Unemployment-Gate – What Didn’t The Government Know, And When Didn’t They Know It?



Dirty Harry To SEC: Make My Day



Pandit To Sheila Bair: Make My Day



Dollar To The World: Make My Day


Floyd Norris shared a story in his blog (2 October, “Recession?  What Recession?”) hinting that Bank of America may not be the only major institution to withhold key information from its shareholders.

“In early 2008,” writes Norris, “a small band of people were arguing that we were in a recession. But the conventional wisdom – including at the Federal Reserve – was that the employment numbers said otherwise.”  “Otherwise” as is, “you don’t go into recession when you are losing 60,000 jobs a month.”

We can all agree that 60,000 jobs do not a recession make.  But Norris says Bureau of Labor Statistics dramatically underestimated the number of jobs lost.  The total projections of less than 6 million were enough to shake folks up – but the current estimates have been revised to in excess of eight million.  This is not a rounding error. 

Is this another example of those smart enough to actually predict trends going to work on Wall Street, where they can make a fortune – and the government taking the leavings?  Why do We The People have to rely on folks who couldn’t make the grade in the real world?


We are currently witnessing the prosecution of BofA’s management for sharing Bad News with their shareholders – but hiding how Truly Bad the news was.  Was their rationale that they could fudge an explanation after the fact?  That somehow if they ignored the extra few billion in losses, it might go away?  That the shareholders and the markets would be more focused on the receipt of the billions of dollars in government aid, and figure it would all come out in the wash?  By trying to rush through a settlement, the SEC would rob us of the opportunity to hear the testimony of BofA’s managers and directors, which is the only way we might learn any of this information.

It’s bad enough to contemplate The Evil We Know, which is a government process riddled with sheer incompetence.  Still worse would be the evil that we didn’t know: maybe they actually did have a firm handle on the unemployment trends and tampered with the early estimates.  This may have been testing the waters with respect to levels of acceptable public panic.  Or maybe they were just hoping that, by the time the actual figures came to light, either there would be significant improvements to point to, or some other problem would arise to make it seem insignificant. 

When we can’t even get the SEC to investigate a possible multi billion-dollar fraud involving the nation’s premier financial institutions, who will investigate the BLS and the Administration?  Andrew Cuomo, are you reading this?

Make My Day

You’ve got to ask yourself one question: “Do I feel lucky?” 

 -  “Dirty Harry”

“Dirty” Harry Markopolos appeared last weekend before the Investment Management Consultants Association Professional Development Conference.  His remarks, recorded for posterity by the press (Financial Planning, 5 October) include the following gem:  “The SEC has to get better, or die, or be killed.”  Shades of the original Dirty Harry Callahan, who says shooting people is all right, as long as the right people get shot.

The simple fact it, despite everyone’s high hopes for Mary Schapiro (well, perhaps not quite everyone…) the “new” SEC has thus far done little to make us sanguine about the future of the financial markets. 

The step-up in Enforcement actions since Chairman Schapiro took over appears to be merely the effect of removing the shackles of the Cox era.  This is an invidious comparison and does not speak to increased dynamism at the Commission. 

For a more telling comparison, look to the statements of new SEC Enforcement Chief Robert Khuzami in response to the SEC’s failures in the Madoff matter.  In an important address to the New York Bar Association in August, he spoke with pride of “the most impressive organization response to criticism I have ever witnessed.”  In the aftermath of Madoff, Khuzami stated the SEC had opened 10% more investigations (525 versus 474), obtained 118% more orders granting the Commission subpoena power (275 versus 126), filed 147% more Temporary Restraining Orders (52, ,compared to 21) as compared against the same period in 2009.

These figures fail to impress us.  The alacrity with which these actions came tumbling forth made it clear they were old files that had been thrown into enforced dust-gathering in the do-nothing Cox days.  Merely taking the cuffs off created a flurry of activity, as quashed files were resurrected.  While it is appropriate for Chairman Schapiro to say “Do something!  Do anything!” we must wait for next year’s Enforcement actions to see what the current staff will produce.

In the same speech, Khuzami said the Enforcement Division would focus on “building strong cases so that defendants settle quickly on the Commission’s terms or face a trial unit armed with compelling evidence.”

