Comparative legal analysis

May 31 2007

What do these two suits have in common?

Couple sue Wal-Mart over slip in vomit” (AP/Nashville Tennessean) and
ACLU: Boeing offshoot helped CIA” (AP/Houston Chronicle)

Simple:

  • They each have a distinct odor associated with them
  • They’re both based on slippery circumstances
  • They’re both as baseless as the day is long

Only one of them, however, appears to have been categorized by the Associated Press as an “Odd Story”. So let’s look at that one first:

Couple sue Wal-Mart over slip in vomit

DAVENPORT, Iowa (AP) — A woman’s fall in a puddle of vomit has resulted in a lawsuit against Wal-Mart. June Medema, slipped in the vomit at a Davenport Wal-Mart on June 13, 2005, according to the lawsuit, filed by Medema and her husband, James, in Scott County District Court earlier this month.

Medema claims that she was seriously injured in the fall.

The lawsuit alleges that Wal-Mart’s negligence led to Medema’s fall, but it does not specifically say how the store was negligent.

John Simley, a Wal-Mart spokesman, decline comment saying he hadn’t seen the lawsuit.

The lawsuit claims that Medema suffered serious neck and upper back injuries in the fall and has undergone several surgeries and is unable to work.

It’s a mercifully short story, so it’s included here in its entirety. All you need to know is in that third paragraph – “…but it does not specifically say how the store was negligent.” In order to prove negligence, of course, the Medemas will have to prove that Wal-Mart knew the vomit was puddled on the floor. Which will be rather difficult – if they didn’t see it, why should Wal-Mart have done so?

As to the second story, I can completely understand the ACLU going after a Boeing subsidiary – They can’t sue the US government or the CIA on a classified matter, so they simply picked someone else in the transaction chain to sue.

NEW YORK — A Boeing Co. subsidiary that may have provided secret CIA flight services was sued Wednesday by the American Civil Liberties Union on behalf of three terrorism suspects who claim they were tortured by the U.S. government.

The lawsuit charges that flight services provided by Jeppesen Dataplan Inc. enabled the clandestine transportation of the suspects to secret overseas locations, where they were tortured and subjected to other “forms of cruel, inhuman and degrading treatment.”

The ACLU, of course, has been known to provide valuable legal services. They’ve also been known to tilt at windmills in pursuit of an agenda that tends to be decidedly leftist. Not “liberal” – leftist. As I said, I can understand their grasping at straws to find someone to sue, because money-grubbers have to go where the money is, even if they expect to get no money out of the matter.

I can’t understand why they think their suit will survive a summary judgment request. Jeppesen Dataplan didn’t man the flight, didn’t own the plane, and didn’t load or unload alleged passengers from the alleged extraordinary alleged rendition alleged mission. Jeppesen provides flight planning services. Logistics.

Undaunted by this bit of reality, the ACLU soldiers on:

The ACLU said the company “either knew or reasonably should have known” that they were facilitating the torture of terrorism suspects by providing flight services for the CIA.

That’s one of the ten most absurd things I’ve read in the last 48 hours. Having been on flights which used the services of flight planning companies like Jeppesen, and having occasionally been with the pilot when he was planning the flight, I’m comfortable asserting that in no case did a flight services vendor demand to know, let alone show even the slightest interest in, what the purpose of the flight was. Which is just as well – it would have been none of their business, and they’d have been told as much.

It occurs to me that there are two other things these two suits have in common – they’re both weakly disguised fundraising attempts, and neither one will be successful at anything other than garnering publicity for its plaintiff.



The beginning of a groundswell?

May 30 2007

I can’t be certain, since I didn’t read Wednesday’s LA Times, NY Times, or Financial Times, but based at least on tangentially related articles in WSJ and the UK Telegraph, there’s a rumble in the markets about cheap consumer debt, and the ill effects thereof.

First came the WSJ story, “DAY OF RECKONING – ‘Subprime’ Aftermath: Losing the Family Home“.

Mortgages Bolstered Detroit’s Middle Class — Until Money Ran Out

By MARK WHITEHOUSE
May 30, 2007; Page A1

DETROIT — For decades, the 5100 block of West Outer Drive in Detroit has been a model of middle-class home ownership, part of an urban enclave of well-kept Colonial residences and manicured lawns. But on a recent spring day, locals saw something disturbing: dandelions growing wild on several properties.

Ouch. It’s a long story, well worth a read if you haven’t seen it (and you’ve got a WSJ online subscription).

The Telegraph story, in tomorrow morning’s edition, is entitled “A million debtors face court action“. It’s specific to the British market, and isn’t directly related to subprime mortgages, but does involve easy credit:

Up to a million households struggling with rising living costs and lured by offers of easy credit will face court action over their debts this year.

Easy credit, generally described, can be laid at the doorstep of banks trying too hard to put money to work, saturating the market in good credit risks, and forcing a need to move down-market to the riskier borrowers. It happens in cycles, is specific to the banking and credit card industry, and, aside from central bank interest rate target setting, tends not to be driven by government attempts to help broaden the credit base. The same problem, of course, exists at times (including now) in the US.

Where the US credit problem, typified by Detroit in the WSJ story, differs is that it’s not the banks and credit card companies driving the train. They’re involved, of course, but the prime drivers have been mortgage brokers (the 21st century version of used car salesmen?), Wall Street, and the federal government. No, it’s not been the Federal Reserve’s interest rate setting mechanism in this case, but instead the well-intentioned efforts to ensure that credit is more widely available, particularly for home purchases:

Back in its heyday, the idea that West Outer Drive could suffer from a glut of credit would have seemed far-fetched. Many blacks moving into the neighborhood had to either depend on federal mortgage programs or buy their homes outright. That’s because banks actively avoided lending to them, a practice known as “redlining” — a reference to maps that designated certain neighborhoods as unduly risky. Various attempts to get the money to flow, such as the Community Reinvestment Act of 1977, which pushed banks to do more lending in the communities where they operated, had only a limited effect.

Bank charters, and particularly those of banks seeking to merge or sell themselves to larger banks, have periodically been tied up in state and federal oversight, with one of the exits from that maze being commitments to increase their home community lending. All well and good.

Where does Wall Street come into the picture?

But beginning in the mid-1990s, the evolution of subprime lending from a local niche business to a global market drastically rearranged lenders’ incentives. Instead of putting their own money at risk, mortgage lenders began reselling loans at a profit to Wall Street banks. The bankers, in turn, transformed a large chunk of the subprime loans into highly rated securities, which attracted investors from all over the world by paying a better return than other securities with the same rating. The investors cared much more about the broader qualities of the securities — things like the average credit score and overall geographic distribution — than exactly where and to whom the loans were being made.

There are many good reasons for consolidating loans into securities, not least of which is the ability, just as insurance companies do, to pool risk and manage it via a larger sample by statistical means. The fact that a market has evolved and matured to facilitate that is utterly unsurprising. The fact that sleazy mortgage brokers have seized on that market to essentially steal from unsuspecting or unsophisticated borrowers is equally unsurprising, and deeply unsettling to any right-thinking person.

Given the broad expanse of mortgage brokers who’ve hit the market in the past seven years, many feeding on borrowers’ silly belief that home prices would continue to rise to the skies, the benefits of homeownership have been overtaken, particularly in the imaginations of subprime borrowers, by visions of massive capital gains. And with those potential (now highly unlikely) gains in mind, people have rushed into debts they would never have incurred in leaner banking times.

