Look Who's Talking

"Should state Attorneys General be able to outsource their legal work to for-profit tort lawyers, who then funnel a share of the winnings back to the AGs? That's become a sleazy practice in many states, and it is finally coming under scrutiny--notably in Mississippi, home of Dickie Scruggs, Attorney General Jim Hood, and other legal pillars. ... The real issue is the way this AG-tort bar mutual financial interest created perverse incentives that skew the cause of justice. A decision to prosecute is an awesome power, and it ought to be motivated by evidence and the law, not by the profit motives of private tort lawyers and the campaign needs of an ambitious Attorney General. Government is supposed to act on behalf of the public interest, not for the personal benefit of trial lawyers. The tort bar-AG cabal deserves to be exposed nationwide", Editorial at the WSJ, 25 February 2008.

I'll get out my violin and crying towel. I might take the WSJ's position seriously when it inveighs against the corporate defense bar-(In)Justice Department cabal and notes "a decision [NOT] to prosecute is an awesome power" which is apparently regularly sold by DOJ empoyees. The DOJ frequently outsources investigations to the corporate defense bar. Where's the WSJ's complaint?

Enron Accounting Redux

"Should we blame the accountants? Surprises multiplied as the subprime problem of 2007 grew into the credit crunch of 2008. ... It is something else, however, for a bank to report a multi-billion dollar loss from taking some risk that had never even been mentioned in its financial statements. ... Senator Jack Reed of Rhode Island ... said ... 'We thought this was already corrected and the rules were clear and we would not be discovering new things every day. Reed, a Democrat, has sent a letter to the [SEC], as well as the [FASB]. ... He is asking detailed questions about what went wrong and how it should be fixed. ... One rule that needs scrutiny now--called 46-R--was passed after Enron. ... Suddenly losses are booked. Investors learn that a company has taken a risk only after the risk has gone bad. ... The rules require that companies make some disclosures about vehicles off their balance sheets, even if they do not put them on their financial statements. ... The SEC, and perhaps the Congress, should ask some companies to explain their earlier lack of disclosures. ... In the report State Street explains why is has not taken any write-off on those conduits, which contain $28.8 billion in what the bank believes to he high quality assets. It can avoid consolidation because other investors would suffer the first $32 million of losses--about one-tenth of one percent of the assets. ... But State Street says its model indicates that defaults on the underlying assets will not cost that much", Floyd Norris (FN) at http://www.iht.com/, 28 February 2008.

"Accounting-rule makers plan to re-examine how banks treat off-balance-sheet vehicles that have played a big role in the credit cruch. ... It is time 'to look under the hood' of rules related to the treatment of these off-balance-sheet vehicles, Robert Hertz, chairman of the [FASB], said in an interview. He said the board still is gathering information about these vehicles and whether problems were due to existing accounting rules or the way banks used and disclosed these vehicles. ... 'But we also don't want to have blanket rules that make everyone consolidate everything.' ... The post-Enron rules were supposed to limit the use of such vehicles, but banks found ways to tailor new structures that sidestepped the new rules. ... Pressure has been building for rule makers and regulators to get a better grasp on off-balance-sheet structures that helped fuel the housing boom. ... 'It is vitally important that shortcomings in financial reporting for off-balance-sheet transactions as well as timely disclosure of information about subprime and related investments be addressed in an expeditious fashion,' Sen. Jack Reed ... wrote in a letter to the [SEC]. ... Citigroup disclosed in its annual report for 2007 that it had sold about $77 million in first-loss notes related to Citi-sponsored conduits that have $72 billion in assets", my emphasis, David Reilly at the WSJ, 29 February 2008.

This is nonsense FN. The rules look fine to me. Ask the SEC? Hahahah! See my 6 February 2008 post. Other investors absorbing .00111 of the losses was State Street's (SS) basis to avoid consolidating its conduits. Amazing! Where is the DOJ? Is it readying indictments? They should be easy to draft. The facts should be stipulated! The question: did SS and its employees believe what they said when they created those conduits? I ask: would SS make me an unsecured, non-recourse loan on say, a portfolio of stocks with .00111 down? If not, the convictions should be easily secured, the only issue being criminal intent. SS's 2007 proxy statement shows it paid Ernst & Young (E&Y) $12.5 million last year, including $7.9 million for its audit. I guess $7.9 million in audit fees doesn't go very far nowadays. Hey Mark Olson (MO) at PCAOB, what will you do about this? Anything? Of course not, unless Congress breaks your arm, after all as a "former" E&Y partner you must be a "West Side Story", 1956, character. I got it: beat up a dozen more small CPA firms, each of which audits less than say $1 billion in market cap of SEC registrants in lieu of looking at SS's conduit accounting. Does the PCAOB accept the new ".001 standard" for conduit non-consolidation? What is the PCAOB's position, or will it defer to the FASB to say .001 ain't enough? MO, this Leonard Bernstein-Stephen Sondheim song's for you:

