A Many Faceted and Complex Thing

An energy trader, seen here allegedly wrecking your summer driving plans.

Futures contracts are devices used to stabilize prices of commodities into an unknown future. Anyone in the commodities industry, though, will tell you that futures trading is about as stable as a Tsunami.

All a futures contract does is guarantee a fixed price today, on the future delivery of a product. Once the right to purchase a barrel of oil for delivery in August at say, $65 is agreed upon, the seller goes home and prays the price will drop to $50 and the buyer hopes it will jump to $75. That way they’ll screw the other guy.

Theoretically, there isn’t much any party should be able to do to affect the price of oil in August. Like in horse racing, though, a few huge bets will cause the bookie to reconfigure the odds, which will affect all future bets. A massive bet that the price of oil will rise can cause the rise itself, sometimes in defiance to the market fundamentals.

Those huge bets, gentle reader, are the reason futures contracts on oil have come under such fire. Oil consumer like airlines and transport companies hedge their costs buy buying oil in the form of futures contracts. It is not these major consumers of oil that, however, Washington has turned its glare.

“Non commercial” traders, such as investment banks and hedge funds poured billions into oil futures, mostly betting that prices will rise, ahead of last July’s $147 a barrel price spike. Then banks seized up and imploded over the last quarter of 08, and by December the price of oil had dropped to $33 a barrel. A little caution is needed here: coincidence and correlation are not the same thing.

There is likely some truth to theory that major banks and hedge funds fueled the run up in oil prices by trading billions in contracts with no interest in the underlying asset. They certainly fueled a disastrous housing boom playing with mortgages they didn’t want. But the price of a commodity with global demand and local production is a many faceted and complex thing. and politicians don’t like many faceted or complex things that can’t be shrunk into a sound bite. Congress can’t pass a law to make Hugo Chavez play nice or the force the Saudis run their taps full bore. What they can do is give the wounded and shamed bankers another Madoff-style shove to the chest. And that is exactly what Washington is doing.

While I’m inclined to agree that many Wall Street types deserve a good kick in the pills, it’s debatable how much good it will do. Global demand for oil skyrocketed over the same time that prices tripled, and OPEC cut production when demand fell back. They are still well below production capacity to achieved what Saudi Arabia believes to be the “fair price” of $75 a barrel. Now that there are signs of economic recovery, investment banks are pouring more money into oil futures. The speculators probably can’t make oil jump from $33 to $60, as it’s done in the first half of 09, they’re just betting that the Saudis can.

Of course, the investment banks, who lack any sort of political leverage and know it, are crying foul. They say that setting trade limits on noncommercial trades will make the market less efficient and drive up prices - and behind the scenes they’re balking at the transparency rules.

It’s hard to see how more transparency is going to hurt anything. As far as the proposed trade limits go, it’s equally hard to see they will make too much difference in the face of producers constantly manipulating the supply. The proposed tighter regulation on noncommercial traders will, unlike a lot of government regulation, not do much harm. It’s no silver bullet, though, it won’t do any good either.

Would You Like Fries Or Credit With Your Order?

A Philosophy major cum expresso jockey, seen here contemplating a $2,150 house note a $6 an hour.

The Obama Administration’s proposed banking reform isn’t just an attempt to decouple retailer’s from their lightly regulated finance arms, but to atomize consumer finance altogether. This is bad news for retailers struggling to fertilize the “green shoots” of recovery with consumer spending that probably ought to be spent on all those upside down mortgages. It’s going to be bad for the consumer as well. Both those with good credit and the Starbuck’s baritsa who bought a $200,000 condo three years ago but can’t get their mind around the variable payments behind an Adjustable Rate Mortgage.

In-house financing isn’t just a courtesy stores offer customers, if that were the case it would have been axed in the late eighties along with decent service. Financing ‘stuff’ generally is a better moneymaker than retailing ‘stuff’. Think about the clerk at Target who asks you - sometimes in English - if you’d like “to apply for a Target card today?” Truly this young American is as apathetic to your needs as he appears. He’s asking you this question, repeatedly, because the CFO of Target sees his company as a lightly regulated bank specializing in many wee, unsecured loans. The rest of the store, and everything in it, is simply an excuse for you to take out those tiny loans on the way home from work.

