RWCG


More Stupid Than I Could Have Possibly Imagined
May 31, 2012, 8:22 pm
Filed under: Uncategorized

As dismissive and snide as I’ve been regarding the hand-wringing over JP Morgan’s $2 billion loss, this (which I just saw, just now) is a real story.

If true, it sounds like they had been marking their (tranche? I have to assume) trades at different levels than those set by the dealer desk. And, no internal checks or anything else forced any sort of provision or price adjustment. That? Is mind-boggling.

Jumping ahead, what it presumably means is that they were valuing and marking index tranches purely to a model, unadjusted. At least, I can think of no other explanation. The best I can imagine on their behalf (that is, if I assume the explanation involving minimal stupidity on their part) is that in their ongoing trading they were consciously trying (and perhaps succeeding, for all I know) to take advantage of tranche skews vs. the index, and came up with a way of marking accordingly (i.e. for which sum of tranches would always = index). This is a known issue with these instruments, but to actually skew marks accordingly on open positions just strikes me as dumb. They would have been only fooling themselves: when the time comes to get out of the trade, the market doesn’t care about your ‘model’.

But this would explain, perhaps, the longtime mystery of why they always seemed to see so much value in this or that tranche that they thought it made sense to push the market around: the market was ‘wrong’, they felt, because their model said so! So they just kept on buying. Oh brother.

Somewhere in some comments section, I forget where, someone brought up the possibility to me that this was a model issue. I dismissed the idea as obviously ridiculous on grounds that all the instruments in question have visible, quoted prices and no one here and now, in 2012, would have been so stupid as to actually mark index tranches purely to a model for their books & records (and not adjust valuations back to market, i.e. to the dealer marks). It appears that I may have to eat my hat on this one: if the above article is any indication, JP Morgan’s CIO was indeed that stupid.



Reminder: Technically, Too Big To Fail Is Not Actually A Thing
May 31, 2012, 6:02 pm
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Despite its almost comically hypermelodramatic title, there’s little to argue with in Simon Johnson’s post Jamie Dimon And The Fall Of Nations at Baseline Scenario. Little, that is, if you let this slide:

This bank [JP Morgan] is “too big to fail” – meaning that if it were to get into difficulties, substantial financial support would be provided by the Federal Reserve System (and perhaps other parts of government) to prevent it from collapsing.

This is stated so matter-of-factly it’s possible to gloss over it as you’re reading without quite stopping to ask…well, I mean…Huh?

Here’s the thing. I looked in my pocket copy of the U.S. Constitution for the section on “too big to fail”. Didn’t find it. Curious, I went over to the Stanford campus and borrowed Finance Professor Anat Admati’s textbook on introduction to banking. Turning to the index, I looked for Too big to fail and Fail, Too big to. Not there. The plot thickened.

When did we all agree that “too big to fail” was an objective thing that we weren’t going to argue with any longer? I’m still here. I’m still arguing.

JP Morgan is a company. There is a thing that can happen to companies when they can’t pay their bills for whatever reason, which is that they can declare bankruptcy. I am sorry, but that is the established process. If you are arguing for some other process, there is no legal basis for it, so you’re the one with the burden of proof, not me. Fuck this too big to fail bullshit already. I’ll see your too big to fail and raise you one chapter 11.

In fact this is something both left and right should (supposedly) agree on right? We’re all mad about the bailouts aren’t we? Isn’t the consequence of being mad about bailouts supposed to be, fuck bailouts? How did things get so convoluted that when everyone got mad about bailouts we proceeded directly to assuming bailouts were business as usual unchangeable facts of life?

And the thing is, if you take away this “too big to fail” nonsense, the rest of Simon Johnson’s article basically becomes moot. Try it at home. No too big to fail, no perverse asymmetric banker incentives to lead to Our Nation’s Fall. Done. Problem solved.

Now I know what you’re going to say, you’re going to say that I’m being dumb/naive because ‘realistically’, under the current political-economy context we have in place, Congress is very very very likely to treat certain banks as “too big to fail”, JP Morgan among them. Fair enough. So, we can both agree we have a problem on our hands, which is, and let me try to state the problem fully not partially, When (a) [certain stuff e.g. a bank blowup] happens, (b) Congress will [bailout/other stuff that treats a bank as "too big to fail"], (c) costing us money and probably also leading to the ill effects/incentives Simon Johnson talks about.