Several vignettes from the WSJ story that don’t flatter the mortgage brokers:

Minority-dominated communities attracted more than their fair share of subprime loans, which carry higher interest rates than traditional mortgages. A 2006 study by the Center for Responsible Lending found that African-Americans were between 6% and 29% more likely to get higher-rate loans than white borrowers with the same credit quality.

Is that redlining? An argument can be made that it’s not. Not a good argument, but an argument.

“A lot of people were steered into subprime loans because of the area they were in, even though they could have qualified for something better,” says John Bettis, president of broker Urban Mortgage in Detroit. He says a broker’s commission on a $100,000 subprime loan could easily reach $5,000, while the commission on a similar prime loan typically wouldn’t exceed $3,000.

That extra 66% commission? From selling initially attractive mortgage rates that soon became quite ugly. Like this one:

April Williams was feeling the pain of the downturn back in 2002, when she saw an ad from subprime lender World Wide Financial Services Inc. offering cash to solve her financial problems. …after a loan officer from World Wide paid a visit, they became convinced they could afford stainless-steel appliances, custom tile, a new bay window, and central air-conditioning — and a $195,500 loan to retire their old mortgage and pay for the improvements. The loan carried an interest rate of 9.75% for the first two years, then a “margin” of 9.125 percentage points over the benchmark short-term rate at which banks lend money to each other — known as the London interbank offered rate, or Libor. The average subprime loan charges a margin of about 6.5% over six-month Libor, which as of Tuesday stood at 5.38%.

“I knew better than to be stupid like that,” she says. “But they caught me at a time when I was down.”

(ellipsis and emphasis mine)

Of course she knew better, but she was borrowing in an environment that seemed to encourage hucksters and dirtballs to actively seek out people in her position. And she was hardly the only one:

Raymond Dixon, a 36-year-old with his own business installing security systems, borrowed $180,000 from Fremont Investment & Loan in 2004 to buy a first home for himself, his wife and six children, across the street from Ms. Hollifield at 5151 West Outer Drive. After all the papers had been signed, he says, he realized that he had paid more than $20,000 to the broker and other go-betweens. “They took us for a ride,” he says.

Good grief. Sure, he got taken for a ride, and he should have known better, but what ever happened to the protections that are supposed to be built into the system to keep people from rushing into bad deals? That $20,000 for the broker and the go-betweens? It was based on the juice available when the interest rate reset and Dixon’s monthly mortgage payment went up by 33%.

But the other structural problem in the market is summarized here:

“You have no time to look really deeply at every single borrower,” says Michael Thiemann, chief investment officer at Collineo Asset Management GmbH, a Dortmund, Germany-based firm that invests on behalf of European banks and insurance companies. “You’re looking at statistical distributions.”

It’s possible to offer too much separation between lenders and risk, to the point where the lenders can rely on statistics, rather than reality, to comfort themselves that they’ve done well. And where the statistics tell untruths is in cases like West Outer Drive, where:

Subprime mortgages accounted for more than half of all loans made from 2002 though 2006 in the 48235 ZIP Code, which includes the 5100 block of West Outer Drive, according to estimates from First American LoanPerformance. Over that period, the total volume of subprime lending in the ZIP Code amounted to more than half a billion dollars — mostly in the form of adjustable-rate mortgages, the payments on which are fixed for an initial period then rise and fall with short-term interest rates.

That’s the other side of the coin, and the counterargument to whether redlining is occurring when “African-Americans are 6% and 29% more likely to get higher-rate loans”. When a neighborhood like West Outer Drive is inundated with homeowners who’ve been flatly taken advantage of by mortgage brokers who are unchecked by the financing system, the good risks get mixed in with the results of the bad, and the good risks become bad risks themselves, just due to neighborhood deterioration. Improperly managed, synonymous in my mind with “managed with far too many levels of indirection between borrower, property, and lender”, pockets of default risk can be found in any securitized mortgage pool. Mix the good with the bad and the mortgage pool can come out unscathed. Not so the neighborhoods with clustered risk that doesn’t register in the larger statistical picture of the mortgage pool.

The Basel Capital Accord of 1988, designed to manage risk in the global banking system, has been the subject of much debate since then. Among the many suggestions for change over the years, you could find many titles, such as “Reforming Bank Capital Regulation: Using Subordinated Debt to Enhance Market and Supervisory Discipline“. The key to such regulatory changes is simple – it ensures that a noteworthy chunk of a bank’s capital comes in a form that invites far closer scrutiny, from more sophisticated investors who have the power to shut a bank down if its operations seem to be spinning out of risk control.

If such a think makes sense for the banking system (and it does), it hardly seems rational to exempt the mortgage market from some strictures that would force its participants to be far more cognizant of the riskiness, and clustered risks, of its borrowers. Too much indirection in risk concern, let alone risk control, can have severe effects on neighborhoods, cities (Detroit needs all the help it can get), and social classes. I’m all for free markets and the ability to parcel out risk to willing buyers, but without any recourse to the ultimate purveyors of these poisoned dreams of homeownership (the mortgage brokers), the risk that’s being sold off into the mortgage pools is only imagined to be all the risk that really exists.

Why should regulation be considered to seriously crack down on the abuses? Because we’ve seen what happens when Detroit is in flames, including every Halloween. Left unchecked, this issue could become one in which the federal government is forced, politically, to step in and bail out those who’ve been fleeced. I shudder to think of the cost of that, political and financial, even though doing so seems more justified than spending billions to turn New Orleans back into something it never was.

Addendum – And no, rising Treasury yields aren’t going to be enough to solve the problem.



SEC Allegiance? What’s the mystery?

May 29 2007

In today’s WSJ, a story: “SEC’s Allegiances Are Put to Test“. Opportunities like this for achieving melodramatic judicial/regulatory outcomes occur periodically, given the repetition with which a given question is asked. The SEC, of course, has every right to attenuate its position on such matters, since things change over time, and with those changes come changes in regulatory stance. The Supreme Court hasn’t yet asked for an amicus brief from the SEC in a current case involving ongoing litigation in the Enron matter, but that hasn’t stopped melodrama seekers from making the request themselves.

When the Securities and Exchange Commission files a brief in legal disputes, it is usually a nonevent. But the cases usually don’t involve Enron Corp.

In recent weeks, the agency has been publicly and noisily pressured by a congressman, a union leader and a Democratic presidential candidate, amid increasing consternation the agency is favoring business interests in its decision making. As a result, the SEC’s decision about whether to weigh in on a Supreme Court case — as well as on a similar case seeking the high court’s attention — has become a test of its own motto: “investor protection.”

It seems that in 1994, the Supreme Court limited the ability of shareholders to sue third parties (presumed, by me, to mean primarily underwriters but I suppose it could include lawyers, accountants, and window-cleaners, among others) for “aiding and abetting” fraudulent activities on the part of their clients. I find that interesting, given certain examples of which I’m aware that came after 1994. Detail excerpt, from one of the 1997 cases against Donaldson Lufkin & Jenrette:

IV. On January 24, 1997, various money management firms and others who allegedly purchased and/or beneficially owned $116 million aggregate principal amount of Senior Subordinated Notes (the “Notes”) issued in May 1994 by Mid-American Waste Systems, Inc. (“Mid-American”) filed a complaint against DLJSC and a number of other financial institutions and several former officers and directors of Mid-American in the Court of Common Pleas, Franklin County, Ohio. The action seeks rescission, compensatory and punitive damages. The suit alleges violations of federal securities laws and the Ohio Securities Act, and common law fraud, aiding and abetting common law fraud, negligent misrepresentation, breach of contract, breach of fiduciary duty/acting in concert and negligence.

