Thursday, May 24, 2012

Looking for a Level Playing Field

There are investors, and then there are investors, and if you need to ask which group you're in, you're not with the big boys (neither am I), and it's not even close to being a level playing field.

The news about the Facebook IPO has been unrelentingly bad, from the Nasdaq snafus that delayed initial trading to the stock's non-existent opening "bump" to the current allegations of unfair play.

To date, to be clear, no one at Facebook or at its lead underwriters (Morgan Stanley, Goldman Sachs, and JP Morgan) has been charged with any illegal behavior. But at very best, it's grossly unfair behavior.

Here's what happened, according to Henry Blodget's Business Insider blog, the Wall Street Journal's Gina Chon, Jenny Strasburg, and Anupreeta Das (article here; subscription required), Evelyn M. Rusli, Ben Protess, and Michael J. De La Merced at the New York Times' "DealBook" blog, and others:

A Facebook executive (or executives) told the underwriters' analysts that its second quarter results would fall short of the analysts' previous estimates. That information was conveyed to larger institutional investors, but not to everyone.

As Blodget writes, "The estimate cut appears to have influenced the investment decisions of at least some institutional investors, dampening their appetite for Facebook stock, and crucially, affecting the price at which they were willing to buy Facebook stock."

He goes on to term this uneven sharing of information as, "at best ... grossly unfair". At worst? It's "a violation of securities laws."

As the Times reporters note, "Under securities rules, a soon-to-be public company is permitted to provide “material” information to research analysts. But if that data is inconsistent with the company’s public prospectus, the issuer must revise the regulatory filing."

The Securities and Exchange Commission has apparently opened an inquiry, and Congress may do the same. While these investigations may well show that no laws have been broken -- just "business as usual" -- it makes it clearer than ever that the institutional investors operate with advantages that retail investors can never match.

If it's not illegal, it still stinks.

Tuesday, May 15, 2012

Dimon's in the Rough

Like many of you, I suspect, I've been following the JP Morgan Chase story with a certain amount of "Dimonfreude" (oh how I wish I could take credit for that coinage!).

It's true that the $2 billion loss won't materially affect the bank's solid position (the bank is still expected to make more than twice that amount this quarter). But it certainly has shaken Jamie Dimon's position as the "America's least hated banker", as he was termed in a December 2010 New York Times profile by Roger Lowenstein.

Questions about the "London whale" trading activity arose in April. and Dimon dismissed the concerns as a "tempest in a teapot".

More recently, Dimon has been quoted as saying that the trade -- part of a hedging strategy to protect the bank from big losses -- was a "terrible egregious mistake".

But the disastrous outcome shouldn't have been that big a surprise -- Jessica Silver-Greenberg and Nelson D. Schwartz report in today's New York Times that for months, if not years, "risk managers and some senior investment bankers raised concerns that the bank was making increasingly large investments involving complex trades that were hard to understand."

What's the solution to the endless series of banking disasters and near-disasters?

Joe Nocera argues in today's Times that banking needs to be "boring" again, and regulation is the way to accomplish that:
Which brings us, inevitably, to the Volcker Rule, that part of the financial reform law intended to prevent banks from doing what JPMorgan was doing: making risky bets for its own account. JPMorgan executives have insisted in recent days that the London trades did not violate the Volcker Rule (which, for the record, has not yet taken effect). But that is only because the banks have lobbied to protect their ability to hedge entire portfolios. A letter to regulators written in February by a top JPMorgan lobbyist — a letter denouncing the potential effects of a strictly interpreted Volcker Rule — describes a trade that sounds exactly like the ones that have just caused all the problems. Such trades need to be preserved, the lobbyist argues.  
It shouldn't surprise you that I'm in Nocera's camp on this, although I don't think he goes far enough.

I have come to the conclusion that if corporations are persons, then regulation is their superego.

People -- even people working and managing corporations! -- have consciences, but corporations don't. They're sociopaths, if you like, lacking that awareness of others' selfhood that makes us fully human. Since corporations don't have an internal compass, we have to provide them with an external one.

What I'd like to see is a new Glass-Steagall Act, fully separating high-risk investment banks from traditional commercial banks. Will I get it? Probably not, given how actively the banks have been lobbying Congress.

