Archive for the ‘SEC’ Category

The SEC now has a proposal for how to implement the Dodd-Frank requirement that institutions retain some of the risk of loans when securitizing and selling loans.  The idea of this requirement is to give originators better incentives to originate and sell good loans.  Not sure why the private sector screwed this up – one reasonably hypothesis is that a few large players screwed it up, AIG, Lehman and others — but anyway.  The proposed SEC rules are here for public comment.  To make things interesting, important government officials are now weighing in.  Here is the comptroller of the currency’s response (mostly concerned with fighting exemptions), and here is the press release for Tim Geitner’s (Treasury is supportive of the general rule and accepting of the specifics).  In my opinion, financial institutions need retain no common or systemic risk to be properly incentivized, they just need to hold the risk of the loans they originate relative to similar other loans.  Otherwise, systemic crises damage bank capital.  But I have blogged a fair bit on this before . . .

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Proximate Changes

In response to concerns over the cozy relationships between some boards of directors and executives at public companies, the SEC has reformed its guidelines for shareholder voting (proxy voting) so that significant long-term shareholders can “. . . under certain circumstances, include a nominee or nominees for director in company proxy materials.”  Previously, the board controlled the ballot.  Under these circumstances, a shareholder movement to add a certain board member or defeat a proposed board member was extremely unlikely to succeed (they were extremely rarely successful).  Given all the restrictions on the proposal, it seems minor, but it has created a firestorm of debate because it changes the power balance in the control of corporations. Here is the SEC’s summary of their proposal, and the public comments that argue its merits.

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Dow Jones dip, May 6

On May 6th, the Stock market crashed and rebounded all in about one hour.  In this period some stocks lost half their value or more, then regained this value.  A very strange day. I am not sure if it suggests that market microstructure (meaning how markets are made, orders submitted and cleared, and so forth) is critical (the crash) or irrelevant (the rebound). Anyway, we now have two things to think about.

First, the CTFT and SEC have issued the preliminary findings of their investigation of this event.  Link here.

Second, we now have circuit breakers that operate across exchanges.  I am not sure why we have circuit breakers, but if we have them, it surely seems better to have the be universal rather than exchange-specific.

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On April 20, David Letterman read the Top Ten Goldman Sachs Excuses.  Oddly, the list includes all three of Goldman’s main arguments against the SEC charges.  See if you can guess which three (answers below):

(Link) Tuesday, April 20, 2010
Top Ten Goldman Sachs Excuses


9.You’re saying “fraud” like it’s a bad thing

8.Planned on using money to buy everyone in America delicious KFC Double Down sandwich

7.Distraught over George Lopez’s move to midnight

6.We were framed by evil menswear company Goldman Slacks

5.Since when are financial institutions not allowed to screw their customers?

4.Hey sport, how much to make these questions go away?

3.America needed a villain both Republicans and Democrats can hate

2.Everyone we ripped off got an “I Got Cheated By Goldman Sachs” tote bag

1.Uhh, it’s Obama’s fault?

Answers: 9 and 5 (and a little 10).  Seriously.  The defenses so far center around the idea that not disclosing that short interest selected the mortgages to put into this particular synthetic CDO deal was not illegal. The argument is that their customers should be aware that they may be trying to screw them. And the company seems to be fine with what happened, as long as they were making a buck without doing something illegal (yet to be determined of course).

Question: what is better for Goldman, 1) claiming this was a terrible mistake, that Goldman seeks to always disclose any and all pertinent information to clients, and that the company will build stronger internal safeguards to protect its clients, or 2) the current strategy?  Question: what is better for America?

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The SEC’s suit against Goldman has clobbered the bank’s stock, and energized the public so as to shift the balance of power  away from the banks towards the government.  It is now much harder to oppose significant regulation because of the populist impact of the documentation of Goldman salesmen making like con men. This has raised a question from the House Oversight and Government Reform Committee Republicans. They ask of the SEC: was there “any sort of pre-arrangement, coordination, direction or advance notice” from the SEC to the Administration or Congressional Democrats. Justice should not be about PR, and while the Republicans are not contending that the enforcement of laws has been compromised, I guess the timing looks fishy. But fishy timing is a minor issue. This is a reminder that regulators are not independent of those who want more regulation or those who want less – they have bosses who will seek to use or badger them for their own political goals. Just maybe, this was the goal of the question in the first place.

