The SEC's Revolving Door

"Steven Richards left the SEC in July 2008 as a top accountant in the enforcement division to join the global business advisory firm FTI Consulting. Five days later, he signed on to represent a client involved in a 'nonpublic investigation' by his old division. ... The two ex-SEC men were among 66 former SEC employees who filed 168 letters with the SEC secretary in the first nine months of 2009 disclosing clients or new employers they planned to represent before the agency, according to documents obtained through a public-records request. ... John. P. Freeman, a former SEC lawyer and professor of professional and business ethics at the University of South Carolina School of Law, has done his own research that documented that a relatively high proportion of SEC employees go on to work for the industries they once policed. ... Others argue that employees of every government agency leave for the private sector and that the rules in place guard against conflicts of interest. ... Martin Dunn, a former deputy director of the division of corporation finance, left the agency in August 2007 after 19 years to join the law firm O'Melveny & Myers. ... In an interview, Mr. Dunn said he understands the interest in the revolving door, but said he and the SEC both take the issues seriously. 'Everybody I know cares intensely about following the ethics rules,' he said", Tom McGinty at the WSJ, 5 April 2010, link:

http://online.wsj.com/article/SB10001424052702303450704575160043010579272.html.

I'm sure Dunn speaks the truth. Everyone follows the rules if they lack substance. I again cite Graffam v, Burgess, my 24 October 2007 post: http://skepticaltexascpa.blogspot.com/2007/10/call-out-cops.html.

Alan Meltzer Strikes Again!

"Last year the New York Times ran several articles about the end of capitalism. ... Then--just in the nick of time--we were allegedly saved by timely, forceful and intelligent government actions. The groundwork was laid for the next phace: more government regulation of financial and economic life. Left out of this narrative, is the government's disastrous mortgage and housing policy. Without the policies followed by Fannie Mae and Freddie Mac--and the destructive changes in housing and mortgage policies, like authorizing subprime and Alt-A mortgages for impecunious borrowers--the crisis would not have happened. ... Would bankers have made so many errors if there had never been a too-big-to-fail policy? ... Quite the opposite. The new financial regulations, spearheaded by Sen. Chris Dodd (D., Conn.), only bring back too big to fail by authorizing a Systemic Risk Council headed by the Treasury Secretary. ... Consider the Basil Accord, passed following bank failures in Germany and the US in the 1970s. This was supposed to reduce banking risk by requiring banks to increase capital if they incresed holdings of risky assets. But financial markets circumvented it by putting the risky assets off their balance sheets. Unusual? Not at all. ... This is because regulation is static, while markets are dynamic. If markets don't circumvent costly regulations ar first they will find a way later. The answer is to use regulation to change incentives by making the bankers and their shareholders bear the losses. ... Secretaries Timothy Geithner and Hank Paulson told Congress at the AIG hgearing earlier this month that they faced a choice: a bailout or another Great Depression. This is not true. ... The market is not perfect. It is run by humans who make mistakes. But the same humans run government where they make different, often more costly, mistakes for which the public pays. ... Regulators talk a lot about systemic risk. They do not--and probably cannot--give a tight operational definition of what this means. So setting up an agency to prevent systemic risk, as Mr. Dodd has just proposed, is just another way to pick the public's purse. ... We will not get sound banking until the CEOs of the large banks and their shareholders are forced to pay for their mistakes", my emphasis, Allan Meltzer (AM) at the WSJ, 19 March 2010, link:

http://online.wsj.com/article/SB10001424052748704231304575092141898417002.html.

As usual, I agree with AM. AM says it all. Imagine, incentives count!

