Saturday, September 29, 2007

The Classical Agency Problem Yet Again

Lester Brinkman, a Yeshiva University law professor notes, "to date, no court has declared the practice [of plaintiff's lawyers conspiring with defendants] illegitimate. The failure of the legal profession to enforce its ethical rules and lawyers' fiduciary obligations is an indelible indictment of the bar's claim to self regulation based on its acting in the public interest", WSJ, 25 Sept.

Why should lawyers be any more ethical than CPAs? Self-regulation is nonsense. As Adam Smith told us in 1776, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices", The Wealth of Nations. Are lawyers people too?

Royalty Returns

Ben Bernanke "replaced Alan Greenspan as Fed chairman in early 2006. But until now, Bernanke had faced no crisis and his policies had shadowed Greenspan's", Robert Samuleson in Newsweek, 1 October.

What is important in this article is the title, "The Bernanke Era Has Begun". It made me think of the time before the US existed and Americans were Colonists. For example, in 1570 the British passed a new bankruptcy law. It was denominated "13 Elizabeth" signifying it passed in the 13th year of Elizabeth's reign. Similarly, should we now call 2007 "2 Bernanke"? In the early days of the Republic the US Supreme Court listed its terms by court reporter. For example, 2 Cranch refers to 1802 so there is some US precedent for this.

Thursday, September 27, 2007

Let the Market Work

SEC Chairman "Christopher Cox admitted he has no power to police the accuracy of ratings from these government-recognized ratings providers. ... There is a better answer: End the practice of giving ratings providers any official blessing in the first place", WSJ, 27 September.

Suppose the SEC could police the accuracy of the ratings agencies, would it do any better than it has done policing the CPA firms for the last 35 years? I say end the PCAOB and the rest of this useless alphabet soup of agencies and let the plaintiffs' bar sue 'em into better behavior.


"Rating agency Moody's is changing the way it rates complex debt products backed by US subprime mortgage bonds to reflect mounting losses in the stricken market", Financial Times, 25 September.

Throw the models out. They are useless. Changing the models after the fact shows it. Instead of admitting the obvious, Moody's is tweaking its equivalent of a pre-Copernican geocentric model of the solar system, i.e., the Sun circles the Earth. Eventually we threw that model out. Similarly, eventually even Moody's will see its models are a search for the philosopher's stone. They want to turn models into GOLD.

Bush Lies, the Dollar Dies

"'The policy of this government is a strong-dollar policy.' President Bush has consistently stuck to this story throughout his White House tenure, which spans three Treasury Secretaries. ... We need a meaningful global currency", Judy Shelton in the WSJ, 27 September.

I remember Judy Shelton. She wrote The Coming Soviet Crash in 1989, before it happened. I didn't think the USSR would dissolve. Boy was I wrong. As to a global currency, mankind has had one for 5,000 years. It is the four-letter word: GOLD!

One should never listen to anything politicians say about money. I remember in 1967 when the British Pound was devalued, until the day before it happened, the Chancellor of the Exchequer denied it. After the fact he said he couldn't tell anyone lest he enrich the speculators. Remember, neither Bush nor Paulson's statements need be vetted by the SEC.

Are They Really This Stupid?

"'We've never seen anything like it in structured finance,' says Paul Kerlogue, senior credit officer at Moody's in London. 'Things just behaved in a way that we were not able to predict'. Says S&P's statement: 'Our original ratings were based on the best available data at the time.' It adds that the credit quality of the CDOs' underlying investments is still strong. ... 'They were looking at historical data in a brand new ball game with brand new products,' says Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago-based consulting firm and a longtime critic of the agencies. 'You have to understand what you're modeling. That is Statistics 101, and they failed.' S&P and Moody's say they did significant stress testing on their models to account for the risk", BusinessWeek, 1 October.

This is absurd! The rating agencies had no business rating CDOs, etc., These products were created for " gaming the regulators", Economist, 20 September. Amen. Three cheers for Tavakoli! Again, where were the CPAs? The CPA firms had no business opining on any entity that issued or held these products. Did they learn nothing from Enron?

Wednesday, September 26, 2007

We are all Saudis Now

"The Interior Department's program to collect billions of dollars annually from oil and gas companies that drill on federal lands is troubled by mismanagement, ethical lapses and fear of retaliation against whistle-blowers, the department's chief independent investigator has concluded. ... The report stopped short of accusing top agency officials of wrongdoing. ... It suggested that the agency was too cozy with oil companies and that internal critics had good reason to fear punishment", NYT, 26 September.

Who are these guys at Interior? "Diplomats" looking to be posted to Saudi Arabia so when they leave State they can do very well indeed? Do they want to make friends in the oil companies? Stay tuned for further developments on this. Particularly if Hillary is your next President. I have no more confidence in the Inspector General's report than I have in a Big Four audit.

