Live-Blogging the Congressional Oversight Panel Hearing

I'm just sitting down to live-blog, intermittently, the hearing of the TARP Congressional Oversight Panel, or COP. This hearing is about regulatory reform, BTW, not the panel's ongoing inquiry into what on earth Hank Paulson has been up to.

This isn't my first try at live-blogging a hearing, but the soporific effect of droning Congressmen has foiled my past attempts. However, this isn't a Congressional hearing, so perhaps I can stay awake.

Chair Elizabeth Warren gave her introduction, and now the panel members are each giving statements.

9:08 am - Damn, I forgot there's a Congressman on the COP - Republican Jeb Hensarling; he's speaking now. Must try not to fall asleep. I think he's warning against an overreaction that might lead to overregulation. Thanks, Jeb, but I'm going to worry about that one later.

Damon Silvers of AFL-CIO followed, but my toast was popping up so I missed him.

9:19 am - Former Senator John Sununu just made a good point - that it's not just what regulations you have, but how those regulations operate in practice. I feel like people don't say this often enough.

9:24 am - Richard Neiman, NY State Banking Supervisor: Not much of interest. Sorry, Mr. Neiman.

Now cometh the witnesses: (here's the witness list).

9:29 am - Gene Dodaro, acting head of the GAO: Regulatory system is outdated, has gaps, etc. New products, like credit default swaps, aren't sufficiently regulated. But we must avoid "unanticipated consequences" of any changes we make. (Well, Gene, how does one take steps ahead of time to avoid unanticipated consequences? Do you see any flaw in that concept?) He notes that no one regulator is charged with looking at risks across the whole system. Yes indeedy, that's been a problem.

9:46 am - Hensarling says prosecutors are focused on terrorism and don't investigate and prosecute fraud these days unless it's earth-shaking. An interesting point - is he right, and is this an underestimated factor in the meltdown?

9:48 am - Dodaro has what I'd swear is a classic New York accent - and a face to match it - even though Wikipedia says he grew up in Pennsylvania. He really ought to be starring on Law and Order. Oops, my attention is wandering. Detailed Q&As going on about pros and cons of different federal regulatory structures, involvement of states, etc. State regulators, says Dodaro, give you "eyes and ears on the ground" so we should keep them in place.

10:05 - Second panel is seated. Warren just made a comment about having trouble with people's names and this being like a "confusing dinner party." No wonder I'm so hungry.

10:07 - Sarah Bloom, Commissioner of the Maryland Office of Financial Regulation. Her not-so-thinly-veiled message seems to be that the state regulators have been doing their jobs, but the feds have not. From her state "foxhole," she says, she's watched "classic regulatory capture" take over in Washington. Go, Sarah. Oooh, she even managed to mention Katrina and FEMA. She claims the states were on top of subprime lending and saw the flaws of the Basel capital accord (you know, that brilliant decision to let the banks calculate their own risk and decide how much capital they needed).

10:13 - Joel Seligman, President of the University of Rochester and serious securities law guru in his past life: Lays out his broad principles for a new system, including: (1) let's make a clear distinction between emergency moves and long-term restructuring, and (2) financial regulation should be comprehensive, including all products, folding in insurance companies (AIG, anyone?), credit rating firms, investment advisers. We have a "partial" regulatory system at the moment. In his new dream system, the Fed would be at the top. He also mentions "private rights of action" as being part of the regulatory structure. This means lawsuits, by those dreaded trial lawyers. Wow, I didn't expect that one, but I kind of like it.

10:19 - Robert Schiller, Yale economist: Brags that he's written 2 books about this subject, and seems to be implying "why haven't you guys read these already?" He wants to "democratize finance." Government should subsidize personal financial advice and financial education. He agrees with Elizabeth Warren's idea of a "Financial Products Safety Commission." We need to improve risk management. He wants to create "continuous workout mortgages;" i.e., in recessions the mortgage payment and principal would automatically adjust down. Good luck with that one, Bob. Have a nice drive on Utopia Parkway.

