Regulated leverage, or imposing endogenous market regulation?

Before I start writing todays post, I am glad to announce that I have successfully mastered a milestone in the CFA program, and passed the Level I exam. Due to future career prospects I may get with having passed this exam, I have decided to enroll in the second leg of the curriculum.

The former chairman and CEO of Citigroup appeared on CNBC to share his views on the ailing economy and about prospects for future reform concerning the banking industry. Since I am unable to embed the video file in this blog post, I will write out the main tenants of his monologue.

Sandy Weill said:

- break up investment and commercial banking

- manage a system that will not allow excessive leverage, somewhere in the 15 to 18x debt to risk adjusted capital

- force banks to book derivatives on their balance sheets and not manage risks off balance sheet

- protect taxpayer funds from having to bailout TBTF banks

Now, with all due respect to Mr. Weill, who also stated that the biggest banks were also the main providers of capital and growth in the global economy in the past two decades, he is putting the cart before the horse on some of these issues.

To be fair, he did state that investment and deposit banking should be broken up. I put commercial because in the mainstream, the two coincide with one another. But the problem with this reasoning is that somehow deposit taking and making commercial loans will make the investment banking business much to tied up with the former and the latter will be in a constant conflict of interest which will force the government through regulatory measures to force financial institutions to construct “Chinese” walls between departments so no kickbacks may occur and no hefty commissions be generated. To Mr. Weill’s point, it is not the commingling between these activities that cause the problems, but the fraudulent nature of loan origination that occurs in todays economy through secondary deposit creation.

His second point deals with leverage. Leverage as an instrument of magnification, may boost returns that may not be generated without the debt standing behind it. But capping this somewhat arbitrary number will again not solve the problem. Especially when banks, in response to a low yield environment must be forced to generate returns sufficient enough to satisfy customer needs, as well as not losing their revenue base to alternative investment vehicles or pools of funds. Also, on this point, different industries operate on different degrees of leverage. (To make a point, there is a difference between operating leverage, which shows the effect of fixed assets and gross profits on revenue, as well as financial leverage, which shows the difference that operating profits have on net income).  

Now, in respect to derivatives, I do agree that these instruments, as like any other that abide to commercial law, must be placed on the balance sheet as a source (asset) and flow (income) to the company. The problem with derivatives, is that, any change in price stemming from the contract (variation of the instruments fair value), and especially if the instrument is booked as AFS under IFRS, doesn’t show as an unrealized gain or loss in the income statement, but rather as a change in the OCI component at shareholder’s equity. That is point one, and point two, if companies, wish not to keep it on their books, in the form of a SPE, they can do whatever they want; but if there are guarantees and contingencies, they ought to be represented as a liability when calculating financial ratios.

And finally, to protect taxpayer funds, why bailout anybody? Why the need for this made up TBTF notion? They are a drag to the economy and should be allowed to reorganize and selloff unsound units and business ventures.

But all in all, someone that sat at a ranking position should have had the courage to speak out regarding these problems in foresight, and not in hindsight.

Gun control–a logical a priori or a posteriori by Karl Denninger

 

Even though I like writing my own thoughts, I feel that sometimes, the best thing to do is just paste an article from a fellow blogger because it gets into a more in-depth and solid view of a subject that maybe I lack thereof.

Karl Denninger, from market-ticker.org, wrote a article regarding the recent gun violence in Colorado, USA which ended in the death of more than a dozen and injured considerably more. Here is his blog post:

“I was not going to comment in a political context on this tragedy until I saw the following:

New York Mayor Michael Bloomberg, a long-time advocate of gun control, called on both candidates to address what they would do to help prevent such tragedies.

“No matter where you stand on the Second Amendment, no matter where you stand on guns, we have a right to hear from both of them concretely, not just in generalities --specifically what are they going to do about guns?” Bloomberg said today on WOR Radio. The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

Gun control is why this murderous assailant managed to kill 20 people and nobody had a crack at shooting him, as they were unarmed.

