Hedge Funds Going Public

Oh, boy.

Hedge funds, i.e., multi-billion dollar investment firms created just to sell exotic stuff to institutional and very rich individual investors (you can't sell such things to the general public, see), are themselves going public.

This means that management won't be on the hook when that exotic stuff makes losses -- rather, those losses will be spun off to shareholders.  I expect that the hedge fund management, meanwhile, will get fixed salaries on top of bonuses for profits made.

This presents something of a moral hazard, to say the least.  This is the now-familiar "private gain, public losses" problem.  Otherwise known as "betting with someone else's money, but keeping the winnings."  Or, as known by more serious writings, "excessive risk-taking."

Theoretically, hedge funds can sell exotic assets, i.e., assets that are non-public and therefore not subject to the SEC's reporting and transparency requirements, to institutional investors and rich people because those folks are savvy enough investors to watch out for their own interest.  At least according to the law.  So issuers cooking up these assets don't need to publish their financial statements (and prepare them in accordance with GAAP), nor distribute 10-Ks and 10-Qs to the market.  

Of course, these investors didn't do such a bang-up job avoiding the subprime mortgage-based assets.  They have their own moral hazards to deal with -- nevermind that anyone might be ill-equipped to deal with the kind of complexity that characterizes capital markets lately.

And nothing's changed to expect they'd do a better job in any other new-fangled, and risky, security to spin around the market.

Add on top of that the hedge fund's reduced incentives to monitor risk itself, due to going public.

I sure hope your pension fund isn't a one of these hedge funds' clients.

Goldman's Diverse Shareholders

Goldman, it seems, is about to shed the last vestiges of its old partnership form.

The New York Times suggests this might be good news, leading to increased transparency as the firm prepared more thorough 10-Ks and 10-Qs for its shareholders.

One could also argue, of course, that the removal of the last 5-10 guys with any "skin in the game" as far as the success in the firm will only increase its risk-taking activities.

Partners tend not to gamble with firm assets, because losses come out of their own pockets.

On the other hand, directors, executives and management who get paid base salaries and bonuses based on profits (with no downside for losses, other than the loss of bonuses) might be more willing to wager the house on the dream of a hefty short term profit.

Of course, this all depends on the fact that Goldman couldn't figure out how to spin-off risk to a bunch of chumps to begin with.

It's good to be a middleman.

Schneiderman Exploits Civil Discovery

It can't be anything other than good news that NY AG Eric Schneiderman picked up the ball that now-governor Cuomo dropped.  He's started to investigate (again? finally?) Wall Street's involvement in formulating toxic mortgage loan portfolios.

Yet, it's not the government that's actually doing its job.  It's the government free riding off the lawsuits brought by institutional investors against big banks for selling them crappy pooled loans:

“Part of what prosecutors have the advantage of doing right now, here as elsewhere, is watching the civil suits play out as different parties fight over who bears the loss,” said Daniel C. Richman, a professor of law at Columbia. “That’s a very productive source of information.”

For anyone out there complaining that American culture is too litigious -- well, it's not like the cops on the beat are doing their job.  Someone has to.

Meanwhile, one can see the power that ordinary folks have because of their pension funds.  It is without a doubt that Schneiderman had a fire lit under his butt by these funds -- and not by anyone else.

Citizens United Fallout: Will Shareholders Step Up to the Plate?

And will Congress help them?

Yesterday in the NYT, a former Vanguard chairman stressed the necessity that shareholders, in the wake of Citizens United, really begin to assert themselves when it comes to corporate political speech.

It's not surprising this kind of comment comes from Vanguard -- it, unlike other private fund managers, operates more like a credit union than like your typical wall street investment bank. Not to do a corporate plug but, if you're lucky enough to have money to invest for retirement, Vanguard, unlike most money managers, is more likely to take your concerns seriously.

Anyway, institutional investors, using their new powers of proxy access, can submit bylaw proposals requiring, for example, that corporations seek the approval of a majority of shareholders before contributing corporate assets to political campaigns.  This sort of reform pulls the rug out of under (at least partially) Citizens United -- in the end, it's the actual people who decide what kind of speech they make.

The problem is, of course, is that it's difficult to get your Fidelity Funds investment manager to get off his tush to represent shareholders actively.   Either he doesn't care, has too short term of an an attitude, or is more worried about pissing off the same corporate management he relies upon to hire him to run its employees' retirement funds.

And, according to this NYT piece, these sorts of managers represent about 70% of American shareholdings.*

But not all institutional investors are so lazy.  Public union pension funds regularly submit bylaw proposals to change corporate policy.

So what makes public union pension funds so different?

First: they're not governed by the part of Taft-Hartley that requires that employers get equal (or greater than equal) say on pension fund investment practices.  Needless to say, this makes it a lot easier for public union funds to swing their weight around on the policies and practices of the companies in which they invest.

Second, public union employees tend to be more aware of where their collective money's going.

These observations give us some simple how-tos to encourage the shareholder franchise in American politics.

First: repeal that part of Taft Hartley.

Second: Promulgate more robust disclosure laws that require fund managers to reveal to their beneficiaries what they're doing about political spending -- and other investment policies.  This movement is already well underway in Europe.

Third (and a little pie-in-the-sky): start educating people regarding the role corporations play in their life -- if they realize that their choices are equally, if not more constrained, by the actions of companies as they are by the actions of government, perhaps they'll take their franchise rights more seriously.

* Note: no one, as far as I can tell, has ever done a serious and comprehensive study on the type and size of various different kinds of investors, both institutional and individual, what kinds of companies they invest in, and what kind of policies they pursue in connection with their shareholdings.  And I've already asked the folks at OECD.  Any ambitious grad students out there???

Today I asked a electrical workers' union member, who's actively involved in a local chapter of a national socialist party, why his union didn't pay more attention to what its pension fund was doing and think more about what it could be doing.  He responded:

I know we own a big chunk of blue cross.  But they haven't done shit for us.  Our benefits keep getting worse.   Our pension fund managers don't do shit and then the union bureaucracy.  And then we also own a big chunk of the philly inquirer -- brilliant investment, that, in this internet age.

Two points here.  One: American unions don't pay enough attention to a source of power and leverage they already have -- the tens of billions of dollars of corporate equity they own.  This could be made even more powerful if there's a movement to get rid of the part of taft-hartley that lets corporate execs have a hand in fund management.

Two: How to handle the perverse incentive of owning a company and wanting to make a profit from it --- while still staying true to labor reform?  Making profits as a shareholder, after all, can mean cuts to wages and benefits.

Legal Personalities and Evildoers

There isn't any bourgeoisie anymore.  If there ever was.  It is the corporation that uses capital now.  And those companies are owned by diversified shareholders -- who often include among their ranks the workers themselves. 

Except "ownership" isn't really the right word.  Diversified shareholders don't look and act like owners.  They don't use their property, don't monitor it, and, in fact, don't really care much what happens to it, so long as they get dividends and can sell their shares for a profit.

In fact, it's fair to say that no one really owns the corporation.  The people who run the corporations, meanwhile, the managers and directors, well, they get paid wages, too.  And the people who decide where capital gets allocated -- they're on wall street, and have motives altogether different than whether a particular business succeeds or not.

So who's the bourgeoisie, then? 

When one goes to think about a Marxist kind of political economy, one has to remember Marx's most important point -- it's concentrating on dialectic relationships.  it's concentrating on materialist history. 

It's the economic system, not the evil, amorphous, unidentified "theys."  It's the social and economic forces that lead to the formation of corporations -- which are, in their essence, social and economic relations among workers and among capital providers (who are, in this age of public corporations, also workers).

So why do socialists hold up banners screaming in outrage that "GE paid no taxes!!!" when GE isn't, in fact, a real person.  It's a group of people doing stuff in concert, hopefully to make a profit.  This entity that didn't pay taxes, well, it's just a social machine.  A machine that hires workers. And pays dividends to its shareholders -- who are also workers.

