What the film didn’t point out, however, is that the crisis has spawned a whole new set of abuses, many of them illegal as well as immoral. And leading political figures are, at long last, showing some outrage. Unfortunately, this outrage is directed, not at banking abuses, but at those trying to hold banks accountable for these abuses.
The immediate flashpoint is a proposed settlement between state attorneys general and the mortgage servicing industry. That settlement is a “shakedown,” says Senator Richard Shelby of Alabama. The money banks would be required to allot to mortgage modification would be “extorted,” declares The Wall Street Journal. And the bankers themselves warn that any action against them would place economic recovery at risk.
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First, the proposed settlement only calls for loan modifications that would produce a greater “net present value” than foreclosure — that is, for offering deals that are in the interest of both homeowners and investors. The outrageous truth is that in many cases banks are blocking such mutually beneficial deals, so that they can continue to extract fees. How could ending this highway robbery be bad for the economy?
Second, the biggest obstacle to recovery isn’t the financial condition of major banks, which were bailed out once and are now profiting from the widespread perception that they’ll be bailed out again if anything goes wrong. It is, instead, the overhang of household debt combined with paralysis in the housing market. Getting banks to clear up mortgage debts — instead of stringing families along to extract a few more dollars — would help, not hurt, the economy.
Citing the Supreme Court’s decision in Morrison v. National Australia Bank, on February 22 a federal district judge in New York threw out most of a securities class action jury verdict that plaintiffs’ lawyers had estimated was worth $9.3 billion. The jury’s verdict, rendered against the French media conglomerate Vivendi, S.A. thirteen months ago—before National Australia was argued and decided, and thus under now-overturned law—upheld claims that were predominantly “foreign-cubed” (asserted by foreign investors against a foreign issuer for losses on a foreign exchange) and “foreign-squared” (asserted by American investors against a foreign issuer for losses on a foreign exchange). In categorically dismissing all the claims of those investors, the decision in In re Vivendi Universal, S.A. Securities Litigation, No. 02 Civ. 5571 (RJH) (S.D.N.Y. Feb. 23, 2011), according to Vivendi and its counsel, eliminated at least 80%, and perhaps up to 90%, of the liability that the verdict could have produced.
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The so-called “listed” securities theory. The most ambitious plaintiffs’ theory relied upon the statement in Morrison v. National Australia Bank that Section 10(b) of the Securities Exchange Act of 1934 applies “only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” (Emphasis added.) Plaintiffs’ lawyers took this to mean that whenever the home-country security of a foreign issuer was “listed” on a U.S. exchange (as must often be done, for example, in order to issue and list American Depositary Receipts), trades in that security anywhere in the world would be subject to Section 10(b). Thus, if a foreign company sponsored even a small issue of ADRs, or if it dual-listed its home-country shares on an American exchange, global foreign-cubed and foreign-squared class actions would be fair game.
Financial advisers continue to sell risky products to unsuspecting investors — a “widespread” problem for the securities industry, according to a new survey of investment professionals. The survey respondents identified “mis-selling” by brokers as the top ethical problem facing the industry.
“It is hard for people to find high-quality, objective financial advice,” said one respondent to the survey, which is to be released later this month.
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Registered investment advisers have a fiduciary duty to put their customers’ interests ahead of their own. Brokers, sometimes called financial advisers, currently face a lower standard that allows them to plow client money into any investment — so long as it is “suitable.”
Good Read via Jonathan Weil @ Bloomberg (H/T Going Concern).
Interesting Excerpts:
Last August an electronics manufacturer named Molex Inc. (MOLX) did something remarkable, at least by today’s standards for disclosing bad news. It filed a special report with the Securities and Exchange Commission known as an 8-K, saying it had overstated its shareholder equity by $101 million and that investors shouldn’t rely on its financial statements for the previous three years.
What made this event so unusual is it was the only negative restatement disclosed in this manner last year by a company in the Standard & Poor’s 500 Index. That’s according to Audit Analytics, a Sutton, Massachusetts, research firm that tracks such data. Molex, based in Lisle, Illinois, included its corrected results in its fiscal 2010 annual report the same day.