Let's look at the facts of this event.  Metal detectors and searches would have done nothing to prevent this, but would have treated every patron as a felon.  The assailant came in through a back door, which means he tampered with a crash-bar equipped exit at some previous time or had "help."  Those exits are necessary for fire safety purposes.

Reports are that the assailant was wearing body armor.  This would have made him much more difficult to shoot and stop for an armed citizen, but body armor is not "bullet proof"; it is bullet resistant, and if you take a round in the chest while wearing it the energy is still dissipated on your chest -- it just doesn't make a hole.  Continuing to shoot people while being punched in the chest (pretty much what the shooter would be experiencing) would be difficult -- but not impossible.

The presence of a bunch of openly-carried or concealed weapons might have done nothing.  A pistol against a guy toting a rifle or shotgun is not a "fair fight" but it beats nothing, which is what the victims had.  The option to fight back is better than no option at all, whether you can or do choose to use it or not.  Oh, and let's not forget that it appears that Cinemark, the company that owns the theater, appears to prohibit by policy law-abiding citizens carrying concealed weapons.  If the assailant knew this (and it is, apparently, posted on signs at the ticket counter of at least some of their theaters) then he knew that every patron in the place was literally a walking target unable to defend him or herself as law-abiding citizens are disarmed by signs -- but criminals are not.

We do not know what the shooter's beef was with the theater or the people in it.  We will likely learn at least some of that in coming days and weeks.  The alleged shooter is in custody and reportedly has no prior criminal record, so clues are not to be found there.

The simple fact of the matter is that there is a tiny percentage of people who are cracked in the head.  Walking into a theater armed to the teeth and carrying incendiary devices to intentionally drive people to where you can more-easily shoot them is the act of a depraved mind and evidences obvious premeditation and intent.  The criminal justice system will mete out the punishment it is able for this circumstance, which will be wholly inadequate as you can only take a murderous thug's life once with capital punishment.

The Second Amendment and fully-recognized Constitutional Carry is the only means available to mitigate these sorts of events.  Firearms and smoke bombs are neither difficult to acquire nor can they be made difficult to acquire or even construct for someone with murderous intent, and as such the idea that "gun control" will ever do anything other than disarm law-abiding citizens is the worst sort of crap argument from ethically and morally-bankrupt fascists who themselves employ armed security around them at all times.

Mayor Bloomberg can pontificate on whether Constitutional Carry should be prohibited and the Second Amendment amended, which is the only lawful means to alter it, if and when, and only if and when, he dismisses all of his own armed security and turns over his own firearms -- all of them.”

Bashing a company to help expropriate funds to the government

Microsoft is in the headlines again. This time the fuss is regarding its operating system Windows 7. In the following report from WPCentral, the EU commission is looking into punishing Microsoft for the apparent breach of customer service when selling their software. The following bellow is the full article:

“The European Commission announced plans today to open an investigation to determine whether or not Microsoft has failed to comply with its browser choice commitment, which was applied in 2009. The commitment saw the software giant presenting customers of its Windows operating system with a screen listing available alternatives to Internet Explorer. This was put in place due to Microsoft being found guilty of abusing its dominant position with IE in the browser market.

Joaquín Almunia, Vice President of the Commission in charge of competition policy, had the following to comment.
"We take compliance with our decisions very seriously. And I trusted the company's reports were accurate. But it seems that was not the case, so we have immediately taken action. If following our investigation, the infringement is confirmed, Microsoft should expect sanctions"

Competing browsers have previously spoken publicly about the potential antitrust violations Microsoft is dancing around by preventing third party browsers access to the same APIs IE uses in Windows 8. With the down-spiral of IE and the massive increase in users for both Firefox and Chrome, is it worth penalizing Microsoft heavily for a ballot box screen, which arguably adds little value to the user experience?

