First Amendment 1, SEC 0

"Today his hedge funds manage over $500 million in assets, and they have averaged more than 15% annual returns over their lifetime. ... His biggest scuffle so far has been a succesful legal challenge to an SEC rule requiring hedge funds to register. ... This time he had run afoul of the top securities regulator in Massachusetts, who accused [Phil] Goldstein of marketing his fund to average investors--a big no-no for unregistered investment advisors. Rather than pay the fine and move on, Goldstein is fighting back. ... 'I have thought for some time,' says constitutional lawyer Floyd Abrams, 'that a day would come when the courts would take a fresh look and conclude that there is a significant level of First Amendment protection that has been denied for many years in securities law. This case is a more than respectable argument.' ... After a few debacles, Goldstein discovered his sweet spot: the quirky, logic-defying world of closed-end funds. ... Goldstein thinks these funds provide a perfect opportunity to exploit market inefficiency. ... They are just a sliver of the mutual fund market: $245 billion in total closed-end funds assets, out of nearly $5 trillion for all mutual funds. ... (In response to all inquiries about Goldstein, SEC spokesman John Nester said, 'We can't publicly discuss investors' private communcations to the commission.') ... So when the SEC came out in 2004 with a new rule requiring all hedge funds advisors to register in an attempt to make the industry more transparent, Goldstein was outraged. ... The SEC did not help its case by refusing to explain why it wanted to regulate hedge funds. ... The Investment Company Act of 1940, which regulates nonpublic funds, does not say anything about talking to the press, much less about websites. ... To Goldstein, it doesn't make any sense that the world can read letters written by Warren Buffett to his investors, but not those by investor Eddie Lampert, who runs a hedge fund", Telis Demos at Fortune, 23 June 2008.

The SEC's contempt for the First Amendment is of long standing. Why did the SEC want hedge funds to register? My guess: to appear to be doing something as opposed to the difficult work of ferreting out and punishing securities fraud. It's easy to collect paper, it's not so easy to conduct investigations of potential wrongdoing. Further, if you do, you might make powerful enemies on Wall Street and limit your future employment prospects. Answer: look busy and do nothing.

Confused Pension Funds

"Pension funds and other long-term investors have been finding it increasingly difficult and expensive to protect themselves against rising inflation over the past few weeks. The reason is that bonds linked to inflation are in desperately short supply at a time when the needs of pension funds and expectations for a rise in the price of food, oil and other goods have ramped up demand for the bonds. ... The surging demand in the past few weeks has helped to drive yields on indexed-linked bonds to new lows and pushed rates higher in the inflation swaps market, where long-term investors go in search of protection against inflation. ... The difference between the yields on nominal bonds and those from inflation-linked issues--known as the break-even rate--reflects demand for protection against rising inflation. That rate has widened dramatically over the past few weeks as demand has jumped. The 20-year break-even rate has risen to 4.16 percentage points from 3.98 percentage points June 6, while the 10-year rate break-even rate has jumped to 3.83 percentage points from 3.56 percentage points June 6. ... The U.K.'s annual inflation rose to 3.3% in May from, 3.0% in April, its highest level since 1992. ... The U.K. government's Debt management Office is stepping in with a record L18 billion in inflation-linked bonds this fiscal year, but that's nowhere near enough to satisfy the demand from pension funds", WSJ, 25 June 2008.

Here's an opportunity for Hank Paulson (HP). Issue TIPS denominated in British Pounds. Modern Roosa Bonds, see my 8 November 2007 and 14 January 2008 posts. I wouldn't touch 'em, but they seem to have a ready market. For a small fee, Goldman Sachs (GS) might sell them. Everybody makes money. Robert Steel (MBA, Chicago, 1984), are you listening? GS, if you approach HP, with this idea, and sell some, send me a 10% "finder's fee". I earned it.

