Monday, September 30, 2013

Fixing What’s Broken

Fixing What’s Broken

This blog isn’t about the government shutdown, which seems likely as the sun rises on September 30, 2013.  Whether or not Congress can cobble together a continuing resolution acceptable to both Houses and the President, the US government will remain among the most dysfunctional institutions in the country. 

Instead I’d like to acquaint you with three snafus that occurred in quick succession yesterday.  The story began at the x-ray scanner at terminal C at the Philadelphia airport.  As I was waiting for a TSA agent to tell me that I was free to retrieve my belongings from the belt, I watched my laptop computer crash to the floor.  The agents monitoring the machine that scans people had slowed because the man in front of me was wearing a number of necklaces.  Meanwhile, the agents scanning baggage continued to push belongings through the x-ray machine.  The bin containing my computer popped into the air, and the computer was ejected from the belt. 
People Issues (1995)
There was very good news and bad news.  The good news was that the computer rebooted.  The bad news was the computer case was cracked.  Having stood on line for better than thirty minutes to clear security, I now spent a bit of quality time with a TSA supervisor.  He wrote up the incident and gave me a website and 800-number in order to pursue a damage claim.  I’m expecting to spend many hours pursuing this small matter and don’t expect a recovery anytime soon.

Next I want to take you to a holding apron just off runway 27R in a new Embraer 190.  We had been shunted to the side where we had a perfect view of plane after plane taking off into the clear blue sky.  It turned out that USAirways hadn’t sent the weight and balance information to the pilots.  After about an hour of idling, the plane had consumed too much fuel, so we made the slow return to the gate.  Refueling isn’t a time consuming process, but USAirways still couldn’t get basic information to its pilots.  The flight crew for the next leg of this Embraer 190 was sitting behind us.  Interestingly, they were kept in the dark about the exact nature of this delay despite repeated calls to their dispatcher.  When maintenance workers entered the cockpit, they finally figured out that the plane’s computer wasn’t receiving the weight and balance data from USAirways’ offices.  After another hour and a reboot of the plane’s computer, we were on our way.

However, during that time my aging Blackberry (yes, I still prefer my keyboard) decided it didn’t want to send any more emails.  It had ceased receiving emails earlier in the day.  I uninstalled and reinstalled my email connection without success and perused the Internet for a solution.   As the pregame for NFL Sunday night began, I decided to call my wireless carrier.  For the better part of an hour I had the same conversation with two different specialists before they gave up and transferred me to Blackberry.  At least Blackberry didn’t bombard me with advertising while I was on hold, but their background music soon became annoying.  A Blackberry technician made me repeat every step I’d done on my own, plus all the steps I’d undertaken with each of the AT&T representatives before they disappeared for extended periods of time to consult with someone.  Finally, as the football game entered the third quarter (I was following the score on my Blackberry), the Blackberry technician conceded defeat.  I had a very bad feeling as she handed me to some kind of supervisor.

The conversation was brief. For the fourth time I was asked to explain what was wrong with my phone.  Without hesitation the supervisor told me he could fix the phone. He told me to hang up and he would send instructions to the device to restore email service.  He suggested I retire for the evening and that the phone would be sending and receiving emails in the morning.   I’m not sure I believed him, but I was exhausted.  The phone is working again this morning.

So the race is now on between my computer claim with the TSA and Congress’s attempt to agree on a budget and raise the debt ceiling.  There are long odds on both, but I’m betting on the TSA.

Thursday, September 26, 2013

The JOBS Act Meets Bitcoins

No sooner had the advertising provision of the JOBS Act become effective than someone decided to raise a bitcoin fund.  While the fund will be limited to accredited investors[1], the sponsor, Secondmarket, has launched a media campaign to help raise the private fund.  Barry Silbert, the CEO of Secondmarket[2], told The New York Times, “We want to make it [bitcoins] an accessible asset class.[3]

Secondmarket isn’t the first firm to market a bitcoin fund.    Cameron and Tyler Winklevoss, who battled Mark Zuckerberg over the ownership of Facebook, filed to launch an Exchange Traded Fund that would hold bitcoins.  See, “ETF Speculation Taken to Another Level: Bitcoins [July 4, 2013].”  Whether bitcoins are held in a mutual fund, ETF, or private fund, this is an inherently bad investment product.

Whether currency is created by government fiat or computer algorithm, it isn’t an asset class.  As I’ve explained in previous posts, an asset classes either have to generate income or have the potential to generate an income stream in the future.  Currency doesn’t fit within the definition.  Currency can be held as a hedge, to fund purchases, or as a long-term speculation.  The Bitcoin Investment Trust fits into the last category; a long-term speculation.

Job creation and capital formation were the avowed purposes of the JOBS Act.    There’s nothing about investing in bitcoins that will promote either objective.  I’m impressed that it only took three days to demonstrate that the Act was about giving Wall Street yet another chance to do what it does best: market.

