On 02/05/2008, I authored a post “Benevolent Dictators Make Good Government”. Examples are King David – Israel – (1010 BC –970 B.C.) in ancient times and General Douglas McArthur – Japan – (1945 –1947) in modern times. I started musing about what I would do if I were absolute dictator of the United States to fast track our country back to a position of greatness and prosperity. Therefore I am submitting a series of posts to PA Pundits (many controversial) about how I would provide solutions to the major issues facing our nation.
I would issue an order that would set up walls of separation in the financial world. Banks will be limited to traditional functions of the banking industry, brokerage houses will be limited to traditional roles in stocks and bonds, and insurance companies will be limited to traditional roles of selling insurance. One of the major problems with Wall Street had been a blurring of roles for these industries. The financial crisis was the result of a fundamental failure from Wall Street to Washington. Wall Street took irresponsible risks that they didn’t fully understand and Washington did not have the authority to properly monitor or constrain risk-taking at the largest firms. When the crisis hit, they did not have the tools to break apart or wind down a failing financial firm without putting the American taxpayer and the entire financial system at risk. Also, I will issue an order that hedge funds, derivatives, and speculators will be outlawed. Commodities are the latest Wall Street instruments that need to be rigidly controlled. Compensation for all company officers will be voted on at annual stockholder meetings, not determined by a Corporate Board of Directors. This will make compensation packages responsive to the shareholders and what they feel is the performance of the management team. In addition, Congress will be directly responsible for corporate negligence or fraud (Bernard Madoff), and not delegated to some third party or agency. Since I eliminated the Securities and Exchange Commission (SEC) and Federal Reserve (Fed), Congress will be accountable to the voters for the control and health of these industries.
There has been a move under way by some economists and liberals in Congress to cap CEO salaries at $500,000. This shows that Marxism/Communism and class envy/class warfare are alive and well. Karl Marx said, “From each according to his abilities, to each according to his needs”. Limiting CEO salaries to $500,000 for top managers who are responsible for the livelihood of thousands of people is ridiculous. Steve Jobs, Apple, Inc., has an annual salary of $1, but made $616 million last year. Why should only executives of corporations be subject to the cap? There is no reason movie directors, movie stars, and athletes should be immune. Why not limit the compensation for Steven Speilberg ($332 million), Angelina Jolie ($20 million per movie), or Alex Rodriquez ($28 million)? In a free capitalist society, the marketplace and stockholders determine the compensation package. CEO’s are paid what the board of directors and stockholders decide is the value of their contribution to the organization. There is a quote attributed to Babe Ruth, when asked by a reporter why he was demanding $80,000 a year when President Herbert Hoover was only paid $75.000. Ruth replied, “I had a better year than Hoover”.
“The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind.” Gordon Gekko – In the movie Wall Street (1987).
As Gordon Gekko said, “Greed is good”. However, hedge fund managers have taken greed to a new level, and hedge funds need to be eliminated. As major markets and economies careened downward last year, 25 top managers reaped a total of $11.6 billion in pay by trading above the pain in the markets, according to an annual ranking of top hedge fund earners by Institutional Investor’s Alpha magazine James H. Simons, a former math professor who has made billions year after year for the hedge fund Renaissance Technologies, earned $2.5 billion running computer-driven trading strategies. John A. Paulson, who rode to riches by betting against the housing market, came in second with reported gains of $2 billion, and George Soros, also a perennial name on the rich list of secretive moneymakers, pulled in $1.1 billion. Their earnings were not unscathed by the extensive shakeout in the markets. In a year when losses were recorded at two of every three hedge funds, pay for many of these managers was down by several million, and the overall pool of earnings was about half the $22.5 billion the top 25 earned in 2007.
The managers’ compensation, which was breathtaking in the best of times, is eye-popping after a year when hedge funds lost 18 percent on average, and investors withdrew money en masse.