Sovereign Debt Risk

"Optimists say that emerging-market defaults are a thing of the past. ... Already a good share of Argentina's debt is in default. What else do you call it when a government owes over $30 billion in inflation-indexed debt manipulates its consumer-price statistics? Through a variety of crude measures (such as firing its top statisticians), the government is publishing an understated inflation rate that is used for calculating indexation payments. The official inflation rate in Argentina for the past 12 months is under 10%. But the true inflation rate appears to be at least 30%, according to virtually every neutral source. Fudging indexation clauses to effectively default on debt is an old game. ... Considering the duress of domestic bond holders across the world as global inflation rises, it is surprising that both private investors and multilateral international financial institutions seem so complacent about the rising risks of defaults on external debts", Carmen Reinhart and Kenneth Rogoff (R&R) at the WSJ, 24 June 2008.

R&R, welcome aboard. Now Kenny, apply your thinking to Uncle Sam's debt, see my 14 June 2008 post, where you failed to see what's primarily responsible for the commodities boom. See also my 30 January and 24 April 2008 posts. Kenny, do you think Unc has a "Plan"? How will Unc pay his $9 trillion national and $53 trillion actuarial debts? Will we have 165,000% inflation as the Houston Chronicle, 26 June 2008, reports in Zimbabwe? I doubt it. But a decade of 10-15% inflation as say John Williams might report it at http://www.shadowstats.com/, with "CPI inflation" of 4-6% would reduce Unc's real debt burden by: 48% (1.12 to the tenth is 3.11; 1.05 to the tenth, 1.63; 1.63 / 3.11 = .52, 1- .52 = .48), not enough. The "spread" between "real" and "nominal" inflation must be greater to effect say an 80-90% reduction in the real value of Unc's debts. Alternatively, Unc's "installment plan default" could go on for decades. A 20% spread, like in Argentina, would reduce the real value of Unc's debts by about 84% after a decade; now that's more like it! See my 29 May 2008 post mentioning Walter Wriston.

Citigroup's Investment Bankers, etc.

"Citigroup Inc., in the latest sign of bloodletting on Wall Street, is set this week to embark on an aggressive round of layoffs within its investment banking division. ... The New York bank ... will dismiss thousands of investment-banking employees world-wide as part of a plan to cut the roughly 65,000-employee group by 10%. ... Entire trading desks in New York and other cities are expected to be eliminated", WSJ, 23 June 2008.

"Regarding your headline 'Citigroup to Close Hedge Fund; Blow to CEO' (page one, June 12): Let's have some perspective on this 'blow' to Vikram Pandit. Your article notes that Mr. Pandit 'personally reaped at least $165 million' when Citigroup bought Old Lane Partners last year. ... However, I don't think the closing of Old Lane is really a blow to the CEO", Robert O. Gurman letter to the WSJ, 23 June 2008.

Connie Yu, are you listening?

The WSJ's article about Pandit and Old Lane read like a "puff piece" written by Citigroup's PR department, see my 24 June 2008 post. WSJ, after having read you daily for 34 years, I expect better.

The Bear Stearns Two

"A federal grand jury in Brooklyn, New York, indicted two former Bear Stearns Cos. hedge-fund managers, alleging they misled investors when their fund was in peril, lied about their financial interest in the portfolios and destroyed evidence in the investigation. ... The 27-page indictment paints a picture of the scramble by the managers, Ralph Cioffi and Matthew Tanin, to keep their hedge funds alive. ... The managers pleaded not guilty and were released. Messers' Cioffi and Tannin [C&T] posted $4 million and $1.5 million bonds, respectively, secured by various properties. ... 'We are shocked and disappointed that the government has seen fit to fix blame on these two decent men,' said Edward Little, Mr. Cioffi's lawyer in a prepared statement. ... In a separate statement, Susan Brune, who represents Mr. Tannin, described him as 'a scapegoat for a widespread market crisis.' ... Defense lawyers are likely to argue that debates about the economy and the stability of the credit markets were standard fare last year as U.S. housing prices began a long slide", my emphasis, WSJ, 20 June 2008.

