Friday, April 23, 2010

Paul Ingrassia On Ed Whitacre's Publicity Stunt

Paul Ingrassia, the one-time Wall Street Journal reporter, bureau chief and senior executive, and Pulitzer Prize-winning author, wrote about Ed Whitacre's big publicity stunt on Wednesday, in this morning's edition of the Journal.

Echoing my own comments, Ingrassia explained that the amount of government equity in GM, versus the 'debt' it loaned the bankrupt company, was really a matter of discretion. Not some market-determined mix.

As such, Ingrassia pointed out that, while it's true Whitacre paid off a $5.8B loan far ahead of anyone's expectation, GM still owes the government, meaning you and me, about $52B in 'equity,' which was really just old GM debt converted, via government bailout money, into government ownership of the defunct car maker.

Ingrassia then smugly noted that market-leader Ford, a much healthier and better-managed competitor, by comparison, has a market cap of only $48B.

This reinforces the point I made in that post,

"It is just this process that is frustrated by crony capitalism such as we've witnessed in the GM bailout. Instead of the resources wasted at GM being freed up to be used elsewhere in the economy, they were allowed to remain in place, then more capital added, from taxpayers, as a free equity injection. Free to GM, but very costly to taxpayers and the economy in general.

Force GM off government life support, force it out into the private sector whole or in pieces, forcing taxpayers, the federal government and, most of all, you, Ed, to see what a discount to the government's bailout price is taken on the IPO.

Now, wouldn't that be eye-opening? Somehow, Ed, I doubt you'd be toasting that event."

Thanks to Paul Ingrassia's convenient provision of Ford's numbers, we can easily see that GM could not possibly get $52B from private investors to replace the government's "equity" position. It's underwater.

So far from repaying a loan in full, Whitacre merely made a downpayment of just over 10% of our taxpayer bailout to GM, or about $6B of the $58B in old GM balance sheet capital replaced with public money.

Quite the different picture, eh? A 10% payoff, not 100%.

Keep trying, Ed. You've got a very long way to go.

The Democratic Push For Financial Regulatory Phony Crony-Reform

I'm listening to the resigning Senator from Connecticut, Chris Dodd, misrepresent his flawed financial regulatory 'change' bill. It's unworthy of the adjective "reform."

Evidently, Dodd is now brain-damaged, as his remarks on CNBC reflect an alternative-universe sort of description of what happened to the financial sector in this last decade.

Among the many lies Dodd is telling as I write this are:

-Unlike health care reform, which most Americans didn't understand, they understand the ins and outs of financial reform.

-Fannie and Freddie need reform, but aren't in the first rank of problems.

-His bill brings 'shadow markets' into the a sort of regulatory light.

-Any opposition to his bill is political, and consists of niggling details meant to totally foil any financial regulatory reform.

Honestly, Dodd is so grafted-up and confused that he can't even come close to knowing reality when he sees it anymore.

Here's the truth about his deeply-flawed bill to change- I won't dignify it with the word "reform" - the financial sector of the US economy.

First, both in Dodd's bill, and his party's president address yesterday at Cooper Union, much is made of various new rules for the sector.

Derivatives are to be cleared through an exchange- subject to the CFTC's chairman's choice.

Banks will be judged for solvency by a federal regulator.

Regulatory officials, not Congress, via legislation that remains clear and unchanged, will decide what is 'proprietary trading.'

Between the president's failure to acknowledge Congress' and the Fed's roles in starting the financial mess, via too-long and too-low interest rates, accommodative monetary policy for a decade, and converting Fannie and Freddie into low-cost public housing finance agencies, and Dodd's bill's many reliances on the discretion of regulatory agencies, the Democratic regime is attempting to inject more, not less uncertainty into being a financial service firm.

This morning's Wall Street Journal lead staff editorial notes how much of the currently-proposed legislation defers important regulatory definitions and rules to an ever-shifting group of federal bureaucrats. A group that will change with each new administration.

Rather than a fairly simply, clear set of rules, a la Glass-Steagall, the muddled Dodd bill, which the president demands be passed without significant change, actually allows markets to experience regulatory changes from strict to lax. Wait long enough, and perhaps a permissive administration will allow what was once forbidden.

How does this help provide lasting clarity and certainty to the US financial markets and sector?

