Slouching Towards Wall Street… Notes for the Week Ending Friday, 8 June 2012
Larry And The Amazing Technicolor Dream Economy
Currency debauchery threatens to spread from nation to nation like a fire rushing through a row of connected houses. A secret society of unelected technocrats, all fluent in a jargon understood neither by the politicians who follow their lead, nor by the mass of citizens who pay the price — are looking at ways to beggar their neighbors. Germany has been holding the line against a full fiscal union across the eurozone. Sharing a currency is not the same as sharing fiscal responsibility, and the Germans seem determined to protect their robust economic position as long as possible. The downside of true cross-national fiscal union is, there is no one left to beggar.
Not so, apparently, the homeland of global financial ruin — that would be the United States. We are so in love with ourselves that our entire culture has become an unending act of onanistic ego stroking. We watch ourselves constantly (reality TV), we listen to ourselves, and like infants bringing their pooh to their cooing parents, we present every slightest thing that comes to mind as our own personal contribution to the cosmos (Facebook, LinkedIn, Twitter). We even revel in being desperate losers (Pawn Stars).
What we Americans do not revel in, it seems, is self respect and demanding accountability from government or from the marketplace. Rather than encourage We the People to engage in a fundamental debate about where America should be going, the dominant political parties and the frenzied shrieking media have manufactured a multi-year election cycle — a media fest where no issues are ever debated to the core, and that has all the reality of the “feelies” from Brave New World. Meanwhile the Best and Brightest continue to look for ways to shred the last tatters of our economic and social fabric.
One of the Brightest of all is Lawrence Summers — former president of Harvard, former Treasury secretary, former member of the Committee to Save the World and, according to those who have worked around him, a good guy to have at your side in a fight. Summers has a reputation of not being afraid to wade in when things get nasty, or to make sure they get nasty — famously by speculating that “issues of intrinsic aptitude, and particularly of the variability of aptitude” may be the cause for the underrepresentation of women at senior levels in scientific and engineering-related positions in industry and the academy. But brashness also helps people advance. If nothing else, Summers has bounce-back-ability. The same foot he places in his own mouth is also the best one forward towards his next venture.
Summers shares this quality with the Biblical character of Joseph, whose career is inauspiciously launched when he blabs his dreams to his family — dreams which foretell his brothers (all older than him) and parents bowing down before him — after which the brothers toss him down a well, from which he is drawn up and sold into slavery in Egypt. Joseph, like Summers, is a capable administrator, possessed of a keenly analytical mind. As a slave in Egypt, he runs his master’s household, where — Summers-like — he gets himself in trouble by boasting that his master’s wife is the only thing his master prohibits him to have. When she tests this, he ends up in jail.
In short order Joseph becomes head of the prison, chief assistant to the warden, and the man charged with spying on the other prisoners. But just when it looks like he might get out, Joseph relies on other prisoners to bring his case to Pharaoh. He languishes in prison until Pharaoh, in desperation and exasperated at the incompetence of his advisers, says “bring me someone smart!” Pharaoh, the canny politician, senses in Joseph a kindred soul — a man willing to use his wisdom to benefit his benefactor. To do well by doing good — for the right person. Thus is Joseph elevated to the position of viceroy.
This is not as chi-chi a position as it may seem. In the ancient near east, the person placed in charge of the food supply would be taken out and execute in public if the bread ran out. This is not the same as in America, where an unelected official can run amok, wrecking the economy and undermining the foundation of our society while the President and Congress stand by gaping and saying “Gee, he’s really smart with numbers! I wish I understood what he was talking about…” Like Joseph standing before Pharaoh, Summers has seen the economy through fat years and lean years. And, like Joseph, he has come up with a plan.
Writing in the Financial Times (4 June, “Look Beyond Interest Rates To Get Out Of The Gloom”) Summers advances the notion that, as we have operationally twisted ourselves down to historically low interest rates, “governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more not less.” Summers issues a call to aggressive new government borrowing aimed at “accelerating any necessary maintenance project,” and — our favorite — says the government should “issue debt and then buy space that is currently being leased.”
When the lean years hit Egypt, the Book of Genesis recounts how Joseph’s careful hoarding of the nation’s food resources enabled him to trade with the populace. First he sold them grain until he had taken all their money. Then they traded their flocks and herds, then their real property, and finally their very bodies, as the people of Egypt sold themselves into perpetual bondage to Pharaoh in return for grain. By the time the years of famine ended, Joseph had converted the entire nation of Egypt into property of the throne. A neat trick that Professor Summers now advocates the US government should undertake.
Both Summers and Joseph point to the complex relationship that has always existed between transcendent power and earthly power. Summers , a native of Hedgeye’s home town of New Haven, is possessed of one of the finest minds on the planet today. His transcendent intellect has enabled him to link with a series of earthbound institutions — the World Bank, Harvard, the White house — to his own enduring profit, if not always to the best outcome for those served by the institutions he has advised.
