Slouching Towards Wall Street… Notes for the Week Ending Friday 7 October 2011
“Cretan camouflage, sir. If you want to blend in with a bunch of drunken Greeks there’s nothing better.”
US Air Force sergeant Adrian Cronauer hosted a military radio show called “Dawn Buster” during his stint in Vietnam in 1964-1965 and subsequently helped write the script for a movie about his experience. Wikipedia informs us that Cronauer is “a lifelong Republican” who worked actively on Bob Dole’s 1996 presidential campaign, as well as George W. Bush’s run in 2004. A member of Mensa, Cronauer holds a master’s degree in media studies and is a lawyer focusing on the information and media sectors.
Cronauer says that, unlike the Robin Williams portrayal of his radio experience in the movie “Good Morning, Vietnam,” his broadcasts were “faced with more apathy than opposition.” Until a few weeks ago, that appeared to sum up America’s response to the serial financial crises we have been facing, starting in 2008.
Serial crises? It feels like we have been experiencing the same crisis over and over. Like a prolonged attack of vomiting, we experience spasm after spasm. Each time we hope that will be the end of it, but in a moment along comes another heave. And another. Hedgeye CEO Keith McCullough has observed that government meddling to control markets does not fix anything: it serves instead to heighten volatility and to shorten the cycles between crises. Brazilian finance minister Guido Mantega has observed that the 2008 financial crisis never went away, but morphed from a bank crisis into a sovereign crisis. The can has been kicked repeatedly down the road, but what we need to bear in mind is, it is the same road.
Which bring us to the quote about blending in with a bunch of drunken Greeks. In the movie, the Robin Williams character has just been transferred to Vietnam from the Greek island of Crete and has not been issued his new fatigues. Those of us who open the financial press each day are suffering from Greek Fatigue of our own. And while today’s Greeks may not be drunk, we presume the price of ouzo is being held down in a desperate effort to provide mass consolation.
The Greeks, in fact, are stone cold sober and stone cold angry. As depicted in Michael Lewis’ latest book, Boomerang, Greeks appear to have a cultural penchant for despising one another, which would help to explain why, in the early stages of unrest over their economic plight, a raging mob killed a pregnant bank clerk, and not the bank’s president. Continuing his travels, Lewis’ visit to Iceland makes it look like a society that never outlawed crack cocaine because they heard Americans were using so much of it.
But they — the Greeks, the Icelanders, the Irish and others depicted in this slender, rollicking volume — have reason behind their rage, if not method in their madness. It is the deliberate randomness of the current protest that has allowed observers to dismiss it as a madness that will soon pass. We think that would be a serious error, and we caution those who facilely dismiss the Occupy Wall Street dis-organization. This agglomeration of the aggravated has drawn thousands of the peeved to the pavement, all shouting what appear to be undifferentiated, and not well thought-through slogans of general disapproval.
As an obvious example, Occupiers have made comments about millionaires not paying taxes. First, trust us when we tell you that being a millionaire is not such great shakes these days. And yes, Virginia, “millionaires” do pay taxes. Critics of the Obama tax proposal charged his “millionaires” bill would raise taxes on small business owners earning more than $250,000 a year. Quite a lot of these folks are defined as “millionaires,” but that does not take any of the pressure off, and their businesses struggle and fail too. Besides, given the infinity of loopholes in the tax code, any business owner who shows more than $250,000 a year in taxable income is an idiot who should be made to pay.
But commentators who seize on silly, uninformed, obnoxious and outright idiotic spoutings are deliberately missing the point. We predict that they and their followers will pay for their willful blindness.
In a display of partisan cynicism that would make Vladimir Putin blush, Republican House Majority Leader Eric Cantor referred to the “mobs” that he warns are “pitting Americans against Americans.” We find the random and relentless nastiness of the Republicans troubling because it indicates that no one is in charge anywhere in Washington. A dose of perspective is provided by New York Times chief financial columnist Floyd Norris who chatted George Schultz — “the former more-or-less everything” (NY Times blog, 16 September, “George Schultz On Politics And Budgets”). Schultz said “the current poisoned atmosphere in Washington is ‘not recognizable.’” So it’s not just us. Faced with The Little President That Couldn’t, we expected the Republican machine to positively romp over their opponents — but the New Republicans have targeted the Old Republicans as fiercely as the Democrats and now the freshmen are running Congress. With office buildings across the nation going smoke-free, we look in vain for a Smoke-Filled Room so that a bill can get passed.