Rather, what is more despicable about corporations is that they make public messes and they don't pay for the clean up.  Those costs are distributed among all of society, while the profits are kept by the corporation's specific constituencies -- workers, executives, shareholders, and creditors.

The activists, however, aren't the only people who like to personify business organizations.  Our laws treat corporations like they're people, too.  They enter into contracts and they pay taxes.  Recently, our supreme court even granted them free speech rights.

It's time to get back to the nuts and bolts.  We all need to acknowledge what's really going on, so we have a prayer of changing things.  This means we can't string up some goldman sachs insider trader and stone him and call it finished business.

This goes much deeper.

It's illegal for everyone to steal bread...

... but you never find any rich folks in jail. 

Thus, a law perceived to be neutral, e.g., against the stealing of bread, actually hammers down on certain people harder than others and fails to take into account the mitigating circumstances that would lead most people, on further reflection, to conclude that the stealing of bread by poor people ought to be decriminalized or, at the very least, carry punishments less severe than we are wont to apply. 

It's been argued that this aspect of our legal order reflects and mitigates class conflict.  Specifically, its implementation illustrates class conflict (only poor people go to jail) while, on its face, it appears completely neutral (it's not a class thing, it applies to everyone equally).  Thus the law, because of its superficial neutrality, serves to quell moral outrage at the disparate way we treat rich people and poor people.

Well, that's a bit drastic -- there's not some cabal of evildoers sitting around a board table on the 100th floor of some high rise plotting this stuff out.  But there's something to it.

For example.  This phenomenon reveals itself most explicitly when we consider that rich folks who steal stuff -- by peddling assets worth pennies for thousands -- usually get away scott free.  They certainly don't go to prison.  Why's that? Well, the law against stealing stuff doesn't apply to what they're doing.  The laws that apply to this kind of behavior are embedded into our labrynthine codex of securities regulation.

This tendency to apply the same legal standard to vastly different circumstances, or to apply different legal principles to similar circumstances, depending on what those circumstances happen to be and who they happen to most often -- also reveals itself in the securities fraud context. 

In plain vanilla commercial litigation, breach of disclosure cases are more common than Applebees chains in strip mall suburban communities.  In these cases, where one company buys another, there's usually a claim that the seller breached its represesntations and warranties about its financial condition.

Usually there's nothing very nefarious going on.  Usually, there's no outright fraud.  Sure, you get seller representatives "spinning" bad situations, and perhaps not emphasizing the weaker part of their business.  Inevitably, however, when the buyer finds out that its new company isn't as spiffy as it thought it would be, it sues to get some or all of its money back.

It's sort of the same thing as a consumer going to the grocer's to buy a diet drink that promises to remove the extra bags on the saddle.  When, lo and behold, not all the bags are gone after a few weeks, the consumer marches back into the store, with guns blazing and trumpets sounding, to waste a good part of the weekend afternoon stewing in a customer service line. 

But really, no one ever expected the bags to really disappear. 

So it is in deal litigation. Except that in the M&A case, the buyer hires an army of pricy lawyers and spends a couple million bucks litigating the deal before courts.

And courts and the law expect commercial parties, like the diet drink consumer, to figure out what kinds of representations are just commercial fluff and spin, and which are supposed to be hard facts.  You can't lie about those hard facts -- especially if you warranted, in your contract, that you provided all of them, and all of them accurately. 

Does this work the same when it comes to misrepresentation in securities fraud cases?

Well, the courts certainly think it does.  So you get shareholders and bondholders suing because their broker sold them a bunch of toxic assets.  And you get courts saying, well, so long as those brokers didn't make any hard promises and turned over all their balance sheets, you're on your own when it comes to protecting your interests.  you've got to do your own due diligence to figure out if it's a good deal.  The only caveat: the broker can't outright lie.  But they don't have to point out for you the weak parts of their P&Ls for you.

It seems logical or, at least, consistent. 

Until one considers that investors, in reality, trust their brokers to fish out good deals for them. Add on top of that the fact that the "investors" are really just a bunch of working stiffs who rely upon their investment managers to do a good job avoiding risk and fishing out productive investments.  Of course, those managers -- who get paid via bonuses based on short term performance -- perhaps don't pay as much attention to what they're buying with other peoples' money as they ought. 

And suddenly the "buyer beware" mentality, when it comes to securities fraud, maybe isn't such a neutral and objective rule.  The "buyer" -- the auto factory worker with the pension plan -- physically *can't* beware.  He likely doesn't know that his pension fund was even looking to buy anything.  And the two intermediaries standing between him and the bad investment deal -- the broker and the investment manager -- aren't "bewaring" either. 

And "buyer beware" works only if there's a buyer actually, um, capable of "bewaring."

So, just like a law against stealing bread, the law that governs mispreprentation and disclosure cases reflects something about our society.  Its implementation harms working stiffs more than it harms corporate M&A counterparties, and thus reflects a difference between the way our society values workers versus corporations.  And its superficial neutrality -- applying equally to both securities fraud cases and to M&A litigation -- mitigates that tension.

Cracking Down on Collective Bargaining - Institutional Investor Style

After Dodd-Frank's corporate governance reforms, it appears that the opposition to governing corporations in the interests of anything else except short term profits and executive insiders isn't content to merely challenge the SEC's proxy access rules before SCOTUS.

Now, a movement to reign in proxy advisory firms. 

Institutional investors like pension funds hire these companies to monitor corporate performance and to provide advisory services on upcoming shareholder votes.  As most institutional investors are heavily diversified (often required by law to be so), they need this sort of service to do their jobs properly.  Think of it as enabling collective action.

Certainly, reforms that require these advisory firms to be transparent and to refrain from entering into conflict-of-interest transactions (when they're hired by a firm who invests on its own behalf, as well as by the firm's own investors) make sense.   After all, it makes sense for Moody's and S&P, who get paid by the very same firms whose securities they are rating.

The thing is: oversight failure over Moody's & S&P leads to unacceptable systemic risk.  People bought AAA rated securities toilet assets on Moody's good recommendation.

Riskmetrics, ISS et al don't tell investors to buy trash.  They don't tell investors how to invest their funds.  Rather, they tell investors where executive compensation is out of whack, when getting rid of a staggered board would make sense.  Their services, in other words, are to help investors after they've bought securities.

So it would make sense, given their different purposes, that they would be subject to different regulations. 

Don't let the hubbub coming out confuse you.  Advisory services aren't the same villain as the credit ratings agencies.  And so they should be punished as if they are.

The other governments we should pay attention to

FT Editorial Page:

Shareholder values

How shareholders choose to vote is above all a private matter. Investors are free to tell the companies they own to pursue goals besides profit. One goal can be concern for safety and the environment: complaints from faith-based and other investors in BP have grown louder since the Deepwater Horizon explosion and oil spill. Another is fair pay: the Church Investors Group wants pay ratios between top executives and the lowest-paid tenth of employees to fall below 75 .

Is such shareholder activism also in the public interest? It could be. If more owners thought, like some faith-based investors, that they had a duty of stewardship, they could provide a useful check on managers. No lofty motives are needed for this to be in the interest of shareholders, whose money is after all the first to be lost to overly risky strategies or to remuneration that extracts more value from a company than it adds.
Whether it is good for society at large, too, depends on what shareholders use their activism for and to what degree they succeed. As to the former, taking a stand on executive pay is a healthy change from the usual apathy. Depending on the warmth of relations between executives and pay committees, “pay for performance” often turns into pay without the performance. Incentives are easy to game and can undermine people’s intrinsic motives for doing a good job.
If more institutional investors join the activist game it could even have an effect. Crude caps on pay multiples may not be the best solution. But they would hardly scare executives away. Most institutions are “universal investors” and if the same rules apply to all their holdings, managers feeling under the thumb would have nowhere else to go. Unless it is where ethical investors fear to tread: tobacco, alcohol and pornography. Perhaps it is all a divine plan to put greedy executives on the wages of sin.

