Slouching Towards Wall Street… Notes for the Week Ending Friday, 1 April 2011
A year ago Tilikum the 6-ton killer whale made good on its name by dragging his trainer into the performing pool at Orlando’s SeaWorld where, before the horrified audience, he shook her to death. Stories around the tragedy pointed out that Tilikum had been involved in two deaths in the 1990’s, including another trainer. After last year’s killing of trainer Dawn Brancheau, SeaWorld instituted new safety rules. They also sequestered Tilikum, giving him a twelve-month time out. (We can hear his long-suffering trainers saying “Use your words, Tilikum! Use your words!”)
Now (The Week, on-line edition, 31 March, “Should Tilikum the Killer Killer Whale Return to Work?”) SeaWorld says it is time for the whale to return to the public eye. After all, they say, performing for the public is all the creature knows, having been in captivity virtually its entire life. A SeaWorld spokesperson said performing “is an important component of his physical, social and mental enrichment.”
Says one observer, “isn’t it time to look for another, safer way to bring in money?” Clearly, they don’t have to.
Which brings us to the other current debate about rehabilitating dangerous actors.
Writing on the opinion page of the Financial Times (30 March, “How Dodd-Frank Fails To Meet The Test Of Our Times”) former Fed Chairman Alan Greenspan challenges the legislation designed to address the financial system’s ills, saying “the financial system on which Dodd-Frank is being imposed is far more complex than the lawmakers, and even most regulators, apparently contemplate.”
Greenspan says Dodd-Frank “may create the largest regulatory-induced market distortion since America’s ill-fated imposition of wage and price controls in 1971,” a curious prognostication coming from the man some blame for singlehandedly creating the financial disasters of the past few years. Many see Greenspan’s relentless lowering of interest rates — in the interest of the American Dream of home ownership — coupled with his unrelenting dogmatic insistence on not regulating the financial markets — in the interest of Free Market Capitalism — as the necessary and sufficient cause of the financial collapse. During his reign at the Fed, Greenspan was granted such accolades as “Maestro” and the “Oracle” and was buttered up by more than one president as the man solely responsible for the wealth of this nation — even as it was won at the expense of the wealth and stability of others.
It is not a year and a half ago that Greenspan admitted to Congress that he had been wrong — “partially” — to insist that government not regulate the markets. Greenspan testified he had “found a flaw” in his own reasoning and was “very distressed by that fact.”
That this “flaw” led large numbers of people to become very distressed — not to mention unemployed, homeless and on the dole — seemed not to weigh upon Greenspan whose pain related to his own failure to completely comprehend and foresee the collapse of “the whole intellectual edifice” of “the modern risk-management paradigm.” A man’s mind is his palace.
Greenspan lays out a handful of bullet points as examples of why Dodd-Frankenstein will fail. We largely agree with Chairman Greenspan’s examples: neither those in Congress, nor the people who vote for them have the courage to force actual change.
To harp on only one of our favorite points, Greenspan starts with Ford Motor Credit benefiting from the SEC no-action letter allowing it to issue a billion-dollar asset backed security without the legally mandated credit rating.
A handful of rating agencies benefit from a government-guaranteed oligopoly — Warren Buffett testified before Congress that he invested in Moody’s because they enjoy a government-guaranteed monopoly. Dodd-Frankenstein threw the NRSROs (Nationally Recognized Statistical Rating Organizations) into a tizzy by saying they must be held accountable for their ratings. The raters say they are “only” publishing their opinions, which are protected under the First Amendment. The NRSROs refused to rate Ford’s asset backed issue, and the SEC gave Ford a pass. We note that Mein Kampf is similarly accorded First Amendment protection, and we wonder which American politician will be the first to brandish a copy in the halls of Congress.
We agree (11 March, “The Revolution Devours Its Children”) with Chairman Schapiro’s decision to suspend the rating requirement, because it makes the directors of both the issuer and the buyer of the asset-backed notes directly responsible for the quality of the instrument. While the NRSROs may have done a credible job of rating much of the garden variety debt that runs through their models, they proved spectacularly inept at assessing the safety of even marginally complex paper. The fact that there is no federal action pending against them for their role in mismanaging the financial crisis is astounding to us — we would sooner see the SEC go after the NRSROs for what they have already failed to do than create a forward-looking liability standard — but the world seems to have accepted as writ Warren Buffett’s observation that the NRSROs were just as stupid as everybody else, a position Congress is only too happy to accept (speaking of folks who are just as stupid as anyone else.)
