Monday, July 30, 2007

The Clinton Service Academy

OK, I hate Hillary as much as the next guy, which means I fully expect her to win the next election. But her new proposal to have a national service academy for public servants is one of the most boneheaded idea in an election season full of boneheaded ideas. (See Clinton: Create Public Service Academy). Does the United States really need a École Nationale d'Administration? After all, that's proven such a font of ingenuity for all things French and bureaucratic. And, besides, don't we already have Georgetown University?

Sunday, July 29, 2007

The UK FSA lapdogs

I know it's been a while since I bitched about the UK Financial Services Authority, but last Monday the Wall Street Journal (of all places!) published an article by Alistair MacDonald titled Assessing U.K. Watchdog -- FSA's Regulatory Model Gets Some Raves in U.S.; A Lapdog at Home? Of course, you have to have a subscription to the WSJ to read it -- a silly policy that's contributing to why Rupert Murdoch is going to buy out their asses and fire a quarter of the staff. Nonetheless, for a newspaper committed to a "principles-based" approach to financial regulation, I found the article both fun and interesting.

The WSJ article describes the FSA as a toothless "lapdog," barely regulating and never enforcing even the rules it has. (You can really get the British goat by calling something a "lapdog" these days. Ah, the effects of Murdoch already...) The WSJ draws on some recent research by Howell Jackson, a Harvard Law School professor currently studying how different countries regulate their securities markets. (One of Jackson's recent preliminary papers on this topic can be read here.) Jackson's research, along with a recent paper by Columbia Law School professor John Coffee (which can be read here), show that the degree of enforcement of securities regulations in the United States is qualitatively different from other countries. When compared to the UK FSA, this is particularly apparent. The US spends considerably more on securities regulation than does the UK, even when accounting for market and economic size. But the area that really stands out is enforcement. Between 2002 and 2004, on average, the US Securities and Exchange Commission took 639 enforcement actions, and levied $2.1 billion in fines. By contrast, the UK FSA took 72 enforcement actions per year, and on average levied $27 million in fines.

And this actually understates the differences, since the FSA combines within it many of the regulatory functions that in the US are divided among the SEC, the self-regulatory organizations (such as the National Association of Securities Dealers), and some state regulators. When all of those are added together, the US brought 2,985 enforcement cases and levied $5.3 billion in fines. Even this, however, understates enforcement activity in the US since, as Coffee shows, US private enforcement activity (i.e., securities class action suits) levies the equivalent of another $2 - $9.7 billion per year.

What this all means is that if you misbehave in the United States, you can expect to be slapped with a market-adjusted fine that is 10 times greater than similar activity might fetch you in the UK. And that's not counting the private lawsuits, which are very rare in the UK. Or the criminal penalties. Did I mention the criminal penalties? Oh, yeah -- Coffee notes that between 1978 and 2004, joint SEC-Department of Justice investigations led to criminal indictments of 755 individuals and 40 companies for various kinds of severe market shenanigans. The indictments led to 1230.7 years of incarceration (or 4.2 years in the hoosegow on average). In the UK, criminal indictments for securities law violations are very rare, and convictions as rare as hens' teeth.

Your chances of getting busted in the US are also much higher, not least because the US devotes considerably more resources towards investigating infractions. Coffee notes that 40 percent of the SEC staff are part of the Division of Enforcement, while only 12 percent of the UK FSA is in enforcement -- and this group splits it time between policing the securities, insurance and banking sectors.

None of this necessarily means anything, of course. It's possible that the US devotes so much of its regulatory resources to enforcement because its market is plagued by crooks. It's also possible that you can over-enforce -- an argument that Coffee also makes, particularly with regard to private lawsuits. In other words, a scourge of scorpions may not be the best thing for market efficiency. However, another recent study -- this by the team of Craig Doidge, George Karolyi, and René Stulz argues that the stronger investor protections and enforcement system in the US provides a markedly lower cost of capital for foreign issuers listing on a US exchange. (See "Has New York Become Less Competitive in Global Markets? Evaluating Foreign Listing Choices over Time" (July 2007)). Doidge, Karolyi and Stulz also show that this US listing premium has not diminished since passage of the Sarbanes-Oxley Act. So take that, all you SOX haters out there. Yeah, I'm talking about you, Bainbridge. You too, Ribstein.

And while I'm at it, you too, Paulson Committee and Chuck Schumer and Michael Bloomberg. One of the interesting points in the Doidge, Karolyi and Stulz paper is that, when you look at the types of foreign companies that have listed with NASDAQ and the New York Stock Exchange in the past, there hasn't actually been a drop-off in IPOs in New York since passage of SOX, contrary to what the Paulson Committee and others claim. Doidge, et al. analyze the types of companies that traditionally have listed in New York in the past and find that these tend to be larger companies with a history of cash flow and high Tobin's q ratios. By contrast, many of the IPOs over the past several years have been smaller companies, with no cash flow, and low Tobin's q ratios. Indeed, these types of companies have become the bread-and-butter of London's Alternative Investment Market (AIM). (I'm not saying these companies suck, but can you say "Russian corporate governance"? I mean, without snickering, ducking, or hiring a food-taster.) In other words, most of the issuers "not going to New York" these days wouldn't have gone to New York even before SOX. Most likely, they would have just borrowed from a bank or had to recapitalize earnings.