"When I heard that federal authorities has arrested the people that the government tells us were responsible for much of the subprime meltdown, I anxiously awaited the perp walk that would befall some notorious characters. Would we see Ben Bernanke wearing handcuffs, still dressed in his cams after having thrown even more money from the helicopter? Would the person shuffling before the media be Alan Greenspan, the architect of 18 years of legal counterfeiting? Had the federal authorities finally come to their senses and arrested the people most responsible for the chicanery and outright theft of the savings and investments of millions of people? ... Instead, I was to find that the Great Villians of Wall Street are [C&T], two former Bear Stearns hedge fund managers. ... Moreover, we can be sure that this is going to be the beginning of a busy prosecutorial season in which government officials will attempt to criminalize the actions of people who, in the end, were far less responsible for the meltdown than officials from the [Fed] and the U.S. Department of the Treasury. Indeed, the latest criminal charges are based on the fact that [C&T] privately had doubts about the quality and future of their hedge fund, but did not tell investors about their doubts. Lest anyone believe that such a state of affairs is 'criminal,' perhaps we should then wonder why Greenspan and Bernanke are let off the hook? After all, both men--and especially Bernanke--have made optimistic statements before Congress, only to be proven wrong. ... The larger point is that [C&T] are scapegoats, pure and simple. ... As more indictments come down the pipe, don't expect the media to ask the hard questions", William Anderson, (WA) at http://www.lewrockwell.com/, 20 June 2008.

"Anyone surprised by last week's arrest of two former Bear Stearns hedge fund managers must have slept through the Enron era. If Enron, WorldCom, Tyco--and the list goes on--taught us anything, it is that whenever the investing public suffers staggering losses on Wall Street, we can expect to see someone hauled off in handcuffs. ... Despite the complex nature of the subprime meltdown, the government has presented an indictment that reads very much like a garden-variety fraud. ... There is no question that at some point permissible spin crosses the line and becomes willful misrepresentation. That is really what this prosecution is all about. ... All of these alleged misrepresentations go to the question of intent--whether the statements made by [C&T] to their investors were knowingly false--and form the basis of the charges of securities fruad, wire fraud and insider trading. But this case also raises the more troubling question of whether all of Wall Street's ills can--or should--be reduced to criminal prosecutions, rather than leaving it up to appropriate financial regulators. ... Let's put this case in some perspective. This is not Enron. ... Nor is it Tyco. ... Rather, this is part of a much larger failure that extends well beyond these two defendants and their former employer to include many of our largest financial institutions. ... But these two hedge fund managers were not alone in reaping huge profits for years from the subprime market", my emphasis, Robert Mintz (RM) at the WSJ, 26 June 2008.

I wonder if Little and Brune will conduct a "scorched earth defense"? Whaaaat? For a first witness, call, drumroll please, Helicopter Ben (HB). Ask him if he and the other Fed heads discuss the condition of the economy. Introduce Fed minutes as subject to judicial notice. Who knows? If C&T regularly discussed the same things HB & Co., did, I can see it now: Hank Paulson (HP), "formerly" of Goldman Sachs (GS) calls Benton Campbell (BC), US attorney for NY's Eastern District and mirable dictu, the indictment is quashed. Alternatively, the jury will wonder why HP and HB aren't on trial. I can see HB in the witness box as an "adverse" witness, yet C&T's expert.

