Solve the fiscal cliff revenue issue by eliminating state/local tax deduction

The Obama administration wants to raise $1.6 trillion in revenue over ten years and the Republicans have countered with a proposal to raise $800 billion through unspecified eliminations of deductions and loopholes. There is one deduction that can be eliminated that will raise the $800 billion and hopefully satisfy both constituencies and that is to eliminate the state and local income tax deduction which disproportionally favors the wealthy (which Obama would like), but also benefits people who largely live in blue states with big state governments, something Republicans should like. As a generalization this deduction is a net wealth transfer from Republican leaning states like Tennessee, Florida, New Hampshire and Wyoming to Democratic states like New York, California, Massachusetts and Oregon. Of course some states that voted for Obama also have no income tax like Nevada and Washington.

Obama might object because there are people who earn under $250,000 who benefit from this deduction. But as a public policy matter this is a far superior option to raising marginal rates. Because raising rates is a tax on success on often on the success of small businesses who are the job creators, whereby eliminating this deduction essentially penalizes state governments that simply spend too much and would create pressure to shrink the size of these state governments. It also empowers the people by saying, if you don’t like your taxes going up because of the elimination of this deduction, complain to Sacramento and Albany which is the real source of the problem – not the federal deductibility of state and local income taxes.

For similar reasons, Congress should end the tax exemption for municipal bonds that are not directly tied to capital projects. This does not mean that all GO (General Obligation) bonds would be taxable. It simply means the state and local governments would need to show the money was used to build a road or a school instead of plugging holes in the operating budget and paying for pensions and salaries of workers.

The analysts firings at Citi

In July, I wrote an article on analyst’s research to whom analysts owe fidelity and to whom they don’t and that the majority opinion and SEC view on this issue is both unconstitutional and bad policy. You can find it here:

The firing of two Citib analysts last week make my July article even more relevant because it deals with many of the same issues.  If these analysts opinions had no more legal status than the political opinion of your barber or some stranger at a bar none of this would have happened and valuable time and money would be saved by taxpayers and companies; or arguably, if it has as much legal status in terms of constitutional protection of free speech, there would be no issues.  Before I get to the Facebook IPO issue and IPO treatment at large. just let me state generally that opinions on the revenues of a Google subsidiary (You Tube) to which Mr. Mahaney had no inside or confidential information on, is not a subject that FINRA or Citibank should have rules against him talking about to anyone at any time. Meaning most of the time analysts have no more information than is available to anyone else, they are wrong often and I said in my July piece – their opinions should not be held in the same regard as factual statement from companies on earnings, acquisitions etc or government data like unemployment, natural gas supplies, crop reports etc.

The Facebook IPO is actually prima facie evidence that all Spitzer/SEC actions from the internet bubble have failed to produce change that matters. It simply made investment banking and research more costly to deliver, less efficient and a less pleasant place for people to work, but failed to address the core problems. I know firms where investment bankers cannot call an analyst in the firm to wish them a happy birthday or to discuss how the Jets did without a compliance officer in as a third party to the conversation. Yet, under the rules particularly FINRA 2711 which was cited in the Massachusetts complaint, it remains permissible to bring analysts “over the wall” and give them proprietary confidential information about an issuer.

We need to stop trying to be half pregnant. Either research should be a completely separate function and analysts NEVER should be given non-public information or we should acknowledge the analysts at major banks are marketing agents more than stock pickers and just warn the public of such.

In actuality, both analysts got fired for doing their jobs but tripping over technical rules. Neither one was trying to line their own pockets or do anything nefarious. What the junior analyst did in providing work in progress to a media source even if it was just to “brainstorm”, was inappropriate, but what the senior analyst was terminated for which is answering some basic questions for a reporter while technically a rule violation as he did not receive pre-clearance, did not rise to a level where he should have lost his job.

The better question is why are sell-side analysts talking to the media at all? If there was a pure research driven model paid for by cash or trading commissions – they would not or should not be giving away for free what clients are paying for. There are small boutique research firms many operated by former bulge bracket sellside analysts that never talk to the press for this reason. But the reality is the big bank analysts are talking to the press, because their job is still to market, and help snag IB business.  In some part, being in the press may even help their firms snag some trading business or perhaps get new “research” clients.

In my view this should all be simplified – sellside analysts should never be taken “over the wall” Anything a company discloses to an investment banker or to a ratings agency should be disclosed to the public at large. While there is always the “trade secrets” argument, the reality is most companies competitors already know this stuff. If it so secret it can’t be public, companies should not tell the bankers either. Everyone gets to know, but the public investor. It always amazed me that the credit agencies got more information than the people and institutions buying the bonds.