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“It’s one or the other,” says Don Whalen, research director at Audit Analytics. “Either companies’ internal controls have improved dramatically, so they’re not making mistakes. Or it’s too good to be true, and the information is not getting out.”
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The figures for banks, in particular, look unnaturally low. Forty-four banks restated last year, one fewer than in 2009. Even more curious, there were 133 banks that issued corrections from 2008 through 2010. That was down from 169 banks during the previous three-year period, before the financial crisis took off in earnest, which makes no sense.
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About 53 percent of all restatements by U.S. companies in 2010 were handled this way, on the grounds that the errors supposedly weren’t big enough to warrant more prominent disclosures. Sometimes called “stealth restatements,” the corrections instead got tucked elsewhere, such as footnotes in press releases or companies’ quarterly and annual reports.
The bottom line as far as I’m concerned is that you can enact a law or rule and tell businesspeople precisely what to do, but you can’t make the economy or companies comply with policies and social aims. Regulations are limited in their scope and effect, and like a balloon, when you push in one place, self-interested behavior pops out in another. As these articles indicate, those who enact regulation sometimes get it right at first glance, but they’re rarely able to anticipate and control the response of those being regulated or the second-order consequences of the rules.
Errors and misdeeds will occur as long as imperfect, self-interested humans stray into excessive risk-taking. And as long as these things lead to bubbles and resulting crashes, the willingness to dispense with regulation and rely on free markets will never be complete, regardless of regulation’s limitations.
Just how mobile are these rootless corporations in their global chase for profits? It's hard to know, because they're anything but forthcoming about the extent of their employment abroad, much less the number of formerly U.S. jobs they've actually offshored. Some companies reveal the number of their foreign and domestic employees in their annual 10-K reports to the Securities and Exchange Commission, but many don't, as there's no requirement to do so. The Commerce Department's Bureau of Economic Analysis (BEA) releases its own report annually on the total number of workers employed by U.S. firms here at home and by their foreign subsidiaries. But there are almost no figures on how many employees work for foreign firms with which American companies contract to make all or part of their products -- the Foxconns of the world.
Still, looking at the BEA data on foreign and domestic employment from 1982 through 2008 (the most recent year available) gives us some sense of the shift in the employment patterns of U.S.-based multinationals. In 1982, 26 percent of the workers at these companies worked for their foreign affiliates. As recently as 2000, that figure had increased only to 28.9 percent, but by 2008, it had risen to 36 percent. The same growing shift toward foreign employment is evident for leading multinationals. In 1992, Ford reported that 53 percent of its employees were in the U.S. and Canada; by 2009, the share of its workers in North America (including Mexico as well) had shrunk to 37 percent. In 1993, Caterpillar's workforce was 74 percent domestic; by 2008, it was just 46 percent domestic.
First, money not in bankers' hands is viewed as more worthless with each year that passes. This is a problem for regulators who hoped deferred bonuses were the answer. If all bankers care about is what they get up-front, then they'll continue to seek short-term profit and ignore long-term risk: they'll consider any deferred payments marginal anyway, so they won't care of they're lost.
Second, it appears to provide a surprising observation on bankers' risk adversity when it comes to their own money. Their risk tolerance appears very low. Think about the example above where there's a 75% chance of receiving some money now or more money later. If you are more risk adverse, then you would prefer less money now, because you would not want to factor future uncertainty in as a variable for pay out. Bankers don't appear to be comfortable with the risk time poses, even though the expected value of the payout is nearly double.
In 2003, the S.E.C.’s enforcement program was under attack from Wall Street, which complained that overregulation and too much enforcement hampered the effectiveness of American markets in competition with financial centers in London and Asia. The S.E.C., like other agencies involved in the investigation and prosecution of white-collar crimes, received fewer resources to work with as the federal government ramped up its spending on antiterrorism programs.
It is not surprising that a case involving options backdating in that time period would be de-emphasized, at least before the practice gained the national attention in March 2006 when The Wall Street Journal began publishing a series of articles titled “The Perfect Payday” that outlined the huge gains that some executives reaped from backdating. As accounting cases went, it did not look anything like the types of frauds that occurred at companies like Enron and WorldCom, which were the S.E.C.’s primary focus at that time.
