Posts Tagged ‘Rule of Law’
Prop Trading and Pay at Banks
There is an article in today’s edition of The Wall Street Journal that attempts to frame Citi’s pay “dilemma” with trader Andrew Hall of its Phibro unit as some type of Gordian Knot: Citi in $100 Million Pay Clash. It’s not.
It seems that Citicorp will legally owe Mr. Hall about $100 million for his compensation in 2009, but Citi’s senior managers are concerned about the political ramifications of paying such a large amount. The last time we checked, Citi had taken about $45,000,000,000 – yes, $45 billion – from wealthy, middle-class, and poor taxpayers, and those taxpayers had guaranteed losses of a few hundred billion more.
We suppose that folks at Citi are concerned that the Obama administration and the populists in Congress will attempt to penalize the firm – or possible incriminate the management – for making such large compensation payments. (Note: since at least the founding of the FDIC in 1933, Congress has had the legislative power to have ban such contracts, but has chosen not to do so.)
We’ve written a few times about the importance of the rule of law, and it’s quite shameful that many of our elected officials and representatives place such little value on it. (These are exactly the individuals that our Founding Fathers tried to protect against.) It’s almost as shameful as Mr. Obama stupidly inserting himself into the Gates/Cambridge Police mess; he does need to learn to shut-up.
We wrote about the AIG pay controversy in It Truly Is Disgraceful! and Confiscatory, Abusive Taxation: It’s Alimentary (and Dangerous), and we don’t see this emerging controversy as being any different.
That being said, we do believe that prop trading should be eliminated at insured institutions, including Citicorp, because we see no reason that taxpayers, including ourselves, should subsidize their risk-taking. We first recommended it in October in the aptly titled, Eliminate Proprietary Trading at Insured Institutions, and mentioned it many time since then, including our recent post, Paul Volcker Has It Right.
It seems that Mr. Hall earned his huge compensation award because he and his trading group gambled and won big. However, it was quite possible for him to have lost (and lost big). That would have increased the size of Citi’s losses and required additional taxpayer subsidization.
We don’t know Mr. Hall, but we do wish him every success in the world. We just have absolutely no desire to backstop him (and it’s not just his penchant for modern art).
We prefer that he work for a trading unit of a non-insured institution or run a hedge fund so that we don’t have to support him if he fails. In fact, a very short article in the Journal’s Heard on the Street section, Hedge Funds’ Proprietary Advantage, describes how many hedge funds are currently doing quite well (after many recent disasters last year). That’s the nature of the business. Let those willing to take the risks, reap the rewards AND bear the consequences of failure. (Is it too really much to ask?)
Perhaps Mr. Hall would like to purchase the Phibro unit from Citi and accept those same risks and rewards that other fund operators face. It seems that closing the sale before the end of the calendar year would (or could) be a grand outcome for both Mr. Hall and Citi. We think that banning prop trading at insured institutions as of January 1, 2010, would go a long way towards slicing through similar knotty situations at other banks.
One final note: in the tradition of horrendously-arranged government web sites, see the above-mentioned FDIC site. It’s ugly and busy and has no focus, and it’s just what we expect from our bureaucracy. Does the reader have any higher expectations? Be honest.
Does Empathy Lead to Anarchy?
The Rule of Law or Rule of the Most Aggrieved?
We think that empathy is an very valuable trait for any number of jobs, tasks, and situations, including many of the services that we provide. For example, we think it is a crucial trait when designing incentive schemes and information systems – e.g., it helps to answer questions like, “How will a subordinate respond to a particular compensation scheme?” It also helps when designing web sites, e.g., it doesn’t matter which technical terms or jargon are used within your organization; what matters is the words that potential clients will use to get to your site and your products or services.