But let’s not forget that solutions to this problem (and avoiding (c)) can involve addressing/preventing (a), as most of conventional wisdom seems to be trying to do (futilely, IMHO), or they can involve addressing (b). All I am saying here is, give (b) a chance. It’s not like anyone’s making me super confident they have a good solution to (a) after all.



Does Talking About A Problem Cause The Problem? and other stupid questions
May 31, 2012, 9:50 am
Filed under: Uncategorized

Since it’s apparently react-to-things-I-flagged-yesterday day here at RWCG, I felt like I should say something about that paper on whether ‘the debt ceiling debate hurt the economy’. The problem is I can’t figure out how to respond since no matter how many times I read it and spin it around in my head, I parse it as a nonsense question, something that is simply ill-constructed.

To my way of thinking a ‘debt-ceiling debate’ simply can’t, logically, ‘hurt the economy’. The economy could have been ‘hurt’, or gotten markedly worse, around the time the debate occurred, obviously, and I gather this is what the authors marshal evidence to ‘prove’, but that’s a nonsense way of looking at it. If the economy was ‘hurt’, which okay is possible, it’s not because of the ‘debate’ or the ‘standoff’, it’s because of the underlying factors that led to that debate/standoff (which at most ‘released’, or laid bare, those factors). To say otherwise is like saying medicine (however ineffective) caused the disease. So I tend to dismiss this idea as yet another economist-foisted, statistics-heavy ‘analysis’ that is automatically wrong based on the methodology.

But if you want to read a more thorough and measured response, try PostLibertarian.



Wake Me When The Market Becomes ‘Fair’
May 31, 2012, 9:03 am
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Deus Ex Macchiato says it is fundamentally corrupt for investment bankers to give discounts/better execution to preferred clients. While on a theoretical level that sounds right – and while I’m sure there are plenty of regulations and training courses and ethics pledges and such, even ones that (for all I know) specially apply to investment banking, to back it up – when people say things like this I wonder why they single out finance for their scorn here.

Insiders and preferred clients getting better deals just doesn’t strike me as something magically thought up and invented by investment bankers. To me, it seems like the way of the world.

You can get better prices on yogurt by using a supermarket’s ‘club card’. You can get better prices on clothes buy buying them during a ‘sale’. You can get a better deal on your cable (or telephone, or car insurance, or…) by calling them up, acting like a parsimonious dick, and threatening to switch. You can get free hotel rooms in Las Vegas by gambling a lot. Businesses get better deals on health insurance for their employees by ‘negotiating’ to buy that insurance in bulk (indeed, everyone seems to approve of this). People with good bargaining skills can get better deals on cars. Or houses. Which reminds me, I assume people who know good brokers have the inside scoop on houses coming to market, what the likely clearing price will be, etc. as against people who don’t. And so on.

This isn’t meant to be an exhaustive list, and obviously these aren’t all instantiations of exactly the same phenomenon, but all I’m trying to illustrate is that these concepts of ‘best execution’ and ‘fair access’ that are, supposedly, ‘the foundation of a fair market’, don’t actually seem to exist anywhere that I can see. I would kinda like it if they did! Maybe there could be one giant centralized website that openly posts best-execution prices for all goods and services in the economy. But till that day comes I’m not sure I understand the reason to specially criticize them for not existing in one particular area of the economy e.g. new stock issuance arranged by investment bankers.



The Principles-Based Community
May 31, 2012, 8:47 am
Filed under: Uncategorized

Okay, I’ve officially lost the narrative regarding what ‘principes-based regulation’, or Pabst Blue Ribbon for short, is even supposed to be. Arnold Kling:

My claim is that with principles-based regulation, you could be asking this question ["How were they [JP Morgan's CIO team] compensated on an annual basis? Were they paid a salary and a bonus, and was the bonus a function of the profitability of the group, or was the bonus a function of the hedging ability of the group?”] ahead of time during an onsite audit.

I suppose it’s true that with PBR, the government could ask JP Morgan this question. But! I also suppose it’s true that the government could ask JP Morgan this question without PBR. Kling is quoting someone named Andrew Lo, who says flat out: “I know that certainly the government can get that answer with a single phone call.” Does Kling think Lo is wrong, and that we need “PBR” first? Is that his point?

