Slouching Towards Wall Street… Notes for the Week Ending Friday, March 25, 2011
State-Sponsored Financial Terror
Men make their own history, but they do not make it as they please.
In observance of the French revolutionary month of Germinal, which started last week, we offer some thoughts inspired by those heady years.
Historians of the French Revolution observe that much unnecessary social disruption — up to and especially including the Terror — was the result of putting a theoretician in charge of policy. Robespierre was a stunningly persuasive orator, and even his bitterest enemies conceded that he hewed unwaveringly to his principles. But a man whose sole experience of the world emanates from exhorting large crowds of people to common action is often not the right choice to manage profound societal displacements. Readers may be tempted to draw a parallel to the current state of our own union…
Whether the revolution be political, social, economic — whether stirred up by the intelligentsia or springing spontaneously from the underclass — each movement needs an able administrator who is persuasive, yet capable of forcing compromise; who can dissuade others — and especially himself — of deeply-held beliefs to keep pace with reality, and who recognizes that outcomes are uncertain and, more important, are unlikely to resemble theoretical ideals. Robespierre’s inability to modulate his own principles for the survival of the revolutionary project was directly responsible for the Reign of Terror and the ultimate failure of the very Republic he helped launch. His inability to weave practicality into the fabric of Revolution made the entire dream unsustainable, practically from inception.
Robespierre, a leader who believed he forged his own destiny, defined Terror as “nothing other than prompt, severe, inflexible justice.” It was this inflexibility that led Robespierre to call for a purge of French society — over the course of about one year some 30,000 people were led to the Guillotine. And it was this same inflexibility that ultimately destroyed both Robespierre and the Revolution he championed. By July 1794, in the Thermidorian Reaction, both Robespierre and the Terror met their end, literally at one stroke of the blade. By 1799 the Republic and its constitution had been swept aside and a trio of provisional Consuls ruled. No sooner had this triumvirate seated itself than one of them, who likewise believed he could create his own destiny, shunted the other two aside, drafted a new constitution, and established himself in the former royal residence at the Tuileries. His name was Napoleon Bonaparte and the rest, as we say, is history.
Thus are the far-reaching consequences of those who govern by theory, rather than by practice. For theoreticians believe their destiny is theirs alone to make — only a practitioner recognizes the need to bend to the world’s realities. One sure sign of mistaking theory for reality is an inability to communicate with the very people one serves. King Louis XIV’s l’etat c’est moi grates on American ears because we read it in the context of our learning to be voters in a fully emancipated democracy. In fact, Louis reportedly made this statement to the Paris parliament to assert that, despite his youth, it was he who ruled France and not the acting regent, Cardinal Mazarin. This was at a time when some still subscribed to the notion of the divine right of kings. In historical context, Robespierre’s statement “I am The People” is far more grating — the same Robespierre who said the king was far from divine, and who insisted that the Will of the Crowd was sufficient for Louis XVI to be summarily beheaded.
Speaking of inability to communicate, our government also has turned the running of the world over to theoreticians. The government printing press and the disposition of the dollars that flow from it are under the direction of a former college professor, and of a lifelong bureaucrat. We admire Chairman Bernanke’s intellectual prowess, but we are flabbergasted at the passivity of a nation that allows its Decision Maker-In-Chief to abdicate in favor of the Ivory Tower. The ability to reel off statistics and to parse subtle relationships that led to social upheaval during the Great Depression makes Professor Bernanke an exceptionally valuable adviser. It does not make him an able driver of policy. President Obama is not the first to fall under the sway of academe, which does not mitigate the image of the Leader of the Free World (we have to get mileage out of that phrase while there’s still some left) standing haplessly by while America’s currency, world influence, and domestic social contract all vanish in an inflation-induced puff.