A few years ago, GM sold off GMAC – its financing arm – in an effort to improve its credit rating. This certainly improved the company’s debt ratio, but is was a pyrrhic solution because they sold off, quite literally, the only profitable arm of the company. Just look at them now.

Retailers like their in-house financing arms because it keeps consumer money with them and not the banks. In recent years, retailers have flocked to Utah to charter their Industrial Loan Companies (ILCs) which take in deposits, make loans and issue credit cards like real banks just not very well regulated. Not unlike marriages chartered in the same state.

The Obama administration wants to regulate these ILCs as it would any bank and retailers are crying foul. Customers Macy’s card, or the modest financing it takes a dentist to buy a h=Harley Davidson, the retailers argue, are not the reason for the late unpleasantness in finance, nor do they pose a systemic risk to the market as a whole. This is without a doubt true, but the banking industry has poured millions (TARP money?) into supporting the bill on the grounds that it subjects some companies to tighter standards on what is affectively the same business. That is also true.

The bill have yet to face congress, and despite Senator Franken’s super-majority, it’s unlikely that the bill will survive the wheels of legislation in anything like it’s present form. Mr. Obama is extremely popular with the mob, but in the halls of government he owes a lot of favors to the ones who put him behind the big desk. It’s hard to see how a one term senator is owed any favors from anyone who matters. This puts the president in the awkward position of having to ask his super majority go back to their constituents and say: “I know that you’ve got no money and business is lousy and your job is hanging by a thread and you are upside down in your house note, so we’re going to make it more expensive for you to replace that broken fridge.”

Stop spending is no doubt good advice in these foul times, but political suicide. Mr. Obama hasn’t got anyone willing to fall on the sword for him, yet.

150 Years Is A Long Time

The whole thing largely symbolic – but so is everything is these days. Bernie Madoff’s 150 year sentence wasn’t so much to keep a dangerous criminal locked up till he’s hors de combat at 221, but to send a message.

More to the point, the sentence puts an exclamation point on a message that started with Ken Lay being lead out of the Enron HQ in hand cuffs. The message that saw Conrad Black’s head on a plate for his quip, “I'm not prepared to re-enact the French Revolutionary renunciation of the rights of nobility... We are proprietors, after all, beleaguered though we may be." The message that forced Merrill Lynch’s John Thane to explain expensing a $35,000 antique commode for his office to congress, shareholders and a mob who can scarcely spend that on a car. It turns out, no matter how clever you are, there was just no way to explain a $35mm non-flushing used toilet without looking like a total fool.

Like the French nobility, these executives and financiers lived too large and behaved too recklessly in the assumption that the mob’s money would bale them out. Now the mob has turned, and so have the politicians.

So Mr. Madoff got 150 years and according to federal guidelines, with good behavior he’ll be free in time for his 198th birthday. His lawyer Ira Sorkin refuted the matter of Mr. Madoff’s lack of grief by stating that his client had cried since his incarceration, but when and when and over what he couldn’t say. Sentencing, though, shouldn’t be reckoned on how well you can turn on the waterworks. Despite Judge Sotamayor’s opining to the contrary, judgement should be based on the crime, not your expressed emotional state afterward.

Don’t misunderstand, Mr. Madoff ought to spend the rest of his life in the pokey, but anything beyond, say 15 or 20 years in purely symbolic.

Where Judge Chin caved wasn’t to the pressure of “mob vengeance”, but to the pressure of the reactionary government that sees capitalism as the permanent bad guy. There was an element of the old soviet “show trial” to the sentencing, handing a showcase sentence to cross-armed federal prosecutors for an administration seeking excuses to creep further into the free market.

Capitalism isn’t on trial. It shouldn’t be because the free market is not the problem, even if finance is. Mr. Madoff is is on trial, just a crook who pulled a scam during a market bubble – those are a dime a dozen. We know hat kind of man he is, as for the $50 billion, that was just the price he fetched.

When speaking of “evil” schemes. Lets remember that Mr. Madoff got 27 more years that a pedophile who murdered his victims, and cooked at least one - which he served to the victim's family.

Now that’s evil.