I really can’t envision what PBR has to do with anything here. It seems neither necessary nor sufficient.

The Volcker Rule for example makes some statements about how people are to be paid. Their pay can’t reward risk-taking, or something along those lines. That’s part of the Volcker Rule. Thus, under the Volcker Rule, presumably regulators could and will enforce the compensation part by e.g. asking banks how their employees’ pay is calculated. (Again, I totally assume they already can and do this though). Anyway, is that PBR? Not PBR? If it’s PBR then the Klings of the world should rejoice, as Congress is clearly already passing PBRs up the wazoo. If it’s not PBR, then who needs “PBR”?

The more this PBR thing is elaborated, the more of a red herring I think it is. At least, under the loving stewardship of Arnold Kling’s nascent PR campaign it appears to be quickly morphing into a catch-all for ‘reformist regulations [he] would like’.

To the issue of compensation itself, in a technical sense I’m not sure people focusing on ‘how compensation is calculated’, and wanting it not to be tied to profits, are really thinking things through (or even being consistent). Say you work for a bank. How big is your bonus? Well clearly (unless you have some kind of guarantee or multi-year locked-in bonuses?) if there’s no bonus pool, you get no bonus. How can there be a bonus pool? If the bank makes profits. Does a bank’s profits depend in a nonzero way on the profits of [insert group here]? Sure does! Money is fungible! Profits are fungible!

What this establishes is that, no matter who you are or which group you work for in a bank, your bonus depends in a nonzero way on the profits of your group. In other words, the first derivative of [your bonus] with respect to [the profits your group makes] is automatically nonzero. It might be tiny, but it’s not zero. There’s no way around this. Hence going around hand-wringing over whether this or that group is getting paid based on some formula that depends, at least in part, on their profits is wrongheaded. I’ll answer that for you right now: Of course it is.

Moreover, in other conversations anyway, that’s the way reformers say they want it. Look at the big push to pay people more in stock (or even clever structured products), and have clawbacks. What is that, I ask? If you get paid in stock, and/or your pay can be clawed back, then your pay depends on the bank’s profits. Which (again) depends in part on your group’s profits. If only because of that whole money being fungible thing. So – due in no small part to the tireless bleating of reformers – bank employees are already very long their own employer. It follows that if that employer makes big phat profits, those employees stand to gain, personally. Again this is all fully by intent and design because (before they glommed onto PBR a couple weeks ago) the well-meaning reformers of the world were all agonizing that bank employees were too short-sighted, didn’t have enough skin in the game, didn’t have the right incentives to make sure their bank didn’t blow up, and so on. Well, congratulations reformers, you’ve gotten your wish: bank employees’ personal fortunes are highly intertwined with their banks’ profitability (even more so than any regular employee is long his employer). Just like you wanted!

Except now you suddenly don’t want it.

So, to summarize: Bankers’ pay should be inextricably tied to the profitability of their bank – except, also, it shouldn’t. Do I have that right?

Two words come to mind here: PRINCIPLES. BASED.



I Can’t Wait To Give My First TED Talk
May 30, 2012, 5:05 pm
Filed under: Uncategorized

I wonder what I’ll say in it. Probably something cool.

To be prepared, I practiced saying awesome stuff that people clap in response to, in front of a mirror for 1.5 hours this mid-afternoon. It went pretty well. Preparation is key I think.

It’s gonna be awesome.

UPDATE 6/2: Ok, now I’ve shaved my head and bought a turtleneck. I am so ready it’s not even funny.



Vindication For Dixon-Neely
May 30, 2012, 8:10 am
Filed under: Uncategorized

Presumably because I’m a terrible blogger, I haven’t commented on the weird blogosphere events surrounding some weird, left-wing loser** ex-con whose name would come up in a Google alert if I wrote it out. All I wanted to observe here is that it appears that North Carolina teacher Tonya Dixon-Neely was only partially wrong.

No, you can’t be arrested for criticizing the President. But you can be arrested for criticizing weird, left-wing loser ex-cons.