The underlying issue is that there is no such thing as a free lunch. Americans (at least certain Americans) love to grumble about their taxes. Yet Europeans and Australians are more heavily taxed and are happier with the services they get from their governments (I heard no complaining in Oz and I circulated pretty widely; surveys confirm my impressions re Europe).
One wag remarked that maybe the reason Europeans aren’t unhappy with their government services is that their countries are better at that than the US is. That could actually be true, particularly since the game plan here over the last 30 years seems to have been to make government less competent as a justification for shrinking it further.
But a second reason is our system has become deeply corrupt, and having failed to be attentive to safeguards early on, it is not clear how to reverse that. The US has long been suspicious of career bureaucrats (even though they are the backbone of important agencies like the Department of Defense and the Department of State), yet when the are seen in their societies as an elite (think of the status held by federal judges), they can attract people with a sense of professionalism who are willing to take a bit less than private sector pay to have a stable career, demonstrably important work, and respectability. That may sound simplistic (and there are plenty of cases where the mandarin model falls short of its promise) but right now, even the not-that-successful implementations look a ton better than the revolving door between agencies of the Executive Branch and power broker law firms.
The second reason is timid prosecutors. A commonly invoked excuse for the failure to file criminal cases is that they are hard to win. But the standard set by the investigators seems to be that they will win all or most of the cases, which is bizarre. As long as a prosecution does not look foolish or overreaching, filing cases where there are good grounds for doing so does have deterrence value. High profile cases are costly to the targets: they consume management time and generate bad PR. Stanley Sporkin, the SEC’s head of enforcement in the 1970s was feared all over Wall Street precisely because he was not afraid to go after questionable behavior, even if he might not prevail in court.
And you aren’t going to be any good at litigating financial cases if you are afraid to try them. That in turn leads to a vicious circle: you won’t attract high caliber law school grads if you aren’t seen as being a good training ground (by contrast, the County of New York Robert Morgenthau was always able to attract talent because it was recognized in the law profession as a top flight operation; Sonia Sotomayor, Eliot Spitzer, and Andrew Cuomo were all assistant DAs under Morgenthau).
An obvious example is the SEC’s recent failed prosecution against former Bear Stearn hedge funds executives. Conventional wisdom is that the outcome proves that the loss confirms that it is hard to win complex criminal cases. But Enron was vastly more complex, yet it resulted in a raft of settlements (with jail time and big fines) and convictions. The fact is the SEC did a bad job. It made rookie mistakes, like relying overmuch on e-mails that looked damaging and failing to do adequate discovery on the surrounding circumstances.
Complacency exists in part because the certain cost of being anything more than passive is not expected to be offset by the uncertain benefits. The vast majority of investors choose to place their trust in the integrity of the financial reporting regulators – to have put in place a system that clearly signals when financial performance has lagged, or that excessive risks have been taken.
That the accounting standard setters have utterly failed to live up to the trust that investors have placed in them is the overarching theme of this blog. Only the notion of investor complacency can explain why investors have not yet stormed the FASB's headquarters, much as Egyptians demonstrated in Tahriri Square to protest a plutocracy operating behind the façade of democracy and due process.
I have no suggestions for altering the calculus leading to consistent investor complacency. The only solution is for regulators, most especially accounting standard setters, to embrace the reality that investors will not tend to exercise their right to be heard, rather than to exploit that vulnerability. For example, accounting standards should acknowledge that investor preferences dictate that disclosure – even under the best possible circumstances – cannot be an adequate substitute for financial statement recognition. They should also acknowledge that due process is clearly not working even though thousands of comments against a proposed standard have been received from issuers, largely with the objective of drowing out those few investors who care to be heard.
In reading the history of nations, we find that, like individuals, they have their whims and their peculiarities; their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.
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Some delusions, though notorious to all the world, have subsisted for ages, flourishing as widely among civilized and polished nations as among the early barbarians with whom they originated, -- that of duelling, for instance, and the belief in omens and divination of the future, which seem to defy the progress of knowledge to eradicate entirely from the popular mind. Money, again, has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper. To trace the history of the most prominent of these delusions is the object of the present pages. Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.
