Obama’s Neglect of Volcker Emperils Economy – Summers and Geitner Stonewall Reforms

President Obama’s best chance for turning around the economy is to make sure that Paul Volcker, Federal Reserve Chairman prior to Greenspan, is in charge of needed economic reforms.   Although Tim Geitner showed promise when nominated Treasury Secretary, he looked more like Michael (Katrina) Brown than a competent leader in his first press conference.   He may indeed be nothing more than a figure head for unregulated hedge and private equity funds.  After all, the Chairman of the New York Federal Reserve Bank– where Geitner came from– was formerly with Goldman Sachs, and now works for a leading private equity fund.

Geitner actually proposed that these unregulated hedge and private equity funds could be a key part of the solution to the current financial mess, a mess they created.   While Volcker is calling for immediate registration of hedge and private equity funds with the SEC, Geitner and Summers, both of whom have strong ties to these funds, are silent on the issue.

One has to ask how long the markets, in particular the equity markets, will wait for transparency and integrity to be restored before sending a strong message to President Obama.  Below is an excerpt from a Bloomberg article summarizing Volcker’s concerns with respect to Summers and Geitner’s inaction.

Karl Rove and General Wesley Clark Debate at TD Ameritrade Institutional Advisor Conferenc

This week TD Ameritrade held its annual institutional advisor conference at Cesar’s Palace in Las Vegas.  CEO Fred Tomczyk, pictured on left below, summarized TD’s strong financial position in addition to his belief that money market accounts should be about safety and stability. For this reason, TD has chosen to minimize both duration and credit risk in these accounts. Tomczyk is clearly the right person to be leading TD Ameritrade.

Tom Bradley, pictured on right below, leads the institutional area and was instrumental in successfully advocating against the Merrill Lynch brokerage exemption rule, a rule which allowed investment professionals to avoid registration with either the state or SEC.  It is now up to the SEC to take action regarding this rule which has led to such widespread abuse.

I asked the first question of Tom after his presentation.  The question was, will TD Ameritrade now aggressively advocate that private equity and hedge funds be required to register with the SEC.   This same question was asked of both Karl Rove and General Wesley Clark, in addition to whether or not they are personally invested in private equity or hedge funds.  I will mention their responses below.

My sense is that requiring hedge funds and private equity to be registered with the SEC is essential to restore transparency and investor confidence. Bradley  responded that he is optimistic and sees the new SEC chair as a reasonable person but stopped short of committing to lead this much needed effort.  Bradley also noted that the SEC has had difficulty regarding effective enforcement, as indicated by the $50 billion Madoff scandal that broke in December.

In response to my question directly to Rove and Clark, Karl Rove said “I am too poor to invest in private equity and hedge funds,” but added that he thought that as long as these investors are large sophisticated investors, perhaps there is no need for registration.  He added that if he were not speaking at the conference he would be hunting with T. Boone Pickens, one of the nations largest private equity investors.

Pickens spoke the previous day and noted he had lunch with President Bush that week, a lunch Bush requested.   Pickens added that Bush asked him straight out, “Boone do you understand all this stuff Wall Street has created.”  Pickens replied, I am a geologist and have no idea what they were doing.

What neither Rove or Bush seem to realize is that the biggest investors in these hedge and private equity funds are now tax exempt public pensions, endowments and foundations.  What this means is that teachers, janitors and college students financial futures are directly tied to these investment vehicles, making registration with the SEC imperative.  Not to mention their interlocks to banks and their government insured deposits.

Clark was articulate in his response, noting that elimination of the “uptick rule” had fueled short selling by hedge funds, perhaps adding to market volatility.   He did not however answer the question regarding whether he was personally invested in such funds.  Clark also cited the Bush administration as being lax in its regulatory responsibilities.  Although perhaps true, Rove repeated several times that it was the Democrats who blocked the Bush administrations efforts to regulate Fannie Mae, a key catalyst to the current financial crisis.

