Paul Wilkinson

The Oil Casino: SEC Heading for Monte Carlo, Part I

First, Alan's description of the toxic asset crisis is priceless:

"Statistical rocket science wrongly predicted a AAA happy meal from diseased meat, lean tails, and worthless guarantees."

While no one wrote an analysis like Alan's warning investors in advance about potential or perceived problems with data rules for asset-backed securities, the good news is that this is now a topic for open discussion in the oil and gas sector. Without commenting on the merits of Alan's analysis, I'd note that the full text of the rule and its justification are available here: sec.gov/rules/final/20...

In the case of ABS, the rules allowed disclosure to be satisfied with ASCII data that was largely impossible for most investors to analyze (except for the short sellers who did). Even ratings agencies had problems using unstructured data from "tapes," meaning the pay-to-rate incentives overwhelmed incentives to get the analysis right.

A careful reading of the oil and gas rule and critical analysis should help investors arrive at their own balance among cash flow, various types of claimed reserves, and other information available to them to use to evaluate oil and gas companies. I would merely note Section 8 of the rule, which suggests a path toward a global standard to provide data in an industry standard format:

~~~
"VIII. Application of Interactive Data Format to Oil and Gas Disclosures

"In the Proposing Release, we sought comment on the desirability of rules that would permit, or require, oil and gas companies to present the tabular disclosures in Subpart 1200 in interactive data format in addition to the currently required format. Most commenters addressing the topic supported the use of XBRL for oil and gas disclosures.314 They believed using interactive data would be very helpful to investors and analysts.315

"However, they also recommended that the Commission wait until a well developed taxonomy exists.316 Some recommended that the Commission implement it in stages, initially with a voluntary program.317 One commenter recommended that the SEC work with other groups like SPE, IASB, and the United Nations to ensure tags ultimately become the industry standard.318

"We agree that much of the disclosures regarding oil and gas companies would be conducive to interactive data. We intend to continue to work on developing a taxonomy for such disclosure. Once a well-developed taxonomy is created, we will address this issue further. We are not, however, adopting interactive data requirements in this release. We will continue to consider whether to require interactive oil and gas disclosure filings in the future and, if so, when such filings should be required based on the development status of an oil and gas disclosure taxonomy."
~~~

The ABS industry wasn't too excited about creating a taxonomy for ABS, and only some participants now realize that an investor-friendly taxonomy would help restore the ABS market to its production possibility frontier (and keep future bubbles from expanding quite as far past the ABS PPF). Moreover, a taxonomy alone is not enough. To prevent GIGO, any taxonomy must be created in a way that allows for objective evaluation of the quality of its application, whether by auditors, a self-regulatory organization, effective deterrents to the use of bad data, sufficient openness to allow third party testing, other methods, or some combination thereof. Fortunately, it's easier, and in the long run less expensive, to audit machines and business processes than it is to audit human judgment. One of XBRL's key features is its potential integration with validation rules. That's not to say character isn't critical -- tone from the top can be a vital investment criteria -- but it is to say that the part of President Reagan's favorite Russian proverb after the conjunction is pretty important too: Trust but verify.

(There's a comment letter on the topic of XBRL for oil and gas reserves at www.sec.gov/comments/s... -- worthwhile reading.)

Yahoo's Dispute of Eric Jackson's Articles

Nice point Joe. The interplay between options, restricted stock, and cash compensation is rather complex, to say the least. Attempting to figure it out obviously consumes a lot of valuable investor time. Of course, much of this complexity would be unnecessary if it weren't for the cap on corporate deductibility of cash compensation. Shareholders and boards could simply pay their executives cash based on a prudent formula measuring share value, share price stability, long term growth, stable dividend payouts, and other factors they find to be in shareholders' best interests.

Of course, that would make tax law less complex, resulting in fewer billable hours. Since tax lawyers appear to rank among K Street's most powerful lobbying shops (Exhibit 1: convincing Congress to introduce this complexity with the tax preference for options over cash), perhaps reform is a pipe dream. Too bad investors don't have a comparable lobby.

However, it would certainly be in the government's interest to adopt policies to encourage more stable revenue streams. Tax rules facilitating compensation policies (and hence tax revenue streams) based on long term shareholder value instead short term performance couldn't hurt. Executives could focus on company performance instead of spending time figuring out exercise programs and dealing with second guessing of exercise disclosures.

The aggregate effect might even strengthen the dollar. With 10,000 public companies increasing their demand for dollars relative to equity rights, it couldn't hurt. To the extent companies in the global capital market decided to stick with or move to a more dollar-friendly tax and regulatory regime, that would help the dollar. And non-employee shareholders could win too, with more capability to create more effective incentives and less reason to worry about dilution, another complexity that could be mitigated by smarter tax policy. Perhaps someday tax policy will overcome the politics of envy that facilitated the so-called compensation ceiling, and simplicity will overcome complexity. The dollar could certainly benefit from more dollar-friendly tax laws. The ongoing dollar trend seems as good a reason as any to promote dollar-friendly tax, spending, and monetary policies.

