Yesterday, after babbling along a bit about The New York Times, the new administration, etc., I ended up with a brief discussion of the credit rating agencies. I want to pursue that point today.
I wrote that "I'd just like to point out in a cynical spirit that S&P and Moody's could strike back were they to feel really threatened by any regulatory change. They could lower the credit rating of US Treasury bonds. How devastating would that be to the ability of the US to keep borrowing on a world-historically absurd scale."
The chairman of S&P's sovereign ratings committee, John Chambers, raised the issue of lowering that rating four months ago.
Now, ask yourself: does this really have deterrent value? Would it be devastating? I can imagine treasury Secy Geithner telling President Obama, "Our bonds will be just as valuable the day after their downgrade as they were the day before. There will still be the uninterrupted history, from Alexander Hamilton's day to my own, in which every payment has been made on every bond. Are there lots of other institutions with such a 200-year-plus track record? Let's not fear S&P. They can't make our bonds unattractive by calling them names."
But if Geithner gives such a speech to the Prez, won't it imply that markets can IN GENERAL look beyond the S&P rating (and the Moody's rating too) and reach rational conclusions about the instruments being rated?
Are the ratings agencies irrelevant, or are they important? If they are important enough to be worth regulating, aren't they important enough to be a serious threat to the marketability of bonds?
Obama might after all reply to Geithner in our imagined conversation in the Oval Office: "If we shouldn't fear S&P, it is because they don't really matter to the buyers of such instruments. But if they don't really matter, what is the point of regulating them?"
And that would be a very good question.
Monday, January 26, 2009
Sunday, January 25, 2009
The New York Times
A front page story in today's New York Times, by Stephen Labaton, onthe basis of "recent interviews with officials" and statements at the incoming crowd's confirmation hearings, tells us that the new administration will "move quickly to tighten the nation's financial regulatory system."
Both Mary Schapiro and Timothy Geithner -- the new heads of the SEC and the Treasury Department respectively -- say for example that they want to change the compensation model of credit rating agencies.
I'll link you to what I said about this issue in October in my other blog. If you don't feel like chasing that link, here's an incentive. Cows are involved.
But if even that incentive leaves you unmoved, here's the crucial (non-bovine) paragraph:
There is a powerful case to be made that the credit rating agencies have had an inherently conflict-prone business model, and that this has introduced an element of instability into the US financial system in recent years. In short, they're paid by the issuers they rate. If they rate an issuer's garbage AAA, that issuer will presumably give them repeat business. If they downgrade, the issuer has had the option of shopping around for a higher rating elsewhere. So there's been a race to the bottom, and anyone can get a AAA.
My own instinct, when faced with a perverse incentive structure of that sort, is to ask not "how soon can we get the government to prohibit this?" but raher, "what has the government done to encourage/empower this?"
In ther case of the CRAs and their compensation model, there are good answers to the latter question. But I don't like to become too predictable, so I won't pursue that. Consider it your homework assignment, dear reader.
Instead, I'd just like to point out in a cynical spirit that S&P and Moody's could strike back were they to feel really threatened by any regulatory change. They could lower the credit rating of US Treasury bonds. How devastating would that be to the ability of the US to keep borrowing on a world-historically absurd scale.
Mutual assured destruction. Just like the old Cold War.
Both Mary Schapiro and Timothy Geithner -- the new heads of the SEC and the Treasury Department respectively -- say for example that they want to change the compensation model of credit rating agencies.
I'll link you to what I said about this issue in October in my other blog. If you don't feel like chasing that link, here's an incentive. Cows are involved.
But if even that incentive leaves you unmoved, here's the crucial (non-bovine) paragraph:
There is a powerful case to be made that the credit rating agencies have had an inherently conflict-prone business model, and that this has introduced an element of instability into the US financial system in recent years. In short, they're paid by the issuers they rate. If they rate an issuer's garbage AAA, that issuer will presumably give them repeat business. If they downgrade, the issuer has had the option of shopping around for a higher rating elsewhere. So there's been a race to the bottom, and anyone can get a AAA.
My own instinct, when faced with a perverse incentive structure of that sort, is to ask not "how soon can we get the government to prohibit this?" but raher, "what has the government done to encourage/empower this?"
In ther case of the CRAs and their compensation model, there are good answers to the latter question. But I don't like to become too predictable, so I won't pursue that. Consider it your homework assignment, dear reader.
Instead, I'd just like to point out in a cynical spirit that S&P and Moody's could strike back were they to feel really threatened by any regulatory change. They could lower the credit rating of US Treasury bonds. How devastating would that be to the ability of the US to keep borrowing on a world-historically absurd scale.
Mutual assured destruction. Just like the old Cold War.
