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Friday, October 26, 2012

Cameron to Van Rompuy: No Negotiation on E.U. Budget

Just days before the House of Commons debated whether Britain should secede from the E.U., Prime Minister David Cameron and his deputy, Nick Clegg, met with Herman Van Rompuy, President (or chair) of the European Council, to discuss Cameron’s threat to veto any proposed seven-year E.U. budget that is higher than the previous budget (allowing for inflation). The European Commission had proposed a 5% increase over the current budget, setting the stage for a clash of the titans across the federal and state levels. The British refusal even to negotiate on the federal budget exposed a major vulnerability in the E.U. itself just as it was being relied on internationally to protect the euro from succumbing to the systemic risk of Greece or Spain defaulting.

The complete essay is at Essays on Two Federal Empires.





Anti-Federalist Britain: South Carolina on Steroids

If Douglas Carswell, a member of the House of Commons, had his way, Britain would secede from the E.U. before Prince Charles could say, “hip hip!” Carswell's Private Member's Bill, submitted for debate in late October 2012, would repeal the European Communities Act (1972), by which Britain became a state in the former European Economic Community in 1973 (after France had vetoed Britain’s first request). Although Private Member’s Bills rarely become law in Britain, merely having a debate on whether to have a referendum on the question of whether the Kingdom should secede from the empire-level union would stir the pot. The Prime Minister, who was on record in support of not pulling out of the union, but for only economic reasons as his state had been benefitting from the large common market. So even if Carswell’s effort is ultimately unsuccessful, even such a revolt by Tory back-benchers could undercut David Cameron’s power in the midst of a languid economy in the state.


The complete essay is at Essays on Two Federal Empires.


                                     PM David Cameron of Britain at the European Council. Is he onboard?     AFP/Getty

Thursday, October 25, 2012

The U.S. Sues Bank of America: A Spanking or Slap-on-the-Wrist?

In late October 2012, federal prosecutors in New York formally accused Bank of America of “carrying out a scheme, started by its Countrywide Financial unit, that defrauded government-backed mortgage agencies by churning out loans at a rapid pace without proper controls. In a civil suit, prosecutors seek to collect at least $1 billion in penalties from the bank as compensation for the behavior that they say forced taxpayers to guarantee billions in bad loans.” The guarantee can be considered a moral hazard, in that Bank of America (or Countrywide) was not the party on the hook. In other words, the mortgage service company had an artificial incentive to produce mortgages riskier than would otherwise be the case because they would be guaranteed by another party (i.e., American taxpayers).

The full essay is at "U.S. Government Sues Bank of America."

Wednesday, October 24, 2012

Political Risk in Systemic Risk: Finnish Pensions Err in Debt Crisis

Finland became a state in the European Union in 1995 and adopted the euro at its birth in 1999. In terms of population, the state is between Wisconsin and Minnesota, both of which are states in the United States. The Finnish culture prizes saving as well as paying-off debt on time. As the Wall Street Journal put it, the Finns are more German in this sense than are the Germans themselves. It is easy to understand, therefore, why the Finns would not have been excited about the write-offs in Greek government in 2012. The Finnish cultural attribute here is an ideological proclivity. Such a value-system so deeply held can even eclipse or interfere with an otherwise unfettered risk-return trade-off presumed to be part of the market mechanism. Just as the risk-return investment-pricing froze rather than adjusted upward with the leap in risk in CDOs and the related insurance swaps that occurred on Wall Street in 2007 and 2008, the decisions of Finnish pension fund officers in the wake of the European debt crisis to pull out of Greek and Spanish bonds rather than simply to demand a higher rate of return, given the higher risk, likely means that the market mechanism itself freezes rather than functions at levels of high risk (or when risk is increasing dramatically). In other words, the theory of the laissez-faire market, which Adam Smith never advocated, has a serious flaw that is reflected in the mechanism in operation when there is a spike in risk. Un prix ne marche pas quand il y a beaucoup du risque. The free market mechanism in the investment market tends to freeze up rather than re-price instruments whose risk is quickly increasing to a significant degree.


The full essay is in Essays on the E.U. Political Economy, available in print and as an ebook at Amazon. 