Our financial bureaucrat-in-chief, Tim Geithner (by his own admission, not an economist — by his own testimony, not a politician) has brought in a theorist of his own. We wish to point out that just because someone worked at a Wall Street address, it doesn’t mean they are any more in touch with reality. We are speaking of former Goldman economist William Dudley who replaced Tim Geithner at the helm of the New York Fed. In an exchange that has been made much of in the press, an exasperated Dudley explained that America’s low-income wage earners had no business being unhappy, because iPads have gotten so cheap. One interlocutor shot back “you can’t eat an iPad,” which led to a spate of clever headline writers all clamoring together “let them eat iPads.”
Doesn’t the head of the New York Fed have PR flaks to advise him? Dudley may be a brilliant economist; he may be a devastatingly shrewd Fed Head. But he sure lacks the Common Touch — or did he genuinely believe the poor are fools because they fail to see the benefit to them when rich people can buy their toys at half off? When will the iPad trickle down to the loading dock worker? In his “18th Brumaire” Marx famously corrects Hegel to say that history repeats itself: the first time as tragedy, the second as farce. Begging Marx’ pardon, we wish to offer the notion of a third incarnation.
The history of capitalism in America went through a tragic stage when the robber barons amassed their fortunes, driving many of the common folk off their land and into the poverty of low-wage labor enforced by the free hand of club-swinging thugs. This tragedy was repeated in the dust bowl migrations, the Mexican farm workers, and even today in illicit sweat shops where illegals serve their American capitalist masters at home, or children work 16 hour days abroad.
The farcical incarnation was exemplified by the spate of major investment banks all going public: capital markets were intended to raise investment capital for businesses, enabling new ideas to come to market which otherwise would be starved in the cradle. Instead, the bankers used the markets to cash in their chips, making the public the holders of the Risk part of the business, while the bankers continued to pay themselves out of the Reward, all the while trumpeting this as the Triumph of the Free Market.
But what shall we call the avatar that comes after farce? We wonder what Marx would make of Mr. Dudley’s farcical performance — which betrays a deeply tragic reality. We are tempted to call this stage The End of History — because we shudder to think what might come next — but perhaps the third stage is the revolution that famously eats its own children.
Our government passed laws permitting our financial institutions to create a consumer debt crisis by hounding even unqualified buyers into home ownership (Tragedy). The government then encouraged those institutions to ship their risk into foreign markets (Farce). When foreign markets became saturated, the banks turned inward and were encouraged to crush the people of this country in the name of profit. The government refused to permit the regulatory agencies to do their job of overseeing those markets, standing idly by when the financial system devoured itself in a paroxysm of greed. When the last drops of blood had been sucked from the market, the government took a trillion dollars of taxpayer money and paid off those same financial institutions and their executives before the sad wondering eyes of the nation (The Revolution Eats Its Children). They then hired a bunch of smart professors to tell the world why it is OK that the elected officials don’t do their job, and anyway this is really too hard for a bunch of lawyers and medical doctors and all those other mediocre minds in Congress.
So the bureaucrats and professors have their hands on the spigot of global wealth — and their foot on the neck of We the People. So it is that the bankers paid themselves record bonuses in a year where America’s middle class became America’s working poor and the working poor ended up on the trash heap. Remarkably, a number of citizens still believe the system fundamentally works and they actually show up when a government official visits to talk policy. And the best this country can do to respond to these folks’ concerns is to tell them their lives are better than they think, because look how cheap iPads are.
Let us compare government effectiveness: Colonel Gaddafi tells his citizens “I will kill you!” We tell ours “we’ve got it all under control.” Our money’s on Gaddafi. He’s not a theoretician — he’s a practitioner.
Some time ago there was speculation that the FINRA endowment was broke (8 May 2009, “An Offer We Can’t Refuse.”) In what looked to be a severely opaque report to its membership, FINRA’s endowment listed 45% of its holdings as “alternative investments.” It was not immediately clear whether the estimated value of $1.5 billion in endowment assets was stated at original cost, or marked to the market — (or perhaps, a la the State of New Jersey, it was reported at the highest historical price for the respective assets because, you know, it traded there once so why shouldn’t it trade there again when we have to sell it?) Nor could journalists get anyone at FINRA to specify the nature of those “alternate investments” — presumably hedge funds — nor who was managing them. This led to speculation that the cash had been handed to Bernie Madoff and had vanished. And the rest, as they say, is Farce.