Regardless, President Obama recently stated that he wanted his first Supreme Court nominee to have “empathy.” In the past few weeks, many commentators have written their interpretations of what that means – from judicial activism to judicial “realism.” As the reader will see below, we think it’s more of the former than the latter, and note that the best general evidence against judicial “realism,” or the belief that one is a victim of their circumstances and biases is the continued existence and success of our great nation, and more generally, Western Civilization (versus tribalism, for example).
But ignore that for the moment, let’s conduct a thought experiment. Let’s take President Obama at his word: empathy. Set that as the legal decision criterion. Such a criterion permits one to disregard existing laws, and the Constitution for that matter. There’s no need for interpretation of those sorts of outdated things. All that matters is “feeling your pain.”
Presumably, court cases would be decided in favor of the most aggrieved party. Regardless of the facts, whichever party felt the worst, should win under the “Empathy” standard. So, if you’re guilty but you felt really, really bad or justified or if the other party said something perfectly “legal” but it reeeeally annoyed, you, the defendant, then you couldn’t be guilty or held accountable for your actions.
Of course, as any economist knows, it’s impossible to make interpersonal utility comparisons: “I feel really bad.” “No, I feel worse than you do.” “No, I do.” Thus, such a standard could only be applied subjectively, which, of course, some readers might like, but we don’t because it leads to tyranny.
However, consider other ways that the adversaries could provide evidence of their level of aggrievement, or their irritation, sadness, outrage, whatever. What are easy ways to do that? Well, legal protestation is one way, but behaving antisocially is another. (“He was only willing to yell about his displeasure, but we were willing to burn down a building or kidnap/hurt/maim/kill an innocent person, and we would have never have done that if we hadn’t be so aggrieved.”)
We already seen that excuse any number of times during various riots. Is that something we, as a nation, want to reward and encourage? In the long-run, without tyranny, could anything except anarchy to be achieved? We don’t think so.
We much prefer a consistent rule of law. The fact that laws might be enacted, enforced, and interpreted by imperfect, fallen humans, is nothing new, but the ideal of blind justice is still one worth striving for. Why? Because the alternatives are far less pretty.
The collective genius of this country’s founders was the fact that they took as given the fallen nature of man, in general, (and themselves, in particular) and designed laws and institutions (and checks-and-balances) that have been incredibly robust to self-serving actions and factions for over two hundred years.
In that regard, since May 18, we’ve wanted to note this excellent column about Guatemala by Mary Anastasia O’Grady in The Wall Street Journal: Finally, a Real Revolution. In our mind, a legal standard of “empathy” would make our nation a lot like the Guatemala that she describes, (and it appears that the majority of Guatemalans don’t want, either).
Why should any of us want it for ours? (Is it only so we can use updated, Clintonesque platitudes: “I feel your pain.”)
With thoughtfully defined/legislated and interpreted laws, can’t we as a nation be synergistically more than the sum of each flawed, individual one of us? (Haven’t we already?) Again, isn’t that what the ideal of blind justice strives for? And, isn’t it preferable to the modern-day tribalism and factionalism that persists throughout many parts of the world, including Central America, and including such phenomena as the tyranny of the majority in other lands, as well? (Or is such hope only an immutable function of being a Greek-Russian-Slovenian-Catholic-PhD-consultant-father-husband-web-designer-coach as a judicial “realist” may believe?)
P.S. We wanted to write more extensively about Ms. O’Grady’s column, particularly as it relates to a recent article in The New Criterion about Stalin and the Soviet archives; so, we may append or edit this post at a future date.
Separating the Mortgage Débâcle from the Liquidity Crisis
Hernando de Soto has an interesting opinion column, Toxic Assets Were Hidden Assets, in today’s Wall Street Journal.
He makes the point that we’ve been making since September: that the mortgage débâcle is separate from the liquidity/confidence crisis.
We think that he overstates the effect of derivatives – what he calls hidden assets – in creating the problem; however, we do think that the lack of accounting and the opacity of the contingent claims have exacerbated the liquidity/confidence crisis and make more difficult any restoration of confidence in large financial firms. Despite the massive government subsidiaries and guarantees, few investors have little faith in firms like AIG and Citicorp.