Tuesday, October 23, 2012

Anticipating the U.S. Presidential Election of 2012


I wonder which has more import: which party gets its base out or which way the independents lean? Realistically, the result in a given state is likely to be a mixture of the two ( e.g., independents may lean toward Romney, overcoming the Obama campaign's excellent ground game). Even though the Electoral College is by state, I suspect that both in regard to the ground games and how the independents go, the trend will be the same from state to state because the campaigns are national and what independents are taking in does not differ from state to state. In other words, we should be able to discern a subtle "will of the People" at the national level in the election results.

My own hunch is that both parties will get their respective bases out. The big unknown to me is how or whether the independents will break one way or the other. I think the independents are the true "jury" on Obama, so I think how they vote as a group is the thing to watch as the returns come in. A leaning one way or the other can be taken as their verdict. I agree with commendators that the election really is a referendum on the incumbant, even though a myriad of reasons go into voters' decisions.

I had the sense in the second presidential debate that Obama looked smug, even arrogant, as if he were running the debate in virtue of his office. His tone directed at the moderated seemed to say, "Ok Candy, you may proceed with that." Perhaps the two labels are unfair, though people who have had contact with the president in person tend to provide similar feedback. I suspect the average Joe (not necessarily "the plumber") voter is turned off by conceit. Watching the debate, I had a subtle sense that whispered in my ears, "American viewers might be reacting negatively to his personality, as if saying to themselves, 'now we see how he really is . . . hmmm.'" There is the brand and the man. In other words, apart from the speeches and the orchastrated ads, Barak Obame might not be someone we would necessarily want to get to know, after all. I wonder if this recognition or awareness was occurring for the American people only then, during the debates, as we observed Obama interact with a rival in real time. "So this is how he plays with others . . . hmmm."

In divining what prompts the electorate's leaning one way or the other in a given election, we would be wise not to leave out "comfort level" with seeing and hearing the candidate at issue. Mentality or attitude is relevant because we know that whoever is elected president will be a regular fixture in our lives, albeit vicariously through electronic means. I am not referring only to whether we like the guy; the matter extends to our comfort with his attitude. This is a very subtle thing. Personality and attitude can thus be understood to play a role, albeit a subtle one, in how a candidate for president is "evaluated." An election is not simply about policy, which is a reason why the latter should be included on a ballot separately. 

Of course, Obama's attitude was not the only one on display during the debate. I have in mind Romney's duplicity, even lying, in his claim, "I care about all Americans" during the debate after he had said in private that it would not be his job to worry about 47 percent of us if elected no doubt turned many people off (at least those of us who follow politics). As he looked straight into the camera and made his statement as though sincere, I wondered whether the highest politicians have such an astonishing ability to act. That is to say, the true gift of a politician could be the ability to come off as incredibly sincere when he or she is simply acting the part. "Wow he's good" was what came to my mind. Of course, the excellence of a skill is of little value if the skill itself is a vice. Perhaps what we are left with is a fleeting glimpse of how little we know about either candidate, and yet we presume we know so much about both. "Obama cares" and "Romney is compassionate" may turn out to be marketing-driven rather than real, yet we cannot be wrong about what we believe to be the case, right?

To give another example, we watched Andy Taylor, the nice sheriff in Mayberry; from this experience of the man we felt a loss when Andy Griffith died in the summer of 2012 even though the man was reportedly not "good with people." That is to say, the man behind the sheriff was not as kind, yet we mourned as if we had lost the sheriff. For some reason, the human mind is susceptable to acting. Where most of an electorate do not get to meet the candidates in person, as in the case of the election for an empire-scale office such as the U.S. Presidency, the susceptability is particularly strong because the contact comes only through television and perhaps a mass rally.

I suspect that many independents (and perhaps even Republicans and Democrats) were left after the debates with the sense of why we as a people could not have done better in coming up with two nominees (and why not more than two?). This suspicion was confirmed for me when I learned after the third debate that the candidates presumed to discuss domestic policy even though the debate was to be on FOREIGN policy. Such a lapse can itself be a red flag respecting boundary issues or problems with "keeping within the lines" (i.e., as in coloring books).