The bulk of the financial sector's activities are, contrary to the profoundly misinformed Senator Dodd's belief, not only not understood by most voters, but not even known. Few citizens understand the arcane and complex worlds of structured finance underwriting or derivatives and swaps trading and accounting.

Further, as the Journal's editorial notes, Dodd's bill doesn't bring much of anything 'out of the shadows.' Instead, it will guarantee even more expensive, perpetual lobbying by financial firms to influence the changing corps of bureaucrats who oversee the industry.

Laws which are clear and unchanging don't promote constant attempts to interpret them differently. Dodd's bill, which puts so much regulatory action at the discretion of appointed bureaucrats, without clear language or metrics, invite constant attempts to curry favor and buy favorable rulings at federal agencies.

This is how big government gets bigger. Write murky law and leave it to unnamed, unelected agency officials to make key decisions, thus making business dependent upon the political class for their daily survival.

The president's glaring omission of mention of Freddie or Fannie in his address yesterday confirms his inability to actually understand how the seeds of financial trouble were planted. Even though he voted to stop legislation that might have reined in these two GSEs, which were the true origin of the financial mess. A mess which gained momentum when private mortgage finance operations got rolling to feed the demand by Fannie and Freddie for low-quality mortgages via "liar loans" and subprime paper.

Holman Jenkins, Jr. wrote, in Wednesday's Wall Street Journal,

"It's true that such deals gave housing bulls an additional way to lose money. But to blame shorts for making the bubble worse comes close to saying salvation for the markets is to exclude participants who are bearish.

This is especially peculiar since the bubble's true Rosetta Stone is being ignored, though it has been hammered away at by a member of Washington's own Financial Crisis Inquiry Commission, in the person of Peter Wallison.

Mr. Wallison has publicized new data showing that Fannie, Freddie and FHA financed a lot more subprime and Alt-A loans than anyone realized (because they were mislabeled). It turns out almost half of the $10.6 trillion in U.S. mortgages outstanding in 2008 were low quality. This is the data that might have changed investors' minds—suggesting that the American public's capacity to shoulder housing debt was far more saturated than anybody knew."

I was struck by yesterday's Yahoo Finance page headline declaring that Obama was going to New York, the 'source of the financial collapse,' or words to that effect.

How misleading! Washington, not New York, originated our recent financial meltdown. Then mortgage, commercial and investment banks obligingly fed Fannie, Freddie and FHA with the low-quality loans they demanded, at Congress' behest, then also obligingly repackaged the GSE paper as CDOs to sell globally. Alan Greenspan's and Ben Bernanke's ultra-low Fed interest rates helped this party continue by inflation housing values and supplying plenty of low-cost funding.

How you come to blame commercial and investment banks for this mess is difficult to understand.

Thus, our president and his party's lead Congressional legislator on this topic, Chris Dodd, both have earned zero credibility by ignoring the truth, and substituting their false account of the debacle.

From these false explanations of the financial crisis' origins, you cannot expect effective financial regulatory 'reform' to come.

Add the Democrats' demonization of any Republican who dares suggest that Dodd's bill is not, a la Candide, 'the best of all possible financial reform legislations,' and you have a new disaster in the making.

Finally, politicians of all stripes and both parties are running about blathering about how 'getting financial reform right will help the economy, but getting it wrong will be a disaster.' Even Karl Rove wrote that in his Journal column yesterday.

I respectfully disagree. Getting it wrong, yes, will invite new disasters. But getting it right just allows the economy to function smoothly. It doesn't magically create wealth or economic growth.

There are a few glaring, existing problems that need to be addressed immediately, and, like health care, could be done in a one-page bill. As my friend and experienced senior financial executive, B, foresaw over a decade ago, something approximating Glass-Steagall or the Volcker Rule needs to be enacted as clear, simple and unyielding legislation right now.

Simply put, any financial institutions that enjoys the protection of federal, taxpayer-provided insurance cannot be allowed to engage in risk-enhancing activities including: proprietary trading, investing in assets other than Treasuries, or underwriting of securities. They also can't invest in companies or businesses, either arms-length or as subsidiaries, which use leverage and/or do any of these activities.

