Slouching Towards Wall Street… Notes for the Week Ending Friday, December 30, 2011
Out With The Old — In With The Same Old
Capitalists, whether merchant princes, financiers, or industrialists, invariably try to ally themselves with political authorities to limit the freedom of the market.
The most important book of 2011 is certainly David Graeber’s Debt: The First 5,000 Years. By the time you arrive at this sentence, on page 260, it will strike you as one of those notions that We Always Knew, but that required another person to reveal its obviousness. This kind of socially transmitted awareness enables groups and whole movements to spring up seemingly from nowhere when one person publicly declaims what is latent in the minds of many, suddenly legitimizing their unspoken discomfort.
This year it was the Arab Spring, which sprouted from the self-immolated body of Tunisian street vendor Mohamed Bouazizi and unleashed protests in the most unexpected places — Tunisia and Egypt, to be sure. But civil war in Syria? Religious and secular Jews demonstrating together in Israel for economic and social justice? Tens — or hundreds — of thousands turning out to oppose Putin in the streets of Moscow? Indeed, the only place where the rage of the people appears to have fizzled is Brazil where, like a caricature of themselves, the thousands who turned out to protest corruption earlier in the year recently failed to show up for a series of planned protests. It seems the organizers had called for protests during a holiday week, and then it was raining and not good weather for either the beach or a march. Finally, some few anti-corruption protestors showed up, only to find that their march had been scheduled at the same time and place as a demonstration demanding rights for cross dressers and transsexuals. Undaunted, Brazil’s President Rousseff continues to clean house, canning cabinet ministers and officials high and low alike with such rigorous even-handedness she has jeopardized her own ruling coalition.
Observers have been calling this the Zeitgeist — a term popularized by German philosopher Gottfried Herder (1744-1803) in a polemic aimed at his contemporary, philologist Christian Adolph Klotz. Klotz coined the term genius seculi — the guardian spirit of the age — which Herder, true to his affection for the German soul, dutifully Teutonified. Today no one studies Latin, and few educated Americans could accurately translate Klotz’ term. But the word Zeitgeist is, well, very much part of the Zeitgeist, as the news media ceaselessly attribute the waves of protest washing across the globe to the Big Z. Today’s Zeitgeist is very precisely defined — sometimes in as few as 140 characters — and widely disseminated. Thanks to social media the pace of change has accelerated. Revolutions that used to take multiple generations are now touched off in flashmobs. An Egypt that could well have seen another generation of Mubarak rule, for example, is hurrying to wheel the former president into the courtroom on his hospital bed, afraid he will die before they can convict him. At this rate, the Messiah will have to sprint.
Speaking of social media, our CEO, Keith McCullough, recently surpassed 10,000 Twitter followers. While it puts him nowhere near the likes of Lady Gaga (17.3 million) or Justin Bieber (15.8 million) — or Hugo Chavez (at last report, over 1.8 million) — Keith is nonetheless in rarified company. Twitter reports having 100 million active users, only five percent of whom account for 75% of tweeting activity.
Saudi Prince AlWaleed recently bought into Twitter. His $300 million, for a three per cent stake in the enterprise, gives Twitter a value of $10 billion and translates into AlWaleed paying $100 per active user, which may prove to be a bargain.
Social media users are not fungible. Returning to Keith’s 10,000 follower milestone, only 6.3% of tweeters have more than one hundred followers — and only about 7% follow 100 people or more. Keith may not be in the million-plus club, but he’s certainly running in the money. AlWaleed values the average user at $100. The calculation is clearly skewed to those 6.3% with over 100 followers, with the price going up as the number of followers mounts. As a side note, we think AlWaleed is trying to get on the Early Warning screen for the Saudi Spring, though we suspect his millions may buy him no more than a few minutes’ lead time. The volume of Arabic-language tweets rose more than 2000% in the twelve months ended in October. When the Saudi Spring comes we expect it to be true to form, with a large number of people killed and many more beaten savagely, and official sources claiming the numbers are much smaller than “anti-government terrorists” claim. Unlike other governments in the region, it will be difficult for the Saudis to blame the Americans, but we should not expect common sense to be a bar to political discourse. Note, for example, the ongoing national embarrassment of the Republicans primaries. Hey, it’s the Zeitgeist.