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In the present state of civilization, society has often shown itself very prone to run a career of folly from the last-mentioned cases. This infatuation has seized upon whole nations in a most extraordinary manner. France, with her Mississippi madness, set the first great example, and was very soon imitated by England with her South Sea Bubble. At an earlier period, Holland made herself still more ridiculous in the eyes of the world, by the frenzy which came over her people for the love of Tulips. Melancholy as all these delusions were in their ultimate results, their history is most amusing. A more ludicrous and yet painful spectacle, than that which Holland presented in the years 1635 and 1636, or France in 1719 and 1720, can hardly be imagined. Taking them in the order of their importance, we shall commence our history with John Law and the famous Mississippi scheme of the years above mentioned.
BoA never ceases to amaze me... definitely take a look at the presentation founded by Wikileaks. Slides 13 & 14 blow my mind.
Commentary via Empty Wheel:
In other words, in addition to proposing to conduct cyber attacks on Wikileaks’ European-based infrastructure (complete with a picture of WL’s bomb shelter-housed servers), the proposal appears to recommend that these companies be paid to troll social media, like Twitter, to not only “identify risky behavior of employees” but also, presumably, “push the radical and reckless nature of wikileaks activities.” You know–the kind of trolling we often see targeted at Glenn (and in recent days targeted against David House, who was also listed in this presentation).
In addition, the presentation proposes to create a concern over the security of the infrastructure. Interestingly, when additional newspapers in Europe got copies of the State cables (including Aftenposten), some people speculated that the files had come from a hack of Wikileaks servers. (Note how the slide above notes the disgruntled WL volunteers.)
That doesn’t mean we’re seeing this campaign in process. After all, Glenn has a ton of enemies on Twitter. And if the intent behind leaking additional copies of the cables was to suggest WL’s infrastructure had been hacked, that perception has largely dissipated as more and more newspapers get copies.
One final note: according to Tech Herald, the law firm pitching these firms, Hunton and Williams, was itself recommended to BoA by DOJ. As the presentation makes clear, these are significant government contractors. (Remember, we’re getting these documents because Anonymous hacked HBGary Federal, which was offering what it had collected to DOJ.) To what extent is what we’re seeing just an extension of what our own government is trying to combat Wikileaks?
Now, the Securities and Exchange Commission is aiming to wean the industry off its dependence on ratings, many of which proved inaccurate during the financial crisis.
“This effort is part of a larger movement across the world to generally reduce reliance on credit ratings,” Mary L. Schapiro, the S.E.C.’s chairwoman, said in a statement.
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A report generated by the Congressional panel that chronicled the financial crisis called the largest rating agencies — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — “essential cogs in the wheel of financial destruction” and “key enablers” of the downturn.
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“Standard & Poor’s believes the market — not government mandates — should decide the value of our work, which is why we support removing rating requirements from financial regulations,” said Ed Sweeney, an S.&.P. spokesman.
Some light reading via Christopher Lind for the middle of the week. Would be interested to hear your thoughts.
When I ask people what can be done to make the economy more moral, they typically respond with ideas for personal reform. Banks should have Codes of Ethics so employees are forced to be honest. Oil companies should have training programs for their executives so employees don’t lie, and so on.
These are good responses as far as they go, but that isn’t far. You see, I actually think big business can be moral but all of us are caught up in social systems that are far larger and more influential than our personal relationships. Strong personal ethics are necessary for a moral economy but they are not sufficient. A moral economy also requires a social ethic. What goes into a social ethic? There are many principles but one of them would be mercy.
Bankruptcy is an example of the principle of mercy applied to modern economies. Bankruptcy is a declaration that the commercial enterprise is broken and cannot be fixed. So, the principle of mercy is applied. The remaining assets are divided among the creditors according to certain criteria and the enterprise is over. The parties are now free to restart this or another enterprise. This principle of mercy applies both to personal bankruptcy and to corporate bankruptcy.