Government scrutiny over Wall Street pay is also mounting. Hedge funds are facing proposals for new taxes on their gains, and Treasury Secretary Timothy F. Geithner said he would seek greater power to regulate hedge funds. To make the cut this year, a hedge fund hotshot needed to earn $75 million, down sharply from the $360 million cutoff for 2007’s top 25. Still, amid the financial shakeout, the combined pay of the top 25 hedge fund managers beat every year before 2006. “The golden age for hedge funds is gone, but it’s still three times more lucrative than working at a mutual fund, and most other places on Wall Street,” said Robert Sloan, managing partner of S3 Partners, a hedge fund risk management firm. “But this shouldn’t pop up on the greed meter. They made money. That’s what they’re supposed to do.” In an interview, Paulson, whose lofty 2008 earnings were down from the $3.7 billion that Alpha estimated he earned in 2007 – said his pay was high in large part because he is the biggest investor in his fund. In fact, he said he receives no bonus. The pensions, endowments and other institutions that invest in his fund do not mind the hefty cut of profits he and his team take, he said. “In a year when all their other investments lost money, we’re like an oasis,” Paulson said. “We have investors who were invested with Bernard Madoff, and they can’t thank me enough,” he added.
There have been several attempts in Congress to reform Wall Street. The laws enacted have met with some success, but the Wall Street gurus have managed to outsmart the politicians.. Here are the major Congressional Acts.
The Glass-Steagall Act of 1933 – This placed a “wall of separation” between banks and brokerages, which was largely repealed by the Financial Services Modernization Actof 1999. Though some commentators regard the restoration of the 1933 bill as crucial, even calling it “the most vital element of Wall Street reform” House Democratic leaders refused to allow an amendment by Rep. Maurice Hinchey (D-NY) to restore Glass-Steagall as part of the 2009 Frank bill. Hinchey introduced his proposal as a separate bill, the Glass-Steagall Restoration Act of 2009. Nonetheless, the “Volcker rule” proposed by the Obama administration has been described as a “new Glass-Steagall Act for the 21st century”, as it establishes stringent rules against banks using their own money to make risky investments.
Sarbanes-Oxley Act of 2002 – This Act, by Sen. Paul S. Sarbanes (D-MO) and Rep. Michael G Oxley (R-OH), was signed into law by George W. Bush in July 2002. The bill was enacted as a reaction to a number of major corporate and accounting scandals, including those affecting Enron and WorldCom.
The “Volcker Rule” – This was proposed by President Obama based on advice by Paul Volcker, and a draft of the proposed legislation was prepared by the U.S. Treasury Department. It limited any one bank from holding more than 10% of FDIC-insured deposits, and prohibited any bank with a division holding such deposits from using its own capital to make speculative investments. The Volcker rule faced heavy resistance in the Senate and was introduced as part of the subsequent Dodd bill only in a limited form.
Financial Stability Oversight Council – Chaired by the United States Secretary of the Treasury, a new multi-authority oversight body called the Financial Stability Oversight Council of regulators will be established. The council will consist of nine members including regulators from the Federal Reserve System, U.S.Securities and Exchange Commission, Federal Housing Finance Agency, and many other agencies. The main purpose of the council is to identify risk in the Financial system. Also, the council will look at the interconnectivity of the highly leveraged financial firms and can ask companies to divest holdings if their structure poses a great threat to the Financial system. The council will have a solid control on the operations of the leveraged firms and also help in increasing the transparency.
House Bill H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, and Senate Bill S.3217, (that included a $50 billion liquidation fund) drew criticism as a continuing bailout, and was removed by pressure from Republicans and the Obama administration. Both bills passed. Differences between them were to be worked out in United States Congressional Conference Committee, including whether the new consumer protection agency would be independent (Senate) or part of the Federal Reserve (House), whether to require banks to issue credit derivatives in separately capitalized affiliates (Senate); how exactly the Federal Deposit Insurance Corporation (FDIC) will wind down or bail out large institutions that fail; the circumstances under which large institutions could be broken up; a 15 to 1 leverage limit in the House bill; the terms of a Fed audit (continuous as in the House bill or one-time as in the Senate bill). Both bills include the Volcker rule that prohibits proprietary trading by bank holding companies, but both have a caveat that would allow regulators to overrule the rule. Both bills propose to regulate credit rating agencies, but the Senate’s bill is much stronger.
