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So busy is the SEC these days chasing down scoundrels, boodlers, and yeggs, it doesn’t appear to have time to make rules. My quick review of the last couple of weeks of the What’s New page turns up one alleged scam after another.
My eye was caught by the case of Sean David Morton, accused of overstating his ability to predict what the foreign-exchange market will do, as well as diverting to the “Prophecy Research Institute” a whack of money investors had asked him to invest in said market.
Morton has taken the whole thing personally. In 2009 he sued (under RICO) a senior SEC lawyer from New York named Bennett Ellenbogen (Ellenbogen also teaches at Cardozo and almost won the New Yorker cartoon caption contest), accusing Ellenbogen of concocting the case against him so that Ellenbogen could get a free trip to California and “eat In and Out Burgers at the taxpayers’ expense.” The trial court, demonstrating a limited appetite for sarcastic pleadings, dismissed the suit. Morton appealed to the Ninth Circuit, but the Ninth Circuit demurred calling the appeal “so insubstantial as not to justify further proceedings.”
Self-Selected Group
The SEC warned former Madoff “investors” to beware of scam websites seeking to defraud them again. While it can be argued that Madoff’s victims have already been proved gullible, it is also true that Madoff already stole all their money. One wonders what these scammers were hoping to scam. A home-cooked meal?
Volcker Located
Many thanks to Steven Frankenstein for pointing out that the Treasury had quietly slipped the draft “Volcker Rule” bill onto its list of proposed legislation. How’s that for transparency?
That’s Not What I Meant!
I went to art school in Providence, Rhode Island. Our nearest academic neighbor was Brown University and as a result, some of us shacked up with our more academically inclined neighbors. My friend Don, for instance, lived with a semiotics major. Once we found out what semiotics meant, us creative types were incensed! Who were these eggheads to tell us that our work wasn’t necessarily about what we said it was about, or worse, that it didn’t even matter what *we* thought it was about!
Thus, my relationship with poststructuralism has always been a bit adversarial (poststructuralism hasn’t noticed). So, I was interested to bark my shin upon “A Poststructuralist Analysis of the Legal Research Process,” (thank you HeinOnline) in a 1992 Law Library Journal (Farmer, 85 Law Libr J 391, 1992 also, the response). Reading the old poststructuralist arguments really took me back – to a simpler time when Ronald Reagan was President and Madonna was on the radio. The author’s point (not that it matters – SORRY – I am so full of cheap shots these days) is that legal research is mired in the positivist idea of finding the true and correct answer. That made sense to me for a while and then I started to think that for everyone except the current Supreme Court, legal research and interpretation are the original poststructuralist project.
Constitutional law is probably the best example, and I will refrain from embarking on a long excursion into constitutional law because you don’t have to go much further than Brown v. Board (349 US 294) to see that what the authors of the Constitution meant isn’t that important in Constitutional law – they were a bunch of white slave-owners and they died 200 years ago. Did they really think that racial discrimination in public education was unconstitutional?
We Have Seen the Future(s)
Once, in San Francisco, I saw a guy (long hair, flip flops) wearing a t-shirt with “Google is SkyNet” written on it. For those not up on their terminator-ania, SkyNet is the computer system that runs amok and starts a nuclear war, necessitating four sequels-worth of to-ing and fro-ing through time. The plot of all three terminator movies is driven by our heros trying to destroy a big computer before it ends the world. The first movie came out in 1984 (when companies had UnNecessary CapitaliZations in their names) and the second clanked and whistled into theatres in 1991, and in between, a real, giant computer system almost destroyed the financial system.
Portfolio insurance, devised by two UC Berkeley finance professors, works on the idea that an institution with a large, diversified portfolio can hedge its exposure to market downturns by engaging in a little time travel – in the stock index futures market. Thus, if your portfolio is so large that it represents the whole stock market, you can take the opposite position by trading stock index futures. The trading is done by computers, using Black-Scholes and other options-pricing arcana, to decide when to buy and sell (this is called “dynamic hedging”).
LOR, the first portfolio insurer (and the creation of those finance professors I mentioned), was organized in 1980. The company was so successful that it soon had imitators and by 1987, the three largest portfolio insurers were “insuring” $60 billion in investments. I put insuring in quotes because portfolio insurance isn’t really insurance – it’s an investment strategy (hello, FTC!) and in October of 1987, the “insured” discovered the negating power of those quotation marks.
