Wednesday, August 29, 2007

The New Version of Whac-A-Mole: Whac-A-Bank

I'm feeling particularly insolent today as it pertains to financial companies. The Times had an article yesterday citing regulatory filings that State Street management has been busy baking chocolate chip cookies. I guess that's what they've been doing because there aren't alot of plausible explanations of how actually managing the company could have created one hell of a ticking problem. A problem for the owners of the company. As a reminder to management, that would be the shareholders. And, doing so by playing off balance sheet games. I had no idea Anderson Consulting was back in the auditing business. How else do we explain these time bombs showing up on a regular basis? Sarbanes-Oxley and corporate governance reform were for everyone except the financial sector because the auditors have been taking a long nap at State Street and seemingly every other large financial institution. Does that include government banking regulators? Back dating stock options? That's for losers. How about a $22 billion shell game at State Street? This off balance sheet game is way too common of an occurrence amongst financial institutions. Not just off balance sheet but off company. So, for the bulls I have a question. Do you want to bet your savings on the accuracy and quality of earnings at financial institutions? One of the biggest shell games is the dance between hedge funds and regulated financial institutions. That's for another post. Too much to write about and not enough time. Isn't it ironic that unlike banks, hedge funds are a exempted from regulation by the Securities Act of 1933 and the Investment Act of 1940? What better way for regulated companies to skirt regulation? Just a thought. Maybe this is all an anomaly and we'll see a return to Goldilocks. So, I'm rather curious. What industry is the biggest lobbyist in Washington? Could it be? Possibly the financial industry? The same industry that spent $300 million to overturn Glass-Steagall?

The premise argued against hedge fund regulation is what? By some leap of faith rich people are smart and smart people don't need oversight? You mean like the rich and by inference smart bankers at State Street? Countrywide? American Home Mortgage? No, a more plausible generalization is that rich people are greedy and greedy people need oversight. (This is not a bashing of people with successful careers. I absolutely do not espouse such a position. People can be or do whatever they want just as long as they aren't bankers managing my life savings or pension and lobbying for reduced or no regulation.) What happens when hedge funds not only lose their own money but jeopardize my savings through an intricate web of deceit or even legitimate faux pas?

But we shouldn't tax capital. And if we institute too many regulations the money will go overseas. blah, blah, blah.
Cry me a river. A river of financial loss for shareholders and the economy. If we are so worried about competitiveness then we shouldn't allow tax credits for offshoring factories or tax business investment. I guess that's just capitalism at work thanks you your friendly politician. Please, this horseshit about not taxing capital is mindless nonsense beaten into your consciousness by those who benefit. The U.S. economy was a raging success before the current tax code. I don't believe any taxes should ever be raised or any type of class warfare should be used to increase taxes but let's get real. Japan has never been a destination for international capital (I'm not talking about financial shenanigans or carry trades but actual investment.) yet Japanese companies have generally thumped their international competitors for forty years. My point? The primary key to prosperity is to incentivize investment be it on the corporate or individual level not by making sure private equity has a tax loophole to pay lower rates than a school teacher. Does anyone honestly believe a country with an end market as large as the U.S. would attract enough capital with a positive investment tax policy instead of loopholes for private equity? Instead of going to Wall Street as much of it does today, it would reach main street in the form of sustainable investment that creates jobs, increases labor's talent, drives innovation and the associated higher wages. Maybe business investment wouldn't be at such dreadful levels if we had such a policy.

Expect these shenanigans to go on for quite some time. With the new Whac-A-Bank game as one company's mess seems to be contained, expect another to pop up. And as that mess appears contained, we will likely see another. But hey, the game show channel has plenty of guests telling you that financials are a compelling buy because of that great 3%-4% dividend. A little hint for those telling me to invest in financial institutions. There are plenty of ways to actually calculate risk versus the risk free rate of return on government bonds. The Fed Model is not a risk based investment calculator for those still yammering about how cheap stocks are. Anyone recommending financial stocks on a risk adjusted basis is a fool. Anyone not taking into account risk when talking about financial stocks is an even bigger fool. And, what do they say about fools and their money?

Oh, one more thing? This is not 1998. Oh, and one more thing. What does any of this have to do with housing? Housing is a symptom not the problem.

Right on time. As I wrote last year, we are going to see a massive political shift in the U.S. I didn't say it would do any good. But, crisis creates opportunity and it also drives meaningful change. It's all part of the process. A seemingly ugly one but one that does work. That is, until problems are but a distant memory and then we start the cycle all over again.

I'll leave you nuggets of a prescient article from the Post. Not surprisingly it was written two years ago. Was anyone listening?

Nor should it be surprising that such scams went undetected. Hedge funds are notoriously secretive, fending off regulations with the argument that they deal only with wealthy and sophisticated investors.

Former SEC chairman William Donaldson could see this coming but was able to push through only modest regulatory oversight of hedge funds. His successor, Christopher Cox, must show his mettle. At a minimum, hedge funds should be required to send audited, quarterly statements to investors and the SEC. With college endowments, insurance companies, pensions and mutual funds now so heavily invested in hedge funds, this has gone well beyond protecting rich investors.

With $1 trillion in assets, hedge funds have become a dominant force in capital markets, accounting for as much as half the daily trading on the stock market, hundreds of billions of dollars in bank loans and a healthy chunk of the profits of Wall Street brokerages. Federal regulators cannot guard against systemic risk to global markets if they don't know what hedge funds are doing.

This is not a case of a few rotten apples. It's a case of an industry that has become so rich and arrogant -- and so littered with charlatans and con men -- that government must step in to protect the public interest.

posted by TimingLogic at 10:40 AM

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