Wednesday, January 21, 2009
The Chicago Sun-Times
Davidson Kempner Capital Management says that it has received the votes (technically, the "consents") that it needed for the success of its solicitation campaign. It says it is entitled now to have its nominees on the board of the Sun-Times Media Group, the parent company of the Chicago Sun-Times, and take control.
Sun-Times Media hasn't yet conceded defeat. It says it will retain an independent inspector to verify the results.
Davidson Kempner has criticized what it calls the “cash burn rate” under the incumbent directors. The cash balance apparently fell by about $20 million in the course of the third quarter of 2008.
Earlier this month RiskMetrics Group/ ISS endorsed the consent campaign.
Looking at the stock chart insert, youy can understand shareholder unhappiness. But such are the difficulties of the dead-tree newspaper business these days that it isn't obvious a change of control will do a lot of good.
Tuesday, January 20, 2009
Patent trolls and trading algorithms
US patent law may have turned away from a cliff in recent months.
Bernard L. Bilski had tried to patent an "energy risk-management method." Basically, he was seeking to claim rights to the idea of commodity hedging, as a "method of managing the consumption risk costs of a commodity [such as heating oil] sold by a commodity provider at a fixed price."
This was not a frivolous claim, either. There was some language in the precedents that seemed to encourage it. The more's the pity.
Fortunately, the US Court of Appeals has upheld the Patent Office in rejecting Bilski's claims.
The court said that a business process is eligible for a patent if and only if it is (a) tied to a particular machine or apparatus, or (b) involves the transformation of particular article into a different state or thing.
Anyone have any illuminating comments on business process patents, trading algorithms, etc. in this context? I'm all ears.
Bernard L. Bilski had tried to patent an "energy risk-management method." Basically, he was seeking to claim rights to the idea of commodity hedging, as a "method of managing the consumption risk costs of a commodity [such as heating oil] sold by a commodity provider at a fixed price."
This was not a frivolous claim, either. There was some language in the precedents that seemed to encourage it. The more's the pity.
Fortunately, the US Court of Appeals has upheld the Patent Office in rejecting Bilski's claims.
The court said that a business process is eligible for a patent if and only if it is (a) tied to a particular machine or apparatus, or (b) involves the transformation of particular article into a different state or thing.
Anyone have any illuminating comments on business process patents, trading algorithms, etc. in this context? I'm all ears.
Monday, January 19, 2009
Ramius' white paper
Ramius Capital, an activist hedge fund we have had reason to discuss here before, has put out a white paper, "The Case for Activist Strategies."
I read these things so you don't have to.
Here are five key points from the paper:
1) It traces the recent prevalence of activist strategies in part to Eliot Spitzer. Spitzer successfully pushed for certain reforms back when he was New York's attorney general that had the consequence of pushing professional analysts away from the sell side. Unsurprisingly, those analysts have found another lucrative use for their skill set: on the buy side.
2) A crowding-out effect is observable in the empirical data on this strategy. This is a textbook point: if a business plan works often enough to draw emulation, the emulation will reduce the profitability of that plan. Specifically, "the average benchmark adjusted return attributed to hedge fund activism ... declined during the 2001 to 2006 time period."
3) Many activist investors have had negative results in 2008. This is not, Ramius assures us, a defect in the strategy, "the performance of top-tier managers relative to equity indices has been outstanding."
4) Even in the case of not-so-outstanding results, the authors of the white paper don't want us to fault the strategy, because macroeconomic factors and technical pressures "completely overwhelmed fundamentals [last year], causing companies to trade at or below intrinsic value despite the activist manager's otherwise thoughtful plan to unlock value."
5) When allocating capital to an activist investor, it is a good idea to consider that they aren't all the same, and that the best variants of the strategy for the present climate may be those that push primarily for strategic or operational change (rather than financial or governance changes).
I read these things so you don't have to.
Here are five key points from the paper:
1) It traces the recent prevalence of activist strategies in part to Eliot Spitzer. Spitzer successfully pushed for certain reforms back when he was New York's attorney general that had the consequence of pushing professional analysts away from the sell side. Unsurprisingly, those analysts have found another lucrative use for their skill set: on the buy side.
2) A crowding-out effect is observable in the empirical data on this strategy. This is a textbook point: if a business plan works often enough to draw emulation, the emulation will reduce the profitability of that plan. Specifically, "the average benchmark adjusted return attributed to hedge fund activism ... declined during the 2001 to 2006 time period."
3) Many activist investors have had negative results in 2008. This is not, Ramius assures us, a defect in the strategy, "the performance of top-tier managers relative to equity indices has been outstanding."
4) Even in the case of not-so-outstanding results, the authors of the white paper don't want us to fault the strategy, because macroeconomic factors and technical pressures "completely overwhelmed fundamentals [last year], causing companies to trade at or below intrinsic value despite the activist manager's otherwise thoughtful plan to unlock value."