Monday, May 7, 2012

Don't Rock the Boat, Board! (Except: You Should)

Last July, when the News of the World scandal was unfurling in all of its non-glory of phone hacking, computer hacking, police bribes, and the like, I wrote a post about how Rupert Murdoch had thrown the NotW staff under the bus -- except for the ones who were really responsible (including Rupert himself, but we couldn't expect much of a mea culpa from him, could we?).

I closed the post by asking what the News Corp. board would do, as they are, ultimately, responsible. When would they hold Murdoch to account for his company's failings?

Today's New York Times has a deliciously acerbic answer: Not anytime soon, thank you very much. (Article, by David Carr, here)

As Carr writes, "Being a board member of News Corporation is not a bad gig; it pays over $200,000 a year and requires lifting nothing heavier than a rubber stamp."

The board is independent only in name, and barely in that (board members are listed here). There are a bunch of Murdochs there, plus others who may at first glance appear to be independent, but whose connections to the family just aren't immediately obvious:
  • Natalie Bancroft, an opera singer. Opera singer? Oh yes, and a member of the Bancroft family, that made a lot of money selling Dow Jones (and its crown jewel, The Wall Street Journal) to News Corp.
  • Viet Dinh, a law professor at Georgetown. Also: a former Bush administration official, and godfather to Lachlan Murdoch's son.
  • Sir Roderick Eddington, of JP Morgan. Formerly: a deputy chairman of a News Corp. division.
  • Andrew S. B. Knight, of J Rothschild Capital Management Ltd. Another former senior News Corp. executive.
  • And so on.
How far do you think these people will rock the Murdoch boat?

Isn't it time for genuinely independent boards? Past time, I'd say.

Friday, May 4, 2012

Thankfully, Mr. Conard, It's Not Just About the Money

Despite economists' fondness for complicated equations and computer models, economics is not a true, hard science. And even most economists will admit that.

Which is why you can end up with completely different world-views, each backed by its own set of economists-with-equations.

On one side are the Horatio Alger stories of boys who, through sheer grit, determination, smarts, and courage, lifted themselves out of the mires of poverty to great personal success. Call it the "Bootstraps Tribe".

On the other side are those, like Elizabeth Warren, current candidate for US Senator for Massachusetts, who believes that there is "nobody in this country who got rich on his own." Call this the "Hanging Together Tribe". (I'm playing with a quote attributed to Ben Franklin, at the time of the signing of the Declaration of Independence: "We must all hang together, or assuredly we shall all hang separately.")

I wrote about these two positions just a few days ago, after reading an AlterNet review of a new book, The Self-Made Myth: And the Truth About How Government Helps Individuals and Businesses Succeed.

The other perspective just got a lengthy write-up in this Sunday's New York Times Magazine, in which author Adam Davidson interviews retired Bain Capital executive Edward Conard (full article, here). Conard has just written a book himself, to be published next month by Portfolio: Unintended Consequences: Why Everything You’ve Been Told About the Economy Is Wrong.

Conard makes a strong case for why inequality is good (more investors making investments in improvements that make all our lives better). The value of investment to society at large is, of course, one with which most economists would agree. As Davidson notes,
Dean Baker, a prominent progressive economist with the Center for Economic and Policy Research, says that most economists believe society often benefits from investments by the wealthy. Baker estimates the ratio is 5 to 1, meaning that for every dollar an investor earns, the public receives the equivalent of $5 of value. The Google founder Sergey Brin might be very rich, but the world is far richer than he is because of Google. 

Conard considers the 5-to-1 ratio too low, and makes a case for 20-to-1. In other words, "we should all appreciate the vast wealth of others more, because we’re benefiting, proportionally, from it."

And it's not just the investors behind products like laptop computers or services like Google who benefit society as a whole -- it's the investment banks and other financial institutions who make the system more efficient. Conard apparently doesn't agree that complex instruments like credit-default swaps were key elements in the 2008 financial crisis: they were "fundamentally sound" and "served a market need for the world's most sophisticated investors."

I could go on and on, but you should read the article for yourself (I haven't read the book; unlike Davidson, I can't get pre-publication copies, but I do intend to once it's out. I think I'll wait, however, until my library has it -- I don't think Mr. Conard needs my royalty payment....).