I agree with WA, C&T look like scapegoats to me. I went to the WSJ's website and found the 27-page indictment. I conclude C&T are guilty of something thousands of others are: puffery and incompetence. I saw two statements in the indictment, which if proven, look criminal. They were statements of fact, not opinion. Why did BC select C&T for prosecution? My answer: to help HP's case for increasing the Fed's powers to protect investment banks (IB). On 19 June Chris Cox, SEC chairman had a piece in the WSJ, looking to expand supposed regulation of IB, see my 2 July 2008 post. The only thing I saw in it was granting IB Fed discount window access. The indictment indicated to me that C&T did not understand the products they sold. They could have used Eugene Fama's or Bob Hamada's class at Chicago. They might have learned something. Another witness for C&T, Moody's Yuri Yoshizawa. She only looks backwards. Also, drumroll please, the GSer who said we saw a 25-sigma event, see my 15 August 2007 post. Why not indict him? A 25-sigma event, wow! A mere 6-sigma event is a 1.01 billion to one shot!

I agree with RM about the "larger failure". Perhaps RM, now with McCarter & English and a former federal prosecutor can explain to us why C&T were selected for prosecution. I think I have the answer.

Obama-Constitutional Scholar

"It amazes me that Barack Obama [BO], who taught constitutional law at the University of Chicago Law School for more than a decade, would be unaware of the legal controversy surrounding Nuremberg and the commotion it caused within the U.S. Supreme Court. ... When [BO] was asked about this on June 18th, he suggested that Osama could be adjudicated in the same manner of the Nazi War Crimes Tribunals at Nuremberg. ... The following day, John McCain replied on his website giving Obama a short history lesson. McCain wrote, 'Unfortunately, is is clear Senator Obama does not understand what happened at the Nuremberg trials and what procedures were followed. ... It also signifies that [BO] does not understand 20th Century history. ... Up until a few weeks ago, Obama thought it was the Americans, not the Soviets, who liberated Auschwitz. ... Nuremberg was prosecuted and adjudicated by an international team consisting of lawyers and judges from the United States, Great Britain, France and the Soviet Union. ... Or does Obama think Osama should be tried in an international forum like, well, Nuremberg? ... If Obama taught the U.S. Constitution to his students the same way the Reverend Jeremiah wright preached to his congregation then heaven help us all", Aaron Goldstein, 23 June 2008 at www.intellectualconservative.com/2008/06/23/obama-does-not-understand-nuremberg/.

Imagine, Obama was on the Harvard Law Review. Bonus points: what was Robert Jackson the last Supreme Court Justice not to have?

Citigroup's Argentina Bond Accounting

"Citigroup Inc. agreed to settle a lengthy federal investigation into its accounting of Argentina bonds during the debt crisis earlier this decade. ... In reaching the settlement with the [SEC], Citigroup agreed to cease and desist from future securities-law violations, a relatively light sanction. The SEC alleged Citigroup failed to keep accurate books and records and didn't maintain sufficient internal controls over accounting, but it didn't allege the New York bank committed fraud. ... We are very pleased to see this accounting matter from six years ago resolved with no fine or penalty,' said Citigroup spokeswoman Shannon Bell. ...The Argentina crisis saddled some banks, including Citigroup, with billions of dollars of losses. Many of the debt products at the heart of the currency credit crunch don't trade on public exchanges. And once the over-the-counter market for them dried up, banks turned to in-house models to value the debt. How banks came up with those models, what assumptions they used and how timely they were in taking losses are areas the SEC is interested in. ... The Citigroup case 'highlights the importance for all companies to make sure they conduct proper impairment analysis and use reasonable assumptions when they're valuing securities,' said Scott Friestad, co-deputy director of the SEC's enforcement division. 'In this instance, Citigroup failed to do that' when confronted with the crisis in Argentina. ... The SEC says Citigroup should have reported pretax losses between $236 million and $416 million, instead of the $82 million the bank reported", my emphasis, Kara Scannell and David Enrich (S&E) at the WSJ, 17 June 2008.

