Category: Financial Institutions

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Argentina and Sovereign Insolvency

Thanks to Gerard for the nice introduction. Indeed, I am here to rant about bankruptcy, securities, and corporate, mostly. The vineyard lies dormant now (but any offers for it will be considered).

So, how about Argentina and Elliot? We pay our nice subsidy to the IMF out of our taxes and it finances sovereign restructurings by essentially buying the vote of bondholders into accepting restructurings that are good for both the bondholders and the insolvent sovereign (compared to it wallowing in a depression for years). Then, after the sovereign turns around its economy, our own courts let the holdout bondholders collect on the bonds that, if everyone had held out as they did and the sovereign stayed in a depression for decades, would not have had much value.

We could have a sovereign insolvency regime but the banks opposed the IMF charter amendment to that effect and it did not go through. Or our courts could go back to their equity receivership jurisprudence and try to fashion a sovereign insolvency regime.

Instead, our courts give ammunition to the holdouts, making bonds of insolvent sovereigns more attractive gambles, and pushing up the amount that the IMF will have to pay to buy out the bondholders’ vote in the next restructuring.

How would a sovereign insolvency regime work? It would not be pretty but it would be much prettier than this. Think of Detroit. It makes a bankruptcy filing and proposes a plan that keeps taxes rational and the city viable. No lender of last resort needs to get involved. Bondholders cannot extract any favorable bargains. Our tax dollars do not get wasted.

Failed Fiduciaries: Pension Funds’ Alliances with Private Equity Firms

As Yves Smith has reported, “the SEC has now announced that more than 50 percent of private equity firms it has audited have engaged in serious infractions of securities laws.” Smith, along with attorney Timothy Y. Fong, has been trying to shed light on PE arrangements for months, but has often been blocked by the very entities taken advantage of by the PE firms. As Smith concludes:

[I]nvestors have done a poor job of negotiating agreements so that they protect their interests and have done little if any monitoring once they’ve committed to a particular fund. As we’ll chronicle over the next few days, anyone who reads these agreements against the disclosures that investors are now required to make to the SEC and the public in their annual Form ADV can readily find numerous abuses. . . . But rather than live up to their fiduciary duties, pension funds that have invested in private equity funds haven’t merely sat pat as they were fleeced; even worse, they’ve been staunch defenders of the private equity industry’s special pleadings.

The SEC Chair has also harshly criticized the arrangements. States are making token efforts to reform matters after being exposed, but don’t expect much substantive to be done. The key problem is the distinction between those running pension funds, and what Jennifer Taub calls the “ultimate investors“–those whose accounts are being managed. Until their interests are better aligned, expect to see more sweetheart deals via “alternative investments.”

Beyond Too Big to Fail

After documenting extraordinary rent-seeking (and gaining) by financial institutions, John Quiggin comes to the following conclusion:

[A]ny serious attempt to stabilize the macroeconomy and return to sustainable improvements in living standards must involve a drastic reduction in the size and economic weight of the financial sector. Attempts at regulating derivatives markets have proved utterly futile in the face of massive incentives to take profitable risks, backed up by the guarantee of a government bailout.

The only remaining option is to separate these markets entirely from the socially useful parts of the financial system, then let them fail. Publicly guaranteed banks should be banned from engaging in all but the most basic financial transactions, such as issuing loans and bonds and accepting deposits. In particular, banks should be prohibited from doing any business with institutions engaged in speculative finance such as trade in derivatives. Such institutions should be required to raise all their funds directly from investors, on a “buyer beware” basis, and should never be bailed out, directly or indirectly, when they get into trouble.

The theme of separating out the utility-like, payment systems management functions of banks, from speculative finance, is something I’ve been hearing in a good deal of British thought on financial regulation.  I expect American policy makers to catch up soon.