My overall take on the Rove Clark debate is that Rove overlays his economic philosophy with too much politics and not enough basic math, although he was certainly right on the Fannie Mae issue.  Clark is a brilliant articulate leader, perhaps able to contribute to solving this mess, yet he is simply naive with respect to the impact of hedge and private equity funds.  One thing is for sure and that is the increasing importance of Paul Volcker to the Obama administration.  Volcker appears to be the only visible leader who truly “gets” what is needed to stabilize the system.   Pictured below is a photo of Rove and Clark responding to my question.

William Poole, pictured below, was also keynote speaker.  His presentation was superb, yet like many distinguished economists he is handicapped by not understanding accounting and taxation.  His perspective seemed to be that free market solutions are always best and did not seem to understand the importance of adequate disclosure to generate transparency and related investor confidence.  I asked Poole after his presentation if he supported hedge and private equity funds being required to register with the SEC and he replied no because they might just move to London.  He clearly has no grasp regarding the significance of this vast shadow banking system and how it has destabilized our economic system.  Such funds are now receiving most of their funding from US based public pensions and endowments and therefore the SEC or another government regulator clearly has the leverage to generate this needed oversight.   It is not likely that these funds will abandon their funding sources.

Public Pensions Fuel Short Selling by Lending Their Security Portfolios to Hedge Funds

On January 31st I posted a brief video on youtube summarizing a program in which the Oregon Investment Council is lending its securities portfolios, using State Street as an intermediary, to hedge funds and private equity firms so that they may meet the ownership standards required to conduct short selling– betting on the declines of stocks.   The video can be seen by searching for Bill Parish Public at youtube.com or by following this link: Public Pensions Fuel Short Selling.

Below is the Agenda, note this was for January 2009, it mistakenly lists Jan 2008, highlighting the review of this program in addition to a photo of Tom Motley, the representative from State Street in charge of Security Lending.

It is somewhat astonishing that these hedge and private equity firms are therefore profiting on the decline of the very same securities owned by the Oregon Investment Council.  Clearly, the lending of securities owned by public pensions should be banned immediately by the Obama administration.  While short selling may be an important part of the overall market, the notion that right of ownership can be lent for the purpose of such investments is simply ridiculous, no matter how long it has gone on.

A link to this video was also sent to several leading journalists and today the Wall Street Journal printed a story today regarding AIG’s security lending portfolio.   Although AIG’s program is different in detail, the same overall concept is used.  That is, AIG was lending its right of ownership to others so they could engage in transactions which regulators would otherwise prohibit.

Oppenheimer College Savings Plan Infected by Madoff Scandal – Obama’s State Illinois and Oregon both Impacted

On Sunday December 21, 2008  Oregonian columnist Steve Duin wrote a column  titled  “A fool and his trust are soon parted.”  Clearly, Oregon State Treasurer Randall Edwards, in his management of the plan, has breached his responsibility to Oregon’s parents savings for college, saddling those making conservative bond choices with losses of almost 40 percent.   President elect Obama’s home state, Illinois, also uses Oppenheimer.

In 15 years as an investment manager, perhaps the most disappointing experience for me was when Edwards, pictured below far left, and Richard Solomon, far right, who later went from the College Savings board to chair Oregon’s $70 billion PERS fund, chose Oppenheimer to be the key vendor to Oregon’s College Savings plan over Vanguard.

Most startling about the choice was that they had full information regarding why Vanguard was a better choice, including documentation from me outlining the unique risk involving the Tremont Group, a wholly owned Oppenheimer subsidiary, that lost $3 billion on the Madoff Scandal.   Even today, after numerous scandals, few are openly recommending that hedge and private equity funds register with the SEC, something I have aggressively pushed for since 2003.

The deciding factor in Edwards and Solomon’s choice was $350K in advertising Oppenheimer agreed to contribute in order to promote the plan.  Those would be the television ads Edwards appeared in, ads that, well, greatly simplified his re-election campaign.  Also particularly disappointing was the fact that Edwards wife had recently been Chair of the Portland Public Schools board, a role in which the importance of a quality college savings plan would seem most apparent.