How Much Did Cash-for-Clunkers Boost Auto Sales?

And as Paul Atkins pointed out at yesterday's TARP hearing, creating moral hazard is also a real cost. He was discussing subsidizing banks and car manufacturers directly, but in this case, moral hazard arises when future consumers decide it's a good idea to postpone consumption, and more consumers do so at the margin based on hopes that if they continue to wait, the government might fund another incentive program. The clearer and more consistent the rules, the quicker the market gets you to a market clearing price. Government command and control activity only interferes with that mechanism.

Beyond SIGTARP's $23.7 Trillion Headline

Tables 3.5 on p. 140 and 3.8 on p. 156 are worth checking if you can download the 10.6MB PDF. (Available at oversight.house.gov.) Media attention to the $23.7 trillion figure seems a bit simplistic after looking at the careful report. (Of course, GSE's were never supposed to cost so much either, but look at the costs of the consequences of their existence now!)

Wired on Google Facing Increased Antitrust Scrutiny

Donald,

Another great post -- you're making my leisurely blogging schedule look lethargic.

Here's an idea: To compete with Google (or more likely, help it improve its services), let's solve the economic data problem and improve competition at the same time. The House Oversight and Government Reform Committee approved legislation last month that would apply the industry standard computer language used for U.S. GAAP; Japan GAAP; International Financial Reporting Standards; mutual fund and credit rating agency reporting; standardized business reporting in Australia, the Netherlands, and elsewhere; to information collected by the U.S. government. More information, including the CBO cost estimate published last week, is at paulwilkinson.com. I talked with Doug Holtz-Eakin about this project way back when I was just getting into it, and he had some very good ideas about how XBRL could help CBO do its job. On the competition side, it's fascinating to contemplate what impact a standard business reporting language might have. We saw how html, xml, and mp3 made the travel, realty, on-line brokerage, music, and other industries more competitive. Expanding Internet standards to other industries for which dead tree problems haven't been solved would be interesting, to say the least.

Cheers,

Paul

Why Solving the Credit Crunch Is Key

On Jun 22 05:49 AM Moon Kil Woong wrote:

>...Don't we need to hunt that down and cage it with some form of constraint...

Yes -- and the cage is the transparency data base Mr. Greenberg suggests. Just as the U.S. GAAP taxonomy empowered investors to identify public company security risk factors in the 1900s, an XBRL taxonomy could empower investors to identify asset security risk factors in the 2000s. The more transparency that came to public company markets, the more difficult it was for Wall Street insiders to extract economic rents, driving the search for less transparent securities, such as ABS. Mr. Butter's article at seekingalpha.com/artic... and his prior posts are worthwhile reading with this one. Since the XBRL taxonomy exists now, the only reason to wait 10 years seems to be a lack of enlightened leadership.

Will the SEC Give the Buy Side What It Needs?

Alas, it surely wouldn't be a $700 billion (or whatever number you want to use) hammer! Check out the RMBS ASCII posted on EDGAR if you haven't had a chance. It is simply astonishing in its uselessness, but Phil Moyer, who commented at the Butter post, has explained how he used the same XBRL technology being used for GAAP and FDIC reports to tag the ASCII RMBS data, which proved quite useful to short sellers before the depth of the current crisis was widely known.

On Jun 19 07:43 AM Gary Greenberg wrote:

> Paul,
>
> Re: Your comment -
>
> "What it left out was the need to disclose the detail and subsequent
> data in a format that can be easily analyzed by potential buyers.
> That format, for which a list of data tags already exists, is XBRL.
> All that is needed is the leadership to force the sell side to disclose
> instead of muck around in opacity that's further confused by potential
> and actual taxpayer subsidies."
>
> The solution is a "mother of all databases." See my blog entry: rwbeerdiet.blogspot.co...
>
>
> The concept proposed by TYI, LLC of Needham, MA is for a centralized,
> database administered by an independent third party that would collect
> the relevant data on a daily basis, standardize it, verify and report
> it the next-day, delivering it to the desktops of investors and regulators
> around the world so that they could use the analytics of their choice
> to value and price the securities.
>
> Getting the loan-level information is an issue, as you've stated.
> A crowbar, hammer or similar instrument of persuasion will likely
> be necessary. Barring that, legislation or regulation will have to
> suffice.
>

Will the SEC Give the Buy Side What It Needs?

Actually, since they were getting gov't help after Lehman (note the AIG conduit to Goldman Sachs et al.) and it was not at all certain that full transparency would result in better prices, the more risk-averse position was to hold and recapitalize and wait rather than go for full transparency. Andrew Butter's article from Tuesday, and its comments, have it right: seekingalpha.com/artic...

Mr. Greenberg is also exactly right:

"Essentially, what would cause the buy side to return to the market and allow credit to flow through securitization again would be giving them more granular data on a more timely basis so that they could perform their own due diligence and have more trust in the ratings agencies methodologies."

