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Category: Corruption

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Power, Power, Power

In Washington, banking is known as one of the most powerful lobbies.  So this is an important call from an American Banker editorial “Big-Bank CEOs Need a Bigger Policy Profile in DC:”

The industry should enlist the help of its largest customers to make the case that big US companies need big US banks. Imagine the impact of having the CEOs of Boeing or Cisco testifying next to a couple of large financial firm CEOs.  The timing is ripe.  The Obama administration has adopted a more open attitude toward big business with the president hiring former JPM executive Bill Daley as his chief of staff and selecting GE chief Jeff Immelt to advise him on job creation. . . . Doors in Washington are opening.  Bankers should capitalize on the opportunity.

Thank goodness some things in America never change!  Best wishes to Prof. Elizabeth Warren and anybody else in Washington trying to help anyone other than those who can help themselves.  

Hat Tip: Lynn Turner

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Some Thoughts on DC Corruption

I’d like to thank the good folks at Concurring Opinions for inviting me to guest blog. The CoOp team has always been tremendously generous to me over the years–advising me on the teaching market (Dan, Frank), reading and commenting on draft  law review articles (Dan), and reposting some of my thoughts (Danielle).  And they’ve been kind enough to let me guest-blog for two months, as I was working through a law review article (grandly titled First Amendment Architecture–someone please publish it).

I tend to write about free speech and technology–like policies to ensure net neutrality, Internet access for all, or online innovation without permission. I am interested in media and the Internet because they are among our dominant means of speech, and speech is a basic input into all the decisions of our democracy. To the extent we design our speech systems more or less democratically, that affects all our policy decisions. I spent a few years in DC, working on media reform and network neutrality, among other issues.

I will write about technology soon. Today: corruption.

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Creating Value

I’ve talked in previous posts about a “closed circuit” economy among the wealthy. A plutonomy at the top increasingly circulates buying power (be it luxury goods, real estate, gold, or securities) among itself. The middle class used to dream that a rising Wall Street tide would lift all boats; as Felix Salmon shows, that hope is fading. Whatever innovations arise out of these companies aren’t doing much for average incomes.

On the other hand, financial innovation has done wonders to extract purchasing power from the broad middle into the closed circuit at the top. Here, for example, is how one of our leading firms created enormous value in 2006:

Consider the tale of Travelport, a Web-based reservations company. [A] private equity firm and a smaller partner bought Travelport in August 2006. They paid $1 billion of their own money and used Travelport’s balance sheet to borrow an additional $3.3 billion to complete the purchase. They doubtless paid themselves hefty investment banking fees, which would also have been billed to Travelport.

After seven months, they laid off 841 workers, which at a reasonable guess of $125,000 all-in cost per employee (salaries, benefits, space, phone, etc.) would represent annual savings of more than $100 million. And then the two partners borrowed $1.1 billion more on Travelport’s balance sheet and paid that money to themselves, presumably as a reward for their hard work. In just seven months, that is, they got their $1 billion fund investment back, plus a markup, plus all those banking fees and annual management fees, and they still owned the company. And note that the annual $100 million in layoff savings would almost exactly cover the debt service on the $1.1 billion. That’s elegant—what the financial press calls “creating value.”

The corporate geniuses at Boeing offer another display of modern-day business acumen.

The more stories like this you read, the more you realize that massive unemployment isn’t a bug in our economic system; it’s a feature. A country can’t have legal rules that permit these moves without expecting to hemorrhage jobs. All the Michael Porter homilies in the world can’t put this Humpty Dumpty back together again.

Liar Loans: White-Out & Scotch Tape at the Subprime Art Department

Doug Henwood has a good eye for the best of recent business analysis. Henwood’s interview with Michael W. Hudson (about Hudson’s new book, “The Monster”) is a must-hear for those interested in the subprime mess. From the book website:

This book tells the story of . . . subprime by chronicling the rise and fall of two corporate empires: Ameriquest and Lehman Brothers. . . . By the height of the nation’s mortgage boom, Orange County was home to four of the nation’s six biggest subprime lenders. Together, these four lenders—Ameriquest, Option One, Fremont Investment & Loan, and New Century—accounted for nearly a third of the subprime market. . . .

Under its pugnacious CEO, Richard Fuld, Lehman helped bankroll many of the nation’s shadiest subprime lenders, including Ameriquest. “Lehman never saw a subprime lender they didn’t like,” one consumer lawyer who fought the industry’s abuses said. Lehman and other Wall Street powers provided the financial backing and sheen of respectability that transformed subprime from a tiny corner of the mortgage market into an economic behemoth capable of triggering the worst economic crisis since the Great Depression. . . .