Hopefully the new incoming State Treasurer Ben Westlund will replace Oppenheimer as the key vendor with Vanguard and make it possible for advisors like myself, who are residents of Oregon, to recommend the Oregon plan.   Thus far I have recommended the TD Ameritrade plan, based upon Nebraska’s plan, which is mostly Vanguard funds.  Unlike Oppenheimer, Vanguard does not pay kick backs to advisors and public officials or what are often referred to as “fees” and “administrative reimbursements,” by recipients.

In many states, parents mistakently choose their home state plan, i.e.  Oregon, in order to receive a deduction for state income tax purposes.   Simply changing this policy, as Pennsylvania did, is another easy way to fix the problem.  That way parents can choose the best plan for their children and escape the plans that were structured to benefit advisors.  The following summarizes the change in Pennsylvania:

Pulitzer Prize winning reporter Nigel Jaquiss of Willamette Week also wrote a story this week about the Oregon 529 Plan which includes pdf files of correspondence from myself to former State Treasurer Randall Edwards regarding why Vanguard should have been chosen rather than Oppenheimer.  Jaquiss story  Titled “Bill Cassandra Parish” provides a good detailed summary of what happened in 2004.

Immediate 6 Step Program to Turn Around Economy Proposed

On November 18, 2008 I gave a presentation to the local chapter of the American Association of Individual Investors (AAII) at the Multnomah Athletic Club here in Portland, Oregon regarding the overall state of the financial markets.  The talk focused on how we arrived where we are and what to look for going forward.  Also included were what I believe to be the six most important regulatory reforms– all of which could be implemented immediately– that would collectively turn around the economy.

VIEW EXCERPTS FROM AAII PRESENTATION

These could all be passed and implemented in one week, the only missing ingredient being desire.  It is somewhat astonishing how the current solution is focused on providing trillions of taxpayer dollars to various failed institutions when, if the objective is increased market confidence, these measures can be implemented with little or no cost.  They are:

1)  Requirement that hedge and private equity firms register with the SEC and disclose their top 25 holdings, top 25 sources of funding  and key accounting policies on a quarterly basis.

2)  Expanded oversight of bond rating agencies and requirement that Warren Buffett and other investors who do significant business with these rating agencies divest themselves of equity positions in the same rating agencies.  Buffett is currently Moody’s largest shareholder.

3)  Provide the SEC with oversight of public pensions, now the nation’s largest investment pools.  They currently have no jurisdiction or oversight over such funds, which is simply astonishing given their growth and related impact on the market.

4)  Expanded oversight of proxy firms and development of new competitors in this crucial area.  Currently one firm, Institutional Shareholder Services (ISS), has a monopoly over the market.  ISS is owned by Risk Metrics, a company that recently went public, whose primary owners are unregulated hedge funds.  It is unthinkable that unregulated hedge funds would hold the levers over the most important entity with respect to corporate governance, the entity that votes key corporate resolutions for many leading fund managers regarding mergers, executive compensation, etc.

5) Stock option accounting must be standardized and based upon values captured when such options are exercised rather than using arcane math formulas and related assumptions.  This is simple but has been bitterly fought against by the technology industry, most notably John Chambers of Cisco Systems.  Microsoft has provided the leadership when it terminated its stock option program in 2003, it now provides restricted stock that vests 20 percent each year and whose cost is fully accounted for.

6)  Reform the tax code to prohibit net operating losses (nol’s) from being aggregated and used to purchase profitable companies and avoid taxation.  Such losses should be amortized over 15 years, as is the case when profitable companies purchase other companies with operating losses.  Such amortization was created when a loophole was closed in the 1980’s due to a public outcry, the closure was led by then Republican Senate Finance Chairman Bob Packwood of Oregon.  Packwood and others never conceived that the loophole would be worked in reverse to escape the reform, that is someone aggregating losses and rolling in profitable companies.  Closing this loophole will slow down mergers that make no economic sense and preserve millions of jobs that would otherwise be lost for no sound economic reason other than a few managers leveraging growth in their stock options for short term gain.