While I’m sure there’s a difference between my example and those supposedly scope-limited by the Court, the (highlighted) allegation at least throws some confusion into the mix.

The SEC itself last formally addressed the issue, known as “scheme liability,” in 2004. Then, the SEC filed an amicus brief in a case before a lower court in which it said that an investment bank may be classed as a “lead violator” if it intentionally engaged in a “deceptive act” as part of a scheme to defraud investors.

Seems clear enough – since the third parties (supposedly) cannot be sued for aiding and abetting, the class action hounds want to ensure that the legal system has left some avenue from which to attack them. I get that. What I don’t get is why the SEC is being “publicly and noisily pressured” to weigh in again on the matter, a scant three years after having already done so.

The SEC hasn’t been asked by the Supreme Court to file a “friend of the court,” or amicus brief, but lobbying by high-powered plaintiffs lawyer Bill Lerach, who represents shareholders in the Enron case, has boxed the agency into a corner. Unless it sides with shareholders, the SEC could be criticized as an ally of business for wanting to restrict the number of ways investors can sue.

Where the SEC comes down is “an absolute litmus test” of the agency’s leanings under Chairman Christopher Cox, said Ralph Ferrara, a former SEC general counsel who is now in private practice at LeBoeuf, Lamb, Greene & MacRae LLP. He thinks the agency should support the plaintiffs: “The SEC should be in there saying this is what’s best for small investors,” he said.

Great. A couple of lawyers, neither of whom impresses me with his past actions, want the SEC to reaffirm its stance as the protector of the otherwise bereft investors of America. Calling it a litmus test? Brilliant, unless you count the fact that the SEC already made its stance on this issue perfectly clear.

The issue in Lerach & Ferrara’s minds is apparently this: The SEC filed a brief earlier this year (in the Tellabs matter) that was seen by some to be “pro-business”, whatever that means.

In the brief, the SEC said investors need to establish a “strong” inference that defendants acted with fraudulent intent compared with a standard of a “reasonable” inference that is being challenged.

In response to complaints that followed the brief, the SEC said its view is in line with a majority of courts. Mr. Cox, a former Republican congressman, himself championed a 1995 law aimed at preventing frivolous lawsuits.

After reading it, a reasonable reader could (and I did) view the SEC’s stance not as “pro-business” in the Tellabs case, but “anti-frivolous lawsuit”.

That same reasonable reader could further infer that when Lerach, Ferrara, et al argue for the SEC to act clearly and unambigously for “investor protection”, they actually mean “class action lawyer protection”. Forcing companies to defend against ill-supported lawsuits does far more harm to investors than Lerach and his ilk would be willing to admit in public. The SEC’s already-articulated stance against frivolity cramps their style, without providing any sort of “litmus test” that the agency is acting against the interests of investors, notwithstanding Ferrara’s politicking in opposition.



Does the man protest too much?

May 25 2007

Seen in an article from today’s WSJ, Overstock.com Chairman and CEO Patrick Byrne is again in the news. Not for the first time this year, it seems that Overstock.com has lost another director: “Overstock Director Resigns, Citing Suit Against Brokers”. Ray Groves has resigned from the board. The storyline back on Feb 23, when John A. Fisher resigned? “Independent Director at Overstock Resigns Over Brokerage Lawsuit”. We’re way beyond having the makings of a pattern here.

Mr. Fisher, an investment-banking adviser who has served on Overstock’s board since 2002, praised Chief Executive Patrick Byrne’s leadership in his resignation letter filed with the SEC, but said he didn’t agree with the company’s lawsuit, which alleges a massive, illegal stock-market manipulation scheme by major brokerage firms.

It’s old news to anyone who’s followed this particular melodrama, but Byrne’s own father, John, resigned from the board on July 31, 2006. Initial reports (WSJ, March 3, 2006) claimed that he planned to relinquish his chairman’s post while remaining a director, and that he held of 9% of the company’s equity.

Among the reasons Mr. Byrne says he may leave that post is disagreement with one of his sons — Overstock Chief Executive Patrick Byrne — over the amount of time the younger Mr. Byrne is spending on a highly public battle with short-sellers and analysts the son alleges are conspiring to damage the company’s stock.

“I don’t think it’s a wise idea to be chairman with a headstrong son,” the elder Mr. Byrne added. However, he said he intends to remain on the board as a director and will also remain an investor.

Patrick Byrne has often referred to his fight with these shorts and analysts as a “jihad,” …

“I can’t tell whether this ‘jihad’ adds to the value of the stock or subtracts from it, but what it does is takes from Patrick’s time,” the father continued. He says he has voiced his concern to his son “endlessly,” but so far hasn’t been heeded.

(ellipses mine)

The current board of directors contains only 4 members for now. At least three directors, including his father, thought he was carrying his “jihad” too far.

The lawsuit at the center of the director resignations? (filing available at Overstock’s website)

Overstock’s $3.5 billion lawsuit, which alleges a massive, illegal stock-market manipulation scheme by major brokerage firms, including Morgan Stanley & Co., Goldman Sachs Group Inc., Bear Stearns Cos. and Citigroup Inc., has been a major source of tension within the company.

The Feb 2, 2007 filing named defendants, including those not listed above (BofA, Merrill Lynch, Credit Suisse, Deutsche Bank, BoNY, UBS, and “Does 1 through 100″), alleged to make up 80% of the prime brokerage market, based on “aggregate client assets”. That’s one way to measure size in the prime brokerage market, though I don’t know why it matters in this case. They could have radically simplified and shortened the filing without changing its meaning much simply by listing as defendants “Everyone”.

What is the problem they cite? You can read the full details either in the filing linked above or in the CEO’s FAQ at Overstock’s website, but in a nutshell:

  • When a trader believes a stock’s overvalued, s/he can sell it short, profiting if able to repurchase it at a lower price. The mechanics of this are similar to normal trading, in that s/he buys low and sells high, just in the opposite order.
  • In order to sell stock you don’t own, you must borrow it from someone who does
  • The purchaser of your short-sold stock has the stock “delivered” (normally electronic book notation), T+3, or three business days after trade
  • If the short seller, or the short seller’s broker, can’t locate stock to borrow, the book notation doesn’t occur, and a technical violation called a “failure to deliver” is triggered. Effective Sep 7, 2004, with compliance required from Jan 3, 2005, Regulation SHO was supposed to stop these failures to deliver, by forcing firms to do a “locate” (find borrowable shares), before selling on behalf of their own short selling client.
  • Marketmakers are generally exempt from this rule, for liquidity reasons
  • According to Byrne, the rule doesn’t work or isn’t enforced.

Having been on the sharp end of a shortseller campaign a time or two, I understand the Company’s instinctive reaction to try to do something about the problem. I’d even agree that some reaction is appropriate. My advice? Try addressing or proving wrong the naysayers, with actions not words.

Whining and bellyaching, on the other hand, are of no help. Ever. Neither, in the case of anything but the most solid and profitable company, is encouraging one’s stockholders to transfer all company stock from margin accounts into cash accounts, or worse, into physical share certificates. Such requests never come from solid and profitable companies, by the way, because they never have Overstock’s problem. Normally, such transfers would make it impossible for the stock to be lent. In Overstock’s case, it doesn’t matter, they claim, because their stock’s being naked shorted, and that the new buyers aren’t receiving the stock they bought. The effect of this, according to Byrne?