Investors, creditors, and possibly the firms themselves, can’t answer the question: what would the firms owe to whom under which circumstances (when), and that knowledge seems to be a necessary condition for the restoration of confidence.
As we see it, the mortgage débâcle helped engender the liquidity crisis because it informed investors that bank managements were far less competent than they had previously thought; so, investors and creditors lost confidence.
Risk management was lax, incentives were misaligned, and oversight at these firms was perfunctory at best. We have written extensively about these issues during the past year.)
An aside: as regular readers know, we think risk management is too narrow of a field to capture the true nature of the task at hand–uncertainty management–because neither the likelihoods nor the magnitudes of all possible bad outcomes can be measured or even identified. Someone can calculate a “statistic” from a historical times series, but that doesn’t mean that the notion exists or is usable. In arithmetic, numbers can always be added together – even if what they represent can’t be, e.g., seven oceans and a dozen apples; ergo, our motto, “thought before calculation.”
Anyway, it was the mortgage débâcle and its implications, combined with either panic (Henry Paulson and Congress) or disinterest (President Bush) that created and then extended the liquidity crisis. (See what we wrote in late September/early October about the government’s reaction and how that would prolong the crisis.)
Clearly, Mr. de Soto’s focus of attention speaks to another failure of the financial reporting system and its promulgators – the SEC and FASB – particularly the lack of published details about contingent claim contracts. This isn’t a valuation issue, it is simply publishing the nature of the contracts and the claims. It’s quite simple (although detailed and boring), and it is as much counting as accounting, but that lack of detailed breadth in financial reports will harm recovery efforts.
He offers several six sensible recommendations to mitigate such opacity problems in the future. As we read them and his conclusion, those six can be narrowed down to two (or so) basic principles: clear property rights and precise (and valid) language.
Has any economy, including this nation’s, ever long-prospered without those basic principles? It’s a rhetorical question.
Confiscatory, Abusive Taxation: It’s Alimentary (and Dangerous)
Beware of the e.coli!
Update: Since publishing this post on Friday, we’ve seen any number of folks comment on this abusive, dangerous, and ex post facto tax proposal. For example, in this morning’s (03−23−09) edition of The Wall Street Journal there are at least four columns devoted to the topic: Counterpoint: Wall Street by Heidi Moore, The Bonus Tax is Just Plain Stupid by Jonathan Clements, Suzanne Garment’s Populist Anger is Hard to Control and the Editorial pages’ Review & Outlook column, A Smooth-Hawley Moment. We think that only the last one conveys a sense of the terrible destruction such careless and thoughtless acts can induce. We’d hope that our Congressional leaders were above such petty, silly, and misdirected venegeance. Alas, they’re not, and that is something we may all rue for a very long time.
Oh boy!
So, the United States House of Representatives votes overwhelmingly to tax-away the AIG bonuses at a 90% rate. Unfortunately, our own representative, Jason Altmire, didn’t have the good sense to vote against it.
Let’s see: the bonuses totaled only $165,000,000, but once publicized they required immediate consideration. However, we were recently told that the earmarks and other voluntarily–identified waste in the stimulus bill were only about 1% of the total or about $8,000,000,000 and not worthy of elimination or consideration because “something had to be done quickly.” (Perhaps our leaders believe that we have the attention span of…hey, look at the cardinal in the magnolia…do you think Pitt will win it all?)
Now, the executive and legislative branches of the government assisted mightily in creating the problems that led to AIG’s collapse and terminal condition by (1) overreacting to and (2) under-thinking the issues in the autumn, and the Obama administration has exacerbated the problems with similar impulsive and poorly considered initiatives – they weren’t/aren’t thoughtful enough to be called plans – and now all parties must deal with their implications. (New readers can search the archives for (1) our repeated criticisms of the many failures of elected and appointed officials regarding the economy and the finance industry, in particular; and (2) our proposed solutions to the messes.)