China's a Bubble-2

"It is still on the market, but Charles Tong, the developer of Tomson Riviera, a luxury riverfront complex in the heart of the financial district here [Shanghai], says he is having no trouble finding takers for similarly priced units. 'We're selling three to four apartments every month,' said Mr. Tong, seated in a white Versace easy chair. 'Now, people here want something more luxurious; they'd like a new lifestyle.' ... When other recent booms collapsed--in the [US], for instance--they depressed entire economies. In China's case, a bursting bubble could affect much of the world. China is the fastest-growing large economy and, so far, a main engine pulling the world out of recession. ... Last year, a record $560 billion of residential property was sold in China, an increase of 80 percent from the year before, according to government statistics that are widely considered reliable. And with prices soaring, developers are scrambling to build more mansions, villas and high-rise apartments with names like Rich Gate, Park Avenue and Palais de Fortune. ... In the city of Tianjin, in north China, developers have created a $3 billion 'floating city,' a series of islands built on a natural reservoir, featuring villias, shopping malls, a water amusement park and what they say will be the world's largest indoor ski resort. 'This is wild,' said Andy Xie, a former Morgan Stanley economist who is now an independent analyst. 'By all tradtional measures, like rental yield, this is a bubble.' Speculators are snapping up properties on the expectation that prices will continue to rise, as prices have nearly every year for more than a decade. ... Prices [in Shanghai] have risen more than 150 percent since 2003, pushing the price of a typical 1,100 square foot apartment up to $200,000, according to real estate experts. (Shanghai residents typically earn less than $5,000 a year.) ... The apartment complex's entrance has original artworks by Salvador Dali and well-known Chinese artists. The apartments, a few of which have been decorated by Armani and Fendi, as well as Versace, lease for $7,000 to $17,000 a month--to high-level executives from companies like General Motors. ... Despite the fear of a bubble here, Mr. Tong said prices were just right, particularly because of so much hidden wealth in China. The publicly listed company is controlled by his family. ... The most recent apartment sold for about $2,300 a square foot. The average luxury apartment in Manhattan sold for just under $1,900 a squarte foot in the fourth quarter of 2009, according to Prudential Dougals Elliman real estate", David Barboza at the NYT, 5 March 2010, link:

http://www.nytimes.com/2010/03/05/business/global/05yuan.html.

Jonathan Swift's "Laputa" rises in China. A 1,100 square foot condo in Houston could be had for $80,000 to $250,000 depending upon location. To some extent we are seeing the same effects of monetary inflation in China as say in Argentina, where people are "selling" the local currency to buy real goods. China's a bubble!

Sic Semper Whistleblower-2

"A crusading legislator who had made a considerable reputation following up on whistleblower charges once told me that nearly all the whistleblowers she had met shared two qualities. First, they were onto something--that is, there was at least some truth to what they were saying. Second, they were 'a little bit nuts.' ... Through common sense at first, but ultimately through brilliant analytical detective work, Mr. Markopolos [HM] figured out precisely what Mr. Madoff was up to--and showed why Mr. Madoff could not bea earning the amazingly consistent returns that he claimed for his investors. ... The response of the SEC's enforcement staff was nothing less than appalling--a complete derelication of duty. ... The crook simply outmatched the watchdog. As Mr. Markopolos observes: 'The quants who create these financial products understand differential equations and nonnormal statistics; they program in languages the SEC doesn;t speak; they run statistical packages the SEC doesn't even know exist. The quants are busy data mining with supercomputers while the SEC is still panning by hand.' ... Mr. Markopolos writes: 'In my mind, at leat, I was convinced that someone high up at the Journal had decided it was too dangerous to go after Bernie Madoff.' No evidence for this charge is offered or even suggested. ... Now we come to the second quality that whistleblowers often sow. The author of 'No One would Listen' is fond of describing himself as 'slightly eccentric,' but he is not exactly self-aware. ... Mr. Markopolos tells us that for years, fearing for his own and his family's safety, he checked for bombs under his car; he also carried a loaded gun and slept with it at his bedside. He did so becase he believed--though he offers no evidence--that Mr. Madoff's clients included Russian mobsters and Latin drug cartels", Richard Tofel books review at the WSJ, 9 March 2010, link:

http://online.wsj.com/article/SB10001424052748703936804575108180543849168.html.