Jim Grant Strikes Again

Jim Grant blasts Alan Greenspan's new book in the WSJ, 18 September. "The fantastic irony of Mr. Greenspan's career path ... seems hardly to have registered on Mr. Greenspan himself. ... A deeper kind of libertarian might have added: 'Maybe nobody can know enough to set interest rates for an entire economy'."

If Greenspan understood the economics of information, he'd know this. Does anyone know what the Fed does? It buys and sells bonds. Don't we have people who do that privately? Yes, we call them bond traders and they work for Goldman Sachs, Merrill Lynch, etc. Why should a Fed bond trader know anymore than one working for a brokerage house? Worse, we go back to 1773 and 1776. Most economically inclined people know Adam Smith wrote the Wealth of Nations, 1776. They have heard of the "invisible hand". Few know that in 1773 Adam Smith wrote the Theory of Moral Sentiments. After reading it, I read these books in 1973 and 1995 respectively, I learned that Adam Smith was a Presbyterian minister. This got me to thinking: whose invisible hand was he talking about? For Greenspan to know enough to set interest rates, he would have to be a deity. Speaking of Fed head as a God, see "Song of Bernanke" in the WSJ, 31 August. It's a laugh riot.

Hearts and Flowers From the NYT

"'With so much sacrifice, we tried to get ahead, all for the possibility of this man to come and take the house that we are paying with such effort', said Prospero Torralba, a 36-year-old constuction worker. 'It was no fair'," reports the NYT, 26 September. What was Torralba thinking? He claims he didn't understand someone held a second mortgage on his house? OK. The NYT wants us to feel sorry for "immigrants and minority borrowers ... because they may not speak fluent English or understand the complex loan terms and documents". The NYT should reserve its sympathy for whoever holds the paper arising from these real estate sales.

Tomas Hernandez made about $4,000 a month and bought a $745,000 home in San Jose. What was he thinking? What was whoever made him the loan thinking? Where were the rating agencies? 6% of $745,000 is $44,700 per year. If Hernandez only had to pay $15,000 a year in property taxes on the house that's a total cost of about $60,000 a year. What goes on here?

Tuesday, September 18, 2007

Captain Renault Returns

"The SEC said it reached settlements with 28 of the audit firms and 22 partners who agreed to be censured and to cease and desist from future violations. ... 'Registration is what affords the PCAOB their oversight authority', ... said Mr Conte [of the SEC]", WSJ, 14 September.

The PCAOB is another government sponsored con game. The Big Four CPA firms audit 98.8% of all SEC registrants by market cap. Three smaller firms audit another 0.8%, the 1300 smaller firms audit 0.4%. Who cares what they do? Imagine, the Big Bad SEC beats up some miniscule CPA firms to protect the investing public. As Captain Renault said in Casablanca, "Round up the usual suspects". The SEC should be ashamed of itself. It should spend ten times as much time with the ExxonMobil audit as all the work done by all the 1300 small firms combined. No matter what these firms do, there is little damage they can do to the investing public.

Incentives Count

The poverty level has varied between 11 and 15% since 1973. "Perhaps we shouldn't be surprised. LBJ's War on Poverty programs proved to be an irresistable draw to millions of impoverished foreign born--who could enter legally after the floodgates were opened by the 1965 immigration act", Edwin Robinson at, 17 September.

As the prophet Milton Friedman used to say, we can have the poverty we are willing to pay for. Since 1965 we have paid about $11 trillion in current dollars and it still ain't over.

Monday, September 17, 2007

A Belated Admission

Alan Greenspan (AG) said, "'the presumption that we were fully independent and have full discretion [to set interest rates] was false',", 17 September. AG adds, "'I am coming to the conclusion that bubbles are inevitable. ... Human beings cannot avoid them. ... They cannot learn'."

Welcome aboard Alan! I've said this for 27 years: we repeat our grandfathers' errors. Now AG is where I was 27 years ago. AG now tells us the Fed is not independent. Anyone who knows US monetary history should know of the "period of the peg", from about 1942-46. During this time the Fed held long-term interest rates at 2.5% to finance World War II. The Fed has never been independent. It was never intended to be.

Suggested reading: Sidney Homer's History of Interest Rates and Karl Marx's Communist Manifesto (CM). Marx? Plank 5 of the CM reads, "Centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly". Marx favored a "flexible currency" and central bank! To think, AG was a central banker, and a libertarian. Wow! What Orwellian "doublethink".

Wednesday, September 12, 2007

Arthur Levitt Returns

"The scope of this crisis is not the only similarlity to the Enron-era scandaals. They also share root causes that include conflicts of interest, a lack of accountability, and limited transparency leavened with a healthy dose of naive greed. Then, these symptoms were found among a key group of gatekeepers--auditors. Now they are found in an equally critical gatekeeper--the credit ratings agencies", Arthur Levitt in the WSJ, 7 September.