 

 

 

 

Finance’s Failures: Lack of Accountability

This week I’ll be highlighting some excellent, recent articles on problems in the US financial sector.  First up is Jennifer Taub’s Reforming the Banks for Good.  On the way to introducing six valuable reforms, Taub notes the following:

 In 2013 JPMorgan Chase (the bank that bought WaMu) agreed to pay $13 billion to the U.S. government related in part to the sale of bad mortgages to government-sponsored housing enterprises Fannie Mae and Freddie Mac. The settlement was heralded by the government as the largest ever with a single institution in U.S. history. But the board of directors at JPMorgan Chase awarded CEO Jamie Dimon a 74 percent pay increase (to $20 million) that same year. Dennis Kelleher, president of Better Markets, called this move “as shocking as it is indefensible,” noting, “It’s a real slap in the face to the [Department of Justice] and financial regulators who think that the actions that they’ve taken in the last year have been appropriate to punish and deter JPMorgan Chase.” It is hard not to conclude that those who helped create a global financial calamity have not and will not suffer personal consequences.

I’m looking forward to reading Brandon Garrett’s Too Big to Jail this fall to explore some systemic responses to the problem. If it’s not solved, fines simply become a cost of doing business. And for too big to fail banks, no mere fine can deter bad conduct. If any particular penalty really endangered a bank, it would just be funneled back to the bank in the form of a bailout.

The Logic of Extraction

Despite happy talk from corporate chieftains (and their friends in government), deep flaws in the American economy are becoming harder to ignore. Two recent articles have been particularly insightful.

First, despite America’s self-image as a crucible of cutthroat competition, our top businesses specialize in eliminating rivals. As Lina Khan and Sandeep Vaheesan observe,

Since the early 1980s, executives and financiers have consolidated control over dozens of industries across the U.S. economy. . . . [This strategy] has even become a basic formula for successful investing. Goldman Sachs in February published a research memo advising investors to seek out “oligopolistic market structure[s]” in which “a smaller set of relevant peers faces lower competitive intensity, greater stickiness and pricing power with customers due to reduced choice, scale cost benefits including stronger leverage over suppliers, and higher barriers to new entrants all at once.” Goldman went on to highlight a few markets, including beer, where dramatic consolidation over the past decade has enabled dominant companies to use their market power to extract more from suppliers and consumers — and thereby enrich investors.

Of course, Goldman had its own angle on the beer—a commodities shuffle to make money off the 90 billion aluminum cans consumed in the US each year.

Khan & Vaheesan are right to focus on finance as the key driver in the transformation. Gautam Mukanda has explored how leaders in the sector have enforced a short-term, extractionist mindset on US industry:

Pressure to reduce assets made Sara Lee, for example, shift from manufacturing clothing and food to brand management. Sara Lee’s CEO explained, “Wall Street can wipe you out. They are the rule-setters…and they have decided to give premiums to companies that harbor the most profits for the least assets.” In the pursuit of higher stock returns, many electronics companies have, like Boeing and Sara Lee, outsourced their manufacturing, even though tightly integrating R&D and manufacturing is crucial to innovation.

Clayton Christensen argues that management’s adoption of Wall Street’s preferred metrics has hindered innovation. Scholars and executives alike have criticized Wall Street not only for promoting short-term thinking but for sacrificing the interests of employees and customers to benefit shareholders and for encouraging dishonesty from executives who feel they’re being asked to meet impossible demands.

Considered in this light, it’s no wonder Wall Street & its enablers are trying so hard to hide the terms of its deals with states. We’ll need to look elsewhere for economic leadership.

Conference: Critiquing Cost-Benefit Analysis of Financial Regulation

I am looking forward to attending (and briefly speaking) at a conference on May 19-20 in Washington, D.C. on “Critiquing Cost-Benefit Analysis of Financial Regulation.”

The event will take place at George Washington Law School. Co-sponsors include Center for Law, Economics and Finance (C-LEAF), the Association of Professors of Political Economy and the Law (APPEAL), Americans for Financial Reform (AFR), Better Markets, the Center for Progressive Reform (CPR) and SUNY Buffalo Law School.

Confirmed keynote speakers include John C. Coates, (author of “Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications”) and law and economics professor William K. Black (whose classic book The Best Way to Rob a Bank is to Own One still influences policy debates).

