyances" (PDF, 2 pages) and appears determined to prevent the use of taxpayer bailout funds for bonus payments.

I wonder, though, how he could conclude anything but that taxpayer funds will be used for the bonus pool. Consider this excerpt from this morning's report on the matter by The New York Times:

Mr. Cuomo added that he would closely examine the books of the nation’s biggest banks to ensure that no government money went into bonus pools.

Money is fungible. If, say, Morgan Stanley receives $25 billion from taxpayers and pays out $10 billion in bonuses, to some extent or another, the taxpayer funds were a source of funds for the bonuses. It could be no other way.

Grant Thornton: "Chrysler as we know it will cease to exist very soon"

2008-11-03T04:28:00.000-08:00

Accountancy Grant Thornton LLP suggests that a merger between GM and Chrysler is inevitable, as any alternative would be worse:

"Chrysler as we know it will cease to exist very soon," said Kimberly Rodriguez, principal of Grant Thornton's automotive practice. "At this point, there are very few options available to either company. We believe a transaction between GM and Chrysler is likely because it would be the most expedient way to protect cash and jobs at both companies. If one or the other company were to fail, we would face a much bigger calamity -- the collapse of the North American supply base and the potential endangerment of all three Detroit automakers and businesses that depend on them."

Grant Thornton's automotive advisory experts estimate that as many as 74,000 people may lose their jobs as a result of the merger: 12,000 production workers, 12,000 administrative workers, and up to 50,000 employed by suppliers.

Putting the bank bailout in perspective

2008-11-02T17:49:00.000-08:00

We know that several large, U.S. banks will receive $25 billion in taxpayer funds that Henry Paulson says they don't need.

Among the $25 billion beneficiaries is Wells Fargo Bank, whose chairman, Richard M. Kovacevich, is said to have protested strongly that his bank did not need a bailout.

So massive and unprecedented is the scale of this fleecing of the American taxpayer that $25 billion no longer sounds like an astronomical amount of money, but in an interview with the editorial board of The Wall Street Journal last year, Genentech CEO Arthur D. Levinson helps us put that figure in perspective:

...look at how much society is investing in cancer. In the absence of better care, 42% of everybody out there is going to get cancer. And half of those 42% are going to die of cancer. It's the leading cause of death among Americans under age 85. So how much are we spending on drugs for cancer? We have a $12 trillion GDP [gross domestic product]. And we're spending $15 billion. If I do that math, 1/800th of GDP for the leading cause of death. And people say cancer drugs are bankrupting America! Give me a break.

Presuming Dr. Levinson has his facts straight, U.S. taxpayers are giving to a single bank whose chairman doesn't want the money - and the Secretary of the Treasury says doesn't need the money - almost 70% more money than they invest in a year on cures for cancer.

Pimco's Bill Gross: queen of corporate welfare

2008-10-27T17:54:00.000-07:00

I must admit that prior to the widespread recognition of the massive pyramid scheme masquerading as Wall Street ("financial crisis"), I never got Bill Gross.

He was either incredibly smart and lucky or else incredibly stupid and lucky - I couldn't discern which. His infamous, trade-execution method - the "Pimco drive-by" - is moronic on its face. Surely Gross couldn't be such a rank amateur as to pull that stunt more than once, could he? Surely his counterparts couldn't be forgetful enough to fall for the cheap trick more than once, could they? Well, I guess many of us are guilty of overestimating the intelligence of bulge-bracket traders...

The man was clearly adept at talking his position. Evil short sellers are punks in the market-manipulation game, compared to this guy. But surely loose lips were not enough to account for his reputation as the master of the bond universe...or were they?

His monthly missives were all over the map, philosophically. Was he a capitalist? A socialist? A fascist? A communist? Couldn't really tell...

Then came the financial crisis, and the twin realizations that (i) Bill Gross was scoring more tube time than Obama and McCain combined, begging at every turn for the mother of all taxpayer bailouts and (ii) the man was performing not a public service, but a very private one, namely, whimpering behind a snarl for rescue of his reputation as bond genius. Somehow, this guy had managed to stuff a $100 billion bond portfolio with the biggest losers in the universe.

Bill Gross needed corporate welfare on a previously-unimagined scale. Without it, his reputation would be shattered and his investors a lot poorer for his reckless and imprudent concentration of risk in Fannie, Freddie, and Wall Street.

Years of practice at talking his book for smaller scores worked like a charm, though, and in the end - or at least for now - he was saved from himself.

