Wednesday, May 30, 2012

“Wall Street’s Death Wish”

Sydney M. Williams

Thought of the Day
“Wall Street’s Death Wish”
May 30, 2012

If an enemy wanted to undermine confidence in our capital markets they could hardly have inflicted worse damage than that which we have done to ourselves.

While his article was interesting and well researched, Azam Ahmed in his Sunday New York Time’s article, “The Hunch, The Pounce and The Kill” missed an opportunity. His piece makes clear that banks remain too big, that they continue to speculate and that Dodd-Frank has done nothing to prevent the abusing of credit default swaps, but he failed to conclude, as I have, that Wall Street is committing self-immolation.

The article detailed the $100 billion bet made by Bruno Iksil (the “London whale”) of JP Morgan and which has cost the bank between $2 billion and $3 billion. Mr. Ahmed also reveals details of those who bet against Mr. Iksil and won big, especially hedge fund manager, Boaz Weinstein. Despite these enormous losses – borne by shareholders, and potentially taxpayers – the “whale” will be leaving JP Morgan a very rich man, indicative of Wall Street’s questionable morality.

It is impossible to read the article without becoming angry that the lessons of 2008 have gone unlearned. We, the taxpayers, remain at risk. While blame for the credit crisis includes almost all aspects of our society, including consumers who purchased homes beyond their means, the accelerant was provided by politicians who placed personal favors above responsibility, regulators who did not regulate, corporate-types from AIG, Fannie Mae and Freddie Mac and investment bankers and traders at banks who created and sold derivatives whose value is solely for speculators. It was crony capitalism at its worst. The passage of Dodd-Frank did nothing to remove the accelerants. Banks are bigger than ever and the trading in naked credit default swaps (CDS) remains.

When one looks back at the 2008 period from a perspective of time and distance what is most remarkable is that not one of the perpetrators, including members of Congress, has gone to jail. An honest adhering to fundamental principles has become a mugs game. Are we considering the lessons we provide future generations?

Bruno Iksil was shorting a security known as Investment Grade Series 9 10-Year Index CDS – a bet that the European debt crisis would moderate and the value of the Index would decline. According to the Times, “Boaz Weinstein and a wolf pack of like-minded hedge fund managers” took the other side. In May, when problems in Europe re-surfaced, the Index rose and Mr. Weinstein and his group began to win. The result cost Mr. Iksil his job, but it remains unclear as to whether his past compensation will be ‘clawed back.’

Credit default swaps, according to Robert Jarrow of Cornell’s Johnson School of Business, were first created in the mid 1990s at JP Morgan. The intent was to limit Morgan’s exposure to bonds they were underwriting and to loans they had outstanding. Like so many Wall Street products, the concept behind them was well intentioned. But, also like many of Wall Streets more creative products, trading in them exceeded the originator’s intentions. The market for credit default swaps grew exponentially. By 2008, the market had grown to $60 trillion, almost double the size of all U.S.’s capital markets.

The concept of a CDS is simple. It is insurance against the possible bankruptcy of the issuer. As such, it protects a buyer or holder of speculative bonds, allowing the owner to measure his return based on the yield of the bond less the cost of insurance. Additionally, CDSs allow higher-risk issuers to more easily and less expensively access credit markets.

The problem is not that the instrument is capable of “mass destruction”, as Warren Buffett once alleged; for insurance, as Professor Jarrow has stated, is “intrinsically a good thing.” The problem developed because regulators never viewed CDSs as insurance. AIG, the largest issuer of CDSs in 2008, never had adequate reserves. The lack of reserving allowed the insurance company to report big gains in the years preceding the credit crisis – defaults at the time were at record lows – but the collapse destroyed one of America’s premier insurers, costing taxpayers an estimated $180 billion. If AIG had treated the product as insurance and had actuaries accurately measured risk they would never have got in trouble. It is unlikely they would ever have condoned naked purchases, and they would have been adequately reserved. Dodd-Frank addresses none of these issues.

The second lesson to be learned from Mr. Ahmed’s article is that it becomes increasingly difficult to believe that Bruno Iksil was hedging. The bets were simply too big. He was playing the game still too common on Wall Street – heads, I win; tails, you lose.

A third lesson is that regulation should curb trading in instruments that have little, if any, economic value. It is in Wall Streets long term interest to do so. The bets that Mr. Iksil was placing could have been made in Las Vegas or Macau, except casino operators are more diligent as watchdogs than are the SEC and the CFTC. In fact, Mr. Weinstein who made $40 million a year at Deutsche Bank before losing $1.8 billion in 2008 (and you can bet there was no claw-back provision in his contract at the bank!) was banned from the Bellagio in Las Vegas for card counting.

As our capital markets have taken on a more casino and carnival-like atmosphere, they have been hugely rewarding for those who take enormous risk, with rewards personalized and losses socialized. The losers have been the millions who seek decent returns for their far more modest investments and legitimate businesses seeking to raise capital. These are the people integral to the original intent of capital markets – providing capital and offering liquidity. The volatile and, at times, out-sized returns, and the amounts of money made by a few speculators (Mr. Ahmed estimates that Mr. Weinstein made $90 million last year!) have attracted the attention of managers of pension and eleemosynary funds, diverting investment dollars away from real businesses and into products like CDSs that have little, if any, economic raison d’être.

Traders like Mr. Weinstein and Mr. Iksil are obviously brilliant; they benefitted from recent technological advances and the leverage provided by the banks for which they worked. But one cannot help wonder what paths their lives may have taken under different circumstances. In another time, people with their genius-like talents might have invented penicillin or rockets. Instead, we have men who have made themselves extraordinarily wealthy by trading obscure derivative instruments, while back in the real world, cancer remains uncured and we have given up exploring the frontiers of space.

What is worrying about Europe is that it raises the specter of 2008. It is concerning that banks are still too big: the risks they assume endanger our financial system; they reward those who risk depositor and shareholder funds, while losses, if they are big enough, become the obligations of taxpayers. Wall Street has been reluctant to call CDSs the insurance product they are, preferring instead to keep them unregulated, regardless of the consequences. We have permitted Congress to pass regulation which complicates the lives of smaller businesses, yet we protest doing anything that might prevent the sort of cataclysmic event that almost brought down our financial system. We have learned very little.

Wall Street is as necessary a component of freedom as is Main Street. When we allow speculators to alter its original purpose we risk the free flow of capital from investors to businesses. There will always be people who come to Wall Street to make their fortune, but the same thing is true on Main Street. The relationship, when it works as it should, is symbiotic. It relies on confidence. When we permit banks to get so big that they endanger our financial system, when we permit trading in instruments that offer no economic value, we risk destroying a system that has worked well for two hundred years. We have enough enemies; we don’t need to commit suicide.

Tuesday, May 29, 2012

“The Death Throes of European Socialism?”

Sydney M. Williams
Thought of the Day
“The Death Throes of European Socialism?”
May 29, 2012

“It probably is about time to judge the eurozone as a failed idea – and rarely is it wise to double down on failed ideas.” So wrote Tyler Cowen in Sunday’s New York Times, mimicking a piece by Martin Jacomb in last Thursday’s Financial Times. A single currency, while attractive in the abstract, is unworkable without common fiscal unity, regardless as to whether the seventeen Eurozone nations can issue bonds in common. The bigger question: Does the failure of the Euro mark the end of Europe’s experiment with Socialism? It is largely unasked, as leaders in several countries have based their careers on Social Democracy being sustained. Nevertheless, such speculation hovers overhead.

A small number of countries like Sweden (not part of the eurozone) have elected more conservative governments, reduced government spending and limited the role of unions, and so may be able to maintain a more modest version of social Democracy. Baltic and East European countries, recently emerged from the yoke of Communism, fully understand the many false promises of statism, no matter its name.

Democratic Socialism is a function of wealth. Poor nations are concerned about far more basic needs – shelter, adequate food, water sources, and defense against enemies. All societies depend upon a few to protect the many. But, as nations become richer, the greater is their sense of altruism, that more of the wealth should be redistributed, so that no one should suffer. This attitude gives rise to a sense of entitlement. It is not dissimilar to what happens in very rich families. A distant ancestor creates enormous wealth. Succeeding generations, who have benefitted from their inheritance, become increasingly distanced from what they consider to be the “crassness” of the talented founder of the family fortune. Some begin advocating policies that would have made impossible the accumulation of wealth in the first place. Eventually the money runs out and the heirs must go to work. Governments, like families, if they want to provide for the less fortunate, must encourage the creation of wealth. In much of Europe today, as in the United States, money is running out. The people will have to return to work.

The only rational response is an emphasis on free markets, private enterprise and a sense of individual responsibility. We must reduce dependency. People must be free to innovate, to take risks; those with capital must be incentivized to invest. Losses cannot be socialized. Regulation must ensure that no one enterprise grows so large that it risks our system. There should be no Long Term Capitals. When banks, businesses and unions become too large they create the foundation of crony capitalism, a problem with which the U.S. is currently wrestling, from banks “too big to fail” to favored companies like Solyndra. Such actions allow a crony-like, symbiotic relationship to develop between government, union management and large business.

Greece needs a government that will encourage entrepreneurship and investment; and investors need to understand that the opportunity for reward is accompanied by risk and involves individual responsibility.

The urging by many of the more profligate members of the eurozone countries, including France, to issue Euro bonds is simply an attempt to forestall the inevitable. Borrowing the name of Alexander Hamilton to legitimize their decisions is inaccurate and offensive. It is true that the first Treasury Secretary of the U.S. urged the national government to assume state’s debts incurred during the Revolutionary War, but it was not intended that the national government assume debts unrelated to the Revolution. That would be as though Washington would have the citizens of Indiana assume responsibility for California’s fiscal profligacy. When prodigality goes unpunished it only breeds further intemperance. While no one can foresee the future, I find it hard to believe that Americans would allow that to happen. Yet those like François Hollande and Mario Monti would have that happen in Europe!

