donzelion

Taking Issue with David Dreman

"How can we recommend people buy shares in a company when we really have no idea what its business environment will look like in 6 or 12 months?"

We never have any real idea what the business environment will look like in 6-12 months. We make guesses, and have faith that managers will respond prudently to whatever events transpire (and trust that we can hold them accountable should they mess things up too much).

"Faith" crosses the line into "gambling" when we cease to act as owners and delegate all duties as owners to others. When one won't even bother to vote in shareholder events, or obtain sufficient knowledge upon which to base a vote, then one is gambling.

Getting a Tax Clawback Right

Prudentinvestor - a "windfall profits tax" is still a variation on an income tax, and in the oil/gas sector, you'd impose it by simply disallowing certain deductions that would otherwise be available for large corporations (in oil and gas, the 'negative taxes' that the companies paid in subsequent decades pretty much made them whole).

A tax clawback like the proposal, is a punitive tax imposed for purposes of correcting an abuse. When it comes to dishing out punishment, do you prefer to have the IRS select the guilty from the innocent, or a judge, before whom you can at least defend yourself?

Now, a tax plan that applies a modest surcharge for certain types of "income" (e.g., "income" based on selling instruments which could be future liabilities) makes sense. But punitive clawbacks are a risky path.


On Mar 18 11:01 AM prudentinvestor wrote:

> Back in the late 70's or early 80's congress passed a "windfall profits tax" on oil companies, that was a sort of clawback on corporate profits, and is a precedent. The rationale was that egregious profits were obtained to the detriment of the public.
> One can argue that there is a difference between corporations and
> individuals, but a counter argument is the recent development by

AIG Watch: The Taxpayer Is Being Fleeced Twice

Alas, Monday1929, such an appealing solution has far, far too much precedent...

Actually attributing guilt is difficult, expensive, uncertain, and almost always disappointing (Slobodan Milosevic died of a heart attack in the Hague years after playing for worse games; folks in Rwanda are still awaiting justice). Even if you could properly allocate it, seizing assets is even more difficult, expensive, and uncertain - IF you want to do it by legitimate means.

By illegitimate means though, it's quite easy: find some group you don't like, blame them, arrest and execute them quickly, then silence anyone who questions you. It was a preferred tactic in 1930s, is still prevalent in many corners of the world today - and the fact that America will never do it is one of the greatest reasons I love my country.

On Mar 18 07:47 AM monday1929 wrote:

> Not if you try the guilty execs for TREASON and hang them if found
> guilty by a jury of their peers. Seize the stolen assets of the past
> ten years....

Getting a Tax Clawback Right

"A good law would...firmly establish the principle that the individuals who run critical financial institutions can be decompensated if they let those institutions melt down on their watch."
-------
Would you believe it, such a law already exists? It's called tort law (negligence) - which we've been emasculating for a good 15 years or so.

A tax clawback could lead to the same outcome, but changes the legal environment to a greater extent than populists might realize. Folks don't like the IRS much already; just wait when we start giving them any authority whatsoever to make moral judgments about our character, as well as about what we owe and don't owe.

Negligence, on the other hand, means that those who do the wrong will pay (and will pay punitive damages if they were grossly negligent). Instead of broadening the government role, we broaden the duties of the bankers and broaden the penalties for breach of those duties. Treat negligent bankers the same way we treat negligent manufacturers who dump toxic sludge in the river...

(Admission: while negligence law should be the first line of defense, taxes may become necessary as a supplement; it's real hard to define a duty and prove a breach when the products in question are extremely complex and resist objective testing...)

Why AIG Wasn't Allowed to Fail

If you see folks playing hot potato with hand grenades, then you'll probably walk away and leave them to their fate. But not if you're all flying on the same airplane. Point is: bailing out AIG appeared to be the least worst option when the decisions were made.

There's nothing wrong with CDSes, and there's nothing wrong with hand grenades - provided the people using them know what they're doing, exercise proper care, and don't do it on airplanes.

Problem is, it's hard to tell who knows what they're doing when everyone's a salesman. Traders know who lobbed the most grenades, but nobody knows who did it properly (they just know they haven't gotten blown up yet). The incentives are utterly out of whack - nobody was judged by proper handling of dangerous items, but only by volume handled.

Hence the outrage at the bonuses (rewards for a screwy incentive scheme) - as opposed to the billions of the bailout. Sometimes, the common sense (and sense of outrage) of the American people is more rational than we give ourselves credit for.

AIG Watch: The Taxpayer Is Being Fleeced Twice

The taxpayer is indeed being fleeced here - every now and then, we need reminders that the "free market" isn't really "free" - and that all freedom has its price. In this case, I don't see an appealing solution to the problem presented by AIG:

(1) Let AIG die, let all debts fall where they may. While "wiping the slate clean" is attractive, in reality, only a divine act can "wipe a slate clean," and only by paying a hefty price. The rest of us mere mortals will be stuck watching as the clean up effort goes on through bankruptcy court - taxpayers STILL wind up paying, but lawyers and judges will control the outcomes, and AIG's collapse will bring down an unknown number of counterparties - some of which may be innocent.

(2) Preserve "Zombie AIG" through taxpayers, gradually spin off assets. This is today's solution. It's also Japan's solution in 1991, which we've spent the last 18 years mocking as cowardly. No one knows how much it will cost, but at least we know who calls the shots here. Also, we can try to limit collateral damage.