There are three problems with this.  First, the Commission’s excessive reliance on lawyers.  The Commission continues to hire lawyers – and continues to refuse to create programs that might attract seasoned Wall Street professionals.  Lawyers almost never go to court.  Rather, their whole training, and the caste of the American legal system, is to seek settlements.  Actors who play lawyers go to court – the typical practicing attorney in the US can’t tell whether he is standing in front of the courthouse, or the post office.

Even when the SEC manages to hire a highly qualified market professional, they waste the opportunity by mummifying them in bureaucratic red tape and by making them subject to the vagaries of the government pay grade system.  While Khuzami spoke enthusiastically about his program to deploy seasoned SEC staff to best advantage, it is still not the same as bringing in market professionals. 

We wish to take this opportunity – yet again – to promote our own idea of hiring fifty of the top compliance and operations professionals on the Street, giving them a three-year mandate and a staff of accountants and lawyers.  Markopolos, in his recent presentation, said the SEC needs to “hire capital markets people instead of lawyers.”  We couldn’t agree more.  Not to put too fine a point on it, the refusal to recast the Commission in a more effective form is clear proof that the SEC – from junior staff, up to the Chairman – do not want to revolutionize the regulation of the markets.

The second problem we find is that perpetuating the practice of seeking to settle every case promotes a legacy of conflict of interest, as highlighted by Judge Rakoff’s very public excoriation of the Commission for its attempt to push through the $33 million settlement with Bank of America.  The deal is so egregiously insufficient as to imply government strong-arming.  Chairman Schapiro’s judgment is subject to being clouded by political pandering – for example, her initiative to promote shareholders voting directly for board members was likely a sop to the labor unions – and the longstanding symbiotic relationship between Wall Street and its regulators does not look set to change. 

The practice of making settlements is the time-honored tradition whereby Wall Street agrees to be taxed for driving recklessly on the toll road of the American marketplace.  A review of the FINRA website shows a monthly litany of fines from $5,000-$50,000 for the unavoidable ministerial infractions that beset the trading desks of major firms – late trade reporting, out of sequence reports, failure to timely display an order.  When committed by major firms, these infractions are more often than not mere oversights or carelessness.  Cynical anti-capitalists notwithstanding, Goldman Sachs does not make its money by skimming pennies from customer orders.  The largest and most substantial Wall Street firms recognize the value of their franchise and are noted for particularly robust Compliance and risk-management departments – Goldman and JP Morgan are standout examples. 

By pushing for more settlements, Khuzami reaffirms the inherently corrupt Old System – one that places the regulators at the very bottom of the food chain, reinforces the supremacy of those with money, and does everything possible not to rock the boat.

Finally, the third problem with Khuzami’s position is the role of the courts.  The idea that a defendant might fear showing up in court to face SEC charges is almost laughable.  Read the OIG report on the SEC’s mishandling of the Madoff affair if you don’t believe us.  The case-building standards and practices within the organization have been so pathetically weak, and in such widespread fashion, and so very persistently over such a long period – many believe the Commission went into a tailspin after Arthur Levitt’s tenure – there is barely a peg on which to hang a prosecutorial hat.

Wall Street defendants can afford better lawyers than the SEC can ever come up with.  The problem they face is the cost of time: time may work in one’s favor in a commercial litigation, but in the government one faces an adversary with a bottomless pit of time.  Moreover, when a firm sees that a judgment will likely go against them, why do the regulators allow them to settle?

In the retail brokerage business, brokers who generate large numbers of complaints are often coaxed into submitting a voluntary resignation.  It is so much easier for a firm to file a voluntary U5 (termination of employment filing) than to explain what kind of problems the broker caused, and why the firm itself should not be held liable for failure to supervise.  This has resulted in literally thousands – if not tens of thousands – of fraudulent referrals throughout the industry, as dishonest brokers have been given a clean bill of health by employer after employer and have gone on to pillage customer accounts at a succession of firms.

In what way is the regulatory process substantially different?  A firm or individual that makes a settlement – and which is not required to admit to any improper activity – is free to continue in business. The art or managing money, as we all know, is the art of having money to manage.  And the key to accessing OPM is marketing, marketing, marketing.  The financial markets are replete with Elmer Gantry types who don their red vests each morning and – believe it or not – always come home with a new sucker.  When the sucker asks the salesman why he made a settlement with the SEC, the answer is always, “It was a business decision: either settle now, or spend the next five years, and possibly millions of dollars in legal fees to win the case.”  By making a policy statement that the SEC will actively seek to force settlements, rather than convictions, Khuzami is signaling to Wall Street that they shouldn’t worry.  Things aren’t really going to change all that much.  Downright scary, we say.