“Greeks too Western to Pull Off Baltic Rebound, SEB Says.” The Bloomberg headline, quoting the head of Estonia for one of Sweden’s largest banks, is a not-so-subtle stinging acknowledgement that European Democratic Socialism, at least as practiced in the Mediterranean countries, has been an abysmal failure. If they want to resolve their problems, Europeans – not just the Greeks – will have to turn toward free market capitalism. To stay the current course condemns them to a slow but certain death.

The article makes the point that Greeks, for at least two generations, have directed government spending toward maintaining a social welfare system that they can no longer afford. As such, it has become impossible for them to adjust their behavior. The hand-wringing of bureaucrats in Brussels and Berlin, fail to recognize this simple truth. They argue for austerity on the part of the Greek government, but provide no roadmap that would allow stimulus from the private sector – tax cuts, relaxation of regulations and incentives to the aspirational.

David Malpass, in Thursday’s Wall Street Journal, understands the difference, a subject I broached last Monday in an essay: “Europe’s Quandary – Socialism or Free Markets.” Mr. Malpass writes, “The reality is that Greece’s government is imposing too much austerity on others and not enough on itself.” He goes on to add, ominously but accurately, “The U.S. is making the same mistake.”

Mr. Malpass suggests that the best answer would be for Greece to stay in the Euro, reduce spending and ask for Europe’s help as it downsizes government. But, to be successful Greece must also incentivize the private sector. I happen to agree with the people from SEB and suspect that it will only be under the duress of returning to the Drachma that will focus the Greek people’s attention on the necessity to returning to a government that respects and has faith in the individual and that foregoes dependency for personal responsibility. I also suspect that Brussels’ bureaucrats way overstate the disruptive consequences of Greece abandoning the Euro. There is no question that there will be a period of disequilibrium, but that is preferable to the torturous death Greece is experiencing under its current domination from Brussels and Berlin. Returning to the Drachma will give the country the flexibility necessary to move forward.

At the end of the day, the economy of Greece, representing about 2.4% of the Eurozone’s GDP, is a small enough not to cause a systemic problem. However, if contagion were to spread to Italy and Spain, the matter becomes far more serious. Those two countries represent 26.4% of the eurozone’s GDP. Monetary policy alone cannot solve what is in fact a decades-old, political-sociological problem. One could argue that the common currency has served to accentuate existing bad habits. For years, the Euro masked a deteriorating economic situation in Greece. Government spending and union demands continued, while the ability to pay for such entitlements eroded. There was no coalmine in which a canary could sing. Standing alone, the Drachma would have weakened, alerting investors. Instead, a Euro that remained relatively strong allowed profligate nations like Greece to borrow less expensively than would otherwise have been the case, while fiscally virtuous nations benefitted from a lower-valued currency, aiding exports (i.e. Germany.) On the other hand, a single currency has prevented the Greeks from devaluing their currency, as a means of correcting their downward spiraling economy.

A major problem of big governments is they construct bureaucracies that become self-perpetuating, and almost impossible to dismantle. We see that phenomena in Washington (and in capitals like Sacramento, Albany and Springfield.) Additionally, they generate myriad regulations with which all businesses must comply. Regulations become less about ensuring the safety of people and more about protecting unionized government jobs. It seems remarkable, for example, that among the thousands of pages of Dodd-Frank nothing has been done to rein in the size of banks, or the use of credit default swaps – an important contributor to the near meltdown of our credit markets four years ago, and which are now playing an important (and not helpful) role in the unwinding that is going on in Europe.

But back to Greece; while it appears increasingly obvious that Greece will abandon the Euro, it is not so clear that that act alone will cause the Continent to abandon the culture that propagated their Democratic Socialism. That, unfortunately, may take more time and more pain.

Wednesday, May 23, 2012

“How to Weather the Storm”

Sydney M. Williams

Thought of the Day
“How to Weather the Storm”
May 23, 2012

Ironically, as portfolio management has increasingly become the purview of professional managers, the most fundamental reason for individuals to invest appears to have been forgotten. It is to produce a portfolio capable of generating a reasonably assured stream of rising income – to supplement government provided Social Security upon retirement. Instead, the market has become a casino, with high frequency traders accounting for 70% of total volume, and with a proliferation of a variety of derivative products ranging from indexes, to ETFs, to futures and options. Investment banks can create virtually any product to mimic any asset. Long term has become settlement date. Instead of attracting individuals into the market, such activities have driven them away.

After rising 26% between mid August and April 2, the S&P 500 declined 7.2% through yesterday. The market is lower than it was a dozen years ago. The flash crash of two years ago is vividly remembered by individuals. Bernie Madoff and MF Global have done nothing to improve confidence. Not one person responsible for the credit meltdown has gone to jail. Main Street has concluded that the game is rigged. Sentiment numbers show persistent concern. Interest rates are so low that cash is not a real alternative. Inflation simply erodes your assets more slowly. Morgan Stanley’s inept job of pricing and allocating last weeks’ Facebook offering, and NASDAQ’s mishandling of after market flow, only accentuated the lack of credibility in a legitimate and transparent market. What’s an investor to do?

Investing involves risk. It always has and always will. The extrapolation of recent events affects behavior. In 2000, most people were bullish. The crash of 1987 was long ago, and the market was sitting atop an eighteen-year bull market. Now, after more than a decade of poor performance the easiest path is to assume recent history will continue. Nevertheless, over time markets rise and fall, but mostly rise, reflecting the natural economic growth of the country.

Alternatives are limited. As stated above, cash makes little sense for those at or approaching retirement. For one concerned with preserving principal, there is no alternative to the Three-month Treasury Bill. A million dollars will generate $900 annually, substantially below the inflation rate and too little to feed one’s dog. In order to live, one would have to eat into capital. A million dollars in the Thirty-year bond would provide an annual income of $28,740.00. However, there is no chance that the yield would increase. Additionally, the investor assumes the risks of a rise in rates, which would cause a decline in one’s principal, and the erosion of the purchasing power of the dollar. An increase in rates to where they were ten years ago (which was a third of what they had been twenty years before that) would mean that the million dollars would be reduced to half a million dollars, and inflation would have reduced the value further. A holder would still receive his annual $28,740, and would have his million dollars returned in 2042, but with no assurance as to what the value of that million dollars would be.

Corporate bonds present some of the same problems as do Treasuries in that their price will decline should rates rise. Also, like Treasuries, the rate of interest will not increase, providing no protection against inflation. Unlike a Treasury, there is some risk that the bond could default. However, in the meantime the million dollars will produce somewhere between $40,000 and $77,500, depending on the quality of the bond purchased. Like Treasuries, though, the annual interest payment will not go up.

Commodities such as gold, silver or platinum may serve as protection against inflation, but provide no income, and can also incur a cost, for example for storage.

We are left with equities. Equities distinctly involve more risk than bonds. In the event of bankruptcy, they are last in line. Separating disinformation from accurate information is often difficult. When speaking with investors, company managements generally focus on opportunities, not risks. Brokers get paid by transactions, so despite regulations demanding they adhere to rules like suitability, incentives encourage them to generate trades.

Equities are also subject to all sorts of events including external pressures. The fear that Greece, with an economy that is roughly 2% of the U.S., might leave the Euro zone can cause American shareholders to lose sleep. When it is pointed out that Greece’s GDP is equivalent to less than two percent of U.S. equity values, the nay-sayers will talk about contagion. There is always something to worry about, and some of it we should. However, there is no way of predicting the future – good or bad. All we can say with any sort of certainty is that today’s prices will be different tomorrow. J.P. Morgan (the man, not the bank that now mocks his name), when once asked by a curious reporter what will happen to stock prices, responded, “They will fluctuate.” That they will.

Nevertheless, with all the problems we have, many of which I have described in earlier TOTDs, the U.S. still seems the safest place to invest. On a relative basis there are very few countries whose governments are more open than ours and whose legal system is as fair. We may be on a downward sloping path, but we remain the preferred venue.

Good, dividend paying companies seem an obvious strategy. Within the S&P 500 companies, there are eighty-eight that pay a dividend yield ranging from 2.5% (Microsoft) to 3.5% (Kellogg.) Among those eighty-eight companies, one should be able to create a decent portfolio whose payout ratio allows some ability for growth. While such a portfolio would not protect an investor against the vagaries of the market over the short term, the portfolio’s income should be reasonably protected. Obviously such a portfolio would have to be monitored for conditions that could cause a dividend to be cut, or against the possibility that a stock might rise to such a premium that the (current) yield would no longer be attractive to a buyer.

Dividends have risen during most years. Between 1960 through 2011, average annual dividend growth for the S&P 500 was 5.4%. That could be compared to an average annual increase in inflation over that same period of time of 4.1%.

Protecting capital is the preferred strategy in times of uncertainty. Protecting income, while preserving the opportunity for upside in income, would seem to be the more attractive strategy in today’s world for those looking toward retirement. It is estimated that 10,000 people per day for the next sixteen years will reach 65. What makes the strategy of simply protecting capital so unattractive in today’s environment is the fact that the only way to do so is through Treasury Bills that pay only a nominal rate. No other asset class is assured of protecting one’s principal. A twenty-year bond will return your investment when it matures in twenty years, but in the interval the bond will trade based on the direction of interest rates and according to its perceived credit risk. Additionally, should inflation in the next twenty years approximate the last fifty years, the million dollars would be worth about $400,000 in today’s dollars in twenty years. No one can accurately predict the volatility in commodities, bonds or stocks.

While nothing is ever assured, it is easier to forecast the general direction of a company’s earnings than the price that company’s stock might sell for over the next six months.

