The best overall regulation the U. S. could impose is to limit the size of every financial institution so that the possibility of out right failure guides every actor.
Monday, December 23, 2013
It matters whether the investment is good or bad
Regarding Paul Krugman's editorial "Bits and Barbarism" I'll
leave it others to comment on Gold and Bit-coins and dwell on the
Keynesian idea that it doesn't matter how the money is spent for the
economy to grow. While World War Two did pull us out of the
depression and war is pure consumption, this economic notion of
Keynes needs testing in other settings. The recent global mal-investment in real estate
is a drag that would not be reversed by additional spending in
housing. Japan's inability to pull out of it's lost decades comes in
spite of huge infrastructure expenditures tried
in the 90's.
Nor should we expect the forthcoming clean up spend on nuclear waste
and plant dismantling will help out, especially if every nuclear
facility lays dormant as another of the country's mal-investments.
An example of what an investment Bank could do
Europeanutilities have on occasion had to pay a penalty for excess power put on the grid. This penalty phase comes about when wind and solar
power is filling the grid and the less desirable nuclear and carbon
based power can not be shut off. Hydrogen powered automobiles that are about two years away from commercial deployment and where the
problem is distribution of hydrogen gas to filling stations. What
could an investment bank do with sort of information?
First,
secure a long position in depressed European utilities, then sell the
idea of making the electric grid the means of conveying hydrogen gas
to the various filling stations for automobile use. Filling stations
would convert electricity into hydrogen thru electrolysis on the
spot. The electrolysis would happen when sensors on the grid inform
the various stations that excess capacity needs to be sopped up.
Usually post midnight to 6 am and of course anytime high wind and
good solar collecting is filling the grid. Such a system would
tolerate waste in electric transmission and conversion to hydrogen as
it would be preferable to paying a fine. Since the utility wires are
already in place, infrastructure costs are minimized. Safety is
enhanced because of the small volumes of hydrogen gas of this scheme
versus any other.
The
scheme solves the utility battery problem as well as promoting a
clean energy solution that is safe and distributed for auto and truck
transport. Utilities will price their power more optimally and
improve their valuations in stock and bond portfolios. This is an
example of a long term win win type of proposition that investment
banks were made for, versus Goldman Sach's scandalous rent seeking
intrusion in the aluminum trade exposed early in 2013.
Friday, December 20, 2013
Volcker rule is irrelevant
The
Volcker rule of the Dodd Frank Act, named after former Federal
Reserve Chairman Paul Volcker, is an attempt to re-instate in some
form or another the Glass Steagall act of 1933 where commercial banks
and investment banks were separated. The separation allowed
government regulation of commercial banks using a self funded FDIC
insurance program to guarantee deposits. Investment banks on the
other hand were allowed to act freely and practice unprotected
capitalism. The Volcker Rule is a modern yet muddled attempt to
micro manage between commercial and investment banking. Well paid lobbyist are
eviscerating it, but the market's current aversion to dicey financial
instruments will keep abuse to a minimum in the near term. The why of
this observation requires a short history.
Investment
banks used to raise capital for factories, transport and the public
infrastructure required to promote and maintain useful activities to
generate an economic good. As more debt was sold, these banks
developed trading desks to keep a liquid market for the bonds that
were issued. This market activity was a low level low pay operation
that was understood to be operating in a zero sum environment.
Traders began to assert their importance when the crumbs falling
their way were millions of dollars. Harvey Golub's rise at Lehman
Brothers in the late 70's is a well documented example of this change
in banking.
As
systems improved among competitors and customers the trading desks
developed artificial products, derivatives, to hedge various
positions. These instruments were hard to figure out and price so
that firms issuing them found extra profit. An egregious example of
bad faith with these derivatives was in 1993 when Bankers Trust sold
their customer, Proctor and Gamble, a particularly one sided deal.
Years later in a hard fought suit it was revealed in audio tapes that
the traders were high fiving themselves for having made a huge
windfall by duping their customer. Bankers' reputation did not long
survive that revelation, but the casino mentality of milking the
customer completely took over Wall Street in that decade so that the
raising of capital became secondary. A current sickening example of
a worthless manipulation is Goldman Sach's aluminum trading operation
exposed recently. The scheme moved inventory from warehouse to
warehouse to justify price increases. To reap the fullest price the
stock of aluminum ingots had to be inventoried and moved around for
eighteen months, solely for the purpose of taking advantage of
customers such as Boeing, a large user of aluminum in the manufacture
of aircraft.
The
investment community has taken notice of Wall Street shenanigans by
pricing the stocks of too big to fail banks with low valuations, low
price earnings ratios in finance parlance. The lowest PE ratios are
with those with the most opaque business model. Bernie Madoff, for
example, had an opaque business model. Ironically some firms are
spending big money for legal talent in Washington for the right to
write opaque money losing contracts. That banks are currently
minting money hand over fist is in spite of their trading desks, not
because of it. With the current Federal Reserve Bank policy of
lending at practically zero and banks lending back to the government
at a few points higher does not require exceptional bonus generating
talent.
That
Goldman Sachs just was added to the Dow Jones Industrial Index is an
indication of how far it has coasted on it's reputation for
excellence. The aluminum scheme described previously not only shows
that Goldman currently is an impediment to industry but it also shows
a business model bereft of purpose. For it to be honored as an
“Industrial” is an Orwellian use of language that real investors
see through. Currently GS is valued with a PE of 10, a C-. Imagine
that, GS is the dummy in the room,
The
Volcker Rule will not be abused in the near term because no financial
officer wants to over pay for a tax fiddle that will blow up on
them. Considering the legal and structured investment fees required,
many companies select more transparent schemes, such as not
repatriating foreign income. It will take generations for the
financial idiocy perpetrated by too big to fail banks in the first
decade of the millennium to be forgotten. When it is, then the rule
will be trampled over by a herd of credulous bulls which will bring
forth another financial crisis.
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