Casting about for new ways to pay themselves, FINRA’s latest money-making initiative is to charge licensing fees for people who’ve never had licenses before. Investment News reports (20 March, “B-Ds To Finra: Back Off Back-Office Registration”) that FINRA is gearing up to ring the cash register by requiring back office and administrative personnel to pass licensing examinations.
The IN piece is, unsurprisingly, slanted against the notion of registering clerks and attempts to finesse the point right off the bat by calling FINRA’s proposal “a controversial plan,” saying that “historically, registration has been limited to individuals working in sales or trading.”
We think what is “controversial” is that Wall Street doesn’t want yet more oversight, yet more paperwork, yet more reasons that a regulator can look under our skirts. But back office personnel are responsible for moving around vast sums of money and vast quantities of securities, and the question of their qualifications is a legitimate one. We will not argue that Bernie Madoff would not have been able to pull off his scams if there had been required back-office registration, but in an ideal world the registration of clerical staff would lead to greater standardization and transparency in the operations areas.
The IN article says the proposal “marks a substantial and potentially onerous expansion of registration requirements,” and points out that low-level employees, and even outsource consultants would have to register. As an example, it quotes one financial CEO, who is part of the FINRA Small Firm Advisory Board, saying that small firms might have to register their receptionists. This sounds positively fascistic until you realize that, in very small brokerage offices, the receptionist is frequently the person who locks physical securities in the safe in the boss’ office, and who logs customer checks and mails them to the clearing firm.
We wondered how much money FINRA stands to make off this, if the rule is implemented. All non-registered brokerage personnel are overseen by registered supervisors, so we believe the requirement would probably extend to require registration of two groups of clerical workers: one would be the first level down from the supervisory person, the other would b e clerical staff working at what are called non-supervisory branch offices, where their direct supervisor may not be on premises. FINRA’s website says the SRO oversees “nearly 4560 brokerage firms, 163,465 branch officer, and 630,830 registered securities representatives.” We bet the new registration would apply to at least one clerical employee in each branch office. How much will the licensing exam cost the member firm? Let’s say it’s $75 apiece. Times 163,456 branch offices. How do you spell “WINDFALL”?
Here’s why it may be a good idea. The Wall Street Journal warns that new financial rules that appear to benefit individual investors should not be taken at face value (26-27 March, “Will New Rules On Fees Slow Down Eager Beaver Brokers?”) FINRA, says the WSJ, is about the change the so-called “5% Rule.” It is “so-called” because, as any broker can tell you, capping customer commissions at 5% per transaction is not a Rule, but what the regulators call a “guideline.” Brokerage firms used to make sure their employees did not charge more than 5% on any given trade — and some firms used to make sure their employees never charged less than 5%. There is a companion notion, known as a “proceeds transaction.” This concept states that, if a broker sells a customer’s holdings in one security, then uses the proceeds to buy another, the commission on both trades should not add up to more than 5% of the value of the sale. This led to a generation of cautious brokers who would tell their customers to sell security A today — because we have made enough profit / taken enough of a loss on this position — and we are watching security B very closely, and we think we’ll buy it tomorrow. It took the regulators a little while to catch on to the fact that, by selling on Monday and buying on Tuesday, brokers were hiding the “proceeds” nature of the trades and were charging 5% on each transaction.
The WSJ piece uses municipal bond transactions as examples of how investors can get raked over the coals. This raises the broader issue of pricing: bonds can be sold at large markups because the dealers agree where they will price them. Or because yours is the only trade in the market this morning. Bonds generally trade in a negotiated over the counter market which doesn’t post bids and offers like equities markets do. The opacity of the market has led regulators to question the legitimacy of pricing practices. In the munis market, FINRA required a separate order period for retail buyers before new-issue bonds are offered to institutions. The logic was that retail buyers could get better prices if they were not forced to compete against dealers. Evidence that this may be accurate was provided when some dealers entered fictitious retail orders to get a jump on the institutional bidding sessions. This would seem to indicate that the market is fundamentally hostile to the interests of individual investors.