[Helped by Lehman,] Ameriquest Mortgage unleashed an army of salespeople on America. They numbered in the thousands. They were young, hungry, and relentless in their drive to sell loans and earn big commissions. One Ameriquest manager summed things up in an e-mail to his sales force: “We are all here to make as much f****** money as possible. Bottom line. Nothing else matters.” [This activity] helped fuel the mortgage empire that in 2004 produced $1.3 billion in profits [for Ameriquest's CEO].

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Flaming the Victims

Two recent items have me wondering about overinvesting in victim claims: (1) Christine Hurt’s new article on the implications of the Madoff scandal, Evil has a new name, and (2) Janet Tavakoli’s claim (if the link doesn’t work, this is also squibbed in the margin) that financial institutions caused the mortgage mess, the “biggest fraud in history.”  Both tell important—and perhaps accurate—stories about massive frauds that certainly produced victims. But both overlook an obvious point:  Not all victims are created equal.  As Pogo said, “we’ve seen the enemy, and he is us.”

Pogo victim dance

When Madoff first hit, I heard two interesting things from (reasonably) reliable sources which complicate the victim calculus.  First, one person who claimed to know a number of Madoff investors, said that many  believed that Madoff was able to guarantee outsized returns because of his access to inside information.  This, of course, is a kind of securities fraud. So, my friend said, “everyone knew Madoff was committing fraud—they just thought it was a different fraud.” You have to wonder how innocent investors were if, as Hurt reports, they were sworn to secrecy when they gave him their money.

I realize I will likely be flamed by holocaust survivors for insensitivity to their losses.  To the extent they were innocent, of course, I have nothing but sympathy for them.  The point, however, is that, as Madoff’s bankruptcy trustee is learning, there is little moral clarity in some of these claims.

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Rule of Law in Russia

This presentation by Bill Browder at the Stanford Graduate School of Business is a pretty astonishing account of the Russian economy over the past two decades. I am familiar with the usual story of oligarch profiteering, but Browder’s experience shows how even the ostensibly sound legal arrangements of today can quickly unfold into a nightmare for investors. As the Stanford GSB news puts it,

Browder soared to fame and fortune investing in Russian equities amid the chaos and corruption of the post-Soviet economy. His hallmark: finding hidden values in Russian companies and driving up their share prices by exposing corporate malfeasance and mismanagement. His widely publicized campaigns for shareholder rights and corporate governance helped propel the Hermitage Fund from $25 million in 1996 to $4 billion a decade later. But eventually the U.S.-born financier ran afoul of the Russian government, which banned him from the country in 2005 as a threat to national security.

According to Browder, “Anyone who would make a long-term investment in Russia right now, almost at any valuation, is completely out of their mind. . . .My situation is not unusual. For every me, there are 100 others suffering in silence.” And for a “bigger picture” presentation about the “disembedded markets” and the types of forces Browder was a victim of, Nancy Fraser’s Storrs Lecture podcast on “Predatory Protections, Tragic Tradeoffs, and Dangerous Liaisons: Dilemmas of Justice in the Context of Capitalist Crisis” is also well worth listening to.

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Compstat and Police Subculture

Last Friday the New York Times reported that a New York City police commander and four officers are facing internal charges stemming from their alleged failure to record criminal complaints.  These charges are just one piece of a larger story about the reliability of information fed into NYC’s Compstat program.  In a study released earlier this year, more than 100 retired high-ranking officers reported that they were aware of “ethically inappropriate” changes to crime complaints that fell into the seven major felony categories tracked by Compstat.  A patrol officer in Brooklyn’s 81st precinct has also reported widespread manipulation of crime statistics in 2008 and 2009.  (You can hear a This American Life episode about that officer here, along with excerpts from surreptitious recordings the officer made on the job.)

These recent revelations raise questions about the extent to which crime has actually fallen in New York City.   But the focus on crime reduction obscures another important issue about the occupational subculture.  For decades, police reformers have written about the importance of bringing down the “blue curtain,” that is, an occupational subculture in which a code of loyalty and secretiveness reign.  This subculture is widely believed to contribute to an “us and them” mentality which, among other harms, encourages police officers to do whatever is necessary to protect themselves and their fellow officers from criticism and administrative and legal penalties.  This mentality ultimately poses risks to those caught up in the criminal justice system and undermines public confidence in police work. 

When success is measured according to statistics, the temptation to manipulate is near irresistible.  Couple this with the dominant occupational subculture and almost anyone could have predicted that the data being fed into Compstat was unreliable.  The more important question is whether Compstat and its progeny are counterproductive to police reform over the long-term because they have the effect of reinforcing the dominant occupational subculture instead of remaking it.