A Tough Week

A lot of people died last week. We’ve been spared that loquacious expression of grief that sometimes accompanies celebrity deaths - but not the media coverage. Perhaps I’m not one of those people who readily identifies with people on screen. The only person on television I’d really like to be stuck in an elevator with is Dos Equis’s “Most Interesting Man In the World”, but that’s really more of a concept.

Ed McMahon and Farrah Fawcett were distant figures that had peaked in the eighties, and so was Michael Jackson, but no one bothered to tell him that. Ms. Fawcett was trying to turn her misfortune into a good for others, which is a noble thing to do. Michael Jackson’s major achievement – other than setting the “celebrity train wreck” bar at dizzying heights – was to moon-walk out of sexual battery of a minor charges. He didn’t bridge any entertainment gap between blacks and whites, Sanford & Son did that.

Someone else died last week as well. Yesterday morning, I was sitting in the back of Grace-St. Luke’s Episcopal Church in Memphis looking at remains of Caroline, a friend of my nine year old daughter. Last week the pancreatic cancer took her small body.

By all accounts she’d been a trooper about it - the little ones usually are. Perhaps they are unaware of the potential their parents see in them. Perhaps they are simply stronger that we give them credit. When I held my own Littlebit the first time, I saw forward to first steps, crushes and then I could clearly see myself walking her down the aisle at some distant wedding. I’m sure Caroline’s father saw the same thing, I’m sure mother saw Caroline in labor one day as well.

What Caroline saw was a massive, pink, pink layer cake. She was a food network junkie. After the chemotherapy started and she lost her blonde hair, Caroline wore a chiefs hat because that what she wanted to do in the adulthood that she’d never have. She wanted to feed people she loved. It wasn’t going to happen and Caroline knew it.

It will not do to dwell on what could have been. Her potential was not, in fact, untapped.

Unlike Jacko, who left a mesmerized press and world scratching it’s head thinking, “Where did come off the latch?” Caroline didn’t come off the latch. She held it together, held a lot of people together. And still does.

Last week she died. She’s the one I’ll miss.

God's Holy Trousers

Mr. Stanford is pleading Innocent. Governor Sanford is pleading satisfied but guilty. Farrah Fawcett is dead, at 62. And Governor Palin is mad at someone else.

An Honorable Mention To The Guy With The Moustache

Sir Allen - seen here unaware that he's only number two.

Poor ole R. Allen Stanford - even in bank fraud, timing is everything. In 1985 he and the Mrs. flew to the Caribbean island of Montserrat to charter a fake bank with a mysterious $6 million dollars, his outsized, but bruised, Texan ego hell bent and determined to perpetrate the world’s biggest banking fraud.

Now with the game over, he will forever be lost in history of the great schemes as just another “also ran”. It wasn’t even a close second: sort of like losing the 100 meter dash by a minute and a half.

Mr. Stanford claims the money came from real estate deals in Houston. There are a few problems with this story, not the least is that in 1984, no one made money in Houston real estate. To boot, he was fresh from bankruptcy after running his chain of health-clubs into the ground and was literally flipping burgers. Junior’s Hamburgers was a family owned joint (his family) and within a few months Mr. Stanford ran that one into the ground as well. The real kicker is that the real estate in question wasn’t developed by Stanford until the late eighties, after the bank was established.

Given that his joy ride lasted exactly 24 years, Christopher Marlowe might suggest that Mr. Stanford got his money the old fashion way: from Mephastophilis. Bear with me, this explains a lot: a broke Mr. Stanford gets $6 million is seed money from his broke dad whose hamburger joint just went toe up, and set off to Monsterrat to open a bank.

Incidentally there is only one reason to open a bank in Monsterrat, and Stanford knew it. One former employee said that home office had a few adult black ladies and one white teenager sitting in front of computers that weren’t even turned on. Yet he attracted investors from around Latin America by offering CD rates 2% higher than American banks.

Eventually, he moved the bank to Antigua, ingratiated himself to the government and became “Sir” Allen when Antigua knighted him. That Antigua has an order of chivalry just may be the strangest revelation in this sad tale. The bank opened branches that oozed cheaply bought respectability, founded a cricket team and managed to throughly offend the English on the pitch by simply being himself: a Texas con-man calling himself “sir”, attempting to outclass the British in their national sport while being a colossal redneck at the same time.