When you're a Jet, You're a Jet all the way. From your first cigarette To your last dying day. When you're a Jet, If the spit hits the fan, You've got brothers around, You're a family man. ... When you're a Jet, You're the top cat in town, You're the gold medal kid With the heavyweight crown

Well MO. What is a "former" E&Y partner gonna do? Do you prefer my composite version of this song, at http://dragon.sleepdeprived.ca/songbook/songs2/s2_28.htm. ?.

Rufus Rastus Johnson Brown Watcha gonna do when the rent comes round Watcha gonna say, watcha gonna pay Watcha gonna do on judgment day.

Now MO: Rufus Olson Bernanke Paulson Brown, Watcha gonna do when fraud and insolvencies comes round Watcha gonna say, watcha gonna make Joe Sixpack pay Watcha gonna do on judgment day

Hmm, $77 million, $72 billion, .00107. Hmm, That's the new standard, .001 or greater to avoid consolidation. Don't most lenders want PMI if a home buyer puts down less that 10%? Doesn't SFAS 13 paragraph 5 have a 90% criterion to capitalize a lease? I realize it is difficult to analogize conduit non-consolidation and lease capitalization so no one at KPMG told Citigroup, .001 ain't enough, consolidate. Well, MO? What will you do about this? Will you revoke E&Y's and KMPG's ability to audit SEC registrants? Well?

Iron-Ore Boom

"Investors looking to strike while the iron-ore market is hot have a host of new companies to consider. But be forewarned: Developing a profitable new iron-ore mine is a tough task, and many of the companies trying to do so probably won't survive. ... Many of the deposits are relatively low-grade. ... In some cases, companies are pursuing projects that never would have been seriously considered when iron-ore prices were lower. ... Major steel producers in China and elsewhere are eager to encourage new competititors to offset the growing market clout of BHP, Rio Tinto and Vale", WSJ, 20 February 2008.

Dollar prices of all commodities are rising and will keep rising as long as Helicopter Ben runs his printing press.

Death to the Rating Agencies

"Standard & Poor's rewarded bond insurer MBIA Inc. for raising $2.6 billion in capital by affirming the company's triple-A financial-strength rating while keeping its outlook 'negative'. ... S&P also kept its triple-A rating on the other large bond insurer, Ambac Financial Group Inc. ... As part of its action, S&P took MBIA's rating off 'credit watch negative,' a state in which downgrade is an iminent threat over the next three months", WSJ, 26 February 2008.

"What happens when the feds license only a few companies to provide a service, and then require investors to buy that service? For the answer, take a look at the mess in today's bond market, where investors have been hanging on whether the main government-appointed credit-rating agencies--[S&P] and Moody's would downgrade bond insurers MBIA and Ambac. ... But why were the bond insurers facing downgrades in the first place? ... By now no one should care what the rating agencies [RAs] think, but the problem is that by law we have to care. Since 1975, the [SEC] has limited competition in the market for credit ratings by anointing only certain firms as 'Nationally Recognized Statistical Rating Organizations' (NRSROs). ... Over time, federal and state laws and regulations have explicitly required NRSRO-rated securities to be held by money market funds, insurers and others. This is turn has created the impression that these ratings are something more than merely financial opinions, which are often less informed than opinions you can read in a newspaper. ... Not surprisingly, the rating agencies are coming up with their own ideas for 'reform', none of which seem to include more competition. .. No doubt, S&P and Moody's would love Congress to add rules that raise the cost of entry for new competitors. If Congress takes the bait, it will repeat the mistakes of Sarbanes-Oxley", Editorial at the WSJ, 26 February 2008.

"In the latest sign that the clouds are starting to clear over an important part of the financial markets, Moody's Investor Service affirmed its top-notch credit ratings to MBIA Inc, the world's biggest bond insurer", WSJ, 27 February 2008.