5) When allocating capital to an activist investor, it is a good idea to consider that they aren't all the same, and that the best variants of the strategy for the present climate may be those that push primarily for strategic or operational change (rather than financial or governance changes).
Sunday, January 18, 2009
Mary Schapiro
Schapiro, the incoming President's nominee to head the Securities and Exchange Commission, testified before the Senate Banking Committee on Thursday.
In my lazy Sunday sort of way, I'm just going to paste the bulk of her opening statement at that hearing here.
Like millions of families, my parents worked hard to save enough to buy a home, send their children to college, and have a secure retirement. They taught my siblings and me right from wrong – and that we could get ahead by working hard and playing by the rules.
Perhaps that’s why I’ve spent my career – at the SEC, CFTC, and most recently at FINRA – committed to building a financial regulatory system that protects investors and supports and strengthens free and fair markets.
We cannot underestimate the situation we are now in: the capital markets have collapsed; trillions of dollars of wealth have been lost; our economy is in recession; and investor confidence has been badly shaken. Middle-class families who were relying on that nest egg to pay to send a son or daughter to college or for a secure retirement now, don’t know where to turn.
There are many reasons for this crisis – and one of them is that our regulatory system has not kept pace with the markets and the needs of investors.
It is precisely during times like these that we need an SEC that is the investor’s advocate – that has the staff, the will and the resources necessary to move with great urgency to bring transparency and accountability to all corners of the marketplace, to vigorously prosecute those who have broken the law and cheated investors, and to modernize our country’s regulatory system to match the realities of today’s global, interdependent markets.
These urgent responsibilities would fill any agenda, but, Mr. Chairman, allow me to highlight a few of my top priorities.
First and foremost, if confirmed as Chairman, I will move aggressively to reinvigorate enforcement at the SEC. With investor confidence shaken, it is imperative that the SEC be given the resources and the support it needs to investigate and go after those who cut corners, cheat investors, and break the law. As the first SEC Chairman, Joseph Kennedy, told the nation 75 years ago in explaining the agency’s role, “The Commission will make war without quarter on any who sell securities by fraud or misrepresentation.”
I look forward to working closely with you, Mr. Chairman, and the members of the Committee to ensure the SEC has the capability, to fulfill this critical mission – as well as to perform all of its other important duties.
Second, I want to re-engage the SEC with the people we serve, namely, investors. The investor community – from the largest pension fund to the family who has scrimped and saved in their 401(k) or 529 plan – needs to feel that they have someone on their side, that they can go to the SEC for advice, to seek redress, or to have their opinions heard.
Third, as I work to deepen the SEC’s commitment to investor protection, transparency, accountability, and disclosure, I also want to ensure these commitments are preserved in any regulatory overhaul that may be undertaken.
Indeed, as a member of the President’s Working Group on the Financial Markets, I hope I can offer its members, the Administration, and Congress both the benefits of my years as a regulator as well as the decades of experience the professionals at the SEC have in these areas.
The American people want and expect us to update the regulatory system that has failed them – and to prevent the kinds of abuses that have contributed to the economic crisis we now face. I assure you that I will always keep their concerns front and center.
Seventy-five years after the SEC was founded, the Commission finds itself in a situation where, once again, it must play a critical role in reviving our markets, bolstering investor confidence, and rejuvenating our economy.
I am under no illusion that this will be an easy job. There is a lot of work to be done – quickly and diligently – in the months ahead. But I look forward to this challenge, to helping the millions of investors who rely on strong markets and a strong economy, and to working with the professionals at the SEC and the members of this Committee.
In my lazy Sunday sort of way, I'm just going to paste the bulk of her opening statement at that hearing here.
Like millions of families, my parents worked hard to save enough to buy a home, send their children to college, and have a secure retirement. They taught my siblings and me right from wrong – and that we could get ahead by working hard and playing by the rules.
Perhaps that’s why I’ve spent my career – at the SEC, CFTC, and most recently at FINRA – committed to building a financial regulatory system that protects investors and supports and strengthens free and fair markets.
We cannot underestimate the situation we are now in: the capital markets have collapsed; trillions of dollars of wealth have been lost; our economy is in recession; and investor confidence has been badly shaken. Middle-class families who were relying on that nest egg to pay to send a son or daughter to college or for a secure retirement now, don’t know where to turn.
There are many reasons for this crisis – and one of them is that our regulatory system has not kept pace with the markets and the needs of investors.
It is precisely during times like these that we need an SEC that is the investor’s advocate – that has the staff, the will and the resources necessary to move with great urgency to bring transparency and accountability to all corners of the marketplace, to vigorously prosecute those who have broken the law and cheated investors, and to modernize our country’s regulatory system to match the realities of today’s global, interdependent markets.