Now a company called PhoneDog is suing a former employee over who owns twitter followers (NY Times, 26 December, “A Dispute Over Who Owns A Twitter Account Goes To Court”). The former employee, Noah Kravitz, claims he had a deal with the company to take his 17,000 followers along when he left. PhoneDog is claiming damages of $2.50 per month, per follower. Though it is early days in this case, we have not yet seen analysis of how this may impact AlWaleed’s valuation. The value of a social network should derive from the number and character of its users. AlWaleed values the average user at $100. The PhoneDog suit is the first of its kind and could break new ground, establishing legal precedent for ownership of social media contacts. PhoneDog values Kravitz’ followers at $30 a year and is asking for over $350 million in damages. If we use that number as a benchmark, it means Twitter must retain an active user for over three years before AlWaleed breaks even on his valuation. See how complicated market economics can be?
Financial firms should look to develop robust policies around social media, particularly as one’s contacts are now clearly a monetizable asset. FINRA issued guidance in January 2010 (Regulatory Notice 10-06, Social Media Web Sites) advising firms that they have regulatory responsibility for recordkeeping and archiving, suitability review of recommendations made using social media, and the active surveillance of employees using interactive social media for business. In short: if your employees are actively using Twitter, you have regulatory liability and legal exposure for any communication they send. At $100 a head, you may want to ensure that you define ownership of your employees’ Twitter followers. We think this may be seen as similar to the ownership of retail customer accounts, a matter settled by the courts in favor of the firms, but firms should not wait to become a test case in what could be a major new market.
Markets, as any practitioner can tell you, can be devilishly complex. Which is why, says Graeber, capitalists ally themselves with politicians. It is basic risk management, says Graeber. “Markets are ways of exchanging goods through the medium of money” — in economic notation, C-M-C’, which means “commodity-money-other commodity.” But “capitalism is first and foremost the art of using money to get more money (M-C-M’).” This puts a new light on the idea of the service economy. A group of people will reasonably arrive at a market clearing price for a loaf of bread, and we should expect that price to fluctuate with supply, demand, quality and variety. But how much is a computer program worth? How much is a leveraged buyout worth? A video game? The genius of modern market capitalism is that our economy is now based entirely on intangibles which are largely priced by those who offer them, not those who consume them. Pricing, not value, has become the primary metric. As Graeber points out, the way to ensure a flow of revenues without risk is to monopolize the stream of sales of a good. The easiest way to do this is through government fiat, which is why there is a natural affiliation between capitalists and legislators: the capitalists buy the elections for the legislators, and the legislators guarantee the capitalists their stream of income.
Before you chuckle disdainfully at our Left-Wing naiveté, we refer you to Warren Buffett’s testimony before the Financial Crisis Inquiry Commission. When asked why he made an investment in Moody’s, he explained to Congress — with the cherubic patience of Mr. Rogers telling his viewers it is wrong to take other children’s toys — that the rule requiring banks to hold portfolios rated by the Nationally Recognized Statistical Rating Organizations was a government guaranteed monopoly. (For good measure we remind you that, when challenged on his investment in Goldman Sachs, Buffett said “I haven’t seen anything in Goldman’s behavior that makes it any more subject to criticism than Wall Street generally.” If you didn’t know, now you know.)
In fact, our economy is now an economy of meta-intangibles, as Wall Street creates trillions of dollars in nested transactions. The commerce department records $1.235 trillion in financing and issuance in the financial services sector in 2010, representing 8.4% of GDP. But financings are the merest tip of this iceberg as trillions of dollars of transactions are generated daily in multiple markets, a figure that is widely skewed by region. Before the 2008 financial crisis, New York State received over 20% of its revenues from the finance sector. NY State Comptroller Thomas DiNapoli cautions that state revenues from the finance sector have fallen to only 14% (wnyc.org, 11 October, “DiNapoli: Wall Street Tax Revenue Drops, Threatens Balanced Budgets”) and appear to be trending lower.
DiNapoli says “the scariest number was the 10,000 jobs Wall Street is expected to shed in the next year,” and observes “declining tax revenues may engender cognitive dissonance among Occupy Wall Street protestors,” as social programs become the collateral damage of slashed banking revenues. The implicit message is not merely that the engine of Capitalism also fuels social good, but echoes Upton Sinclair’s cynical observation in The Jungle that, if only those starving children slaving in the cold and dark knew their labor would enable the robber barons to dedicate parks and libraries, they would deem their suffering worthwhile.