Stanford Financial had been investigated a number of times over the last two decades, but somehow, it never stuck. According to his indictment on Thursday last, he’d paid an Antiguan official $100,000 to frustrate FBI attempts to investigate the allegation against the bank. Despite this, Stanford Financial never really took off where its namesake wanted it to – in America. Several large US investors were jetted down to his island paradise, took one look at a bank of blank computers manned by a handful of Caribbean women and balked. Apparently they their someplace sensible like a Madoff feeder fund.

When the end came, it must have been horrible for a man like Stanford. No paparazzi, no round the clock coverage, no chance to shove photographers out of the way. The FBI raided bank offices in February and no one even bothered to arrest him until last Thursday. Mr. Stanford doesn’t even get Bernie Madoff’s grim satisfaction of thinking he’s the smartest guy in the room. Yet everyone knew Mr. Stanford was guilty for years. He doesn’t even get a decent “boo” in the bargain.

That’s what is so Faustian about the whole thing. He can’t even go out in a blaze of glory now that his 24 years are up. The attention grabbing Texan’s great downfall is hardly even noticed in the shadow of a secretive New York trader whose name was barely known outside banking circles.

Eight billion...my dog could steal that.

Progress Of A Sort

I have a friend from college whose ambition was not just to be on the cover of Fortune magazine, but to eventually have his company broken up by the government. He’s partially retired now and by his narrow definition, a failure. Still, he’s happily married with three beautiful daughters who thankfully look like their mother, was a self-made millionaire in his mid thirties and semi-retired millionaire in his mid forties. Not bad.

Those were the dreams we had in the eighties, when ambitions were teased higher than the hair. This week, however, the Obama administration released its proposed overhaul of the financial system. It too, is a sign of the times. You can still reach for those dizzying heights, but the government is going to charge you for the honor.

The administration is touting the overhaul of the US financial system as the reform since the great depression. But, and this is something of theme of the Obama White House now that the breathless honeymoon period is over, the promises don’t entirely match up with the delivery. The proposal appears to be a few regulatory tweaks with the fanfare of seismic reform.

This is a relief because the accelerant to last years meltdown wasn’t lack of regulation, so much as the end result of the government’s obsession with making every citizen a homeowner. The proposal is not without its strong points: a few securities, like derivatives, that had operated beyond the pale of the federal radar, are now firmly on it.

It also adds capital requirements for companies that become “too big to fail.” Just what those higher requirements are, or what deems a company to be “too big” have not been determined. The question is how the costs of this new regulation will affect the businesses that are not too big to fail. I’m sure after this fight is over, sometime is early 2010, the answer will be unfortunate.

As if we needed a sign that the universe had twisted into something strange, it was a Republican Representative from New Jersey, Scott Garrett, who said the overhaul “stays on square one on the big issues. It creates a cycle of bailouts.”

Possibly not. There is a provision giving the federal government the power to seize financial holding companies if they become insolvent. This isn’t the government seizing a company, like Fannie Mae and Freddie Mac, this is the government overseeing the selling off of the good parts and the orderly unwinding of the bad. Which is what it should have done with Fannie and Freddie.

Not that federal receivership is a great option, bankruptcy is certainly better, but it is preferable to bailouts because a) they are cheaper and b) by leaving the option of failure on the table, the moral hazard created by the faith in taxpayer funded bail-outs is removed.

It wouldn’t be a government plan without inherent contradictions, though. Banks, large and small, will be required to retain a 5% stake in the loans they make. The thought is that this will prevent dodgy loans from being made, and it certainly will. What it doesn’t address is the fact that the government (both parties) has made, as a matter of policy, the deranged fantasy that everyone needs a house. That’s where the problem lies, not the mechanism through which it’s achieved.

If the administration wanted to scotch dodgy home loans, they’d ask for higher lending standards. They don’t. What they need is to fix the blame for not giving a loan to some poor slob who can’t balance his checking account on the banks. That way, in ten years when we’ve all forgotten about this foul business, the government can point to the mean ole bankers and say “you, sir, are stifling the American dream!”

So we are back to the American dream, the desire to shoot beyond the cover of fortune and into the realm of government dismantling. For a new generation of American entrepreneurs, that dream could be realized sooner rather than later.