My conclusion: The best port in this storm for the uncertainty we face will likely continue to be a focus on preserving one’s income by buying high quality dividend paying companies where the opportunity for increases exists. Assets will fluctuate; so look for stability in income.

Tuesday, May 22, 2012

“A Squall Over a Squaw”

Sydney M. Williams

Thought of the Day
“A Squall Over a Squaw”
May 22, 2012

“Honest Injun!” I am Cherokee. So proclaimed Harvard Law School’s pre-eminent “Native American” scholar, otherwise known by her white, Christian name, Elizabeth Warren.

Harvard’s difficulty in separating truth from fiction had already been questioned. Barack Obama graduated from the Law School in 1991. He became the first African-American president of the Harvard Law Review. Miriam Goderich, his literary agent and presumably getting the information from Harvard, referred to him as having been born in Kenya. We now know he was born in Hawaii, but, like having Cherokees on their staff, having presidents of the Law Review from Kenya sounds more ‘inclusive’ than having been born in a paradisiacal island like Hawaii. It is not the truth that shall set us free (at least at Harvard); it is whatever works in their politically correct world. Sixteen years later, Mr. Obama’s literary agent changed Mr. Obama’s place of birth to Hawaii. By that time, of course, Kenya would have been inconvenient as a place of birth.

All politicians lie. I don’t think Mark Twain had Ms. Warren specifically in mind when he said: “There is no distinctly native American criminal class, except Congress.” But he could have. Her claim of descendancy relied principally on the “high cheek bones” of her grandfather (from a Republican such characterizations would have been considered racial!) So she comes close to fitting Mr. Twain’s description of a criminal; she is an American and an aspiring member of Congress. Of course, if she were an “Honest Injun” she would never have made such a claim in the first place. If she had an ounce of respect for the law, which she taught, and regard for the people she hopes to represent she would have resigned her campaign. Further, if she also gave up her teaching position, she would provide an opening for a real Native American, so that Harvard’s claims would prove true. More than anything, she is a model for “Julia.” Ms. Warren inhabits the Orwellian world she would like to provide the rest of us. Affirmative action, now getting long in the tooth, served a valid purpose, but it was never intended to be based on lies.

What Ms. Warren did was not only unfair to Native Americans, in securing a position that may have gone to a person of true heritage, but is also insulting to women, in that it implies they need help. Campbell Brown, a former news anchor for CNN and NBC wrote an op-ed in Sunday’s New York Times, entitled “Obama: Stop Condescending to Women.” In the piece she wrote” “Women don’t want to be patted on the head or treated as wards of the state. They simply want to be given a chance to succeed based on their talent and skills.” They do not need to be patronized. As a society, we have moved beyond that point. Today, we all want the opportunity to succeed or fail based on our abilities, desire and diligence.

As I said, all politicians fabricate. It seems to be part of their genetic makeup. Republicans are as guilty as Democrats. The most obvious example was the crook, Richard Nixon, who dishonorably (but appropriately) resigned from the Presidency. But two others come to mind. John Rowland, former governor of Connecticut and Mark Sanford of South Carolina. As they should, both resigned, with Rowland spending ten months in Jail for corruption. He is now working for the city of Waterbury. Mr. Sanford, who was accused of misusing the State’s travel funds to visit his Argentinean mistress, was censured, but not impeached. In October of last year, he was hired by Fox News, where he has been noticeably invisible. In all three cases, immoral and illicit behavior condemned the perpetrators, properly, to lives far from the spotlight.

Democrats have fared somewhat better. Of course some of them disappeared into the miasma of politicians corrupted by greed and power. Wilbur Mills (for eighteen years, Chairman of the House Ways and Means Committee) had an unfortunate assignation with Fannie Foxe, a stripper from Argentina (it is fascinating how Argentina beauties have attracted powerful politicos!) When confronted by Park Rangers, she jumped from the car into the Tidal Basin. Mr. Mills had suspicious looking scratches on his face, and, in time, admitting being in the area. Gary Hart was the clear front runner to get the Democratic nomination for President in 1988 until his antics with Donna Rice became fodder for the press. Instead, he earned a Doctorate in Philosophy for politics from Oxford and, ironically, now has a blog, Matters of Principle. Eliot Spitzer, New York’s sanctimonious Attorney General-turned-Governor (another Harvard Law School graduate) made the silly mistake of paying for hookers (Emperors Club VIP) with his American Express card. He now pontificates about politics on a nightly TV show, “Viewpoint with Eliot Spitzer.”

But, some are covered in Teflon. The most obvious being the Kennedy clan, which continues to be treated by much of the press as though the mythical Camelot actually existed and, in fact, still does. It begs belief that a thirty-seven year-old U.S. Senator could abandon a trapped and drowning girl in a car that he had driven off a bridge on Martha’s Vineyard and then get re-elected six more times, becoming, in the words of an adoring press, the “Lion of the Senate.” Most people would have been taken in by the police and tried for manslaughter. His brother’s were rogues, at least where it came to women. His nephew Robert’s behavior this past weekend was repulsive, but, then, he is not a politician, only a Kennedy. Bill Clinton, the closest thing America has ever had to having a billy goat in the White House, seems to have survived and thrived his sexual escapades in the “People’s House,” if one can call oral sex, sex.

The cynicism toward Washington is not surprising given the feelings of entitlement our elected leaders have. That same feeling of entitlement pervades the upper reaches of much of Wall Street and corporate boardrooms. Crony capitalism, which includes politicians, union leaders and some in the corporate world have created an “us versus them” system. Other than Bernie Madoff, not one Wall Streeter or government official – those who helped bring our credit system to the brink of collapse – has been sent to jail. (Mr. Bush’s Attorney Generals were far more effective in sending corporate miscreants to prison than has been Eric Holder.) Mr. Madoff’s crimes, as bad as they were, did not cause nearly the costs as did the managements of Fannie Mae, Country Wide Credit, Freddie Mac, AIG, General Motors, Lehman Brothers, Bear Stearns, Goldman Sachs, Merrill Lynch – the list goes on and on. Congressmen like Bernie Frank and Chris Dodd were equally culpable, but they like their cohorts on Wall Street are held to a different – and lower – standard.

What is sad is that such behavior on the part of leaders is causing much of Main Street to lose faith in our system. But all is not lost. A week or so ago, I was in a taxi driven by a Bangladeshi, who had come to this country fifteen years ago speaking only Bengali. Within a few years he met the women who became his wife. She had come from Pakistan and spoke Farsi. Both became citizens. English became their common language, and is the only language their young children speak. His pride in his American children was tangible, as he told me, no matter what one reads of discontents in his native country or here, that America remains unique; it provided him an opportunity that would be impossible anywhere else.

The problem extends beyond this particular squall. When those like Elizabeth Warren game the system – pretending to an American Indian heritage she does not have, to secure a situation she does not deserve, while allowing Harvard to satisfy a dubious need – and when crony capitalism serves to protect the status quo, we are all the losers. When we allow those who cheat and steal, whether they be in government, businesses or unions, to go free because of who they know, it is all our loss. The fact that Ms. Warren can lie without a sense of shame speaks to her moral emptiness. There are millions of people, many of them recent immigrants, who believe in the principles that made this country what it is. For leaders to behave like entitled royalty goes against the fabric of which our country is made.

Monday, May 21, 2012

“Europe’s Quandary – Socialism or Free Markets?”

Sydney M. Williams

Thought of the Day
“Europe’s Quandary – Socialism or Free Markets?”
May 21, 2012

The G8 meeting at Camp David this past weekend was to strategize about Europe and how best to stimulate growth. The President met a day earlier with François Hollande, a Socialist and opponent, like Mr. Obama, of “austerity”. All parties are interested in promoting economic growth. Even the recalcitrant Germans who appear to emphasize austerity over government stimulus recognize the need for growth. In fact, it is the only way out of the mess in which Europe finds itself. It is the means, not the end that separates the two groups. Socialists like Mr. Hollande and statists like our President opt for the government leading the way. Free marketers argue that the only way to achieve long-lasting economic growth is to let the private sector take the reins.

The goal of any political leader should be to do what is best for the greatest numbers of their people. The bottom line is how best to improve the average person’s standard of living, while helping those without means or ability, and providing opportunity for the aspirational. Its foundations are a sound education and the assumption of personal responsibility. Policies should be aimed at reducing dependency, and should embed a respect for all people and a belief in their ability and good sense. Unfortunately, as the Obama campaign video “The Life of Julia” makes clear, personal independency is not the Administration’s goal.

M. Hollande presides over a country that generates about 61% of its GDP from government. And his policies would increase that percentage. Government spending for the 27 Euro nations generates just over half of GDP spending. In the U.S., when we include state and local governments, public spending is about 40% of GDP. In all cases, as government spending has increased as a percent of GDP, two things have happened: The absolute rate of growth has declined and the level of public debt has increased. For much of the post-war period in Europe (and in the U.S.), two trends helped: First, demographics favored the welfare state; there was, in the early post-war days, a surfeit of labor and a deficiency of retirees. The second trend has been a thirty year period of declining interest rates, giving cover to the long term costs of increased debt. Rates may decline further, though even my grandchildren realize there is not much juice left in that glass. Recent declines in rates have been artificially induced by the Federal Reserve.

Sunday’s article in the New York Times on the G8 was misleading in the sense that they characterized the choices as being between the “austerity” favored by Angela Merkel of Germany, versus the “growth” favored by François Hollande and President Obama. That simply is not the choice. There is no one who does not want growth. Only an idiot would claim otherwise. It is the wellspring of economic growth that is at dispute – should it be state fostered, or should economies rely more on free markets? Austerity, in some measure, is inevitable. If Hollande and Obama prevail, government spending will increase, but so will taxes. If Merkel is successful, taxes will be lowered and government spending will be reduced. Politicians promise that extrication will be painless, but in that they are wrong. They should be exploring the least painful way toward the most rapid growth possible.

