Financial Arbitrage Capitalism

"However, unlike the earlier epoch of finance capitalism, the emphasis was not upon the capital development of the economy but rather upon the quick turn of the speculator, upon trading profits. ... As managed money grew in relative importance, more and more of the market for financial instruments was charaterized by position-taking by financial intermediaries. ... The main financial houses became highly-leveraged dealers in securities, beholden to the banks for continued refinancing. A peculiar regime emerged in which the main business in the financial markets became far removed from the financing of the capital development of the country. Furthermore, the main purpose of those who controlled corporations was no longer making profits from production and trade but rather to assure that the liabilites of the corporations were fully priced in the financial market. ... Today's managers of money are but little concerned with the development of the capital asset of an economy. ... I am even more convinced today than six years ago that a whole new financial system has evolved--and that it is definitely 'retrograde'. The title 'Financial Arbitrage Capitalism' is fitting for a Credit System and economy now dominated by an expansive 'leveraged speculating community' seeking profits from variations and permutations of 'borrowing cheap and lending dear'; by bond and investment fund managers whose entire focus is beating some indexed return; by rapidly explanding Wall Street balance sheets and influence; and by the entire wave of new Credit instruments, derivatives, and sophisticated models and strategies used for the paramount purpose of capturing 'above-market' returns and resulting in huge financial rewards. ... But reflationary policies and other assurances will not rescue the system, specifically because there is today nothing to stem the ongoing distortions to the underlying real economy. .. And, in the end, it's only real economy fundamentals that will determine the soundness and sustainability of a system's Credit and Financial Structure. ... Indeed, Washington's validation of the current dysfunctional Credit system structure could very well lay the groundwork for extreme global price distortions, volatiility and social/political unrest. ... Now, however, with acute inflationary effects prevailing throughout global markets for food, energy and commodities, one should be prepared for the likes of problematic supply bottlenecks and shocks, hoarding, trade frictions and interruptions, and generally a heightened geopolitical instability", my emphasis, Doug Noland (DN) at http://www.prudentbear.com/, 2 May 2008.

Right on DN! DN missed one thing, the system also "borrows short and lends long". Any one who lived through 1979-83's S&L crisis should know of the significance of this. Yves Smith has an excellent post discussing DN's article at http://www.nakedcapitalism.com/, 4 May 2008. Howard Katz's (HK) 14 April 2008 post at http://www.thegoldbugnet.blogspot.com/ has a good explanation of the source of our current difficulties. "Paper money cannot cause an increase in wealth". To think otherwise, to use Keynesian "analysis" is to live in the alchemist's world of making lead into gold. The "media ... accepted intellectual theories which preached (the economic version of) up is down, black is white and 2 + 2 = 10. ... But the Fed did not create something out of nothing. What it did was to rob from an under-class (savers, workers and commodity producers) ... In essence, modern economists ignore the losses to creditors, workers and commodity producers and report the gains to banks, large corporations, real estate speculators and Wall Street as the economy. This is what Bernake means when he says he is bailing out Bear Stearns to save the economy". Bush's appointing Hank Paulson and the rest of his crew of "Goldman Sachs alumni" to Treasury was horrible for politically disfavored Americans.

Oil Speculation?

"Our mounting economic downturn was supposed to curtail demand and drive prices down. ... 'All the conventional wisdom about the oil markets is wrong,' said Jeffrey Brown, an independent geologist in Dallas who studies energy market data. ... I called him ... because of his work developing the Export Land Model, a counterintuitive theory that says as oil prices rise, exports from oil-producing nations will fall. ... The message here is simple: We have to share the world. Other countries want a piece of the living standard we've enjoyed for decades. For us, that means $120 isn't a spike, it's just another milestone on oil's upward journey. Let's talk in a few more months", Loren Steffy at the Houston Chronicle, 25 April 2008.

I agree with Brown. I do not expect say, the Saudis to increase oil exports as prices rise. Why should they sell oil likely to increase in value for dollars, likely to decrease? As long as oil exporters think oil's future price will at least keep up with long-term US dollar interest rates, why should they sell now? What a radical notion, that the Saudis, who hold about 260 billion barrels of oil reserves, are also speculators in the oil markets.