Chris Lehmann, Rich People Things

The late Benoit Mandelbrot was a true polymath, inspiring new ways of thinking far beyond his own field of mathematics. In an interview conducted a few years ago, he made the following point about communication:

Many scientific articles are completely flat because they are written for people who do not have to be convinced. They are part of a small circle within a well-established domain; they write for each other, know more or less everybody, or are introduced by their thesis supervisors or mentors. As a result, style is a very secondary and unimportant thing for them. In my case, the fact that I write for an unknown public necessarily influences and shapes my style. Whether it is opera or Greek drama, one must know how to enter into a subject quickly because one cannot assume that the public will wait to understand. One has to be able to speak to people in their style, motivate and perhaps amuse the reader a little.

Chris Lehmann is a master at drawing people in. Though caustically titled and serious in intent, his Rich People Things made me laugh every few pages. He’s plied his trade on the RPT blog for about a year, but trust me: buy the book. As he notes in a brutal few pages on the Free-deology of Wired guru Chris Anderson, the web is rapidly moving toward a “feudal model of enterprise, whereby managerial rentiers . . . extract fees far upstream” from actual creators.
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Will Charles Ferguson be Our Ferdinand Pecora? (Review of Inside Job)

In his post on Michael Perino’s book Hellhound of Wall Street, Lawrence Cunningham observes that “Our predecessors were fortunate to have someone like Ferdinand Pecora to uncover top-secret financial shenanigans. No such person appears in our midst.”

It’s a tragic situation, especially because there are some real truth tellers out there—Yves Smith, Mike Konczal, Michael Greenberger, and many affiliates of the Roosevelt Institute come to mind. The difference between Pecora’s time and ours is a fragmented and manipulated media that a) can barely follow a complex financial story for more than a few hours, and b) fastidiously counterbalances every account of a Wall Street misdeed with some “expert” assuring us that it’s just business as usual in an industry that’s way too complicated for ordinary people to understand.

Charles Ferguson’s compelling film Inside Job steps in for a phantom mass media. Every citizen should be conversant with the basic narrative Ferguson puts together. Andrew Sheng, Chief Advisor to the China Banking Regulatory Commission, puts it in a nutshell: there was massive private gain in the US financial sector leading to massive public loss. Looking back, we might have all been better off if the finance tycoons profiled in the film had simply demanded hundreds of millions of dollars directly from the government back in 2000, and retired to Capri.

Instead, these deci- and centimillionaires helped build up the Rube Goldberg contraption of derivative deregulation, CDO’s, and CDS’s Ferguson describes. Fortunately, the film concisely explains that farrago in a way that will both educate the uninitiated and intrigue those who’ve read some books on the crisis. The film’s real contribution lies in four arguments it makes.
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Rakesh Khurana’s “From Higher Aims to Hired Hands”

Rakesh Khurana’s book From Higher Aims to Hired Hands: The Social Transformation of American Business Schools and the Unfulfilled Promise of Management as a Profession is a profound contribution to sociology and institutional analysis. It is also a persuasive critique of some of the most disturbing trends in the American economy. While B-schools may seem of marginal relevance to the actual conduct of CEOs, Khurana observes in the book that they “occupy the commanding heights of higher education . . . and the kinds of knowledge and skill they purvey [are] now seemingly more essential to the tasks of university—and indeed societal—leadership than anything taught elsewhere on campus” (367). Khurana describes how leading B-Schools gained a world of power, prestige, and influence in the 20th Century, but lost their soul along the way.

The Biblical echo here is intentional: like Weber, Khurana traces the religious origins of the concepts of vocation and higher education. His focus on values—as well as his harsh indictments of business education past and present—could easily lead Khurana to jeremiads or charismatic prophecy, but he skillfully resists both of these temptations. He offers a sober vision for hope in the future of business education. Khurana’s work should inspire legal academics as well as business school professors (as it already has in a conference at the University of St. Thomas Law School (pdf) last year).

Khurana’s book has several points of interest for legal scholars. He focuses on the role of community and norms as sources of values distinct from markets and governmental hierarchies. As post-crisis interventions in the health care, finance, energy, and transport have demonstrated, the old debates over “market vs. government” solutions, or “private vs. public” spending, are of fading relevance for serious social theory in the US (however potent they may be on the campaign trail). Flaws in the “government” are all too often rooted in flaws in the “market,” which are in turn rooted in past flaws in policy, ad infinitum. Recent liberalization of campaign finance rules will only accelerate that dynamic of capture. Institutions that generate values are some of the few entities capable of short-circuiting this pernicious circularity.
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