Other than that, virtually every other aspect of Dodd's bill needs to be reconsidered, rewritten and carefully debated, with testimony in open hearings by players in the financial sector, before anything is passed.

As with health care, the president, in his Cooper Union address, is again wrong to demand immediate passage of proposed legislation just to 'get something done,' while characterizing anyone who dares disagree with this bum's rush approach as anti-regulation, anti-public good, and merely greedy and self-serving.

As I noted in this post yesterday,

"I wasn't about to waste my time listening to an uninformed, naive politician natter on about financial regulation. Experience has shown that, from this president, all you'll hear about financial sector regulation is some ill-informed notions of consumer protection, the vilification of private institutions, and a complete ignorance of Congress' own culpability in the recent financial mess.

I'm sure the evening cable news programs and tomorrow's Journal will provide me with all the details I need to know about this morning's speech. How the president railed against and demonized the legitimate expression of opinion by publicly-held banks, through lobbyists, concerning regulation affecting the sector."

It develops that I was correct. Our uninformed president provided nothing remarkable, nor new, in his remarks. They were the usual bashing of current businesses and the petulant demand to pass his party's legislation, unchanged, or risk being publicly targeted as anti-social.

If this is good governance, we're in big trouble. And we are.

Thursday, April 22, 2010

The Financial 'Blah Blah' At Cooper Union This Morning

I didn't listen to the president's address this morning, from Cooper Union, on regulating the financial sector.

Leaving aside the not-so-subtle attempt to portray himself as the second Lincoln, using that venue, I wasn't about to waste my time listening to an uninformed, naive politician natter on about financial regulation. Experience has shown that, from this president, all you'll hear about financial sector regulation is some ill-informed notions of consumer protection, the vilification of private institutions, and a complete ignorance of Congress' own culpability in the recent financial mess.

Including, by the way, the president's participation in obstructing cloture on a vote for a Republican financial regulation reform bill that helped lead to the 2007-2008 meltdown. And Obama was, according to Peter Wallison, writing in Tuesday's Wall Street Journal,

"the third largest recipient of campaign contributions from Fannie Mae and Freddie Mac, behind only Sens. Chris Dodd and John Kerry."

And, besides, I begin to become physically ill when I hear him begin his sing-songy drone in that annoying tone of voice. Complete with what he evidently thinks is a folksy dropping of occasional "g"s. I'm from Illinois, and we don't actually talk that way out on the Plains, once we've been to college. Not to mention grad school.

Funny how he forgot to mention those campaign contributions, when he recently accused Republican Senate Majority Leader Mitch McConnell of meeting with banking representatives before deciding on his position regarding Chris Dodd's deeply-flawed attempt at financial regulatory "reform."

I'm sure the evening cable news programs and tomorrow's Journal will provide me with all the details I need to know about this morning's speech. How the president railed against and demonized the legitimate expression of opinion by publicly-held banks, through lobbyists, concerning regulation affecting the sector.

With this in mind, I expect to write more in tomorrow's post about this morning's political non-event at Cooper Union.

Recent Revelations Concerning The SEC v. Goldman Sachs RE: ACA

I first, and most recently, wrote about the SEC's civil suit against Goldman Sachs on the day after the former filed its suit, on Friday of last week.

Since that time, various news organizations have been scurrying about, interviewing, or attempting to interview, major players in the several years-old case.

Paola Pellegrini, then with Paulson's hedge fund, Laura Schwartz, then with ACA, and Fabrice Tourre, the Goldman employee most involved with the Abacus deal, were all spotlighted in the Wall Street Journal yesterday.

The most revealing information that has appeared in the public domain since last Friday has been attributed to Pellegrini. His alleged contentions seem to directly contradict several assertions in the SEC's case.

Specifically, it appears that Pellegrini says that ACA knew that Paulson's firm was involved in the deal. ACA also apparently exercised considerable discretion in rejecting some of Paulson's suggested inclusions, substituting other mortgages which, it later developed, actually reduced the quality of the resulting CDO.

What's losing credibility, though, is at least one of the SEC's two charges against Goldman- that it hid Paulson's involvement from ACA.

On CNBC this morning, several people debated whether Goldman would, if it could, settle this case. The preponderance of opinion was that it would not, since it needs to refute the SEC's charges in court, in order to emerge free of taint of actual illegal behavior. I would agree.