We know Overstock has sold just over 19 million shares to the world, but that the world seems to own between 35 to 40 million shares of Overstock.

Byrne is able to seem, in some cases, like a reasonable, intelligent executive. Heck, he might even actually be reasonable and intelligent. But I don’t know where he gets his numbers, either about number of shares naked shorted or supposed shares outstanding. Currently, it seems there are 21 million. And if he thinks that the imaginary 14-19 million phantom shares of stock are the reason the price is no longer $71 (Dec 2004), but instead $18.40 (today), then he should have no trouble rounding up private equity to take out the 21 million shares of equity, causing great financial loss, pain, and consternation to the supposed evildoers who’re trying to destroy his company. Pay no attention, of course, to the fact that as of Mar 31, 2007, several of his largest institutional holders happen also to be on the list of defendants in the Feb 2007 lawsuit.

He’s made his company a joke with his years-long battle against people who are either right, and the stock will go down, or they’re wrong, because he and his business model will be proven to be superior, causing his stock to go up and his short-sellers to lose the shirts on their backs.

PR and lawsuits on matters like this never work, and groups of aggressive shortsellers (as distinctly opposed to individual shortsellers) are, believe it or not, almost always right. The stocks they short don’t go down solely or even mainly because they sell them short or manipulate the market. They go down because they’re overpriced. Cause, meet effect.

As a side matter, the fact that marketmakers are allowed to naked short is interesting, particularly in the case of a small-cap stock like this one. If they decide to sell stock they don’t own or possess, they can do so until the cows come home. They risk getting smoked if the stock goes up instead of down, but they’re big boys.

Back during 1992 & 1993, a marketmaker and bankruptcy arbitrageur named the Scattered Corp sold short more of the stock of LTV than existed everywhere in the market. Think of it as naked shorting on steroids, pre-Regulation SHO. Scattered Corp made out like a bandit, along with any other short sellers in the market at the time, because when LTV exited bankruptcy on June 28, 1993, its stock was functionally extinguished, replaced with warrants valued at three or four cents per share. Gain? $27 million in 22 trading days, totally legal, and the result of nothing but legitimate use of the market. The inevitable legal case in the matter was styled “Sullivan & Long Inc. v. Scattered Corp.” and a Google search returns 20 or 30 links to other cases referencing it, plus an entry at the Scattered Corp. website, which is a copy of a pleading in a follow-on case by Scattered against the Chicago Stock Exchange et al, related to the LTV trading. That derivative case spells out the facts of Sullivan & Long Inc. v. Scattered Corp. pretty well. The original case was dismissed with prejudice, with dismissal confirmed on appeal. A highlighted version of the Seventh Circuit opinion (Judge Richard Posner’s court) in the dismissal is also available.

…the principal defendant, a Chicago Stock Exchange market maker (a dealer willing both to buy and sell a particular stock or other security for his account on a regular basis, 15 U.S.C. sec. 78c(a)(38)) with the alarming name of Scattered Corporation, sold short huge quantities of the old LTV shares. It sold short, in fact, tens of millions of such shares a week, for a total, when trading ended on June 29, of 170 million shares, far more than the 122 million old LTV shares outstanding. The excess of shares sold short over total shares outstanding is the focus of the plaintiffs’ complaint.

The effect of trading on an information advantage is to dispel, by penalizing, ignorance and to bring market values into closer, quicker conformity with economic reality. The profit that such trading brings at the expense of less knowledgeable traders provides the incentive for a private, for-profit firm, such as Scattered, to provide this economic service.

(ellipsis mine)

If you want to see an alternative take on naked shorting, the rest of the decision is an interesting read. See also the Business Week articles (from the 8/5/1996 issue), “The ‘Bad Boys’ of Chicago Arbitrage“, “The Secret World of Short-Sellers“, and two related tables, “The Truth About Those That Sell Short” and “Four Ways Shorts Get Stung“. (The rules under which Scattered did all of this have, of course, changed.)

The markets work when they’re allowed to work, as Byrne has apparently heard from at least three associates, along with their recommendation that he ought to focus on his business. If he dropped the matter and got on about proving his business really is a good one, in no time at all, the naked short problem would vaporize. Short sellers never do so for personal reasons – it’s always financial, and remans so until they’re proven wrong. Byrne does himself and his company no credit by feigning outrage and continuing his jihad.

Addendum – I hold no position in OSTK, long or short, by the way.
Addendum – 5/26/2007 – BusinessWeek details added



Well intentioned self-deception in the pursuit of rank politics

May 24 2007

This month’s dose of stupidity, widely and deeply covered everywhere (really, Google it if you don’t believe me – 17 million items found as of this writing), is the Comprehensive Immigration Reform bill (a variation which will only find you 1,180,000 Google hits).

I don’t pretend to be able to add anything new to the debate that’s not been said before, but think it interesting to note here, for myself, what’s right, what’s wrong, and what’s wildly fanciful about the process of this bill, as it progresses to its conclusion.

First, a couple basics that inform my thoughts on the matter:

  • Illegal immigration is just that – illegal, and it’s illegal for many reasons, not least of which is national security
  • We, as a nation, have failed lamentably in securing our borders, and the Immigration Reform & Control Act of 1986 was an honest attempt to remedy that, providing amnesty for 3 million illegal aliens
  • Depending on whose numbers you use, there are between 12 and 20 million illegal immigrants in the US today, most from Mexico and Central America
  • Clearly the 1986 act failed in every meaningful way to solve the stated problem
  • Undaunted, our legislative overlords are in the process of rushing through a new bill, to do the same thing, only larger by a factor of 3 to 6 times in scope
  • Amazingly, they pretend to think that this time, it will work, when a three year old could argue that it won’t, and win convincingly
  • Notwithstanding all the difficulties of this newly planned amnesty, uprooting 12 to 20 million residents and throwing them out of the country is too cold-hearted for most Americans, including me, to countenance
  • So we’ve got a problem here, and some rational compromise is required
  • Added for clarification: I don’t believe illegal immigrants, particularly from Mexico, come here primarily for the public benefits

However, the currently proposed immigration bill is assuredly not the compromise we need, and isn’t in fact a compromise at all – it starts on the side of aggressive generosity, and is now being whittled and wheedled (Pelosi – no skills tests, Bingaman – cut guest visa numbers from 400,000 to 200,000, risking calls for additional concessions and giveaways elsewhere, Bush – we can’t ask illegals to pay back taxes or fines) to become an even more toothless/worthless/harmful piece of legislation, one that will have the effect of throwing our Southern border wide open, and placing a drain on the country’s resources that will be bad for all, including the illegals presently here.

A page containing the summary status on S.1438 can be found here.
The full bill can be found starting here.

A quick look at the White House’s backgrounder page on the issue finds these nuggets:

President Bush Discusses Comprehensive Immigration Bill

“Immigration is a tough issue for a lot of Americans. The agreement reached today is one that will help enforce our borders, but equally importantly, it will treat people with respect. This is a bill where people who live here in our country will be treated without amnesty, but without animosity.”

President George W. Bush
May 17, 2007

Three Key Points About The Bush Administration’s Border Security And Worksite Enforcement Achievements

1. Since The President Took Office In 2001, The Administration Has More Than Doubled Funding For Border Security – From $4.6 Billion In 2001 To $10.4 Billion In 2007.

