Wednesday, December 30, 2009

Lobbying by firms which are majority-owned by U.S. Treasury

Spurred by news that GM had hired lobbyists, someone asks if I "could explain how a company which is 63% owned by the US Government could justify spending money to hire lobbyists?" Here is my response...

Personally, I do not subscribe to the notion that  "lobbying" is some kind of social "evil" that is counter to the interest of citizens. Lobbying is primarily an informational process, with the lobbyist trying to "paint a picture" that is advantageous to their client, frequently in terms of how legislation or regulation may help or harm "jobs" and "businesses" in the politician's local district. Lobbying per se is not directly tied to illegal political "contributions" or bribes.

Whether the government owns 0% or 100% of a firm has no bearing on the business-value of engaging in lobbying of Congress and regulators. If the will of Congress and the regulators can affect your business, you have a right and fiduciary obligation to your owners (including Uncle Sam) to make sure that Congress and the regulators are informed of the business and economic ramifications of their actions.

The U.S. Treasury is the nominal owner of that 63% government ownership. They have a fiduciary duty to their "owners", the citizen taxpayers of the U.S., to get a "return" for that investment. Treasury certainly has an obligation to make sure that the firm acts in the best interests of the firm and assuring that Treasury gets its return.

That is not to say that every action of the firm is 100% aligned with Treasury's interests, but generally Treasury can "justify" the actions of the firm if those actions are likely to be in the best interests of the firm's survival and health and "return" of the investment money to Treasury.

Sometimes the interests of firms are way out of line with the interest of U.S. citizens (e.g., Wall Street "banks"), but that is more the exception than the rule.

The simple truth is that Congress and the regulators depend on the lobbyists because the lobbyists generally tend to have a better grasp of the facts and principles involved than the politicians and regulators and their staffs. The problem is weeding out the bad apples without throwing out the overwhelming majority of good apples.

Of course, political partisans who have a contrary interest to the legislative and regulatory priorities of the firm may not agree with the positions being "lobbied" by the firm, but that is all about politics and not about whether lobbying is "justified" or not.

I understand the negative popular image of lobbyists and the political "power" that accrues from attacking them, so maybe it is just another one of those "grimace and bear it" scenarios where you publicly deplore what you privately support. The old saying in Washington is "Never confuse public pronouncements with private intentions."

So, in short, Treasury should publicly decry and excoriate the use of any of the taxpayers' money for lobbying, but privately encourage them to lobby as aggressively as they need to and maybe even offer to help them do it.

But let me reiterate that this is all independent of any illegal financial "contributions" from any firm to any member or staff of Congress or any regulator.

I also understand that many naive individuals lump the legal forms of lobbying in with illegal activities and call the whole collection "lobbying" with no distinction, but that is a misuse of the term. Put more simply, not everyone who "lobbies" is necessarily a "lobbyist". True lobbyists must be registered and are regulated by the government.

In any case, I have no problem with GM lobbying Congress and the regulators. The (temporary) majority ownership by the U.S. Treasury should have no impact on what lobbying activities the firm can engage in.

Ditto for Fannie Mae and Freddie Mac.

-- Jack Krupansky


Friday, December 18, 2009

Harvard's big bet on derivatives (with help from Wall Street)

There is a Bloomberg article entitled "Harvard Swaps Are So Toxic Even Summers Won't Explain" that goes into the gory details about how Harvard used derivatives to "bet" that interest rates would go higher in 2008. Interest rates went lower instead and Harvard had to borrow $2.5 BILLION in expensive bonds to "pay off" the Wall Street banks for these derivative "contracts" that were requiring additional "collateral". Ouch. Even the smart guys at Harvard thought they were doing the right thing at the time.

Lots of states and municipalities were doing the same thing. They were not "gambling" or "speculating" per se, but believed that they could "save a little money" by entering into these seemingly innocent contracts peddled by Wall Street.

Adding insult to injury, they thought they were doing the right thing by buying out of the contacts at the worst possible time in December 2008, since the contracts have "recovered" since then.