There also needs to be a frank and open discussion as to what caused the mess in Europe, as well as talk as to why our recovery has been so anemic. Unemployment in the U.S. has gone down, but that is in large part because so many people have left the labor force. The participation rate of the U.S. workforce, the more accurate depiction of the labor situation, is at 63.6%, the lowest rate since 1981, a subject that Mr. Obama avoids. In contradiction to the President’s policies, red states have had a job growth rate almost twice that of blue states – Since recovery began, Texas, with 474,000 new jobs leads the way. California, with a loss of 285,000 jobs is the nation’s biggest loser. There is an irony in that the “high road” (growth) is being taken by M. Hollande, whose Socialist policies are the root cause of Europe’s economic woes, and Mr. Obama, who has presided over the feeblest recovery in the post-war years, while the “low road” (austerity) is being encouraged by Ms. Merkel who has presided over the most successful of the G8 economies.

Europe finds itself embedded in a deep and structurally unsound financial position. The U.S. is not far behind. While we are able to devalue our Dollar, which we have been doing, Euro zone countries doing poorly have no such opportunity. Extrication will be difficult. The most efficient and effective solution would be a combination of lessened regulation and tax reform that encourages investment – promoting free markets. But that is not the way of M. Hollande or President Obama. They both want the state to lead – states that have made pacts with their crony capitalist partners and that have made promises to the poor, handicapped and elderly that they will be unable to keep. They and their crony union leaders have made assurances to government employees that can never be fulfilled. They have sought a never-never land; instead, they find themselves aboard a houseboat on the River Styx.

The choice, contrary to what the Left would have us believe, is not between austerity and growth. No matter what happens, there will be some austerity – socialist policies have determined that. No, the choice is between statism and free markets. Press reports that do not make that clear are doing the public a disservice.

Friday, May 18, 2012

“Will Obama Dump Biden?”

Sydney M. Williams

Thought of the Day
“Will Obama Dump Biden?”
May 18, 2012

Wednesday, in an appearance in Youngstown, Ohio, Vice President Biden appeared more like a candidate for McLean Psychiatric Hospital than a candidate for Vice President. He got so wound up that at one point he ranted, “My mother dreams as much as any rich guy dreams. They don’t get us. They don’t get who we are.” There was no clear indication as to who “they” are. However, if by “they” he meant “rich guys” (his term, not mine), I presume he was excluding the sycophantic George Clooney and his $35,000 a plate fund raiser.

Vice Presidents have long held the unenviable job of being a heartbeat away from the Presidency, while occupying a seat that Franklin Roosevelt’s first Vice President, John Nance Garner, once described as being “not worth a bucket of warm piss.” As we know, Vice Presidents are used as attack dogs in re-election campaigns, so that the President can remain above the fray. However, Mr. Obama works on the assumption that two attack dogs are better than one. He lambasts anyone who has the temerity to suggest that fairness is based on equal opportunity and meritocracy. If the state has not determined something fair, then it is not fair – a morally disingenuous and dangerous attitude.

Nevertheless, it is disconcerting that a man who could become President in a heartbeat can seem so unhinged, if not deranged. At one point, he said, apropos of who knows what, “My mother and father believed that if I wanted [to be] President, I could be, I could be Vice President.” Nice catch, Joe, but did you have to go there?

There has been speculation in the press that Mr. Obama may discard Mr. Biden for a new and improved model, which should not be hard to find. However, the President did use his malleable Vice President as a trial balloon for gay marriages a few days ago. Vice Presidents are often chosen to balance a ticket, geographically or politically; they are rarely selected for their abilities to become President. In fact, in the last eighty years, the only man that I can think of who was picked because he would be a good President was Harry Truman in 1944. Mr. Truman was selected by Franklin Roosevelt for his fourth term. In doing so, Mr. Truman replaced the mercurial Henry Wallace. Roosevelt, I suspect, knew he was dying and recognized that Wallace was too far outside the mainstream to become President of all the people.

In fact, Mr. Wallace was the last man jettisoned as Vice President. Twice Roosevelt dumped his Vice Presidents. In 1940, the conservative Texan, John Nance Garner, who had collided with Mr. Roosevelt on a number of issues, like the Supreme Court and the role of labor unions. He was replaced by Henry Wallace, the leader of the Progressive Party. Wallace was a man who had been seduced, as so many liberals were at the time, by what he saw as the progressive nature of Stalin’s Communist Soviet Union, apparently willing to look beyond the millions of people Stalin had had murdered in his gulags.

It is curious that the last time a President ditched his Vice President was in 1944. Truman, Carter and George H.W. Bush, in their failed candidacies for a second term, kept their Vice Presidents on the ticket. Presidents have been urged to make changes. Many of Eisenhower’s confidants wanted him to replace Richard Nixon in 1956, and the nation would have been better served had he done so. In the post war period, of the twelve Presidents, four served as Vice President – Truman in 1948, Johnson in 1964, Nixon in 1968 and George H.W. Bush in 1988. Most of the other Vice Presidents will be little more than footnotes in history. For example, how many Americans know who Alben Barkley was? Hubert Humphrey is a name I will always know, but as time goes on, knowledge of him will fade. Walter Mondale, Dan Quayle, Al Gore and Dick Cheney are still alive, so are known now, but likely will not be in a generation or two.

Like many CEOs, Presidents do not like to be upstaged by underlings smarter or more articulate than themselves. Thus they have a habit of picking people weaker and less capable. Only truly self-confident Presidents will pick a strong, competent Vice President. Kennedy did so, and so did Lyndon Johnson. Nixon did not, but Carter and Reagan did. George Bush, senior did not, nor did Clinton. While some will disagree with me, George W. Bush did, but one has to keep in mind the esteem in which Cheney was held in 2000. Obama selected a much weaker man.

Given the recent pass, the odds favor Mr. Obama sticking by the volatile Mr. Biden. Should Biden de deposed, Mr. Obama runs the risk of a backlash from the Vice President’s friends. But the President must weigh that risk against the damage an unleashed Joe Biden can do. The Democratic Party has plenty of good alternatives, far more capable of assuming the position of Commander in Chief than the erratic Joe Biden. But, time will tell.

Oh! By the way, it isn’t as though we don’t “get” you, Mr. Biden. The problem is we do.

Wednesday, May 16, 2012

“Markets – Are Things What They Seem?”

Sydney M. Williams

Thought of the Day
“Markets – Are Things What They Seem?”
May 16, 2012

On August 13, 1979, Business Week published an issue that became famous for its cover story, “The Death of Equities.” From the article: “At least 7 million shareholders have defected from the stock market since 1970, leaving equities more than ever the province of giant institutional investors.” Further on: “Younger investors, in particular, are avoiding stocks.” As inflation hedges, stocks failed investors. During that decade, stocks compounded at 3.9%, while the CPI grew at 6.5%. In contrast, according to a Salomon Brothers report, the price of gold compounded at 19.4% and diamonds at 11.8%. Bonds fell in price, with the yields on AAA Corporates rising from 4% to 11%.

On May 15, 2012, the lead editorial in the New York Times, read “End of the Affair?” “Investors are shunning the stock market,” began the editorial. The Times’ editors wrote of the absence of trust and confidence, and that there is a feeling that “the market has become increasingly unfair.” They wrote that stocks had risen 10% since March 2000, “a paltry gain.” (While their point is correct, the Times facts are wrong. The S&P 500 is actually 10% lower today than it was at the end of March 2000.) More importantly, stock prices have compounded at 2.3% over the past ten years, while gold has compounded at 17.2%. Bonds have risen in price, with the yield on the Ten-Year falling from 5.04% to 1.78%.

When one looks back over the past one hundred years, there have been three times when stocks have lost favor for extended periods of time – the 1930s, 1970s and the decade just passed. The first two periods were followed by very different wars and extended periods of growth. The 1940s saw the greatest destruction of human life the world has ever known, as forces for democracy defeated maniacal despots of Nazism and Fascism. The 1980s saw the forces of freedom finally prove victorious over the tyranny that was Communism in a Cold War that lasted forty-four years, and culminated without a shot being fired. In the first instance, economic and stock market growth was accompanied by gradually rising interest rates and inflation, a period that lasted twenty-five years. In the second, interest rates and inflation both fell over three decades.

Long-lasting rallies always begin from deep wells of skepticism. If that were not the case, as a wise friend of mine once put it, then tops would be bottoms and bottoms would be tops. Perhaps the fundamentals may not yet be in place to allow for a long lasting revival of markets and economies, but skepticism appears widespread. It does not show up in the VIX, which seems to suggest complacency, not concern. Nevertheless, the last four years have seen $400 billion drained from equity mutual funds. The percentage of U.S. households owning individual stocks or stock funds has declined from 59 percent in 2001 to 46.4 percent in 2011. During a time (March 2009) to the present that saw the Wilshire 5000 add $9 trillion in value, individuals have been net sellers. Will the next couple of decades be similar to the 1950s and ‘60s? Nobody knows. History may not be a compass, but it is a guide.

Harvard philosophy professor, George Santayana, warned that “those who do not learn from history are doomed to repeat it.” Clarence Darrow once acknowledged that, yes, history does repeat itself, “and that’s one of the things wrong with history.” In fact, what Mr. Darrow was observing was that we ignore what history teaches us. We evolve technologically, but emotionally we are the same people we were 2000 years ago, governed by the same feelings of guilt, love, hatred, greed, generosity, fear, honor, etc. We extrapolate rather than analyze. We react subliminally to recent events rather than objectively to a diligent study of the past. Behavioral economists suggest such people are suffering from a “recency bias” – they fear another melt down ala 2008-2009.