10:22 - Joseph Stiglitz, Columbia economics professor and Nobel laureate: This bailout, and past bailouts, reflect the failure of our system to meet basic requirements, like evaluating creditworthiness. In fact, America's financial system is pretty much a failure overall -- lack of transparency, flawed incentive structures that foster risky, short-term behavior. Good regulation can attract capital and encourage creativity. Derivatives should be approved by that wonderful Financial Products Safety Commission that could exist in the future. TARP has failed because there's been no regulatory reform accompanying it. We could have used $700 billion to create a new institution - huh? sounds intriguing but he's not explaining it. I kind of expected more from Nobel Prize Guy.

10:30 - Marc Summerlin, Managing Director at the Lindsey Group (who is this person? I must look him up): Fed should take a more active role in preventing bubbles and mitigating boom/bust cycles, and in fact the Federal Reserve Act says so. (I'd like to hear more about that part.) Fed has created "a bias toward overvalued assets." Buying a house with no down payment "is not home ownership; it is renting with risk." Nice point. Also, binding leverage ratios work and we should have more of them, he says.

10:37 - Peter Wallison from the American Enterprise Institute: Regulation itself introduces moral hazard, because people think the government is on top of things. There is no policy reason why the government should take responsibility for preventing business failures - let 'em fail. Regulation hasn't been working, so why have more of it? (Gee, you'd think this guy was from the American Enterprise Institute or something.) It is "a very bad idea" to empower an agency to identify "too big to fail" institutions because you end up with numerous Fannies and Freddies that have a competitive advantage over purely private firms. So what does he want to do? Require more transparency about the risks that firms are taking, and pay more attention to short selling and hedge funds.

Question period starts: Elizabeth Warren goes directly to Wallison's argument that regulation hasn't worked. She refers to the "regulatory capture" that state regulator Sarah Raskin described and asks him: isn't it really "non-regulation regulation" that has failed here?

Wallison (who still believes in oxymornons like market discipline) answers that creditors, not regulators, are the ones that can effectively "regulate," as long as there's transparency. Warren invites Raskin to respond. She says she believes regulation has worked, again praising state regulators. I hope she's right, though I'd feel better if she weren't a state regulator who fears being legislated out of existence.

Seligman comments that "effective regulation can increase confidence." But "non-regulation regulation" can undermine that confidence. (Will the oxymoron "non-regulation regulation" spread and become the new catch phrase for policy geeks?)

Hensarling, being a good Republican, apparently woke up when Wallison mentioned Fannie and Freddie; he asks for comments on the role of the GSEs. Summerlin says Fannie/Freddie had an incentive problem - they could "privatize profits and socialize losses." So the government backing made things worse, right? asks Hensarling. Yeah, I guess, says Summerlin.

Silvers from the AFL-CIO, who's been strangely quiet, asks Seligman about regulatory consolidation. Seligman talks about balancing the useful expertise of separate regulators (e.g., for securities and commodities) against the danger of regulatory arbitrage.

Silvers asks Raskin how Fannie/Freddie mortgages have performed versus purely private sector mortgages. She doesn't really answer the question.

Silvers asks Stiglitz what he thinks of the Fed as a regulator. Stiglitz says the Fed was " too easily captured in the spirit of the bubble." It must become more explicit about its mandate, and that must be to create financial stability, not just to monitor inflation. And it should be more "representative." In Sweden, he notes, labor has representation at the central bank. I'm proud of the American Enterprise guy for not immediately jumping up and calling Stiglitz a socialist just for mentioning Sweden.

Gotta go now - you're on your own.

Financial Oxymoron of the Year: The Envelope, Please

OK, it's that time again. (Or maybe it was that time a few days ago, but whatever.) Here comes Proxyland's second annual, and slightly renamed, Financial Oxymoron of the Year Award.