Note: these bonuses are small and insignificant compared to the long-term damage done and the wealth destroyed by our federal government’s panic and missteps.
Given that, we see the attempt to confiscate (steal) the bonuses as being identical to a toddler’s attempt to change his or her own diaper after a particularly messy bowel movement. It’s just as messy, just as disgusting, and just as impulsive – both the initial uncontrolled action and the urge to remedy the situation.
Whether the reader agrees or disagrees with our analogy, he or she may wonder why we believe such action is dangerous. Why? Because it will destroy more wealth – not just the wealth of a few AIG employees, but everyone’s wealth.
How? Congress’s behavior is a form of tyranny, and tyranny is never good for general economic wealth. In this case, it may be popular tyranny, but that’s just tyranny of the majority against a handful of unfavored folks who woke up one late winter morning on the wrong side of an issue. It must seem almost Kafkaesque to those men and women and their families. (Such tyranny may be good for a few, select, favorite individuals and firms, but it is bad for everyone else, and the arbitrariness and capriciousness of tyrannical rulers keeps the favorites in uncertain, tenuous positions, and that hampers economic growth, too.)
At this stage, the AIG bonus story also reminds us of the immediate aftermath of a bad auto collision at a dangerous intersection. The public, including investors – like witnesses to the crash – are still fixated on the events and the gruesomeness – what happened, where are all the body parts, etc – rather than on the long-term implications, e.g., the pain, the physical therapy, the lawsuits, the avoidance of the road, etc.
But, we like our self-changed diaper analogy better. Toddler’s do it because they’re just trying to help, but it’s not clear how far or wide the bacteria has been spread during their ill-fated cleanup attempts. In some cases, the e.coli is nearly invisible and in all cases it very harmful. It can cause sickness and death to otherwise healthy individuals who touch it and consume it.
Let’s see how investors respond when they stop gawking and internalize the implications of this latest government abuse. We’d imagine that it would be like foreign investors running away from Russia last August and September.
On 9−11−08 we wrote, It’s Freedom, Baby! Yeah! Mr. Putin and in early October, we wrote The Importance of the Rule of Law which mentioned the fall of Russian equity markets as an implication of abandoning clear governing principles, including property rights.
Why should the effects be any less severe when the politicians in the USA abandon the same principles (for which our nation has a much longer and consistent tradition)?
It reminds us of the poem, “First They Came” by Martin Niemoller:
- “In Germany, they came first for the Communists, And I didn’t speak up because I wasn’t a Communist;
- And then they came for the trade unionists, And I didn’t speak up because I wasn’t a trade unionist;
- And then they came for the Jews, And I didn’t speak up because I wasn’t a Jew;
- And then … they came for me … And by that time there was no one left to speak up.”
“First, they came for the bonuses,” or maybe, “first they taxed the unpopular bonuses at 90%, but I said nothing. In fact, out of envy and rashness, I cheered.”
Be careful what you wish for!
Oh boy, indeed!
P.S. Of course we don’t agree with the granting of the bonuses, BUT THAT“S NOT THE POINT!
What a Civilized Country!
Approximately ten days ago, after his release from jail, we caught a brief glimpse of Bernie Madoff on the television news.
He was walking along the sidewalks of New York, presumably near his apartment, and he was surrounded by a swarm of news reporters and cameramen.
It seemed that someone accosted him – pushed him – but the episode didn’t last very long. We didn’t think much of it at the time and figured that it was a disgruntled neighbor who was also an investor in Mr. Madoff’s funds who had happened upon him and his entourage, and that was that.
Upon further reflection, we had our titular thought: what a civilized country we live in!
Many very rich, clever, and relatively powerful people seem to have lost substantial sums of money by investing with Mr. Madoff. Yet, he was arrested and arraigned and released on bail – all according to our laws – and upon his release he felt safe enough to venture into public.