Moreover, the sheer length of the primary "season" (year) and the general election campaign suggest that something rather basic in the American electoral system is off-balance, both relative to presidential campaigns in U.S. history and simply in terms of efficacy. Stretching something out for months does not necessarily mean better quality as a result. In fact, tangents can fill voids as the media seeks to keep up their viewers' attention when it naturally goes to something else. So I suspect that a lot of us will feel a sense of relief on "the day after" simply because the damn thing is done.

Sadly, we will then likely have gridlock to look forward to, regardless of which party has the White House, because of the expansive use of the filibuster in the U.S. Senate and the fact that one party is not likely to control both chambers of Congress and the Presidency. In terms of policy, the presidential election matters to be sure (and even more in terms of judicial appointments), but not nearly as much as we suppose. It is not as though whoever occupies the White House can simply snap his fingers and one of his campaign promises is enacted into law. I think we, the American People, need a strong dose of reality when it comes to buying into all the hype surrounding the alleged importance of the campaign and what a president can do. In other words, we need to tone it down a bit and come down to earth. Maybe then we can address the matter of the sheer length of the campaign "season" and how we can come to know the candidates behind the actor-personas and one-liners.

 

Monday, October 22, 2012

Predicting Future Events in Political Risk Analysis: On the European Debt Crisis


Political risk assessment is a nasty business in that the future has a stubborn habit of not wanting to be too predictable. Even though tomorrow displays a remarkable tendency to be similar to the world of today—the status quo enjoying the right of default—forecasting future events is notoriously difficult. To use statistics to nail down probabilities may actually involve considerable luck. Not even the stature of the person making the predictions may be decisive, after all. I have in mind the predictions of Alexei Kudrin, the former Russian finance minister, on the European debt crisis and the euro.


                                                             
The full essay is in Essays on the E.U. Political Economy, available  in print and as an ebook at Amazon.

Putin Embraces BP


The Russian state-owned company, Rosneft, reached separate agreements in October 2012 to buy TNK-BP from BP and a group of Russian billionaires. According to the Wall Street Journal, the deal represents “an acquisition that promises to reshape the Russian oil industry in favor of the state-owned company.” The Russian federal government was set to own or control nearly 50% of the Russian oil industry. Lest it be supposed that the legacy of inefficient state enterprise might compromise that industry in Russia, the state would have the benefit of literally sitting on the same board with representatives of the experienced oil producer from the private sector. By implication, the traditional dichotomy between public and private could be further blurred, such that the easy labels of “socialism” and “capitalism” may become less and less relevant or useful (except in the rhetoric of American presidential contests). Rosneft itself is a case in point of privateness and publicness coming together with a shared vocabulary or at least financial aim. Before addressing this point, I present the basics of the deal itself.

                                                     Robert Dudley, CEO of BP, talking with Vladimir Putin at the Kremlin.   Source: Telegraph

According to the Wall Street Journal, “(u)nder the terms of the transaction, BP will receive $17.1 billion in cash for its 50% stake plus shares representing 12.84% of Rosneft, worth $9.7 billion on the bid date. It will then use $4.8 billion of that cash to purchase an additional 5.66% of shares Rosneft from the Russian government, taking its total holding up to 19.75%, BP said in a statement. . . . BP will get two seats on Rosneft's nine-person board as part of the deal and expects to be able to account for its share of Rosneft's earnings, production and reserves on an equity basis.” Rosneft would acquire the other half of TNK-BP for $28 billion from the AAR consortium of Russian oligarchs. “Rosneft will finance the transactions, which have a total cash value of $45.1 billion, from a combination of existing cash resources and new borrowings.”  In short, we’re talking about a lot of money—a lot at stake. In other words, the implications of the deal deserve a lot of attention and analysis.
 
Expanding on the traditional notion of interlocking directorates, BP would be sitting on the board alongside officials or representatives of the Russian government. The latter would be able to nurture and develop contacts in the corporate world and BP would have access in Russia far beyond Arctic exploration rights.  That is to say, collusion could become worse, and this could undercut the public interest in the interest of private gain—private here applying both to corporate retained earnings and government coffers. That is to say, government itself could become more “private” and less “public,” leaving the public interest without a proper guardian or advocate.
 