Here is a link for registration, and additional details. I’ve pasted the agenda below.
Read More

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Buffett’s Evolution: From Stock-Picking Disciple of Ben Graham to Business-Building Devotee of Tom Murphy

While everyone knows that Warren Buffett modeled himself after Ben Graham for the stock picking that made Buffett famous in the latter 20th century, virtually no one knows a more important point for the 21st century: he has modeled himself after Tom Murphy in assembling a mighty conglomerate.   Murphy, a legendary executive with great skills in the field of acquisitions that resulted in the Capital Cities communications empire, engineered the 1985 $3.5 billion takeover by Capital Cities of ABC before selling it all to to Disney a decade later for $19 billion.  You did not hear that explicitly at Saturday’s Berkshire Hathaway annual meeting, but Warren mentioned it to me at brunch on Sunday and, when you think about it, it’s a point implicit deep in the meeting’s themes and many questions.

In fact, Berkshire mBBB COvereetings are wonderful for their predictability.   Few questions surprise informed participants and most seasoned observers can give the correct outlines of answers before hearing Buffett or vice chairman Charlie Munger speak. While exact issues vary year to year and the company and its leaders evolve, the core principles are few, simple, and unwavering.  The meetings reinforce the venerability and durability of Berkshire’s bedrock principles even as they drive important underlying shifts that accumulate over many years.  Three examples and their upshot illustrate, all of which I expand on in a new book due out later this year (pictured; pre-order here).

Permanence versus Size/Break Up. People since the 1980s have argued that as Berkshire grows, it gets more difficult to outperform. Buffett has always agreed that scale is an anchor. And it’s true that these critics have always been right that it gets harder but always wrong that it is impossible to outperform.   People for at least a decade have wondered whether it might be desirable to divide Berkshire’s 50+ direct subsidiaries into multiple corporations or spin-off some businesses.  The answer has always been and remains no.  Berkshire’s most fundamental principle is permanence, always has been, always will be. Divisions and divestitures are antithetical to that proposition.

Trust and Autonomy versus Internal Control. Every time there is a problem at a given subsidiary or with a given person—spotlighted at 2011’s meeting by subsidiary CEO David Sokol’s buying stock in Lubrizol before pitching it as an acquisition target—people want to know whether Berkshire gives its personnel too much autonomy. The answer is Berkshire is totally decentralized and always will be-another distinctive bedrock principle. The rationale has always been the same: yes, tight leashes and controls might help avoid this or that costly embarrassment but the gains from a trust-based culture of autonomy, while less visible, dwarf those costs.

Capital Allocation: Berkshire has always adopted the doubled-barreled approach to capital allocation, buying minority stakes in common stocks as well as entire subsidiaries (and subs of subs).  The significant change at Berkshire in the past two decades is moving from a mix of 80% stocks with 20% subsidiaries to the opposite, now 80% subsidiaries with 20% stocks.  That underscores the unnoticed change: in addition to Munger, Buffett’s most important model is not only Graham but Murphy, who built Capital Cities/ABC in the way that Buffett has consciously emulated in the recent building of Berkshire.

For me, this year’s meeting was a particularly joy because I’ve just completed the manuscript of my next book, Berkshire Beyond Buffett: The Enduring Value of Values (Columbia University Press, available October 2014). It articulates and consolidates these themes through a close and delightful look at its fifty-plus subsidiaries, based in part on interviews and surveys of many subsidiary CEOs and other Berkshire insiders and shareholders.   The draft jacket copy follows. Read More

The Symbols of Government, SEC Edition

SEC Commissioner Kara Stein “played an integral role in drafting and negotiating significant provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.” She was Staff Director for the Senate Banking Subcommittee of primary jurisdiction over the SEC. She’s a very well-respected professional with extraordinary experience in the law of financial regulation. And here’s what she had to say today on the SEC’s 3-2 vote to “overturn the automatic disqualification of Royal Bank of Scotland Group from eligibility as a “Well-Known Seasoned Issuer:””

Among the many disqualification and bad actor provisions enacted by Congress and the Commission, loss of WKSI status may have the fewest ramifications. Nevertheless, when, as here, a subsidiary of a large financial institution is convicted for committing a crime that helped skew the value of trillions of dollars’ worth of financial instruments and contracts worldwide, we still grant relief. Say what you will about how isolated or insignificant this conduct was within the context of the entire institution, it still managed to wreak havoc on financial markets across the globe. Yet we provide our implicit “Good Housekeeping Seal of Approval,” and tell the investing public that this issuer is still deserving of reduced Commission review and subject to fewer investor protections.