**the fact that this person is a loser is merely my personal opinion, unsupported by objective fact



Conventional Wisdom To Banks: Don’t Take Risk! Also, Don’t Hedge!
May 30, 2012, 8:03 am
Filed under: Uncategorized

I agree that this piece advocating against bank hyper-hedging is interesting, but I do hope all the conventional-wisdom-spouting folks linking approvingly to it realize that he’s essentially advocating an anti-Volcker Rule.

Banks don’t hedge = banks take outright risk

So, Volcker fans, ‘banks shouldn’t take risk!’ or ‘banks shouldn’t hedge!’ – feel free to pick one. I’ll be here.



Obama On Syria: Instead Of Arguing, Can’t He Just Not Do It?
May 29, 2012, 4:30 pm
Filed under: Uncategorized

It’s possible that Mitt Romney is making a purely logical observation when he refers to “need for more assertive measures to end the Assad regime”. That is, absent such measures, the Assad regime will not end. If so, it seems a reasonable point. If he’s actually calling for such measures, however, I disagree with him.

As far as I can tell, the argument for US involvement in this place is that bad stuff is happening in the place. If there’s more intellectual content than that feel free to point it out in comments.

Unless/until then, I must stand squarely with President Obama and his administration in, I guess, opposing military action on our part there.

Although I hasten to add that it’s slightly disorienting to read news of a U.S. President ‘opposing military action’ on the part of the U.S. military in a place. Who is he arguing with or ‘opposing’? What argument does he think he needs to win? Dear U.S. President: you’re the President. If you ‘oppose’ military action, all you need to do is refrain from ordering it. Absent your command, it won’t occur.** That’s how it works. So, please continue to do so (=not order military action). Don’t tell us you ‘oppose’ it, just don’t do it.

(**OK I suppose that the U.S. Congress could, in theory, declare war against Syria over the President’s objections, and then he’d have to wage war despite opposing it (I guess?), but I’ll cross that bridge, blog-post-wise, if/when we come to it.)



Links
May 29, 2012, 12:18 pm
Filed under: Uncategorized

You heard me. Links.



Why Isn’t Maiden Lane ‘Prop’?
May 27, 2012, 9:46 am
Filed under: Uncategorized

We note Citigroup won the latest ‘Maiden Lane III’ auction. For those unaware, this is an auction of $1.6 billion face value of securities (stuff that used to be in CDOs, as it happens) that the Federal Reserve (our central bank), like, bought a while ago. Note also, every time this happens it noticeably affects/moves the markets. It’s almost as if the Fed is acting like a ‘whale’ when they dump these things…

Let’s back up. A while ago, during the The Financial Crisis™, the Federal Reserve bought a ton of bonds (the ‘Maiden Lane’ portfolios). Let’s leave aside why. This means they didn’t have them previously, but then they handed over ‘their own money’™, and got them. They’ve been holding onto them. Our central bank. For years. Billions of dollars’ worth of bonds and whatever the hell.

Recently, from time to time, they’ve been auctioning some of them off. Part of their stated rationale is, usually, ‘improving market conditions’. This means that they bought them for one price, then, possibly not being idiots or wanting to lose money, waited for the price to go up before selling them, so they could make money or at least not lose money on them. (Yes the Fed may have other motives i.e. ‘not wanting to spook the markets’ etc. but I don’t know why we’d assume they don’t prefer not to lose money as well.)

Now Citi and other banks have been buying them up in these auctions. This is a process in which the Fed asks some banks, ‘how much will you give us for this stuff?’. Each bank came up with a bid. ’72′. Or whatever. The Fed said to the highest bidder: ‘yours!’ For example, in this latest auction, Citi didn’t have the securities. Then when they won the auction, they handed over ‘their own money’, and then got the securities. And now they have the securities!

Now before you protest, yes it’s possible, even likely, they turned around and traded some of those securities to interested clients right away, clients who had said ‘we’ll bid through you guys’. What is unlikely to have happened is that their entire bid for the full $1.6 billion came entirely from clients to which they sold right away. Some of it, they presumably just took down, and now own, and are trying to offload over time.

So, to review, and sorry to be pedantic, but:

  • The Fed asked ‘who wants these bonds?’
  • Citigroup said ‘we do! we’ll pay X!’
  • The Fed sold them to Citigroup
  • Citigroup got them (or whatever portion wasn’t crossed immediately anyway).