Sentencing Snipes

"Actor Wesley Snipes was sentenced Thursday to three years in prison for refusing to file federal tax returns. The decision in federal court [in Ocala, Fl.] came after a daylong hearing. ... Attorney Carmen Hernandez, a recent addition to his defense team, said, 'Mr. Snipes was sentenced because he's Mr. Snipes. The judge said the actor's celebrity status had no bearing on the sentence. ... 'It'll be a fraction of what he owes,' [$5 million] said M. Scotland Morris, an assistant U.S. Attorney who made the argument for the government. Morris said a rough estimate of Snipes' outstanding tax liability will exceed $20 million. ... Hernandez argued that Snipes' crimes were not serious, pointing out that the jury found him guility of three misdemeanor counts of willful failure to file federal tax returns. But Senior U.S. District Judge William Terrell Hodges argued otherwise. 'Any offense that places my liberty at risk is a serious one,' Hodges said", my emphsis, Houston Chronicle, 25 April 2008.

www.sovereign-american.org/docs/IRS/Snipes%20indictment.docx, has Snipes' indictment. Snipes was indicted on one count of conspiracy, 18 USC 371, one count of filing a false claim, 18 USC 287 and six counts of failure to file income tax returns, 26 USC 7203. As usual, I agree with the jury. I would only have convicted Snipes of the 26 USC 7203 counts. The jury convicted Snipes of misdemeanor 26 USC 7203 violations. This is important. Why? Had Snipes not paid $1 billion in income taxes, the most time Hodges could have given him was the 36 months he got. Do I think this reasonable? No. I read Robert O'Neill's (RO) 37-page Sentencing Memorandum, "google" it at Snipes PSR. "This case presents the Court with a singular opportunity to deter tax fraud nationwide", page 18. "18 U.S.C. S 3553(a)(2)(A) & (B) provide that the sentence should 'promote respect for the law' and 'afford adequate deterrence to criminal conduct'," footnote 16 at page 18. Snipes' sentence caused me to have contempt for the law. Does that bother you RO? I bet not. More quotes, "But for the limits of the stautory maximum sentence, the sentencing guidelines would call for a term of imprisonment of more than 10 years", page 2. So? Snipes was acquitted of the felony counts. RO says ignore the jury. "This case accordingly presents the Court with a momentous opportunity to instantaneously increase tax compliance on a national scale. ... The sentence imposed upon Snipes in this case is particularly crucial for additonal reasons that correspond to the audience at issue. The fact that Snipes was acquitted on two felony charges and convicted 'only' on three misdemeanor counts has been portrayed in the mainstream media as a 'victory' for Snipes", page 20. So RO wants Hodges to sentence Snipes for the contents of newspaper articles. Hey RO, ever heard of the first amendment? Wonderful. The Bush DOJ falls in my esteem daily. So? Hodges, I choose to disbelieve you. If Snipes celebrity status had nothing to do with his sentence you should have raked RO's office over the coals for asking you to consider it.

How would I sentence Snipes? Class P at Tax Table 2T4.1 applies to tax losses over $400 million. It gives offense level 36, a 188-235 month sentence with no prior criminal history. Based on Snipes giving $5 million in part payment of his taxes, I assume Snipes falls into class K, offense level 26, 63-78 months. RO writes, "even if the Court were only to find as relevant conduct the $7.3 million loss attributable to the false claim of which his co-defendants were convicted, that loss alone would render a Base Offense Level of 26, calling for 63 to 78 months' imprisonment, but for the statutory maximum", page 9. RO says sentence Snipes for conduct he was acquitted of. What now? If 36 points gets Snipes say 212 months, had he been convicted of everything charged, I get 36 /212 of the maximum sentence. Wait, 16 years, or 192 months is the most Snipes could have gotten. Now what? Multiplying the midpoint of 63-78 months, 71 months; 71 X 36 / 192 = 13 months. Now I show discretion and sentence Snipes to 18 months. There is plenty of basis to appeal here. Hernandez, get cracking. Oops! What now? Will some DOJ idiot see my phrase "get cracking" as my abetting the distribution of cocaine? Well RO, do you intend to have some DEA agent visit me? What a country! Recently Michael Savage (MS) called for the decriminalization of drug possession. MS, welcome aboard!