With the Executive and the Legislative paralyzed, the streets belong to those who occupy them. In the 1960’s (for those with a Wall Street time horizon, several years after the Upper Pleistocene) groups of the disaffected found it more fun to hang out with randomly angry students occupying university buildings, rather than seething impotently in their rooms. Mildly anti-social behavior was ennobled, and people who urinated on university files, set fire to their bras and draft cards, played the guitar awfully and went for weeks without bathing occupied a moral high ground. Before long this union of the unwashed gave birth to the Anti-War Movement. It is still early days for the Wall Street Occupiers. They have been visited by Hollywood stars bearing moral messages, by Big Labor bearing bagels, and by media reporters asking who is in charge. Led by a cross-denominational group of rabbis, some seven hundred folks descended on Zuccotti Park on Friday night for Yom Kippur services, taking their cue from leading American social activist Rabbi Abraham Joshua Heschel that “prayer is meaningless unless it is subversive.”
The Kol Nidrei service — the profoundly moving prayer service on the eve of Yom Kippur — highlighted a fascinating aspect of the Occupation’s structure. With public address systems and bullhorns prohibited to the protestors, they have taken to using the “people’s megaphone,” in which a speaker ascends the podium and delivers an oration one sentence at a time. That sentence is chanted loudly in unison by all who hear it, enabling those farther from the podium to hear the message. They, in turn, chant it outward to the next group, and to the next, until the message reaches the outer fringes of the crowd. This call-and-response creates a profound sense of unity that makes it palpably clear why it is the mode of choice for religious participation. At Zuccotti Park, it fostered a unity that would not be readily found if the speakers had microphones. Without the PA system, no one can afford to ignore any speaker. All become part of the process of conveying the message. All, indeed, become the message. The banning of public address systems has unwittingly contributed to fostering a sense of unity among the Occupiers. It is that sense of unity that will prevail and not, initially, any particular message.
Of course, the political establishment tried to get out in front of this not-yet movement, with Nancy Pelosi telling ABC’s Christiane Amanpour “change has to happen.” The former Speaker attributes the Occupiers’ rage to the failure of TARP, neglecting to mention that she championed the program. Pelosi voted for Obama’s TARP — contrasting it disdainfully with Bush’s TARP — saying Obama’s $350 billion would be overseen by “a president who’ll enforce the law.” But it was the same banks, the same Congress, and the same taxpayers ponying up the unaccounted-for billions. Expect the Occupiers to serve Pelosi her own words for breakfast.
The President is keeping a lower profile, even as he tries to figure out how to get out in front of the coming surge. Mr. Obama checked his veneer of morality and leadership at the door when he assumed the presidency, and we doubt any Occupier worth their salt will consider voting for him. Of course, the business of running the country has to be a major inconvenience for Mr. Obama, now that he is in full-out campaign mode. The last presidential election started as a historical anomaly, but has become the norm. It is now de rigueur to spend two years on a presidential campaign, and Obama and Biden appear to be spending more energy courting votes than forcing important policy issues. This may make no difference, as the distinguishing characteristic of the Obama Presidency has been a stunning absence of leadership, though we note with interest Kenneth Rogoff’s observation (Financial Times, 4 October, “Debt, Deficits And Deadlock: Welcome To 2012”) that we are witnessing a global political Triple Witching, “a once in 20-year overlap of a presidential election in the US with a leadership transition in China,” combined with the 2012 French presidential elections and Germany’s 2013 election of its chancellor. Professor Rogoff expresses a concern that “the overhang of elections exacerbates paralysis around difficult policy decisions,” and that “2012 promises to be a year of even greater politically induced volatility than 2011.” The Occupiers may be our best hope, if the coalesce into a movement that forces issues during the presidential campaign.