We also presume that Citigroup, not being idiots and preferring to make rather than lose money, calibrated their bid X to what they thought they’d be able to realistically sell these bonds for some time later. In other words, they wanted to (drumroll) buy low and sell high, not vice versa. Now they surely would be pleased if whatever Maiden Lane bonds they still have, go up in price. Why? Because that would make them money, silly!

My question: Is a bank just bidding on and buying a bloc of billions of dollars worth of impaired securities, hoping to sell them later for a higher price, a ‘prop trade’? If not why not? If so why is the Fed, in soliciting bids on ex-CDO portfolios from a small number of dealers, knowingly enabling ‘prop trades’ by banks, when we’ve all now agreed that that should be outlawed because Paul Volcker doesn’t like it?

Because perhaps I’m stupid – it never pays to exclude the possibility that I’m stupid – but I myself have no idea why these aren’t ‘prop trades’. More precisely, I can’t imagine an objective definition of ‘prop trade’ to which the Maiden Lane auctions (and indeed, the Fed’s initial purchase of all these things as well! Why are we letting the Fed ‘prop trade’ – aren’t taxpayers on the hook for Fed activity?) wouldn’t apply – unless of course, contra my hunch, each such auction has been entirely and immediately crossed to clients. But clearly, you can note that, outside of perhaps Matt Levine@Dealbreaker, there hasn’t been a lot of handwringing in the past weeks and months musing about whether the Maiden Lane transactions might be ‘prop trades’ thus run afoul of the Volcker Rule.

Why, it’s almost as if ‘prop trade’ has no consistent definition.



Brazen
May 27, 2012, 8:49 am
Filed under: Uncategorized

I don’t know whether this is more a commentary on the thing itself, or on the lack of other decent radio options these days, but in the car I often find myself tuning into those radio broadcasts/rebroadcasts of Congressional hearings they have somewhere over on the left end of the dial. Thus it was that I heard a portion of debate regarding the Law of the Sea treaty, with an eloquent and prepared Secretary of State Clinton testifying and responding to Senators’ questions.

Something about the argument struck me as odd, and I wonder if you see it. Clinton (and Panetta, etc.) said – to paraphrase –

  • there are bad actors/rivals/disputes out there in e.g. the Arctic, making claims that ignore existing/traditional sea law
  • this threatens our security and ability of our firms to contract for obtaining natural resources
  • there’s this treaty though, which could fix things, so
  • we should be part of it.

All sounds pretty reasonable, until you get to some of the questions from e.g. Senator Inhofe. Broadly speaking: won’t this threaten our sovereignty, and isn’t it a bad idea to hand over billions of dollars for a non-US entity to redistribute? Answer (basically):

  • no silly, you’re worrying for nothing, because anything we don’t like about it, we can just ignore.

There’s a best-of-both-worlds (I think she even used that phrase) quality to this argument that is striking when you think about it and all the more striking when you consider that perhaps the Clintons of the world are actually sincere in saying it. We can have our cake and eat it too, she is saying.

The traditional RWCG line of attack would probably be to mock the logic of this sarcastically. Because after all, if we’re going around saying we’ll just ignore any parts of this treaty we don’t like, then why on earth wouldn’t the other parties to the treaty, all of whom are (presumptively) worse actors than ourselves? Either the treaty has teeth or it doesn’t; if it does, and even we don’t plan to abide by its letter, what’s the point, and if it doesn’t, what’s the point?

But it struck me that maybe the Clintons and Panettas of the world are perfectly sincere: they want us to sign treaties to use as ‘tools’, while having every intention of flaunting them whenever convenient. They sincerely think it will work, because their plan is to (a) ignore the terms of the treaty anytime they meaningfully constrain us, but (b) use the treaty as a club with which to beat rivals if/when need arises.

To my ears, this is what they’re openly saying in Congressional testimony about the treaty too. Man, sometimes we democrats, we’re just bastards ain’t we?



The Terms Of Debate
May 25, 2012, 10:12 am
Filed under: Uncategorized

Dear readers, I’m ambivalent about ‘private equity’ firms. Or rather, I have no particular opinion about them one way or the other.