The deal gives the Russian state an interest in the well-being of a foreign private company. This in turn would give the company some leverage in terms of Russian regulations. In other words, BP could use its alliance with the state to essentially “capture” Russian regulatory agencies. "This is a good, big deal, not only for the Russian energy sector, but also for the Russian economy," said Russian President Vladimir Putin, after a meeting at which he approved Rosneft's acquisition of TNK-BP in a meeting with the company's Chief Executive, Igor Sechin. The Russian president would thus have an interest in protecting BP as well as the joint venture. That is to say, from the standpoint of the bipolar dichotomy of “socialism vs. capitalism,” the cosy relationship proposed in Russia puts government and private ownership literally in the same room and having the same financial purpose. Mutual back-scratching would be almost inevitable, not only concerning the interests of the Russian state and BP, but also particular government officials and company executives.
 
Lest it be thought that privatizing the nearly 50% of the Russian Oil industry that would be controlled by the Russian state would be preferable—this option being more in line with the traditional “public vs. private” paradigm—it can be asked whether Russian oligarchs are preferable to Putin’s state. The tradeoff might come down to one of whether the state is really distinct from organized crime in Russia. There might not be much of a difference, with the exception that state-corruption is slightly more transparent. Even if the distinction is meaningless practically speaking, it can also be asked whether the oligarchs deserve their wealth and profits, especially if they came out of cheap post-Soviet sell-offs based on connections. For that matter, the anti-democratic response of Putin can cause one to ask whether his government deserves the added revenue. The Wall Street Journal reports, “A Rosneft takeover of TNK-BP would bring the Russian state's control over oil production to nearly 50% and mark a major milestone in Mr. Putin's reassertion of Kremlin control over the strategic oil sector, much of which was sold off in the privatizations of the 1990s to well-connected tycoons like AAR's owners. Since Mr. Putin came to power in 2000, the tide has turned the other way in an industry the Kremlin depends on both as a source of international influence and more than half of all tax revenues.” One might ask whether Putin deserves this even as he represses political opposition—even arresting a major figure following a “documentary” on television produced by the state. Faced with the abuses that more wealth and BP-connections might give the Russian president,  a reasonable person might be left with the conclusion that neither Putin’s pals nor his government is worthy of owning vast wealth; the world envisioned by Adam Smith as against the concentration of great wealth might come out the winner, even if only in the world of thought.
 
In addition to the downside, which may admittedly be so abstract and contrary to the status quo to be of any practical effect,  it is also worth pointing out that putting government officials and business managers in the same room could enhance both the efficacy of government regulation and corporate public affairs departments.  That is to say, knowing the otherness of the other could improve how one relates to the other “above board.”
 
Being on the same board, government officials or their representatives in Russia would no doubt see up close how private business executives “think” (i.e., the logic of business), while executives in the private sector (at BP) would gain a better understanding of the political calculus of government officials. That is to say, business and government would take one step closer together from that of “arm’s length” transactions and the regulatee-regulator relationship. Understanding how the other thinks is indeed a good thing where two parties must interact (e.g., regulation). At the very least, the efficacy of government regulation could in principle be enhanced as it could be put in sync with how managers think.
 
Understanding how business managers use regulation strategically—even preferring more regulation because it is easier for one’s own company than one’s competitors to comply—can enhance a regulator’s ability to craft regulations that achieve the desired public-policy outcome.  In other words, being able to anticipate the policies that business managers would enact in reaction to a proposed regulation can give the regulator a sense of the outcome up front. The regulation can thus be tailored with the anticipated reaction in mind such that the outcome sought would stand a better chance of resulting. A regulator could anticipate, for example, how managers would attempt to circumvent the proposed regulation, and the latter could be adjusted to close off that possibility.  A Russian official who has seen BP executives in action on Rosneft’s board could say to a regulator of another industry, “No, that won’t work; they would only do X to get around it. I know how they think.”
 