Copyright The Financial Times Limited 2011. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.

So, Carl Levin's Read Michael Lewis

Today's FT reports that Carl Levin's senate investigation committee is referring a few cases to DOJ for prosecution.  Namely, cases based on the fact that banks like Goldman and Deutsche were selling toxic assets while at the same time going short on those assets.

It reads straight out of The Big Short.  With even a shout-out to Greg Lippman.

Good to know that the Senate investigations' committee is has just as many investigative resources as a single author.

Auction-Rate Securities Settlements - Paying off the Richies, but not Your 401(k)

Another comment on the Morgenson/Story piece in today's NYT:

In one of the SEC's rare prosecutions of the shenanigans leading up to the financial crisis, the SEC extracted compensation from banks that hoodwinked investors into buying "acution-rate securities" by promising that they were liquid and safe.  But only for retail investors, i.e., investors rich enough to trade on their own accounts.  The rest of us -- anyone with a pension fund or 401(k), got screwed:

But Mr. Alvarez suggested that the S.E.C. soften the proposed terms of the auction-rate settlements. His staff followed up with more calls to the S.E.C., cautioning that banks might run short on capital if they had to pay the many billions of dollars needed to make all auction-rate clients whole, the people briefed on the conversations said. The S.E.C. wound up requiring eight banks to pay back only individual investors. For institutional investors — like pension funds — that bought the securities, the S.E.C. told the banks to make only their “best efforts.”

This shift eased the pain significantly at some of the nation’s biggest banks. For Citigroup, the new terms meant it had to redeem $7 billion in the securities for individual investors — but it was off the hook for about $12 billion owned by institutions. These institutions have subsequently recouped some but not all of their investments. Mr. Alvarez declined to comment, through a spokeswoman.

Perhaps the SEC was hoping the pension funds would fulfill their fiduciary duties and sue these banks themselves for securities fraud.  We should look forward to a wealth of new caselaw in the coming years.  

Financial Crisis Prosecution: Elephants in the Room, Farting yet still invisble

The NYT's Gretchen Morganson and Louise Story posted an "expose" today about the embarassing dearth of financial crisis criminal prosecutions.  Pointed is their description of the cosy, crony-capitalistic structure of banks and other financial isntitutions and the so-called regulators that ostensibly babysit them -- as well as their identification of the anti-regulatory cultural consciousness that herded regulators into inaction.

The  excuse offered up by regulators that has the most purchase, though, is the fact that even should they get money from these companies, that money would come straight out of the accounts holding taxpayer-funded bailouts.  Or, worse yet, would undermine financial stability.

Even if that's true and salient -- which assumes, of course, that financial engineering, especially to this degree, has some sort of overall social benefit:

Clawing back the hefty paychecks of the individual financial executives, traders, and dealers wouldn't implicate such issues.  And they're the individuals whose risky behavior the regulators are supposed to regulate to begin with.  Financial institutions aren't just some giant non-human hive-mind that has a life of its own.  It's the people working for them that do the bad things.

Moreover, the law does not limit fraud actions to corporate behavior.  The individuals involved in the fraud, theoretically, are liable too.  In fact, corporations only face liability for fraud because the law holds them, as employers, vicariously liable for the acts of their employees. 

Certainly, the securities laws don't offer the same kinds of claims as plain vanilla common law fraud -- execs, for example, aren't always individually liable for misstatements in the company's 10-Ks -- but there are other tools in the toolbox.

Meanwhile, wall street pay is through the roof.  Still.

Free Speech, As Long As It's The Right Kind of Speech

Petitioners' reply briefing in the Biz Rountable v. SEC, is pretty cute.  Scarily cute.

From the folks at Race to the Bottom:

The petitioners contend further that the shareholders most likely to use the rules [governing proxy access] are union and government pension funds, which have a history of using shareholder activism to pursue non-investment-related objectives that depart from other shareholders’ interests. The petitioners fault the Commission for claiming that the rules further shareholder rights, when the mandatory rules instead disenfranchise the vast majority of shareholders, who may wish to avoid the tremendous costs that proxy access would impose on their company.

The rules violate not only the APA, the petitioners explain, but also the First Amendment by forcing corporations to carry the campaign-related speech of others who necessarily oppose the company’s position, even when that speech is false and misleading. The Commission was obligated to tailor its rules to avoid infringing constitutional rights, but the Commission failed to take First Amendment rights into account when crafting the rules.

While we sputter, a few points.

First.  When the Supremes gave corporations free speech rights, they necessarily gave certain shareholders the power to force others to "carry the campaign-related speech of others."  Unless, of course, the Court meant that shareholders should always vote unanimously.   Shareholders elect directors.  Directors decide how corporate free speech is exercised.  If shareholders don't like the speech, they can vote out the directors.  But it's majority rule.  Someone's going to feel like their voice got drowned out.  That's the nature of the beast.

Second.  Ostensibly, a corporation's right to free speech hinges on the free speech rights of individual investors.  If this is the case, since when must those investors confine their speech to investment-only objectives?  Because that's what the Biz Round says when it bristles at shareholders voting for "non-investment related objectives."

It's sort of like telling people they cay only vote according to their tax interests.

That certain special-interests lobbies "drown out" (or, in the Biz Round's parlance, "disenfranchise") the voices of other voters is nothing new in democracy.  Can we really call society undemocratic because AARP gets more lunch dates with congressmen than does Mr. Smith writing to Washington?  The squeaky wheel gets the oil.  It is, at the very least, amusing -- and blatantly hypocritical --  to hear the corporate lobby whining about the power of "special interests" lobbies, when they represent the biggest and most powerful of them.

Remembering Williams v. Geier and Tenure Voting

Back in the Long Term Capital Management days, Delaware courts were grappling with all sorts of protective devices cooked up by corporate boards (and Martin Lipton) that served as fortresses against the Gordon Gekkos of Wall Street.

One of the many gems of corporate jurisprudence emanating from the courts, Williams v. Geier, dealt with a management and majority-shareholder approved plan to grant weighted voting rights to long term shareholders.

At the time, the minority investors screamed.  Indeed, their cause was a bit sympathetic, especially because the corporate board and the majority of shareholders were dominated by a single family.  Minority shareholders, in this kind of situation, can get the shaft.
But here's the thing.  In Williams v. Geier, the Delaware Supreme Court noted that the board, in giving better voting rights to long term shareholders, was perfectly reasonable corporate policy.  That policy was not one aimed at short-term profits, but instead long-term, sustainable business strategies.  Even if the pursuit of long-term growth  disenfranchisws short-term investors, the Court thought it was still a-ok.  Or, in corporate law parlance, a perfectly legitimate exercise of a board's business judgment that could only be rebutted in the face of evidence of a breach of fiduciary duty.

Notable in this case is it the Justices' dissent: the priority given to long-term interested shareholders over the "equally legitimate investment objectives" of short term investors provoked their ire.

It's very much open to debate, of course, whether the short-termism of minority investors is an "equally legitimate investment objective."  Such short-termism, after all, lead to the kind of financial mysticism that leads to financial crises.
Something to chew over as we finally start paying attention to the fact that not all shareholders are created equal.

What they're teaching the kiddies in law school these days

From Hal Scott's textbook on international finance, v. 17th ed. -- for real:

[public officials regulating fraud aren't as good at enforcement than markets] may be true in developing countries but does not translate to the us where public enforcement officials are not corrupt or captured, and are very well trained (due largely to the revolving door with the private sector).

Is this a joke? Bad editing?  The author, certainly, has an underdeveloped sense of irony and the oxymoronic.


The scary thing is: he came out with the new version precisely to take account of the financial crisis.

History Doomed to Repeat Itself Every 2 Years

Risky debt abounds once again on the capital markets, according to the FT.

So, we've already figured out that there isn't going to be much in the way of regulatory reform.  But one would think that the industry would at least be a little gun shy.