Right now the best Mr. Obama can come up with to address the rot at the core of our financial system is telling us to close our Bank of America accounts because the bank wants to charge $5 a month for debit cards. Suddenly, folks are up in arms. There was little outcry when BofA hid billions of dollars in losses arising from its monumentally stupid acquisition of Merrill Lynch — and nary a whimper when it emerged that the Treasury Secretary may have threatened BofA’s CEO personally if he uttered a peep about those losses. When the SEC and BofA agreed to a settlement that looked like a cover-up — it cost the bank nothing, its shareholders several tens of millions, and did not name individual bank officials for their roles in the mismanagement — only Judge Rakoff had the temerity to tell them to do better. In the end, even he had to hold his nose and bless the deal that looked blatantly like the SEC diving into bed with a major institution that may have committed multi-billion dollar fraud.
But charge $60 a year to provide my money with an FDIC guarantee? We like to believe the American people are not fools. But the politicians keep undermining our thesis: they get elected.
Occupy Wall Street and its clones in other cities are building up a head of steam. Someone, some idea, some event will trigger a change. The disorganized Occupiers will coalesce into a force for substantial change. Commentary has come from as far afield as China, where the Xinhua news says “Occupy Wall Street unveils underlying social problems in US” (8 October). The article quotes Columbia University political scientist Jean Cohen saying this is “a social movement seeking influence” that will ultimately force Washington to make “the correct decisions.” We think this has the potential to be another Anti-War movement, and we note anecdotal news stories where citizens of other countries are energized at the protest. Folks from the Moslem world have commented that, for the first time in years, they see the possibility of America regaining its credibility as a force for Right (as opposed to the Far Right). Some dismiss this notion, saying America is not Egypt, and our young people are different from the youth that sparked revolts in Tunisia and Yemen. Those pundits would do well to consider how closely many of these corrupt governments of were tied to the US. Much of the rot being burned out in other parts of the world originates here. We have no idea who or what the catalyst will be, but it will come, and it will have the power to change the world.
Tea Party Republican Paul Broun dismissed the Occupiers saying “They don’t know why they’re there. They’re just mad.”
Exactly. Good morning, Washington.
If you are upset about the disarray in the markets because it may hamper your ability to become a High Frequency Trader, you may have been the right age to watch “Teenage Mutant Ninja Turtles.” The dark villain of this series of movies was the ruthless killer known as The Evil Shredder.
SEC Chairman Mary Schapiro may wish she had brought her nunchucks in the latest confrontation with SEC inspector general David Kotz who reportedly supports charges by Darcy Flynn. Flynn, a lawyer who has worked in the Enforcement division for many years, has charged the Commission with destroying documents relating to open files, called Matters Under Inquiry, or MUIs (Screed 19 August, “A Shred of Evidence”). Flynn blew the whistle to Senator Charles Grassley, who now expects “the SEC to own up to its behavior” (Wall Street Journal, 8-9 October, “SEC Cop To Back Claim”). The Journal reports that “behavior” also includes “misleading another federal agency, the National Archives and Records Administration,” which “confronted the SEC last year about the destroyed records.”
As we observed when we first mentioned this matter, we very much like the fact that current SEC Enforcement lawyer and whistleblower Flynn is represented by former SEC Enforcement lawyer and whistleblower Gary Aguirre. Enforcement chief Khuzami does not believe “current or future investigations have been harmed” by the SEC’s practices around document destruction, but it is not clear that Khuzami has a dog in this fight, as he only came on board in 2009. The deleting of MUIs is “a longtime SEC policy,” part of document retention policies which the Commission deemed “proper at the time they were adopted.”
Inspector General Kotz has the authority to make a criminal referral if he believes it is warranted. We expect Senator Grassley to push for it, looking to put maximum pressure on Schapiro & Co. It has been reported (Rolling Stone, 17 August, “Is The SEC Covering Up Wall Street Crimes?”) that wiped files include MUIs relating to Madoff and to alleged Lehman Bros fraud, and insider trading reviews involving Goldman Sachs, as well as several major hedge funds. If IG Kotz is criticizing the Commission over this policy, we assume it is because certain files have been permanently deleted, with no hard copies remaining. Regardless of the rationale for deleting the files, if records have been lost forever it will not help Chairman Schapiro’s ongoing quest for more funding.