Chairman Greenspan makes the fundamental point that Dodd-Frankenstein “fails to capture the degree of global interconnectedness” of the securities markets. Indeed, regulatory inefficiency imposes unnecessary costs on those regulated — and we note that those costs which are ultimately passed on to the hourly employees, union members, and other wage earners who covered by the pension funds who are the primary buyers of such instruments as ABS. We fear that many will take Chairman Greenspan’s piece as proof that regulation is a bad idea altogether. We don’t buy the argument that, since we can’t really regulate the global markets efficiently, we shouldn’t bother.
Chairman Greenspan’s piece seems to harbor a retread of the anti-regulation trope he played to the hilt throughout his tenure at the Fed — the same argument he has since admitted was flawed. Perhaps he wishes to recant. Perhaps Mr. Greenspan now considers it was not that flawed. Coming at the end of March, we wondered whether the Greenspan OpEd was the FT’s notion of an April Fool’s piece, but then we reflected that Chairman Greenspan is noted for many things — but a sense of humor is not one of them.
Greenspan’s ultimate question is the relationship between the increased percentage of global GDP represented by the financial sector and growth in those economies where this ration has risen. Pointing out the “as yet unproved tie between the degree of financial complexity and higher standards of living” sounds compelling, until we pause to consider where the alternative has already led us.
Mr. Greenspan has left the fundamental question unasked: what is the public policy philosophy underlying Dodd-Frankenstein? He points out that the financial sector has continued to grow to an ever greater percentage of GDP, a phenomenon that did not reverse during the recent disaster years, and wonders whether this indicates that increased financial complexity is an engine for economic growth. Call us simpletons: it is evident that increased financial complexity stokes economic growth for investment bankers, traders and hedge fund managers — but 44 million Americans are on food stamps.
Our opening line is a double pun, referring to the world’s greatest whale story, but also to the Biblical slave trade. Joseph, cast down a well by his brothers, is carried off to Egypt by a band of Ishmaelites, who sell him into slavery, a transaction that represents the ultimate triumph of market price over intrinsic worth.
Fixated on the dollar (“In God We Trust”), Americans refuse to look under the hood at what is happening to our society. Rising stock prices are not an indicator of economic growth, they are merely an indicator of rising stock prices. Greenspan’s question rests on two assumptions that Americans never question: that wealth will Trickle Down from Lloyd Blankfein to the over 10% of Americans who are out of work, and that economic growth can go on forever. What if these ideas turn out to be wrong?
This is like saying it has not been scientifically proven that coal power causes environmental damage — an argument we see on the horizon as America takes another of its periodic shots at weaning itself from demon oil. Americans balk at the notion of tightening their belts, demean all mention of “sustainability” as Socialism, and razz the President when he talks about green energy. “It hasn’t been scientifically proven” is the clarion call to employing more environmentally dicey technology to maintain our 17 miles to the gallon way of life. But when we are dealing with so delicate a phenomenon as the survival of life on this planet, how badly do we want to find out?
Brazilian energy giant Petrobras is to start drilling in the Gulf of Mexico. Petrobras, which last year issued the greatest share offering in the history of capitalism (US$ 67 billion) has brought great wealth to Brazil with its deepwater drilling. Using technology that the rest of the world envies, they drill under the “pre-salt” geological formation of the Brazilian continental shelf to extract oil more than 5,000 feet below the water. What Brazilians know — and what of the world will learn — is that this technology is not foolproof. Brazilian commentators and politicians say Petrobras has been lucky, and they worry what will happen as the drilling proceeds to 6,000 feet and beyond. America is the lab rat.
Greenspan doesn’t mention two counter-intuitive positives: increased regulation promotes creativity on the part of bankers and their legal advisors. It also makes small infractions more popular, turning them into major abuses. One outcome gives rise to new market facilities, the other drives bad practices into the open.
As pathetic as it is, Dodd-Frankenstein is the starting point on trying to rein in abusive market practices. If we believe in the Art of the Possible, then this toilet-worthy piece of legislation is about as good as we have any right to expect. We hope Chairman Greenspan’s piece will be used to counter the lack of thought that went into crafting this legislation, and not as ammo for those who wish to scrap market oversight altogether.
The counter argument to taking preventive action is dollars and cents based on stock market valuations, corporate profits, and the narrow measurement known as GDP. Chairman Greenspan’s question requires consensus on the part of the most compromised and politicized group of intellectuals on the planet: economists. We have heard the argument: as long as we haven’t proven that it’s harmful, we should let the markets continue unregulated. As the story from The Week rhetorically inquires: “what part of ‘killer’ whale don’t they understand?”