Is  this the result of the so-called "moral hazard" of government bailouts?  For once, perhaps the conservatives were right.  Perhaps government really can't take the place of markets in some situations.  Sometimes, people need to go broke to learn a lesson.

Michael Lewis, in an interview he gave regarding his fantastic historical account of the financial crisis, The Big Short, speculated that perhaps the mess wouldn't have been so bad had investment banks not gone public.  If they had remained partnerships, perhaps the mess wouldn't have been so bad.  Partners in a partnership generally don't let their employees throw billions of company dollars on a roulette table -- especially when odds are much worse than 50/50.   Because what's getting thrown away is the partners' own money.

Not so with corporate executives.  They haven't got any skin in the game.  Their diversified public shareholders? They can pull anything over on those dupes. 

With public corporations, we're left to the government as the only watchdog.

Oy vey.

The Benefits of Technology Into the Laps of Shareholders

Krugman's column today emphasizes that no matter how much "education" students receive (I mean the kind that trains folks for highly-skilled jobs, which is necessary, but not sufficient, for a real eduction), there always remains the spectre of outsourcing and out-moding that comes from globalization and technology advances.

So what can we do to make sure that these turn of events doesn't lead to mass poverty and mind-numbing inequality?

Certainly, redistributive tax policies and collective bargaining helps.  Unfortunately, an effective response is one that must be globally coordinated.  Else we will hear that famous "giant sucking sound" that is the race to the bottom.

The crux of the problem, though, lies with what drives our economy to make these technological advances.  Competition among industry, of course, drives firms to acquire increasing returns of scale, greater efficiencies, and lower costs of production (including technological advances and lower wages).  Where do the profits go?

To shareholders.

What can shareholders do? They can re-invest in capital markets.  They can invest abroad.  Generally, they go where the returns on their investments seem best.  To companies that do the best at cutting costs and increasing efficiencies.

But who are the shareholders?

Certainly, many wall streeters and other members of the upper echelon of wealth.

But they are also many of the rest of us: anyone with a pension fund or 401(k).  Who have a choice and a voice.

If the government doesn't do anything about the non-economic policy of the kind of free market capitalism that's bringing us to these turn of events, the shareholders can.

On Shifting Economies

The newest range among young people -- farming.  It's not unusual to see hipsters flee the cities to go farm somewhere -- whether it's as a group of migrants abroad, or in a small plot of land in Maine.

Though many terrible things can be said of industrial farming -- the Meatrix comes instantly to mind -- that American youth are embracing this form of work seems to reflect the inevitable economic shift arising as a result of globalization.

For much of the last century, farms turned into Agribusiness, and family-owned farms, just large enough to be handled by a few workers, was the lot of the "developing" world.

Perhaps it's time we re-think our definition of which states are the "Developed" and "industrial" kind, and which are not.

The Dangers of Relying on Economic Serendipity

Back when workers, investors, executives and their creditors all relied upon the success of each other for future prosperity, our system of corporate governance worked pretty well better. 

Companies paid workers well, because those workers bought the company's products.  Creditors of the company were on board; their loans would only be made good if the company was in the black. 

And if investors wanted to make money on their savings, they'd invest in these companies.  Wanting those companies to do well, so that they can make that profit, they'd also look kindly on paying workers living wages.

Thus, a hands-off approach to corporate governance, along with an absent-minded (or malicious?) neglect of unions, seemed to work.  In fact, many went so far as to conclude that because of these laissez-faire attitudes, American was assured a future of enduring prosperity.

But it only worked because the companies relied on the prosperity of their own workers.  Or, at least, were forced to through collective bargaining.  And investors, in turn, relied upon the prosperity of those companies. 

In other words, it only worked because of a historical accident: an economy functioning in isolation, on a continent separated from its developed-country peers by entire oceans. 

Enter globalization. 

Suddenly, a company can propsper without the purchasing power of the American consumer.  If it can cut costs and gain competitive advantage by moving to cheaper labor markets, why not? They can suck American consumers dry and, if the pot runs out, well, there are these growing middle classes in India and China.

Moreover, investors can now move their capital freely.  If there's more profit to be made in Bangladesh or Burma or Croatia, that's where they'll go.  The increased capital investment, in turn, leads to changes those countries' comparative advantages -- likely to  investment in longer-term projects that will give them comparative advantage in more sophisticated industries.  Or in any industry whatsoever -- including those industries that America used to embrace. 

With the opening of borders, America's future doesn't look so bright.   We don't have any claim to the world's capital investment.  We don't have any fences limiting the customer base of industry.  In other words, we're out in the deep water with the rest of what we so quaintly referred to as the "Third World."

And our "serendipity" style of corporate and labor governance hasn't got a lifeline to throw us.

Might we look to Western Europe as an example, whose corporate governance regime includes a greater safety net, and whose members started integrating economically decades ago?

Puke

Daley (chief of staff JP Morgan stooge) opinion column in today's FT -- talking about how "pro-business" Obama is.  Citing, inter alia, proposed free trade treaties and the elimination of discretionary spending.

You know, the stuff that hurts working people and the environment.

Wells Fargo - A Bit of Sunshine?

U.S. banking regulators are discussing new rules that would require banks that originate home loans to require larger down payments before they may fully "securitize" the balance.  They aim to make sure lenders, asset-backed security investors and borrowers all have skin in the game.

In other words, if lenders make subprime loans (that require little down payment), they have to suck up some of the credit risk of the borrowers, rather than passing it all on to someone else through derivatives.  As we have all learned to our great regret, those other investors remained ignorant of that credit risk -- whether because they relied on bogus credit agency ratings or because they just rode the real estate asset bubble like everyone else.

The rest is demand and supply: lots of investors wanting home loan securities drive up the price.  Which causes lenders to make more and more of them.  More and more subprime loans.  Which, of course, drive up real estate prices.

Unsurprisingly, most banks are fighting this proposed regulation kicking and screaming.  Some even have the gall to assure us that the financial crisis "self-correction" already caused lenders to fix their lending and securitization practices.

But one bank stands out:

The notable exception has been Wells Fargo, which has pushed for even tighter underwriting standards than the regulators seem to favour. In a recent letter to regulators, Wells Fargo argued that borrowers should be required to make down payments of at least 30 per cent before banks are allowed to fully sell the loans to investors.

“The point we are making, unlike others, is that risk retention is a good idea,” John Gibbons, an executive vice-president with Wells Fargo Home Mortgage, told the Financial Times. “Rather than being something rare or unusual, it should be common in the mortgage industry to align the interests of lenders, borrowers and investors.”

Priorities of the NYT - Today's Front Page

Because the cleanliness of the Wisconsin capital building is what's really newsworthy.

Some Motivation

From Matt Taibbi's blog:

...Nomi Prins’s book, It Takes a Pillage. Nomi, who used to be a VP at Goldman but is now one of the leading authorities on where the bailout monies have been spent and why, frequently makes the point that the bailouts were more about paying off bets than they were about stabilizing the economy. This is from her second chapter, “This Was Never About the Little Guy”:

Here are some numbers for you. There were approximtely $1.4 trillion worth of subprime loans outstanding in the United States by the end of 2007. By the first quarter of 2009, there were forclosure filings against approximately 4.4 million properties. If it was only the subprime market's fault, $1.4 trillion would have covered the entire problem, right?

Yet the Federal Reserve, the treasury, and the FDIC forked out $13 trillion to fix the housing “correction”… With all that money, the government could have bought up every residential mortgage in the country – there were about $11.9 trillion  worth at the end of December 2008 – and still have had about a trillion left over to buy homes for every American who couldn’t afford them.  

And to cover the devastating losses these wankers sunk on teachers' pension funds, we want to take away collective bargaining rights? Of people who make $40k a year (in a generous state) and drive a '98 Ford Taurus????

Union Busting and Book Burning

Paul Krugman noted in his blog today:

That Iraq Feeling

I don’t watch cable news, or actually any kind of TV news. But I gather that there’s a virtual blackout on the huge demonstrations in Wisconsin, except on Fox, which portrays them as thuggish and violent.