Doublethink from Steve Forbes

"The Bush Administration must take two steps immediately to quickly halt the unending, enervating credit crisis: shore up the anemic dollar and, for the time being suspend 'marking to market' those new financial instruments, such as packages of subprime mortgages. The weak dollar is pummeling equities, disrupting the economy, distorting global trade and giving hundreds of billions of dollars in windfall revenues--through skyrocketing commodity prices--to our adversaries such as Iran and Venezuela. ... The [Fed] can rally the markets for a day or two by finding some new mechanism through which to lend more money to banks and other financial insititutions. ... The U.S. Treasury Department could buy dollars in the currency exchange markets. Our allies would gladly cooperate with such an operation; their exports are being hurt more and more. ... The other measure: The Treasury Department and the Fed should get together with the SEC, the Comptroller of the Currency and other bank regulators and announce that financial institutions for the next 12 months will no longer have to write down the value of exotic financial instruments. ... Instead writedowns will occur only when there have been actual losses on those assets. If a mortgage defaults, a bank will then--and only then--recognize the loss. ... Such assets are being marked down to increasingly arbitraty low levels. ... Worse, when forced by panicky regulators and lawsuit-fearing accountants to write down the value of these securities, institutions will dump assets in a market where there are temporarily few or no buyers", Steve Forbes (SF) at Forbes, 7 April 2008.

"Why have U.S. stock markets been such relatively poor performers this decade? ... It isn't as if the U.S. economy has been laggard. ... The Bush Administration and the [Fed] believe a weak greenback means greater exports, fewer imports and thus a smaller trade deficit. In the short term they're right. ... The excess money created by the Fed led to the housing disaster and the return of inflation. ... The White House and the Fed should be less bullheaded about their misbegotten dollar policy and openly vow to take whatever steps necessary to buck up the buck", SF at Forbes, 21 April 2008.

I love SF. I have read Forbes for about 25 years. I consider "boy" Forbes a lucky boy. He is so smart, he knows what the "exotic" assets are worth. Sure! If he thinks they were written down to "arbitrary low levels", he should shut his mouth, pull out his checkbook and buy! On margin! I'm sure SF could get say, Citibank to sell him some mortgage-backed securities for 70% of par with 20% down. SF wants to change accounting concepts that have stood us well for over 100 years, like: writing down assets when the evidence indictates their value has been impaired. Why should our allies buy more Treasury debt? They're already drowning in it! SF wants the Fed to print more money and to strengthen the dollar at the same time. How? My idea Steve: let the SEC suspend the 10-K, 10-Q and 8-K requirements for financial institutions for the next 24 months. Imagine the market reaction to a financial institution availing itself of the new SEC rules.

All right genius. What should the Fed do? Hint: raise US interest rates. Imagine SF wrote these editorials two weeks apart.