2. As A Result Of This Investment And Other Deterrence Factors, The Number Of People Apprehended For Illegally Crossing Our Southern Border Is Down By Nearly 27 Percent In 2007 From This Point In 2006.

3. Immigration And Customs Enforcement (ICE) Has Replaced The Old System Of Administrative Hearings And Fines With A Much Tougher Combination Of Criminal Prosecutions And Asset Forfeitures – A Much More Aggressive Approach Toward Cracking Down On Employers Who Knowingly Hire Illegal Aliens. This has resulted in a significant increase in arrests for criminal violations brought in worksite enforcement actions.

…&c, &c, &c.

All that would be grand, if it mattered at all – it doesn’t, and the reasons it doesn’t matter are precisely the same as those which guarantee the functional failure of the present proposal if it’s enacted. The number of people apprehended for violating our border is down 27%. Even assuming that this actually indicates better enforcement, it’s telling that the true numbers behind the statistic aren’t disclosed here. To the extent that the number of people who evade apprehension is any meaningful non-zero number, it proves enforcement, however much more is spent on it today, is a failure. 12-20 million existing illegals is further proof.

The increased enforcement actions touted in his third bullet point sound quite draconian, until you realize he’s not talking about enforcement actions against the myriad groups of wandering day laborers in cities like Houston and other border states. He’s talking about employer actions, because this is now and has always been all about ingratiating the Republican Party with the Hispanic community, legal and illegal. Color me unimpressed.

It’s not as though Bush hasn’t always claimed to want to fix immigration – he’s actually quite good at following through with his stated intentions (not always achieving the goals, of course, but he seldom drops an issue he claims to find important). The problem is that in particularly in immigration reform, where the electoral beneficiaries are far more likely to be his opposition, he continues to play deal-maker, and gives in at the hint of opposition, even when a rational assessment would indicate he’s being played like a rube. Bidding against oneself is never good. Doing so, as Bush is presently, against the wishes of the American people (46% against, vs. 26% for), and is clearly opposed by some of those he wants to carry water for him in Congress.

Remember that justification, above, for pushing the immigration bill through? No, not the one about simply trying to regularize a tough situation for a lot of present illegals – the other one, involving ingratiation? From the Rassmussen poll link above:

The challenge for proponents of the legislation is to convince voters that they are serious about enforcement and that the proposal will truly work. Until that can be accomplished, public opposition to immigration reform is likely to remain very high. In an era where voters overwhelmingly believe that members of Congress are more interested in their careers than the public good, that will be a difficult goal to achieve.

Groveling for future votes, in a manner opposed by present voters, seems pretty craven. And par for the course, to be honest.

Lindsey Graham (R-SC), has a couple pages on his website attempting to debunk what he calls the myths surrounding the bill. He’s also got a 4 page summary of the plan, in PDF format. Both do a creditable, if not credible, job of calming fears about what the plan is, and how it will work. They even provide specific answers to some of the more inflammatory objections put forth so far, such as Hugh Hewitt’s apparent misread, in which he came to the conclusion that the bill provides ICE 24 hours to approve or deny an applicant for the “Z Visa”, conferring semi-regular status. According to the mythbusters on Graham’s site, it appears Mr. Hewitt was wrong.

Both Hewitt and Dr. Thomas Sowell, whose opinion I generally find respectable and intelligent, appear to have facts wrong in a couple of places, including their shared assertion, including Sowell’s from an article published today at National Review Online, that the “the 700-mile fence on paper that has become the two-mile fence in practice”. The White House page linked above makes specific reference to “86 miles of primary fencing” in existence today. When the goal is 700 miles, 86 doesn’t seem a lot. When the comparison is 2 versus 86, the proponent of the lower number needs to support it, or be seen overreacting.

But time will tell, and these gentlemen’s skepticism, as well as that of others, seems well warranted by other actions on the part of this bill’s supporters. Including (ahem) Lindsey Graham (R-SC), while tongue-bathing a gathering of La Raza:

It’s a 4 minute video, and aside from the mealy-mouthed thanks to McCain and Kennedy, and the repeated attempts to be seen to be as Hispanic as his audience, the money shot is in the last 10 seconds, where he says
We’re going to tell the bigots to shut up.

Not smooth at all, and not indicative of comfort in his position, by a long shot. There’s also Michael Chertoff, the Secy of DHS, who has repeatedly made unkind assertions about anyone who doesn’t think the current proposal is tough enough:

MICHAEL CHERTOFF, HOMELAND SECURITY SECRETARY: You know, Wolf, first, I understand there’s some people who expect anything other than capital punishment is an amnesty.

…and

I understand that some people think it’s not tough enough. Maybe they want people thrown in jail for 10 years or they want people executed.

Also not smooth, and based on his repetition, apparently it’s part of the designated talking points.

As with the hideously expensive and poorly designed Medicare Part D entitlement extensions, which Ted Kennedy called “a good down payment”, to Bush’s complete lack of embarrassment, it looks as though Bush and his team are being led down a path to destroying the remaining credibility of the Republican party, while the Democrats laugh up their sleeves.

But that’s all just politics. What about the reality?

It’ll be completely unenforceable. The presumption that 12+ million illegals will willingly pay an immediate $1,000 penalty (the provision designed to pretend this isn’t an amnesty), followed by a $4,000 fee before getting a green card, exiting the country, and getting in line for years to get back in, is interesting, if a bit laughable. Even if the bureaucracy is mustered to put those requirements into effect (hardly a guaranteed happening), the alternative, simply remaining in the underground economy, remains, and might well be the preferable alternative. We’ve shown a complete inability to effectively manage this part of the population in the US over the past decades, and there cannot be a realistic expectation that this bill will suddenly change that.

If we’re not prepared to throw out all the illegals (and we’re not, nor should we necessarily be), we’re also not prepared to deal with non-compliance to the new legislation.

I’ll leave it for others to explain the third plank of inadequacy for this proposal. There’s the politics, the enforcement, and the ruinous cost to our economy. One prediction of that last bit can be seen in the May 10, 2007 testimony before the House Committee on Small Business by Robert Rector, of the Heritage Foundation. $2.5 trillion is a big, big number.

Addendum – For a rebuttal of Rector’s numbers, see this non-bylined piece in today’s WSJ.

For an interesting bit of alleged backroom intrigue, see “Pelosi: Immigration bill will pass over my dead body“.

See also this, I don’t know what to call it, so I’ll call it a “head fake”, from Dick Morris – “Republicans should back immigration compromise“. The crux of Morris’ argument appears to be encapsulated here:

Democrats want Hispanics to vote but don’t want them to work and compete with their labor union allies for jobs.

Republicans want them to work (since the employers are mostly Republican) but don’t want them to vote.

This bill, unfortunately, allows current illegal immigrants to work immediately but defers giving them the franchise for almost a decade. It’s a bill a Republican should love.

As arguments go, this one’s neither flattering nor convincing.



Congressional silliness, populism, or economic illiteracy?

May 23 2007

In a Houston Chronicle (AP) story from yesterday evening that I initially missed, I find that the “House approves anti-OPEC bill“.

WASHINGTON — Decrying near-record high gasoline prices, the House voted Tuesday to allow the government to sue OPEC over oil production quotas.