What that makes me think of is January-February 2003, when anyone watching cable news would have believed that only a few kooks were opposed to the imminent invasion of Iraq. It was quite spooky, realizing that hundreds of thousands of people could march through New York, and by tacit agreement be ignored by news networks whose headquarters were just a few blocks away.

And it’s even more spooky to see it happening all over again.

Thus, you wouldn't know, for example, that according to a NYT/CBS poll, over 60% of independents support collective bargaining rights -- and over 70% of democrats.

Phil Merritt, 67, a retired property manager from Crossville, Tenn., who identifies himself as an independent, explained in a follow-up interview why he opposed weakening bargaining rights for public workers. “I just feel they do a job that needs to be done, and in our country today if you work hard, then you should be able to have a home, be able to save for retirement and you should be able to send your kids to college,” he said. “Most public employees have to struggle to do those things, and generally both spouses must work.”

Fair wages for fair work.  Unions being the only stopgap (toilet clog? Thanks Mssr. Perot) between our economy and ones found... in Mexico.  And Egypt.  


And this is definitely a class issue.

Although cutting the pay or benefits of public workers was opposed by people in all income groups, it had the most support from people earning over $100,000 a year. In that income group, 45 percent said they favored cutting pay or benefits, while 49 percent opposed it. In every other income group, a majority opposed cutting pay or benefits: Among those making between $15,000 and $30,000, for instance, 35 percent said they favored cutting pay or benefits, while 60 percent opposed it.

It's time folks started standing up for themselves.  To point out to Washington that the emperor has no clothes it sold out to Wall Street -- and that includes, most especially, Obama -- and we've finally pulled the wool from over our eyes.

Silencing the Voice of Activist Investors

Today, the NYT describes a trend in state legislatures to roll over defined benefit pension plans into a version of 401(k).  401(k) funds (because of Taft-Hartley?) are decidedly not-activist.  They are even accused of "apathy" by certain defenders of director primacy when challenged by opponents who decry the lack of "democracy" in corporate governance.

The biggest player? CALPERS.  Who made news last week by forcing Apple into majority voting, and who is now under attack by the Juggernator:

California’s problems are so acute that just last week a government-appointed commission of experts urged the state to consider at least a partial switch to 401(k) plans; six years ago, an effort by Arnold Schwarzenegger, then governor, to move new employees into such plans was blocked by local governments and public-employee unions.

Making everyone roll their pension fund into a 401(k) will kill CALPERS.  Which is exactly what industry wants.

Exec Pay as a Strawman?

Biglaw partner Jeremy Goldstein has a piece on why corporate directors deserve their hefty paychecks.  Certainly, the downward pressure on these paychecks is coming from many directions -- from Dodd-Frank, from institutional investors with their say-on-pay votes.  A manifestation of populism and deep frustration at our crap economy and the financial boondoggles that have made us all victims.

Over the past decades, we've seen the paychecks of working people stagnate, subsidized by easy credit, while the surplus value got allotted directly into the pockets of the uber -- and growing uberer -- rich.

But has anyone ever done a study to see how much more corporate executives have been making vis a vis the bankers?  Arguably, at least corporate executives do productive things, like, um, run companies that make things and pay workers.  The bankers, though?

One might even argue that the crowing of activist pension fund investors is a bit misplaced.  They should be targeting not so much corporate leadership, but the titans of wall street.

Noon Tomorrow

Get off your couches and find your local rally.

Our unions are our last best hope to preserve a comfortable middle class lifestyle.

Moody's and Union Busting

To bring this issue full circle, in an attempt to lay blame where it's due:

State pension funds are supposed to invest in safe assets.  Indeed, the law even requires them to buy up only "investment grade" securities.  I.e., those assets rated AAA to B- by ratings agencies.  This was supposed to make up for the fact that all of them got privatized and therefore people didn't have their retirement income funded directly by the government.

And they did what they were supposed to do.  With gusto.  They bought all those AAA-rated toxic mortgage backed assets.

Unfortunately, Moody's and S&P slapped this pristine AAA wrapping on all cowpaddie mortgage derivatives.  Why, why, oh why would they do this?

Among Mr. Clarkson’s [former Moody's exec] duties: make nice with Wall Street. Some banks and debt issuers in the 1990s regarded Moody’s as uncooperative, even rude, which led firms to seek ratings elsewhere.

“From the day that I started at Moody’s, Moody’s was deeply concerned about the relevance they had in the marketplace,” he said in his private testimony with commission examiners. “A rating agency may have a methodology that is superior. But if they’re not assigning any ratings, they don’t have any relevance in the marketplace.”

Okay.  So credit ratings agencies gave big warm bear hugs to spinoff entities birthed by Bear Stearns that contained nothing but toxic assets.  Even if Bear Stearns was actually betting against those assets.  So they could stay "relevant."

And here's another question.  Why, why, oh why do our regulations force our reliance on these private ratings agencies by requiring our pension funds to rely upon their ratings?

And, lastly, why oh why are credit ratings agencies immune from lawsuits over the crappyness of their ratings? (according to our courts, such ratings, as mere "opinions," can't serve the basis for claims for fraud and misreprentation against the agencies that give them. 

Of course, at the same time, the bankers themselves hide behind the ratings to shield themselves from liability.  Their argument goes like this: they couldn't have committed fraud in selling these crap securities while telling everyone they were safe -- Moody's, after all, gave those securities AAA ratings.  It was just a big mix up.  No criminal intent here.

So who gets stuck with the bill for all this? The union pension funds, of course.  Which are so broke that state governors like Walker are using it as an excuse to bust the unions in the first place. 

Putting Money Where Your Mouth Is -- and Spitting It Back

So much about the proposed federal budgets -- anyone's version -- is shocking and awful.  But this is particularly apropos to this blog:

Republicans propose cutting the budget of the Commodities Futures Trading Commission by one third.  This is the agency that is supposed to be regulating the shadow-banking "derivatives" industry that got us all into such terrible trouble.

You know, the same reason why everyone is clamoring about austerity to begin with.

Though the point has been iterated ad nauseum, here it is again: you can't have good government if you starve it to death and outsource the rest.  Or, in the words of a CFTC commissioner:

The process “will mean nothing, squat, diddly, if we don’t get the resources to do the job,” he said. “If we get cut, we’re going to be in a world of hurt.”

It should be noted, too, that the CFTC still has a reputation of being a watchdog with some teeth, unlike the SEC, who was and remains wall street's BFF. 

The Great American Frontier

According to Tim Geithner, American High Finance will lead us marching proudly into the future.  Providing finance to other countries that actually make things and could use the cash to invest.  I suppose he's assuming that all Americans will benefit by getting jobs working for wall street.  Riiight.

After all, High Finance thus far has worked out so well for the rest of us.  But I suppose Geithner has a good reason to think the past has no bearing on the future.
Not that Tim Geithner has any skin in the game or anything -- I'm sure after his tenure as treasury secretary, he won't go back into Wall Street but will get a job pruning bushes and welding at a plant in Detroit.

Note to parents: quit pushing your kid to get that football scholarship.  Enlist little Susie and Timmy into tots 'n quants.

Puke

Even people in the UK, public sector unions are BAD because their members get better terms than private counterparts.

Why can't we ever compete up, and not down?

<insert flushing toilet sound>

Ross Perot, we miss you.

"Americans Choosing to Pay Overdraft Fees"

ahhh, linguistics.  And one would expect better from the lofty intellect of the financial times....

Just like they "choose" to pay 500+% on their payday loans.

The Exercise of Shareholder Democracy

Yields majority shareholding reforms at Apple.    A favorite child of activist institutional investors like the CALPERS and TIAA-CREF pension funds, majority voting measures prevent the election of directors without the votes of a majority of shareholders.  And rumor is that more reforms are on the way in many publicly traded companies.

