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Where There’s Smoke… – Notes for the Week Ending Friday 28 November 2008

In the shadow of the steeple I saw my people.
By the Relief office, I seen my people.
As they stood there hungry, I stood there asking
Is this the land made for you & me?
 Woody Guthrie

We sat at our table this Thanksgiving surrounded by family, aged twelve to 95, and friends from as far off as Bosnia and Israel. We spoke about what makes America great – and about those who have never been part of the Thanksgiving narrative. Lincoln said this nation was “conceived in Liberty…” yet, some deformation appears to have taken place in the birth canal. This is not the place to dwell on issues of race, ethnicity, and dual national identity as part of the uniquely flawed – and yet uniquely great fabric of this nation. But we acknowledge that societies are defined by access: who Gets In, and who Doesn’t Get In, and in every society there are groups that we define as Structurally Dispossessed.

As much as anything else, the recent election is the result of self-assertion by groups who heretofore never believed themselves to be full participants in American society. One need only look at the hundreds of thousands of people who had been registered to vote for years, but who never actually pulled a lever until this year. The rules remain the same. Yet, by broadening to include as “Americans” the Structurally Dispossessed, the American narrative may change dramatically. Many are shocked by this handing of political clout to large groups of people who have never participated in the process. It is the ultimate Trickle Down. Next Thanksgiving will see a different United States of Obamerica.

With all the changes we anticipate at every level of society, what might the implications be for the world of market regulation?

We Americans are unusually prone to injecting morality into our political discourse, no less in our view of securities regulation than elsewhere. We damn short sellers as being evil. When markets get choppy, we outlaw them – despite the fact that short selling is one of the fundamental mechanisms that has made our markets superior to any other securities markets in the world. We can quibble over data sets used to analyze the effectiveness of the Uptick Rule, but the fact is that Shorts are always smarter, as a group, than Longs. Their activities force realistic pricing in the markets, and their capital sustains market liquidity. Thus, regulation trashes the very markets it attempts to salvage.

The Obama Administration promises some tough new regulation. Media reports are full of words like “broad” and “sweeping”. But what philosophy will that regulation support? Rules, as we see over and over again, are meant to hide behind. It is striking to note that the violation of securities rules is often viewed as a business decision. Owners and management assess how much they will make if they violate a rule, versus how much it is likely to cost them if they get caught. It is the nature of the current regulatory process that regulatory penalties paid out by Wall Street firms generally fall short of the profits generated by the behavior that led to regulatory action.

The new Obama administration has assembled an impressive economic team. Now they must define their Narrative. We often hear that Business is more effective than Government, because of the Profit Motive, as though this were an alchemical formula for fiscal policy. As discussed in the Wall Street Journal (“Government By Contractor is a Disgrace” – 11/26/08) paying the private sector to do government work is not only not efficient, but leads ineluctably to corruption and excess. The observation that Government has a lot to learn from the private sector is dead on, but the profit motive is not the silver bullet.

The constant seeking after profits is not what makes businesses successful. It is what makes them lose sight of their long-term objectives, and often it is what makes them corrupt. The success factor in capitalism is neatly summed up by Secretary Paulson’s testimony to Congress on why he diverted TARP funds away from their original intended purpose of buying up toxic mortgages: “When the facts change, I change my mind.” The true genius of Capitalism is its ability to reinvent itself. The key question a successful entrepreneur asks is not “How many of these can I sell?” but rather: “What business am I in today?”

In the current shouting match we have heard some regulators pushing for principles-based regulation, as opposed to the standard rules-based regime, which is inherently prone to abuse. Perhaps government can do no greater service to the people and the markets by guiding the discussion about What Country Are We In? This is by its nature a fluid conversation. It is an ongoing discourse, and the principles by which we will regulate our markets in the future must emanate from that discourse. Put another way: law and regulation are an outgrowth of how the country defines itself. We now have an opportunity to make a conscious decision of what we want America to look like, to be, to do. The Obama narrative rests largely on increased Access for more Americans. If this is to succeed, it will have to very visibly undo Business As Usual, and push creative reinvention. The new administration must lead the national dialogue in asking over and over again, What Country Are We In?