The White House objected, saying that might disrupt supplies and lead to even higher costs at the pump. The Organization of Petroleum Exporting Countries is the cartel that accounts for 40 percent of the world’s oil production.

My reaction wouldn’t be much different if they’d deigned to “allow the government to give every citizen a unicorn”.

The current, nominally “record high”, prices at the pump are a populist’s dream come true. They provide a platform from which our congressmen can cater to the least-intelligent of their constituents, those who think Congress can solve all problems.

“We don’t have to stand by and watch OPEC dictate the price of gas,” Judiciary Committee Chairman John Conyers, D-Mich., the bill’s chief sponsor, declared, reflecting the frustration lawmakers have felt over their inability to address people’s worries about high summer fuel costs.

Actually, John, yes you do have to stand by and watch, because it’s their oil, and they control both the price and the market availability of the basic commodity from which we get our gasoline.

Conyers accused the OPEC engaging in a “price fixing conspiracy” that has “unfairly driven up the price” of crude oil and, in turn gasoline.

His measure would change antitrust laws so that the Justice Department can sue OPEC member countries for price-fixing, and would remove the immunity given a sovereign state against such lawsuits.

OPEC is often referred to by its common name. No, not “The Organization of the Petroleum Exporting Countries”, the other one – “The OPEC cartel”. Here, from Chapter 1, Article 2 of the OPEC charter:

A. The principal aim of the Organization shall be the co-ordination and unification of the petroleum policies of Member Countries and the determination of the best means for safeguarding their interests, individually and collectively.

B. The Organization shall devise ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations.

C. Due regard shall be given at all times to the interests of the producing nations and to the necessity of securing a steady income to the producing countries; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on their capital to those investing in the petroleum industry.

Sure, they mention, in passing, the “economic and regular supply” for consuming nations, but their prime purpose for existence is to ensure their own well being. And everyone, with the exception of those impressed by this symbolic populism in Congress, knows this. The situational congressional populists themselves even know it.

I was initially left wondering what jurisdiction the US Congress and court system has on this matter. There isn’t an international law of which I’m aware that forbids cartels, even those which blatantly (and transparently, in OPEC’s case) seek to control price via production changes.

Consider as a case study in extraterritorial law enforcement the divergence between US laws on bribery (verboten) and those elsewhere outside the OECD (winked at in some places, positively ingrained in the social fabric in some others). Solution? Easy – the Foreign Corrupt Practices Act (as extended in 1988 and amended in 1998) attempts, and largely succeeds, to ensure that US persons and issuers of joint stock cannot pay (and therefore, presumably, can’t be forced to pay) bribes outside the US.

But applying such reverse judo to those within the US whose business involves transactions with OPEC isn’t so simple. If the government were to try clamping down on the buyers of OPEC oil, it would crush the US & world economies, long before it motivated change on the part of OPEC. It would likely be a massive failure, even as it separately had the desired effect. And perhaps worse, if OPEC blinked, and Congress’ effort didn’t fail, how would the US be any better than Hugo Chavez, another well known expropriator of others’ property?

Changing antitrust laws probably seemed like a great idea, until one realizes that the targets of such legal maneuvers are not subject to US law, being themselves sovereign states. So Conyers took it a step further, proposing the removal of sovereign immunity in an attempt to extend US law internationally. This is clearly bad policy, as the administration points out,

…because such suits could spawn retaliatory measures and lead to oil supply disruptions and an escalation in the price of gasoline, natural gas, home heating oil.

Just what we need – more oil supply disruptions, and the price eruptions that go with them. Thanks, Mr. Conyers! Assuming the Senate is equally so ill-advised as to attempt economic alchemy, Bush will surely pull out his veto sword for the third, count ‘em, third time. Won’t he?

In that same article, there was a vague hint of light near the end:

“Increased crude oil prices have played a relatively minor role in (the recent) increase in retail prices,” William Kovacic, a member of the Federal Trade Commission, told Stupak’s subcommittee. He said the price of benchmark West Texas crude increased no more than 15 cents a gallon over the last three months, while retail gas prices jumped 80 cents to 90 cents a gallon, depending on location.

But it was quickly overwhelmed by the acrid smoke of more economic illiteracy from Rep. Bart Stupak, of Michigan:

“Big Oil is often quick to blame world crude oil prices, but that argument doesn’t appear to be the full story,” said Stupak.

“While consumers pay record prices, oil companies are making record profits,” said Stupak. Refinery profits have jumped sharply to as much as 70 cents for every gallon of gasoline produced, he said.

No kidding? He’s saying that crude oil prices don’t appear to be the full story? Of course they’re not – once the oil is extracted, it has to be turned into gasoline and other byproducts. “Big Oil” knows this, just as Stupak does. And the economics behind that aren’t linearly related to the price of the inputs. Supply and demand play a huge part, and the availability of refinery capacity hasn’t exactly been steady this year. As an example, see the Reuters story from last Thursday, entitled “Oil surges to $70 on U.S. gasoline concerns“.

Despite record gasoline pump prices above $3 a gallon, there has been no let up in robust demand in the world’s top consumer.

That increase in demand, particularly in advance of the “summer driving season” starting Memorial Day weekend, coupled with refinery and pipeline disruptions is easy to pinpoint as the main driver in gas prices. (How that would drive the price of oil up escapes me just now, but if I’m eventually able to attribute rational basis to the Reuters headline writer, I’ll make an addendum to this piece.) If supply of refinery capacity increased along with the demand, price would stay steady, given steady input pricing.

But over the last 10 years, according to the US Energy Information Agency, refining capacity has increased from 15.6 million BPD in March 1997 to 17.5 million BPD in February 2007. That’s roughly 1.1% per year, and has come without the completed construction of a single new refinery in more than 30 years, relying instead on capacity upgrades at existing facilities, and even then at a rate too low to keep up with demand growth. Why? The cost of upgrades, let alone brand new plant, is out of control. From an Apache Corp report in March, 2007:

Many refiners now express reluctance to invest in expensive upgrades. Bruce Smith, Tesoro’s chief executive officer, noted recently that industrial development in India and China have forced materials costs (such as steel) upward, which in turn has pushed refinery construction costs higher. In some instances, costs have doubled from original bids.

While the latest figures as of this writing available at the DOE are for 2004, even then the daily demand for distilled oil products exceeded 20 million BPD. Stupak’s not alone in thinking the market’s rigged – the San Francisco Chronicle’s March 9 2007 story, “Refinery profit margins double in West“, tried hard to make the case that refiners in CA and elsewhere were “pulling an Enron”, by withholding supply in order to increase prices. Read the entire article, however, and both the refiners and the California Energy Commission make clear that there’s no incentive for them to do so.

So, among many factors, there’s your problem, Messrs Conyers and Stupak. Why not just force the US refiners to build even more capacity? Or force those greedy souls in China and India to quit competing for commodities that refiners need in order to build refineries affordably? Doing either would make precisely as much sense as pretending to force OPEC to quit being OPEC.



I guess that’s one indication of bad economics

May 21 2007

Who knew that trail mix was cheaper than corn? Not me, at least not until this morning’s WSJ article entitled “With Corn Prices Rising, Pigs Switch To Fatty Snacks“.

GARLAND, N.C. — When Alfred Smith’s hogs eat trail mix, they usually shun the Brazil nuts.

“Pigs can be picky eaters,” Mr. Smith says, scooping a handful of banana chips, yogurt-covered raisins, dried papaya and cashews from one of the 12 one-ton boxes in his shed. Generally, he says, “they like the sweet stuff.”