It's time the RAs were sent to sleep. With the fish. Their carefully considered opinions are worthless. The CPA profession has its Big Four, the RAs, their Big Three (TBT). Anything TBT do should be viewed skeptically. Mike Shedlock (MS) has a nice post on this topic at http://www.globaleconomicanalysis.blogspot.com/ 26 February 2008 . MS makes it clear the RAs retention of AAAs for the monolines is absurd by comparing them to Pfizer, a real company. I have an idea for Moody's and S&P: lobby Congress to become subject to PCAOB oversight. The PCAOB can form a sister organization to create standards for the RAs then fill it with former rating agency employees and harass the non-NRSROs to show the PCAOB does something. We'll call it: Rating Organization Bullying Oversight Team, ROBOT. ROBOT can go on its "tick and tie" adventures and do nothing to protect the public from bad TBT ratings. If Mark Olson (MO), PCAOB head, doesn't like ROBOT, how about Rating Agency Craven Knavish Enforcement Thespians, or RACKET. How about it MO? You can have RACKET start by reviewing Egan-Jones. Whadda say?

UK Inflation

"For months, economists have fiercely debated the path of UK inflation. As usual, the vast majority have dismissed concerns about price pressures as 'historic' and 'academic'. ... Determined to push the Bank of England into further interest rate cuts, 'doveish' analysts in the City and elsewhere have said that inflation poses few dangers. ... On Monday, official figures showed factory gate inflation--the price industry pays for goods and services--rising by a staggering 19 percent annually", http://www.telegraph.co.uk/, 17 February 2008.

With 19% UK "factory gate inflation", what is the US's comparable figure? That City "analysts" are doveish is no surprise. How many Wall Streeters are pushing Helicopter Ben to raise short term interest rates?

Manhunt in the Oil Fields-2008 Version

"With energy prices soaring and oil-company ranks graying, petroleum-engineering graduates have become a hot commodity. ... Top-ranking petroleum-engineering graduates this year can expect starting pay of $80,000 to $100,000, plus signing bonuses and other perks. Enrollment cratered to 1,387 students nationwide in 1990 from a high of 11,014 students in 1983, according to data collected by Lloyd Heinze, a professor of petroleum engineering at Texas Tech in Lubbock. ... This academic year, there were 3,710 undergraduates nationwide pursuing petroleum-engineering degrees--twice as many as four years ago and the highest since 1986, according to Mr. Heinze's data. ... While happy with the turnaround in attitudes, oil companies want to make sure that the pipeline stays full. ... One advantage for the oil companies: Today's students are too young to remember the bad times", WSJ, 21 February 2008.

"Ask just about any oil executive what he considers his No. 1 headache, and he will undoubtedly bemoan the the dearth at his company of high-caliber earth scientists, the term that loosely describes the foot soldiers of the hydrocarbon hunt: geologists, geophysicists, and petroleum engineers. ... The real manhunt, however, is not for fresh-scrubbed college graduates, but for seasoned veterans whose skills have been polished by training in the best finishing schools around, the major oil companies. ... But the hook that most often snags earth scientists is something no major, and virtually no oil company whose shares are publicly traded, has yet offered its full-time employees: a piece of the action. ... The earth sciences are a booming discipline in the colleges now", Alexander Stuart (AS) "Manhunt in the Oil Fields", Fortune, 6 October 1980.

Look at AS's 1980, yes, 1980 article and the WSJ's recent article. My conclusion: we have a long way to go to return to late 1980 oil patch conditions. In the meantime, let the good times roll. The Fortune article appeared about 18 months before the peak in oil patch employment.

IMF Gold Sales

"The U.S. supports a plan for the International Monetary Fund [IMF] to sell part of its gold reserves to shore up the multilateral institution's finances, the Treasury's undersecretary for international affairs said. David McCormick [DM] told reporters the Bush administration sees the proposed sale of 12.9 million ounces of gold as 'probably the most viable' option to ensure the long-term funding of the IMF. Proceeds would be used for an interest-bearing endowment", WSJ, 26 February 2008.

Big deal. 12.9 million ounces of gold at $959 per ounce, as I write, is $12.4 billion. Who is DM anyway? He once worked for McKinsey and has a Princeton PhD. So? The Chinese can buy $12.4 billion in gold in an afternoon. Having a little gray hair, I remember IMF gold sales in the 1970s, when gold was about $106. The IMF has not proven to be a good speculator in the gold market. Got gold? Get more. See my 2 October 2007 post about IMF gold sales from 1976 to 1980.