None of this is much comfort to the NYSE or NASDAQ. Even if these issuers would never have gone got New York to begin with, slumming is big bucks these days and high US standards and a toothy watchdog preclude them from competing with AIM in attracting mobbed-up Russian issuers and risk-tolerant suckers investors. But, in my opinion, US regulators shouldn't be in the business of improving the NYSE's bottom line. They should be in the business of providing US companies with the lowest cost of capital. That's a key difference between the US and UK market.

Wednesday, July 25, 2007

New New Name for Consolidated Regulator

Last March, the New York Stock Exchange and the National Association of Securities Dealers announced that they would combine their self-regulatory organizations (SROs) into a single consolidated oversight body. The idea behind this was to end some of the minor differences that crop up over time between the NYSE's rules and the NASD's rules, and also further separate the regulatory side of what the exchanges do from their business side. Originally, this new organization was to be named the Securities Industry Regulatory Authority (SIRA). However, just recently it was discovered that "Sira" in Arabic means a biography of Mohammed. Of course, it doesn't mean that in English--in English, it just means Tom Cruise's artificial child. But, rather than risk offending anyone, Sira's head Mary Schapiro announced a name change, which you can read here. The new name? The Financial Industry Regulatory Authority, or "FINRA". They decided on "FINRA" rather than the more appropriate "FINIRA" because, of course, "Finira" is a goddess in the religion of Poetology, which I invented when writing a science fiction novel. (Tom Cruise, as you might expect, is a charter member.) Since I was potentially so offended, FINIRAwas out.

But that just leaves one question: Didn't Finra fight Godzilla in one of those 1960s Japanese monster flicks? You remember, the guy in the fish suit who twirled around knocking over the little buildings with his radioactive fins? Anybody?? Buddies with Gamera? Hey, you don't believe me, just Tivo it on Nick at Night or Spike or something. I've even got a picture (see right).

Sunday, July 22, 2007

U.S. signs on to implementing Basel II

This is one of those really really big deals that practically nobody knows about--a case strong enough to resurrect Mancur Olson just so he can point his finger at all those Public Choice haters out there and say, "See, this is exactly what I meant!"

"Basel II" is the second set of international agreements on banking regulation created by the Basel Committee on Banking Supervision, which is itself a group of central banks from a dozen or so of the world's most developed economies. Unlike securities regulation, which tends to focus on investor protection, and insurance regulation, which tends to focus on the safety and soundness of the institutions, banking regulation is all about systemic risk. (Of course, all financial regulators focus on investor protection, soundness of financial institutions, and systemic risk, but we're talking about emphasis here.) From a banking regulator's perspective, the worst case scenario is not that a bank fails or some customers get ripped off, but that the system itself is brought into question. When that happens, as it did in 1929, you get the proverbial run on the banks, and then the world goes to hell in a handbasket, regardless of how many investor protections you've built into your regulation or how strong the individual institutions are. And, as we all know, the only thing that's going to save your economy's sorry ass when that happens is Jimmy Stewart explaining basic finance to a bunch of town yokels.

The second accord of the Basel Committee on Banking Supervision (or Basel II, as it's known to its friends) is designed to help protect the international financial system against systemic shocks by setting global standards on capital reserves and other aspects of banking regulation. The lessons of banking crises over the past 30 years or so (and particularly the 1997 Asian Crisis) shows that a collapse of the financial system in one country can be contagious and produce risks to the financial systems in other countries as well--even if those other countries have better regulatory oversight. That's because, in today's world, everybody is invested in everybody else, so if everybody in one market defaults at the same time (as happens more often than you might think), it could effect a major international bank invested in that market. And if that major bank goes belly-up, people start wondering about the strength of all those other major banks--and pretty soon you have a run. So, to put a stop to this type of problem, the big country central banks got together to create a uniform world standard on how banks should measure risk and set cash aside for a rainy day. Being a world standard would make it harder for some countries to "cheat" and let their banks set aside less than everyone else.

The first Basel accord, agreed to in 1988, was very basic by today's standards and was soon overtaken by new risk-measurement tools. Hence, Basel II. The fun thing about Basel II is that it is absolutely incomprehensible to everyone other than a handful of banking regulators, who themselves are incomprehensible to all other humans. Nonetheless, like all banking regulation, it involves a whole lot of money. I mean, really really really large sums of money. So, a tweak here or there can mean some bank goes out of business or else the president of that bank gets a $1 billion check in his or her Christmas stocking. Making matters more fun has been the long-standing disagreement between two of the United States' myriad banking regulators--the Federal Reserve and the Federal Deposit Insurance Corporation. I don't really understand the details of this disagreement--and by "details," I mean "anything at all"--except that the large US banks wanted one thing and the small US banks wanted something else, with the result that the European banks were worried that in the end they were going to be really screwed over. Hmmm, so many delicious choices! But all of this led to a very interesting situation where you had Congressmen holding hearings on this issue and reading questions off index cards to the various banking regulators, with neither the questions nor answers being understood by either the Congressmen or their staffs. This, itself, is not that unusual, but what was really interesting was that the industry lobbyists pushing for various concessions often didn't understand what they were pushing for, either. It's just that arcane.