Thus, I’m stumped as to whom I should vote for for President. After all, that’s what this election is about, and nothing else. The media told me so.

I guess I’ll just have to either study up on and form an opinion on ‘private equity’, or sit this one out. In fact perhaps there should be a voter-literacy sort of test to ensure that all voters come to the polls armed with a judgment one way or the other about ‘private equity’. You wouldn’t want to have a bunch of people who don’t give a rat’s ass about ‘private equity’ one way or the other to actually have a say in who should be their President.



Give That Professor A Contract
May 25, 2012, 9:46 am
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As far as I can tell, what Matthew Yglesias is belatedly discovering with this post is that people who sit in a role very distant from the day to day realities of a risky business, i.e. people on some kind of board-level ‘risk committee’ and who on paper ‘oversee risk’, might not actually be all that well-positioned to know, understand, let alone manage any given risk in question they supposedly ‘oversee’. This is far from news to some of us.

Of course, to Yglesiocrats the obvious solution to this problem is to hand off more risk oversight/power over e.g. JP Morgan to folks who are even more distant from the issue, i.e. some GS-14s in Washington DC and whatnot. And admittedly, it’s not obvious they’d be worse. But I digress.

The immediate problem arises when he and others assume, almost charmingly, that having a different set of people on this committee would have made a significant difference; as the Bloomberg article (which also dutifully quotes my favorite go-to Stanford professor Anat Admati) complains about this board whose role is to rubber-stamp VaR/etc. limits already decided upon earlier by people who actually know what’s going on ‘oversee risk’,

JPMorgan, with $1.13 trillion of deposits, is the only one of the six largest U.S. lenders that doesn’t have a former banker, regulator or finance professor on its risk committee.

Hey…wait a sec…guys! Anat Admati is a finance professor! She even opened a basic textbook about banking once, and it led to some stimulating lunchtime discussions. The solution is clearly right before our eyes.



Researching The Blues
May 24, 2012, 8:03 pm
Filed under: Uncategorized

Embeds don’t work on WordPress. Oh well.
Can’t wait for August 7th.

https://player.soundcloud.com/player.swf?url=http%3A%2F%2Fapi.soundcloud.com%2Ftracks%2F46810174

Redd Kross – Researching the Blues by MergeRecords



PBR #2
May 24, 2012, 11:08 am
Filed under: Uncategorized

Followup to the Great PBR Debate Of Late May 2012:

The issue has been painted as being about regulating via rules, or ‘principles’. This is slightly misleading. I claim that ‘principles-based regulation’, in practice, will still lead to rules. Arnold Kling in the original post even cited common-law in defense of why his approach doesn’t violate rule of law. Well, ‘common law’ results in…rules. It’s just that they are constructed/settled/discovered via a different process. Either way you get ‘rules’, the question is how you get them and where they come from.

Stripped to basics, PBR advocates are suggesting that rules should be made-up by bureaucrats. Leaving aside that (as I think Foseti would agree) that’s more or less what already happens, it should be understood that this – and not a whole different way of regulating that somehow avoids ‘rules’ altogether – is what is being advocated.

Those taking (kinda-sorta) the other side of the debate from myself appear focused on making sure rules are enforced. Sure that’s nice, if the rules are good and important. But how about also trying to make sure bad rules don’t exist, and can be pruned? Who, if not me, is going to speak up for averting bad rules? In theory (haha) the way this works in a democracy is that those who make rules are accountable to the people, and are forced to defend them logically, in the open. However much that theory is perverted in practice, to openly advocate that unaccountable bureaucrats make-up rules as they go along, guided only by ‘principles’ that are hopelessly vague even when the person putting them forth is trying very hard not to make them vague, can do nothing but make this situation worse.

If rules are transparent and out in the open, then it seems to me we have a better chance of staving off the bad ones. Perhaps that’s a pipe dream. But if you want to convince me of that, acting like you don’t care at all if rules are stupid (or, aren’t aware they can be), just that they ‘succeed’, is not a good way to get there.

Of course, none of these are new or original concepts. I shall not be able to recapitulate 60+-year-old Hayek writings in a blog format. The main point I wanted to make is, it’s depressing that one would even have to.