According to the announcement, the EC believes that Microsoft may have failed to implement the browser choice screen from February 2011 onwards with the release of Windows 7 SP1. It'll be interesting to see the outcome of this investigation, especially from a financial standpoint, with a possible fine of up to 10% of Microsoft's total annual turnover, should it be found guilty of breaching the commitment.”

Now, this is the dumbest case of government expropriation from a bunch of unelected bureaucrats this year. (I am putting aside the shadow banking bailouts, because those concern finance.) 

This “malpractice” coming from Microsoft had to do with an earlier massive fine it had to pay for “monopolizing” the market in browser software. The Commission seized the opportunity to pounce on Microsoft because it violated its commitment to give the option to the customer of choosing an alternative to IE. The Commission is furious because Microsoft neglected making to make this change.

First of all, The Commission should have left the doings of a private company alone. If a customer was dissatisfied with the product he purchased and the service rendered for the amount paid, there are civil courts where these matters are disputed. In my view, I am certain, that the customer couldn’t care less about this option, because Windows 7 allows you to download an alternative to IE.

And even if Microsoft did promise to make this change, and it failed to comply with this regulatory statement, any customer could have complained. I haven’t heard of any complain against Windows for not installing an optional step in the installation process of its software.

The part of the article that struck me most was the following:

“Competing browsers have previously spoken publicly about the potential antitrust violations Microsoft is dancing around by preventing third party browsers access to the same APIs IE uses in Windows 8. (italics added)

It seems that the competition wants a free ride on the back of Microsoft and is using the government to do their bidding. According to Wikipedia:

“An application programming interface (API) is a specification intended to be used as an interface by software components to communicate with each other. An API may include specifications for routines, data structures, object classes, and variables. An API specification can take many forms, including an International Standard such as POSIX or vendor documentation such as the Microsoft Windows API, or the libraries of a programming language, e.g. Standard Template Library in C++ or Java API. (italics added)”

The competing vendors are complaining because Microsoft’s API language doesn’t allow for competing vendors API to be successfully integrated into Windows.

My answer is: And, so what?

Microsoft, as a private company doesn’t need to comply with the whims of the competition. If individuals didn’t enjoy the service provided by Microsoft, it would leave Microsoft and buy a different software provider. Now, the case comes, where Microsoft is accused of being a monopolist. It is too massive and too expensive to compete against them. But this surely is not the case.

Google Chrome, Firefox and others have successfully pummeled IE into the ground. They have successfully integrated their browsers to work with Windows. They have therefore worked around this supposed stranglehold that Microsoft has.

But, to a bigger issue. If Microsoft is fined 10% of yearly turnover, which amounts to about 20*4 billion= 80 billion dollars of revenue according to Microsoft Investor Relations, the fine would be around 8 billion dollars Now, where is this money going to go to? Is it to the competition? Is it to the EU coffers?

In any way, Microsoft will later be forced to contract business, as well as the inability to possibly fund this request by the EU Commission.

This next image is also a revelation that IE cannot be charged of being a monopoly product: Google Chrome has overtaken IE, with Firefox close behind IE. Even if Google or Mozzila had to pay a license to Microsoft, it still managed to create a better product, forcing Microsoft to rethink IE and make itself a better browser.

This would be the equivalent as Apple suing Microsoft for on being able to run their OS Leopard or Lion on any other hardware other than on Mac’s. Which is absurd, because Apple designed their OS specifically for Mac’s.

This is just another attempt for the government to rake in a substantial amount of cash for their dwindling budget. And, since the EU is giving away money to shore up the bankers reckless behavior, they would probably be able to bailout Cyprus with this money:

“The little island of Cyprus became the fifth European country to request a bailout for its struggling banking sector, and the estimated 10 billion euros needed to set things right would amount to more than half its total economy.”

I am sure to get the remaining 2 billion, the ECB will just lower some reserve requirement and get the desired excess liquidity. Wouldn’t it be interesting to see the possible statistical correlation of this possible expropriation and the bailing out of Cyprus? Wouldn’t be surprised if it brought on a p-value < 0,0001 in the tails of the distribution.