In my prior post, I emphasized that even if Goldman didn't engage in illegal activities, this case may finally convince many institutions to be wary of dealing with Goldman, having evidence that you simply cannot trust the firm to view any counterparty as a 'valued client' whom the firm won't treat roughly when given the opportunity.

To me, reviewing the additional information of the past week, the SEC's case appears much weaker than it did when first announced.

Yesterday's Wall Street Journal's column by Holman Jenkins, Jr., made a convincing case that this suit is the SEC's attempt to accomplish a largely political task, i.e., fight for and win a larger role in financial regulation under the currently-proposed so-called 'reform' bill. Others allege that the SEC is attempting to fill the media with stories about the SEC that don't focus on its decision to leave Allen Stanford alone years ago. In short, the high profile Goldman case is meant to focus public attention on the agency and a major financial sector vendor. Perhaps even curry favor with Congressional Democrats for delivering a convenient victim in time to drive passage of the legislation. Jenkins wrote,

"The need for villains frequently (not always) conflicts with the need for understanding. The SEC certainly understands the need for a rapid route to rehabilitation for itself if it hopes for a share of the power and budget up for grabs in the Senate debate over financial reform. If you don't think this played a role in the suit it sprang on Goldman last week, we have a CDO to sell you."

Jenkins also argued persuasively that much about the Abacus case involves a latent public and regulatory distaste for those who profit on the short side of transactions. Though necessary and helpful to real, free markets, short-side activity carries a stigma, since the profit comes from the destruction of someone else's financial value. He also contended in his column,

"Goldman will have to decide for itself if its business model can be defended in the court of public opinion. But let's admit there's an implicit long bias to the SEC's case. Nobody would give a hoot if Mr. Paulson were the party who lost money. The SEC would never have gone on its hunt for something, anything, to hang a fraud case on."

I think it's fair to say that dealings between a complicated, multi-business financial giant like Goldman and institutional counterparties is very different than from, say, GE's jet engine business and an airline.

There are lots of rules governing how the execution of trades in financial markets are to be performed which, generally, lend a bias against the legality of too much coziness between parties in the business. For example, a firm having securities underwritten by a firm like Goldman must understand that Goldman couldn't hide material information about the firm when selling the securities to its customers.

Years ago, Frank Quattrone, then of CSFB, was accused of illegal behavior resulting from alleged ties between IPO allocations and other business activities.

My point is that employees at institutions dealing with major market-making, trading firms, including the now-commercial banks such as Goldman Sachs and Morgan Stanley, are wise to view any solicitations to buy securities cautiously.

One natural reaction of a potential buyer could, and should be,

"If it's such a great deal, why are letting me in, and not keeping it all for yourself?"

There are some valid answers, such as selling a sufficient amount of a security to ensure a liquid market for future trading and valuation. But the core of the question is germane, especially to a firm like Goldman, which has so many different businesses in the financial sector. Its GSAM asset management group could well provide a sufficient appetite for many choice Goldman underwriting products.

From this perspective, it's simply ludicrous that the SEC would claim that Goldman failed to tell potential buyers of the CDOs who had been involved in their creation. All of the sophisticated investors with whom they dealt, former SEC legal personnel's opinions notwithstanding, had both the savvy and opportunity, as Holman Jenkins noted in his column, to ask for sufficient information prior to their purchase of the CDOs from Goldman.

If it were truly important to an institutional investor to know the provenance of the entire Abacus deal, and Goldman refused to disclose it, well, I would expect such an investor to refrain from buying the CDOs.

At no time does it appear that any Goldman employee put a gun to any institutional investor's head to force her/him to buy any of the Abacus deal.

At this point, I'm guessing that Goldman is eager to get to trial, in order to publicly dimantle the SEC's case. Short of that, a withdrawal of the suit by the agency would be the next best remedy.

Failing the disclosure of some truly illegal, explicit misrepresentation of the Abacus deal by Goldman personnel, though, it's looking less likely that the SEC complaint has merit in the context the world of sophisticated institutional investors.

Wednesday, April 21, 2010

Ed Whitacre's Disingenuous Photo-Op

Unelected, government-appointed GM CEO and Chairman Ed Whitacre wrote an editorial timed to appear in this morning's Wall Street Journal in conjunction with his CNBC photo-op showing him repaying $5.8B of government loans to the US and Canada.