The SEC has S&P in its crosshairs over what appears to be a policy of asking its clients to do what is right, rather than what is expedient. The Commission has reportedly told the rater it may face civil charges over the way it assigned ratings to a $1.6 billion collateralized debt obligation (Wall Street Journal, 7 October, “Rating Firms’ Asset Game”).
The SEC review of the three major raters — S&P, Moody’s, and Fitch — indicates all three approached CDO ratings from the same point of departure. When assembling the assets to from the collateral, issuers often assigned dummy placeholders, pending identifying actual assets for the final package. Analysts at Moody’s and Fitch, according to the Journal, always rated the CDO on the assumption that the assets ultimately placed in the instrument would be the worst allowable quality. This “worst-case-scenario” analysis supposedly provided a more realistic assessment of the CDOs’ risk.
S&P, in contrast, reportedly assigned a rating to the CDO-under-construction by rating the assets that were actually in the instrument. They then reminded the bankers that they should keep to the level already assigned as they fleshed out the collateral. Apparently, there was no requirement to revisit CDOs as more assets were added — and there is the possibility that “S&P overrode its own internal controls when it continued to assign the deal its highest rating after the actual assets were traded into the deal.” The deal in question was Delphinus CDO 2007-1, issued by a unit of Mizuho Financial Group. This story raises two obvious questions: how could a rating agency, charged with objectively assessing the risk of a financial instrument, expect the bankers to be on the honor system and not recheck the instrument before affirming an investment-grade rating? More obviously, how many more of these stinkers are out there?
The SEC recently completed a report of the NRSROs (Nationally Recognized Statistical Rating Organization). The summary is available on the SEC website at sec.gov, under Release 2011-199 (30 September). The report notes overall improvement at the NRSROs, but states that the staff “identified concerns at each of the NRSROs,” including failure to follow firms’ own internal procedures, failure to establish internal controls, and failure to “adequately manage conflicts of interest.”
The SEC was empowered to create effective NRSRO oversight in 2006, thus the Commission may not be solely responsible for the general failure to police the rating agencies.
The Rating Agency Reform Act (“RA-RA” — but never mind…) of 2006 gave the SEC authority to establish a registration and oversight program for the NRSROs. It thus appears that, prior to 2006, the SEC had broad responsibility for the NRSROs, but there was neither a clear plan of action, nor clear legal authority for them to require or implement a reporting regime. As the SEC’s raison d’etre is Transparency, it appears they may have been at a dead end with respect to the raters until receiving explicit authority from Congress. In 2007 the Commission promulgated rules requiring certain records to be maintained and furnished to the SEC, and requiring certain public disclosures. According to the SEC report, “the Commission’s rules also prohibit an NRSRO from having certain conflicts of interest and engaging in certain unfair, abusive, or otherwise coercive practices.”
Not until the passage of Dodd-Frankenstein last year was the Commission granted enhanced authority to pursue a disclosure regime. Newly proposed NRSRO rules include requiring NRSROs to file annual reports about internal controls, to report specifically on conflicts of interest regarding sales and marketing, and conducting a “look-back” review “of rating in which former NRSRO employees participated to determine whether employment opportunities with a rated entity, issuer, underwriter, or sponsor influenced the rating.”
That last item is a classic. One of the biggest secrets about the NRSROs has been the departure of senior staffers, not just to issuers and the investment banks that package CDOs, but historically to the bond insurers, where they have been in a position to influence their former underlings — themselves eager to be employed at higher paying jobs.
We wonder where anyone at the SEC finds it ironic that the Commission is pushing for this type of scrutiny. The Commission itself has long been a well-oiled revolving door. Whether for departing enforcement chief Linda Thomsen, now a partner at Davis Polk & Wardwell, or for a third-year drudge who goes to work in internal audit at a major hedge fund, the Commission has in recent years been the place to come from, not the place to go to. Will that change? Will Harry Markopolos replace Mary Schapiro?
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