To date he has suffered nothing worse than a push.
Thus, so far, it seems that his investors have been content to let the government take the lead in prosecuting him, and they have not implemented or acted on any vendettas or thoughts of revenge.
Now, this is the same country that responded quite aggressively to 9/11 – some say too aggressively – so, we don’t believe that we live in a sissified, effete country. (And it’s certainly not that way outside of the gun-controlled cities and states where our media tend to reside.) So, we’d argue that it is simply self-control (of others) that permits Mr. Madoff to walk the streets.
Of course, the future could prove us wrong and perhaps some folks are patient and want to serve their revenge cold. Until that time, we’ll marvel over the fact that Western Civilization seems alive and impulses seem to be well-controlled.
The Importance of the Rule of Law
“You’re riding high in April, shot down in May.”
–Dean Kay Thompson, composer(s), of (Frank Sinatra’s) That’s Life!
Okay, so the line is several months premature, but it reminds us very much of Russia’s August and September. Unfortunately, it’s not “back on top in June,” err, October.
We mentioned Russia twice last month, primarily in It’s Freedom, Baby! Yeah! Mr. Putin.
Today, we read in The Wall Street Journal that its bailout is failing: Russian Investors Want Bailout of Bailout.
Given the circumstances, particularly the unfortunate timing of its recent invasion, we ask rhetorically: how could it not fail?
In August, when Russia invaded Georgia, it was on the top o’ the world, and it once again showed itself to be a less-than-reliable neighbor and partner. When the good times end, that’s not the reputation to have.
See, when times are good and everyone wants your stuff, maybe it doesn’t hurt to remind one’s trading and investing partners of one’s uncooperative past, e.g., the Russian bond crisis of 1998, the czarist bond crisis of 1918, etc. When times turn bad it seems unreasonable to expect positive outcomes from such a stark reminder, and that is the case this autumn.
Like the Russian government, it seems that the WSJ is trying to make the current Russian crisis part of the global financial crisis, but we think it is only tangentially related via the price of oil. Perhaps “only tangentially” is an understatement, but we mean that we view Russia’s problems to be distinct and unique and unrelated to dubious mortgages and mortgage-related securities in the USA.
While we see a distrust of certain asset classes and banks in the West, we think that investors distrust the entire Russian political and financial system, but maybe we’re projecting. (Maybe they’re just ahead of their time.)
That distrust wouldn’t be so harmful if oil were at $150 per barrel, but that’s not the case when oil is at $90.1
As we see it, if oil is around $90 per barrel today, it might well be at $45 or lower by December. Why? Because, these are the times and settings when cartels fail; each member deviates from the publicized and agreed-upon strategy to try to generate the marginal cash flow needed to pay for its commitments.
Many of those commitments could only be supported by high prices and were likely set under the assumption that those high prices would continue from here to eternity. (That has a familiar ring to it, doesn’t it Lehman, WaMu, Wachovia, and friends? Or anyone one that remembers oil prices in the 80s.)
So, dear reader, we ask: if in the past, Russia has defaulted on its debt; tried to squeeze its western neighbors using the supply of natural gas as a vice; nationalized various industries; imprisoned and harassed internal critics; and invaded its southern neighbors – Georgia this time – does the reader think that it would not behave opportunistically within the oil cartel? (Note: excluding movie scripts, there is rarely honor among thieves.) Ergo, our prediction of substantially lower prices in the near future.
See, what our Russian cousins have not learned is that the Rule of Law does not only protect others or only protect only the weak. It also protects one from his or her own self; it protects oneself from being shunned and avoided by others – even the weak. For as weak as they are, the strong may still need them to survive. If those same leaders had learned that lesson and practiced it, we doubt that there would be a new Russian crisis ten years after the last one.
- Oh, look, Dr. Spero’s May 1st prediction in Commodity Bubbles? Yeah, probably, might be turn out to be an incredibly lucky guess. ↩