Why Harvard, with its huge endowment fund (now 30% smaller) was borrowing money to begin with makes little sense. The basic reason seems to be that the endowment fund was leveraged and they thought they could make more money with the fund than the cost of borrowing money for its expansion program.

Maybe the simple summary is that Harvard was being "Penny-wise, Pound-foolish."

But everybody was doing it... it was the "right" thing to do... or so the Wall Street story went.

Obviously it was all a very bad thing to do, but back in the years immediately preceding the crisis there was pressure on states and municipalities to "save money". Maybe you were personally one of those pesky taxpayers demanding that "your" government do more to "cut costs." For any of the money-management professionals to "say no" would have seemed irrational and offensive to "taxpayers" and their elected leaders who expected "their" government to "save money." If the crisis had not happened, any politician who hadn't tried to "save money" using these exotic instruments would have been likely to have been hounded from office for "wasting taxpayer money."

In fact, the infamous "New Jersey Swaps" that are costing $22,000 (see the Bloomberg article entitled "New Jersey Swap for Unsold Bonds Costs $22,000 a Day") a day are roughly the same thing and were "entered" back in 2004, nominally to "protect taxpayers against rising borrowing costs". Nobody objected at the time and everybody agreed with the "objective". Nobody thought of this as "gambling". They actually thought it was the "prudent" thing to do -- or so Wall Street misled them to believe.

"Penny-wise, Pound-foolish" definitely seems to fit the bill.

I would add the comment that it perfectly illustrates the danger of borrowing money. Borrowing seems so easy and relatively cheap, but it is crucially dependent on a future that none of us can know with the degree of certainty that our borrowing presumes. Borrowing is "seductive", but borrowing is also an "addiction" - where does it stop? After going through personal bankruptcy four years ago, it is now unlikely that I will ever again ever borrow even one cent or pay one cent of interest ever again for the rest of my life.

The thought that just crossed my mind... "We're from Wall Street and we're here to help you." Yeah, right... with friends like you, who needs enemies. These guys are more destructive to the American economy than any terrorist ever hoped to be.

And one more thing... if I ever try to borrow any money from you, please do us both a favor and just say "No."

-- Jack Krupansky

Thursday, December 17, 2009

Morality of short-selling

Short-selling pops up a lot as a topic of discussion, usually when the markets are distressed in some way. I finally decided to write down some of my thoughts on the topic.

Stated simply, my position is that short-selling (as opposed to selling to liquidate a long position) is 100% immoral since you are acting counter to the interests of the party that actually owns the shares that you are selling short, although mostly legal. Naked short-selling is illegal in addition to being immoral. A short sale is the sale of something that you do not own. You may be able to "borrow" shares to sell them short, but that is usually somebody's broker "loaning" shares of a customer who has a long position that is "held in street name" without informing them of that "loan" or in any way compensating for either the "value" of the "loan" of the stock or any of the loss that results from the downwards pressure on price from the short sale. This is all legal, but still 100% immoral, unless you have the moral values of a Wall Street trader.

I would be tempted to say that short-sellers have the moral values of a piece of dog poop, but that would be an insult to dog poop. In my personal hierarchy of moral values, short sellers and the brokerage firms that "enable" them have moral values somewhere well below the moral values of al Qaeda. The only people with worse moral values than short-sellers might be partners at Goldman Sachs and pedophiles. [I have already decided that I will never be applying for work at Goldman.]

Sure, non-naked short-selling is still legal, but slavery and a lot of other barbaric practices were also legal at some point, so being technically legal is no justification of moral value. Contributing to the detriment and even destruction of the economic value of a portion of the real economy (since each short sale does place downwards pressure on the stock price and stock price is a key factor in a company's ongoing ability to raise capital) is clearly immoral. But, some people clearly place a high value of short-term "financial" profit even if it comes at the expense of real economic "value."

There is one exception on short-selling, "shorting against the box", which is the short sale of shares that you in fact own is perfectly reasonable since you do in fact have an economic interest in the financial instrument that you are selling. I wouldn't say that it is 100% moral, but at least it is marginal.