O Lord, won’t you buy me a Ford Pinto?

Are we the only ones who found it odd that the UAW came to Washington together with the CEOs of the No-Longer-So-Very-Big Three? This looks like an ex-spouse looking over one’s shoulder and checking the numbers on a lottery ticket. As curious as it was to see the UAW and the Soon-To-Be-Downsized Three waltzing in arm-in-arm-in-arm-in-arm, it is shocking to us that Congress even debated their proposal. But then, this is the same Congress that approved $700 billion for Fannie and Freddie, but did not summarily fire their bosses. The auto industry conversation, in a nutshell, is: “Our business model doesn’t work. Please give us $25 billion to sustain our unsustainable business, until we can convince you to give enough of your other $700 billion to enough people to force them to buy our trash.” As we all know, What’s good for General Motors…

We note with interest that the President of the atoll nation of the Maldives is actively looking about for a new homeland – and willing to pay for it. The 350,000-odd inhabitants of this island nation feel all too keenly the imminent risk of being swallowed up by a rising sea level. One modest proposal might be to have them move to the interior of China. Half of China’s population now lives in the cities, and more are fleeing daily. The 750 million or so people still living inland are largely older – their children went to Beijing, they stayed behind. They are also largely dependent, in traditional Chinese society, on their children taking care of them as they age, a phenomenon that looks just about to go by the boards. Would they not welcome a new family into their midst, if they came bearing cash? The 350,000 people fleeing the Maldives would be a tiny blip on the radar of a nation whose population is one-fifth of all humanity. “When the facts change, I change my mind.” President Mohamed Nasheed could teach Detroit a thing or two.

Twenty-five billion dollars is a fair chunk of cash. If it is handed to the Big Three it will likely vanish in a puff of smoke. On the other hand, it is approximately $40,000 each for the 620,000 or so members of the UAW. Instead of buoying a sinking ship, we could set up a combination home mortgage guaranty and professional retraining program for auto workers. We could sock $25 billion into an artificially high-paying interest bearing account – say ten percent – and require the auto manufacturers to match the revenues. They should have no trouble doing so. As they have not tired of telling us, if they get rid of their losing US business, their profitable overseas operations will restabilize their finances. With $250 million a year from Government, matched by an equal amount from each of the Three, we have an ongoing stream of $1 billion a year to dole out to UAW members while they redeploy.

Black, Black Friday

This weekend marked the beginning of the holiday shopping season. Preliminary figures appear to indicate that reports of the death of the American consumer have been somewhat exaggerated. Bloomberg quotes the market research firm ShopperTrak RCT as saying sales were up 3% over last year. This would be the smallest increase ever recorded – but an increase, nonetheless. Retailers are on tenterhooks and will be counting every penny of revenues, hoping to pull out a profitable year.

The Bloomberg story reports that retailers advertised “doorbuster” sales nationwide. At least one location proved true to this name, as shoppers at a Wal-Mart in Valley Stream, Long Island, literally not only tore the doors off the building, but trampled a worker to death as they surged into the store. Fellow workers who tried to break up the flow of stampeding shoppers and rescue their colleague were met with angry shouts of “We’ve been waiting all night!” This gives new meaning to the concept of Pent-Up Demand, and shows the folly of the current Washington plan. If consumer spending represents 70% of American GDP, then the $700 billion should not be given to the banks, but to those who will spend it. Washington should hold a contest, with consumers being asked to describe their ideal family shopping spree. We could sponsor the ultimate reality TV show – Shopper For A Day – and Washington, as the producer, could sell advertising time, thus generating additional revenues for the consumer bail-out. Why not offer this opportunity to the UAW? The $700 billion package works out to over one million dollars per Union member. Let’s give them a shopping spree. The money will be handed out on the sole condition that it all be spent within no more than thirty days, and all within the borders of the United States.

Instead of appointing Henry Paulson to fix this mess, we should have appointed Sam Walton. He knew how to stimulate spending!

Moshe Silver
Director of Compliance

* Dedicated to the memory of Jdimytai Damour *