The Ratings Game

"Bond-rating agency Moody's Investors Service used to be an ivory tower of finance. Analysts were discouraged from having a drink with a client. Phone calls from bankers went unanswered if they rang during intense, almost academic debates about credit ratings. ... A firm once known for its bookish culture began to focus on the market share that affected its own revenue and profit. The rating firm became willing, on occasion, to switch analysts if clients complained. ... Moody's acknowledges it sometimes got things wrong in judging mortgage bonds, but says these were honest mistakes and not the result of efforts to garner market share. It says it has maintained its rigor and objectivity in a rating process that is still adversarial toward big investment banks. ... Brian Clarkson [BC] ... maintains that his focus on making Moody's friendlier to Wall Street was what the company needed early this decade. 'We're in a service business,' he says. 'I don't apologize for that.' ... Bond issuers, knowing that a higher rating means they pay a lower interest rate, have an incentive to shop around among rating agencies. ... In 1996 ... Clarkson took over the group at Moody's that analyzed [mortgage securities]. The firm added new analysts and overhauled its ratings approach, allowing for higher ratings in the area. ... In 1999 Mr. Clarkson ... shook things up, firing or reassigning about two dozen analysts, and hiring new ones who started giving higher grades under a new methodology. ... Paul Stevenson a former Moody's executive who now works at BMO Financial Group [said] 'the most recent problem .. is that the rating process became a negotiation.' ... Mark Froeba, a former Moody's analyst says, 'There was never an explicit directive to subordinate rating quality to market share. There was, rather, a palpable erosion of institutional support for rating analysis that threatened market share. ' ... Clarkson says ... 'we don't change methodology to garner market share.' ... On occasion, Moody's agreed to switch analysts on deals after bankers complained. ... Clarkson's structured-finance group grew to account for 43% of Moody's revenue in 2006. ... Since becoming Moody's president in August, [BC] is spending up to half of some weeks dealing with regulators. 'They want the same things we do,' he says. ... Clarkson says analysts have kept their 'adversarial' approach, but adds, 'One of the things we have to do going forward is be more skeptical'," , my emphasis, WSJ, 11 April 2008.

BC, I agree, Moody's "services" the public as a bull does a cow. Why hasn't the SEC adopted the CPA firm change 8-K reporting requirement to the rating agencies? The SEC has plenty of regulatory powers. Here's another 8-K idea for you Chris Cox (CC): make any Wall Street house request of a rating agency to change an already assigned analyst, or to avoid an analyst to be assigned, be submitted to your enforcement people. In writing, within 72 hours. A failure to submit the writing being securities fraud. With the analyst able to respond in writing. And the rating agency told any retaliation against the analyst might lead to an indictment under 18 USC 1513. Well CC, well Mark Olson? How about it? Will the SEC force something effective on the ratings agencies? Will the SEC push the DOJ to indict BC for securities fraud, if he knowingly induced his employees to issue higher ratings to "game the system"? Well? Or would this irritiate the large investment banks? Now, CC, you don't want to do that. Do you? "A negotiation". How interesting. Hey Mike Garcia, could you ignore some nickel and dime (ugh) crack dealers for the next few months and draft an indictment here for conspiracy to commit securities fraud? If you snare enough Wall Street Managing Directors, New York's next Governorship might be yours. The most interesting thing BC said was that the regulators "want the same things we do". To protect large investment banks?

The SEC as Crazy Eddie

"The [SEC] accused a former trader of spreading false rumors about a Blackstone Group takeover bid and then profiting from the ruse, a case that will inflame critics of short-selling and bolster concerns about rumormongering on Wall Street. In a complaint filed in U.S. District Court in New York, the SEC alleges that Paul Berliner, a trader for New York trading firm Schottenfeld Group, used instant messaging to circulate the notion that private-equity group Blackstone was considering lowering its price for Alliance Data Systems, a processor of credit-card transactions it had agreed to acquire for $6.4 billion six months earlier. ... Over the next seven minutes, Mr. Berliner began selling short 10,000 shares of ADS stock, a bet it would fall in price, the SEC said. Almost immediately, as the stock fell, Mr. Berliner began buying it back at the lower price, turning a $25,000 profit on the trades within 10 minutes. ... Many company executives, especially some Wall Street CEOs, have been complaining bitterly that short sellers are profiting from spreading false rumors about major firms, essentially manipulating the market. ... Thursday, on CNBC, SEC Chairman Christopher Cox, who has been under fire for lax enforcement, said the case was evidence that the SEC can move quickly and that the 'cop is on the beat.' In a written statement, he called such market manipulation a 'witch's brew' that the agency will prosecute vigorously. ... Berliner agreed to settle the charges, without admitting or denying wrongdoing, and to pay $26,129 in profits and interest and a penalty of $130,000. he is also barred from working at a brokerage firm. ... According to the SEC, Paul Curnin, an outside lawyer for Blackstone, was inundated that day with phone calls from investors asking whether the rumors were true. He placed a call to Walter Riccardi, deputy director of enforcement at the SEC, who assigned the matter to Scott Friedstad, an associate director. Mr. Friestad set up a team to track down the instant messages and emails. ... The SEC was already investigating the origin of the instant message, the SEC officials say. The large number of specifics was one reason the rumor moved the stock price and was also a key element of the SEC's case. ... The deal between Blackstone and ADS eventually fell apart for unrelated reasons", my emphasis, WSJ, 25 April 2008.