This is another SEC triumph for investors; a "cease and desist order", a nothingburger. Bell is pleased Citigroup got no "fine or penalty". Good. Look at Craig Giles (CG) fate, see my 25 June 2008 post. Was CG Citigroup's blood sacrifice to Mike Garcia (MG)? Should MG have thrown CG into a volcano's mouth? The SEC "alleged Citigroup failed to keep accurate books and records". Was that an FCPA violation? What's your opinion MG? Friestad indicates Citigroup did not "conduct proper impairment analysis". Do Friestad and the PCAOB think KPMG should have found this? If so, what will they do about it? Amazing, CG goes to prison over $2 million and Citigroup used its own models to justify not reporting at least $154 million ($236 - $82) in losses and no one is indicted, nor subject to a civil fine by the SEC.

2008's Palmer Raids

"Authorities are investigating some 'relatively large corporations' as part of a sweeping mortgage-fraud probe, [FBI] Director Robert Mueller said. ... Mortgage fraud is 'an area that we are going to aggressively pursue,' said Deputy Attorney General Mark Filip. He declined to say if rating firms or others are targets of the investigation. ... The Justice [sic] Department and FBI officials sought to demonstrate progress in the mortgage-fraud fight Thursday, announcing that roughly 400 indviduals have been criminally charged for their roles in home-lending schemes, with 60 arrested Wednesday alone. ... 'Operation Malicious Mortgages' swept up criminal investigations from March 1 through mid-June, and produced 144 cases nationwide. FBI officials estimate the losses from, the alleged scams reached $1 billion. ... 'We will investigate, we will prosecute and we will bring those individuals to justice,' seeking prison terms where appropriate, Mr. Mueller said", my emphasis, WSJ, 20 June 2008.

"Referrals of potential criminal securities-fraud cases by the [SEC], which brings civil fraud cases, are at near-record lows, records show. ... John Nester, a spokesman for the SEC, said the commission has 'aggressively enforced the securities laws and ... has worked closely with criminal authorities to appropriately punish wrongdoing and deter wrongdoing.'," WSJ, 20 June 2008.

This is more DOJ guerrilla theater. Another source reported 406 arrests. With $1 billion in damage, that's $2,463,000 per arrestee. My guess: 90% of the "Mueller 406", would flunk my "Blankfein Test" and I would release so the (In)Justice Department can chase some real criminals, like those who wholesaled the mortgages as opposed to these "street level financial crack dealers". We saw a similar misuse of federal law enforcement resources between 1919 and 1921 when over 10,000 persons were arrested in the notorious "Palmer Raids". Most were ultimately released. What's really going on here? My take: these arrests are part of the Bush administration's continuing efforts to portray banks as victims of scam artists as opposed to their co-conspirators.

I'll let Nester speak for himself. What he means depends on what "appropriately" means. I conclude Nester should not look for an investment banking managing directorship when he leaves the SEC. He has a much more promising career ahead of him in stand-up comedy. With George Carlin's recent death, Nester has a fine opportunity.

We Never Learn

"The governor of the Central Bank of Luxembourg raised some eyebrows when he questioned the integrity of the fast-growing balance sheet of the European Central Bank. ... In so many words, Mr. [Yves] Mersch charged that the commercial banks are gaming the central bank, a situation he called of 'high concern.' ... It was [Walter] Bagehot who laid down the law that, in a credit crisis, a central bank should lend freely against good collateral at a high rate of interest. ... Neither Bagehot nor [Francis] Baring seemed to anticipate that, before many hundreds of years would pass, the Bank--indeed, many central banks--would become, so to speak, 'le premier resort.' ... What passed for good banking collateral in the mid-19th century were bills of exchange, i.e., short-dated, self-liquidating IOUs. ... By now, a busy reader of Grant's Interest Rate Observer might be wondering why the editor is reaching back to 1867 for actionable ideas on the 21st-century monetary situation. ... [Thomson] Hankey, in a losing cause, marshaled two principal arguments against the Bagehot doctrine. No. 1, moral hazard. ... No. 2, simple fairness. ... How far the world has come: Gold, the most liquid of monetary assets, today is officially demonitized, whereas mortgages, the least liquid of banking assets, are now--all of a sudden, because there seems to be no choice--being embraced, or at least, tolerated. ... 'Ready money,' writes Hankey ... 'cannot from its very essence bear interest; every one is therefore constantly endeavoring to make is profitable and at the same time to retain its use as ready money, which is simply impossible.'," James Grant (JG) at www.nysun.com/opinion/walter-bagehot-was-wrong/80283/