See the comments to the Butter article for links to ways to produce that more granular data. The Treasury plan yesterday at least called for disclosure of loan level detail. What it left out was the need to disclose the detail and subsequent data in a format that can be easily analyzed by potential buyers. That format, for which a list of data tags already exists, is XBRL. All that is needed is the leadership to force the sell side to disclose instead of muck around in opacity that's further confused by potential and actual taxpayer subsidies.

Bear Stearns tried to offer some of its junk to the public in 2007 but nixed the deal, presumably when they found out that the transparency required wouldn't get them the price they wanted. Here's a quote from the FT at the time:

"Jack McCleary, head of asset-backed securities syndication at UBS said: 'The market does good job of sniffing out leverage. Dealers will look at funds with similar positions to ensure valuations are appropriate.'" -- www.ft.com/cms/s/0/f7b...

Alas, Mr. McCleary was all too prescient about the ability of the market. Too bad there wasn't more transparency sooner to help it move faster, before opacity exacerbated the bubble.

Is the U.S. Style Securitization Model Dead?

Brilliant in that your article shines a great deal of light on the issue! Phil Moyer has it right -- and there's more info at this link:

xbrl.us/News/Pages/200...

Both the 29-page testimony and the white paper will be of interest (and not only because XBRL US was nice enough to include my Wall St. Journal letter on the topic at the end of its testimony!).

On Jun 16 01:31 PM Andrew Butter wrote:

> Hey thanks - brilliant was perhaps an over exaggeration but I liked
> candid.
>
> I don't understand XBRL - so does that give every transaction and
> easy to access data that you can use?

Is the U.S. Style Securitization Model Dead?

Brilliant and candid. There is a way to expose the circuits the same way GAAP exposes the circuits of public companies: XBRL. Public companies were slow to embrace full GAAP disclosure in the 30s and MBS makers are slow to embrace full XBRL disclosure now. It will happen. The question is when the golfers will let it happen.

Paul Krugman says California's collapse has him rattled, and wonders if America will follow it into ungovernability. "Who would have thought that America’s largest state, a state whose economy is larger than that of all but a few nations, could so easily become a banana republic?"

If "governability" means multiple taxation and regulation at the local, state, and federal levels, let's hope governability is suffering. Government is too big and it costs too much, particularly if you're a Californian. Californians are fleeing the state despite the great weather because it costs too much to live here. Lower taxes and less government will make for a stronger California, a stronger nation, and a stronger world. It might sound warm and fuzzy for majorities to coerce people to tolerate attempts to extract wealth politically, rather than empower people to create wealth economically, but coercion is coercion, and the people of California showed they were tired of it last week. If we're lucky, that election will be a harbinger like Proposition 13 30 years ago. The New York Times hated that and it's no surprise they don't like the potential of another prairie fire helping someone else follow Gov. Reagan's path.

This Chart Launched the TARP

The high interest rate argument assumes lenders couldn't do what they were in business to do: set interest rates to earn a profit in a competitive lending market. Bankruptcy works well, except for those who cause it. Any wonder those who cause it prefer bailouts? Had the market been allowed to operate, equlibrium would have been reached within days. It wasn't and we're still waiting for it. Leadership appeals to principles, not to fears. Next time Congress is told "do this or else" perhaps it will make the principled choice instead of the expidient one.

Debt, Equity and Credit: Are Secretive Debt Markets Becoming More Transparent?

Good point. I should have written "mortgage debt," and been clearer that it's the "securitization" process that's the problem -- in quotes because it was an opaque banking process, not a genuine equity-style transparent securitization process.

Four Reasons We're Hurting More Now than in the Dot-Com Crisis

I blogged three government policies that contributed to your #1, 2, and 4 yesterday. paulwilkinson.com. If there were the leadership to make such policies investment neutral, the size of future swings might be a bit more reasonable.

FAS 157 and Other Regulatory Actions: Good Intentions, Unintended Consequences

Jack,

I think part of the reason there is not yet a solution stems from a complex cultural stalemate among lawyers, accountants, investors, and regulators. Lawyers like documents, accountants like numbers, investors like numbers in context, and regulators don't know how to proceed. Politicians simply throw up their hands and take the "easy" way out -- earmark more of "other people's money" to prevent what they are warned would otherwise be "catastrophic."

I can't understand why the President, who has spoken eloquently on the power of markets, doesn't command a market solution. Perhaps today's WSJ story on creating public-private investment funds is another trial balloon about a bureaucratic attempt to address these "complex" issues without frightening too many people into the realization that what they hold is worth either what a buyer will pay for it or the net present value of future cash flows to them -- but no more. (See paulwilkinson.com/2009.../.)

Politicians hate giving bad news to their constituencies. Bankers won't take sub-optimal prices as long as there's a reasonable chance that waiting for government money is a better option. We've yet to see the leadership -- the guts -- required to restore a functioning market. Someone, some time, will step up to lead. Until enough economic actors know who and when, the economy, which most of all depends on information that can be used by market participants to make decisions, will continue to suffer.
Paul