I am not unmindful of the pitfalls facing us. We have lived a charmed life for a long time, for many of those years riding the back of a debt monster that seemed imbued with everlasting life. From the end of World War II to the fall of the Berlin Wall, the United States served as a beacon for those who would choose freedom over oppression. However, we live in a world that remains dangerous, with rogue nations developing nuclear weapons and with terrorists still intent on killing innocent Americans. We must make tough decisions regarding entitlements we cannot afford, yet too many in Washington and state capitals prefer to look the other way, hoping that their fiscal problems will simply go away. Europe’s unfortunate unraveling affords us the opportunity to face the hoary monster of socialized democracy head on. Yet there are still those in denial.

We have an administration that has chosen ideology and social issues over meaningful fiscal reform – gay marriage versus 12.5 million unemployed Americans – and a Congress that has determined that obstruction is preferable to conciliation. Without fiscal reform, we face an impending crisis of rising taxes in a feeble economy. We have a media more interested in a fifteen year-old’s behavior, rather than evaluating the policy responses of the same person, as he campaigns for the Presidency.

There is also the question of time. While the market bottomed in June 1932, it was not until late 1954 that the Dow Jones breached the 1929 high. Of course, a worldwide depression covered the globe for much of the 1930s and a world war cost about 100 million lives in the first half of the 1940s. In the 1970s, it took 16 years (1966-1982) before the Dow Jones pushed meaningfully through the 1000 level. In our current situation, the S&P 500 reached 1517 in March 2000 (The market did go slightly above that level in October 2007, but for my purposes that was resistance.) It remains to be seen how long it will take to start another major leg up. Are we, to paraphrase Churchill, at the end of the beginning, or the beginning of the end? I don’t know, but I do know we are not at the beginning of the beginning of the downturn. That happened twelve years ago.

Macro events swirl about our heads, demanding our attention and becoming the topic of conversation, especially when they carry a negative tone. War, accidents and murder sell far more ad dollars than peace and reconciliation. Nevertheless, and hidden from sight, people’s lives go on and businesses function. Real life is not unlike the opening scene in “Our Town”, as the stage manager details the dull, boring, but necessary habits of living. Investors should be wary of getting too caught up in the emotions of the moment. But, keep in mind that while it is fun to poke fun at the editors of Business Week who brought out that infamous publication thirty-three years ago, the eighteen-year bull market did not begin until three years later. Three years is a lifetime for a trader and even a very long time for a nervous investor. If answers were simple, we would all be rich; so let old fashioned common sense dictate your behavior. Remember your history, but be aware of the present.

Tuesday, May 15, 2012

“It’s Fiscal Reform that is Needed, Not More Monetary Easing”

Sydney M. Williams

Thought of the Day
“It’s Fiscal Reform that is Needed, Not More Monetary Easing”
May 15, 2012

“Risk markets need more ammo if they are to stay up,” Bill Gross wrote on Twitter last week. He and Goldman Sachs’ strategist are suggesting that investors should be prepared for additional bond purchases by the Federal Reserve. A sluggish economy at home and a Europe in disarray obviously influenced their opinions. But I suspect a 4.5% decline in U.S. stocks since the first of May and a recent sell-off in commodities added urgency to their predictions.

Debt was the single most important element that led to the credit crisis in 2008. Growth in debt over the past decade greatly exceeded growth in GDP. In fact, debt has been growing as a multiple of GDP for the past forty years. According to data from the St. Louis Fed, in 1970 U.S. GDP was $1.0 trillion, supported by $1.6 trillion in debt – a ratio of 1.6X. By 2000 that ratio was 2.8X. And by 2008, the ratio had expanded to 3.7X, with GDP of $14 4 trillion and total debt of $53.6 trillion. Obviously, deleveraging will have a deleterious effect on growth.

In response to the credit crisis in the fall of 2008, the Fed’s balance sheet increased from roughly $860 billion, where it had been at the beginning of 2007 to $2.226 trillion at the end of 2008. The increase was a necessary response to the failure of Lehman, the forced merger of banks like Merrill Lynch, the government take over of AIG and GM, and the near collapse of Goldman Sachs and Morgan Stanley. During the last three months of that year, a little more than $1.5 trillion was lent by the Fed to the banks. During the month of December, Federal Reserve lending to banks reached its cyclical peak of $1.56 trillion. The TED spread (LIBOR over Three-month Treasuries), which had peaked in October 2008 at 465 basis points had declined to 131 basis points by year-end 2008. While markets knew it, though Washington still remains clueless, the credit crisis had been contained.

The subsequent decline in lending to banks (today at $220 billion, an 80 percent decline from three and a half years earlier!) was more than offset by the Fed buying Treasuries, Agencies and Mortgage Backed Securities. While one can conclude that the credit crisis was over before Mr. Obama became President, the recession was not. Thus the Fed’s purchases over the past couple of years have been aimed at priming the economic pump, by keeping long term rates low. However, in keeping Fed Funds rates at near zero, banks gained more liquidity than they needed.

In a de-leveraging economy, which is what we have (and need to have), there is less need for monetary easing than there is for fiscal reform. Unfortunately, there has been none. There is plenty of blame to go around. Congress has been of little help. But most of the fault must lie with the President. He sits at the desk where the buck is supposed to stop. However, Mr. Obama wasted his honeymoon period by focusing on ideological issues – healthcare, card check, green energy, etc. – instead of focusing on the economy. Who can forget Rahm Emanuel’s cry that a crisis is a terrible thing to waste?

In the meantime, the Fed has been providing essentially free money to banks that do not have loan demand. It should not be surprising that JP Morgan searched for investments, or trades, in conventional places. The bank, according to the same reports, has $1.3 trillion in deposits, but loans of only $700 billion. Why the Fed felt the need to provide additional free funds to banks without loan demand is beyond my understanding, and is a question worth exploring. It is generally expected by depositors, who receive little if any return, that their money will be invested in safe instruments. An irony is that the Fed, because of QE2, in fact placed themselves in competition with banks for low-risk investments – longer dated Treasuries, Agencies and Mortgage Backed Securities. Arguably, the Fed effectively created the environment that caused banks to seek higher returns with distinctively unconventional derivatives and securities.

Additionally, the Fed’s actions have had the consequence of hurting those living on fixed income, seniors and savers. Those unfortunate souls have seen their income decline, in some cases, as much as 80%. Dollar depreciation may not bother the Federal Reserve, but it is deadly to those living on fixed income.

It could be argued that the Fed stepped in because Congress and the President failed to act. But common sense says that lowering the price of money won’t help in a deleveraging environment. If the consumer is 70% of our economy and is deleveraging, as he should, reducing the price of money does not create more demand. What the consumer needs is confidence that he can keep his job, or find one, and that the value of his Dollar will be maintained. What business needs, in order to create jobs, is confidence that tax rates, at whatever level, will be permanent, that the angst over healthcare reform will be laid to rest, and that regulation will be fair and easily understood.

The only possible positive fiscal effect on the economy of low interest rates is that it creates Dollar weakness, and thus may help exports. But the price being paid to possibly help a relatively small segment of the economy seems inappropriately high. Too many seniors and savers have been hurt, and too many speculators – individual and corporate – have been helped.

Now the Fed has raised a trial balloon about a possible third round of easing, driven it would seem, by the recent decline in asset prices, both financial and commodity. While such easing may provide temporary relief to the stock market, it is the wrong response for several reasons. First, it is akin to pushing on a string. Banks have plenty of liquidity. There is little demand for loans, as consumers gradually persist in deleveraging, again, as they should. An emphasis on monetary easing is a Santa Claus policy for banks, while Congress and the President should be focused on fiscal policy – tax reform and the Grinch-like, but necessary cuts in entitlement spending that will have to be made at some point. Easing money today serves to detract from the unpleasant fact that if nothing is done, January 1, 2013 will witness the biggest tax increase the U.S. has ever experienced, a fact that will be of increasing interest to equity and bond markets as the year unfolds.

The President can argue that the Bush tax cuts were meant to be temporary, which they were, and all he is doing is letting the cuts lapse. As logical as that argument may be, it is the behavior of people that is critical to the success of any policy, and rescinding a “temporary” tax cut that has been in place for ten years will be considered a “permanent” tax increase, which it will be. The tax increase will include a tripling of the tax on dividends and a doubling of the tax on capital gains, while raising taxes on ordinary income, along with a host of new taxes to pay for the Affordable Care Act. Combined, the increases will have a depressing effect on what amounts to an anemic economic recovery, and on capital markets, the life blood of job creators.

There is little question that our economy continues to struggle. Dissonance in Europe does not help. The Federal Reserve deserves credit, as does Treasury, for staving off what could have been a catastrophic collapse of financial markets three and a half years ago. Both agencies responded quickly and effectively. But monetary expansion has done little for economic growth in the years hence. Taking the period from the first quarter of 2008 through the third quarter of 2011, the Federal Reserve expanded its balance sheet by $1.8 trillion. The increase in GDP during that time? $86 billion. A 0.05% return over three and a half years should be unacceptable. It is time to turn to fiscal policy.

Monday, May 14, 2012

“Dewey & LeBoeuf – A Lesson in Capitalism”

Sydney M. Williams
Thought of the Day
“Dewey & LeBoeuf – A Lesson in Capitalism”
May 14, 2012

Businesses sometimes go bad. Tough luck is encountered, or mistakes are made; misfortune ensues. There are countless examples every day. Most go unreported by the press. Overextending one’s self has become common. In part, that is because of the ease of filing for bankruptcy and the lack of stigmatization attached to such action. In part, it is due to a decline in moral responsibility on the part of owners and managers of enterprises. And, in part, it has to do with low interest rates and still easy access to credit. The pain of bankruptcy is felt by the owners of the enterprise and, unfortunately, shared by those who work for them. Recently the pain has too often been felt by taxpayers as well.