Without such reforms, directors can be elected, theoretically, by just one vote, i.e., the majority of shareholders that bother to vote.    Most shareholders, like most Americans, don't bother voting.

The result is a system of political entrenchment, especially as individual shareholders have to first pester their brokers to exercise proxies on their behalf.

Before we throw any parties, though -- activist investors, at least in American firms, are focusing their activities only on voting reforms.  It is still up to them to elect directors that will do something good for the world.

And as do-gooder investors like CALPERS and TIAA-CREF represent only a small minority of share ownership, we can have every expectation that directors will be still judged and selected by short term share price.

D'oh

Whaddya know.  Self-regulatory bodies can't get no cooperation from those they self-regulate.  Even when it comes to disclosing petty crimes that don't have anything to do with securities fraud.

How very.... efficient.

Command and Control - Incomplete Contracts and Workers

Paul Krugman's post from yesterday touches a point regarding which most scholars of corporate governance are familiar:

February 19, 2011, 10:07 AM

Thank You, Boeing

For providing such a clear illustration of the forces driving the theory of the firm.

Oliver Williamson shared the 2009 Nobel mainly because of his work on a question that may seem obvious, but is much less so once you think about it: why are there so many big companies? Why not just rely on markets to coordinate activity among individuals or small firms? Why, in effect, do we have a lot of fairly large command-and-control economies embedded in our market system?

Williamson answered this in terms of the difficulties of writing complete contracts; when the tasks that need to be done are complex, so that you can’t fully specify what people should do in advance, there can be a lot of slippage and strategic behavior if you rely on market incentives; in such cases it can be better to do these things in-house, so that you can simply tell people to do something a particular way or to change their behavior.

In Boeing’s case, they outsourced far too much, only to find that they were getting parts that didn’t do what they were supposed to — and also to find that the subcontractors were seizing a lot of the rents. They discovered, in effect, that there are times when it’s better to rely on central planning than to leave things up to the market.

Obviously this isn’t always true. There’s a tradeoff. But that’s the point — and it’s this tradeoff that determines how big firms should be. Boeing has now provided a clear motivating example. Their loss, the economics profession’s gain.

*******

These "incomplete contracts" are used by director-primacy type scholars to justify a command-and-control structure.  The board and management run the show and, as long as they're not stealing, everyone else has got to eat the results or get out.  Theoretically, according to these scholars, it's more efficient for everyone.  Having to re-negotiate with adverse third parties every time you want to get something done can be wasteful and counterproductive.

Thus, adding in shareholder meddling in corporate governance can undermine the efficiencies of command-and-control.  Suddenly, stuff's being re-negotiated again.  Usually to the benefit of the shareholder.  And the company is spending time and resources re-negotiating.

Yet, allowing more negotiation isn't inherently a bad thing.  It can also lead to fairer results and efficiencies.

The problem comes when you only allow one group to re-negotiate.   The folks without a seat at the table tend to get screwed over.

 Think of it this way: a subcontractor that provides mail and shipping services to a corporate client will get paid better than in-house secretaries, file clerks, and drivers.  They can negotiate their prices upwards, while secretaries, file clerks and drivers can only apply the same amount of leverage through collective bargaining -- and then, only when employment contracts come up for renegotiation.  Meanwhile, they've just got to swallow orders.

In the public corporation, because they have a seat at the table, shareholders can force directors to pay more attention to stock price.  Non-unionized employees have no such power.  The result? lower wages and layoffs.

Closing the Circle on the Financial Crisis

How did we get into this mess? Certainly, poor regulation.  Certainly, wall street greed.  Certainly, government-subsidized home ownership.  But where did it all start? Poor regulation, government subsidies, and wall street greed are nothing new.

Trade imbalances, offers Bernanke.   And the roots can be seen in the fact that Americans don't own any real estate in America anymore.  And the fact that Americans don't make anything anymore.  Remember when Rockefeller Center was sold to Mitsubishi??

As a result of free trade policies, among other things, Corporate America picks up and moves shop to cheaper labor and regulatory markets.  Cheaper labor and regulatory markets start selling Americans cheap stuff, and get a bunch of cash.  Americans, instead of making things, buy more stuff from abroad than they sell abroad.

Soon, these cheap labor and regulatory markets start sitting on dollar-denominated savings gluts.  What to do with it all?  They start snapping up investments denominated in dollars.  They're risk adverse, so first it's real estate.  Like commercial real estate in Manhattan.  Their job is made easier by trade rules greasing the movement of capital across borders.

And then when the real estate market got saturated -- or foreigners' savings grew -- it was AAA rated securities for which they hunted.

Meanwhile, the privatization of pension funds -- both overseas and American -- also start looking for places to dump folks' retirement savings.  UK institutional investors and SEIU pension start looking to snap up "safe assets."

Bear Stearns, Lehman, Goldman et al. were happy to comply -- aided by credit ratings agencies.  "Structured Finance" entities that bundle and collateralize and securitize home loans, for example.  An easy pick, given the glut of home loans.

And so Chinese dollar reserves and retirement savings funds bought those risky assets.  A lot of them.  And Goldman et al kept making more.  The demand for AAA investments was too high not to. 

Perhaps it wouldn't have happened if these AAA investments were actually investment-grade.  Had ratings agencies and home loan markets not gone bananas.  And perhaps there wouldn't have been so many of these crap AAA investments had the U.S. government not bent over for wall street lobbyists to repeal Glass Steagall.

But the money was there to be taken.  Somebody would have grabbed for it.  We shouldn't be surprised that someone did, and did it poorly.

How do we fix this?

We make sure labor markets and regulatory markets everywhere are on a level playing field.  Take care of our trade imbalances.  And we get serious about defined benefit pension funds.

More Wet Noodles

And Finra's enforcement chief is going private.

Finra -- the NYSE's and NASD's enforcement arm -- of course well-known for its stern treatment of financial crisis crooks.

Well, at least public worker unions in Wisconsin finally got tired of getting laughed at.

Fat Chance

Bill Daley, Obama's new chief of staff, got $9 million in comp from JP Morgan last year.

The only feet that are, or ever will be, held to the fire are those of working stiffs who don't have any retirement savings anymore.

Why Civil Suits Aren't Enough

Now that we all know that America's law enforcement agencies aren't going to do much more than caress and tickle crooks' derrieres with wet noodles, one can hold out hope that investors' fraud suits would at least make them pay.

Except -- who's actually paying?

Rarely is an individual's feet held to the fire -- by civil plaintiffs or by the government.  It's the company itself found wanting.  And even if the individual is a complete crook who did lots of very bad things, it's the company itself that pays the bills.

For example.  Angelo Mozilo, the Countrywide Crook, was once the most highly paid executives in the country.  From 2000 to 2008, in racked in a $521.5 million paycheck.  But, when the SEC slapped a criminal fine on him for fraud, his employer paid $45 million of his $67.5 million settlement.    So, $500 million of that comp walked away into the sunset with Mozilo, while investors, employees and corporate coffers got stuck with the bill.  For both.  Meanwhile, the DOJ has dropped its own investigation.  

Likewise, so-called maverick Judge Rakoff of the SDNY held his nose approving weak-kneed settlements between the SEC and Goldman, noting that the folks paying the fines were the shareholders themselves -- yes, the same folks injured by wrongdoing to begin with.

Vampire Squids Redux

The State of Illinois is planning a bond offering to subsidize its commitment to contribute to state workers' pension funds.  

Who's underwriting? Morgan Stanley, Goldman Sachs, et al. 

Why does the State of Illinois need to borrow to subsidize its contribution commitments?

Well, the funds are about $86 billion in the hole.  In part because of huge losses -- like those everyone else suffered -- in 2008 and 2009.

So, immediately we see that while the taxpayer is supposed to bail out financial conglomerates for investing in risky and toxic structured financial imbroglios -- enabling banksters to walk away with seven-figure bonuses -- they're supposed to ignore the plight of state hospital janitors, victims of those investment schemes.

