• It's Here!

    Etf Pro

    Get the big financial market moves right, bullish or bearish with Hedgeye’s ETF Pro.

  • It's Here


    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

The Committee To Trash The World

There ain’t no way to find out why a snorer can’t hear himself snore.
  - Mark Twain

“Economist heroes?  It all sounds silly unless you understand how close the world came to economic meltdown last year.”  That quote is not Fox News’ latest endorsement of Bernanke and Geithner, nor is it the Wall Street Journal’s grudging acknowledgement of Paul Krugman.  No, it is Time magazine trumpeting “the Committee To Save The World”, as they praised Alan Greenspan, Lawrence Summers, and Robert Rubin on February 15, 1999.  Ten years later, they anointed successor Ben Bernanke as Person Of The Year for 2009.

For many observers, the handing on of the politicized economic legacy could not have been more explicit if a puff of white smoke had issued from a turret atop the Fed building, for Ben Bernanke is the child of his Trinity of spiritual fathers. 

A glimpse into the world of ten years ago is instructive.  Making him seem like some international sex symbol, Time describes Summers sitting in the Frankfurt airport on his way back from “a hectic trip to Moscow.”  After presenting a litany of the globe’s financial woes, the article gives us this prescient gem: “awful as the Asian correction is, it was, in a sense, inevitable because those economies had trundled billions of dollars into useless real estate and industrial development.”  Apparently Summers – returned to Washington with the Obama Administration – failed to see a correspondence to the real estate excesses, coupled with the overbuilding in the financial sector that combined to tip America and the world into the toilet this time around.  We aren’t economists, and even we get it.  The scary thought is, perhaps the reason that we get it is because we are not economists.

“We start with the idea that you can’t repeal the laws of economics” says the Ghost of Larry Summers Past, “even if they are inconvenient.”  Astonishingly, even as he spoke those words, Summers and his two partners were in the process of giving that fundamental point the official heave-ho.  Indeed, as this triumvirate was directly responsible for the government policy of abandoning regulation, one might say the laws of economics had been suspended by government fiat, even as they were being touted.

Tracing the waves of financial disaster as they emerged from the “Asian Contagion”, Time identifies the “breathtaking” speed of the global collapse as proof that markets had changed and become fundamentally much more volatile.  Quoting Summer’s favorite analogy, the article likens the global capital markets to a jet plane.  “They are faster, more comfortable, and they get you where you are going better.   But the crashes are much more spectacular.”

The fact is that this team of three Really Smart Guys had also been credited with some major accomplishments.  The Time story credits Rubin, for example, with single-handedly preventing the Korean debt panic from morphing into a crash in the US marketplace.  Students of economic history disagree about the extent to which Rubin also directly caused that crisis by forcing the Korean financial markets to buy up derivative contracts created by US investment banks as a condition of Korea receiving $57 billion in loans from the IMF. 

A fourth RSM (“Really Smart Guy”) makes a cameo appearance in the article.  Tim Geithner, then a 37-year-old Undersecretary for International Affairs, is quoted as saying Rubin ran Treasury “more like an investment bank”.  We are not told what Geithner meant by that remark, though in the next sentence, other staffers credit Rubin with fostering discussion and eliciting ideas from his staff.  It is astonishing to think that the development of brilliant ideas might not be what the job of governing is supposed to be about – and perhaps equally surprising to realize that investment banking is less about coming up with brilliant concepts than it is about forcing someone else to hand over their money.

The remaining question is: how did these RSM’s get it so wrong?  And maybe the answer is simply that they blurred the distinctions between government and business with the conviction that the private sector knows best.

President Clinton supposedly found Hillary’s friend Brooksley Born too boring to make her his Attorney General.  As a consolation prize, she was put in charge of the Commodity Futures Trading Commission.  She has long refused to speak for the record, but her staffers were unequivocal that in her first meeting with Greenspan, the Fed Chairman attacked the notion that free markets need any kind of regulation at all.  Free markets, he is supposed to have told the newly-minted CFTC chief, do not need regulation.  They will regulate themselves.

As with every other idea the RSM’s came up with, this notion of self-regulated markets worked really well. Until it didn’t.

Let’s face it, Wall Street executives think politicians are a bunch of idiots, so going into politics is seen not so much as making a contribution, as showing them how to really run the system properly.  Folks like Rubin really believe that the best “service” they can perform is to show government how it’s really done.  As young Tim Geithner said: run Treasury more like an investment bank.  You know, winners and losers…  It’s a short step from bringing private sector know-how into government, to placing government at the service of the private sector.

Fade out, fade in.  Ten years have gone by and the latest RSM, Bernanke, is on the cover of Time magazine.  While we have admiration for his intellect, and for his academic achievements, both Mr. Bernanke and those who rely on him would do well to keep an eye on the interface between Government-Think and Wall Street-Think.  If the Fed’s job is to manage inflation, then its brief is to permit growth, not stimulate it. 