The wizards of Wall Street have figured out that it’s a lot easier to make a buck off basic needs – commodities – than corporate paper, and they are fueling another commodities bubble that is pushing millions of people around the globe into poverty and despair. Not content with destroying America’s housing market, they are now forcing us to pay higher prices for gas and groceries. It’s a Wall Street tax. The mainstream business press would have us believe higher prices are being driven by the specter of Parson Malthus, who argued more than 200 years ago that food production could not keep pace with population growth. Wall Street analysts describe a “super cycle” in commodities being driven by growth in emerging market economies like Brazil, India, and China. While true to a certain extent, the facts are that the current upward trend in prices and increased volatility is mainly fueled by speculative investment activity from Wall Street. There’s nothing like a good bubble for Wall Street profits, and there’s nothing like profiting on the things people need. From 2000 to 2008, financial flows into commodities increased from $10 billion to $270 billion – an increase of over 2,500 percent! And these same forces that pushed oil and food prices up in 2008 are driving the current commodity bubble.
Since the mid 2000s, Wall Street banks have been investing in companies that transport and store commodities, “These days, the Wall Street banks are more like those grain traders than you might think,” Business Week reported last July. “They have equipped themselves to take delivery of raw materials when they choose to…Goldman owns a global network of aluminum warehouses. Morgan Stanley (MS) chartered more tankers than Chevron (CVX) last year.” In other words, Wall Street banks are now commodity traders. But it takes two to tango, and Wall Street needed chumps who would blindly increase demand for futures contracts. Enter the Exchange Traded Fund (ETF), an investment product that is a hybrid of mutual funds and stocks. A mutual fund buys assets and sells “shares” to investors that can be bought/sold at the end of each day; an ETF buys a fixed bundle of assets, and sells shares that can be traded during the day like a stock. The first commodity ETFs were created around 2001-2002 to invest in gold and silver.
The current oil price spike is being blamed on turmoil in the Middle East and North Africa (affectionately known as MENA) that is supposedly disrupting the supply of oil, causing gas prices to exceed $4/gallon. However, oil storage facilities in Cushing, Oklahoma, one of the largest in the US, are at capacity—it’s awash in oil. Why? Because markets make it profitable to buy and store oil, which is exactly what the big players, including Wall Street banks, are doing. Supply is not the problem. It’s the huge flow of speculative money betting on oil, and other commodities, causing increased prices and greater volatility. The Fed’s QE2 bond-buying program has added fuel to the fire by raising inflationary expectations, causing investors to put even more money into ETF commodity investments, thus creating a self-fulfilling prophecy. Wall Street banks have taken control of the futures markets, and the regulators have let them. They make more money when markets are rigged to function more like casinos than providing the true economic function of price hedging. Speculative investment flows are the major influence on commodity prices now, and the more money that flows in, the higher prices go, and the more profits Wall Street makes.
Futures markets, like the Chicago Mercantile Exchange (CME), were created to allow farmers and merchants to protect themselves against price movements. A futures contract is an obligation by the seller to deliver (or take delivery if one is a buyer) a given quantity of wheat (5,000 bushels, for example) at some point in the future (say, six months) at a price determined today (say $2/bushel). Rather than worry about what prices will be at harvest time, farmers can lock in a price today by selling futures contracts at the time they plant their crops. Note, in this example, the total value of the contract is $10,000 ($2 times 5,000 bushels), but the farmer is only required to put up about five percent of the value as collateral ($500 in this case), known as margin. With margins so low, futures markets naturally attracted speculators. Speculators have always been welcome participants in futures markets because they provide liquidity—they make it easier to buy and sell contracts. However, since commodity markets are significantly smaller in size than other asset markets, they are easier to manipulate. Because of this, speculators were limited in the number of contracts they could hold, known as position limits. This was done to ensure that fundamentals—the underlying supply and demand from producers and consumers—determined commodity prices, not speculative activity. Note also, that true speculators make bets on price movements up or down. This is a hugely significant innovation. If the hedge fund directly used the futures market to bet on commodities, it would have position limits; but in using OTC swaps from Goldman, there are no position limits on either firm. The hedge fund is no longer restricted in the number of bets it makes, which means speculative investment flows will have a greater impact on prices.
Credits – Ted P. Schmidt Artvoice – New York Times