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The SEC action against Goldman again has me asking whether the industry might not actually be better off with some serious regulation of adverse selection. Goldman sold an asset hand-picked to fail as if it were just the average security. The retail investors has lots of protection, and so does the consumer. Imagine buying a car, and then being sold one off the lot that the mechanic who just tuned the engine is betting will break down. And not being told this. If car dealers could do this, cars would be hard to sell (this is the model and application for which George Akerlof won the Nobel prize in economics). Adverse selection makes assets illiquid. The more disclosure is required in simple, transparent ways, the more easily assets can be traded. If Goldman can hide the adverse selection behind tens of thousands of pages of “disclosure,” surely it makes it harder for any bank to securitize?

And this need not be regulation. Why doesn’t some bank start a private initiative of this sort?  In the car market, dealers provide guarantees.  Suppose that one of Goldman’s competitors made a pledge and provided a money back guarantee on losses directly caused by a listed set of shady practices. Wouldn’t that that bank almost never have to pay off and wouldn’t it gain a huge amount of business? Is the industry colluding to keep things opaque so they all decrease liquidity and increase profits?  I thought innovations that provided greater liquidity were the source of securitization and the financial boom, but maybe not . . .

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The SEC has proposed new rules governing various aspects of the asset-backed-securities (ABS) market. One in particular is a true surprise:  The SEC wants to require that ABS issuers release Python code (!!) that will codify (literally) the contractual provisions of the ABS. The SEC also wants to reduce the reliance on credit ratings during the issuance process. To think about these proposals, we first need to  remember what an asset-backed security is.


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We learn from the New York Times that the SEC is prosecuting a psychic, Sean David Morton, for securities fraud. He is quoted as saying “I have called ALL the highs and lows of the market giving EXACT DATES for rises and crashes over the last 14 years.”

For the victims, this is financial Darwinism at its most brutal. But for those without the stomach to watch evolution at work, it’s great to see the SEC protecting us from fortune tellers who get it wrong. I’d like to go a step further and have the agency recognize those who get it right. The SEC could create a brand new NRSRO designation (“Nationally Recognized, Systematically Revelatory Oracle”). Presumably Sean David Morton would not have qualified. But given how the original NRSRO designation worked out, who knows?

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Securities and Exchange CommissionWhile the stock market collapse and recession are not the Great Crash and the Great Depression, the SEC is starting to act like it is.

The SEC amended to Rules 200(g) and 201 of Regulation SHO (on shorting) that will restrict short selling shares when a company’s shares drop more than 10% in a day (new release here). The regulation of shorting dates to 1934, when many restrictions were implemented in a significantly misguided attempt to prop up share prices. This regulation does not look good, although it is quite limited in scope. It means that short sellers have to wait for those with shares in hand to sell before selling. A good sign that the rule is bad is the defense given in the press release: “to preserve investor confidence. . . ”  If it actually had a large effect I would be worried – if I am buying a stock that has declined I would worry that a lot of people have really bad news and have sold out of the stock and that the price does not reflect fully their bad news because they are unable to short the stock until its price seems reasonable to them. Thus, I may pay a price to buy that many people might know is overinflated but are not able to make profits and make the price far. But what will the rule actually do? Well, I expect not much. People wanting to speculate on the decline of a stock can still take positions in the futures market and make their money and get their views out there. As long as enough people are paying attention and the market is liquid enough, the actions in the future market should lead to downward price pressure in the stock.

All that said, I understand the motivation for the rule. It is my view that today almost all firms are basically banks, funding long term projects with short term commercial paper (instead of deposits). This exposes them to the risk of a run.  And a decline in share price may lead to a run. Which might justify the decline in share price and make speculators very wealthy.  But the solution seems to me either 1) allow this to happen, equity holders will get burned and then run the firm with less maturity mismatch or buy some sort of run insurance or 2) provide a lender of last resort for corporations, the way the Fed does for banks.

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Here’s a wonderful idea for a financial product: raise trillions of dollars from investors, invest in a variety of risky assets, and then lie to investors about what the shares of the fund are worth. Just to make this easy, claim that each share is worth $1, even if it’s really worth less. To support this fiction, redeem shares at $1. If prices fall and investors suspect that the shares are actually worth less than $1, they will race to withdraw their funds. The first to withdraw receive $1, the last receive whatever is left, perhaps nothing.

You can be forgiven for thinking that I’ve just described Bernie Madoff’s investment fund. In fact, I’ve described the operation of money market mutual funds in the U.S. (Note that these are mutual funds, not insured “money market accounts” offered by banks.) (more…)

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