The scam worked so well, in fact, that Gross has now publicly embraced corporate welfare as an investment theme:

"We like the ones that are submitting applications: Key Bank and Regions and a host of others that are large enough and well capitalized enough to be admitted to the club," Gross said in a Bloomberg Television interview from Newport Beach, California. "The government is investing 10 to 15 percent of the banks' total capital themselves into the company and so why not be a partner with the government at a higher yield than the government is giving? It's a slam dunk in my opinion."

You have to love his nonchalant patter about clubs, partnering with the government, and slam dunks - a perfectly-reasonable-sounding synthesis of Edmund G. Robinson, Michael Irvin, and Benito Mussolini - hiding the monstrous reality of the corporate-welfare monarchy: behind the queen are a bunch of guns, and anyone who refuses to go along with the confiscation of his hard-earned wealth - anyone who rejects the "we're all in this lifeboat together" malarkey - will be imprisoned, if necessary, in order to secure compliance with the queen's wishes.

But why dwell on such unpleasant thoughts? Reality is so...distasteful. For now, at least, the Pimco Total Return Bond Fund has been saved, the reputation of its master is saved, and the day of reckoning is postponed, for the good of all. Long live the queen.

Davos promoters snivel: "We tried to warn them"

2008-10-25T06:47:00.000-07:00

The World Economic Forum Annual Meeting in Davos, Switzerland routinely engendered a fair amount of concern and derision among free-market advocates and devotees of the U.S. Constitution - conspiracy theorists, in other words - who were convinced that participants used the occasion to scheme and plot the emergence of George H.W. Bush's New World Order.

Apparently, the meetings were little more than an exercise in preening. Bloomberg's Craig Copetas reports in 'Out of Control' CEOs Spurned Davos Warnings on Risk that Wall Street titans took more interest in snow polo and the sizes of their party rooms than in the serious seminars organizers had prepared for them:

"The partying crept in," says Klaus Schwab, the 70-year-old WEF founder and executive chairman. "We let it get out of control, and attention was taken away from the speed and complexity of how the world's challenges built up."

How Paulsen brought nine CEOs to heel

2008-10-19T17:08:00.000-07:00

Asked by Leslie Stahl on 60 Minutes (CBS, aired tonight) why it was so important that the nine largest banks went along with U.S. Treasury Secretary Henry Paulsen's "take it or take it" investment of taxpayer funds, Bank of America CEO Ken Lewis answered:

"If you had a bank in that group that really, really needed the capital, you don't want to expose that bank."

Virtually all U.S. banks are insolvent

2008-10-19T14:12:00.000-07:00

With the exception of the Brown Brothers Harriman & Co. partnership bank in New York, substantially all other U.S. banks are insolvent. They would be unable to redeem customer deposits on demand, as promised, and would be forced to default if more than a small fraction of their customers demanded return of their funds.

Insolvency is an unavoidable feature of fractional-reserve banking, in which banks create money out of thin air. When customers make deposits in a bank, they are lending money to the bank and become creditors of the bank. From the bank's perspective, a deposit is a liability - money it owes to a customer.

Banks keep only a small percentage of customer deposits - typically less than ten percent - readily available to meet the demands of depositors for return of their funds. They lend or invest the rest and account for these loans and investments as assets.

When a person deposits his paycheck in the bank, other than any portion he sets aside for saving, he expects to be able to redeem his deposit on demand to pay for groceries, rent or mortgage payments, utility bills, and the like. Typically these expenses will arise within thirty days.

The bank, however, will not keep those funds readily available, so that it can without fail and with utter dependability return them when its customer's utility bill is due. It will instead lend most of the deposit to someone else to buy a car, or to purchase a copier for a business, or for some other purpose, or it may even speculate in stock of other financial institutions with those funds.

The bank cannot make the person to whom it lent funds to buy a new Corvette sell the car and return the funds on short notice, should the depositor from whom it obtained the funds to make the Corvette loan suddenly need them back to pay the electric bill. It will instead have to "borrow" funds supplied by another depositor or lender.

In essence, almost all modern, U.S. banks are legalized pyramid schemes. If people demanded return of more than a small fraction of their funds on deposit with the bank, the bank would fail.

Perversely, blaming bankers for operating the pyramid schemes that are their banks would be unfair. Regulators practically insist that banks operate as pyramid schemes. It is doubtful, in fact, that regulators would give a banking license to a new bank that proposed to operate only as an absolutely safe and reliable warehouse for the hard-earned money of its depositors.

Several years ago, I made just such an inquiry of banking officials in the State of California. Would it license a new bank that did not make loans and did nothing more than secure deposits with high-quality investments of matched duration? These officials told me that such a bank would not qualify for a license, because unless it were making loans, the new bank could not "fulfill its obligations to the community in which it operates."