In large banks, those that are deemed “too big to fail” and large businesses with a unionized workforce like the auto companies, the socialization of debt obligations threatens our capitalist system; for as Carnegie Mellon Professor Allan Meltzer has written on innumerable occasions, “capitalism without failure is like religion without sin.” In 2008, preventing the failure of the banking system justified the assumption of large losses by taxpayers. However, if we continue to allow large banks, auto companies and large “essential” businesses to function free from fear of bankruptcy we will have created a monster impossible to corral. The most elemental aspect of capitalism, as Professor Meltzer taught us, is that without risk it cannot survive. Small businesses and small banks do not receive such guaranties. The lesson of 2008, as taught by Washington politicos, was get bigger and take on more risk. The partners of Dewey & LeBoeuf listened.

No matter how badly we feel for the innocent victims, it would be a mistake for taxpayers to assume the burden of their mistakes. Articles like the one on Saturday that appeared in the New York Times, are geared toward engendering sympathy for innocent victims of Dewey & LeBoeuf – retirees and lower level employees. Individually, we would like to help those people. As a society, we should not. When retirees call in asking: “How could this have happened?”, the answer is easy. The partners got greedy and ignored rules of prudent behavior. For example, partners were required to keep 36% of their compensation in the firm. But “they sometimes borrowed the money to meet the requirement.” That’s not keeping money in the firm.

I am reminded of a letter I have that my grandfather wrote to my grandmother just before they were married in 1908. He was a partner in a small bond brokerage firm in Boston and fully understood the rewards and risks of partnerships. “I went into business with less than $100 in the world. After six years, I became a partner and was given a small interest in the business. Since then my income has averaged about $3000 –as high as $6000 and as low as nothing…For several years I have helped support my aunt and my sister…Last year, on account of the panic, the firm’s profits amounted to practically nothing. So that living expenses took the two or three thousand that I had saved up to that time…These are the facts. I give them to you because you ought to know them.” Do we hear such transparency and honesty today? Partnerships are one of capitalism’s purist examples. They can be highly rewarding. But they involve confidence and trust in one’s partners. When that is lost, they can be very risky. In the case of liability, partners are held jointly and severally responsible. Nevertheless, they reap the benefits and suffer the risks. It is as it should be. Anything Washington does to moderate the risk will have detrimental consequences and will prove expensive for taxpayers.

Law firms are not capital intensive. There should be no need to borrow money, other than to fund a credit line to periodically pay for needed capital equipment, i.e. computers. By definition, partnerships provide variable returns to its partners. There will be good years and bad years. The guaranteeing of compensation to partners is antithetical to the concept of a partnership.

Retirees, lower level employees and, in fact, partners chose to look the other way, as Dewey & LeBoeuf elected to guaranty compensation to partners, as opposed to offering them larger shares of what proved to be a shrinking pie. It is not the notion of partnership ownership that should be under the microscope; it is that the tenants of partnership were violated by the partners at Dewey & LeBoeuf. Ironically, limited liability partnerships, like Dewey & LeBoeuf, remove some of the risk for individual partners, but increase the likelihood a firm will over extend. Nevertheless, the idea of partnerships – shared risk and reward – is fundamental to capitalism.

That concept seemed to have been missed by John Gapper in an op-ed he wrote for last Thursday’s Financial Times, entitled, “Law firms have struck the limits of partnerships.” They have not “struck the limits,” Dewey & LeBoeuf violated the principle of partnerships. Mr. Gapper’s answer to the failure of the firm is to take a lesson from law firms in the UK and Australia – divide the industry into a few top-end firms and “some large utilities that employ paralegals and lower-paid lawyers to do standard work.” He also suggests permitting some law firms to be owned by non lawyers, tantamount to public ownership. Does he believe that management will then be less risky? If Mr. Gapper believes that utility-like regulation and public ownership of law firms will remove the risks of another Dewey & LeBoeuf, he has not paid attention to the lessons from the near-collapse of the financial sector of a few years ago. The more one is distanced from risk, the less cautious he or she becomes. It is the fear of failure more than regulation that ensures prudent behavior. Capitalism’s best governor is the threat of bankruptcy; it is not another regulator in Washington, and certainly not the socialization of risk.

Bruno Iksil’s trade that cost J.P. Morgan Chase $2.3 billion is a case in point, and points out the flaw of getting bigger just to be the biggest guy in town. The dollar amount relative to the bank’s assets may be very small, as Holman Jenkins pointed out in Saturday’s Wall Street Journal. But that is not the critical point. The dollar loss is large, and the fact that it was only 1% of shareholders equity only serves to prove the point that the bank is just too big. It is ironic that under Mr. Obama’s watch – he the supposed scourge of Wall Street – big banks have gotten bigger and there is nothing in Dodd-Frank that will make them smaller and therefore less risky for taxpayers.

In fact, it has been the more conservative commentators and practitioners who have urged a more commonsensical approach, one that would reduce risk for taxpayers. Richard Fisher, President of the Dallas Fed, has spoken of preventing banks from getting too large by breaking them up or re-imposing something akin to Glass-Steagall. Allan Meltzer, the economist, has suggested something far simpler – just raise the capital requirements of banks as their assets increase. That way management would be incentivized to stay smaller and more profitable, instead of taking Mr. Dimon’s route, which appears to be, become as big as possible, ignoring the risk to taxpayers, (or, more likely, relying on them.) The problem with former Fed Chairman Paul Volcker’s rule is that, in determining what constitutes hedged trades and what is proprietary, it depends on regulators who are smarter than bankers. With all due respect to government workers, that is simply wishful thinking.

There was no reason, other than greed and stupidity, for the managing partners of Dewey & LeBoeuf, to have fallen as far as they did. They had no need to take on the level of debt that they did. Guaranteeing payments to partners goes against the very principle of what a partnership is. Promising benefits without funding those benefits is dumb. While we may feel sorry for individuals, there is no way that society should make amends. It is a lesson of capitalism, a system that has benefitted millions, if not billions, of people. Capitalism, more than any other system, has raised living standards around the world. But nothing in life is without risk, and that is the lesson we should take away from the misguided misfortune at Dewy & LeBoeuf.

Thursday, May 10, 2012

“Honor Among Thieves”

Sydney M. Williams

Thought of the Day
“Honor Among Thieves”
May 10, 2012

Confidence in our capital markets has been waning for years. There has been a growing sense among individual investors that markets are rigged. As far as politicians are concerned, there is no difference between the investor class and the “one percenters.” It matters not to those bozos in Washington that several of the “99 percenters” occupying wherever or whatever they choose to occupy are trust-fund kids, or that half of all Americans have exposure to the stock market through a variety of retirement plans. Regulations, like Sarbanes-Oxley, Fair Disclosure or Dodd-Frank, have done little to change this attitude. Hedge funds are deemed by the press to be secretive, and therefore bad. High frequency traders operate in a manner totally incomprehensible to the average person, or even to the not-so-average Wall Streeter. Crony capitalism, the relationship between corporate boardrooms and Congressional offices, functions undisturbed. Yet, inherent to our democracy are free functioning markets, and critical to their success is faith that our markets are fair.

A story in Sunday’s New York Times speaks to another hurdle for investor’s confidence. Nathaniel Popper wrote of a study by Woodbine Associates that looked at rebates offered by exchanges as enticements to brokers to direct orders their way. “Best price” is the governing rule for brokers when it comes to execution of orders, but the offer of a rebate, even one as small as $0.001, may be enough to lure an order away from one exchange to another.

What makes the practice of rebates so difficult to monitor is the very small amounts of money involved on a per share basis and the very large number of shares traded each day. In spite of those difficulties, in aggregate Woodbine puts the total cost to investors last year at a little more than $5 billion. The $5 billion is predicated on an estimate that investors lost $0.004 on 1.37 trillion shares traded. It should also be noted that rebates are perfectly legal and all thirteen exchanges have rules governing the practice. Nevertheless, rebates are one of the single largest costs to exchanges. For example, in the first quarter of this year, NASDAQ paid out $306 million in rebates, or nearly half of its revenues. It is also indicative of the slim margins on which the exchanges operate

Twenty years ago almost all trades were conducted on the exchange on which the stock was listed. Today, thirteen exchanges and electronic communication networks (ECNs) compete for orders. Competition is always a good thing. Free markets operate with greater efficiency. It forces businesses to compete on a basis of price and value, allowing consumers to make a choice that suits their specific needs. When competition is curtailed, as it is for example in health insurance where companies are prevented from competing across state lines, consumers suffer.

However, it gets complicated when a third party is part of the process. Stock exchanges are a good example. Brokers are intermediaries between buyers and sellers, accepting orders and then executing them either electronically or on exchanges. Their responsibility is to get the best price for their client. The business was simpler when the New York Stock Exchange and NASDAQ held monopolies in the shares of the stocks they listed. Brokers had no choice as to where to execute their orders. But costs were considerably higher than today. In fact, most academic studies have found that the costs of executing trades are at record lows.

Criticism of rebates is not new, as Mr. Popper makes clear. Two years ago, a report from two former chief economists for the Securities and Exchange Commission (SEC) noted that “in other contexts, these payments would be recognized as illegal kickbacks.” However and indicative of the fact that often the right hand does not know what the left is doing, Edgar Ortega, writing on Bloomberg three years ago, noted: “SEC rules made it easier for marketplaces to compete for trades.”

High-frequency trading firms argue, according to Mr. Popper’s article, that rebates increase the level of trading; thereby creating greater liquidity, so lowering overall trading costs. That seems a self-serving argument, justifying their business which is, using very high speed computers, to pick up a penny or two on millions of trades each day, sometimes in front of a real clients order.