As an example, if Ken Lewis is guilty of defrauding investors, then he should be found guilty and jailed accordingly.  Allowing him to weasel out by paying – whether with his own money or anyone else’s – discredits the system.  And how about this?  What if he’s innocent?  Khuzami has boldly announced to the world that the “new” SEC is setting out to beef up the system whereby no one will ever really know what goes on, and criminals will be pampered instead of caught.

We think a more forceful approach to Enforcement would be to dedicate a portion of the judicial system to expedited hearings for the SEC to bring litigation.  The more standing in court with the possibility of an adverse judgment, becomes a reality, the less managements will be inclined to cut corners, and the more vigilant boards of directors might be.  A new legislative package that gives the SEC enhanced subpoena power, that makes it costly and difficult to bring retaliative lawsuits, and that leads to an expedited hearing process before highly qualified judges could work wonders.

Wall Street has been likened to the Wild West, where gunslingers roam free and fire at will.  If bankers, brokers and traders knew they would face conviction for their misdeeds, might prove a strong corrective to the worst offenders.  The world of finance is not yet like the world of professional football.  Unlike the NFL, on Wall Street having a felony conviction still poses a stumbling block to one’s career.  

Markopolos’ remarks are a rehash of what we have already heard – from him, and from the SEC OIG report.  Still, it is worth reminding the public how dismally ill-served we are by our elected officials, and by the political appointments they make.  Finally, as Markopolos came to the end of his presentation, he dished out one last bit of criticism, saying “if the SEC was asleep, the banking regulators were comatose.”

This appears to put Goldman Sachs and Morgan Stanley in the truly enviable position of arbitraging one set of clueless regulators against another set whom they appear to have snugly in their pocket.  When they converted to bank holding companies, these firms switched primary regulator from the SEC (clueless) to the Fed (back pocket). 

As an aside, we are not the only ones who think the government officials charged with overseeing the financial system are compromised.  For a hoot with teeth, see businessinsider.com of 17 September, “The Geithner-To-Goldman Clock,” in which Henry Blodgett – yes, that Henry Blodgett – predicts Tim Geithner will leave the public sector and join Goldman Sachs one year into President Obama’s second term. 

Some in the financial press have expressed their sympathy (Reuters, 11 June, “Goldman Could Shed Commercial Bank Charter”), saying the new banks “faced significantly tighter regulation and much closer supervision by bank examiners from several government agencies.”  You can’t seriously believe these various agencies have a chance against Goldman or Morgan, given their interlocked relationships with Treasury, the New York Fed, and the White House.  And now that the SEC is on record as committed to a new round of high-stakes Business As Usual, it looks like clear sailing for the robber barons once again.

Where will the next major regulatory disaster come from?  Clearly, regulatory and legislative fecklessness are built into this corrupt and conflicted system, and the possibilities for implosion are limitless.  There will continue to be plenty of jaw-jaw, but no real change-change.

No Comment Required

Some stories not only tell themselves, they comment on themselves.  When the Government ordered Citigroup to undertake a thorough review of their operations, the company brought in an independent auditor – of their choosing.  To no one’s great astonishment, the conclusions were positive, with CEO Pandit singled out for praise.

FDIC Chair Sheila Bair is not buying it (Wall Street Journal, 9 October, “Review Of Citi Draws Wary FDIC Response”), the implication being that she is no more sanguine about Pandit & Co’s ability to run a faltering behemoth now that he has received high marks from his fellow troglodytes at Citi.

It is difficult for us to fault Egon Zehnder, the highly-respected international executive search firm that produced the report.  Indeed, Pandit-pandering market commentators are crawling the web, saying Bair has been “kicked in the teeth”, (industry.bnet.com, “Why It’s Time For Sheila Bail To Apologize To Citi’s Pandit”), and this tale may end with Ms. Bair being served a dish of corbeau a la Pandit.  Whether or not she consumes it will be a different story. 