[1] An accredited investor has $1 million in assets, excluding principal residence or a person whose income exceeded $200,000 in the last two years.
[2] Secondmarket is a firm that makes markets in private securities such as Twitter.  The idea is to allow founders to sell and sophisticated investors to buy securities before the company goes public.

Wednesday, September 25, 2013

Brief Hiatus This Week While Much is Brewing

Brief Hiatus This Week While Much is Brewing

Meditations on Money Management is taking a brief break this week for a big family event.  There are plenty of stories brewing that will command attention.  I am particularly interested in the negotiations now underway between the Justice Department and SAC Capital and the potential settlement between government regulators and JP Morgan concerning its mortgage business. 

As Congress stumbles toward the fiscal cliff and the debt limit, I think I have a clearer understanding of the Fed’s decision not to begin the process of tapering its purchases of long-term debt.  I have no idea whether Congress will cobble together a continuing resolution or lift the deb ceiling.  Common sense says they should come to an agreement on both issues.  However, common sense is a rare commodity in Washington these days.  

For money managers, correctly predicting the future earnings of companies or handicapping the next move by the Fed are difficult endeavors.  Forecasting the outcome of a political circus is  an order of magnitude more difficult.

Tuesday, September 24, 2013

Too Big To Jail Revisited: JP Morgan Settles the Whale Case

Too Big To Jail Revisited

Last January Frontline broadcast a documentary entitled “Too Big To Jail” detailing the Justice Department’s failure to bring criminal charges against the biggest players in the credit crisis.[1]  In the last week we’ve gotten a stark reminder that too big to jail is still alive.  JP Morgan settled the London Whale case with the SEC and other regulators by paying $920 million in fines and admitting that it had poor internal controls.  The Commodities Futures Trading Commission continues to pursue charges against JP Morgan for market manipulation.  The Justice Department brought charges against two traders last August and still has an open investigation.
Reaching Agreement (1999)
While the settlement amount of $920 million is significant in comparison to the overall loss of $6 billion, JP Morgan’s admission isn’t very significant.  In 2012, when the trading impropriety first surfaced, JP Morgan had to restate its first quarter financials, which was a tacit admission that its internal financial controls were flawed.  Will higher ups at JP Morgan be indicted?  I doubt it. It’s easy to rail against the Justice Department for its poor record of bringing indictments against the high and mighty at the big Wall Street banks.  However, as I’ve looked back I’ve come to recognize the impenetrability of the banks’ defenses.

Senior executives at major financial institutions are well insulated from criminal charges.  In fact, there are several layers of protection.  Because these organizations are so vast and have complex reporting lines, it is exceedingly difficult to reach the requisite level of proof to show that senior executives had direct knowledge and involvement in any particular impropriety.  Thus, it’s much easier to trace Raj Rajaratnam’s insider trading as the CIO and founder of the Galleon hedge fund than tracing Richard Fuld’s involvement in Lehman’s demise.  Galleon was a tiny organization.  Lehman was a byzantine empire.

The big banks don’t just rely on complexity.  They use the revolving door to hire key people from the regulatory agencies.  For example, the general counsel for JP Morgan is none other than Stephen M. Cutler, former head of enforcement for the SEC.  The major Wall Street firms all have their fair share of well-connected Washington alums.

If the regulatory authorities or the US District Attorney decides to pursue the big banks, the major law firms are well stocked with an additional layer of defense.   The top lawyers are available to represent both the corporation and key executives.  For example, this summer Robert S. Khuzami, the former head of the Enforcement Division, joined Kirkland  & Ellis, a leading securities law firm.  I’m sure Mr. Khuzami already has a roster of firms that are too big to jail.  When my former employer, Legg Mason, had a regulatory problem with its high yield mutual fund, we retained a former senior SEC enforcement official who had just departed the SEC to join a major Washington law firm.  The goal was to protect higher ups in the organization from a potential charge of “failing to supervise.”

The big banks add raw political influence on top of organizational complexity and a bevy of former regulators.  It doesn’t matter if the current administration is Republican or Democratic, the big Wall Street firms have more than enough financial clout to bend the politicians to their will.  Yesterday I posted the link to a story about Richard M. Bowen, a whistleblower who worked at Citigroup.[2]  Mr. Bowen’s saga is a great illustration of the power of political influence.

Dodd-Frank did little to prevent the next financial crisis.  In fact, the new law solidified the position of the big Wall Street firms.  The big firms have only gotten larger and more complex.  Our continued adherence to “too big to fail” ensures that “too big to jail” will persist. 

PS: Andrew Ross Sorkin writes in The New York Times this morning[3] that JP Morgan’s shareholders are double victims in the case.  First they suffered the financial impact of the trading loss and then their money funded the penalty.  In my view, the shareholders have been complicit because they’ve failed to standup to management or the board.  In fact, investors idolized Chairman Jamie Dimon and have gotten what they deserve.