Whatever you might say about 2008 - and you've probably said it - this was a great year for oxymorons. Our 2007 co-winners - risk management and financial engineering - pulled a Brett Favre and returned to competition. As the subprime market unraveled early in the year, mortgage-backed securities looked like the oxymoron to beat. In September, Fannie and Freddie's implied guarantee edged ahead.

As the year wore on, analysts warned of an Oxymoron Bubble. Nearly every two-word phrase on the business page seemed to qualify. To wit:

financial services
financial system
market discipline
government oversight
business judgment
free market

Let's throw in Federal Reserve. And is it too soon to add modern civilization? OMG, I need to get a grip.

No way can I decide, so I'm just going to treat these cute oxymorons like a bunch of Wall Street traders at bonus time. In other words, everyone wins! But if you twist my arm to pick one, I'd probably go with market discipline, which a certain Mr. Greenspan once called "the first line of regulatory defense in protecting the safety and soundness of the banking system."

Oh, and Happy New Year --which is not, as of yet, an oxymoron.


photo credit: photoshoptalent.com

Big and Fuzzy Fannie and Freddie

So I woke up on this beautiful day and decided to post on the GSE bailout, even though it’s already inspired so much commentary that one could read for the collective lifetimes of the Presidential/VP candidates’ children (that's 12 kids for the McCain-Palin ticket alone) and still not get through it all.

The federal government’s "implied guarantee” of Fannie and Freddie has turned out to be one stupendously expensive oxymoron.

At a 2004 Senate Banking Committee hearing, a law professor guy (and former assistant something-or-other in the Clinton Treasury Department) said it quite nicely:

The GSEs play an extraordinarily successful double game. They emphatically deny that they have any formal, legally enforceable government backing... At the same time, they work to reinforce the market perception of implicit government backing. In effect, the GSEs tell Congress and the news media, ‘Don’t worry, the government is not on the hook’ -- and then turn around and tell Wall Street, ‘Don’t worry, the government really is on the hook.

As of the past weekend, the game is up. The winner? China. Might as well get used to that, I suppose.

Soup of the Day

Treasury Secretary Paulson's fun-filled Blueprint for a Modernized Regulatory Structure proposes an “optimal” regulatory system that would populate the world with its offspring: FIDIs, PFRA, CBRA, FFSPs, and so forth. As the debate over financial services regulation drags on, everyone now gets to toss around these new acronyms along with the many already in use, thus congealing our so-called regulatory alphabet soup into a big old soggy pasta salad.

Major regulatory overhaul being the stuff of distant dreams, the only new agency Paulson might be serious about creating is the MOC (Mortgage Origination Commission), listed as one of the Blueprint’s “short-term” goals. Through the MOC, federal officials would oversee state licensing and regulation of folks involved in the mortgage origination process. Which inspires me to propose the following acronym: HINFAIFWWTODIIOTSD, or Hey, Inventing New Federal Agencies is Fun When We’re the Ones Doing It Instead of Those Silly Democrats.

It’s odd to see this free market-loving administration dream up a new agency to regulate behavior that “market discipline” (normally an oxymoron here) may belatedly curb on its own. After all, Wall Street is facing the true risks of securitizing crappy loans, rating agencies are unlikely to bestow happy ratings on crappy mortgage-backed securities, bond insurers can longer backstop this crap, and once-beguiled MBS buyers are ready to beat the crap out of everyone involved.

So won't it be pretty tough for rotten mortgages to find shiny new securitized products they can crawl into and contaminate? And, finding themselves unwanted, might these substandard loans not just slither away and leave us all alone?

Gosh, it’s not like me to be so optimistic. Especially on a day when Reuters cheerily reported that UBS's $19 billion subprime-related writedown had spurred a “writedown relief rally” on the FTSE, and this wasn’t an April Fool’s spoof.

Setting an Example

What a difference an e.g. makes.

In the risk factors section of its 2006 10-K, filed about a year ago, Morgan Stanley included what then seemed a snoreworthy statement about its risk management practices: “Some of our methods of managing risk are based upon our use of observed historical market behavior. As a result, these methods may not predict future risk exposures, which could be significantly greater than the historical measures indicate.”