On the flip side, once the above is achieved and the sellside analyst has no inside information, they should be able to speak to whomever they want, whenever they want. Even if they tell some clients about an upcoming rating change, we should let this happen – force the market to adjust. Analyst recommendations are not information, if people buy or sell on this, it is their problem. Every piece of information that can move a market is not proprietary. What would happen if more people started making stock picks on astrologer forcecasts –would the astrologers then fall under SEC regulation too?

What to look for in the Presidential election

When Mitt Romney picked Paul Ryan I wrote an article that it reflected that he was trailing and needed to energize the conservative base, but that Ohio Senator Rob Portman might have proved a better choice. Ryan has not been as damaging to the Republican ticket on issues like Medicare as I thought he would largely because the Obama campaign has been incompetent in many areas and Romney has managed to actually lead in polls in who people trust more with Medicare.

That said, the NY Times ran an article today stating that there is 50/50 chance Ohio will decide the election. This is not that unusual – Ohio decided the Bush-Kerry election with Bush winning Ohio by less than 2% of the vote. But if Ohio decides the election and if the vote in Ohio is close, Romney will spend the rest of his life wondering had he picked Ohio’s Senator would he have carried the state. Vice-Presidential candidates rarely matter – but it mattered for Kennedy when LBJ helped him carry Texas and it might well be the decision to not put Portman on the ticket might cost Romney the election.

Obama’s biggest risk now is a total stock market collapse before the election. The market has been weak lately and if there is any kind of flash crash or 10% or more move down from here– the election is going to Romney. Romney was going to win most of the investor class anyway, but any kind of catastrophic domestic economic event will move the undecideds to Romney.

We also have a risk of one man winning the popular vote and another the electoral vote. Not only would that conjure memories of Bush vs. Gore, but had Bush lost Ohio against Kerry he would have won the popular vote, but Kerry would have been President. It will be interesting to see if this happens if the electoral college can survive. It might only survive because our political system is so paralyzed over more trivial things, there will be no consensus to change it even if the public feels there is a problem electing Presidents who get less votes than their opponent.

If Obama loses it will be he who lost the election. Romney has managed the “etch a sketch” with precision and has only been able to get away with his ever changing positions or a tax plan on vapors – eliminating deductions without specifying one – because the Obama camp has been incompetent in holding this against him. That Obama might have had a credibility lead over Romney vanished with Benghazi.  If he just would have said from the beginning it was clear some people fell down on the job and there would be an investigation as to whom and when – he would have been able to delay the results of that until after the election while accepting responsibility as opposed to something that is starting to look like Watergate in terms of a cover up even if there is no criminal culpability.

The Democrats have been terrible defenders of Obamacare – incapable of pointing out the most unpopular piece of Obamacare – the mandate to buy insurance was not only in Romneycare in Massachusetts, it was proposed at the federal level by Richard Nixon back in 1974, supported by Newt Gingrich when he was the House Republican leader and supported by the last four Senate Republican leaders preceding McConnell. It is an essentially a Republican idea that candidate Obama ran against and then accepted when he was President.

While some people are amazed how close the race is and that Obama is still in the running with an over 8% unemployment rate and is leading in states like Nevada with the highest employment rates, it is actually more amazing that Romney’s 47% comments have not cost him the election at this point. It goes to the partisans being heavily partisan in spite of facts. California and Rhode Island are going to vote Democratic no matter how high the unemployment rate. The anti-Obama sentiment is so strong among the people who hold they will vote for anyone running against him no matter what.  The undecided are undecided because they know in the hearts neither of these guys is going to solve our problems.

Paul Ryan and what his selection says about what Romney thinks about his own chances

The history of “startling” or controversial choices for Vice-Presidential running mates often means the Presidential candidate is in deep trouble. The safe and most electorally advantaged selection for Romney would have been Ohio Senator Rob Portman who was presumed to be the leading candidate. Portman has the resume one wants in a Vice-President and much of the same knowledge of the budget as Paul Ryan, though having been the OMB head during the big deficit years of George W. Bush would have been fodder for Democrats, it is nothing in comparison to the fodder they will make of the Paul Ryan budget plan and its plan to eliminate Medicare (at least plan 1). Portman’s tenure as Bush’s OMB director has not stopped him from getting Tea Party support and the deficits could be explained away by needing to fund wars in response to 9-11 and popular new programs like the Medicare drug benefit. Ohio is a swing state and a state that is the single biggest bellwether on who wins the Presidential election as its residents have voted for the winner in every Presidential election since 1964.  In 2004, Ohio essentially decided the election when Bush won by a mere 2.1% and Ohio’s 20 electoral votes would have swung the Electoral College to John Kerry.