Shorting a stock when you own the bonds is borderline in many cases and immoral in some cases. If you bought the bonds at face value, I would say that a short sale is a reasonable form of "defense". But if you bought the bonds at a steep discount to par (a "fire sale" price), then short-selling becomes borderline predatory. At a steep enough discount, the bounds can become more valuable if the company goes into bankruptcy, wipes out the stock equity, and causes the company to fire employees and void a variety of contracts. "Inciting" that prospect by pushing the stock price low enough that the company cannot raise capital would constitute predatory behavior and be a solid indicator of lack of moral values.

And if you throw CDS into that mix, you are downright and outright "evil" and that may in fact qualify you as a partner at Goldman Sachs.

The only "natural" sellers are owners -- by definition. So, the only "natural" position of a "natural" seller is that they are an owner. In other words, it is "unnatural" to sell that which you do not own.

How can any short-seller believe that selling that which you do not own can be anything other than immoral?

How can any short-seller believe that selling that which you do not own can add productive value to the economy and society?

Buying, owning, and holding stock finances the development of productive capacity in the economy. That is generally considered a good thing.

The additional downwards pressure of short selling during times of financial and economic stress can also damage the ability of normal, average, everyday retail investors with 401K accounts to withstand the dire fear-mongering promoted by short-sellers. These innocent retail investors end up selling at the worst time. Short-sellers add no productive value to their finances or their lives. How much more immoral does an activity need to be before we acknowledge that it is anti-economic, anti-social and plain old immoral? How can we consider such harm to individuals as anything other than immoral?

OTOH, in normal, healthy economic times any financial "games" (e.g., short-selling) are a tiny portion of market activity and can simply be ignored with no great loss. But in times of stress, such activities can begin to be the proverbial tail that wagged the dog, and it is at such times that harm is starting to occur, so it is at that stage when dysfunctional activities that might be marginally tolerated in good times need to be completely shut down. And, they need to be shutdown before any damage occurs, not after, as the SEC did last year when it temporarily banned short-sales of financial stocks. As the old saying goes, it does no good to close the barn door after the horses are gone.

Right now, here we are in the early stages of an economic recovery when the near-term outlook is uncertain. It is at such times that additional capital is critically needed to boost economic activity back to something resembling "normal". Short-selling at times such as this adds no positive contribution to the ability of firms to raise capital.

In short (ha-ha!), short-selling NEVER makes a positive contribution to the economy or the lives of normal people. It interferes with the primary function of a market, to mediate the flow of information between real economic buyers and real economic sellers. Interfering with that flow of information could never possibly be considered a good for society, an essential requirement for morality.

A short-seller may eventually "cover" their "short sale", technically known as "buy to close" or "short covering", but as a general proposition that hardly compensates society or the economy for any economic destruction of value that may have occurred in the interim. Just because short sales eventually are covered or closed in no way makes up for the interim period where non-owners are interfering with the ability of a company to raise capital in the capital markets. The harm has already been done.

Putting it simply (again), short-selling is a form of predation and does not add productive capacity to the economy or "value" to society. It may be profitable, but financial profit by itself does not mean an improvement in the productive capacity of the economy or an increase in "value" to society.

Any number of purported "benefits" are repeatedly put forward, but no list of excuses or purported "benefits", no matter how long or how artfully constructed, can ever excuse immoral behavior.

I have seen a number of arguments (and even formal academic papers) in favor of short-selling over the years and some of them do superficially "sound good", but superficial is not good enough. It is usually deep down in the assumptions were the problems lie. A lot of cute and clever logic and reasoning means nothing if the assumptions are bogus. Bogus assumption #1: "If used responsibly, in moderation, and according to law..." Well, I guess that eliminates 99% of short-selling.

Oh, and I would add that buying "put" options on stock that you do not own is 100% equivalent (and just as immoral) as short-selling.

Even "hedging" a long position with a short position is of very dubious economic or social value. Once again, it hides or distorts the information flow in the market.