If we are going to abrogate our own automatic disqualification provision on these facts, then we should consider discarding these disqualification and bad actor provisions entirely, along with the pretense that they have any real meaning.

Various agencies in American history have slipped into “vestigial” status. The ICC, for instance, had little reason for being after shifts in policy reduced its regulatory role. One has to wonder how much “Seals of Approval” from the SEC are worth if they can persist in cases like this.

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Economic Dynamics and Economic Justice: Making Law Catastrophic, Middling, or Better?

Contrary to Livermore,’s post,  in my view Driesen’s book is particularly powerful as a window into the  profound absurdity and destructiveness of the neoclassical economic framework, rather than as a middle-ground tweaking some of its techniques.  Driesen’s economic dynamics lens makes a more important contribution than many contemporary legal variations on neoclassical economic themes by shifting some major assumptions, though this book does not explore that altered terrain as far as it might.

At first glance, Driesen’s foregrounding of the “dynamic” question of change over time may, as Livermore suggests, seem to be consistent with the basic premise of neoclassical law and economics:   that incentives matter, and that law should focus ex ante, looking forward at those effects.   A closer look through Driesen’s economic dynamics lens reveals how law and economics tends to instead take a covert ex post view that enshrines some snapshots of the status quo as a neutral baseline.  The focus on “efficiency” – on maximizing an abstract pie of “welfare”  given existing constraints —  constructs the consequences of law as essentially fixed by other people’s private choices, beyond the power and politics of the policy analyst and government, without consideration of how past and present and future rights or wrongs constrain or enable those choices.  In this neoclassical view, the job of law is narrowed to the technical task of measuring some imagined sum of these individual preferences shaped through rational microeconomic bargains that represent a middling stasis of existing values and resources, reached through tough tradeoffs that nonetheless promise to constantly bring us toward that glimmering goal of maximizing overall societal gain (“welfare”) from scarce resources.

Driesen reverses that frame by focusing on complex change over time as the main thing we can know with certainty.  In the economic dynamic vision, “law creates a temporally extended commitment to a better future.” (Driesen p. 52). Read More

Law and Economics: The Flow of Ideas is a Two-Way Street

Raul Carrillo and Rohan Grey have recently argued that “law students need macroeconomics…and macroeconomics needs us”—and I couldn’t agree more. They have launched several initiatives at Columbia to build on the excellent finance curriculum offered there:

As Professor Robert Jackson opined in The Modern Money Network’s recent seminar, “The way we talk about money systems in law school has been blocked in a way, because we’re not really honest with each other about the fact that our money system is a legal choice… We may have covered, in legal academia, microeconomics in reasonable depth, but we need to do much more work in macroeconomics.”

When we “do economics” in law school, we customarily confine it to the scale of individual entities, say, firm transactions in Contracts and Corporations. Broader discussion of political economy rarely creeps into the curriculum…. Whether you eventually practice or make policy, negotiate deals or craft legislation, every student can benefit from further integration of political economy into the curricula. This is why The Modern Money Network, a newly recognized student organization, exists. It is a transdisciplinary hub for learning about the interactions between money, finance, law, and the broader economy.

Carrillo has also observed that the Fed used to have far more input from attorneys, but has since become an intellectual monoculture of economists. That, too, has to change. We can only hope to reform the finance sector by addressing power dynamics among boards, CEOs, traders, and investors—the types of dynamics lawyers are expert at creating and manipulating. Moreover, attorneys need to understand the overall effect of finance on the broader economy, and not simply think of ourselves as mere hired guns for the highest bidders. I’ll be closely following the work of Carrillo and Grey, and suggesting some fruitful directions for political economy and law.

They are also looking to expand their approach to other law schools—so try to contact them (@ramencents for Carrillo, @rohangrey for Grey) if you’re interested. It’s great to see the legacy of Robert Lee Hale endure at Columbia!