All that glisters is not gold.
American philosopher Allan Bloom lamented the decline in society. Time was, he writes, a Westerner facing a moral dilemma looked to three time-proven resources for guidance: the Bible, classical philosophy, and Shakespeare. Our society’s triumph of license over responsibility has largely shunted aside any objective standards in favor of individual appetite, a phenomenon abetted by government programs that promise home ownership for all families — America’s version of a chicken in every pot — by a legislative environment that says full employment will be guaranteed by the Invisible Hand, and not by social activism or labor unions, encouraging the brightest students to use their talents to develop new financial instruments, rather than environmentally friendly energy sources.
A book review in this week’s Wall Street Journal (30 March, “A Little Learning”) asks “Does one really have to read ‘King Lear” to be qualified to write speeding tickets?” We get the self-deprecating cynicism of an academic who writes an anonymous attack on the academy (In the Basement of the Ivory Tower, by Professor X) but the Journal fails to answer its own question, whereby it renders its readers no service.
A recent Bloomberg Opinion piece (8 March, “Study This to See Whether Harvard Pays Off”) laid out an argument against higher education, demonstrating that college quite literally doesn’t pay. Boston University professor Laurence Kotlikoff gives examples that show a medical doctor whose peak annual earnings of $185,895 result in only$33,666 in disposable annual income, the effect largely of the indebtedness taken on to get through medical school. This number is a mere $423 a year more than Professor Kotlikoff’s plumber with no college education.
To the professor’s credit, he points out that his examples are “far from exhaustive” and ignore the “tremendous personal and social non-pecuniary rewards” of higher education. (Speaking of higher education and the societal skew, “pecuniary” is an SAT word, and therefore more likely to be understood by white, upper middle class Americans.)
One of the Wall Street Journal’s new line of touchy-feely pieces (15 March, “Is Happiness Overrated?”) discusses “eudaimonic well-being” — a state of happiness that, finds a study, “comes from engaging in meaningful activity.” The article is festooned with multi-colored happy, satisfied, jubilant, comfortable and proud faces, as well as a number of other emotions, and the article discusses “positive psychology,” the professionals’ terms for happiness research. It comes to the final conclusion that “hedonic well-being” — the short-term glow of satisfaction experienced after a good movie, a good meal, or good sex — doesn’t compare with the long-term satisfaction of fulfilling one’s potential and reaching long-term goals that require patient, sustained hard work. The article mentions raising children and completing medical school as two examples of the latter.
What do we care about as a society? The goal-setting imperative of the Journal article indicates that Professor Kotlikoff’s non-pecuniary rewards may be far more important than the $423 differential enjoyed by the hypothetical medical doctor over the hypothetical plumber.
An article in the World Policy Journal (Spring 2011, “We Are What We Measure”) proposes that we not completely write off the work of the Commission on the Measurement of Economic Performance and Social Progress, merely because it was created by French President Nicolas Sarkozy. The primary focus of the Commission is “a clinical dissection of why GDP has failed to do its job adequately,” and the Commission’s studies, overseen by Nobel laureate economist Joseph Stiglitz, are being used by the OECD to try to come up with new policy tools.
As with the shortcomings of Dodd-Frankenstein, there is much that a single statistical measure will not be able to account for. And there will be political pressures to scrap the project. Not the least of these will come from the growing global financial sector. Everyone knew indebtedness had risen to unprecedented levels well before the financial meltdown, “but as long as GDP was going up, nobody regarded that as reason to worry.” As pointed out by Mr. Greenspan, financial services stood at 2.4% of GDP in 1947 and rose to 7.9% by 2009, continuing to rise through the meltdown years starting in 2007. The financial services sector thus contributes significantly to the narrow statistic that is GDP — which does not even measure the relative political influence of the financial sector, which is orders of magnitude greater, since it is also a significant component of that political statistic known as GDP: Gross National Pork.
Simon Kusnetz, the economist who created GDP, resigned from his job as head of the US national income statistical project when he lost the fight “to include unpaid domestic work in the calculation of GDP.” This transcends abstract notions of wage and price levels. People who don’t get counted in economic statistics just don’t get counted, period. The exclusion of unpaid domestic work links directly to the under-employment, under-compensation and general under-empowerment of women in American society.