The place of speculation in the marketplace is to add liquidity, resources, information and a certain depth to the markets.  The social policy reason banks are allowed to engage in investment banking – and in lower-risk ways of making outlandish returns, such as overdraft charges and ATM fees – is to provide low-cost capital for lending, which is the legitimate purpose of banking.  Indeed, this is the clear social policy reason for what we have dubbed the “piggy banker spread” – the lopsided yield spreads that are pouring billions of dollars of revenues into the pockets of Wall Street were supposed to stimulate lending and business investment.  Instead, they are going to year-end bonuses to managements who have generated staggering losses, drawn down a trillion dollars in government bailouts, and wiped out their shareholders.  Financial institutions whose existence is predicated on speculation were transformed into banks by regulatory legerdemain that would make Harry Potter jealous.  Now that they have the backing of people’s life savings, and the guarantee of the Fed, they can continue to speculate without jeopardizing their bonus pools.

The fundamental – though far from simple – job of financial regulation is to keep speculation as a layer in a functioning marketplace.  Speculation, from a regulator’s perspective, should serve the market.  Our markets are being run with the express purpose of serving the speculators. 

As we wave farewell to an eventful year, we suggest Time’s new Person of the Year would do well to look closely at his predecessors’ mistakes.  Events have a nasty habit of proving over and over again that no one is smarter than the market, though quite a lot of folks have turned out to be dumber.

Happy New Year, Chairman Bernanke.

The B.S. Artists Of The Possible

It is by the goodness of God that in our country we have those three unspeakably precious things: freedom of speech, freedom of conscience, and the prudence never to practice either of them.
  - Mark Twain

We have to admit to a bias in favor of SEC Chief Schapiro.  We always thought she was decent, and were impressed by what the market professionals engaged reported about her handling of the NASD/NYSE regulatory merger that gave rise to FINRA.  While we are the first to admit that even we are susceptible to having the wool pulled over our eyes, we think it would be a shame if Mary Schapiro gets knocked down from her pedestal.

A shame – though, in the world of Wall Street, not a total shock.

Slouching Towards Wall Street… Notes for the Week Ending Friday, December 25, 2009 - CS

Bloomberg filed a story on the first day of winter (21 December, “Hot Seat For SEC Chief Schapiro Won’t Cool Off”) reporting on two lawsuits claiming that Schapiro colluded with other senior NASD officials to dupe the membership out of substantial amounts of money in the lead-up to the merger of the NASD and NYSE regulatory regimes that resulted in FINRA.

Those who were NASD members at the time will recall the hoopla about the $35,000 demutualization payment that the NASD doled out to its member firms.  Firms were disdainful, demoralized and disgusted at the pittance they were being handed for their trouble as Schapiro et al showed them the door.  At the time, the NASD insisted that was the maximum the IRS would permit them to pay.

Fade out, fade in, and enter who of all people but Judge Jed Rakoff – will no one rid me of this meddlesome jurist?! – who is hearing the case against Schapiro.  He has instructed FINRA’s counsel to tell the court what the real IRS number was.  The IRS letter on which Schapiro based her statement – which Bloomberg reports was not even issued by the IRS until three months after the number was announced to the membership – is presently under seal, at the request of guess who (hint: not the IRS).  Judge Rakoff is due to rule in January whether the seal will come off. In the meantime, he instructed FINRA to indicate to the court whether the IRS’s number was, in fact, as represented by FINRA, or perhaps somewhat different.  In response to Judge Rakoff’s instruction, FINRA’s counsel said the actual IRS number was “something like $35,000 to $76,000 on top” of the $35,000 figure the member firms actually received.

A stalwart member of the legal profession, a warrior who has crouched in his fair share of foxholes in the Wall Street wars, attorney Bill Singer offered a doozy of a piece on Forbes.com (8 December, “Regulators Plead Poverty”) in which he tossed around some of FINRA’s numbers. 

In November of 2008 – right at the time then-SEC Chairman Cox was admonishing Wall Street firms not to cut back on compliance as a cost-saving measure – “FINRA asked 300 of its senior staff (about 10% of its staff) to take voluntary early retirement.”  Singer estimates this to be a savings on the order of $30 million – taken precisely at the time Chairman Cox was wagging his well-manicured finger at Wall Street about maintaining the Culture of Compliance.

Why did FINRA need all that money?

Singer references an investigative report from Investment News that claims FINRA “spent some $13 million on salaries for just 13 of its heavy hitters” in 2008, the same year that FINRA reported a $696.3 million loss.  The Chief Administrative Officer alone made $4.4 million.  Singer muses “how the hell does a regulator lose $696 million?”  We muse: how does a regulator pull down seven figures?  And when can we apply for the job?

Having that kind of hole in the budget explains FINRA’s need to save cash.  We wonder whether early retirement was also made attractive enough that none of the senior staffers who were mustered out will be disappointed with what they are getting.  These are precisely the folks who know where the bodies are buried.  It is presumably in FINRA’s best interest to keep them happy – and hence, quiet.

As to the magnitude of FINRA’s losses in 2008, loyal readers of this Screed will recall (week ending May 8, 2009, “An Offer We Can’t Refuse”) disgusted FINRA member firms speculating that the reason for a sudden surge in FINRA examinations – and their attendant laundry list of nit picking procedural fines – was not regulatory zeal, but an empty till.  “I can’t believe how many times they’ve been here so far this year,” one incredulous compliance officer said.  “FINRA must be broke!”  How zealous can a regulator be, after all, if it gave its top 300 executives the chop in the midst of the greatest financial crisis in generations? 