RT's condescending manner to HM indicates RT never blew the whistle. My experience with the (In)Justice Department makes me believe HM missed his biggest danger: the SEC would turn him over to Madoff and Madoff's cronies. Having blown the whistle in 1991 on a fraud, admittedly small by today's standards, only about $210 million in 2010 dollars, HM's fears were justified. I had the tires of my car slashed four times. I then parked it blocks away from my apartment. My apartment was burglarized. Strangely, nothing was taken. The investigating Los Angeles Police Department officer asked me who I thought did it and why. I told him. He said I might be in big trouble. I told him If I got killed tell the FBI it was a witness killing, punishable under 18 USC 1513(a). He saw I meant it. I looked under my car for bombs every day for 18 months. I had over 200 "hang up" phone calls from midnight to 1:00 AM in the morning. Who the hell does RT think he is talking to?

What's Gold in the Ground Worth?

"This March two of the world's biggest investors became believers in a company with next to no revenues and $352 million in losses over three years. ... Both Soros and [John] Paulson are seriously bullish on gold, but why did they bet on a Vancouver mining company with an unimpressive history? ... An Oxford-trained historian, [Thomas] Kaplan believes that the last 40 years, when gold was not the world's reserve currency, were an aberration and that gold will revert to the top of the store of value as it was for 5,000 years. He means it: Kaplan's family office, Tigris Financial Group, manages close to $2 billion in gold assets. ... Billionaires, big money managers and Wall Streeters are jumping in, even as few ways remain to play this game. ... But then, if you believe that government spending run amok and easy money will result in the decline of Western civilization, you don't need any multiples to look at. ... Kaplan's NovaGold deal started in January 2009, when his New York investment outfit, Electrum Strategic Resources, made a $70 million investment for a 28% stake and warrants for more. ... One, called Donlin Creek, is in Alaska. NovaGold says it has 29.3 million ounces of gold. The other is British Columbia's Galore Creek, with 7.3 million ounces of gold and 8.9 billion pounds of copper. But investors may be getting ahead of themselves. Both properties are remote and tough to develop. ... NovaGold's annual-return estimate on [Donlin] at $1,000 gold is 12.3%, which is marginal for a big mining project", Nathan Vardi at Forbes, 12 April 2010, link:

http://www.forbes.com/forbes/2010/0412/outfront-gold-kaplan-novagold-soros-paulson-golden-boy.html.

I think and have thought for about 30 years, gold bullion coins are the world's most conservative investment. What about gold stocks? For more leverage, why not? See my 1 October 2008 post: http://skepticaltexascpa.blogspot.com/2008/10/gold-mines-and-operating-leverage.html. Look at NovaGold (NG-AMEX). Now at $7.79, NG has a $1.47 billion market cap (MC). What's NG worth? With 36.6 million ounces of gold and 8.9 billion pounds of copper "in situ" I get gross revenues of $74.8 billion for NG (36.6 million x $1,161 = $42.5 billion; 8.9 billion x $3.63 = $32.3 billion; $42.5 + $32.3 = $74.8). So NG will have $74.8 billion in gross revenues over the next say, 20 years. Assuming 50% operating costs, we have net cash inflows of $37.4 billion ($74.8 x 50%). Now, assume a 35% tax rate, we get $24.3 billion in net after tax cash flows ($37.4 billion x 65%). If coming in evenly over 20 years that's $101 million per month ($24.3 billion / 240 = $101 million). Discounting this at a 7% real rate, per Kenneth Arrow, I get a $13.03 billion value for NG. With NG's $1.47 billion MC. that means the market assumes NG has an 11.3% chance of developing these projects ($1.47 / $13.03 = .113). NG appears to be fairly priced to me. Eugene Fama, take a bow.