Rarely do Vice Presidential candidates even tip their own states. Al Gore even lost his own state when he ran for President on his own.  Clinton in fact chose Gore because he was worried despite being a Southerner himself, being swept away in the South which has become solidly Republican. They did win Tennessee in the 1992 election, but how much Gore should be credited is questionable as he could not carry the state when he ran for President. However, Lyndon Johnson clearly tipped the balance for Kennedy in Texas where they won by only 50,000 votes. Muskie carried Maine for Hubert Humphrey.  Paul Ryan could tip the balance in Wisconsin – he did win a Congressional district that voted for Obama barely and Ryan won with almost 64% of the vote. But that might be a testament to good constituent service and the value of being an incumbent – probably running against someone who didn’t believe they would even win. That is a far cry from carrying a state.

Why is Ryan a risky choice? Because Ryan to his credit has had the rare and unique courage to come out with a specific plan to deal with our unsustainable Medicare and Medicaid entitlements. I don’t agree with his solution, but I commend him for having the coverage to take on politically sacred cows. Unfortunately, his plan is not saleable – and resulted in the Republicans losing a special election to fill a House vacancy in upstate New York last year for a seat the Republicans had held for 40 years. Here is a commercial that ran then and why it is amazing that Romney took this risk particularly as seniors were a demographic Romney was winning in polls:

Romney’s polling success with seniors was in part due because Obamacare includes $700 billion in Medicare cuts mostly from cutting payments to providers. This is the same $700 billion Ryan wants to cut from Medicare, but Ryan makes the cut by directly cutting coverage or changing how people are covered. In other words, Ryan’s $700 billion cut looks more threatening to seniors and prospective seniors in particular than Obama’s, though an argument can be made that provider cuts would lead to less service and providers dropping out as many do for Medicaid which has lower reimbursements than Medicare.  Optically Ryan’s idea looks more ominous and politically will be portrayed as such. In picking Ryan, Romney took a weapon against Obama and made it a weapon against himself.

Most of the time Presidential candidates make safe picks, so the record on surprise choices is limited, but two of them in recent memory are Geraldine Ferraro and Sarah Palin.  In both cases it was hoped that trailing campaigns could be saved by making an historic pick of a female candidate. In both cases, it was hoped the choices would “energize” the base of the respective parties.  While nobody questioned Mondale’s liberal credentials he was seen as boring and bland and was running against a popular charismatic incumbent President (Reagan). McCain was viewed with more suspicion by the right wing of the Republican Party because he was not in lock step view with them particularly on immigration to which he had to change his view to get through the Republican primary much the same way Romney has had to move away from his positions that don’t dovetail with the far right.  By picking Palin he got someone solidly conservative and youthful versus his old age and that would inject excitement into a faltering campaign.

It bears mentioning that Ferraro was also a sitting House member one of the few ever nominated for Vice President. Ferraro though had less stature in Congress and less legislative accomplishment than Paul Ryan who not only chaired an important committee was given almost carte blanche by his colleagues to make a federal budget, unprecedented in the history of Congress. But both Ferraro and Ryan, not because they are House members per se, but based on their work in House did not spend time on foreign affairs or military matters and did and will get questions about their lack of experience here. That was also an issue with Sarah Palin and her response about Alaska being close to Russia only made it worse. When most people think of readiness to take the Presidency on a moment’s notice they are really talking about foreign policy readiness and the ability to be commander in chief. It was why Barack Obama picked Joe Biden who chaired the Senate Foreign Affairs Committee and the Senate Judiciary Committee and had been in the Senate for 30 years. Biden was the fourth most senior member of the Senate when chosen as Vice-President and the 15th longest serving Senator in history – nobody was going to question his fitness for the office.  Likewise, George W. Bush as a Governor of Texas with no foreign policy chose Dick Cheney who served as Secretary of Defense including winning the first Gulf War and when he was in the House rose to the number two position on the Republican side there, so it gave Bush someone with extensive federal government experience.

The Republican ticket is the first one I can think of it my lifetime that has had so little foreign policy experience. The Republican spin on this is that Ronald Reagan had no foreign policy experience and he brought down Communist Russia and ended the Cold War. In hindsight, that looks great but let’s remember candidate Reagan. Candidate Reagan was running against an incumbent President (Carter) who was also a former Governor with no foreign policy experience before entering office that had Americans being held hostage in Iran for a year, our embassy there over run and had a failed rescue mission when American aircraft crashed into each other. Reagan also has George H.W. Bush as his running mate who had run the CIA and was US Ambassador to China, so with George Bush as his running mate and against the backdrop of Carter’s ineptitude – Reagan’s lack of foreign policy skills hardly mattered.