I agree with Levitt's diagnosis. I part company with his perscription. We do not need "more oversight" or "independence". We need lawsuits and indictments.

A Gross Injustice

"A federal court in Manhattan ordered former Kidder Peabody bond trader Orlando Joseph Jett to hand over more than $8.4 million sought by the [SEC] in 2004", WSJ, 12 September.

This is a gross miscarriage of justice. Jett supposedly perpetrated a $22 billion securities fraud at Kidder in about 1994. Singlehandedly. $22 billion? Supposedly he mispriced US Treasuries Kidder held and overstated Kidder's income by $335 milliion. How? Wasn't Kidder part of GE? Don't GE and Kidder have internal auditors, KPMG audits, etc.? How did Jett do this? He had Kidder report the security values in accordance with Kidder's policies. What was KMPG looking at if it didn't test the security pricing? Who knows?

Jett challenged then US Attorney for the Southern District of NY, Mary Jo White (MJW) to indict him. The indictment never happened. Why didn't MJW indict Jett? My opinion: she knew she had no credible evidence against him. I concluded the case against Jett was preposterous. This didn't stop the SEC from bringing civil charges against him in its own "Kangaroo Court" adminstrative proceedings and fining him. This is why we need jury trials. By the way, I think Jett would make an excellent Secretary of State. He's even Black!

MJW? Haven't we seen that name recently? See my 10 August post. Apparently MJW knows which side her bread is buttered on and knew it when she refused to charge anyone at GE with committing the "fraud". I'm sure it looked good on her resume. By not charging anyone "important" at GE with anything she becomes a partner in a large NY law firm and gets to represent Morgan Stanley today. Very nice. This is the classical agency problem again.

William Lerach

"Lerach is probably the most hated man in corporate America because he pioneered the use of the class-action lawsuit as a tool of shareholder retribution. ... Congress even wrote a law to put him out of business. It didn't even slow him down", Loren Steffy in the Houston Chronicle, 2 September.

The reason corporate America hated Lerach is because he wasn't compromised the way the SEC and Justice Department are. If the SEC and DOJ each did its job, Lerach wouldn't have had to do it for them. Instead of repealing the 1995 Litigation Reform Act, Congress gives us SOX, makework for the Big Four CPA firms.

Wednesday, September 5, 2007

The Classical Agency Problem Again

"Asks Jim Chanos, the head of Kynikos Associates, which has a short position in Moody's stock: 'If the rating agencies will downgrade only when we can all see the losses, then why do we need the rating agencies'," Fortune, 3 September.

Precisely. It's like the Big 8 CPA firms and the S&L crisis of 1979-83. Where were they when we needed them? Answer: sue 'em all! Maybe that will make them consider whether or not whatever it is they opine on makes economic sense.

Even A Child Can Understand Economics

"In the present iterations of Aesop's fable, American consumers are the grasshoppers and Chinese (and other Asian) savers are the ants. The trouble is that Asians have put their savings into the balance sheet of US consumers. ... In the case of US mortgages of poor quality ... derivatives technology sought to make a silk purse out of a sow's ear, but it is a purse that still goes 'oink' when opened. ... After instructing China for years on the benefits of free markets, Washington, Brussells and other Western governments have imposed the strictest sort of mercantilist barriers upon the free movement of capital", Spengler in, 4 September.

Yes, the parable of the grasshopper and the ant shows more economic understanding than held by our quants. Or our Treasury Secretary or Fed Head.

The US has engaged in mercantilism before. In about 1973, ostensibly to fight inflation, Nixon embargoed the shipment of soybeans to Japan. The result was: the Japanese learned the US will do whatever it can to get foreigners to subsidize domestic consumption. When the Chinese learn this it's "look out below" for the dollar and long-term Treasury bonds.

I recommend reading Keynes' The General Theory, 1936. 365 pages of obfuscation. When I read it Keynes had me confused up to page 336, when I realized that Keynes was just recycling previously exploded mercantalist policies with new terms.

Saturday, September 1, 2007

Anatole of France Lives

"What's going on in Stoneridge is an attempt to allow the tort equivalent of guilt-by-association. The case involves whether the liability for an accounting fraud at Charter Communications, ... can be extended to implicate some of Charter's deep-pocketed suppliers, including Motorola and Scientific Atlanta", WSJ, 23 August.

This is one of the most misleading editorials the WSJ has ever produced. The case is an attempt to apply the principles of Pinkerton v US and Halberstam v. Welch to securities fraud. It's a long established principle of criminal law tha a co-conspirator is liable for all of the acts of a conspiracy that further it, even if the co-conspirator is unaware of the act.