It was amusing to watch CNBC anchors congratulating themselves and reporter Phil LeBeau for an interview with Whitacre that, honestly, would have been best if it had never occurred. Talk about free advertising while misleading the public! Just another benefit of crony capitalism- more on that a little later on in this post.

It's a truly disingenuous staging of something Whitacre wants us all to cheer, but, in reality, should remind us to be disappointed and angry.

Elements of Whitacre's Journal piece appear below in italcs, with my comments following.

Today, General Motors is announcing that it has made a payment of $5.8 billion to the U.S. Treasury and Export Development Canada. We're paying back—in full, with interest, years ahead of schedule—loans made to help fund the new GM.

Our ability to pay back these loans less than a year after emerging from bankruptcy is a sign that our plan for building a new GM is working. It is also an important step toward eventually reducing the amount of equity the governments of the U.S., Canada and Ontario hold in our company. Combined, these governments hold a majority of GM's equity, and we want citizens to know how their governments' money is being put to work.

Too bad, Ed, as Gerald O'Driscoll recently wrote in the Journal, that citizens of the countries didn't get to allocate that capital via free markets but, instead, were forced to watch their governments engage in crony capitalism. Why bother with the photo-op Ed, when all you have to do is convince Congress and the administration to continue supporting you?

Oh, and that union which was basically paid off, while shareholders and creditors got stuffed. Did you agree with all those actions, Ed?

Wait, you spent your entire career in one of the most heavily-regulated industries in history, telecom. You're used to fawning on your knees to government officials.

Following the initial crisis and the bankruptcy of the old GM last year, a new GM has emerged as a leaner, stronger company. We have eight new members on our 13-member board of directors. Twelve of the top 13 senior leaders are new to GM (from places outside the industry such as Microsoft and AT&T) or in new jobs at the company. You can feel a renewed energy and commitment at GM. Our new vehicles are generating sales, and these sales are allowing us to make investments and create jobs.

To support our steady sales growth at Chevrolet, Buick, GMC and Cadillac, in the past nine months we have made investments totaling more than $1.5 billion at 20 facilities in the U.S. and Canada, restoring or creating more than 7,500 jobs. Just this morning we announced that we will make a $257 million investment in existing plants in Detroit and Kansas City, Kan., to build the next generation of our award-winning Chevy Malibu.

Gee, Ed, aren't you forgetting a little thing in economics called "opportunity costs?"

Who are you, or any government official, to say that the alleged new 7,500 jobs at GM are better than letting capital markets create jobs?

Maybe if GM were allowed to go through a normal bankruptcy, and another firm had bought and reorganized various divisions of the old GM, all that borrowed Canadian and US money may have stayed in the private sector and funded other, better jobs with new firms.

My brilliant boss at Chase, SVP Gerry Weiss, used to remind us that the real value of informed resource allocation across the bank's many businesses was realized by transferring money and employee counts from the least-efficient, money-losing units, to more efficient, more profitable and, typically, much faster-growing units. The major delta in the bank's performance would result from this move of resources from extremes. From extremely bad uses to extremely good uses.

It is just this process that is frustrated by crony capitalism such as we've witnessed in the GM bailout. Instead of the resources wasted at GM being freed up to be used elsewhere in the economy, they were allowed to remain in place, then more capital added, from taxpayers, as a free equity injection. Free to GM, but very costly to taxpayers and the economy in general.

Did you ever consider that, Ed? Isn't that an unseen, hidden, but very real cost to our economy?

What about the lasting damage to the US economy by having global investors watch us bail out a failed company in an old industry with borrowed and printed money? You don't think that will have lasting negative consequences for the US economy in terms of government borrowing costs, or the ability to continue borrowing in global markets? Will investors really want to invest in a country, knowing their funds go to overpaid union workers at a has-been, failed auto company?

Aren't these also hidden costs of the GM bailout?

Of course they are. This is what O'Driscoll highlighted as the downside of crony capitalism. Economics is about efficient allocation of resources in a free market of true prices, not politically-motivated bailouts of old, commoditized industries supporting bloated payrolls of highly-paid, over-paid union workers churning out largely unwanted vehicles. That's how GM managed to go bankrupt, Ed.