Except in times of war, Presidential elections will be decided on domestic issues. More so than most elections with the nation not in a “hot” war, with our troops withdrawn from Iraq and leaving Afghanistan and with unemployment still high – foreign policy has not gotten attention in this election so far. That will change with the debates and there is no way for a Romney-Ryan ticket to look good in foreign policy. Obama is an incumbent Commander in Chief who won a Nobel Peace prize, killed Bin Laden, extracted our troops from the Middle East and has largely followed the national security measures of George W. Bush including keeping Guantanamo open much to chagrin of his liberal supporters and at odds with his own 2008 campaign. So there is not much for Romney to attack on Obama on except his failure to slow Iran down from getting a nuclear weapon and Romney cannot say too much on that because people are going to ask what would you do differently and Romney is adept at not taking firm stances unless pressured by the far right on Obamacare, abortion etc. So Ryan here adds no value and if anything is a net negative because of his lack of foreign policy experience.

Beyond Geraldine Ferraro we don’t have a lot of example of sitting House members as Vice Presidential nominees. Barry Goldwater’s 1964 VP choice  was an obscure House member from upstate New York mostly likely chosen to given the ticket an East –West balance as Republicans in the Northeast still mattered back then (the Rockefeller wing of the party). Goldwater lost in a landslide but his VP nominee was not the reason. There has some mention of John Nance Garner who FDR’s Vice President in his first two terms as being the last sitting member of the House elected Vice-President. It needs to be kept in mind Garner was the Speaker of the House and that puts him in a different category than other House members and he also challenged FDR for President for the Democratic nomination. FDR’s choice of Garner here was much the same as Kennedy picking Lyndon Johnson. Both Garner and Johnson were from Texas and both FDR and Kennedy from the Northeast. Garner was Speaker of House and Johnson was the Senate Majority Leader – something many have forgotten and Johnson had also run against Kennedy for the nomination. Both were examples of geographical ticket balancing and creating party unity.  A sitting House member other than one has been Speaker has last been elected Vice-President in 1908 when James Sherman was Howard Taft’s Vice-President. Sherman notably is the last Vice President to die in office. At the time there was no constitutional mechanism to fill the vacancy and the office remained vacant until the next election. Gerald Ford was actually the last House member to make it to Vice President but he was appointed to fill the vacancy caused by Agnew’s resignation and he was the House Minority Leader at the time (meaning if the Republicans had controlled the House he would have been the Speaker).

Ryan’s nomination has much in common with Ferraro’s and Palin’s although many people will not initially see the commonality other than Ferraro being a House member. They were all risky picks in attempt to save a campaign that the Presidential candidate had concluded he was way behind in. The last two didn’t work and I don’t think this one will either.





An unconscionable security

Floyd Norris of the NY Times wrote a piece on how big banks hosed retail investors on a complicated security. Of course, the bank does not see it this way. The bank in question is Wells Fargo whiach actually inherited this security from its acquisition of Wachovia which actually was the lead underwriter back in 2005. Here is the article:

This is another reason retail investors don’t trust the stock markets or banks and brokers. Libor scandals, muni bid rigging scandals, robo signings, the 2008 meltdown, the Flash crash, the Knight trading debacle yesterday and on and on.

I don’t believe retail investors got taken advantage of in Facebook. In Facebook, they got done in by their own greed and media hype and was just another mania they decided to participate in like the internet bubble or housing.  People who heeded my warnings on the Facebook IPO in February would never have had a problem:

I know a lot about trust preferred securities as I was working at one of the largest institutional investors in the country when these were invented and we bought a lot of them. The problem is not trust preferred securities (TPS) although these complex instruments would not exist if we got rid of rating agencies and the corporate income tax. The Wachovia issue was a derivative based on the underlying TPS using an interest rate swap agreement. TPS are usually sold to institutional investors, though they often might trade in the secondary market on the NYSE allowing retail investors to purchase them.

Investors who would have purchased the actual TPS issued by JP Morgan would have gotten an interest payment that was at the mid-point of the Wachovia security which was designed to have a floating rate. The real difference is the investors in the underlying JP Morgan TPS got all their principal bank, where the Wachovia security holders lost 40% of their principal. Would any rational investor take a risk of a 40% loss, just to at “best case” get roughly 300 basis points more than the underlying security and possibly even a lower interest rate? Of course not and certainly most retail investors would not who invest in fixed income securities .