In terms of corporate public affairs departments (and corporate lobbyists in general), feedback from a company executive who knows how government officials think could advise on how to appeal to them on their own terms. A BP executive with experience with Russian government officials on Rosneft’s board could say to the director of BP’s government affair’s department in Russia and even another country, “If you really want the legislator to pay attention, bring up X because X is likely to be on his or her mind.” That is to say, fit the company’s strategic objective within the political calculus. Knowing the otherness of the other is necessary both to regulators in crafting more effective regulations that are not undercut by the other and to corporate public affairs directors who want to influence legislators and regulators.  As discussed above, however, there is also a downside, and it should not be disregarded either.
 
In summary, the modern world of extensive territorial empires and great concentrations of private wealth in the form of corporations can leave the individual business practitioner and the small investor in the dust along with the public at large. There is indeed value to public policy and government regulation in government officials deepening their understanding of how business executives think. Similarly, corporate public affairs departments could use more insight on how government officials tick. At the same time, the financial stakes and related cosy relationships as evinced in the proposed deal in Russia increase the risk of collusion at even personal financial benefit at the expense of the common wealth and general welfare of the people and even society at large. Putin might conclude, for example, that what is good for BP is good for Russia. This represents a very dangerous step (similar to “What is good for GM is good for the U.S.”) away from democracy in the direction of plutocracy. The question is perhaps less on whether the old “public vs. private” world is antiquated than whether government is really still government—governing the whole in the interests of the whole rather than certain parts—and whether large corporations are still private. On the latter point, it is worth remembering that Clive of the East India Company had a private army in Bengal at his disposal and the title of governor from the state. Indeed, the notion that the CEO of a private company would also be the governor of a territory might give us pause in reflecting on the governmental power that a large public-private partnership might have in Russia.
 
Source:

Selina Williams and James Marson, “Rosneft to Buy Entirety of TNK-BP,” The Wall Street Journal, October 22, 2012.

Sunday, October 21, 2012

Should Citi Be Broken Up or “Prodded”?