Summary:  These are all administrative rules that can be changed next week.  Again, the only missing ingredient is desire.  Please pass this along to any policy makers who might be interested. A VIDEO with excerpts from the talk to the AAII can also be accessed on YouTube by selecting the picture link above, or by searching for “Parish Speaking.”

Warren Buffett’s Credibility Takes a Big Hit

This week Bloomberg disclosed that Warren Buffett, the man who has called derivatives a weapon of mass destruction, has himself afterall leveraged his fund Berkshire Hathaway by making a $40 billion bet in derivatives.

Little known to most investors is that Buffett’s primary source of revenue is his 50 insurance companies, including General RE, his company in which top executives are going to jail for accounting fraud associated with transactions involving AIG. The derivaties revelation was accompanied by a sharp drop in the fund price and the downgrading of Berkshire Hathaway bonds.

It is probably also time that Buffett divest himself of Moody’s, he is the bond rating company’s largest shareholder.  Moody’s played the key role in the subprime mortgage debacle and later claimed that it mistakenly overrated subprime debt due to a computer error.

It has been a tough month for Buffett in which the old expression “walk the walk” comes to mind.

Paul Volcker Makes Treasury Secretary Choice for Obama

On Friday President Elect Obama designated Tim Geithner to be the next Treasury Secretary and the stock market rose roughly 5 percent in minutes.  Clearly, this was former Federal Reserve Chairman Paul Volcker’s choice and once again demonstrates Volcker’s influence as a beacon of integrity and competence.  It also highlights Obama’s good judgement by seeking out and relying on the best advice, i.e. Volcker.

Geithner, top right, is a brilliant choice for many reasons, including the notion that he is a career public servant rather than just another investment banker seeking to expand their Rolodex prior to returning to Wall Street,

Equally important was the decision to safely distance Larry Summers, designated to lead the Council of Economic Advisors,  from the key operational decisions that require the competence and grounding of someone like Geithner.  Also critical was to exclude former Treasury Secretary Rubin, known as the Godfather of hedge funds within the industry.

Yet to be made is the critical decision regarding who will be the next Chairman of the Securities and Exchange Commission (SEC), a role only second in importance to the Treasury Secretary.  What is clearly needed is an aggressive regulator focused upon restoring investor confidence.

Estate Tax and Tax Equity: Bill Gates Sr. Battles Son Bill Gates Jr. as Grover Norquist and Warren Buffett Weigh In

One century ago Republican Theodore Roosevelt was elected president and instituted sweeping changes in government, including the establishment of an estate tax and the national park system.  What followed was an economic boom that lasted for years. Roosevelt knew the importance of circulating wealth in order to revitalize the economy by investing in key infrastructure, including the public education system.

Today fierce battle lines are drawn over whether or not the estate tax should be repealed.  On one side are Bill Gates Jr., Grover Norquist and the Wall Mart heirs and on the other side are Bill Gates Sr. and Chuck Collins.  This is certainly not a case of “like father like son.”

While Bill Gates Sr. has co-penned a book with Chuck Collins calling for increased exemptions but not abolishment of the estate tax, Bill Gates Jr. has been the prime funder of Grover Norquist as Norquist tours the country relentlessly advocating a complete repeal of the tax.  Like Bill Gates Sr., I believe the exemption should be raised to $5 million yet do not support a repeal.

I met Grover Norquist, the nation’s most ardent anti-tax advocate, here in Portland some years ago and was amazed at his persuasive skills, and also his ability to bend facts. When I asked Norquist what he would think if I told him Microsoft made more than $10 billion in one year without paying a penny of federal income tax he replied, good for them.

Norquist seems oblivious to the growing acknowledgment that tax equity or fairness is essential to healthy capitalism.  Even the Howard Jarvis tax institute, founded by his mentor, publicly stated that there were serious fairness issues related to Microsoft’s scheme.