While the NY Times article and the blogs it links to have a lot of focus on whether the disclosure of risks was adequate and I think it was not – it is not even the largest issue. The larger issue is that brokerage firms cannot by regulation sell “unsuitable” securities.  For example, at an extreme it not permissible to allow a 90 year old living on a fixed income to sell naked calls. Nor is it permissible to put someone who wants to invest for income in penny stocks.

Everyone in the industry knows the retail investors don’t read prospectuses – actually either do many institutional investors. People are time constrained, they have neither the time nor patience to read long wordy documents and the retail investor would not even understand it if they read them. They rely on how the broker pitches the sale. I guarantee you people who bought this understood only that the rate could float, the length of maturity and that is was “Wachovia”. The retail investor is thinking Wachovia – they are a big outfit, my money is safe and I will get in back. Never in a million years did retail investors understand the underlying mechanics of this security.

When the auction rate securities market blew up, regulators made firms make their investors whole in spite of the prospectus because it was pitched as a money market alternative, which it wasn’t. Regulators should act here – they should make Wells Fargo make the investors whole. It does not even matter whether Wells made money on the redemption or not and whether they had legitimate costs to unwind the hedge. Wachovia for which they assumed the liabilities of, never should have brought this issue to market – particulary being sold to retail investors – it was simply too complicated for them to understand. In Wachovia’s defense they probably thought a triggering event for a redemption might be like a 100 year flood, but nonetheless – it is by its structure and complexity and even risk/reward, an unsuitable security to whom it was originally sold and hence they should make good on them.







Why Glass-Steagall doesn’t matter

It was big news that Sandy Weill recommended re-enacting Glass Steagall which he helped bring down. People need a history lesson to realize the lack of Glass Steagall did not cause the 2008 meltdown nor did it prevent the S&L failure of the 1980’s. Leaving aside the technicalities that used to exist between S&Ls and commercials banks – S&Ls were even more restricted in what activities they were able to engage in than commercial banks even under Glass Steagall.  This did not stop 747 out of 3,234 S&Ls during the 1980’s and 1990’s from failing and around another 1,000 from disappearing through mergers with regulators’ assistance mostly allowing goodwill to be counted as tangible capital. While some blame the relaxation of these restrictions in 1980 and 1982 for the S&L crisis, people forget these bills were passed to help the S&Ls “grow” out of an already existing problem, the alternative being the federal government would have to bailout the deposit base even sooner. The core problems of the S&Ls were they restricted in what interest rates they could offer in high inflationary times, and saw deposits flee to money markets and most importantly they were “upside-down” on the mortgage portfolios because they had lent long term at fixed rates and were now having to offer higher interest rates to maintain deposits. They had a classic asset-liability mismatch – funding 30 year mortgages with short term deposits. There were even state chartered S&Ls that were not allowed to offer adjustable rate mortgages to help deal with this asset-liability mismatch, until reforms were adopted.

It is worth noting that money markets which have gotten little attention during both the S&L crisis and the 2008 crisis are actually at the center of both of them and their mere existence a major reason why Glass Steagall was repealed. The money markets  siphoning off S&L deposits had to have a means to offer those higher interest rates. What they had was commercial paper. Commercial paper was not only the instrument that money markets used to distintermediate federally insured depository institutions (both banks and S&Ls) from their deposit base, it was the instrument used to disintermediate commercial banks from the corporate lending clients who used commercial paper instead of bank loans. In plain English, if IBM or GM needed some short term money rather than going to Chase Manhattan for a loan they would ask Goldman Sachs to float some commercial paper.  It is also worth noting that a run on money markets caused by Reserve Fund one of the oldest money markets in the country “breaking the buck” did more to bring us close to a complete collapse than anything at any bank.

People need to familiarize themselves with term and concept of disintermediation if they want to discuss regulation. You can’t argue for regulation without having a plan to deal with non-regulated or less regulated entities from competing with banks.  We need to remember that the bulk of the problem home loans that took us to brink of the disaster originated with non-bank financial institutions like Countrywide. Before Glass-Steagall was formerly repealed, it was dramatically weakened by regulatory exemptions, many given to combat the disintermediation issue. This also raises the issues if Glass-Steagall were to be re-enacted, should regulatory exemptions be allowed? – because these exemptions had pretty much gutted the law, particularly the division between commercial banking and investment banking activities even before the passage of Gramm-Leach-Bliley. Has Sandy Weill not wanted Citicorp to buy an insurance company (Travelers), Glass-Steagall would still nominally be on the books, but nothing that took place in the second half of last decade would have been precluded if the weakened Glass-Steagall had still be in effect.