Why Is Everyone So Down On The Rule Of Law?
May 23, 2012, 4:18 pm
Filed under: Uncategorized

Arnold Kling earns a rare (for him) RWCG Demerit™ for writing in favor of “principles-based regulation”, or as I like to term it, Yglesiocracy. What is ‘principles-based regulation’, or PBR as they superfluously acronymize it? (Note to self, idea for new Sonic’s razor: anything for which its proponents have decided to try to push a superfluous acronym, is probably a bad idea). Kling explains:

With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines.

Kling does not go on to explain whether the size of those fines are set according to (gasp) rules, or rather just described via ‘principles’, leaving regulators wide leeway to make up whatever-size fines they want. But you get the idea: in short, Kling is arguing against the rule of law, whose importance he dismisses.

In principle, the advantage of traditional rules-based regulation is that the regulated entity knows exactly what is legal and what is not.

You might naively assume that it’d be a good thing if citizens can know exactly what is legal and what is not as they go about their daily affairs and then kiss their children good-night. But you’d be wrong: some of them should be sometimes randomly fined and/or thrown in jail, according to Kling’s preferred setup, the rule of regulators. Is what you are doing illegal? Ask the commissar, he’ll figure it out, according to ‘principles’, and then inform you. (And, tell you what fine to pay, if there is one.)

He cites three example situations where, he says, “PBR” would be better, and they are all strange. The first is a credit-card company trying to sell $59.95 credit-check service to someone with a $200 limit on the card he has with that company, which is supposedly bad because (per Kling) ‘no business should sell a consumer a product knowing that the consumer has no chance of benefiting from that product’. Leave aside the obvious jokes one could make about how many products this would apply to – really, does any person have ‘a chance of benefiting from’ a Chia Pet? Spam? Soap Opera Digest? Funyuns? etc – not to mention the service deals that places like Best Buy are always trying to hawk when you buy a stereo from them (do they push those things because they think you’ll use them or not-use them, hmm?). Because I don’t even understand the assumption in the first place. Who’s to say that consumer ‘has no chance’ of benefiting from checking their credit record. Just because their limit on that card is $200? But so? Maybe their credit will improve – maybe its being $200 is a result of a mistake and checking their credit record will help – etc. I don’t necessarily think it’s great that a card company would try to push-market this sort of thing, but you can always just say no, and if it really bothered me, I’d cancel the card and switch to some other company. Why does the consumer need ‘protection’ from anything here in the first place?

The second example is Freddie Mac making too-easy loans. Leave aside the fact that GSEs were making easy loans in part due to pressure from the government itself (thus, the idea of this problem requiring a government solution is rather ironic). Kling says this violated a principle he’d set out as, ‘any financial institution that enjoys a government guarantee has a responsibility to behave prudently’. Oh, okay then! Just behave ‘prudently’! I don’t even know what this can possibly mean in practice. Quick, JP Morgan wants to sell $Xmm IG9 10y protection; is that ‘prudent’? Can/should they do it? Says who? How/when shall they know? What about $Ymm? What about buying protection? What are the allowable ‘prudent’ positions in IG9 10y they are allowed to have at any given time? Hopeless. (Later he describes a couple of English-law principles as too ‘vague’ to be of any use. Healer heal thyself.)

The third example, aimed at the MF Global case, says ‘the chief executive of a company has a fiduciary responsibility to make certain that systems are in place to protect customers’ funds’. The thing is, I’m sure that ‘systems were in place to’ protect MF Globals’ customer funds; the problem was not the lack of ‘systems’, it’s that they evidently didn’t work (or were undermined, we still don’t know, I think).

Here and elsewhere Kling seems to confuse the verifiable existence of ‘systems’, ‘checks’, etc. for the actual protection of the thing. How would this work in practice? Either one could say ‘we had systems, they just failed’, and stay clear of Kling’s principle (so what’s the point?), or we have to understand that principle to mean that you can put executives – i.e., people – in jail for events that are, literally and realistically, beyond their control. Oh what’s that you say? It’s not beyond their control? Executives can and should be understood to personally control and be criminally liable for literally all actions and events within some giant x000-person corporation, and this assumption should be written into regulations principles? Yeesh, now who’s guilty of nirvana-fallacy thinking?