Obama, Corporatist

"Socialists believe that the way to paradise is for governments to own 'the means of production'. ... Today's neosocialists are smarter than their ancestors. Instead of outright takeovers, they are achieving much the same goal through rigid regulations. ... Entitlements go hand in hand with sweeping, overbearing regulations. President Obama wants higher education in this country to be free of charge, which is why his Administration is pushing for a government takeover of student lending. ... Senator Chris Dodd's (D-Conn.) recently unveiled package of financial regulatory reforms is a neosocialist's dream. It is also destructively stupid. The bill doesn't address the key causes of the recent economic crisis: the Fed's too loose monetary policy, the behavior of Fannie Mae and Freddie Mac in buying or guaranteeing almost $1.5 trillion in junk mortgages and the failure to properly regulate credit default swaps and other derivatives. ... In the name of fighting Washington's too-big-to-fail doctrine for major financial institutions, Dodd's bill is a de facto institutionalization of them. ... Thus these biggies, like Fannie and Freddie, will have lower costs of borrowing--debt is by far the biggest component of their capital--which will put their smaller competition at a crippling disadvantage. ... Thus the paradox of today: bargain-basement rates of interest for larger firms and higher costs--or no credit at all--for smaller borrowers. ... Chief among its tasks would be assessing the risk of banks and their products and activities, yet Washington has demonstrated that it is incapable of judging risk. ... Sensible debt-to-equity ratios, including stiffer equity requirements for volatile short-term debt, and clearinghouses for almost all derivatives would effectively accomplish what Dodd's monstrosity purports to do and manifestly does not", Steve Forbes (SF) at Forbes, 12 April 2010, link:

http://www.forbes.com/forbes/2010/0412/fact-comment-steve-forbes-neosocialists-obama-obamacare-marx-impressed_print.html.

Amazing. I agree with SF. The Dodd bill will not reform the TBTF banks. Feature or bug?

Sue a Bank?

"A court ruled Thursday that investors who lost money in Bernard Madoff's Ponzi scheme through funds set up by UBS AG can't sue the Swiss bank and its adviser Ernst & Young for the losses they incurred. ... Instead, they must rely on the fund liquidator to obtain compensation for them from UBS. ... One state court in Palm Beach County, Fla., last mont allowed some claims to proceed by investors against a Madoff feeder fund firm, Tremont Group Holdings Inc., and its auditor, KPMG LLP. The court hasn't ruled on the merits of the lawsuit, which alleges professional malpractice, among other things. ... Responding to the ruiling, UBS said only that it welcomes the clarification of the Luxembourg law. The bank has maintained that it set up the fund at the request of wealthy clients who wanted it to invest in Madoff products and doesn't have any responsibility for the result", Mike Gordon at the WSJ, 5 March 2010, link:

http://online.wsj.com/article/SB10001424052748704187204575100932943214368.html.

This ruling may not be that bad if the liquidator vigorously pursues the claims. If. As to UBS responsibility, was it acting only as a broker or as an adviser?

Take Peer Review, Please!

"Last fall, emails revealed that scientists at the Climatic Research Unit at the University of East Anglia in England and colleagues in the US and around the globe deliberately distorted data to support dire global warming scenarios and sought to block scholars with a different view from getting published. What does this scandal say generally about the intellectual habits and norms at our universities? ... Fashionable ideas, the convenience of professors, and the bureaucratic structures of academic life combine to encourage students and faculty alike to defend arguments for which they lack vital information. They pretend to knowledge they don't possess and invoke the authority of rank and status instead of reasoned debate. ... Only a handful of the nation's leading univeristies--Columbia and the University of Chicago at the forefront--insist that all undergraduates must read a common set of books and become conversant with the main ideas and events that shaped Western history and the larger world. ... But how can students who do not know the basics make intelligent decisions about the books they should read and the perspectives they should master? ... By far, though, the most important reason is that faculty generally reject the common sense idea that there is a basic body of knowledge that all students should learn. This is consistent with the popular campus dogma that all morals and cultures are relative and that objective knowledge is impossible. ... Good students quickly absorb the curriculum's unwritten lesson---cutting corners and vigorously pressing strong but unsubstantiated opinions is the path to intellectual achievement. The production of scholarship also fosters intellectual vice. Take the peer review process, which because of its supposed impartiality and objectivity is intended to distinguish the work of scholars from that of journalists and commercial authors. ... But any competent scholar can determine an article's approach or analytic framework within the first few paragraphs. Scholars are likely to have colleagues and graduate students they support and whose careers they wish to advance. ... There is no check to prevent them from benefiting their friends by providing preferential treatment for their orientation and similarly punishing their enemies. That's because the peer review process violates a fundamental principle of fairness. We don't allow judges to be parties to a controversy they are adjudicating, and don't permit athletes to umpire games in which they are playing. In both cases the concern is that their interest in the outcome will bias their judgment and corrupt their integrity. So why should we expect scholars, especially operating under the cloak of anonymity, to fairly and honorably evalute the work of allies and rivals? ... Harvard University Press tells a reviewer the name of a book manuscript's author but withholds the reviewer's identity from the author. It would be hard to design a system that provided reviewers more opportunity to reward friends and punish enemies. ... Then there is the abuse of confidentiality and the overreliance on arguments from authority in hiring, promotion and tenure decisions. Owing to the premium the academy places on specialization, most university departments today contain several fields and within them several subfields. ... Often unable to form independent professional judgments--but unwilling to recuse themselves from important personnnel decisions---faculty members routinely rely on confidential letters of evaluation from scholars at other universities. Once again, these letters are written--and solicited by scholars who are irreducibly interested parties", my emphasis, Peter Berkowitz (PB) at the WSJ, 13 March 2010, link: http://online.wsj.com/article/SB10001424052748704131404575117314262655160.html.