The same words appeared in Morgan’s 2007 10-K, filed last week, but the firm tacked on at the end this parenthetical: “(e.g., recent events in the U.S. subprime residential mortgage market).”

I’m kind of an example lover, myself; I find many concepts easier to understand when someone gives me a “for instance.” So thank you, subprime meltdown, for serving as a “for instance” that has added immeasurably to the world’s understanding of the art of risk management. (Risk management was, of course, named Oxymoron of the Year here at Proxyland.)

The crash of subprime-linked debt, Morgan explains in a spanky new section in this year's 10-K, has been “among the most significant market shocks ever realized… Events of this magnitude are outside of the loss estimates forecast by VaR models and are more commonly measured by alternative risk measures such as stress tests and scenario analyses. However, the market moves associated with the subprime events of 2007 were significantly greater than those included in the Company's stress tests and scenario analyses at that time.”

So we’ve now learned - by example - that the models, stress tests and scenario analyses financial firms use to measure risk are, well, models, stress tests and scenario analyses. Such educated guesses may miss the mark even when made by highly credentialed, nicely dressed folks like those who work at Morgan Stanley. Morgan's risk managers perhaps envisioned a kinder world than the one we live in, a place where mortgages would be repaid even when borrowers lacked the means to make payments. In that world, Amy Winehouse never smoked crack, Kate Hudson did not wear this dress, and my plumber did NOT charge me $350 to replace a stupid bathroom sink. Just for instance.

And the Winner Is...

You and I, dear readers, live life on a calendar year basis and not some weird-ass corporate fiscal year. So the time has come to name this blog's Oxymoron of the Year for 2007. No, I didn’t do this last year.

Had 2007 been a normal year in Proxyland (although normal here looks like the “n” in snafu), our winner would have been Proxy Access, a provocative idea that suffered a premature demise at the capable hands of SEC Chairman Cox. But this is no ordinary time, it seems. Whether you call it the credit calamity, subprime stew or mortgage mishegass, we’re looking at one hell of an ugly broken nail on the invisible hand that's supposed to control the free market. And no manicurist in sight.

This is serious stuff, so I'm going to declare a tie between Risk Management (discussed here) and Financial Engineering.

Take your pick, though the latter sounds more jolly, evoking a video game in which you send bits of risk zinging around the globe and wait for them to explode. And in the meantime you take your own credit-linked stash and, as some wag says in that cute poem you've probably seen, “mark to myth.”

Whichever oxymoron best captures the wisdom of the Wall Street sages who've made fortunes in structured finance, the moral is clear: Karma may not be a boomerang, but risk sure is.

A happy and prosperous New Year to all, come what may.

Where Have All the Profits Gone?

I’m just so tickled by this sentence in the Morgan Stanley (MS) press release yesterday: “Morgan Stanley, with the exception of its mortgage related businesses, delivered exceptionally strong performance this year.”

Yes, and with the exception of my face, hair and body, I look exactly like Angelina Jolie.

When some trades done by a single desk in a single quarter can lead - oops - to a $9 billion writedown (causing Morgan to join Merrill and Citi in the Mile High Mortgage-Related Losses Club), it’s time to add “risk management” to our list of oxymorons.

According to Morgan’s 2006 proxy, one of the jobs of its Audit Committee, and rightfully so, is to oversee the “integrity” of the firm’s risk management. It would be goofy to expect independent directors to take out their calculators and second-guess Morgan’s trading risk assessments, but maybe they could have given a bit more thought to the firm's reporting structure, because you don't need math for that.

Morgan’s risk managers apparently reported to the lately departed Zoe Cruz, who oversaw the firm’s trading as its Co-President. As Pete Seeger sang in the 60s, when will we ever learn? The Street long ago rescued compliance officers and in-house lawyers from so-called "business" reporting lines, and for good reason: Try telling a trader who is also your boss that, sorry, her latest brilliant bonus-driving deal is off because you, the earnest lawyer, have spotted a wee regulatory iceberg on the horizon. Risk managers, like lawyers, sometimes need to be spoilsports or worrywarts; these are tough roles to play, and even tougher when one is reporting to the head of the profit-making machine.