Which gets back to Public Choice theory. Public Choice says that most policy issues are just too complex and tiresome for most people to pay attention to, unless the issue has a very strong impact on them. Hence, we get subsidies for milk producers, even though the average taxpayer and consumer is made worse off by these subsidies--but only a little worse off, while a few milk farmers are made very much better indeed. With Basel II, however, we have a situation were the policy issues may be just too complex and tiresome for anybody. What happens then?

The Financial Times writes about it here.

Saturday, July 21, 2007

SEC Terrorist Sponsor List Deep-Sixed

Not the brightest bunch, but at least they have something of a learning curve. By that, I mean the folks in SEC chairman Christopher Cox's office who came up with the "search tool" that was really just a blacklist of US-listed companies that somewhere, somehow, in some connection mentioned Cuba, Iran, North Korea, Sudan and/or Syria in their SEC filings. "Context," unfortunately, wasn't a feature built into this search tool, with the result that a company mentioning that it was completely divesting of all its assets in Iran (for example) joined the blacklist just as readily would "Bombs 'R' Us" when it mentions that North Korea is its brightest future market.

Cox's statement on this about-face is here. Seems the SEC decided to pull this little fiasco after both Barney Frank (D-Mass.) and Spencer Bachus (R-Ala.) publicly said it was a boneheaded idea. (On the bright side, Cox should be congratulated for helping forge a bipartisan consensus here.)

It's hard for me to feel all that worked up on this issue, particularly since some of the biggest whiners about this have been European companies that really are working too closely with some bad people and are worried that European human rights activists might actually call them on it, via the SEC's blacklist. But the SEC's execution was pathetic enough to give these companies enough ammunition to make themselves look like victims. Cox's office initiated this half-assed scheme as a way to keep Congress from enacting even more draconian rules (though why Cox would care if Congress wanted to shoulder the blame is beyond me).

A much better approach would have been to develop a real search tool--perhaps one based on Cox's beloved XBRL. Such a tool would let an investor (or anyone, for that matter) run a search for a specific country (any country) and pull up their own private blacklist of companies mentioning the nasty country in question, with links to the references so they can do their own research on whether Company X deserves to be blackballed for whatever reason your heart fancies. If you care about only the 5 countries that the US State Department lists as state-sponsors of terrorism, then you just punch in Cuba, Iran, North Korea, Sudan and Syria. If you don't like China because of the way they treat Tibetians, then punch in "China." You don't like the Belgians because they share a border with the Dutch, then... you get the point. Some kind of electronic data gathering, analysis and research tool. Just, you know, more so.

Why didn't the SEC do this? Well, probably because this was being driven by politics rather than real concern over investor interests. Bloody shame. But, hey, that's Washington.

Wednesday, July 18, 2007

I'm not saying W has burned up some of his credibility with me...

But I am saying these guys at Stratfor seem more plausible.

Al Qaeda has reconstituted itself? As strong as they were pre-9/11? Really?? Then what the hell have you been doing for the past six years?
Bush's problem is that the idea that Iraq is linked to al Qaeda rests on
semantic confusion...
Yes, we have a winner! Give Dr. Friedman the "Diplomatic Euphemism of the Month Award"!

Tuesday, July 17, 2007

Russia and Banana Republics

The news today is that the UK expelled a bunch of Russian diplomats to protest the Russians not extradicting a Soviet Russian spy who probably dropped the polonium sugar cubes in former-Russian spy Alexander Litvinenko's tea. (I once stayed in the London Millenium Hotel. And if there were ever a hotel where you'd expect someone to poison a former Russian spy, that would be it. Also, the breakfast bangers are way overpriced...)

Anyway, Bloomberg had the news, plus this interesting quote from Konstantin Kosachyov, the head of the Russian lower house of parliament:
You can act this way toward a banana republic, but Russia is not a banana
Two things. Apparently, Russians are generally fine with kicking around banana republics. Not so much news there, but interesting to actually see someone say it. Second, Russians are really really worried that they are getting treated like a banana republic. (Can you imagine the United States or China saying, "You can't treat us like we're a banana republic!")

Monday, July 16, 2007

I'm baaack....

Yeah, it's been a while. I finished some research and got bored a few months ago, so took a hiatus. But I just started thinking bout a new project, which means blogging is back as a way to think out loud or otherwise divert myself. Plus, there's just so much happening to annoy me, so why shouldn't I complain here?