In Business As Usual lieth our salvation. Let us pray.
Among the fascinating implications of Graeber’s work is the notion that fiat currency is not intrinsically a bad thing. Like so much else in Debt, Graeber attacks not merely the received wisdom — he makes mincemeat of Adam Smith’s assumption that money replaced barter — but also the contrarians’ arguments. In his discussion of Islamic economics he quotes the influential Moslem thinker Ghazali (1058-1111) saying that the function of a market is to enable persons who own unlike things to clear them in an exchange that all will recognize as fair. “How do you compare two things with no common qualities?” asks Graeber, and says Ghazali concluded it can only be done by comparing both to a third thing with no qualities at all.” For Ghazali, this meant gold and silver, “two metals that are otherwise no good for anything.”
Looking elsewhere, Graeber writes that “for most of its history, China maintained the highest standard of living in the world,” saying that even post Industrial Revolution England did not catch up until some time in the 1820’s. This was notwithstanding China’s reliance on a fiat currency. Graeber attributes this success to China being “the ultimate anti-capitalist market state,” whose rulers saw merchants in much the same way they viewed soldiers: fundamentally destructive, parasitic and antisocial — yet capable of being put to use for the greater good. This attitude led China’s rulers to keep both its armies and its capitalists on a short leash. Confucian rulers were mindful of both the potential damage, but also the social application of the profit motive, and encouraged price gouging when dealing with wealthy customers, as a way of subsidizing low prices for the poor.
Quite the opposite of the current debate in our country about the value of education — actually a debate about the price of education and how long it takes to recoup it dollar for dollar — China under its Confucian rulers was administered by a class not of technocrats, but of literati: men trained in the classics who applied the social and moral lessons of literature to the day-to-day management of the empire.
We extrapolate from Graeber’s discussion that the notion of “fiat” is too narrowly applied. The problem arises, not when a nation’s currency is not tied to gold, but when the country itself is not credible. History is full of proof — including this week in the European debate — that all the collateral in the world can not prop up a currency of a morally failed society. Instead of a run on the banks, there is a run on the collateral, as wealthy Greeks and Italians rush to buy up properties in London, Miami and New York.
How does a nation attain credibility? One highly visible way is to rigorously protect the integrity of its markets. We believe the single most important regulatory story of 2011 is the one unfolding before our eyes as the SEC attempts to close ranks and fend off the order issued by Judge Jed Rakoff.
Robert Khuzami was appointed head of the SEC’s Enforcement division in February 2009 and exhorted the troops on his first day in his new position to adopt the “four S’s — for strategic, swift, smart, and successful.” Khuzami told his colleagues that his objective was “to build strong cases, then compel defendants to settle quickly on the commission’s terms or face evidence in court.” We took both Khuzami and SEC Chair Mary Schapiro to task over this when it was reported (see our Screed of 18 September 2009, “Settler Trouble — An Opinion On An Opinion) in the context of Judge Rakoff’s earlier rejection of the SEC’s proposed settlement with Bank of America.
We opined at the time that the SEC knew it was offering a very bad deal — Columbia Law scholar John Coffee noted that, in a case dealing with a major financial institution, the SEC brief should have been signed by high-ranking counsel; instead, the papers submitted to Judge Rakoff for approval were signed by a regional director, leading Professor Coffee to wonder whether “no senior official wanted to accept responsibility.” Worse, we took Khuzami to task for actually stating that his purpose was to obtain settlements, rather than obtaining change in the marketplace.
As bad as the B of A case was, the Citi case is a real stinker. As we pointed out earlier, the purpose of settling large numbers of cases is supposed to be husbanding the Commission’s resources, keeping its powder dry for the really important stuff. This settlement says the SEC does not deem the generational undoing of Glass Steagall that led to the creation of Citigroup — that led to Lehman and Bear Stearns, that led to the 2008 financial crisis, that led to where we are today — important enough to actually try the case.
