Friday, January 16, 2009

Financial World-RIP

"[C]onsider the strange story of Harry Markopolos [HM]. [HM] is the former investment officer with Rampart Investment Management in Boston who, for nine years, tried to explain to the [SEC] that Bernard L. Madoff couldn't be anything other than a fraud. Mr. Madoff's investment performance, given his stated strategy,was not merely improbable but mathematically impossible. And so, [HM] reasoned, Bernard Madoff must be doing something other than what he said he was doing. ... He had no direct financial interest in exposing Mr. Madoff--he wasn't an unhappy investor or a disgruntled employee. ... To judge from his letter, [HM] anticipated mainly downsides for himself: declined to put his name on it for fear of what might happen to him and his family if anyone had found out he had written it. And yet the S.E.C.'s cursory investigation of Mr. Madoff pronounced him free of fraud. What's interesting about the Madoff scandal, in retrospect, is how little interest anyone inside the financial system had in exposing it. It wasn't just [HM] who smelled a rat. ... The fixable problem isn't the greed of the few but the misaligned interests of the many. ... Our financial catstrophe, like Bernard Madoff's pyramid scheme, required all sorts of important, pluffed-in people to sacrifice our collective long-term interests for short-term gain. ... Everyone now knows that Moody's and Standard & Poor's botched their analyses of bonds backed by home mortgages. But their most costly mistake--one that deserves a lot more attention than it has received--lies in their area of putative expertise: measuring corporate risk. ... The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. ... These oligopolies, which are actually sanctioned by the S.E.C., didn't merely do their jobs badly. ... In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it. ... As far back as 2002, a hedge fund called Gotham Partners published a pursuasive report, widely circulated, entitled: 'Is MBIA Triple A?' (The answer was obviouly no.). ...The SEC now promises modest new measures to contain the damage that the rating agencies can do--measures that fail to address the central problem: that the raters are paid by the issuers. But this should come as no surprise, for the SEC itself is plagued by similarly wacky incentives. Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the SEC for what it has become. Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators wth political clout from investors. ... The instinct to avoid short-term political heat is part of the problem; anything the SEC does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the SEC. ... Preserving confidence, even when that confidence is false, has been near the top of the SEC's agenda. ... If you work for the enforcement division of the SEC, you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it. The [SEC's] most recent director of enforcement is the general counsel at JPMorgan Chase; the enforcement chief before him became general counsel at Deutsche Bank; and one of his predecessors became a managing director for Credit Suisse before moving on to Morgan Stanley. A casual observer could be forgiven for thinking that the whole point of landing the job as the SEC's director of enforcement is to position oneself for the better paying one on Wall Street. ... 'In [HM] conversations with [Meagan Cheung, SEC NY branch chief], I did not believe that she had the derivatives or mathematical backgrond to understand the violations.' ... The problem is systemic. The new director of risk assessment was no more likely to grasp the risk of Bernard Madoff than the old director of risk assessment because the new guy's thoughts and beliefs were guided by the same incentives: the need to curry favor with the politically influential and the desire to keep sweet the Wall Street elite", my emphasis, Michael Lewis and David Einhorn, 4 January 2009, at http://www.nytimes.com/.

Similarly, isn't the SDNY US attorney's job to get a NY BigLaw partnership? Let's ask Mary Jo White. My experience with the SEC and DOJ is: everyone I encountered at either agency was innumerate. IRS agents are much better at what they do. Further, I never encountered an IRS agent who I felt had a hidden agenda. Never have I questioned an IRS agent's integrity. SEC and DOJ employees are interested in who is the "relator" and if the "relator" can do something for or to them. The underlying facts are irrelevant. The SEC opened 671 cases, my 9 December 2008 post, mostly insignificant, not 67 cases, each involving over $1 billion. The rating agencies are paid by the issuers. Aren't CPA firms? What has the SEC done about CPA firm compensation in 32 years? Spawned the absurd PCAOB! A related post, 20 December 2007:

8 comments:

Anonymous said...

IA... it's a racket... the big players knew Madoff stunk... but if they rocked his party someone might point the finger at them...

Revolving door... write the rules then go across the Street and help your firm skirt them... pretty pathetic... misaligned interests eh...

Independent Accountant said...

Anonymous:
Relax. When you read this laugh. Some day the judgment will come. Andy Jackson will return armed with many flintlocks and dispense justice from the Battery to Central Park! Until then, laugh! That's an order.

edgar said...

hello ia,

imo anyone who does business with wall street deserves what they get.

Anonymous said...

So endeth the reign of Bush**2**...

I laugh with joy ... according to your order IA ...

Printfaster said...

IA
Believe it or not I sympathize with the SEC. Take a look at these scenarios:

1. The SEC investigates and discredits Madoff. Just like Ponzi, the investors blame the SEC for being too aggressive and blowing their life savings. Also, given the large number of jewish charities and investors, there could even the the cloud of anti-semitism if Madoff were brought down. This is a weird world.

2. Frankly the high powered investors in Madoff's scheme had more resources in many many cases than the SEC to investigate the validity of Madoff's program.

3. The SEC is reluctant to step into these complex financial schemes, because they are frankly above their pay grade. They just cannot figure them out. The smart guys are all on the other side of the trade -- they want more money than the SEC will pay them. That will never change.

So what to do? Send SEC flatfoots around, or let sophisticated investors get burned.

Burn, baby burn. Once burned twice shy. Best remedy for the Madoffs of the world is for them to be discredited so investors get it upon themselves to get off their rear ends and do due-diligence. How many times do we need to say this?

Instead of running to momma and asking her to deal with the bully who took their lunch money.

Anonymous said...

Yeah to Printfaster... it's most astounding (laughing) to me those investors who paid a fund of funds to park their investment at Madoff's...

They PAID commissions to get put there... whoa... big chill everyone... way overdue... maybe look before you leap...

Independent Accountant said...

Printfaster:
I have no sympathy for the SEC at all. The SEC people should be in prison too. As aider-abettors. This stuff is not that complicated to break. It really isn't.

Printfaster said...

IA
Let's explore the contradictions.

First, I unlike you, truly believe that the SEC is incompetent. Like many federal agencies, they are both by design and evolution incompetent. Let's assume for a moment that a competent person shows up at the SEC. What are his choice:

1. Report misdeeds. Result: a lot of hassle, people after you and your job trying to get you fired. After the SEC your career is ended.
2. Ignore misdeeds. Result: favorable reviews by the finance industry on your oversight. A long, lucrative career in finance after your tenure.

Which of 1 or 2 will develop in the system?

Let's explore the aspect of "easy to break". Let's assume that it is easy to break in your words. Then my question is: if industry has better financial analysts, then why are they not catching anything? Back to my original points.

Oh yes, even if a major fraud were uncovered, the immediate response would be to change the laws to make regulation even more onerous for the innocent. Sarbanes-Oxley pillages the citizenry. Dealing with the financial industry is a bit like returning your food to the chef, and finding out that he did something unmentionable to it after returning again to you. The last laugh is on the suckers again, one more time.

IA, for some reason you are appealing to deus ex machina for resolution. Government, cannot, will not, should not, would not, care not, ever be depended upon for investment oversight. Ever.

Now that is not to say the SEC should not play a role. Its role is with the little sardines in the investment world, the modern day equivalent of widows and orphans. But like in medieval times, a champion knight is fine defending little Maude, but it is no match for an opposing army. The SEC is no match for the killer whales and sharks in the financial world. Never.

Financial regulation for big players is a private matter. For small players it is a public matter. The SEC should be limited to handling matters not to exceed say $500,000.