Mr. Smith is just happy his pigs aren’t eating him out of house and home. Growing demand for corn-based ethanol, a biofuel that has surged in popularity over the past year, has pushed up the price of corn, Mr. Smith’s main feed, to near-record levels.

Mr. Smith says he’s paying about $63 to feed a single pig for five or six months before it goes to market — up 13% from last year. His costs would be even higher if he didn’t augment his feed with trail mix, which he says helps him save on average about $8 a ton on feed.

(ellipsis mine)

The presumption that corn-based ethanol was somehow going to be a great net-positive for the US economy has always been based on the thinnest of pretense, put forward by the farm lobby in the US. As covered in an earlier post here (regarding Michael Bloomberg’s energy plan), corn is just about the stupidest way to make ethanol, perhaps second only to making ethanol out of oil itself, if such a thing is even possible.

And even if it were technically wise to do so, the mad rush to corn-based ethanol, driven by government mandates and subsidies that help nobody but the farm lobby, was always going to affect the supply/demand curve for corn.

Better late than never, there appears to be a sudden realization of the problem, if recent press mentions count for anything:

The items above are cherry-picked from among many, many other such recent stories. The last two are of a genre that puts the lie to the entire boondoggle being foisted onto the American consumer, particularly given that cane-based ethanol actually generates far more energy than it takes to produce, unlike corn-based ethanol. Cane-based suffers, however, from the choke-hold the farm lobby continues to wield on the American legislative windpipe.

Much the same as, say, in the waste industry, where at a high enough price for landfill space, people are willing to recycle, prices for oil in the energy market can cause people to willingly overpay for alternatives. But when the costs of the alternatives, direct and indirect, become high enough, as they appear to be doing in the ethanol market, consumers are certain to rethink that entire “energy independence” thing.

Corn based ethanol is “ethanol done wrong”. Add to that the fact that it’s “ethanol done expensive”, and you can just wait for the increased backlash, attempting to drown out the farm lobby. The question, of course, is whether our legislative overlords will be allowed to listen and undo the damage they’ve done over the past twenty years on this front.

A final tidbit from the WSJ piece:

Dwight Hess, a cattle feedlot operator in Marietta, Pa., is located in the heart of snack country, near Hershey and Herr Foods Inc., a maker of potato chips, pretzels and snack mixes. His cattle ration consists of about 17% “candy meal,” a blend of chocolate bars and large chunks of chocolate; 3% of what he calls “party mix,” a blend of popcorn, pretzels, potato chips and cheese curls; 8% corn gluten; and the remainder corn and barley he grows. He says the byproducts save him about 10% on feed costs. Still, it costs him about 65 cents to put a pound on a steer, up from 42 cents last year.

Near the Snake River in Idaho, Cevin Jones of Intermountain Beef is struggling to feed his 12,000 cattle in light of higher feed costs. Traditionally, he has used up to 30% corn or other grains in his feed mix. This year he’s using 100% byproducts, including french fries, Tater Tots and potato peels.

“It’s kind of funny,” Mr. Jones says, “every once in a while, you can spot a couple of cattle fighting over a whole potato.”

I suppose that soon, my family too will be able to eat junk food more cheaply than grains. I’m not looking forward to that, and I have something like 2% of the US population (plus 80% of the legislature) to thank for that sad fact.

See also – Corn Too Expensive? Turn Pigs into Ethanol



Speaking of head-hunting

May 18 2007

Democrats seek “no confidence” vote on Gonzales

As previously covered here, I don’t see the firing of the US Attorneys, itself, as an affair worthy of even 10% of the coverage it’s received over the past several months.

That said, the fact that the Senate is working to craft and pass a “no confidence vote” on Attorney General Alberto Gonzales’ tenure in his present office strikes me as far less silly than does the World Bank’s dogged (and successful) pursuit of Paul Wolfowitz.

The initial response to the Democrats’ concern over the firing of political appointees for (gasp!) political reasons was completely mishandled. Obfuscation, bluster, and confusion were the order of the day. None of this was required, and instead the response should have been to tell the Democrats to get stuffed, as it is the president’s prerogative to fire any of his appointees, without regard for the sensitivities of Democrats looking to make political hay out of thin air.

However, once the AG’s office acted as though they needed to explain the events, bordering on covering up the facts, it seemed clear that the AG wasn’t qualified to handle his office. Subsequent events haven’t been kind to his position, because each has seemed to provide yet another opportunity for him to demonstrate his cackhandedness in office.

Among those subsequent events, the May 14 resignation of Paul McNulty, Deputy AG, and the testimony on Tuesday, May 15, of James Comey, describing the attempts by Andy Card and Alberto Gonzales to get John Ashcroft, then in intensive care, to approve of an administration spying proposal.

Using only NPR as a signpost, have a look at the recent progression of this story:

Gonzales himself has recently opined that it looked like he’d weathered the storm, even while, in a complete reversal of form for anyone in the Bush administration, he took responsibility for the firings, sort of, -ish.

I continue to believe that nothing wrong was done in the termination of the US Attorneys. Far more important, though, is the focus on how the aftermath-that-shouldn’t-have-been was handled, and Gonzales has repeatedly shown himself to be a tone deaf stumbler during his defense.

Such a set of skills seems ill-suited to the highest levels of the Justice Department, and the Democrats (plus either 6 or 11 Republicans, depending on how you count, so far) seem likely to get their vote of no confidence passed, symbolic as it might be. Better still to hope for Gonzales’ resignation as a result, though, as a friend pointed out to me yesterday, how hard might it be to get confirmation for a replacement?



When they want your head on a pike…

May 17 2007

…don’t underestimate their ability to get it. Paul Wolfowitz has announced his resignation from the presidency of the World Bank. Having sensed the inevitability of the outcome, his Thursday started with an offer to resign on his own terms. From this morning’s Financial Times, in a story entitled “Wolfowitz discusses terms of resignation“:

Paul Wolfowitz yesterday began negotiating terms that could lead to his resignation as president of the World Bank. Last night the Bank board said the discussions had been adjourned and would continue today.

His lawyer, Robert Bennett, insisted he would not leave “under a cloud” and would rather risk the prospect of a vote on the board to dismiss him.

Given his repeated insistence, apparently supported by the facts if not by the rhetoric of his (many) enemies within the institution, that he’d done nothing wrong, neither his defense of his position nor his desire, after the defense has failed, to leave on his own terms can come as a huge surprise.

A quick summary of the case, from WSJ’s OpinionJournal:

  • Wolfowitz’s girlfriend, Shaha Riza, was a staffer at the World Bank before he became president in 2006
  • At the time he became president, he was directed by the bank’s ethics committee to find a new job for her, even though he asked to recuse himself from the task.
    The committee suggested an “in situ promotion” to the next paygrade or an “ad hoc salary increase” as part of a “settlement of claims.” The offer was intended to be generous, given that Ms. Riza–who already had been shortlisted for promotion–was being forced out of the bank, possibly for good, for a conflict she did not create and to a job she had not sought.

  • She got an assignment at the State Department, with a significant increase in pay
  • All hell has now broken loose, because he played a role in setting her new salary

Ms. Riza was eventually given an external assignment at the State Department with a salary (paid by the bank) of $193,000, up from the $133,000 she had previously made at the bank. To Mr. Wolfowitz’s critics, this was improper and excessive, especially given that Condoleezza Rice makes about $10,000 less.