In any event: my biggest problem with Conard's position, at least as articulated in the Times article, is that he seems to believe that it's all about the money. In other words, if you can't monetize it, it doesn't have value. So Wall Street needs those outsize salaries because otherwise smart, talented people might go off and do something dumb, like be art-history majors (his choice of pejorative, not mine).

Like Conard, I went to business school in the mid-'80s (me, Kellogg / Northwestern; him, Harvard), so I recognize a lot of the jargon. And there's value to some of it. Capital markets are incredibly efficient.

The problem is, they're not perfectly efficient. Davidson notes, "Nearly every economist I spoke with said that Conard has too much faith in the market’s ability to reward only those who create real value."

Moreover, markets don't know how to account for things that aren't monetized (for example, a housewife's or househusband's contributions). They don't know how to correct for rent-seeking -- Davidson does ask Conard about rent-seeking (the idea that people, or companies, get rich because of their power or access to power, rather than their ideas), and he poo-poos its presence in our economy.

And I found Conard's coldly logical approach to everything (including choosing a wife!) chilling. I can't be sure that he's not right, at least on some points, but his world is not one I would ever choose to live in. And I wouldn't even wish my worst enemy there:

There's no place for levity, for warmth, for non-cost-effective rumination in Conard's world. As Davidson writes, "The world Conard describes too often feels grim and soulless, one in which art and romance and the nonremunerative satisfactions of a simpler life are invisible." Davidson quotes Conard:
God didn’t create the universe so that talented people would be happy. It’s not beautiful. It’s hard work. It’s responsibility and deadlines, working till 11 o’clock at night when you want to watch your baby and be with your wife. It’s not serenity and beauty.

I'm not one to say exactly why God created the universe. But I think that God created us to flourish. In the words of early Church father Iranaeus, "The glory of God is a human being fully alive."

Conard doesn't seem to understand that some people aren't motivated just by money, that some people would flourish most completely in professions that would give them time to create something new and valuable (art-history scholarship! painting! theology! dance!) that won't be wildly remunerated. And by concentrating so much wealth in the hands of a few, I fear he's condemning the poor to endless poverty, and helping the middle-class slide back into poverty. His wealth may improve society as a whole -- but does it do anything for the individual struggling to get by?

I can't help contrasting Conard's concentrate-the-wealth formula with the spread-it-around generosity of the Self-Made Myth's perspective. I'll close with a quote from a foreword to that book, written by an attorney (Conard doesn't like them much -- smart but not risk-takers), named Bill Gates, Sr.:
As an attorney for almost 50 years, I worked closely with entrepreneurs and saw how their business enterprises are boosted by government efforts to create a stable and positive business environment. I also had a front-row seat for the creation and the growth of my son's business (Microsoft), and I observed the many ways our country's publicly supported infrastructure, tax laws, government-funded research, education, patent protection, and so forth helped the company grow.... [If] you had plunked Bill down in some developing country, even with all of his intelligence, creativity, and hard work, the company would have gone nowhere. Being born in this country is the ingredient that most reliably determines whether a person has the opportunity to become wealthy.

Conard would say that "[t]echnology and global competition have made it more important than ever that the United States remain the world’s most productive, risk-taking, success-rewarding society." Like many conservatives, he underestimates the importance of governmental infrastructure (trust in the rule of law; fairness in the marketplace, guaranteed by enforced regulations; roads, rails, airports, and the rest). Would Bill Gates Jr. really have been able to make Microsoft the powerhouse it is today if he'd been born in, say, Zaire?

I expect that Conard also underestimates the "step up" he had by growing up white, male, and middle-class, with parents who encouraged his educational attainments. Not to mention a little bit of luck.

Wednesday, May 2, 2012

Get Rid of the Gimmes (redux)

I've written before about the problem of "gimmes" in the medical / pharmaceutical industry (see here and here, for example), but I know that lots of people still have trouble believing that a pen or a coffee cup or lunch for the office can really affect whether doctors will prescribe Drug A or Drug Q.

So I was happy this morning to hear a further discussion of the issue on Connecticut Public Radio's program, "Where We Live" (audio download, here). Should drug company sales reps be allowed to make presentations, for example, to medical students?

Give it a listen; it's a fascinating discussion.