We remember – alas, we have since lost our copy – a lavishly produced report done for Bear Stearns by a major business consulting firm.  Bound and glossy and chock full of photos, charts and tables, the key conclusion of the report was that Bear had established such a deep-rooted and consistent culture of risk management, of oversight and of performance, and of managerial excellence, that it would take a succession of bad judgment calls, made and followed consistently over a number of years by a large number of employees and senior managers, to undermine the stability of the firm.

‘Nuff sed?

Beggar Thy World

Suck up the float, or you will sink in the moat.

 - Stu Travis, “The Big Man”

It’s fascinating to watch one’s own ideas coming back, recycled as someone else’s insight.  Not to say that great minds might not think alike, but in the world of economic and market analysis, this must be tempered by the awareness that professionals often make statements with great conviction which, upon review, are found to be completely at odds with statements they made in the very recent past – and with no less fervor.

Our CEO, Keith McCullough, has been hammering home the theme of “Dollar Down Causes Everything Else To Go Up In Price.”  To his credit, he has been unwavering in this approach.  To his greater credit, he has been right.  (Frankly, this part of his presentation has become so predictable that we use it as an opportunity to pour a fresh cup of coffee when he launches it in the morning call.)  You would think, in fact, someone else might pick up on it.

In recent months, even the “best” financial media have most frequently addressed this phenomenon by saying “the drop in the dollar was caused by the rise in the price of____”  Plug in your asset of choice: oil, gold, S&P 500, etc.  Precious few of them bother to look at the mechanism from the other side.

Now we have a high-profile bandwagon-hopper in the person of David Malpass, president of Encima Global and former chief economist of Bear Stearns.  Writing in the Wall Street Journal (8 October, “The Weak-Dollar Threat To Prosperity”) Malpass quotes Pimco’s Bill Gross as musing that the Obama Administration must have an undisclosed plan to continue to weaken the dollar.  Gross observes that “one of the ways a country gets out from under its debt burden is to devalue.”

Malpass proceeds to make, well, pretty precisely Keith’s case for the weakening dollar causing everything else to go up in value.  We admit to being mathematically semi-literate. In college we studied “Humanities”.  But we understand this.  It is a simple arithmetical relationship of one price to another.  Adjusted for other factors that influence equilibrium, they have to balance, otherwise there is an arbitrage opportunity. 

Malpass is of course not infallible.  He has been taken to task for his position, while at Bear, that capital gains are an equivalent to savings in an economy.  This is all to the good for someone who gets paid by folks who sell securities for a living, but holds less water from the perspective of the buyers of those securities – particularly if they are acolytes of the gospel of Buy and Hold, who see the Hold go up in smoke.

A follow-up to this piece is a WSJ editorial (9 October, “The Dollar Adrift”) that warns “the more immediate danger – in the coming months – would be if the fall of the dollar becomes a rout.”  This juxtaposes with a line buried in a Financial Times story (9 October, “Dollar Bounces After Bernanke Exit Comments”).  “After Thursday’s session of heavy intervention by Asian central banks to stem the appreciation of their currencies against the dollar, many of those watched their currencies weaken further.” 

Finally – and only a crackpot conspiracy theorist could see a tie-in here – we note several stories this week around the British initiative to bolster their banking sector by requiring banks to dramatically increase their percentage of reserve holdings, and specifically to hold those reserves in “high quality liquid instruments” – regulator-speak for government bonds.  If a similar initiative makes its way through Congress, we will be treated to the happy vision of Asian central bankers frantically trashing their own economies to prop up our currency, joined by our own mightiest financial institutions as stepped-up buyers-and-holders of Treasury debt.  It appears the emerging plan is to suck in the world’s bankers and their economies, until the Fed can manage a sharp spike up in the dollar – media pundits have been forecasting such a move in the first quarter of 2010.  As long as Washington keeps the dollar weak, it remains the currency of choice for the carry trade.  A ten percent surge in the value of the dollar will presumably unleash the mother of all short squeezes.

And then everything will be all right again.  Don’t you see?

For the time being, rhetoric and cash-box rattling aside, the Dollar is firmly on the throne, with no heir apparent.  As we go to press, it looks like Bernanke and Summers are counting on a little well-timed jaw-jaw to motivate bankers around the world to chomp down another cyanide capsule.  Like we used to say in the neighborhood – it’s good to be king.