In October of 1987, computer trading converted a market downturn into the most severe one-week decline in the history of US stock markets. In mid-October of 1987 there were a couple of gloomy economic indicators – a high trade deficit, a proposed tax law that made a number of pending mergers unprofitable – and the stock market started to decline. Eventually, the losses told the portfolio insurance computers to start selling stock index futures and because they were all using the same strategy, they all started selling at the same time – “on October 19, sell programs by three portfolio insurers accounted for just under $2 billion in the stock market; in the futures market three portfolio insurers accounted for the equivalent in value of $2.8 billion in stock.” So said The Report of the Presidential Task Force on Market Mechanisms in its after-action report (known as the “Brady Report”). Other computers, belonging to arbitrage traders, noted the price difference between the stock market and the futures market and started doing a little automated trading of their own.
The Brady Report’s conclusion was that the portfolio insurers, et al, failed to realize that “from an economic viewpoint, what have traditionally been seen as separate markets – are in fact one market.” Thus, a price drop in one market is quickly transmitted to the other. “As the data … make clear, the market’s break was exacerbated by the failure of institutions employing portfolio insurance strategies to understand that the markets in which various instruments trade are economically linked.”
For $6.95 you can buy the HBR case study where the founders of LOR try to decide what to do next with their business.
Also, just a quick mention of the fabulous and wonderful Treasury Library Consortium on archive.org. An expanding wealth of great information!
Feelin’ Dirty
I don’t have access to Westlaw anymore. So these days, through my membership at the Social Law Library, I have been rediscovering the myriad joys of HeinOnline. Yesterday, I stumbled upon an article from a 1982 Law Library Journal titled Research in Securities Regulation: access to sources of the law (75 Law Libr. J. 98, 1982) by Mark A. Sargent and Emily R. Greenberg.
You’d think an article of such advanced vintage would be mostly of historical interest (and prurient, Mark Sargent recently resigned as Dean of the Villanova law school in a prostitution scandal), but that isn’t the case. The first five pages are a great introduction to securities law research and starting on page 109 there’s a guide to using the CCH Securities Law Reporter (if you’re doing securities research and not using the CCH, you’re wasting your client’s money). Also, aside from a weird tendency to transpose the first initials of authors, the treatise section is still useful. Many of the books mentioned, Takeovers and Freezeouts (by Ertie Lipton), and Securities Fraud and Commodities Fraud, by Balan Lowenberg and Alewis Lowenfels for instance, are still in print. Sorry – that was such a cheap shot. I feel dirty.
Closed Doors
Good morning, librarian! Unless something has changed, this morning you will still won’t be able to find the new version of the Senate’s financial reform bill (promised by the Wall Street Journal on Tuesday morning). Last time I checked (11pm, March 4th) the Senate Banking Committee was still trying to hash out the details.
Wait! It gets better! According to Reuters, the administration has prepared some kind of draft legislation that would put into place elements of the so-called Volcker Rule. This document has also failed to surface. If you’d like the see the latest, I recommend avoiding the page marked “the latest” on financialstability.gov
OpenCongress.org has a good summary of the documents that have been made public. They’re mostly from November. You weren’t holding your breath, were you?
SEC Open Meeting Report – quotes
The Schapiro SEC is enamored of coining new terms and the last open meeting was no exception. Thus my profligate use of quotation marks in the post that follows.
At last week’s open meeting, the SEC adopted one of the “alternative” uptick rule proposals. For those who can’t remember back to April, when these rules were floated – the old, non-alternative uptick rule forbade short selling on a falling stock – you know, like that cartoon where Yosemite Sam goes off the end of a diving board and Bugs Bunny hands him an anvil? The old uptick, repealed under Chris Cox, could potentially have slowed the bank runs that destroyed Bear Stearns and Lehman Brothers. The new, alternative uptick rule (Rule 201) has a “circuit breaker” that cuts off short selling, for the rest of the day, if a stock’s price falls 10%. Exchanges have six months to adopt rules implementing 201. Click here for more.