And for those in the financial markets who are "morally-challenged", I would put forward the following simple test: simply imagine if your neighbor did something equivalent in the real world (outside of Wall Street and "the markets") - would you conclude that they are "a good person"? If a neighbor or person who you do not know "borrowed" your car without your permission and returned it badly damaged and killed or badly injured several pedestrians and other motorists while driving your car (again, without your permission), would you say that their behavior was consistent with being "a moral person"?

It has been said that if you leave your securities with a broker you can ask to have them delivered to you so no one can short them. True enough (I think), but that simply is not true for retirement accounts. No such option is made available to customers with retirement accounts, such as 401K and IRA Keogh accounts or for mutual funds. I would also note that no broker that I have ever heard of discloses the short-selling  aspect of keeping stock "in street name." Sure, a lot of people may informally know that, but it isn't even recorded in writing or in any official documents of brokerage firms on the Internet.

To repeat one point: Some forms of short-selling may be legal (currently), but legality is never a moral justification. No amount of excuses can erase or balance out the inherent immorality of selling something that you do not own along with the negative economic and social consequences that can result from that attempt to "make a fast buck".

Anyone engaging in short-selling has no business referring to themselves as an investor.

-- Jack Krupansky

End of speculation

I finally realized a week ago that I will never be able to afford to speculate again in any market for the rest of my life. To speculate in a financially responsible manner, you need to first make sure that your "financial security" is in fact fully secure, either from actual wealth or a predictable cash-flow that will have a sufficient future value for you to be financially secure at some future date. Basically, you cannot speculate with your rent or expense money, for this month or any month in the future. Until you get on a path that will result in financial security at the "target date", speculation is a very strict no-no. Sure, you can play with a very modest amount of "pin money", but speculating with any "serious money" is out of the question. That is my situation. My wealth is too close to zero and my income, especially after expenses, is also too close to zero. Worse, I have no plan or path that would leave me financially secure by any date in the future. And it is not as if my opportunities for work were improving in any dramatic way or likely to do so any time in the future, regardless of any efforts on my part.

I essentially knew that already, but it finally sunk in. No more speculation for me... ever. Sigh.

But the good news is that I can and should completely cut off any effort to follow anything of a speculative financial nature. Maybe that will free up a big enough chunk of my brain to maybe do something interesting.

In truth, speculation only had potential value to the extent that it saved my from having to have a "real job". But it has been years since that was true, so now speculation has no real value for me.

Oh, sure, I can still afford to "speculate" in an intellectual sense, but putting intellectual speculation into a financial transaction is out of the question.

In truth, maybe there is still a 1 in 1,000 chance that maybe I'll win a lottery or find a bag full of money on the street or some other outlandish fortune will fall from the sky or that serendipity will result in some dramatic new and sustainable income stream, but one does not spend any time worrying or hoping for 1 in 1,000 class events.

There is the question of what to do with the stock that I already have, primarily Microsoft and very small positions in Priceline and Applied Micro Circuits, but I can also just let them be, especially since the Microsoft is actually yielding better than most bank accounts. I could convert the stock to a "target date" life-cycle fund, and may do so in the future just to simplify my finances, but that decision can be deferred indefinitely. A bigger decision might be to sell the stock simply to completely disconnect my mental processes from having any concern about the stock market at all.

Whether I might continue to mentally speculate about various stocks is another open question, but my feeling right now is that that would not be a productive use of my limited and incrementally-waning mental capacity. Sure, it is fun, and sometimes it can be profitable, but it is certainly not a productive use of my time or effort.

In any case, it really is the end of financial speculation, for me at least.