The morning after announcing the first quarterly loss in its 72-year lifespan, the usually well-groomed Morgan Stanley is looking a bit haggard. Of course, when Angelina is 72 she may not look so great either.

House Whine

There ought to be a website called BoreYouTube, reserved for items like this video of the hearings held last week by Congressman Henry Waxman to explore conflicts of interest in the world of executive compensation consulting. Having made it through the opening statements before dozing off, we remain convinced this is a non-scandal -- not because we believe the Towers Perrins of the world are truly objective, but because the term “independent compensation consultant” has long been on Proxyland's oxymoron list.

As we’ve argued here before, the parallel Mr. Waxman draws between independent compensation consultants and independent auditors is rather weak, in the absence of some regime that makes consultants legally accountable to shareholders, the SEC, or anyone else. Also, companies don't have to use compensation consultants, which makes these folks less like auditors and more like hair stylists, hired to make their clients look and feel good. (The hair stylist bit is our attempt to avoid repeating our friend Charles Munger’s comparison of compensation consultants to a different service profession.)

The Waxman Theory – that consultants who perform other lucrative jobs for the CEO won't give objective compensation advice – makes sense, but we believe Mr. Waxman is digging into a side dish while neglecting the main course. Consultants’ conflicts, like mashed potatoes, are easy to munch on, but Waxman should grab his knife and saw into the gristly steak of director independence. (If we had an editor, he or she would surely have axed this lame metaphor, but we’re sticking with it.)

If the directors who make up compensation committees truly had an independent mindset, they would (1) make absolutely clear to consultants that independent directors, not management, are the boss of them (2) insist consultants be paid only from a separate and generous compensation committee budget, and (3) employ a network of secret caddy-informants in case the CEO tries to tee off with anyone from the consulting firm.

Loading proxy statements with disclosure about compensation consultant conflicts would merely assign to investors another watchdog job that directors ought to be doing themselves. And we all have better things to do, like finally getting around to watching the famous “I Feel Pretty” video that shows a lovefest among John Edwards, his hair stylist, and his hair.

Pretty Please

The summer wasn't bad, thank you. We got some rest and managed to avoid most of the season’s global warming hot spots.

Unlike us, the Delaware Court of Chancery worked hard over the past few months. One of its summer projects was this decision in the InfoUSA Inc. litigation, commenced by spoilsport shareholders displeased by Chairman/CEO Vinod Gupta’s dedication to the proposition that the company’s money is there for his enjoyment.

The court's opinion dealt with a concept known as “demand futility.” Demand futility has nothing whatsoever to do with your attempts to convince the person manning the DMV window to renew your driver's license. It refers to the fact that, in order for shareholders to start a lawsuit in the form of a “derivative action” (an important tool for activists) they must persuade a judge it would be futile to demand that the directors sue themselves instead.

Believe it or not, establishing futility can be quite difficult. Shareholders generally don't have a right to discovery at this stage, yet must come up with detailed and specific allegations that a majority of the directors are biased (because, say, Mr. Gupta has been giving them free office space) or that the board has behaved so badly it might not be protected by the very forgiving standards of the “business judgment” rule. (Yes, that one is on the Proxyland oxymoron list.)

In this case the plaintiffs succeeded. The Honorable William B. Chandler III, after making gallant efforts to excuse the board’s behavior, admitted the company's directors might have motivation to discourage a lawsuit. Among other things, they'd approved a 10-K that said the company had paid a Gupta-owned entity for “usage of aircraft,” despite being informed by the audit committee chair that Mr. Gupta had spent much of the dough on personal residences and a yacht. (The boat's all-female crew merited a fascinating footnote in the opinion, as did the company’s interactions with a certain former President.)