These urgent responsibilities would fill any agenda, but, Mr. Chairman, allow me to highlight a few of my top priorities.
First and foremost, if confirmed as Chairman, I will move aggressively to reinvigorate enforcement at the SEC. With investor confidence shaken, it is imperative that the SEC be given the resources and the support it needs to investigate and go after those who cut corners, cheat investors, and break the law. As the first SEC Chairman, Joseph Kennedy, told the nation 75 years ago in explaining the agency’s role, “The Commission will make war without quarter on any who sell securities by fraud or misrepresentation.”
I look forward to working closely with you, Mr. Chairman, and the members of the Committee to ensure the SEC has the capability, to fulfill this critical mission – as well as to perform all of its other important duties.
Second, I want to re-engage the SEC with the people we serve, namely, investors. The investor community – from the largest pension fund to the family who has scrimped and saved in their 401(k) or 529 plan – needs to feel that they have someone on their side, that they can go to the SEC for advice, to seek redress, or to have their opinions heard.
Third, as I work to deepen the SEC’s commitment to investor protection, transparency, accountability, and disclosure, I also want to ensure these commitments are preserved in any regulatory overhaul that may be undertaken.
Indeed, as a member of the President’s Working Group on the Financial Markets, I hope I can offer its members, the Administration, and Congress both the benefits of my years as a regulator as well as the decades of experience the professionals at the SEC have in these areas.
The American people want and expect us to update the regulatory system that has failed them – and to prevent the kinds of abuses that have contributed to the economic crisis we now face. I assure you that I will always keep their concerns front and center.
Seventy-five years after the SEC was founded, the Commission finds itself in a situation where, once again, it must play a critical role in reviving our markets, bolstering investor confidence, and rejuvenating our economy.
I am under no illusion that this will be an easy job. There is a lot of work to be done – quickly and diligently – in the months ahead. But I look forward to this challenge, to helping the millions of investors who rely on strong markets and a strong economy, and to working with the professionals at the SEC and the members of this Committee.
Wednesday, January 14, 2009
Second agreement
The December agreement between O'Charley's and Crescendo Partners was actually the second accord between this particular issuer and this particular hedge fund.
They entered into a settlement agreement back in March pursuant to which the restaurant company's board took on three Crescendo representatives (Arnaud Ajdler, Gregory Monahan and Douglas Benham), and agreed to declassify itself.
The company had a nine-member board at the start of 2008, but as part of the March agreement it expanded the size of that board to eleven, and one of the incumbents stepped aside, making room for the three Crescendo reps.
Now, with the renewed discontent of Crescendo, and the revised treaty, the hedge fund has taken another step toward outright control. They're going to get a fourth rep, and the board itself is going to shrink to 10 members. So they'll only need one convert from the non-Crescendo members to produce a tie vote on a given issue.
The fourth Crescendo rep is: Philip J. Hickey Jr.
Mid-market restaurant chains are often squeezed in times like these. Consumers trade down. Those who previously ate at the upper end of the market may go to the mid-market places, but that is more than compensated for by consumers who used to eat at the mid-market who go to the bottom feeder drive-through places or just stay home.
My guess is that Crescendo sees O'Charley's as a long-term play. Eventually, there will be a recovery and the customers will return, and Crescendo wants to be in a position to profit when that happens.
Be fearful when everybody else is greedy, but be greedy when everybody else is fearful.
They entered into a settlement agreement back in March pursuant to which the restaurant company's board took on three Crescendo representatives (Arnaud Ajdler, Gregory Monahan and Douglas Benham), and agreed to declassify itself.
The company had a nine-member board at the start of 2008, but as part of the March agreement it expanded the size of that board to eleven, and one of the incumbents stepped aside, making room for the three Crescendo reps.
Now, with the renewed discontent of Crescendo, and the revised treaty, the hedge fund has taken another step toward outright control. They're going to get a fourth rep, and the board itself is going to shrink to 10 members. So they'll only need one convert from the non-Crescendo members to produce a tie vote on a given issue.
The fourth Crescendo rep is: Philip J. Hickey Jr.
Mid-market restaurant chains are often squeezed in times like these. Consumers trade down. Those who previously ate at the upper end of the market may go to the mid-market places, but that is more than compensated for by consumers who used to eat at the mid-market who go to the bottom feeder drive-through places or just stay home.
My guess is that Crescendo sees O'Charley's as a long-term play. Eventually, there will be a recovery and the customers will return, and Crescendo wants to be in a position to profit when that happens.
Be fearful when everybody else is greedy, but be greedy when everybody else is fearful.
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