Also discussed, but not made public, was a “Work Plan” for studying “convergence.” Convergence is what happens when the US starts using international accounting standards. Apparently, in 2011 the SEC is going to decide whether convergence is a good idea. The Work Plan is supposed to get the agency to the point where they can make and intelligent decision (always a good thing). Click here for more.
Superlatives
A librarian at Harvard Business School mentioned to me that she has often found pre-SEC prospectuses in old newspapers. “Are these notices like tombstones?” I naively inquired – she sent me a sample. Wow. Even with the advent of the Free Writing Prospectus we still have far to go before we’re back in the day of: “the best investment ever offered to the American public!” – that would be the American De Forest Wireless Russo-Japanese War News Service, pitched on June 16, 1904 in the New York Daily Tribune. Another iron-clad money maker was The Mexican Plantation Co. The company’s underwriter, W.E. Pentz & Co., took out an ad in the January 1, 1899 New York Daily Tribune to proclaim that “we have carefully investigated this business and recommend it as … the finest we have ever handled.” For those still harboring doubts, Pentz & Co. offered a more scientific assessment of the Plantation Co.’s prospects, “other companies doing practically the same business have been … declaring dividends from 100 to 300 per cent per annum.” Where’s my checkbook?
To see more, check Library of Congress historical newspaper collection:
http://chroniclingamerica.loc.gov/search/pages/
The Past – Still a Foreign Country
Last week, my foray into economic research about the 1920’s real estate market led me to NBER Working Paper 15573, “Lessons From the Great American Real Estate Boom and Bust of the 1920’s,” by Eugene N. White, a particularly florid example of the limits of using the past to understand the present. White (like Goetzmann) observes that the bubble in US real estate prices that popped in 1926 shared many similarities with the 2008 real estate market crash. White also notes that although the 1926 real estate market crash was bad for the real estate sector, it didn’t take the banking system down with it. So, he concludes, if we can isolate the differences between 1926 and 2008, we can figure out why the 2008 real estate market collapse also took down the US banking system. Then, he lists the purported causes of the 2008 collapse, eliminates the factors not present in 1926, (FDIC insurance and a public policy of encouraging home ownership) and voila!
Political axe grinding aside, the paper contains a trove of interesting information about the 1920’s real estate market. One of the entities that White unearths is yet another multi-tasking real estate thingy called a private mortgage insurance company (specialization appears to be one of the great advancements of post-Depression finance). Private mortgage insurers offered default insurance, but they also acted as mortgage originators and sponsors of a variety of real estate securities (including “participation certificates” backed by mortgage pools).
The private mortgage insurance business was invented in New York in the late 19th century and thanks to what appears to have been complete regulatory capture, these companies convinced the New York legislature to legalize and gradually deregulate their industry between 1904 and 1924. The business grew from one company in 1887 (Title Guarantee Company of Rochester) to 50 by 1929. In the period following the crash of 1929 these companies began going out of business. The “Alger Report” in 1934 portrayed the industry as essentially criminal and New York outlawed default insurance in 1938.
Interestingly, although the PMI industry was under no obligation to align their cash reserves with the value of mortgages they insured, they appear to have done so. Table 6 in White’s paper (using data derived from the Alger Report) shows a consistent 10-to-1 ratio of insured debt-to-assets that doesn’t change when new companies enter the business or as real estate values decline. I have trouble squaring this careful maintenance of capital ratios with the contemporaneous portrayal of the industry as shady, or worse. Robert Moses, for instance, resigned from the board of the New York Title Insurance Company and then wrote to the New York State Insurance Commissioner to complain. He had no desire, he wrote, “to have my name used to make a bad thing look good.” (Moses Denounces the Alger Report, New York Times, October 9, 1934)
For More See:
Herzog, History of Mortgage Finance With and Emphasis on Mortgage Insurance (2009)
Canner, Private Mortgage Insurance, 80 Fed Res Bull 883 (1994)
Browne, The Private Mortgage Industry, The Thrift Industry, and the Secondary Mortgage Market, 12 Akron L Rev 631 (1978-1979)
Johnson, Regulation of Private Mortgage Insurance, C.P.C.U. Annals 92 (1974)
Alger, Report to His Excellency Herbert H. Lehman, Governor of New York (1934)
Chapter 543, Laws of New York, 1904
Chapter 525, Laws of New York, 1911