(3) Monetize the debt so that neither (1) nor (2) is necessary. Of course, this means that we give control to China and other debtholders.

(4) Await the financial messiah to deliver us from evil. (Of course, many such pretenders have emerged - most folks offer their snake oil, and two or three actually "solved" the problem........by plunging the world into global war).

What's the least worst option?

Europe Happy to Take AIG's Money

Since every contract ever drafted is a sort of promise, "moralizing" applies to every deal whenever any party signs its name. The problem with modern markets is that some participants - particularly in the States - have learned how to exploit the costs of enforcing contracts so they can effectively shift nearly all burdens to another party (e.g., an AIG employee obtains a bonus, but the company is destroyed).

America's "free market" tradition permits such burden shifting provided all parties play by the rules, and provided that a party which breaks them pays an extremely heavy price in the form of punitive damages. The European "free market" tradition is to tax companies heavily, but reward them with subsidies, support, and other benefits when they act properly.

It's hard to say which tradition better reflects a "free market." I prefer the American system, since innocent companies shouldn't pay taxes to subsidize the malefactors out there - but for the last 25 years or so, we've given carte blanche for AIG/Enrons to play their games, and are now paying the price for such "freedom."

The Financial Supermarket Is Dead

Goodness, Constructe/Moon, that's a bit conspiratorial of you. Let's think of it this way: banks are supposed to earn their money the old-fashioned way; offer 3% interest to depositors, lend at +3%, and off for golf at 3.

What got us into trouble is that they discovered a new "rule of three" - out of every 30 minutes an investor spends speculating on how well an investment will perform, about 3 seconds are devoted to understanding how the company earns its money. If people think of banks as earning money the old-fashioned way (through the interest spread between deposits and loans), they'll ignore it when the interest rates drop to nothing and yet the banks still earn ungodly sums.

The problem here - and it's a harder one to fix than merely cobbling new regulations together - is that banks can easily "play by the rules" while taking on risks that a shareholder would never tolerate, if the shareholder knew what it was and how it worked. Shareholders, however, don't really care about the risks - we just go pleading for help when our investments fail to operate in accordance with the magic algorithm.

Economic Terrorism and Market Weakness

While I applaud the analytical portions (earnings are both shrinking and unknown - as they MUST be, since so many trillions of dollars of assets are themselves shrinking, unknown, and sometimes, unknowable), if the financials are playing "chicken" with the government, then we have a case of extortion, not terrorism.

It's no small distinction. Terrorism means pull back the troops from Iraq and occupy NYC - and let the troops fix our markets. Extortion means send in the FBI/Justice Dept.

But if things are as I see them - negligence, but not corruption for the most part - then the problems are much harder to fix. When you can't create incentives for managers to be competent, non-negligent, and effective even when you pay them hundreds of millions of dollars a year, what can you do? Must you pay those managers billions a year to become competent? Or is it possible that compensation has nothing to do with it - and we need to reconsider sticks as well as carrots?

While Financials Drag Markets Down, Five Ways to Stay in Play

Constructe is on to something: why shouldn't the US vote as the 80% shareholder to "release the files"? They're our bloody files! (Lawyer in me says, "No, no! What about the non-disclosure agreements? Other lawyer in me says, "Who cares? Let all those other managers who played silly games stop hiding behind secrecy and face the rap).

Conspiracy probably plays a very small role in today's crises. Rather, there's a structural flaw for shareholders, who most often own shares through institutions (mutual funds, ETFs, pension funds, etc.). As a result, they let management get away with bloody murder - and management converts company accounts into their own piggy banks (so long as the managers concoct "earnings" - which, it turns out, with the right leverage process isn't too hard to do).

What to Buy and Why: Barron's 2009 Roundtable, Part II

I actually like Cohen's picks - esp. BAC after its latest itty bitty drop (what's a 30% drop among friends?) ;) The difference between Citi and BAC is that Citi bought premium brands at premium prices - and kept paying premiums above and beyond anyone else simply because "we're the biggest." That works for the NY Yankees over the long run, but it sure doesn't make for the most efficient bank.

BAC bought premium brands at value prices. If you thought Merrill or Countrywide ever had any real value - then you have to believe in BAC now (esp. after yesterday's 30% off sale).

Great Depression Not Imminent, But Inevitable

For the emerging markets, valuation mistakes are a common outgrowth of the normal "favorability biases" afflicting Wall Street stock analysts, but magnified immensely by an absence of available information and by the prevalence of "sham" procedures (e.g., financial statements that are published but which are almost completely fraudulent - yet nobody can challenge them by legal mechanisms, so frauds are compounded over time).

Take the Middle East: financiers in Dubai blame the "U.S. subprime crisis" for recent trading losses, as though their own lending practices weren't orders of magnitude MORE risky (granted, they do ask for higher down payments, they don't securitize the loans to get them off the books, and they almost never file a foreclosure action - instead, they just hide the bad debts, shifting them like hot potatoes from one set of books to another). Real estate brokerages in China, Russia, and several other countries are just as guilty.

The confluence of all these excesses in the emerging markets will have to come to light and work themselves out - and then the region will boom once more.