Spero Consulting

Posts Tagged ‘Rule of Law’

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.

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.

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.

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!

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.

“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.