Regulators are appointed by elected executives, whether governors and presidents, and overseen by elected legislators, whether state or federal. So ultimately, the sorry state of modern banking is the responsibility of the people, and it will be up to the people to take the actions necessary so that they may enjoy the use of safe and solvent banks.

Taxpayers on the hook for $5.1 trillion in bailout funds

2008-10-18T05:36:00.000-07:00

New York Times reporter Steve Lohr estimates that federal officials have obligated taxpayers to $5.1 trillion in bailout funds thus far. His report Government’s Leap Into Banking Has Its Perils questions whether banks receiving bailout will be forced to direct funds to politically-connected borrowers and contains a graphic depiction of the cost of the bailout thus far.

Bank bailout joke confirmed

2008-10-17T05:24:00.000-07:00

No one should be surprised to learn that major banks receiving taxpayer bailouts will use the funds for purposes other than what government officials promised. Just the same, Louise Story and Eric Dash of the International Herald Tribune provide a good account of the carnage to date and the plans that some banks have for these funds.

It might have helped if the strings attached to the funds matched the rhetoric of government officials, the president, and members of Congress who promoted the bailout:

"It is the government's responsibility to set the terms and conditions on this money," said David Walker, the former U.S. comptroller general and now president of the Peter Peterson Foundation. "This is the people's money. They're giving it out with no rules."

Walker noted that the government had yet to put together a board to oversee the Treasury's actions in implementing the bail-out, as was required by Congress.

If the bailout funds are ultimately to be used as promised, taxpayers will have to rely on the sensitivity of banks to public opinion, as the primary regulator for national banks is taking a hands-off approach:

"There is no express statutory requirement that says you must make this amount of loans," said John Dugan, the comptroller of the currency. "But the economics work so that it is in their interest to do so."

Dugan added that he would not examine how the banks use the money, but he said their actions would "be open to the court of public opinion."

Story and Dash note that bank losses have now more than wiped out the supposed, record profits that banks were earning during the salad years and that were the basis for record bonus payouts, as well:

As two financial giants, Citigroup and Merrill Lynch, reported fresh multibillion-dollar losses on Thursday, the industry passed a grim milestone: All of the combined profits that major U.S. banks earned in recent years have vanished.

Further:

For every dollar the banks earned during the industry's most prosperous years, they have now wiped out $1.06.

More specifically:

In the case of the nine-largest U.S. commercial banks — Citigroup, Merrill Lynch, Bank of America, Morgan Stanley, JPMorgan Chase, Goldman Sachs, Wells Fargo, Washington Mutual and Wachovia — profits from early 2004 until the middle of 2007 were a combined $305 billion. But since July of 2007, those banks have marked down their valuations on loans and other assets by just over that amount.

Money is fungible. Some of these funds will eventually make their way via lending back to taxpayers. But some will also be used to pay bonuses to the same executives who made the investment decisions that were the basis for ephemeral profits and have led to a partial nationalization of their businesses, and some will be used to pay dividends to the same institutional shareholders who voted for the same directors who failed in their duties. Or, as Story and Dash put it:

The banks could use the money from the government for any number of things. Some analysts say the banks may use it to acquire weaker competitors. Others say they might use it to avoid painful cost-cutting. And still others say the banks may sit on the capital.

But no one should be surprised by any of this.

So why the federal investment?

2008-10-15T16:07:00.000-07:00

Asked by Larry Kudlow on CNBC tonight how he convinced Wells Fargo to agree to an infusion of federal money, Henry Paulsen didn't answer directly, but did say of the nine banks in the room that they can "survive just fine" without the federal money and didn't need the capital.

Lehman: margin calls on inaccessible assets

2008-10-15T07:47:00.000-07:00

We don't doubt the difficulty or complexity of the responsibilities of Steven Pearson, the PricewaterhouseCoopers partner overseeing the disposition of Lehman's U.K. operations, but his insistence that hedge funds meet margin calls on positions to which they are denied access is unreasonable.

According to Tom Cahill's report "Lehman's Hedge Fund Clients Face Margin Calls on Frozen Assets" (Bloomberg), clients of Lehman's U.K. prime brokerage operation "may have to pay more collateral on $65 billion of assets frozen when the investment bank went bankrupt a month ago."

Pearson justifies this outrage by analogy to the mortgage market:

"If your bank fails, you still have to pay your mortgage," Pearson, 43, said in an interview in Lehman's Canary Wharf office. "Who is the holder of the risk of the securities? The hedge funds. If the value of the securities fell, they have to meet margin calls."

Well, yes, Mr. Pearson, but the analogy fails on two counts.