Glass-Steagall didn’t preclude banks from purchasing risky securities,  it only prohibited them from underwriting them. Hence, the multibillion loss at JP Morgan from the “London Whale” could have occurred even under the Glass-Steagall act as originally enacted in 1933. Except for of course there were no credit default swaps then to speculate in.









Who owns analysts’ work?

Some in the media has done a tremendous job with an assist from the SEC in trying to confiscate private property for the public use without the benefit of due process enshrined in the Constitution. It almost sounds like eminent domain and it is playing out like that, though what I am referring to is not taking physical property to build a road. It is who owns investment analysts opinions? In two articles, in the past two months Gretchen Morgenson of the New York Times has written two provocative articles centering on analyst opinions and who gets them when. Most of the media has lined up in chorus to support her basic thesis that analyst opinions are material non-public information that influence stock market prices and hence should be made available to all on an equal timely basis. The New York Times even just ran an editorial in support of this position:

Analyst opinions unfortunately do influence stock market prices for about one day though rationally they shouldn’t. But that they influence security prices for 24 hours or so does not make them material information, in fact they are not information at all as explained so well here by Felix Salmon:

Now the SEC is partially complicit in this attempt to confiscate private property In April, Goldman Sachs paid $22 million to settle charges about “analyst huddles” where their own traders and select clients were given heads ups on analyst insights and presumably rating changes. The SEC has taken the position that all Goldman clients must be treated equally, while the New York Times has expanded that to Goldman treating the general public which pays it nothing on par with it clients. But the situation at Lehman described in Morgenson’s May article on Lehman seems similar enough to Goldman to raise questions why the SEC took no action in the Lehman case. Perhaps Lehman’s lawyers raised objections that Goldman’s didn’t as to what were the SEC’s powers here anyway.

Most inside trading cases and there is no specific law on “inside trading”, rely under rules and laws about misappropriation and violation of fiduciary duties.  But you can’t steal or misappropriate from oneself.  Lehman and Goldman should be free to use the work product they produce as they see fit, to use it internally or to disseminate early to better paying clients.  Most businesses including banks and brokerage firms treat better paying customers better than lower paying ones. When an online trading firm charges less commission if you do more trades with them or have more assets, they are not treating all customers “equally”.

There is a difference or should be between a government report like unemployment numbers that influence security prices being timely disseminated to all because taxpayers pay for that. But Goldman and Lehman are private companies, most market participants are not their clients and pay them nothing, so why are they entitled to anything? This is their work product produced at their cost not the public’s. Should everyone get a free card from GM or Ford? It is the same concept.  What would happen if leaks were to develop or the media would seek out internal recommendations from buyside firms like Fidelity or Trow Price? These would presumably influence market prices too if they were reported. If these recommendations were leaked without authorization that is one thing, but what happened if busyide firms wanted to share some internal research with its own clients and some of those clients leaked it as would be expected on that scale – would these firms be obligated to share them with the public on a timely basis? Can a buyside firm have research “huddles” with its biggest customers but not all of them? The top institutional clients of buyside firms get access to the firm’s portfolio managers and often one on one meetings. Retail clients who buys those firms products through mutual funds do not get this access – is that some form of violation?

The business model for investment research is becoming extinct. First the SEC in the aftermath of the internet bubble meltdown in conjunction with Eliot Spitzer stopped or cut substantially the ability of the investment banking divisions paying for “research”. Ok, it really wasn’t research often – it was paid for advertising and the “fix” should have been to have it labeled as such, so it would not be perpetrating a fraud on its users that it had an intellectual unbiased basis. But that didn’t happen and now the SEC and apparently many in the media are suggesting even using trading commissions is problematic because everyone should get the product even if they don’t pay any commissions. Meaning if you are day trading from home using Scottstrade you should be able to get word on Goldman rating changes as soon as the people trading through Goldman? Really?

What the SEC should do is put out a public warning about sellside “research”, that the public should ignore analyst recommendations because they are either tainted or because they are getting the information late and also because even when done on the most ethical basis are often wrong. The SEC should formally state that anyone who buys or sells a security solely based on an analyst opinion is a fool and perhaps the public would stop doing it. If the public stops following these analyst changes, the hedge funds and the banks own traders will have no reason to front run them because there won’t be a fool behind them willing to pay a higher price on the buys or sell at a lower price on the sells or downgrades.  I won’t hold my breath waiting from this kind of candor from the SEC.