In that column we reported on speculation that FINRA had been a substantial investor in Madoff’s hedge fund – a logical connection, given how deeply enmeshed Madoff was in NASDAQ/FINRA, not to mention a straightforward explanation of where such a large loss came from.  We also pointed out the coincidence that FINRA had sold out its entire position in auction rate securities – some $800 million in its $1.5 billion endowment portfolio – before this market segment melted down, and before securities regulators in New York and Massachusetts – ultimately even FINRA – issued public warnings to investors on the risks of investing in auction rate securities.

Returning to Singer’s piece, he gives FINRA Chair Mary Schapiro’s compensation as on the order of $3.3 million in her last year at the agency, plus over $7 million in accumulated retirement benefits.  This is a gracious exit, though not excessive for a senior regulator of Schapiro’s stature and accomplishment.  Indeed, the NASD/NYSE consolidation alone was worth millions, and she gets the lion’s share of the credit for making it a reality.  In should not be forgotten that NASD was a private corporation, not a government agency.  Its officers’ compensation was really an issue for the membership, not the public.  Not for nothing, in comparison to what NYSE head Dick Grasso walked away with, Schapiro’s compensation package is an insult. 

Among the losses FINRA racked up, Singer also points out a $1 million item in the budget for lobbying.  This was for their trips to Washington to press for more resources.

On balance, we are more a fan than a critic of Chairman Schapiro.  She has trod the difficult path of being an intelligent, effective woman in the world of both Wall Street and Washington, and has retained her composure.  No mean feat.  In the politics of her current job, she steps far too gingerly to be effective.  Still, if politics is the Art of the Possible, we understand the attitude that believes it better to do 10% of a good job, and do it well, than fight for 100% of what one believes is right, with the assurance that one will lose.  We don’t like it, but we understand it.  In an environment where Congress are looking not for solutions, but scapegoats, and the President is running a severe testosterone deficit, it would be mean-spirited to criticize Chairman Schapiro for not being more like Sheila Bair.

We think the Bloomberg article heralds a coming press onslaught that will savage the regulatory agencies and reveal politicians in all their dirty little pettiness and greed.  Why on earth would anyone want to do that?

There has been much talk in the press about financial reform. Re-Regulation.  It is largely, we note, in the press.  It is not yet a Washington reality. Indeed, Washington seems to be doing everything in their power not to address financial regulatory reform.  On the heels of the greatest financial disaster our generation has known, President Obama immediately mobilized his political troops in an all-out assault on… health care reform.  Having set that well in motion, President Obama then turned his full attention to… climate change.

Now that President Obama has participated in the Copenhagen fiasco, and is on the verge of having his health non-care, non-reform bill signed, he will, like his predecessor, be able to proudly announce “Mission Accomplished!” to the American people and head off to slay the next dragon.  Which will be… financial reform?  Well, in case you forgot, January was the drop-dead date for negotiating with Iran.

We think that ultimately the changes on Wall Street will be far milder than threatened or feared.  When the dust settles, it will emerge that AIG and their ilk were well served by the muscle flexing of Pay Czar Feinberg.  This one-time slap – really a chump change grab in the grand scheme of things – will take most of the wind out of the sails of re-regulation, and will still leave the US looking more hospitable to crooks and capitalists than the UK and its Euro-buddies. 

The US is the only country in the world that does not require hedge funds to register.  So will they now have to do so?  Certainly.  Except for those who do not.  Private equity and venture capital, for example, are likely to be exempted because – so Senator Dodd – they do not pose systemic risk.  Final word on that will likely come only at the end of the SEC rule-making process. 

For those advisers who do register, will the SEC and FINRA become much more of a nuisance?  Certainly, since their examination and inspection functions will likely be run by the same kind of uneducated staffers who have traditionally been in charge.

This is good news for compliance professionals who have been in the business for a long time.  Note to hedge fund principals: you want to seek out compliance people with broker dealer experience, as they have spent years dealing with FINRA staff – of whom least said, soonest mended.  The SEC will no doubt be beset by a new zeal to get the Bad Guys, and cool heads and well organized compliance programs will be the order of the day.  If the past is anything to go by, FINRA and the SEC will hire more people, but not smarter ones.

But this is small stuff.  Wall Street, don’t worry.  This too shall pass – and quickly.  President Obama has not had the intestinal fortitude either to spank his own party for their bad behavior, or to strong-arm the opposition into submission.  As America’s leading Artist of the Possible, Obama has abdicated on both health care and climate change, merely to achieve a vote.  And there are bigger problems looming – problems where Wall Street will be able to play the role of a good citizen by expressing concern and outrage, and by financing the political campaigns of those who agree with them.

Who are you more scared of – Lloyd Blankfein with a registered handgun, or Ahmadinejad with an atom bomb?

Uh-huh.  We thought so.

Moshe Silver

Chief Compliance Officer