First, if a mortgagee (lender) fails, the mortgagor (borrower) still has access to, and use of, his home. You are not allowing Lehman's clients access to or use of their securities.

Second, if the mortgagee is unable to pay the mortgage or concerned his home may decline in value, he is free to sell the property in order to obtain relief. You are denying Lehman's clients that alternative.

The only reasonable justification for freezing these assets is to protect the interests of those with a putative, senior claim on them. If these assets are being set aside for the prospective benefit of others, then those others should bear the risk of receiving the benefit. Otherwise, the trustee is putting senior claimants in a position of having and eating their cake at once, which is untenable and constitutes a taking from the hedge funds who are forced to bear the expense.

Thin clients for cloud computing

2008-10-15T05:39:00.000-07:00

In Revived Fervor for Smart Monitors Linked to a Server, Ashlee Vance of The New York Times provides a good update of developments in the market for thin clients for cloud computing, including the interest of financial-services companies in this technology.

Broken brokerage

2008-10-07T04:44:00.000-07:00

Edgar Ortega at Bloomberg reports that wealthy clients of large brokerage firms are moving their business to smaller advisory firms:

Almost 90 percent of customers of major brokerages say they plan to withdraw at least some of their money, and 70 percent say they want to fire their brokers, according to a September survey by Prince & Associates Inc., which polled 351 people with more than $1 million of investable assets. In July, about 68 percent said they planned to take money out, and 38 percent had had enough of their current adviser.

Exploding spreads in corporate market aid Jefferies, Mesirow

2008-10-02T10:23:00.000-07:00

Bloomberg's Bryan Keogh provides a good report on exploding spreads and declining volumes in the corporate bond market. Firms such as Jefferies and Mesirow are picking up staff and market share from primary dealers.

Of particular interest:

With larger firms committing less capital to making bets, corporate-bond trading volume has decreased about 40 percent to $16 billion a day this year versus the same period in 2007, Federal Reserve data on primary dealers show.

This loss of liquidity has driven a wedge between bids and offers, allowing traders to collect higher fees, said Kumar Venkataraman, 35, an associate finance professor at Southern Methodist University's Cox School of Business in Dallas. He wrote a study on bid-ask bond spreads in 2006.

The gap on about 1,000 investment-grade bonds averaged 32 basis points last week, excluding about 600 securities with spreads of 100 basis points or more, according to composite pricing data compiled by Bloomberg. That amounts to about $24 in commission per $1,000 bond.

SEC extends emergency short-sale ban

2008-10-02T06:00:00.000-07:00

The U.S. Securities and Exchange Commission issued a statement concerning short selling, yesterday, announcing an extension of the temporary prohibition of short selling in financial companies. According to the Commission:

[T]here are circumstances in which short selling can be used as a tool to mislead the market. For example, short selling can be used in a downward manipulation whereby a manipulator sells the shares of a company short and then spreads lies about a company's negative prospects. This harms issuers and investors as well as the integrity of the market. This kind of manipulative activity is particularly problematic in the midst of a loss in market confidence. For example, in the context of a credit crisis where financial institutions face liquidity challenges, but are otherwise solvent, a decrease in their share price induced by short selling may lead to further credit tightening for these entities, possibly resulting in loss of confidence in these institutions.

The Commission did not say whether it had evidence that short sellers were spreading lies.

Behind the ban on short selling

2008-10-02T05:40:00.000-07:00

In "Goldman, Morgan Rewrite Playbooks" Aaron Lucchetti and Kate Kelly of The Wall Street Journal report that the chief executive officers of Goldman Sachs and Morgan Stanley "pushed for rules that are an anathema to many free-market champions:"

During phone conversations [with regulators], both CEOs said they needed new, emergency rules to prevent abuses in the market by investors betting on drops in Morgan Stanley and Goldman shares. The Securities and Exchange Commission had passed other rules to limit the bets, known as short sales, but hadn't taken the more radical step of temporarily banning short sales on financial stocks.

It was an ironic plea. Both Goldman and Morgan service scores of hedge funds, which depend heavily on the ability to short stocks. The two also lend out shares used by others to short. The firms knew that they would face some angry clients by calling for restrictions against a popular investment strategy, but they felt they needed to restrict abuses and protect themselves. The SEC on Friday, Sept. 19 enacted the temporary ban.

AIG bailout beneficiaries

2008-09-25T09:50:00.000-07:00

Ambrose Evans-Pritchard reports today:

It has emerged that French finance minster Christine Lagarde was one of those pleading with US Treasury Secretary Hank Paulson last week to bail out AIG, which had insured over $300bn of credit derivatives to European firms.