Also participating in the debate is Warren Buffet, who like Bill Gates Sr. opposes any repeal of the estate tax, saying:

“We have come closer to a true meritocracy than anywhere else
around the world.  You have mobility so people with talents can be
put to the best use.  Without the estate tax, you in effect will have
an aristocracy of wealth, which means you pass down the ability to
command the resources of the nation based on heredity rather than merit.”                                                     [NYT, 2/14/01]

But Warren Buffet, like the younger Gates, has also been able to sell vast holdings within the structure of his foundation, thereby avoiding all taxes.  The Bill and Melinda Gates Foundation has sold all of its Microsoft shares, not even keeping 10% out of loyalty to the company’s employees.  Of course not a penny of tax was paid on any of these sales and today the Gates Foundation aggressively invests in activities ranging from private equity to currency speculations with all gains completely shielded from any tax consequence.

One simple reform to the system would be to allow tax exempt income status to foundations and endowments only for that portion of their investments invested in US government securities.  All other investments would be taxed at normal capital gain rates.  Perhaps this would help to stabilize the markets and eliminate the excessive risk-taking and speculation many of these tax exempt entities are engaged in, knowing they would have no tax liability on gains.

As the policy debates rage on regarding changes to the tax law, let’s hope that overall fairness has a strong seat at the table, whatever the outcome.

Canadian Dollar – An Underappreciated Currency, What It Might Say About US Stock Market

For several years now I have recommended adding short term Canadian Treasury notes to client portfolios, beginning when the Canadian dollar was roughly 62 cents to the US dollar.  The last of these positions mature in 2008, including those that already matured in July and another group set to mature in December.

Earlier this year the Canadian dollar peaked at 102 and today it sits at 82, implying a decline of 20 percent.  The Australian dollar has by comparison dropped more than 30 percent and the euro has declined 18 percent.  For quality foreign fixed income diversification I have prefered Canada with the notion that Australia is riding a commodity boom yet poorly manages its national finances and the euro is simply being sustained from new countries being added to the euro trading zone.

The question becomes, why the drop in the Canadian dollar when Canada is in a stellar financial postition compared to the US and what does this say about the US stock market.

Canada has consistently run budget surpluses and maintained a strong financial house.  This drop could indeed be rooted in investment funds cashing in these Canadian bonds in order to meet redemptions.  Since highly liquid they are easy to sell.

If indeed funds are selling a high quality sound government security like Canadian Treasuries, a country with much stronger financial footing than the United States, it would also seem apparent that the challenges facing banks and other globally diversified investors could be much greater than anticipated.  This could be particularly true of hedge and private equity funds given the likelihood that large parts of their portfolios are not liquid at the time being.  Current regulations do not require such funds to file reports with the SEC detailing their holdings and their current market values.

Mc Cain’s Weak Economic Judgement and Obama’s Obsession

With only two weeks until the election, it is truly disappointing that Senator John McCain has not reached out to independent competent economic advisors. Instead, he is using “Joe The Plumber” to articulate a message that is inaccurate and nonsensical.   History seems to be repeating itself for McCain.

It was in the 1980’s that McCain played the key role in promoting Charles Keating in what was a veritable factory of financial fraud in the Savings and Loan Industry.  Today 20 years later he has aligned himself with UBS Vice Chairman Phil Gramm at a time when UBS is a key player in several massive financial frauds ranging from selling fake municipal securities to affluent investors, so called auction rate securities,  in addition to numerous toxic derivative products to others.  UBS stock has plummeted as a result.

The contrast between McCain’s strategy and that of Barack Obama is striking.  While McCain is surrounded by incompetence and advocating Henry Paulson’s well known “I am the master of the universe” perspectives and lifestyle, Obama seems obsessed with binding himself to pure competence, as summarized in an excellent article in today’s Wall Street Journal by Monica Langley titled “Volcker becomes part of Obama brain trust.  Volcker is worshipped in financial circles, by both Democrats and Republicans alike.  They are pictured below.

by: Bill Parish