Summers’ penchant for making outrageous statements doesn’t always work out as he intended. While at the World Bank he authored a memo in jest, positing “the economic logic behind dumping a load of toxic waste in the lowest-wage country… I’ve always thought that under-populated countries in Africa are vastly underpolluted.” Not everyone snickered over this — nor did his advance warning that he intended to make an outrageous statement appease his audience when we posited, as president of Harvard, that women may be underrepresented in science and engineering because they might not have the same level of technological aptitude as men.
Summers’ behavior looks quite like Joseph blabbing to his brothers about the dreams that fill his sleeping head. Joseph’s story, like that of professor Summers, is of the partnership between transcendence and earthly power. In Joseph’s case, it is a growing spiritual awareness, a gift of prophecy, and wisdom born of long years of suffering — suffering brought on by his own behavior. Summers has used his transcendent gifts to obtain a seven figure income, highly paid consulting and speaking engagements, and plum positions in both Washington and academia (though it must just kill him that he has never won the Nobel Prize.) Joseph works diligently to serve his earthly master, using his connection to power first to rescue his family, then to effect a reconciliation, and finally to impart to them a transcendent vision for the future.
There is undoubted wisdom in Summers’ current proposal, not to mention historic precedent. Pulitzer Prize-winning historian Alan Taylor’s recent The Civil War of 1812 — required reading in this bicentennial year — describes the economic imbalances in the run-up to hostilities. In the late 1700’s the British freely granted hundreds of acres of land to Loyalists and disillusioned Americans willing to settle in Canada to maintain the presence of the Empire. Meanwhile the Americans were selling off real estate in a panic to raise cash to pay off the debts of the Revolution. In 1791 the government of New York State sold 5,542,170 acres of state land to speculators at a purchase price of less than twenty cent an acre. “Those speculators,” writes Taylor, “profited by retailing the land to actual settlers, who had to pay a premium: usually two or three dollars per acre.”
Speculators flipped government land for 10 to fifteen times the price to people who actually intended living there. George Washington himself bought up land on which the future capital city of the new nation was to be built, an act that earned him both profits and criticism. Summers’ proposes that the government get into the act. It makes sense. Why should bottom feeders and investment bankers make all the money? Summers writes that the government will prosper from this proposal “as long as the interest rate on debt is less than the ratio of rents to building values, a condition almost certain to be met in a world of government borrowing of less than 2 per cent.”
Washington, are you listening? Bernanke & Co. have trashed the Real Economy in failed efforts to stimulate borrowing. The idea was to stimulate consumption and investment, but the economy has stubbornly refused to take the bait. The government is the lender of last resort. It should consider also being the investor of last resort. Washington is in a position to lock in historically low rates for its own spending. Why is it wasting energy — and destroying the credibility of our markets, our currency and our way of life — by trying to get other people to Buy American? Rather than sell off the bits of American companies that are not bolted to the floor, why not buy them ourselves?
Major American industrial names are in the hands of foreign owners. RCA and Lucent Technology (French), Westinghouse Nuclear Energy (Japanese — though perhaps not likely to exploit it aggressively any time soon), and IBM’s personal computer division (Chinese), to name a few. These companies represent massive chunks of American creativity — the IBM PC division alone holds some 500 patents — and the list continues to grow. President Obama needs a Joseph to guide him. We are already printing more money than has ever existed in all of human history. In this environment Summers makes the rational point (he is capable of it) that heaping more government debt on top of existing debt should not fuel anxiety about America’s creditworthiness, “as long as the proceeds of borrowing are used either to reduce future spending or raise future incomes.”
If you object that something might go wrong that would make Summers’ proposal not work, we counter that the money has already been printed, issued and twisted into the markets and, hey, do you notice anything about the current situation that is working? The City of Chicago sold the rights to its parking meters to private investors. For $1.15 billion up front, Morgan Stanley leased the rights to municipal parking revenues for 75 years. In 2011 they netted $80 million and are in litigation with the city over claims totaling almost another $30 million — and they are just getting started. Since the Chicago deal was struck, Indianapolis, Pittsburgh, Memphis, Harrisburg, and now New York City are either signed up or looking to get into the business, and Ohio State University kicked off as the first institution of higher education to seek private investors for its parking facilities. With parking meters and toll roads up for grabs, is there some reason that President Obama — Chicago politician — and Obama BFF and now Chicago Mayor Rahm Emanuel couldn’t have struck a deal? Even in our current fiscal black hole, the federal government ought to be able to come up with $1.15 billion.
With numbers like these flying around, it is just plain stupid for the federal government to not be taking the role of buyer of last resort. Instead, we allow that position to default to investment banks, and to nations like Dubai and China — countries that have both the cash, and the appetite to own productive assets in the US — then we balk and Congress panics because we don’t like the politics of the buyers. Ray Bradbury’s famous opening line could just as well be applied to the current policy of Burning the Buck, burning our market integrity, burning America’s productive capital base, and burning American credibility globally. There is nothing more depressing than to be a prophet of doom whose predictions come true.