We remember late night TV commercials flogging a two-LP set (yes, dear Reader, we are old enough to remember vinyl) containing “all the classical music you will ever need,” as though there were a quota on culture. The social policy theory underlying narrow statistical measures of economic performance links directly to the mentality that says a traffic cop doesn’t “need” to read “King Lear.”
Professor Kotlikoff doesn’t tell us what his hypothetical plumber did with all the free time he gained by not going to medical school. While the hypothetical medical doctor may not have had time to read Shakespeare, we fear the plumber may not have had the inclination. Our society loses far more than we can begin to fathom by measuring success in dollars and cents.
Loyal readers — for whom we are grateful — have asked what we shall make of the situation at Berkshire Hathaway. As anyone not living under the proverbial rock now knows, senior Berkshire executive and Buffett heir apparent David Sokol bought shares in Lubrizol. He subsequently had a series of conversations with investment bankers and with Warren Buffett, leading ultimately to Berkshire purchasing Lubrizol at a price that gave Sokol about a $31 profit on 96,000 shares of stock, whereupon Mr. Sokol handed in his letter of resignation, which Mr. Buffett accepted.
Sokol appeared on CNBC (full disclosure: Hedgeye CEO Keith McCullough is a CNBC contributor and regular guest) to discuss his resignation. Asked about Berkshire’s personal trading policy, Sokol said Buffett circulates a list of companies Berkshire is looking at, and Berkshire employees are not to buy securities of companies on that list. In other words, they are on the honor system.
It is charming that one of the highest visibility entities in human history relies on the good will and proper behavior of its executives. In this day and age, we wonder whether it is sufficient. But regulation is meaningless without the good will and dedication of market participants. We will go so far as to say that Berkshire’s system worked: a senior executive exercised questionable judgment; as a result, he is out. He may face an SEC inquiry, he may face regulatory, or civil, or even criminal action.
Based on what we have seen, we believe it will be difficult to prove that Mr. Sokol bought shares in Lubrizol in breach of any duty, which goes to the heart of insider trading law. Also based on what we have seen, we believe Mr. Sokol made a tremendous blunder, and that resignation was the proper course. We wish Berkshire’s example of relying on its employees’ integrity could become the industry standard, and we are staying tuned for the next act in this drama.
In 2010 the government of Argentina took a novel step in its battle with the nation’s dominant media company, Grupo Clarin, when it passed legislation making the production of newsprint a “matter of public interest.” This end run came as the government charged the owners of three newspapers with crimes against humanity, claiming they illegally took over the nation’s leading newsprint supplier under the military dictatorship. While the alleged involvement of the media families with the dictatorship is not clear, the current government has some transparency problems of its own. We reported on the newsprint law (4 March, “All the News That’s Fit to Quash”) and on Argentina’s threats to jail and fine economists whose inflation projections exceed the government’s.
Now Argentina has awarded the Press Freedom Prize to Venezuela’s Hugo Chavez (UPI, 30 March, “Argentine Press Freedom Award GoesTo Hugo Chavez.”) Decrying Chavez’ relentless suppression of free media, the World Association of Newspapers condemned the act, calling on Chavez to withdraw legislation aimed at silencing Venezuela’s independent press.
But Argentina’s University of La Plata praised Chavez for “dismantling media monopolies and fostering popular mass communications.” Chavez’ arbitrary closing of media outlets is something Argentina’s President Fernandez wishes she could accomplish. Sadly for her, the days of government by machine gun are over for Argentina — at least officially.
Accepting the award, Chavez said Venezuela seeks to promote “a new dynamic of communication and information free from the media dictatorship of the bourgeoisie and the empire” (i.e. the United States.) Chavez has accomplished his “democratization” of media by shutting down privately-owned media companies and imposing on the nation his own television network, Telesur. (“All Hugo! All the time!”) One independently owned television station remains in Venezuela. Its owner has now fled the country, fearful of being jailed on false charges.
We wish to propose a new source of income for the Argentine government as they continue to struggle with the ongoing effects of the global financial crisis. The Wall Street Journal reports (30 March, “China Fuels Waste Paper Boom”) that Chinese exporters, desperate for packaging to ship their goods, are paying $228 per ton for used corrugated paperboard and other waste paper goods. Now that newsprint has been legally made a matter of public interest, the economics of the situation should be obvious, as the government can generate income by selling their paper and pulp to the Chinese.
If you ever wondered ‘What Price Freedom of the Press?’ it looks like the answer is $228 a ton.
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