For other background, see:

If one chose to ignore all the facts, the affair would seem very sinister, to be certain. But of course, it’s not at all. A reasonable person could look at the chain of events and come to the conclusion that Wolfowitz bent over backward to avoid both the fact and the appearance of impropriety. The near-50% increase in Ms. Riza’s salary looks odd, but the fact that it’s more than Dr. Rice makes is a red herring. In any event,

…this is highly selective outrage given normal procedure at the bank.

Of its roughly 10,000 employees, no fewer than 1,396 have salaries higher than the U.S. Secretary of State; clearly “fighting poverty” does not mean taking a vow of poverty at “multilateral” institutions. At the time of Ms. Riza’s departure from the bank, she was a Grade “G” (senior professional) employee; the typical salary in that grade hovers around the $124,000 mark. For the next level, Grade “H”–the level to which Ms. Riza was due to be promoted–salaries average in the $170,000 range, with an upper band of $232,360. No fewer than 17% of bank employees are in this happy bracket.

So, no, it’s not sinister in the least.

Sinister or not, Wolfowitz has now chosen to give up the ghost. As reported in tomorrow’s WSJ, “Wolfowitz Quits World Bank as U.S. Relents“. The mythical “reasonable person” could conclude he was railroaded. (For the record, the corrolary of the previous statement is not “Anyone who thinks he wasn’t railroaded is unreasonable”).

Unable to overcome charges of ethical misconduct, Paul Wolfowitz resigned as World Bank president yesterday within hours of getting a final White House signal that he should abandon a fierce battle save to his job.

So, why all the feigned outrage, and why the blatant politics involved in the ouster of Wolfowitz? At least four things, according to reports.

  • Most often reported is the Bank’s constitutional aversion to ensuring that it’s not flushing money down various ratholes. The signature of Wolfowitz’s administration at the Bank has been his anti-corruption drive. Doing so, of course, makes the jobs of the Bank’s staff more difficult, and it subjects them to standards they’re not used to, and unwilling to abide.
    Some of Mr. Wolfowitz’s accusers–notably, former general counsel Roberto Danino–are angry precisely because he upset their lifetime sinecure by demanding higher performance.

    So there’s that.

  • Also at issue is the discomfiture of the staffers from the other countries which comprise the Bank’s shareholders (of which the US is the largest) at the fact the US has named the last ten presidents of the Bank. Like many of the world’s international institutions, smaller countries get chapped at the continually recognition of the US present role at the head of the table, in terms of financial heft. In addition to their successful hounding of Wolfowitz from office, the rumbles for non-American leadership at the bank are flowing, as advocated at Reuters, pseudo-reported at the Globe and Mail, and surely made part of the palaver elsewhere.
  • Furthermore, there are those who trace the beginnings of this end to Wolfowitz’s involvement elsewhere, to matters utterly unrelated to his actions at the World Bank. An example can be found in the Telegraph story entitled “Downfall precipitated by Iraq war
  • And of course, the generalized “Bush Explanation”, from the Globe and Mail, prior to the resignation:
    The scandal that is likely to cost Mr. Wolfowitz his job was narrowly about favouritism toward Ms. Riza. More broadly, however, the showdown at the World Bank became a metaphor for Mr. Bush’s troubled relations with the rest of the world — and particularly Europe — over Iraq, the broader Middle East, global warming and trade.

Oddly, without giving any of them any credence for operational worthiness, each of those four rationale for his ouster seems far more solid than the one by which he was finally forced to fall on his sword.

Whatever the actual reasoning of those wanting a head on a pike, resourceful enemies in politics, just like activists in the business world or, for that matter, a group of sixth grade girls, can find a way to introduce chum into the water. And if they’re able to fool enough of the people enough of the time, they’ll get their man.

Possible successors, according to the New York Times?

Speculation about Mr. Wolfowitz’s successor ranged from Paul A. Volcker, the former chairman of the Federal Reserve, to Mr. Blair and Stanley Fischer, the finance minister of Israel and a former top official at the International Monetary Fund. Also mentioned have been various prominent figures on Wall Street, including Douglas A. Warner III, a former chairman of J.P. Morgan Chase and chairman of the Memorial Sloan-Kettering Cancer Center.

In addition, speculation has centered on two officials close to Mr. Bush: Deputy Treasury Secretary Robert M. Kimmitt and Robert B. Zoellick, a former deputy secretary of state.

There are some worthies in there, but I’d prefer Fischer be removed from the list, as he’s no longer American (relinquished citizenship and took Israeli residency) and I see no problem with continued American stewardship of the Bank.

My favorite two choices, not on the list? John Bolton, or failing that, Dick Cheney. Because sometimes, the best response to a defeat such as the US (no, not Bush, and not Wolfowitz – the US) has had jammed down its throat by the bureaucrats at the World Bank (or the other international institutions whose design allows the pretense that each crappy little country has just as much to add as all others) is the same thing, only more so.

Addendum – Worth reading, the after-action op-ed at OpinionJournal.



The art of the deal

May 14 2007

When attempting to transact business, whether selling a house, getting a tune-up, or engaging in high-stakes M&A, the responses received during the give-and-take don’t always help get to closure.

I’m not talking about the “No”. I’m talking about the “No, because…”.

The “…because…” isn’t always what it’s cracked up to be, and in many cases, isn’t even the truth. Among the many practices of the art of the deal, then, is finding a way to filter the wheat from the chaff. Getting to the truth is sometimes (not always) a prerequisite to getting to the answer, whichever way that answer goes.

Rupert Murdoch seems to be doing just that, according to today’s WSJ story, just in, entitled “Murdoch Sends Letter to Bancrofts“.

There’s been some noise about his offer being too low, but it’s been muted, and has primarily come from outside the controlling Bancroft clan and outside of Dow Jones entirely. The larger issue, at least the one everyone’s been banging on about, has been the presumed loss of editorial integrity which would come from News Corp ownership of the Wall Street Journal.

What better way to flush out the actual answer, then, than to make an offer like this?

In the letter, which was sent Saturday and distributed to family members on Monday morning, Mr. Murdoch offered to add a Bancroft family member to News Corp.’s 15-member board if the deal goes through. He also vowed to establish an independent editorial board to ensure the editorial integrity of The Wall Street Journal and Dow Jones’s other editorial operations. He did not raise News Corp.’s $60-per-share offer for the company, however.

Of course he didn’t raise the offer. Murdoch’s nowhere near the point in this transaction where he needs to start bidding against himself. Nobody, so far, has been able to muster the business logic needed to override the financial logic which allows him to pay well above the odds for the company.

Quite often, if not most of the time, when someone says “It’s not the money – it’s the principle”, a reasonable person can assume that, yes, in fact, it’s the money.

Murdoch’s latest action seems like a well crafted attempt to get to the real answer. If it’s solely a matter of principle, his proposal provides a compelling reason for the Bancrofts to reconsider. And if it’s not really principle at all, it could get them to admit that, and to propose a higher price themselves. Either way, he could be driving a wedge between the true purists who want to follow the family’s maxim “Never sell Grandpa’s paper.” and those, presumed to be the younger members of the family, who might feel otherwise.

While I’d guess (and have said before) that Murdoch would willingly pay more for Dow Jones, he doesn’t seem likely to do so blindly, or in a vacuum. The ball appears to be firmly in the Bancrofts’ court, within easy reach for a return.