There is a sense, a very trivial sense, in which ‘principles-based regulation’ is unobjectionable. Let’s take murder: surely the various laws against murder basically just say You can’t murder, they don’t bother to lay out specifically every possible conceivable way to murder someone, and then ban that act (‘…and you can’t jam a screwdriver into someone’s eye socket until it damages their brain making them dead, and you can’t…’). So you could say, I suppose, that ‘don’t murder’ is the ‘principle’ that is, then, enforced by prosecutors, judges, and juries sussing out in their minds whether you violated that principle. An analogous example suggests itself in business: don’t commit fraud. ‘Fraud’, in the various laws, is probably indeed described in a ‘broad but well-defined way’ that has to be applied to any given case.

Sure, I’d have no problem with ‘principles-based regulation’ if that’s all it means. But that works in part because the ‘principles’ in question are themselves so well-defined that there is broad background societal and historical agreement about what they mean; they rise above ‘principles’ and connote specific acts that are reasonably well-understood by all in advance. When and where that can be done in financial and other regulation, then okay. ‘Fraud’ appears to be one such example. But to try to expand this to vague ‘principles’ like ‘be prudent’ doesn’t work. And there are cases where we want to regulate things that simply don’t lend themselves to being cast in the form of a principle; quick, how would you state the ‘principle’ behind regulator-enforced capital requirements? ‘Have enough capital’?

I would suggest there are some issues you need to either state in the form of a number, or be silent on. For better or worse, our Congress and regulators take it upon themselves to regulate many issues of this type. Trying to phrase such regulations as ‘principles’ only succeeds in making them vague. But vague laws defy the rule of law. Why is everyone so down on the rule of law?



Apologies
May 23, 2012, 10:10 am
Filed under: Uncategorized

I seem to have taken double-dose of Sarcastrojuice this morning. Bear with me.

UPDATE several hours later: I actually edited this post to correct the spelling of Sarcastrojuice.



Facebook Valuation Tips
May 23, 2012, 9:51 am
Filed under: Uncategorized

We note the Facebook IPO is causing some consternation. It turns out that revolutionizing scrapbooking may be worth not $104 billion as we had previously thought, but something maybe 20% lower than that. Or whatever.

This shows the hazards of working with made-up numbers wholly unrelated to any conceivable revenue scenario. Made-up numbers can change on you like that. (Hm what is the emoticon for snapping-my-fingers?)

For example, when evaluating whether to pour all my life savings into Facebook, which of course I did, I created a giant Excel spreadsheet, made up some numbers, multiplied them together, multiplied the result by 2*(RAND()-.5), and it came out $43.13. That’s howcome I knew it was a total BUY at $42. I imagine you did something similar. After all, this is just established market practice when it comes to INTERNET things.

But as we’re seeing now, the Made-Up Number System is notoriously fickle. When you’re making up numbers, 31 is as good as 42. Actually, to be more precise, if you’re working in M = {the set of made-up numbers}, 42 equals 31. As it does all other numbers. So actually all you folks who got in higher really have nothing to complain about. From a certain point of view you’ve taken no loss at all because the current price is more or less equivalent to where you bought it (in made-up numbers). What? Who’s to say it isn’t?



Why Romney’s Campaign Advisors Should Be Fired
May 23, 2012, 8:00 am
Filed under: Uncategorized

President Obama is surely correct in every detail when he says this:

“Mr. Romney is responsible for the proposals he’s putting forward for how he says he’s going to fix the economy,” Obama continued. “And if the main basis for him suggesting he can do a better job is his track record as the head of a private equity firm, then both the upsides and the downsides are worth examining.”

Now, this is sort of embarrassing for me to have to admit, because it shows how ill-informed I must be, but I had no idea that the Mitt Romney campaign was putting forth the argument that the ‘main basis’ for why he should be made President-guy was that he used to be associated with Bain Capital. I just had no idea whatsoever that Bain Capital is what Mitt Romney was basing his campaign on. If that’s really the case then personally I think all of Romney’s campaign advisors need to be fired ASAP.

But President Obama has a perfectly logical and valid point here: if that’s what he’s basing his campaign on, then both the upsides and downsides are worth examining. (As he is currently only focusing on the downsides, I presume Obama will be presenting detailed outline of the upsides for us shortly.)




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