Loyal readers of the Screed know that we relish opportunities to say We Told You So. Still, it is with deep sadness that we see our predictions borne out with such blatant disregard for the credibility of America’s markets. Settlements undermine the regulatory process, while depriving injured investors of standing to go after firms. Among the surfeit of lawyers now roaming this vast continent, surely there must be someone smart enough and nasty enough to go after Congress and the SEC for depriving Americans of their right to a properly functioning market. The Citi case is not just another case of a Too Big To Fail institution. It is quite literally the Mother Of All Too Big To Fail cases, pitting the guarantor of market integrity against the very institution born from the new theory that markets no longer need to be regulated. Do Khuzami and Schapiro not see the compelling social policy need for clarity and a definitive outcome in this matter? Or are they afraid that Citi’s lawyers will beat the pants off them?
In this election year, we also remind you they are getting no help from the Leader of the Free World. In a sharp piece of analysis (Huffington Post, 19 December, “Obama And The Rule Of Law”) Jeff Connaughton, Chief of Staff to Senator Ted Kaufman, quotes Obama accusing Wall Street firms of “violating major anti-fraud laws because the penalties are weak and there’s no price for being a repeat offender.” Five days after that speech, appearing on “60 Minutes,” Obama said “some of the least ethical behavior on Wall Street wasn’t illegal.” As Connaughton points out, the President seems to be confusing “legal” with “difficult to prosecute successfully.”
Connaughton says the Obama Justice Department has not made high-level fraud enough of a priority to commit prosecutorial resources. The same Justice Department that is busy protecting the rights of Guantanamo detainees by transferring their cases to the US criminal courts, is protecting the rights of the worst financial miscreants by allowing them to negotiate small fines, and not have to admit to wrongdoing. Connaughton, a seasoned Capitol Hill staffer, wastes no time blaming the likes of Khuzami, or even Schapiro for the mild wrist-slappings meted out by the regulatory cops. Connaughton sees this regulatory pantywaisting as coming from the very top. We can not disagree.
Obama arrived in the White House without a powerful coalition — and he still has none. He arrived without any opposition politicians running scared of him — they are not only not scared of him, they are not even scared of their own party, as the freshmen run the established leadership out of town. He arrived mouthing Sunday school platitudes about Bi-Partisanship and is still not anywhere near nasty enough to be effective in Washington. Welcome to the Fiat Presidency: I am president because I say so.
Someone has to stop this degradation of our national credibility. We do not believe Judge Rakoff thinks of himself as a hero, but major change often comes when the Forgotten Man finally grows tired of being overlooked. Before the holiday weekend, the SEC was granted a stay of Judge Rakoff’s order while an appeals court decides whether to review it. Rakoff responded by accusing the Commission of “materially misleading” both his court and the court of appeals (NY Times, 30 December, “Judge Says SEC Misled Two Courts In Citi Case”) saying the Commission improperly requested the stay both from Judge Rakoff, and from the court of appeals, without alerting either court of the other petition. This looks like a piece of obfuscation of which the Obama Justice Department could be proud.
Connaught writes that, under President Obama, the Justice Department “hasn’t tried a single Wall Street executive in a criminal court,” and “filed away its investigations of big banks and Wall Street firms without indicting anyone.” He rightly observes that “American confidence in the system is deeply shaken,” and that the notion that not one financial executive deserves criminal prosecution “strains credulity for millions of Americans,” while “failing to deter financial fraud tomorrow.”
President Obama’s mildly reckless public statement about Wall Street firms routinely breaking the law took us back to the uncomfortable footage of President Obama sipping beers with Harvard professor Henry Louis Gates, Jr. and police Sgt. James Crowley. We wonder what brand of beer Lloyd Blankfein likes to sip while he’s having his ego stroked by way of presidential apology. And exactly how many times must a president get blindsided before he recognizes that reality is not subject to his fiat?
The President continues turning a blind eye on the fecklessness of his appointees in a bid to keep the pump of campaign contributions primed, and his appointees are dutifully not rocking the boat. Congress stymies itself at every step — and the only reason any one of them has a job is because Wall Street finances their political campaigns. And God help us if any of the current crop of potential candidates — Republican or Democrat — gets elected President. Meanwhile, there is much at stake in the Citi case. Is a lone judge whose patience has run out the last hope for American integrity?
Email me when ComplianceEdge publishes or recommends stories