In 2011, the office of the special inspector general for the Troubled Asset Relief Program published a report on the aid provided to Citigroup by the U.S. Government during the financial crisis of 2008. “Unless and until an institution such as Citigroup is either broken up,” the report concludes, “so that it is no longer a threat to the financial system, or a structure is put in place to assure that it will be left to suffer the full consequences of its own folly, the prospect of more bailouts will potentially fuel more bad behavior with potentially disastrous results.” The Dodd-Frank Act of 2010 was an attempt to provide such a structure, with the federal government’s role being oriented to upping reserve requirements for the biggest banks and ordering the liquidation of big banks in bankruptcy, rather than to break up the banks too big to fail. That is to say, rather than add systemic risk to the restraint-of-trade criterion of anti-trust law, Congress and the U.S. president decided in 2010 to allow the banks with $1 to $2 trillion in assets to decide whether to downsize of their own volition or continue to face the raised reserve requirements.
Philosophically, the American body-politic in very general terms tends to view the proper role of government as tinkering with the contours of markets to affect business incentives rather than intervening directly in a company, as in breaking those up that have grown too big (and powerful) for the public good. Making it more costly for a big bank to retain all its lines of business (i.e., its size) instead of breaking it up is believed on a rather subtle level by the society at large give due regard to property rights (i.e., economic liberty). The public tends to view such an approach as balancing property rights with the public good. More nefariously, the approach can also be viewed as a manifestation of the political power of corporations on K Street in Washington, D.C. over Congress and the White House. Actually, adjusting market incentives via regulation can be said to prioritize property rights and private wealth over the public good where the threat to the market mechanism itself and the financial system (not to mention the republic!) is particularly grave. The American orientation to the market mechanism in preference to "big government" tends to disregard this scenerio wherein an improbable systemic collapse is part of the equation.
The fear that the fall of Lehman Brothers would trigger the collapse of the American financial system “by Monday” led Congress to put hundreds of millions of TARP money up for a vote on a “fast-track” that is astonishing by Congressional standards, not to mention democracy itself. The American "approach" itself had to be temporarily put on hold, and by a Republican administration! Not to be outdone, the free market orientation held on in the form of no-strings on the bailout money.
It can be argued that TARP itself was not only insufficient, but also that it actually enabled the marginally-run banks that were too big to fail to endure and thus continue to inflect the system with systemic risk. In terms of the ensuing reform law on financial regulation in 2010, it can be argued that to enable a mammoth bank that is regarded as too big to manage to continue to exist by rejecting the break-up approach (or reinstating the Glass-Steagal Act) in favor of relying only on setting up differential reserve requirements (i.e., regulatory costs) based on total assets and otherwise helping to order the liquidation process of an already-defunct bank may be too detrimental to the public interest. In other words, the tremendous size of the banks and the associated systemic risk may make the market-oriented American approach too property-rights oriented for the public good. 
 In terms of unmanageable banks, I have in mind Citigroup in particular, which I will turn to below, though Bank of America could easily be added to this list, given Ken Lewis's "empire-building" moves to acquire Countrywide and Merrill Lynch. He might as well have hung a sign outside of headquarters in Charlotte, "Dump Your Crap With Us! We'll Buy It!" Being the biggest bank, as though a Walmart in the financial world, is not necessarily a good thing both on the firm level and in terms of systemic risk in the economy.
Referring to Citi, Gary H. Stern, former president of the Federal Reserve Bank of Minneapolis, said, “I ask myself, ‘Could I manage one of these places with lots of capable senior officers?’ and I think the answer is no.” That is to say, the bank had become too large to manage. Like blindfolding a car driver or putting a confused drunk driver behind the wheel, having a heavy piece of machinery running not fully under control can be to invite an accident. It is very risky, even self-destructive, merely to allow such a thing to go on. Relying on the CEO to “pull over” and by analogy reduce obstructions by reducing the vehicle’s size (maybe unhooking a trailer) can be viewed as a luxury that the public interest cannot afford.
Gretchen Morgenson of the New York Times writes that “(g)iven Citi’s close ties to Washington, we can only hope that the change of command [of CEO] also reflects a regulatory prodding to overhaul the company. And if that involves cutting this behemoth down to a manageable size, then taxpayers should definitely cheer.” Regulatory “prodding” can be viewed as woefully insufficient if we are to rely on an empire-building CEO to voluntarily bring his “behemoth down to a manageable size.” That is, the fact that Pandit had felt perfectly fine with Citi being beyond a manageable size does not bode well for taxpayers cheering any time soon on hopes that Mike Corbat might suddenly see the light as he entered the corner office on his first day as CEO. He was more likely to see the power of his new office over such an expansive empire than to reflect on how he could have less under him. The motivation of a CEO is crucial to the question of whether the American market-oriented approach is sufficient to deal with something on the order of systemic risk.
The “regulatory prodding” approach that tends to sway the American electorate as a whole, even if subtly, may be fatally flawed in that economic efficiency and even profit-seeking itself are presumed in the approach to be the exclusive or primary motivators of CEOs and even boards. In actuality, the empire-building motive of power may eclipse even greater profitability, and therefore be oblivious to the prodding of additional reserve requirements. That is to say, the "market-prodding" approach may fall short by treating non-financial motives as extrinsic to the business calculus. Such motives may ignore or even trump "new and improved" regulations designed to channel financial motives in business. A bank's CEO might say, "I'll put up the additional reserves! I don't want to cut off product-lines that otherwise tie into my overall strategy synergistically."  Translation: I want to expand my empire even if it costs more proportionately because I like the pleasure that comes from the additional sense of power. Nietzsche could hardly have put it better.
For our purposes, the following axiom can be set forth for business as a phenomenon as well as at the managerial level:

Business is not only economic or financial in nature; it is also political in the sense that power is in the mix.

Managers are motivated not just by financial considerations such as efficiency, cost-containment, and revenue maximization, but also by the desire to control, which is an application of power.

The market-oriented approach to regulation may not sufficiently take into account this axiom. Structuring the market mechanism itself may need to be supplemented by a more direct intervention in private companies so systemic risk is lowered to a level that does not present taxpayers with a "high risk, low probability" collapse of the financial system itself. The sheer continued existence of Citibank (and even Bank of America) may point to the inadequacy of the Dodd-Frank Act as “reform” adequate to the purpose, given what we learned, or should have learned, from living through the financial crisis in September 2008.


Source:

Gretchen Morgenson, “Citi’s Torch Has Passed. Now Find a Knife,” The New York Times, October 20, 2012.