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Jim Hamilton tells us that the SEC & CFTC got together to talk about how to prevent derivatives traders from gaining ownership of new, and potentially all-powerful, derivatives clearinghouses. They are trying to create a regulatory version of the ownership restrictions that got left out of Dodd-Frank.
Footnoted looks at double-dip worry in SEC filings.
To commemorate the SEC’s public scolding of the credit rating agencies, Broc Romanek provides a vest-pocket history of section 21(a) reports.
From the NY Times – feeling sorry for Dick Fuld.
Mind the Gap
Here in Boston the rain has finally abated and we can see the sun again. That plus espresso has made me incrementally less grouchy. Further lightening my mood is a brief article in the Sunday New York Times (by Louise Story) that describes a difference of opinion among economists.
It seems that David Moss (Harvard) has discovered a correlation between economic collapses and a wide gap between rich and poor. No one has had time to figure out why. Increasing the complexity of the analysis is the fact that there is also a correlation between deregulation and crashes. The article examines this chicken-and-egg-and-another-egg problem.
Moss suggests that a destabilizing wealth gap is caused by deregulation, but Richard Freeman (also Harvard – has the NY Times lost it’s Chicago phone book?), also studying crashes and deregulation, has found crashes without wealth gaps. Freeman suggests that one of the ways super-rich people use their money is to change laws in their favor and thus a wealth gap is evidence not of deregulation, but of political corruption.
R Glenn Hubbard at Columbia (a local call) thinks the whole thing is nonsense – neither of those things causes economic collapses. He stops short of saying we should stop studying economics altogether.
Beta Test
I was recently talking to a friend about beta. Afterward, I spent some time poking around the internet looking for a simple description. I found interesting stuff, but nothing that separated backward-looking beta, from forward-looking investment strategy, and theory. Here is my humble attempt –
Beta is a measure of how volatile a stock was in comparison to some measure of the market as a whole, like the S&P 500. A stock with a high beta was more volatile than the market. Beta measures volatility relative to the market only – a company outperforming the market could have the same beta as a company on the way to the bottom. Joy Global (JOYG), for instance, with a beta of 2.17, saw its stock price go from $39 – $54 in the last year. Salesforce.com (CRM) had a lower beta, 1.78, but its stock price went up a lot more (from $51 – $112). Salesforce.com’s beta can be attributed to the relatively tamer ride they took compared to investors in Joy Global.
One is the beta-midpoint – a stock with a beta near one (like IBM – .73) moves with the market. A company with a sub-one beta is less affected by market fluctuations – AT&T has a beta of .07. For a vivid illustration, go to Google Finance and enter the stock of your choice and then click the radio button next to “S&P 500.” A red line representing the S&P 500 will be added to your chart. Beta is the correlation between the lines. If the red line moves and the blue line moves less, beta is below one. If the lines move in tandem, beta is one. If the blue line catches a cold when the red line sneezes, beta is above one. If the blue line ignores the red line entirely, beta is zero.
Beta is backward-looking, but it is used to predict the future. It is part of an asset-pricing model called CAPM. For more on how beta is used by investment managers see this post from the Hedge Fund Journal and this one from Money-Zine.com. Also, this list, from Seeking Alpha, of the stocks with the highest betas.
Meet the new GM
On the 18th, General Motors Company (“formed by the Department of the Treasury in 2009″) filed an S-1 registration statement for a so-far-unspecified amount of common stock. Morgan Stanley is the lead underwriter, and JP Morgan Securities is next in the list of syndicate members. This isn’t the first time Morgan has owned GM (JP Morgan and Morgan Stanley were the same company until Glass Steagall tore them asunder), and if the SEC hurries along the review process, the S-1 may be effective in time for the 100th anniversary of GM’s very first bailout.
William Crapo Durant organized the General Motors Company, (which the S-1 tactlessly refers to as “old GM”) in 1908, to buy Buick. Durant’s original plan had been to use JP Morgan’s money to buy every car company, but Morgan got cold feet so Durant went stag (Durant had the last laugh – in 1920 Morgan and du Pont bought 51% of GM from Durant for $47 million. “General Motors Control is Sold,” NY Times 11/23/20)
Durant quickly ran old GM aground, and in October of 1910 a “banker’s trust,” including the First National Bank of Boston and J&W Seligman, seized control. The bankers bought debt and equity and forced Durant into an advisory role. (“General Motors Notes,” NY Times 10/2/10)
Quick quiz – which quote is from 1910, and which is from 2010?
“with the funds obtained from the sale … the company will be in a position to pay off all of its indebtedness and be left in a strong position.”
“a strong balance sheet … combined with the automaker’s scale economies … should allow GM to grow along with the expanding … appetite for cars.”
Addending
A commenter hipped me to some private resources helping track our brave new world of campaign spending. First, this article about campaign spending by News Corp and, more importantly, Rick Hansen’s Election Law Blog.
Speechless
On Wednesday, in a New York Times op-ed, Scott Turow connected the Supreme Court’s Citizens United decision with the acquittal of Rod Blagojevich. Turow argues that Citizens United makes bribery the law of the land, so “who could fault a juror for … feeling that Blagojevich had been unfairly singled out?” To me this seems a tad hyperbolic, but things are changing (
Target and Best Buy have already exercised their newly-created rights. Opponents responded with satirical ditties), and they aren’t going to change back. So solidly are the Republicans behind Citizens United that they filibustered (and probably killed) the rather modest DISCLOSE Act on the spectacularly Orwellian grounds that disclosure of information is injurious to free speech.