-- Jack Krupansky

Wednesday, December 16, 2009

Monthly GDP rose a whopping 1.0% in October

Monthly real GDP, one of the five primary economic indicators that the NBER Business Cycle Dating Committee (NBER BCDC) uses to judge recession start and end dates, rose by a "whopping" +1.0% in October or +12.1% annualized, after a +0.2% gain in September, and real Q4 GDP is forecast to rise by +4.2% annualized, according to Macroeconomic Advisers (MA). The government does not publish GDP data at a monthly level, but the NBER Business Cycle Dating Committee says that they refer to sources such as Macroeconomic Advisers (MA) and their MGDP data series. As Macroeconomic Advisers summarized GDP for October:

Monthly GDP rose a whopping 1.0% in October.  Monthly GDP has been rising since July, following roughly a flat trend over the first half of this year.  Roughly half of the increase in October was accounted for by nonfarm inventories, which declined in October by substantially less than in September.  PCE and net exports also posted solid gains in October.  The level of monthly GDP in October was 5.2% above the third-quarter average at an annual rate.  Our latest tracking forecast of 4.2% GDP growth in the fourth quarter assumes a 0.5% decline of monthly GDP in November followed by resumed growth in December.

Back in September their report effectively "called" the end of the recession as June: "We expect monthly GDP to continue to trend higher, marking June as the last recession month."

The trend since June is still very short as GDP trends go, but we are at least on an up-trending track. Employment still has a ways to go, but it is also headed in the right direction.

If the NBER BCDC is the definitive expert on marking of recessions, MA is the definitive expert on calculating real GDP at the monthly level with their MGDP data series.

-- Jack Krupansky

Monday, December 14, 2009

Predatory Capital

I have been using the term predatory capital to refer to large amounts of short selling by hedge funds and the in-house proprietary trading desks of "banks" to attack and even destroy individual firms in the stock market. By artificially pushing the stock price of a company down fast and steep enough, predatory capital can dramatically restrict or even eliminate a company's ability to raise capital, and in the world of modern finance virtually all but a few large technology companies are constantly raising and rolling debt and other forms of capital. We saw this in spades during the recent crisis with Bear Stearns, Lehman, AIG, Fannie, Freddie, Citibank, Merrill Lynch, et al essentially shut out of raising any capital which prevented them from surviving without government intervention. This was a complete failure of "free and open markets."

In a "normal" market, a modest or even moderate level of short selling is okay and maybe a healthy thing. Short selling adds no productive capacity to either the economy or the markets, but is tolerated since it gives idle capital an opportunity to earn a higher return than if left idle.

But in a market under stress, as we had in 2008, that "idle" capital was not seeking to find "productive" assets and investments that would be of long-term value to the economy, but simply short-term profit for the sake of short-term profit with no long-term beneficial effect.

Short selling for short-selling's sake is not investment and does not add any productive "information" to the markets.

In a properly functioning market, the balancing of participants increasing or decreasing their economic stake in companies creates the information that shows us how the market values a company and its prospects. Sure, we tolerate people using short-term trading, options, and even short-selling to "tag along" with the market trend, but those "followers" are tolerated precisely because they merely "follow" the flow of information and do not distort the flow of information in any significant manner.

But once that short-term trading and speculation becomes the preverbial tail wagging the dog and begins to distort the flow of information about participants who are buying or selling true, long-term economic stakes in companies, then the markets are no longer providing accurate information or prices. That is what we saw in 2008.

In fact, the improvement in the economy over the past six months proves that stock prices in the latter half of 2008 were not accurately forecasting the future of the economy and the improvement in revenues and earnings of companies.

I will not claim the term predatory capital as my own invention, but it is not commonly used. In fact a Google News search finds zero hits. Nor is the term or any search matches found in the Wikipedia.

A Google search does come up with some mediocre and unhelpful results, but I did find this interesting result from a review of Jack London's book War of the Classes  in The New York Times dated 1905, that sounds eerily prescient of our current times:

Hmmm... "predatory capital wandering the world over seeking where it may establish itself". I couldn't have put it better myself.

But whether corporations absorb the government or government absorbs the corporation does not seem to be any dominant trend. We do a little (or a lot) of both, but the pendulum continues to swing in both directions with no clear bias towards one direction or the other. The point is that predatory capital exploits any such chaotic motion, not just as a source of modest short-term profit but to profit from the decimation or even destruction of capital that is productively deployed.

My apologies to Mr. London if I have distorted his intended meaning of the term predatory capital.

-- Jack Krupansky