I love JG, or at least agree with 95+% of what he says, see my 31 January, 25 February and 21 March 2008 posts. I've said things like JG writes here for 28 years. Thanks, Yves Smith at http://www.nakedcapitalism/ for bringing JG's article to my attention. Yes, the bankers are alchemists, see my 23 August and 24 December 2007 and 3 April 2008 posts.

Chris Cox in Chavez's Venezuela

"The Fed's opening of new lending facilities to large investment banks this spring, after financing the sale of Bear Stearns [BS], has helped restore confidence to financial markets. It has also posed some difficult questions. ... When [BS] was acquired by J.P. Morgan, Bear's overall capital ratio comfortably met the [Fed's] 10% 'well-capitalized' standard for commercial bank holding companies. Yet this didn't prevent a run on the bank. ... Investment banks, according to the conventional wisdom, were not subject to a run because they do not take deposits. Instead the SEC regulation was supposed to protect the broker-dealer's customers, which it did. ... It is clear that these protections are no longer enough. The Bear experience demonstrated that an investment bank can suffer a crisis of confidence that leads it customers and counterparties to precipitously withdraw funds--and threaten the financial system. This threat is what led the Fed to use its authority as 'lender of last resort' in the Bear crisis. ... [T]he Fed was required to find that Bear's imminent bankruptcy constituted an emergency threatening a severe, adverse impact on the economy. But making Fed lending available to all investment banks has exposed a lack of symmetry with respect to the explicit statutory terms on which commerial banks get this privilege. ... [R]elatively intrusive regulation has long been thought necessary to mitigate the moral hazard problem of central bank backstop liquidity, and other elements of the banking safety net such as deposit insurance. Now the provision of backstop liquidity to the major investment banks has unavoidably reduced the penalties they face for taking excessive risk. ... In my judgment, explicit legislative authorization for what is now a purely voluntary program of SEC supervision [of investment banks] is vital. ... Properly functioning investment banks are a critical engine of growth and innovation. We must be careful to construct a regulatory approach that meets our regulatory objective without disouraging risk-taking or neutering Wall Street's ability to fuel economic growth and innovation", my emphasis, Chris Cox (CC) at the WSJ, 19 June 2008.

The US no longer has the "rule of law". The Fed's invoking "emergency" to bail out JPMorgan reeks of Chavez and "decree laws" in Venezeula. No, I repeat no action CC proposes will reduce "moral hazard". What are CC's "regulatory objective[s]"? To maximize investment banker compensation? How about reducing "moral hazard" this way: any financial institution, aside from deposit takers, must decide if it wants "backstop liquidity". If it does, its executives go to the local OCC office and sign an agreement making the executive personally liable, not subject to extinguishment in bankruptcy for three times his last three years compensation. Such agreements, in the case of publicly-held companies, like National City, would be filed as Form IA-1. Form IA-2 would be the executive's annual statement of compensation and assets and liabilities. Deposit takers must be subject to this. If the executive can't meet his obligation, when the time comes for it, he is forced into bankruptcy. I suspect these enterprises will view risk differently when their managers know their personal fortunes are on the line and any monies they received during the last three years could be returned, thrice! If one doesn't want to be subject to this, let him work somewhere else. Suppose BS had gone bankrupt. What then? My guess, oil might be $20 a barrel cheaper, similarly, wheat, corn, soybeans, etc. all would be cheaper. Well CC, do you think avoiding BS bankruptcy was good for the "economy" whatever that means? I don't. Or maybe you think the "economy" starts at the Battery and ends on 57th Street and only includes Wall Street MDs earning over $2 million a year?