If you can't understand the notion of opportunity costs and efficient resource allocation, Ed, maybe you're not the right guy to chair a major US corporation. Then, again, since GM is, in essence, now just another government agency, I guess you probably qualify as a government bureaucrat, after all those years being just like one while running a Bell System operating company.

As a global car maker, GM is investing in energy solutions that will increase efficiency across our vehicle lineup in the United States. For example, we are adding a third shift and 1,050 jobs at our plant in Lordstown, Ohio, to build the fuel-efficient Chevy Cruze, which has been a hit in every region where it has been introduced. An Eco version of the Cruze, with a 40 miles-per-gallon highway rating, will give customers the fuel economy of a hybrid without the high price tag.

This year, we will introduce the Chevrolet Volt, which can provide up to 40 miles of electric-only, emissions-free driving, backed up with a range extender (a small engine) that can keep you going should the battery run low. Developing the Volt has led to new investments in battery labs and battery manufacturing and it has put GM, and by extension the North American car industry, in the front row of the global electric vehicle race.

Ed, I can't help but think that dozens of smaller, truly electric power-oriented startups would have done much better on this sort of product and component development than you will at GM.

After all, as a conventional car maker, GM failed. You guys couldn't even make money on gasoline-powered vehicles.

Now, with absolutely NO risk premium, but, instead, sweetheart loans and equity injections from Washington, you expect all of us to believe your crew can profitably do in alternative fuel vehicles that at which you failed in a technology in which you had nearly a hundred years of experience?

C'mon, we're not that naive. Capital markets never would have funded GM doing this. That's why you went broke. Instead, many smaller, more innovative, hungrier firms convinced the private sector to invest in their ideas.

You and your company simply mozied up to the public trough and began chowing down on low-cost taxpayer funding.

We still have a lot of hard work ahead of us, but we are making real progress toward our vision of designing, building and selling the world's best vehicles.

Nobody was happy that GM needed government loans—not the governments, not the taxpayers and, quite frankly, not the company. We believe we can best thank the citizens of the U.S. and Canada by making sure that their investments are hard at work every day, building high quality, fuel-efficient vehicles our customers can count on.

Ed, I believe you can best reward citizens by immediately selling the company into whatever pieces private sector buyers might want. And simply close the rest. True, the government-run faux-bankruptcy of GM, to the benefit of unions, and detriment of legitimate creditors, was a mistake.

And we can't really undo it entirely. But we can still terminate it earlier, at less opportunity cost to our economy, by doing now what should have been done over a year ago. Force GM off government life support, force it out into the private sector whole or in pieces, forcing taxpayers, the federal government and, most of all, you, Ed, to see what a discount to the government's bailout price is taken on the IPO.

Now, wouldn't that be eye-opening? Somehow, Ed, I doubt you'd be toasting that event.

Gerald O'Driscoll, Jr. On Inept Regulation vs. Free Markets

Gerald O'Driscoll, Jr., currently with the Cato Institute, wrote a masterful exposition of various aspects of the current US financial markets and economy in an editorial in yesterday's Wall Street Journal entitled "An Economy of Liars." It is an excellent example of why the field was originally known as political economy.

Among the more notable passages in Mr. O'Driscoll's editorial were these,

"Free markets depend on truth telling. Prices must reflect the valuations of consumers; interest rates must be reliable guides to entrepreneurs allocating capital across time; and a firm's accounts must reflect the true value of the business. Rather than truth telling, we are becoming an economy of liars. The cause is straightforward: crony capitalism.

We have now learned of the creative way Lehman Brothers hid its leverage (how much money it was borrowing) by the use of a Repo 105. The Repo 105 meant Lehman temporarily swapped assets (such as bonds) for cash. A Repo, or repurchasing agreement, is a way to borrow money. But an accounting rule allowed Lehman to book the transaction as a sale and reduce its reported borrowings, according to a report by the court-appointed Lehman bankruptcy examiner, a former federal prosecutor, last month.

Are we to believe that regulators were unaware? Last week Goldman Sachs was accused in a civil fraud suit of deceiving many clients for the benefit of another, hedge-fund operator John Paulson.