Peering through the News Corp split hype

The investment community is riveted today by stories that News Corporation (NWS) is considering splitting into two companies one holding its television and movie assets and the other its print publishing business, the latter which has been engulfed in scandal in the United Kingdom. The investment community has a short memory as does the journalists who follow it and nobody is asking have we not seen this before. By before, I do not mean Viacom – which I will get to later. By before I mean the history of News Corp itself.

News Corp was once an Australian company and today is it is a US Corporation incorporated in Delaware.  Because some mutual funds cannot buy foreign stocks or are restricted in such, News Corp over a decade ago spun out a minority interest in Fox which was a US company and its principal asset.  This was done also to “highlight” the value of Fox.  Several years later News Corp did a major corporate restructuring which it converted the parent from Australian to American. There were pragmatic reasons to do this, most of its businesses are in the United States and there are still laws on the book regarding foreign control of television stations which prompted CEO Rupert Murdock himself to change his citizenship from Australian to American years before.  Soon after, News Corp bought back the Fox minority stub.

Despite all the machinations, never mind all the mind numbing stock and asset transfers regarding Direct TV and Liberty Corp – News Corp stock is lower today than it was at the beginning of 2000. Direct TV in contrast since no longer being part of News Corp has a stock trading near a record high.  This brings us to Viacom which bought CBS and then later split into two separate companies, essentially making CBS independent again.  At the time, it was widely assumed the more valuable piece was Viacom with its fast growing cable networks like MTV and Nickelodeon.   CBS was badly trailing NBC in ratings and was considered a network whose viewership was “too old” for advertisers. Since the split in 2006, CBS stock has actually outperformed Viacom, with CBS doing slightly better than the S&P, but Viacom only doing half as well as CBS. This has nothing to do with the split – it is related to fundamentals – the cable networks growth has cooled and CBS found new growth from milking re-transmission fees – these things would have happened split or not.

The big push for the split now is apparently to resolve concerns in Great Britain about News Corp’s dominance in British media markets across assets and pave the way to take full control of BskyB which it now own 39% off. But this assume regulators and politicians won’t notice that the Murdoch family will still control 40% of both newly split companies as it controls 40% of News Corp today. It might also be to remove the taint of the phone hacking scandal from the parent and its assets unrelated to it, but the phone hacking issue will resolved eventually and doing a major corporate restructuring to improve the optics on a temporary blemish is myopic, but Wall Street is myopic. And yes, investors like pure plays – but give them six months and they will find something else they don’t like and what do you do then? This fascination with pure plays is well “fascinating” implying that all these highly paid Wall Street people are not capable of valuing business components and adding them together – they need something simple.

We should not fear the end of the Euro

Robert Zoellick the outgoing chairman of the World Bank is saying the world is heading for a repeat of 2008 unless the Eurozone problem is solved.  The Eurozone is a big problem but not on this level for several reasons. Number one 2008 involved a problem directly in the world’s largest economy and while the Eurozone is larger than the United States in terms of GDP, keep in mind it is still separate countries – this type of analysis would be almost akin looking at North American GDP (including Canada and Mexico). If the Eurozone collapses, Germany its most important member slows, it does not collapse.

The comparison to Lehman as a contagion is also off the mark. Lehman was the fear of a contagion because of derivatives which has so far proved to a solvable problem. It was AIG’s derivative problem that needed a government bailout and even that would not have been necessary had the rating agencies not created a “run on the bank”, something that never should have been allowed to happen.  The real Lehman problem was the psychological shock to the system particularly as it was perceived the government had effectively kept Bear Stearns from just collapsing, so there was an expectation they would for Lehman as well. Beyond that,  Lehman’s failure coupled with Bear Stearns effective failure both tied to real estate was the “proof” the market needed that the “emperor had no clothes” and that the unthinkable of a massive collapse of real estate prices nationwide particularly in single family was happening and that had never happened before.

The Eurozone collapsing is no longer a shock. When the end happens it will be like a person who dies after a long battle with cancer. The shock will be smaller, the mood will be sad, but it will not be the shock of someone dying in an auto accident. In 2008, we are unchartered waters or looking at something people thought was the same as the Great Depression – the complete collapse of the banking system. In Europe, the end game will be Europe will be back where it was in 1999 with countries with their own currencies – that is not so long ago and the world functioned in 1998 and 1992 and 1986 and most of us remember that. The process to get there will be messy for a while, but the outcome will not be unknown fear – it will be where Europe was for all of history except for the past 13 years. Even the value of when issued drachma will be known because it will trade, well “when issued” – we will know the value of the drachma versus the deutsche mark long before they are issued again.  One caveat – would be a complete banking collapse in Spain – though I think the fallout from that will be more limited than the fear of the collapse of the American banking system.