"Walter Riccardi, [SEC] deputy director of enforcement, is looking to leave the agency for the private sector and has recused himself from cases. ... His departure comes amid a shake-up in the agency's ranks. ... The SEC's enforcement program has been criticiized by some members of Congress as needing to more aggressively investigate issues arising from the credit crunch", WSJ, 25 April 2008.

Congratulations, Cox, Riccardi & Co., (CRC) the all-star comedy team shortly appearing in Las Vegas. Your victory over miscreant Berliner is your greatest "triumph" since that over the "PWC Two". See my 19 January 2008 post. Berliner's gain was .0038 of my "Blankfein Test". CRC should have declined to investigate. Has CRC anything important to do? Are we impressed! Did Paul Curnin, a Simpson Thatcher partner, use CRC as its "schtarke"? Schtarke? Schtarke was a title sometimes applied to Murder Incorported's "enforcers". How much time elapsed between the SEC's agreeing to investigate this insignificant case and Curnin's phone call? Tell us Riccardi, when Curnin called, did you respond with, "Yes boss, how may I help you"?

Riccardi, don't worry. Given CRC's "judicious" case selection, I'm sure you'll find something attractive in the not too distant future. Why did I use Crazy Eddie in this piece's title? Because his prices were "insane"? Similarly, the SEC's enforcement case selection.

Rice in Asia

"Some politicians and economists are pressing the Phillipines--the world's biggest importer of rice--to change how it subsidizes the staple grain because of the distortions such measures can introduce into the rice market. ... But some economists and politicians say the impact is being exacerbated by the way some governments restrict imports or distort the market through elaborate and corruption-prone subsidies. ... Sen. Edgardo Angara ... [said] 'If private rice traders are allowed to import and sell rice without any restriction, the supply and price of rise will likely stabilize,' ... in a speech to the Senate on Monday. ... Rajat Nag, managing director of the Asian Development Bank, told reporters in Singapore Tuesday, that steps taken by some countries to curb rice exports or imports are having 'counterproductive effects' on what farmers choose to plant and when. Vietnam, Cambodia and Indonesia have limited rice exports, increasing the demand from the biggest exporter, Thailand. ... In the Phillipines, removing rice subsidies would help eliminate theft and corruption in the state-controlled rice-distribution system, Mr. Angara says", WSJ, 23 April 2008.

"With global rice prices at record highs, Indonesia is stepping up border patrols and taking additional measures to deter rice smuggling to other countries, Trade minister Mari Elka Panestu said in an interview. ... Indonesia, a nation of 230 million, situated just to the south of the Phillipines, is one of the few places where production is increasing. ... But Indonesia, like many other Asian nations where rice is a staple food for millions of people, wants to build up stockpiles rather than export surpluses. Indonesia's trade ministry has issued a decree banning private traders from exporting rice, allowing only the nation's food agency to do so. It now fears smuggling and is cooperating with the police and navy to control the nation's porous borders. ... Indonesian President Susilo Bambang Yudhoyono ... said ... the government would remain vigilant in its effort to stamp out smuggling. ... But while global prices have spiked--...Indonesia's rice price has fallen below the global average", WSJ, 26 April 2008.

Angara has this knocked. I wonder if Henry Paulson, our Treasury Secretary could understand Angara's words. Has mankind learned anything in the last 4,000 years? See my 13 November 2007 post.

Indonesia is a living laboratory for something Ludwig von Mises wrote about 80 years ago, the gist of which is: once you start controlling a country's economy, the things you need control continually expand until the economy collapses or you get something akin to Stalinism. I wish the Indonesian government the best of luck.