The idea that multiplying rules and statutes can protect consumers and investors is surely one of the great intellectual failures of the 20th century. Any static rule will be circumvented or manipulated to evade its application. Better than multiplying rules, financial accounting should be governed by the traditional principle that one has an affirmative duty to present the true condition fairly and accurately—not withstanding what any rule might otherwise allow. And financial institutions should have a duty of care to their customers. Lawyers tell me that would get us closer to the common law approach to fraud and bad dealing.

Congressional committees overseeing industries succumb to the allure of campaign contributions, the solicitations of industry lobbyists, and the siren song of experts whose livelihood is beholden to the industry. The interests of industry and government become intertwined and it is regulation that binds those interests together. Business succeeds by getting along with politicians and regulators. And vice-versa through the revolving door.

We call that system not the free-market, but crony capitalism. It owes more to Benito Mussolini than to Adam Smith.

Distorted prices and interest rates no longer serve as accurate indicators of the relative importance of goods. Crony capitalism ensures the special access of protected firms and industries to capital. Businesses that stumble in the process of doing what is politically favored are bailed out. That leads to moral hazard and more bailouts in the future. And those losing money may be enabled to hide it by accounting chicanery.

If we want to restore our economic freedom and recover the wonderfully productive free market, we must restore truth-telling on markets. That means the end to price-distorting subsidies, which include artificially low interest rates. No one admits to preferring crony capitalism, but an expansive regulatory state undergirds it in practice.

Piling on more rules and statutes will not produce something different than it has in the past. Reliance on affirmative principles of truth-telling in accounting statements and a duty of care would be preferable. Deregulation is not some kind of libertarian mantra but an absolute necessity if we are to exit crony capitalism. "

Mr. O'Driscoll reinforces several points that I've made in prior posts, i.e., fallible regulators and easily-influenced legislators are the reality in our system. It does no good to demand ever more complicated, restrictive laws, when those charged to implement them are less capable than those they are tasked to monitor. Or the laws themselves are written to benefit the currently-powerful.

There's quite a bit of Br'er Rabbit in the current Dodd financial regulatory "reform" bill. Firms such as Goldman Sachs, Chase, Citigroup and Morgan Stanley are quite aware that their special status as bailout candidates will confer upon them lower funding costs from counterparties than their competitors will pay.

Crony capitalism, indeed. Bi-partisan, to be sure, as well.

Those of us who advocate less regulation are often painted as greedy, anti-consumerist, anti-poor, pro-wealthy, and/or desiring a return to some mythical bad old era in the historical vicinity of the years prior to and including the Gilded Age and its so-called Robber Barons.

Being anti-regulation isn't about desiring to give the wealthy or powerful added advantages. Rather, it's fundamentally about acknowledging the inability of so much regulatory activity to deliver on its promise.

For example, SEC regulations mandate that annual reports of publicly-held companies be audited. Have you ever read the disclaimers on standard auditor statements in those reports? They make the concept a mockery.

For many years, I have believed that a much better solution would be for the SEC to drop the requirement. It's my belief that the major accounting firms would quickly offer their corporate clients much tougher, non-disclaimer audits, for a higher price, that would provide a much more credible seal of approval. Not every company could qualify for a clean bill of health under such scrutiny.

Instead, we have SEC-compliant disasters like WorldCom and Enron.

Regulators and regulatory processes are extremely fallible in the best of situations.

O'Driscoll is, I believe, correct to advise that it's better for parties to economic transactions to perform their own due diligence, take precautions as they see fit, and live with the consequences.

If regulators couldn't stop Madoff before his scheme grew to epic proportions, nor discover the Lehman Repo 105 tactic, why should we believe they will ever, under any existing or new regulatory framework, do a better job in the future?

Rather than trust in empty promises and imperfect regulatory schemes, let's stop trying to protect market participants from themselves, and let each be responsible for their own actions.

Free markets reward competence, innovation and appropriate risk management. Those who fail at these ought to lose their capital and be rinsed from the system, lest they become too large a drag on the productivity and growth in wealth, system-wide, that naturally arise from the efficient allocation of resources in a free market economy.