The Journal article doesn’t explain the justification for charging higher commissions. Firms are generally permitted to charge more, the more resources they have to commit to execute a trade. Trades in highly illiquid securities have always been executed at a premium, because of the amount of time required and “high touch” service in these transactions, meaning an actual person has to sit and watch the market, using their own judgment — and reflexes — to get a trade off at the right moment.
Among other new wrinkles, the proposed rule change will require brokerage firms to send a commission schedule to their customers. Currently firms are required to send commission schedules to customers upon request: the rule change would make it mandatory, which means there will be marginally a few more customers who will look at how much it costs them to do a trade.
Will this make a difference? The article mentions one Mr. Wittner who paid a 3.5% commission to buy 100 shares of Wal-Mart. When he complained about the high charge, his Morgan Stanley broker reportedly told him he had received a preferential rate. Quoting Morgan Stanley: “We believe our commission rates and structures are in line with other full-service brokerage firms.” Does this sound like a cartel?
For as much damage as a nefarious broker can do, a corrupt back office clerk can wreak havoc across a firm’s entire customer base. A corrupt broker can empty out his customers’ accounts; a criminal back office manager can bankrupt a broker dealer bring down its clearing firm too, setting off a domino effect where other brokerages will fail because they can not access their own capital. Registering clerical staff is will create a basis for standardized back-office examinations. If you were around in the antediluvian days of the 1990’s you will recognize that such a checklist may have prevented the collapse of Hanover Sterling, and the subsequent failure of a string of clearing houses. In more recent times, such an audit checklist may have resulted in detection of Madoff’s fraud.
Here’s why registering back-office staff is maybe a bad idea: FINRA will administer it. The SEC has been taking all the heat over Bernie, but Madoff was a FINRA member firm, and FINRA had to grant permission — or turn a blind eye — for its activities including custody of its customer assets. In the ongoing regulatory fecal torrent, still no one is asking why FINRA, under Mary Schapiro, failed to turn up the goods.
The Journal says the Morgan Stanley customer “told his broker he wouldn’t pay more than $50 on his next trade.” The broker reportedly took the deal. Schwab charges $8.95 per trade. We wonder what is the Value Added inducement for Mr. Wittner to pay the Morgan Stanley differential. With due respect to that august institution, we doubt it required the resources of a Morgan Stanley to come up with the idea of buying 100 shares of Wal-Mart. Anyway, in this scenario the broker and the firm are still coming out ahead — and the investor way, way behind. Same as usual.
Maybe FINRA should require licenses for customers?
In the category of Stuff Even We Couldn’t Make Up, Brazil’s newspaper O Estado de Sao Paulo reports on World Water Day ceremonies, where Venezuelan president Hugo Chavez said the current military action in Libya is an attempt on the part of Western powers to take control, not only of Libya’s oil, but of its water. We chuckled over the notion of invading the Sahara for its water supplies, but we recognized that just because Hugo Chavez says something, doesn’t mean it might not be true.
In 1953 an oil exploration team in Libya hit a vast underground fresh water source known as the Nubian Sandstone Aquifer System. The Libyan government has since developed this into the “Great Manmade River Project” (GMMRP) which delivers water from the aquifer system to Libyan cities. The GMMRP’s website says it is the world’s largest irrigation project, comprising 4,000 kilometers of pre-stressed concrete cylinder pipe, and growing. Its aim is to provide nearly four million cubic meters of water every day to Libya’s major cities, many of which you have now heard of. Gaddafi, when not sponsoring acts of global terror, has referred to the GMMRP as the Eighth Wonder of the World.
Warming to his topic, Chavez blamed capitalism for devastating the planet Earth. Over centuries, he said, areas that were covered with lush forests and fed by great rivers have all been turned to deserts. Indeed, said the Venezuelan leader, “I have always said — and I have heard — that it would not be strange if a civilization had existed on Mars, but capitalism might have arrived there. Maybe imperialism arrived and wiped out the planet.”
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