A less well-known Bradbury quote comes to mind: “I don’t try to describe the future. I try to prevent it.”
10(b) Or Not 10(b) — That Is The Question
One of our Broad Street Irregulars calls to our attention a decision by the Eleventh Circuit Court of Appeals, which claims the distinction of being “the busiest federal appellate court in the United States.” The recent decision may prove a serious blow to the SEC’s practice of settling fraud cases.
Screedophiles will recognize the SEC’s penchant for settling cases as one of our favorite things to complain about. Whenever we fear we may be in a rage deficit we remind ourselves that superstar Ninja-master federal prosecutor Bob Khuzami — who risked his life to take down drug dealers — waltzed into his job as SEC Enforcement Director with a master plan to… settle as many cases as possible. Today more than ever, we still believe that criminal prosecutions are the only way to effect permanent change in people’s behavior.
Judge “American Idol” Rakoff agrees, and the Eleventh Circuit may be providing him with adding ammo. (As we go to press, star defendant Rajat Gupta has reversed course and will not testify in his own trial — surely a disappointment to Judge Rakoff who instructed attorneys for both sides to keep the proceedings lively, in order to entertain the jurors. See our Screed of 1 June, “How You Play The Game.”)
The Eleventh Circuit invalidated the SEC’s longstanding use of “obey the law” injunctions, saying they fail to satisfy the Federal Rules of Civil Procedure which require injunctions to describe prohibited behavior “in reasonable detail.” This decision may not be immediately definitive, but it is well reasoned and other courts may follow it to question the SEC’s approach.
“Obey the law” injunctions are familiar to anyone who has ever read — or been the subject of — an SEC settlement where the alleged perpetrator agrees to pay a fine and agrees, without admitting or denying, to the entry of a finding that they committed a certain act. Finally, the settling party agrees that they will be enjoined from any future violation of the securities laws. The Eleventh Circuit, ruling on an appeal of SEC v. Goble, rejected this “obey the law” language, pointing out it was not the first time they had done so.
The SEC accused Richard Goble, founder and CEO of North American Clearing, of fraudulent misrepresentation of his firm’s regulatory capital. Discovering a capital shortfall, Goble reportedly instructed his CFO to create a false entry in the firm’s books, showing a $5 million purchase of a money market fund that never actually took place. The phantom transaction was recorded in the firm’s reserve account, established for the protection of customers.
A Florida court found Goble had directed the employee to make a false record. On that basis, the court found Goble had committed securities fraud under Section 10(b) of the Securities Exchange Act of 1934. The court also found Goble violated the Customer Protection Rule, which requires a reserve to protect customer assets. Goble was enjoined from soliciting securities transactions while in violation of the Customer Protection Rule and, as a result of the court’s understanding of “reliance” and “solicitation,” was barred from the securities industry. The Appeals Court found the injunction did not apply to the described activity — Goble had violated the Customer Protection Rule, but had not committed fraud relating to the purchase of securities.
The SEC argued that a money market is a security, and that Goble thus committed fraud regarding the purchase of a security. Further, the SEC said the customers of the brokerage firms that cleared through North American “relied” on the clearing firm to be in compliance with the Customer Protection Rule.
The Eleventh Circuit said 10(b) fraud requires reliance on specific representations as the basis of a specific transaction in a specific security. True, Goble’s act involved a transaction in a security. And true, North American’s brokerage correspondents’ customers relied on the clearing firm not to break the law. But cobbling these together into a finding of Section 10(b) fraud was too much for the court.
The court went further, saying that “obey the law” provisions are unreasonably broad and deprive the defendant of required safeguards alerting them to activities that could trigger future charges of violations of the law. The court added that specificity is increasingly important in Section 10(b) fraud — the object of most SEC “obey the law” injunctions — due to the “ever-changing judicial landscape.”
The appellate court said Mr. Goble could not be permanently barred from the securities industry for a 10(b) violation, as he had not committed one, and that the SEC “glaringly” failed to justify how the lower court’s injunction complied with the Rules of Civil Procedure — which guarantee the defendant a clear indication of what act will be deemed a violation.
We are not aware that any defendant who settled an SEC case has ever been convicted of subsequently violating an injunction — even when their later actions blatantly repeated activities that gave rise to the initial charges. The SEC announces settlements — as though they had cleaned up crime — and reports how much money it takes in. Folks who settle with the SEC almost never lose money on their illegal transactions: the fines they pay are generally a fraction of the total revenues won by the activity in question. Cost of doing business, sort of thing.
This is a call for the SEC to change course. Simply tightening the wording of settlements may not be enough. If the Commission lists specific activities in injunctions, they will be forced to prosecute for repeat violations. This will be good for folks like Judge Rakoff and anyone who likes market accountability. It could be bad for the SEC, which will have to do some actual lawyering for a change.
We hope Mr. Khuzami still has his chops. We’d love to see him in action.
Email me when ComplianceEdge publishes or recommends stories