Tuesday, April 20, 2010

GE's Continuing Troubles

Once again, GE's recent performance demonstrates why the conglomerate needs to be dissolved.
The weekend edition of the Wall Street Journal described GE as reporting a 31% drop in first-quarter earnings.
The nearby price chart for GE and the S&P500 Index over the past five years illustrates that GE continues to have been a bad investment. Thus continuing CEO Jeff Immelt's unbroken record of mis-leadership of the ailing firm.
Without going into details, suffice to say that Immelt is crowing that the company's financial unit seems to have finally turned a corner on managing its losses. Of course, these losses played a big part in driving the once-proud firm into the arms of a government bailout, due to liquidity pressures.
Had the firm been split into its very large, naturally independent and unrelated pieces, the rest of the firm, and its investors, probably wouldn't have suffered so badly from the one unit's mistakes and excesses.
Perhaps the 50% drop in GE's price over the past five years is an emerging signal that investors are finally beginning to just say 'no' to the notion of an outdated conglomerate structure that masks great performances by any one unit, and results in mediocre results for the whole mess over time.

Elizabeth Nowicki's Misunderstanding Re: Goldman and Abacus

Elizabeth Nowicki, a guest on CNBC this morning, was described as a "former SEC lawyer" and current member of a college law faculty.

If she epitomizes the way the SEC views financial markets, then we're in serious trouble.

While participating in a spirited debate with other guests and on-air staff, including a former federal prosecutor, Nowicki displayed a shocking lack of understanding of the current Goldman/ACA/Paulson affair.

Specifically, Nowicki declared that Goldman's behavior in this matter is identical to that of Wall Street analysts, such as Mary Meeker and Henry Blodgett, during the dot com bubble of the late 1990s. Nowicki contended that, just like those analysts, giving public opinions directly to retail investors which may have belied their private views, Goldman similarly duped public retail investors.

That's not even remotely close to what happened. Even if you believe Goldman behaved unethically, it was, at no time, trying to influence retail investors to buy securities which it had underwritten after ACA constructed the securities.

If Nowicki can't distinguish between retail brokerage analysts speaking out of both sides of their mouths, one being to retail investors, and the process of underwriting of complex securities for sale to sophisticated, institutional investors, then it's a good thing she's no longer on the SEC staff.

Question is, are there more like Nowicki, similarly unaware of these differences, still on that staff? And perhaps involved in bringing the Goldman suit?

A suit, by the way, which we've now learned was cleared for prosecution by the narrowest of margins, 3-2. Probably along political party lines.

Nowicki's views tend to reinforce my belief that it's rare to find A-team players among government agencies.

Monday, April 19, 2010

Stiglitz On Patents- How To Choke Innovation

Friday's Wall Street Journal carried an editorial co-authored by Nobel Laureate economist Joseph Stiglitz of Columbia University regarding patents for genes.

Stiglitz and his colleague used most of their piece to advance the usual arguments on this topic against awarding patents for those who identify or create genes.

However, near the end of their piece, the authors tipped their hand regarding their bias against individual property rights when they wrote,

"Had Alan Turing's mathematical insights been patented, the development of the modern computer might have been greatly delayed."

So what? Maybe it wouldn't have been delayed at all. Maybe Turing would have been approached to license his patents to the Institute for Advanced Studies, the University of Pennsylvania, or Sperry, for the design and production of one of the early digital computers.

The thrust of Stiglitz' argument is clearly that individuals shouldn't be allowed to have property rights protecting their inventions.

For the record, it's quite likely that part, if not all, of Turing's "mathematical insights" were funded by either wartime government spending, or some academic institution. So the Turing example is probably not even relevant.

But it does indicate that this debate is not apolitical.

Large companies, finding a small firm has bought a patent which they need, attempt to argue that use of patents ought to trump mere ownership without the means of production. I recall this argument coming up recently, perhaps in the case of RIM.

To me, it seems that Stiglitz, and others, merely want to set some artificially high tests for whether or not an inventor, or purchaser, of a patent should enjoy the rights of that patent.

Just because society may have waited a bit longer for the computer, or the developing company may have had to pay royalties or license fees to the proper owner of needed patents, is no reason to simply turn against assigning patents to discoverers of knowledge which qualifies as patentable according to our laws.

Even some economists, it appears, are subject to using stealthy arguments to cloak their inherent preference for state or oligopolistic rights to inventions, instead of those who actually created them.