That's bad enough.  But, why would normally risk-adverse pension funds be involved wtih this kind of crap investment to begin with? 

Certainly, much of the blame falls on credit ratings agencies.  Yes, the ones who teamed up with Goldman, Bear Stearns, Lehmen etc. to peddle "AAA" toxins to the rest of us dumbasses.  Yes, the same ones that are threatening to downgrade investment ratings on government bonds.  The same bonds that Illinois' got to peddle to meet its pension commitments. 

But some of the blame must fall on the state government.  Who decided, for some reason, to stop contributing to the funds as much as the funds should pay out:

one of the main problems was a state law, passed in 1994, permitting Illinois to contribute less to the pension fund every year than the amount that would actually cover the benefits.

Thus, the funds had to find a way to make a big profit to cover their obligations to pensioners.  And investments with the kind of high profit margins that could accomplish this are inherently risky.  That's why savings accounts yield less interest than junk bonds.

D'oh.  I don't know why they did this.  Maybe they wanted to kill public pensions.  Maybe they thought we'd all get a ride to heaven on the stock market.  Either way, it doesn't matter now.

Meanwhile, the same financial institutions that walked away gloating from the financial crisis that ruined pension funds' balance sheets are the very same vultures gorging on underwriting commissions divied out by the state when they've got to sell bonds just to meet funds' operating expenses.

Who Said Solidarity Was Dead in America

Well, so say most people. 

And here go the pensions and health care benefits for public workers in Wisconsin.  State budget worries, and Paul Krugman's so-called Bond Vigilantes perhaps, serve as another excuse to cut away at the remaining fragments of unions in this country.

Look.  Lower union wages and benefits drags down the entire labor market.  Including yours.  And isn't it a nicer thing to say that "we should all get good benefits, not just government workers" rather than "why should he get the goodies when I don't??" 

How about: we cut the salaries of state lawmakers first. 

Solidarity from here in Delaware, friends.

No Longer Forthcoming

Whups.

Read this. 

Vampire Squids - Forthcoming From Matt Taibbi

Matt had a great quote once about Goldman Sachs:

The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. In fact, the history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled dry American empire, reads like a Who's Who of Goldman Sachs graduates.

Now he's going to publish, very shortly here, a piece explaining that AIG didn't necessarily have to die with its hands in the structured finance cookie jar:

The collateral calls that AIG faced from Goldman and other companies actually had nothing, or very little, to do with the credit default swaps in the actual deals. What happened was this: the subsidiary of AIG that wrote those contacts, a company called AIG Financial Products (AIGFP), wrote them in such a way that their customers could demand cash collateral in the event that the parent company, AIG, suffered a downgrade in its credit rating. At the time the contracts were written, primarily before 2006, the idea that AIG would suffer a downgrade was almost unthinkable; it was the world’s largest insurance company and considered one of the strongest firms in the world.

However, in 2006, AIG got wrapped up in a major securities fraud scandal in which the company was caught using sham transactions to hide losses. AIG ended up having to pay $800 million in fines and the scandal led to a downgrade of AIG’s credit rating, which in turn led to Goldman making the first of its collateral calls in the summer of 2007. Collateral calls happen when an investor or customer is sufficiently worried about your long-term liquidity that it demands cash to make itself feel better about having tons of money tied up in your future. AIGFP’s contracts allowed customers to make such calls in the event of a downgrade, and that’s why the firm became vulnerable so shortly after the 2006 scandal.

 

Better Decisions and Better Deciders

More to follow on what, for sure, will turn out to be a landmark in Delaware jurisprudence.  For now, though, the Court of Chancery's opinion in Air Products v. Airgas, Inc., is noteworthy for the following:

In essence, this case brings to the fore one of the most basic questions animating all of corporate law, which relates to the allocation of power between directors and stockholders.  That is, "when, if ever, will a board's duty to 'the corporation and its shareholders' require the board to abandon concerns for long term values (and other constitutencies) and enter a current share value maximizing mode?"  More to the point, in the context of a hostile tender offer, who gets to decide when and if the corpoation is for sale?

The Court sided with the Board.

Lingering in the back of the Court's mind, one might have found the looming shadow of the 2008 financial crisis -- a crisis whose first manifestations occurred at the expense of the Enron employees who lost their life savings to corporate greed and pressures to inflate short term stock prices. 

Pressures that many blame on shareholders.  Including, so it seems, Delaware's estimable Court of Chancery.  So progressives -- be forewarned.  Delaware's allegedly "business friendly" environment may not be quite so stakeholder unfriendly.

The conflict over the allocation of governance power between boards and shareholders is, of course, overly simplistic.  Not every shareholder is alike.  Some are in it for the long run.  Some want to see their companies do good things.  Some would serve as admirable leaders of the corporate bastion.  But some wouldn't.  Some would strip away corporate assets to finance leveraged buyout transactions and walk away with a boatload of cash... and a truck full of pink slips to hand out.

 So, unless and until the law takes account of "good" shareholders and "bad" shareholders, best to put it in the hands of supposedly "neutral arbiters."  The Board. 

And the conflict fails likewise to give voice to other corporate constituences.  They must rely on that same Board -- members of whom they do not elect.  What would happen if employees governed companies?

Delaware Courts have no answer for that.

Karl and Watson

Perhaps Watson's no Hal.  He's not going to be a maniacal genius bent on destroying humanity as we know it.

But IBM's already gearing up, after the robo-contestant's Jeopardy! performance, for Watson's cousins to replace physicians assistants -- or even, egads, lawyers.

Karl Marx once said something about technology, growth, and working people.  Competition among industry participants leads to greater investment in captial to achieve efficiency gains and lower costs of production.  Generally, these efficiency gains means they need to hire less workers.  At least of the kind that demand decent wages.

Where do the workers go? Marxist opponents would say: to the machines that make the stuff that leads to efficiency gains.

But then you run into the same problem. 

It only works if the economy is dynamic enough to keep shifting to new ideas, new industries.  Yet, babies are born every day, babies that venture companies will hire before hiring a middle aged worker with higher minimum salary requirements and a more limited useful working life.  And the failed industrialists -- the ones who couldn't keep up -- continue to join the ranks.

And it's not exactly if our society is set up to feed them whilst they leisurely bide away their time at home, jobless.

Guess the PAs and JDs (who haven't already lost jobs to doc review corals in India) are going to start to feel like it's like to be a line worker.  Or how it feels like to have an outsourced IT job.

The answer here, of course, is not to disdain technology.  Especially the kind that can improve peoples' health.  The answer is to distribute the savings and gains in such a way so that people don't starve to death.  Not just to the clawing hands of the very few.

Otherwise, we'll have to start calling Watson "Hal."

Derivative Lawsuits: Why are the Bankers Always at the Bottom of It All?

The Delmonte opinion came out today.

Turns out the banksters were turning away bids and steering buyouts to private equity investors.  Rather than to, um, a firm that could use the company to grow its own business or do something else productive and useful.  And probably be better in the long run for the rest of the shareholders, employees, and all the other corporate constituents. 

Well, the Delaware court said this was a big no-no -- at least when you're a bank and you promised the company offering itself up for sale that you wouldn't put the deal together on behalf of private equity.  And did it anyway.

But other than that lie... they probably would have gotten away with it.  So on goes the trend -- companies being bought by private equity.  hopefully private equity actually wants to run a good business.  one that will last longer than their quarterly reports to shareholders.

Required Reading

From today's NYT editorials:

Op-Ed Contributor

Wall Street’s Dead End

By FELIX SALMON

Published: February 13, 2011

THE stock market has been big news in recent days. Last week’s report that Deutsche Börse, a giant German exchange, intends to buy the New York Stock Exchange, creating a company worth some $24 billion, arrived shortly after the Dow broke the 12,000-point barrier for the first time since before the financial crisis.