All I Surveyed
Trolling the securities law blogosphere led me to a number of interesting posts to brighten your dull, dull day, including:
Something I’ve wanted to hear more about: what happens to corporate law when the government is a company’s controlling shareholder (from the Harvard Corporate Governance Blog)?
A fascinating post from the Deal Professor about how change comes to corporate dealmaking – including a brief history of the the material change clause.
Great post from the IDD Asset Securitization Report about how hard its going to be to find a regulatory replacement for credit ratings.
Westlaw Business Legal Currents on trends in o/d liability – containing improper use of the term “corporate veil.”
Basel III and Liquidity Ratios
Liquidity is a measure of how much cash a company has versus how much money it has borrowed. A company’s liquidity, or leverage, ratio is an indication of corporate stability (as in Lehman was leveraged 30/1 – meaning they had borrowed $30 for every $1 they had in the bank). Having cash on hand for a rainy day is seen as a way of ensuring that companies can weather stormy economic storms. Establishing the correct ratio is crucial – if the number is too low (2/1), the company won’t have any extra money to invest, but if the ratio is too high (30/1) the company has no safety net in the event it makes bad investments.
Regulators here and abroad have expressed their commitment to formulating new liquidity ratios to ensure the survivability of banks and other financial institutions should hard times once again call. But, if the travails of the Basel Committee on Banking Supervision (BCBS) are any indication, determining the right ratio, or even what goes on the top of the ratio, and what goes on the bottom, is proving an elusive goal.
In the wake of the financial crisis the BCBS released two policy papers – one on capital and one on liquidity – proposing revisions to the Basel II banking accord. These papers, commonly known as Basel III, established a way for determining a bank’s liquidity ratio. The capital paper narrowed the Basel II definition of Tier 1 capital and the liquidity paper indicated that a bank’s liquidity ratio be determined by dividing Tier 1 capital by debt. Basel III also created a Net Stable Funding rule requiring a bank’s available funding be equal to its required funding needs.
On July 26th, the BCBS Group of Governors and Heads of Supervision revised the December proposals, in response to comments and a quantitative impact study, and in the process upended the simple system devised in December.
The July revision eliminated the proposed Net Stable Funding rule. Although the BCBS reiterated their commitment to the “introduction of the NSFR as a longer term complement” to the liquidity ratio they admitted that the “NSFR calibration as set out in the December 2009 proposal needs to be modified.”
The use of Tier 1 capital as the numerator in the equation was also undermined. The BCBS averred that while there is “strong consensus to base the leverage ratio on the new definition of Tier 1 capital, the Committee will also track the impact of using total capital and tangible common equity.”
If You’re Cold …
There is an excellent article in the most recent Harper’s about how manipulation of the market in commodity futures led to a global food crisis. This, it appears, was also the fault of Goldman Sachs. The idea of cornering the wheat market has such an old-timey feel, I thought I would revisit some of the dusty corners of US financial history (sorry).
In 1889, Augustus Heinze graduated from Columbia and moved from Brooklyn to Butte, Montana. After a few years working in the mining industry he organized a company called United Copper. Instead of prospecting, Heinze used his knowledge of Montana mining law to wrest control of a number of existing mines away from Amalgamated Copper (later Anaconda). In 1906, he sold his interest in United Copper (UC) to Amalgamated and moved back to New York, a rich man.
The following year, Heinze’s younger brother Otto, a banker who owned a small piece of UC, tried to gain control of the company by means of a creeping tender. Otto’s buying drove up the price. Tender offers were entirely unregulated at the time, so other investors had no idea why shares of UC had started to increase in value, but that didn’t prevent them from piling on. Shortly, UC was too expensive for Otto to buy, and he was forced to sell the shares he’d acquired to cover his margin calls. UC’s price collapsed. Other speculators, caught by surprise, sold their UC shares (and other shares as well) to cover their losses.
The whole market crashed, and from the banking system an ominous creaking was heard. A bank that had backed Otto’s bid collapsed and investors began looking askance at other banks associated with the Heinze brothers – particularly, the third-largest bank in the US: Knickerbocker Trust. As Knickerbocker teetered, JP Morgan rode to the rescue. After a few hours in Morgan’s “black library” his fellow bankers agreed to bail out Knickerbocker and the banking system was saved.
The failed attempt to corner United Copper, which became known as the “Bloody Angle” (a popular sobriquet in the post- Civil War period), and the subsequent “Banker’s Panic” ruined the Heinze brothers and led to the creation, in 1911, of US’ first central bank.
Return of the Rocket Scientists
The Washington Post offers a glimpse of what the SEC’s newest Division (Risk, Strategy and Financial Innovation) does. Like the Wall Street quants of old, the new Division uses math and science to analyze huge masses of data, but instead of trying to maximize the earning of money (or hide the losing of same), they’re looking for naughty behavior. The SEC quants aren’t merely reminiscent of the quants of old, they *are* the quants of old. The article focuses on Gregg Berman, formerly of Princeton and RiskMetrics, and Rick Bookstaber, formerly of MIT and Salomon Brothers.
The SEC had better hurry, because barring an attack of conscience, the quants may soon have pecuniary incentives to return to the dark side. CompliancEx reports that Wall Street is hiring again.