Europe’s biggest problem is not what currency to use. Europe’s problem is the same as America’s and Japan’s – how to deal with a less productive aging population that are living far longer than anyone anticipated years ago when so many social promises were made and without having enough young people to support them, even if they were all employed. Europe’s problems are more acute because the social promises run deeper than in the United States and because the United States still has some growth of young people even if it is from immigration and some of that illegal.

Then we have the Soros speech getting all the attention because of two terms “they have three months” and the Euro created a “bubble”. The bubble he is referring to is from structural flaws in the Euro and ECB that led to an overvaluation of sovereign debt. It is an interesting read if you didn’t already know this – but it is looking in the rear view mirror. The three months warning has been around before, perhaps most notable is his belief that Germany will cave into more financial support for its neighbors and it might. I think the harder problem is other countries willing to shed sovereignty – Spain apparently is bad enough that they will but before they said they won’t, but they will not do this on a country by country basis. Countries that are not in Spain’s position and even in a strong position like France are not going to agree to shedding any more sovereignty.

Keep in mind TARP barely passed the US Congress and failed in the House on the first vote. They need 11 countries to go through their own legislative processes to get the kind of legal realignment to do what that they need to do at a minimum – meaning it assumes no constitutions need to be changed and that constitutional issue might be most acute in Germany.

Soros’s speech today talks in detail on the structural problems with the Euro – some known at the time they thought could be glossed over (lack of a single political sovereign) and ones they didn’t (that all sovereign bonds are not the same and lack of a single Eurozone bond instead of separate sovereign debt).

The Euro was a flawed idea that should be put to bed. The sooner the process is started to return Europe to 1998, the better off we all will be – the world and Europe functioned well before 1999, remember that.

From “tempest in a tea pot” to $2 billion loss in one month

JP Morgan has released almost no detail on the positions that caused it to report a $2 billion loss. It has only said it was a position put on to hedge global credit exposure. There are press reports that is was a sale of an CDS (credit default swap index), not even the sale of the CDS itself, but an index designed to track the prices of CDS. In other words, a deriative of another deriative. On its conference call yesterday, JP Morgan admitted it was a “synthetic”.

After all the damage done by financial institutions using synthetics on mortgage CDOs, how do regulators allow banks and/or bank holding companies to continue to engage in this? But here is the real question, was this a hedge or a prop trade?. All news reports indicate JPM was making a bullish credit call here – that alone would fly in the face of it being a hedge to other credit exposures. Most of JPM’s business is credit exposure – it lends money to corporations and individuals. The hedge would be to bet on a systemic sequence of defaults not against them. So unless the press reports on the direction of the bet are wrong, it raises a serious question to how this was supposed to hedge JPMs other long credit exposures.

The other pressing questions is that without any major credit events outside of Greece and Spain in recent weeks, why should there be a mark to market that would produce this kind of loss? Moreover, the reports are the index was one of corporate credits, mostly US companies, so European sovereign debt should have been a non-issue.  The answer might lie in trying to price a synthetic of a derivative in which the underlying derivative is in a less than liquid opaque market. One of the great lessons not learned from the AIG disaster, is that we can’t allow for a situation where systemically important financial institutions are pushed under by “mark to markets”.  In these types of deriatives, there are few institutions making markets and the ones that are being used to price the instruments might have conflicts on interests in pricing these securities. Hank Greenberg, AIG’s former CEO believes Goldman excessively mark down the value of securities that were falling in the market place, but whose underlying payment stream was still intact.

Had their not been regulatory relief on mark to market requirements in 2009, virtually every major bank would have failed. One is left to believe that JPM’s losses here are because of bad marks on their books. That they changed back the way they calculate Value at Risk (VAR) is some evidence of that.

JP Morgan owes public investors more details to explain how a tempest in a tea pot goes to a $2 billion in 30 days without any major events in the market place. Was tremendous leverage being used that magnfiied even small changes in market prices, much the same way LTCM was brought dow?. Because there are only two possibilities here – Jamie Dimon had no real understanding of what was going in these positions or he did know and hoped that his people would get this under control perhaps by deleveraging or unwinding positions to avoid having to take such a hit.  The conference call yesterday suggested the former – that they already knew there were trading losses in the unit and that they might have been too defensive about articles that appeared in the press regarding these trades. It would imply that division heads had assured Dimon it wasn’t that bad even when it was and there was smoke, yet people were telling him there was no fire. We will know for sure if heads roll in the ensuing weeks.