These developments drew headlines because they seemed to exemplify significant trends in the American economy. But look at America’s stock exchanges more closely, and there’s less to them than meets the eye. In truth, the stock market is becoming increasingly irrelevant — a trend that threatens the core principles of American capitalism.

These days a healthy stock market doesn’t mean a healthy economy, as a glance at the high unemployment rate or the low labor-market participation rate will show. The Tea Party is right about one thing: What’s good for Wall Street isn’t necessarily good for Main Street. And the Germans aren’t buying the New York Stock Exchange for its commoditized, highly competitive and ultra-low-margin stock business, but rather for its lucrative derivatives operations.

The stock market is still huge, of course: the companies listed on American exchanges are valued at more than $17 trillion, and they’re not going to disappear in the foreseeable future.

But the glory days of publicly traded companies dominating the American business landscape may be over. The number of companies listed on the major domestic exchanges peaked in 1997 at more than 7,000, and it has been falling ever since. It’s now down to about 4,000 companies, and given its steep downward trend will surely continue to shrink.

Nor are the remaining stocks an obvious proxy for the health of the American economy. Innovative American companies like Apple and Google may be worth hundreds of billions of dollars, but most of them don’t pay dividends or employ many Americans, and their shares are essentially speculative investments for people making a bet on how we’re going to live in the future.

Put another way, as the number of initial public offerings steadily declines, the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money.

What the market is not doing so well is its core public function: allocating capital efficiently. Apple, for instance, is hugely profitable and sits on an enormous pile of cash; it is thus very unlikely to use its highly rated stock to pay for any acquisitions. It hasn’t used the stock market to raise money since 1981, and there’s a good bet it never will again.

Meanwhile, the companies in which people most want to invest, technology stars like Facebook and Twitter, are managing to avoid the public markets entirely by raising hundreds of millions or even billions of dollars privately. You and I can’t buy into these companies; only very select institutions and well-connected individuals can. And companies prefer it that way.

******

Only the biggest and oldest companies are happy being listed on public markets today. As a result, the stock market as a whole increasingly fails to reflect the vibrancy and heterogeneity of the broader economy. To invest in younger, smaller companies, you increasingly need to be a member of the ultra-rich elite.
At risk, then, is the shareholder democracy that America forged, slowly, over the past 50 years. Civilians, rather than plutocrats, controlled corporate America, and that relationship improved standards of living and usually kept the worst of corporate abuses in check. With America Inc. owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the postwar period.

Today, however, stock markets, once the bedrock of American capitalism, are slowly becoming a noisy sideshow that churns out increasingly meager returns. The show still gets lots of attention, but the real business of the global economy is inexorably leaving the stock market — and the vast majority of us — behind.

Right.  The stock markets haven't raised money for Apple since 1981.  I bet it's been financing its operations through retained earnings.  Lines of credit and bank loans where needed. 

So what's the point of stock markets, again?

One criticism of this article:

At risk, then, is the shareholder democracy that America forged, slowly, over the past 50 years. Civilians, rather than plutocrats, controlled corporate America, and that relationship improved standards of living and usually kept the worst of corporate abuses in check. With America Inc. owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the postwar period.

American standards of living did not increase because of distributed share ownership.  It was because the economy was growing and because industry, to forestall major social(istic) federal regulation, decided to give employees health insurance and other benefits.  Corporate abuses held in check more by unions (then more powerful) than by shareholders.

But otherwise, this is very refreshing to see.  Especially from the NYT. 

Subprime Securities Suits: In Plain English

According to the Second Circuit, in an opinion issued yesterday, financial firms dabbling in toxic assets (or, more specifically, selling CDS "insurance" for toxic assets to other people) should have put 2 and 2 together for their investors when it came to the sub-prime meltdown.

They can't hide behind the fact that there was a widely-known downturn in the housing market, or that defaults on mortgage loans were on the rise. 

No, instead they should have (at least under Item 303 of the SEC's Reg S-K) pointed out exactly how that downturn would impact their profit margin -- even if that impact would only affect a relatively small portion of the firm's overall assets.

After reading the Court's opinion, one might conclude that Plaintiffs would have lost their appeal had the culprit at issue -- Blackstone -- not sold its private equity business to prospective investors in quite such glowing terms.  Having made this part of its business -- which included the CDS mess -- its masthead, it shot itself in the foot.  Now it's got to air all its dirty laundry, even if it's just one lone smelly sock in a walk-in closet full of fresh clothes. 

Regardless, the future is yet uncertain for Blackstone, who must now proceed through litigation.  Plaintiff has to leap a higher hurdle this time around. 

The standard on a motion to dismiss based on the alleged non-materiality of a misstatement is something like: you can keep your case as long as you can't say no reasonable investor anywhere would ever find the misstatement material. 

At trial, the standard is something else: the average reasonable investor would have found the misstatement material.

Speaking of plain English.  God bless the lawyers that scribed those juicy little tidbits.

Those Pesky "Special Interests"

You can't stumble through cable news anymore without talking heads spewing the evils of the Powerful Special Interest Lobby. 

The word "special" certainly has special meaning in our national vernacular:

Special.  [spesh-uhl] adj.  (a)  having less mental, physical or emotional acuity than that generally found in people, applied not because it's accurate but because we don't want to be mean.  (b) someone who might be getting something they don't deserve.

In other words, "special interests" don't apply to any old lobby.  They just apply to lobbies that don't cater to the business elite.  But, of course, they don't say "poor peoples' lobby" or "battered women's lobby" or "underrepresented racial minority lobby."  While accurate, these labels imply that their members' hearts are good and deserving. 

"Special interests," lobby, though... that appelation incites the following question: "what makes those people so special that they get special treatment?" And we know Americans; they'd rather shoot themselves in the foot rather than see just one person get something she might not deserve. 

The same, of course, applies when it comes to "special interest" shareholders.  At least according to the Biz Rountable, in the brief they filed in the action they brought challenging the SEC's new sharholder proxy access rule. 

Petitioners brief essentially asserts that access will be usurped by "special interest shareholders" who will -- those villains! -- exert their shareholder franchise in a manner that does not strive to maximize shareholder value at any cost.  Just like "special interests" steal our tax dollars and corrupt our politicians.

And, of course, the purpose of corporations is (who could question this dogma???) to maximize shareholder value.  How very embarassing for us academics and activists and respected Delaware jurists who urge otherwise. 

In particular, the Biz roundtable's brief seems especially bent out of shape when it comes to union pension funds usurping corporate boardrooms with their destructive "special interest" concerns.  How dare they, um, make corporate management deal with labor issues.  It's not like corporate leadership should have to bother about how the corporation treats their workers.  Insane!!!!

Regardless, the folks at Race to the Bottom point out, citing the amicus brief filed by the CII, TIAA-CREF and other funds, it's all much ado about nothing:

the   “special-interest”   shareholder   petitioners   purport   to   fear   is   a phantom.     They offer no credible evidence to support their erroneous assertion that  the actions of “state government and labor union[]” investors often “appear to be driven   by   concerns   other   than   a   desire   to  increase”   shareholder   value.   They offer no evidence that such “parochial” investors have burdened corporations with unreasonable demands in countries with proxy access.   And the one anecdote cited by petitioners undermines their claim.  They do not assert that the Safeway “vote-no” campaign participants would have met the Rule’s 3%-ownership-for-3-years requirement.  To the contrary, the participating funds there “collectively h[e]ld about 7 million of Safeway’s 445   million outstanding shares”—or only 1.6%.  Petitioners’ own example thus proves the Rule’s efficacy.   And if there were outlier abuses, the  across-the-board benefit  to shareholders of  greater director responsiveness abundantly justifies any minimal outlier costs.

So those "special intersts" aren't as powerful as the Biz Rountable would make them out.  Sound familiar?  Just like the special interests lobbies, who try to represent the underrepresented, are supposed to be walking away with all the goodies in Washington -- but aren't.  Who is? Guess.  Obama just made one of them his chief of staff.

They're getting David and Goliath mixed up again.