While investors should be diligent that their brokers are in fact getting the best price, and punishing those who do not, the bigger issue, in my opinion, is to worry less about fractions of a penny (tax intraday trades at exorbitant rates – that should slow down high frequency traders!) and be more concerned with dollars. Long term investing is in need of repair. Fiscal policies should be directed toward encouraging long term investment and savings, and deemphasizing intraday trading and consumption. The internet has allowed a quantum increase in the number of new businesses around the globe offering ideas that can be converted into products and services. Entrepreneurs have need for capital. Millions of people in this country have need to increase their investments. In the interest of Main Street, putting the two together should be the focus of Washington and Wall Street.

Since commissions became negotiated on May 1, 1975, broker’s margins, at least those in the agency businesses, have been squeezed. An unintended consequence of that event has sent brokers scrounging for pennies, or even tenths of a penny. As long as there is pressure on commissions there is no reason to expect the situation to change. Mr. Popper’s article was interesting and illuminating, but it was also incendiary, in that it adds fuel to an anti-Wall Street movement already in place. It may not sell as many papers, but I would rather see the press focus on issues that would help lift confidence in our markets.


Whenever I see the words that title this essay, my mind turns to Wall Street, my home for forty-five years, and the characters in Washington whose antics my tax dollars support. The words “honor among thieves” goes back many years. As a source, Cicero and Shakespeare have both been cited, as has been John Clavell, in his play The Soddered Citizen, first produced in 1630. My preference, though, is for the anonymous person who wrote: “The meaning of ‘honor among thieves’ is the idea that lying thieving bastards can trust each other.” That pretty much sums up the business I know and have known, love and have loved for so many years, and our cronies in Washington to whom I owe a debt for the fodder they provide for my Thoughts of the Day.

Wednesday, May 9, 2012

“Julia’s World”

Sydney M. Williams

Thought of the Day
“Julia’s World”
May 9, 2012

Andrew Wyeth’s famous painting “Christina’s World” depicts a young woman with her back to the viewer, half lying on the grass. She appears plaintive and the landscape is barren. The painting evokes great sadness, and reflects the emotions Mr. Wyeth still felt three years after the death of his father, the illustrator N.C. Wyeth.

Viewing the dozen slides that comprise “The Life of Julia”, I was reminded of Christina. Both women are dependent: Christina because in real life she was a polio victim, so unable to walk; Julia because she has given up all personal responsibility to rely on the beneficence of the state.

Every American – man and woman, old and young, of whatever race or creed – who relishes their independence, should view these slides, available at The slides present an Orwellian world in which the state is involved in every major decision of Julia’s life: from her enrollment in a Head Start program at age 3; to becoming a web designer at 23, thanks to the Lilly Ledbetter Fair Pay Act; to having a child (no mention of a husband or boyfriend is made) at age 31, with free maternity benefits thanks to Obama’s healthcare reform; to retiring at 67 with monthly payments from Social Security that allow her to live “comfortably” with time to work in a community garden. Julia, an educated middle class woman, is seen as totally dependent on government. It sends shivers up one’s spine.

Each slide is accompanied by a written description of what Julia would be provided under a second Obama administration, and how she would descend into untold horrors should Governor Romney become President. The implicit message is that government is integral to her life. It is chilling in its impersonality.

Julia is pre-packaged, described by Mark Steyn as “composite” woman, and by Leftists as “everywoman.” She is emotion-less. She is a product of the state. Her parents only warrant one slide – she is able to stay on their insurance plan after college. They serve no other role. She is simply there at the age of 3, alone except for Big Brother. From the slides we learn of no neighbors or friends. There are no relationships or support groups. Other than a child she had, perhaps divinely, as there is no mention of a father, there is no mention of a husband, or even a boyfriend. She has no social life, nor any religion. She is a product of the state, born into it, lives according to its dictates and presumably dies friendless, with only the state to mourn (or celebrate) her passing.

Of course she is not “everywoman.” At the age of 31, she has a father-less child. The typical first time American mother, as Ross Douthat noted in Sunday’s New York Times, is married and has her first child in her mid twenties. And the typical woman is not a “web designer.” While Mr. Obama is portrayed as the “Great White Father”, Mr. Romney and Representative Paul Ryan are seen as the wicked uncles, intent on spoiling the “good life.” It is a caricature that is sobering and ultimately very sad.

The United States is a country founded on such principles as life, liberty and the pursuit of happiness, and on the concept that power resides in the people, not in government. “…Governments are instituted among men, deriving their just powers from the consent of the governed…” Julia represents a sharp break from our historical past. The only conclusion that one can draw is that Julia represents Mr. Obama’s vision of America, one toward which he wants to lead the country in a second term. It is why every American should watch this Orwellian slide show. George Orwell wrote 1984 in 1944, at a time when democracies were engaged in a mortal combat against totalitarianism. The people in Orwell’s fictional world gradually descend into a world that constantly monitors their whereabouts and controls what they do. As long as everyone is obeisant and obedient – that they never question authority or deviate from the script – they are fine. There is no room for individualism, which means that in such a world there will be no art, no music, no great teachers, no dissenting philosophies. Inquisitiveness would be repressed. A world of sameness does not enjoy the benefits of diversity.

No one wants to see the poor go hungry, the sick without care, or the aged left alone, and Barack Obama and paternalism, no matter their claims, do not have a monopoly on looking after the unfortunate in our society. The slides make no mention of the costs of Mr. Obama’s Orwellian world. Benefits are simply there. There is no recognition that every time we allow government to intrude further in our lives, we give up some measure of independence. We are a fortunate people who have been free of tyranny for so long that it is often immigrants alone who are able to explain what it is like to live without freedom. Julia is a character that would be unrecognizable not only to our founding fathers, but to our own parents and grandparents. She is frightening in her unquestioning acquiescence of an all-powerful government, accepting what they give with no thought of the monetary cost, or of the freedom lost.

“The Life of Julia” is a depiction of a socialist-tyrannical state; thus is the best depiction between what Mr. Obama wants for this nation and what, I believe, the vast majority of the people desire. For that reason alone everyone should see it. It is a sterile, impersonal and unfeeling world that Mr. Obama envisions, a world unlike anything America has known. Watch it and be afraid.

Tuesday, May 8, 2012

“Europe’s Elections”

Sydney M. Williams

Thought of the Day
“Europe’s Elections”
May 8, 2012

In France, the Socialist candidate, François Hollande, won the Presidency. In Germany, Angela Merkel’s party, the conservative Christian Democratic Union, received only 31% of the vote in the northern state of Schleswig-Holstein, the Party’s worst showing in that region since 1950. Change is in the wind in Europe.

However, it is Greece that needs to be watched most closely. For the first time, both Communists and the Golden Dawn (neo-Nazis) will be represented when the Greek Parliament next meets. Together, they garnered about 14% of the popular vote, which indicates the level of frustration Greeks are feeling. Ninety years ago, in the aftermath of World War I, much of Europe, with its infrastructure annihilated, an overwhelming level of debt and a disillusioned populace, descended into anarchy. The response was Fascism in Italy and Spain, Nazism in Germany and Communism in the Soviet Union. And the consequence, as we all know, was World War II and the deaths of perhaps 100 million people.

As the Wall Street Journal noted yesterday, with this election Greece will have the most fragmented Parliament since the restoration of democracy in 1974. The largest gains, in percent terms, were made by the extremists at either end of the political spectrum. The Coalition of the Radical Left, including the Communist Party, won 16.4% of the vote, triple what they won three years ago. “Other” right leaning parties, including the neo-Nazi Golden Dawn Party, won about 18% of the vote, more than three times what they won in 2009. Greece’s two mainstream parties, Pasok (socialist) and New Democracy (conservative), garnered 33% of the vote, compared to 77% in 2009.

There seems little doubt that the origin of Europe’s problems lie with the failure of socialism. It was understandable that following the Second World War people and governments were exhausted. The desire to live peacefully was foremost in people’s minds. At the end of 30 years of war and depression, Socialism was seen as providing what would be best for all. That meant having the wealthy and middle class fund a welfare state; and that they did for many years. Incomes and wealth tended to coalesce around a neutral level. But it was a fiction that did not allow for people’s behavior and desires. People, as Immanuel Kant has noted, are not perfect. It makes little difference whether they work in public or private sectors. Greed infected some in private business; corruption became rife in the public sector. Demand for government assistance began to exceed the ability of government to provide. Unions, working hand-in-hand with government, became intransigent, and utterly unrealistic, in their demands. The law of diminishing returns also applies to tax rates – a lesson Art Laffer demonstrated thirty-five years ago in the U.S. Productive people either leave the country (many emigrating to the United States) or, more commonly, join with bureaucrats to find ways of eluding tax obligations (think Warren Buffett and General Electric.)

In addition and equally harmful, paternalism generates dependency. As states assume an ever-increasing role in the lives of more and more of their people, it is only natural that correspondingly smaller numbers of people generate (and retain) most of the wealth – creating the antithesis of socialism’s goal. It is why socialism never works over the long term, and why democratic capitalism, while not perfect, is the only system that does.

Socialism ultimately leads to despotism, as those who lived in Eastern Europe in the post-war period learned. A consequence of democracy is that it allows criticism. For the young especially, the grass often seems greener on the other side of the fence. In his 2005 book, Post War: A History of Europe Since 1945, Tony Judt wrote of Rudi Dutschke, West Germany’s most prominent spokesman of the 1960s student movement: “When Rudi Dutschke paid a fraternal visit to Prague, at the height of the Czech reform movement in the spring of 1968, local students were taken aback at his insistence that pluralistic democracy was the real enemy. For them it was the goal.”