Stagflation Returns?

"The U.S. faces an unwelcome combination of looming recession and persistent inflation that is reviving angst about 'stagflation,' a condition not seen since the 1970s. ... Even stripping out sharply rising food and energy costs, prices rose 0.3% in January, driven by education, medical care, clothing and hotels. They are up 2.5% from the previous year, a 10-month high. ... The biggest difference is that in the 1970s, the Fed was unwilling, or thought itself unable, to bring inflation down. The Fed today sees achieving low inflation as its primary mission. 'The reason we're so unlikely to see a repeat is we're not adding irresponsible policy,' says Christina Romer, an economist at Berkeley and a historian of Fed policy. ... Higher inflation is still a possibility. Food and energy costs could keep rising, instead of flattening out as futures markets currently anticipate. ... Still, Mr. Bernanke has reiterated the importance of not repeating the 1970s. He and his colleagues believe a persistent escalation of inflation is likely only if workers and firms come to expect the elevated inflation to persist, and set their wages and prices accordingly 'We're a very, very long way from the 1970s,' former Treasury Secretary Lawrence Summers said in an interview yesterday", my emphasis, Grep Ip at the WSJ, 21 February 2008.

The Fed claims "achieving low inflation [is] its primary mission". Nonsense. Romer may be about to dethrone Stephen Cecchetti as my choice for most incompetent "media economist". What do I think the Lord High Executioner of Gilbert & Sullivan's Mikado would wish on Romer? That her entire investment portfolio be put in 30-year zero coupon bonds. Now that's justice! See my recent comments about commodities.

Get Gold

The usually intriguing and insightful Mencius Moldbug has an excellent discussion of gold and uses the "stock-flow" ratio, 28 February 2008, at his website, http://www.unqualified-reservations.blogspot.com/2008/02/return-to-castle-goldenstein-gold.html. Way to go Mencius.

I think one reason gold is money instead of say, platinum, silver or palladium, all "near monies" in my opinion, is that each of these metals has too many alternative uses, i.e., each is too useful to mankind to "waste" as money. As Fred Cederholm would say, think about it.

One thing people need consider in determining what is money, is whether or not the good is endogamous to the economic system or exogenous from it. Gold will be produced when it can be at a profit, hence if too much gold is produced, and its' value falls, which we see as high prices of other goods in gold terms, the mines close until gold production is profitable again. This is clearer in the case of the approximately 400,000 US "stripper wells" which were closed because of low oil prices, some of which are being reopened. Gold mines closed in 1942 by government order, many of which stayed closed after WWII since gold's "price" was fixed at $35 and WWII inflation had reduced the dollar's value, making mining costs too high to be profitable. If too little gold is produced, the gold price of other things falls, mining costs drop and the mines reopen. Again, this is more visible in oil production. The "cost" of oil production is increasing as royalties to land owners go up, countries like Venezeula demand higher severance taxes and salaries to oil workers increase. In effect, the "oil price" of other things falls.

People conjur up demons about new methods of producing gold which might make it a poor store of value. The only time I know of in which gold's value was significantly reduced, except by government inflationary policies, was in about 1500-1540, when the Spaniards came to the New World. The Spaniards found much gold and silver here, which they brought back to Europe leading to a reduction in the metals exchange value for other goods, i.e., "inflation".

Chinese Accounting

"Investors who buy the U.S.-listed shares of small Chinese companies depend on financial auditors to offer independent and expert oversight on their corporate statements. ... There are many reasons accounting problems seem rife in Chinese companies. Kenneth Banet, the partner overseeing Grant Thornton's China practice, explains that Chinese reporting is tax-oriented, and companies don't report sales until customers pay their bills because sales tax is due immediately on receovables. Companies frequently underreport sales and profit to avoid being on the hook for taxes they haven't received. They also often borrow from related-party companies without repaying. ... Audits of Chinese reverse mergers are even more complicated. For one thing, the Chinese partners usually are opaque, with ownership structured through British Virigin Islands holding companies. The SEC doesn't scrutinize reverse mergers, until the new company raises funds", Leslie Norton (LN) at Barron's, 18 February 2008.

Having been involved in the audits of about ten Chinese companies which went public in the US through reverse mergers, I am sympathetic to Banet's observations. In my experience, Chinese companies, by and large lack competent accounting personnel and engage in many types of related party transactions which substance and form may differ.