Very very gradually, the esteemed Delaware courts are starting to accept that when shareholders ask, “hey, is it OK if we sue you?” some boards will say “no” for less than noble reasons.

But at least shareholders receive an answer. That’s more than you get at the DMV, where after failing for days to make eye contact with anyone, you become convinced you do not exist and therefore have no need for a driver’s license, so you slink away and donate your car to charity. Perhaps we'll solve global warming after all.

It's Unanimous

Another day, another oxymoron. Here's a new one on us: "one-person committee."

CDW Corporation (CDWC) seems to be taking the concept of "independent director" way too literally. It filed an 8-K today reporting that its by-laws now allow its board of directors to create committees with only one member. I wasn’t sure I was getting this right, so I checked the by-law amendments and sure enough, where it used to say board committees must have two or more directors, it now says one will do nicely, thank you.

According to the company, this is a perfectly fine thing to do under the laws of Illinois, where CDW is incorporated. With all due respect to the good people of the Illinois legislature (who brought us Denny Hastert), the good people who brought us the American Heritage Dictionary say a committee is "a group of people officially delegated to perform a function." A group.

Isn't a one-person committee basically just someone sitting down, thinking things over and then saying to him or herself, "OK, I guess I’ll do X?" I sure hope the corporate secretary can read minds, because otherwise it’s going to be awfully tough to record the minutes of the meeting.

CDW seems like a really nice corporation. They’ve made Fortune Magazine’s "100 best companies to work for" list for 8 straight years, they give lots to charity, and in the summer their employees (called "coworkers") get free ice cream once a week.

Nevertheless, I move that one-person committees are kinda goofy. And I second the motion, too.

Date With Destiny

Apparently SEC Chairman Cox has restrained his impulse to administer a swift atomic wedgie to whiny shareholders who don’t like how corporate directors are "elected." He's postponed Wednesday’s public meeting on the AFSCME vs. AIG case (discussed here in a recent post).

The SEC will now enter deep meditation or something, and by December 13 – the new meeting date – it might decide the question the judge threw at them: Can shareholders hitch a ride on the company's proxy statement and vote themselves the power to add their own director nominees to the ballot? In the meantime, this quaint notion - known as "proxy access" - shall remain on our list of oxymorons.

The forces for and against proxy access agree on one thing - if it ever happens it will sweep Proxyland like a tsunami, flooding golf courses and private runways alike. In other words, this one really matters. When former SEC Chairman William Donaldson bravely explored the idea a few years ago, he was forced to back down in the face of overwhelming evidence that allowing shareholders to nominate directors would bring about the end of the world.

Thank goodness he came to his senses, because otherwise we’d probably have some wackjob totalitarian dictator waving nuclear weapons at us right now.

Democracy on the March?

In the heading to this site, I refer to “other oxymorons.”

Here’s one of them: “Shareholder Democracy.”

Most companies still operate under plurality voting. This is a delightful system in which 99+ percent of the shareholders can show their hatred for a director by “withholding” their votes (which in Proxyland is the closest they can get to voting against someone), but if one shareholder feels sorry for the guy and votes for him, he's re-elected. Really. Trust me on this. Or trust some law firm.

A recent case, AFSCME vs. AIG, is forcing the SEC to rethink the following question: Can a shareholder force management to include in the proxy (i.e. put to a shareholder vote) proposals to change company by-laws and make the election process more democratic? The SEC looked at its rules and said no, AIG's management didn't have to do that. The court disagreed, basing its decision on the SEC's past interpretations of its own rules. Which left the SEC free to re-interpret them.

This is quite a big deal, really. If shareholders get the power to change how directors are elected, the concept of shareholder democracy might become less oxymoronic. Who knows, this could improve corporate governance enough to put this blog out of business. (Uh, "business" should be in quotes there.)

The SEC will consider its options at an open meeting on October 18, which happens to be the birthday of one Jesse Helms, known for engaging in some rather creative election practices of his own.