The biggest risk to capitalism is the socialization of risk, which is what happened in the U.S. in 2008-2009, and continues to this day both here and in Europe. The Dodd-Frank Bill essentially institutionalizes the concept, in that “too big to fail” banks are permitted, nay encouraged, to get bigger with no mandatory, concomitant increase in equity capital, and are not allowed to fail; thus taxpayers take the hit. Capitalism’s greatest restraint is the threat of bankruptcy. Remove that fear and more leverage will be taken on and more risk will be assumed. As Allan Meltzer, professor of economics at Carnegie Mellon, has often said, “Capitalism without failure is akin to religion without sin.” It is impossible to live in any system pain free. There are always winners and losers. The key is finding a system that provides the greatest opportunity for the most people, while retaining human decency and a moral sense.

An essential problem with the Euro is that it was created without any centralized fiscal or political authority. The currency exists, but there is no central taxing authority. It is hard to believe that it can survive as it is. The Euro has afforded Germany an exceptionally low valued currency, while doing the opposite for countries like Greece, Italy, Spain, Portugal and Ireland. In other words, had Germany still been using the Deutsche Mark and Greece the Drachma, Germany’s exports would have been lower and tourism in Greece would have been greater. Freely trading currencies adjust to changing economic conditions. On the other hand, interest rates in Germany would be even lower than they are, while bond vigilantes would have given earlier warning to Greece’s wayward ways. A strong Euro and relatively low interest rates during the 2000s lulled Greece and other PIIGS nations into believing that their profligate ways could continue.

But the election in Greece has thrown a wrench into the machinery of the Eurozone. The two centrist parties, Pasok and New Democracy, while receiving only a third of the popular vote will get half the seats in Parliament because of a peculiarity in Greek law that grants the party with the most votes (New Democracy) an extra 50 seats. But that means Parliament will not be representative of the way people voted. Conventional thinking in Europe seems unaware of the depths of the feelings of the Greek people. That supercilious and unrealistic sense, still rampant in Brussels and Berlin, could be seen in an EC spokesperson quote yesterday. Bloomberg reported: “The European Commission said the next Greek government needs to abide by bailout terms agreed by its predecessors, and voiced confidence Greece will stay in the Euro, spokeswoman Pia Ahrenkilde Hansen told reporters in Brussels today. She called on Greece to form a ‘stable’ government.” Yes, Pia. Of course, Pia. Whatever you say, Pia! Regardless of Pia’s pleas, however, instability and uncertainty reign in Greece.

What Greece needs is a new start. It seems implausible that they can do it with the restrictions levied by the Eurozone. Officials in Brussels and in Athens should be searching for a way that allows Greece to exit the Euro in the least disruptive manner, even if it is over a period of years. Profligacy, as practiced in Athens, is no longer an option. Austerity, as prescribed by Berlin or Brussels, does not appear viable. Those who claim that the best route forward is growth are correct. But there are diametrically opposed philosophies as to how to achieve growth. Should the state lead? Should private enterprise lead? Or should it be some combination of the two and, if so, what should be the balance. Supply-side economics – my choice – suggests the best way is via the private sector. But, no matter which path is chosen, the immediate future is likely to get worse. There is no way to avoid that. The hole they have dug is too deep. But if the people have confidence that a way forward has been found, things can improve quickly. The biggest risk is that a charismatic, telegenic leader arises from one of the extremist parties, as Hitler did in Germany, Mussolini in Italy or Franco in Spain.

Monday, May 7, 2012

“Jon Corzine – What’s Going On?”

Sydney M. Williams

Thought of the Day
“Jon Corzine – What’s Going On?”
May 7, 2012

It pays to be rich, powerful and a Democrat with friends in Washington. While Anna Gristina, a Connecticut mother accused of being a New York “madam” sits in a cell on Riker’s Island, Jon Corzine, the former CEO of MF Global sits at home in his New Jersey mansion. MF Global, had been a publically traded securities firm with $40 billion in assets, but with liabilities even larger, filed for bankruptcy late last year, after being accused of co-mingling customer funds with its own, a flagrant violation of securities law.

As we all know, prostitution is illegal. Ms. Gristina has been charged with providing attractive young women to testosteronic men for money – a crime, but largely victim-less. Nevertheless, she has already spent two months on Riker’s Island, awaiting a June 21st hearing. Bail for her was set at $2 million in a bond, or $1 million in cash. Despite the mis-appropriation of an estimated $1.6 billion, Mr. Corzine has yet to be charged. Yet 36,000 clients had their money appropriated under his watch. It is hard not to believe that his status as a former Senator from and Governor of New Jersey, and major bundler for President Obama’s campaign has not provided him special privileges. Is not justice supposed to be blind?

It is hard to imagine that Ms. Gristina whose business was to introduce consenting adults could be an enormous risk to society. On the other hand, a wealthy and powerful man who appears to have cheated his clients is a fraud and a menace. MF Global was a public company, until it became the nation’s 8th largest bankruptcy when it filed last October. Thus, not only are customers, for whose funds Mr. Corzine had a fiduciary responsibility, out their money, but shareholders of MF Global lost their investment as well. Of course, it is perfectly possible that the morally challenged Mr. Corzine was unaware that embezzling is a crime. However, as CEO he is responsible for financial transgressions within his firm. It is unfortunate that he is not man enough to admit it.

Mr. Corzine testified before Congress, and claimed not to have been aware that anything amiss was going on. “I simply do not know where the money is.” What a whopper! Keep in mind this is a man who had been senior partner of Goldman Sachs, so not a naïf when it came to financial matters. Until the bankruptcy, Mr. Corzine was on President Obama’s short list to replace Timothy Geithner as Secretary of Treasury. He was not only the CEO of MF Global, Mr. Corzine, according to some reports, was chiefly responsible for the bets on European bonds that got them into trouble in the first place. An e-mail from MF Global’s assistant treasurer appeared to implicate Mr. Corzine in the wrongful transfer of $200 million to JP Morgan, a transfer which included customer funds. But when Ms. O’Brien was asked questions at a Congressional hearing she pleaded the fifth. Why? Was she afraid of Mr. Corzine? Did she feel threatened by the prosecutors? Surely she did not transfer funds of that amount without some higher-ups approval. A lot of us would like the answer to a question recently asked by a reporter for the Financial Times: why wasn’t she granted immunity from prosecution, in exchange for her testimony? Are the prosecutors concerned as to where the answers might lead?

This is not the first time that rich, powerful and politically connected Wall Street types have walked away from prosecution. Prosecutors also took passes on Angelo Mozilo, former chairman and CEO of Countrywide and Richard Fuld, former CEO of Lehman Brothers. Both men disgraced their companies and their industries, while losing millions of dollars for investors who had entrusted their savings with them. Crony capitalism does not only lead to criminal behavior, it reflects a moral decay that threatens our capitalist system and the democracy that underlies it. When the defense uses what Matt Taibbi of Rolling Stone calls a “Wizard of Oz” defense – that the stealing was not deliberate; the misplacement of client funds was due to the chaos that attended the firm’s last few days – it’s obvious the perpetrators, with help from their attorneys, are obfuscating the truth.

Regulatory bodies spend millions of our tax dollars every year supposedly supervising those they are charged with overseeing. The events that led to the financial crisis did not happen because of a lack of regulation; it was a lack of enforcement of existing rules. The response in Washington was, of course, to create new rules, not to punish regulators who did not regulate. The Obama Administration is not afraid of lawsuits and charges. Look at the legal problems his Environmental Protection Agency (EPA) is causing the energy industry. But it is telling that this administration, theoretically so friendly to the poor and defenseless, has not sent one person to jail for the near collapse of the financial system four years ago. They could start by looking at Congress. When it comes to investigating the true causes of the near financial collapse, this administration is the antithesis of Teddy Roosevelt – talk loudly and carry a wiffle bat.

As insulting, has been the response of the Trustee, James W. Giddings. The role of a Trustee is political in the sense that they are awarded by the courts. And they are meaningful in terms of compensation. For example, Irving Picard, Trustee of what is left of the Madoff Ponzi scheme, through last October had billed $225 million. Mr. Giddings firm, Hughes Hubbard, has billed $168.7 million thus far for the Lehman bankruptcy. With that sort of money on the table there is plenty of room and opportunity for shenanigans. Mr. Giddings acknowledged that $1.2 billion has gone missing and that a commingling of customer accounts and corporate funds did take place. But it was, in his opinion at least in part, due to “sloppy” bookkeeping, and computers and employees who could not keep up. That sounds to me like a “Wizard of Oz” defense. Sloppy bookkeeping! Give me a break! This was stealing.

Incredibly, no one has been arrested. Republican Congressman Michael Grimm from New York City has asked for an independent counsel to take over the federal criminal probe being conducted by the Department of Justice (DOJ.) James Koultas, the leader of the Commodity Customer Coalition, an advocacy group for former MF Global clients recently noted the obvious: “I don’t think the DOJ is going to go up against one of the President’s biggest bundlers without an independent counsel being appointed.”

The near-collapse of the financial system four years ago spooked investors. Taxpayers are already rightfully concerned about the cost to them caused by a few rogue traders, who saw millions in personal profits, and lawmakers whose concern about re-election overcame any worries about the consequences of their legislation. When the guilty go unpunished, crime only increases. Joe Nocera, writing a couple of weeks ago in the New York Times, put it this way: “Giving the big guys a pass isn’t good for the financial markets. And it isn’t good for democracy either.” It is the inverse of James Q. Wilson’s “broken windows” theory that says if broken windows are repaired immediately the incidence of crime will decline. When criminal activities such as these go unpunished, the crime rate goes up.

Everyday small time criminals get busted – drug pushers, hookers, purse snatchers and small-time robbers – but wear a white shirt, steal a few million dollars and have friends in high places, and you can stay at home. It is crony capitalism at its worst. Court appointed lawyers get rich; politicians, who have become wealthy, pay back their friends and remain in office. Very few bad guys go to prison. It is a terrible message, if we want to restore faith and confidence in our markets. Democracy is based on property rights and the rule of law. When property is not protected, the law is meaningless. What really is going on with Mr. Corzine?