Sometimes bankruptcy is thought to contradict the principle of responsibility. We all agree that in general, people who borrow money should pay it back, whether they are individual homeowners or big corporations. In practice though, the larger the corporation the more likely it is to be rescued by governments. This is especially so if the corporation is so interconnected to other corporations that its failure threatens the whole lot.
By Professor Sandel @ Harvard University. (Many thanks to Sonia Jaspal for finding this!)
Introduction (Via Sonia Jaspal's Riskboard).
Here is Professor Sandel’s video introducing Immanuel Kant’s philosophy of ethics. In my opinion, one of the best lectures on ethics. Below is an extract for the one hour lesson -
“Kant rejects the notion that morality is about calculating consequences. When we act out of duty—doing something simply because it is right—only then do our actions have moral worth”
Click here to see the full video – Motives and Morality available on Academic Earth. The few questions which come up after watching this video are -Do business ethics really talk about ethics in the true sense ? Is any business ethical? It may seem we are covering business requirements as business ethics, is that why business ethics are not being adhered?
Having a high tax rate and then filling the code with loopholes is a way to support the loophole industry, it is not good economic policy. It makes much more sense to lower the rate and eliminate the loopholes, so that the marginal tax rate is also the rate that businesses actually pay. Ideally this should be done in a way that raises some additional revenue, since we will need more money once the economy recovers.
There is a long list of ill-conceived tax breaks that have been put into the tax code over the years but the best place to start is with the drug industry’s credit for research. As a result of this and other tax breaks the pharmaceutical industry pays just 5.6 percent of its profits in taxes. This puts it just above the biotech industry, which pays 4.5 percent of its profits in taxes.
By Steven Davidoff, William J. Wilhelm, Jr., and Alan D. Morrison @ HLS Forum.
Abstract:
On April 16, 2010 the Securities and Exchange Commission (SEC) filed a civil complaint against Goldman Sachs in the U.S. District Court for the Southern District of New York. The complaint alleged that Goldman violated the anti-fraud provisions of the federal securities laws, in connection with a 2007 synthetic collateralized debt obligation (CDO) transaction, ABACUS 2007-AC1 SPV (ABACUS). Goldman agreed a $500 million settlement with the SEC on July 15, 2010. We analyze the ABACUS transaction and the SEC's complaint against Goldman Sachs in the context of recent technological changes within the investment banking market. Investment banking was historically a relationship-based business, sustained by reputationally intermediated tacit contracts. Recent advances in information technology and financial economics have codified many formerly tacit elements of investment banking. As a result, some investment banking deals are now transacted at arm's length, and rely more upon formal contracts; we argue that, for this type of deal, there is a stronger case for legal rules regulating the investment bank-counterparty relationship. However, some deals continue to be arbitrated by tacit rules and norms and, for these deals, legal rules are less appropriate, because it is very hard for a third party to ascertain tacit understandings made in the context of a long-lived relationship. An attempt to introduce legal rules into reputationally intermediated relationships may even impair the counterparties' ability to arrive at informal arrangements, and so to trade. The supervision of deals like ABACUS should therefore reflect the extent to which they are transactional or relational; we argue that in neither case is there justification for the application of legal rules or the gap-filling standard of fiduciary duties.
"I’ve already mentioned the biggest mistakes we made," he told the Commission. "In mortgage underwriting, somehow, we just missed that home prices don’t go up forever..."
This admission startled one of the commissioners, who asked Dimon, "Did you do a stress test that showed housing prices falling?"
"No," said Dimon. "I would say that’s probably one of the big misses."
Yes, indeed. Home prices still haven't recovered, as the latest Standard & Poor's/Case-Shiller index makes clear. In many big cities, home prices have sunk to their lowest prices in years.
As the article in the Times goes on to point out, "one striking finding (of the FCIC report) is its portrayal of incompetence."
"It quotes Citigroup executives conceding that they paid little attention to mortgage-related risks. Executives at the American International Group were found to have been blind to its $79 billion exposure to credit-default swaps, a kind of insurance that was sold to investors seeking protection against a drop in the value of securities backed by home loans. At Merrill Lynch, managers were surprised when seemingly secure mortgage investments suddenly suffered huge losses."