PB is at the Hoover Institution. I agree with PB. The Sixth Amendment gives us the right to confront our accusers. Why not apply it here? As bad as academic peer review is, CPA peer review is worse. It's a sham to protect the Big 87654 as is the current PCAOB. See William Aiken's 1982 comments at my 1 September 2008 post:

http://skepticaltexascpa.blogspot.com/2008/09/dead-elephant-in-living-room.html.

Now They Ask?

"Unlike past market meltdowns, auditors have so far escaped much of the blame in the current financial crisis. The focus on Ernst & Young LLP [E&Y] in the report released last week by the bankruptcy examiner for Lehman Brothers Holdings Inc. [LBHI] has changed that. ... In a statement Friday, a spokesman for E&Y said the firm reviewed the accounting for Lehman's Repo 105 deals 'on a number of occasions. Out view was, and continues to be, that Lehman's accounting policy for these repo transactions complied with generally accepted accounting principles. The Examiner has not concluded otherwise.' ... That has precluded the kind of in-depth bankruptcy-court examination that resulted after Lehman's collapse. This approach contrasts with the bursting of the tech-stock bubble, when the implosion of Enron Corp. and WorldCom Inc. put auditors directly on the hot seat. ... Those scandals led to the Sarbanes-Oxley Act, which changed some key ways in which accounting firms operate and are regulated. ... While E&Y maintains its audits were proper, the accounting for Lehman's Repo 105 deals appears dubious to some outside experts. 'Unless it's in "Alice in Wonderland," I've never seen this,' said Lynn Turner, former chief accountant of the [SEC]. Even if the deals are within the technical bounds of the accounting rules, experts say it appears they failed to reflect the deals' true purpose. .... These are usually accounted for as a financing arrangement akin to a loan. ... One possible proof of a lack of control is that the securities being exchanged are worth far more than the cash being received. ... Guidance in the accounting rules suggests that an exchange of securities in excess of 102% of the cash value would show a lack of control. ... And Lehman should have had some reason for the 105% level, said Jack Ciesielski, editor of the Analysts's Accounting Observer. ... The problem, accounting experts said, is that in an accounting treatment isn't allowed for a US parent company, transferring a deal to an overseas subsidiary isn't likely to pass muster", my emphasis, David Reilly at the WSJ, 15 March 2010: http://online.wsj.com/article/SB10001424052748703457104575121920770049774.html.

Another Big 87654 disgrace. Had E&Y ever heard of substance over form? The Repo 105 deals were clearly financings. What did E&Y think motivated Repo 105? Answer: end run the 102% rule! E&Y must be full of craven idiots? What should we expect from E&Y which sanctioned the '.001 standard", in another context? See my 20 March 2010 post: http://skepticaltexascpa.blogspot.com/2010/03/lehmans-fiddles.html.

I'm Back

After a three week IRS and SEC induced layoff, Independent Accountant returns. Thank you readers who expressed concern about my well being.