Of Capabilities and Intentions

"In this regard. we must remember the words of Lenin, who told his commissars of education: 'We must hate--hatred is the basis of Communism.' ... And yet, the tide of hatred is rising. It will rise further as the global economy cannot accomodate everyone. Ethnic hatreds are being stirred, on all sides. And weapons of mass destruction--nuclear and biological--are being devised. ... To begin at the beginning, and to reduce future misunderstanding, there is no question that Buchanan's criticism of Bush's foreign policy is valid. ... As it happens, Pat Buchanan and George W. Bush share the same misperception: namely, that the fall of the Soviet Union put an end to the Cold War. ... For all his brilliance, Buchanan completely misses the fact that the Soviet tank divisions withdrawn from Germany in the 1990s were never a threat to America. All along, the real threat was from Russia's nuclear missiles. And those missiles never went away", J.R. Nyquist (JRN) at http://www.financialsense.com/, 18 April 2008.

I agree with JRN. That said, our current policy of putting NATO "allies" on Russia's borders is provocative and does not enhance American security. We waste $650 billion in Iraq as opposed to building nuclear missiles defenses. Crazy!

Krugman on Commodities

"Will limited supplies of natural resources pose an obstacle to future world economic growth? How you answer this question depends largely on what you believe is driving the rise in resource prices. Broadly speaking, there are three competing views. The first is that it's mainly speculation. ... The second view is that soaring resource prices do, in fact, have a basis in fundamentals. ... The third view is that the era of cheap resources is over for for good. There are some very smart people--not least, George Soros--who believe that we're in a commodities bubble. ... My problem with this view, however, is this: Where are the inventories? ... Inventories of food and metals are at or near historic lows, while oil inventories are only normal. ... Meanwhile, resources are getting harder to find. Big oil discoveries, in particular, have become few and far between, and in the last few years oil production from new sources have been barely enough to offset declining production from established sources. ... Suppose that we are really running up against global limits. What does it mean? ... But rich countries will face steady pressure on their economies from rising resource prices, making it harder to raise their standard of living", Paul Krugman (PK) at the Houston Chronicle, 23 April 2008.

I agree with PK, who writes, "I find myself somewhere between the second and third views". I see the first "view" as an empty statement. We always have speculation. So? There are always longs and shorts. Why suddenly did prices rise and are staying high? What changed in the last two years?

What Should a General Do?

"Lt. Col. Gian Gentile, a history professor here [West Point] who served two tours in Iraq ... argues that Gen. Petreus's counterinsurgency tactics are getting too much credit for the improved situation in Iraq. Moreover, he argues, concentrating on such an approach is eroding the military's ability to wage large-scale conventional wars. ... Gentile is giving voice to an idea that previously few in the military dared mention: Perhaps the Petreus doctrine isn't all it's cracked up to be. That's a big controversy within a military that has embraced counterinsurgency tactics as a path to victory in Iraq. ... Two of the five members of the Joint Chiefs of Staff have warned repeatedly that the military's ability to fight another kind of conflict--say a war with North Korea--has eroded. ... Gen. James Conway, the commandant of the Marine Corps, told the Senate Armed Services Committee [in February] that the focus on counterinsurgency means the Marines will 'have to take extraordinary steps to retain the ability to serve as the nation's shock troops in major combat operations.' ... The gist of Col. Gentile's argument is that recent security gains in Iraq were caused by the ceasefire declared last year by Shite cleric Moqtada al Sadr as well as the U.S. decision to enlist former Sunni militants in the fight against Islamist extremists. ... More fundamentally, Col. Gentile, 50 years old, worries that the military's embrace of counterinsurgency--limiting the use of heavy firepower and having soldiers focus on local governance--means it isn't prepared to fight a traditional war against foes such as Iran or China. He says the more time soldiers spend learning counterinsurgency, the less time they spend practising combat techniques like fighting alongside tanks and other armored vehicles. ... Gentile relishes his self-appointed role as a military gadfly. He has already been scheduled to be promoted this summer and his teaching post here is effectively tenured", WSJ, 7 April 2008.

Bravo Col. Gentile! That's the way I see it. See my 14 April 2008 post. I think the Petreus Iraq "strategy" has accomplished nothing except encourage Iran to bide its time until we leave.