hedge funds

Chrysler bankruptcy an opportunity to reject Obama nationalization

by John Berlau on April 30, 2009 · 2 comments

in Bailout Watch, Culture, Features, Politics as Usual

In the next 48 hours, Chrysler is expected to file for bankruptcy because, according to press reports, a significant minority of its creditors object to the Obama administration’s planned takeover in which the government and unions would own a majority stake. The Obama administration hopes to persuade the court to ratify and rubber-stamp its plan.  But the bankruptcy courts should exercise independent judgment instead, as they do in any typical bankruptcy case.

The expected Chapter 11 bankruptcy filing of Chrysler LLC is an action that probably should have happened months ago. It could have spared all involved the chaos of the ”political bankruptcy” we have seen unfold. The process of a judicial bankruptcy will bring a needed check to the Obama administration reorganization plan that heavily favors unions, at the expense of bond and debt holders.

The hedge funds that refused to be strong-armed into the Obama plan should not be blamed for asserting the interests of the investors they represent; investors that could include pension funds that serve middle-class families. The bankruptcy court should be allowed to be impartial and not be pressured to automatically take the plan offered by the Obama team. It should weigh the interests of all involved, using Chapter 11 precedent, and decide accordingly what each party is entitled to, as bankruptcy courts normally do.

The merger of Chrysler and Fiat the government has pushed is pure “industrial policy” of the type that led to stagnation in Japan and other nations where it has been practice. It may not be the most viable choice for Chrysler to specialize in smaller cars. Rather, a merger combination between Chrysler and General Motors with a concentration on larger vehicles such as SUVs may be the best option. This alliance had been discussed for years but was shelved because of concerns it might run afoul of antitrust laws.

The Obama administration should lift any antitrust barriers to effective reorganization — and suspend planned increases in the Corporate Average Fuel Economy standards that would be detrimental to Chrysler and other carmakers – but otherwise stay neutral as to the form the reorganization takes.

The relatively smooth process of recent large Chapter 11 bankruptcies, such as that of mall owner General Growth Properties, shows that far from being “disorderly,” judicial bankruptcies are far more orderly than taxpayer bailouts in unwinding and reorganizing insolvent companies. The judicial bankruptcy process should be given a chance to work in the case of Chrysler and any other companies that follow suit.

See also, my article in the American Spectator comparing the bankruptcy of General Growth Properties to that of the automakers.

Madoff: Hiding in Plain Sight, Thanks to SEC

by John Berlau on December 28, 2008 · 18 comments

in Bailout Watch, Features, Nanny State, Personal Liberty, Politics as Usual, Precaution & Risk, Regulation, Zeitgeist

When news broke of Bernard Madoff’s alleged $50 billion worldwide Ponzi scheme, news accounts first protrayed him as a shadowy hedge fund manager outside the scope of regulation by the Securities and Exchange Commission. But as the sheer magnitude of the fraud became clearer, so did the picture of Madoff’s place in the Wall Street-Washington world.

Madoff’s businesses were actually subject to a variety of financial regulations, something Madoff would actually use as a selling point to investors. Last year in a speech, Madoff said, “In today’s regulatory environment, it’s virtually impossible to violate rules.” He registered as an investment adviser in 2006, and had been under the SEC’s extensive regulatory framework for securities broker-dealers since he founded his firm almost 50 years ago.

And far from being a shadowy figure, Madoff was a pillar of the financial establishment. He showered campaign contributions on politicians, mostly Democrats. He was also quite chummy with many of the financial regulators charged with overseeing him.

For instance, Clinton administration SEC Chairman Arthur Levitt, who has championed onerous mandates like the burdensome Sarbanes-Oxley accounting mandates to preserve “market intergrity,” appointed Madoff during his SEC tenure to what the New York Times describes as “a large advisory commission … that explored the rapidly changing structure of the financial markets.”

An even closer connection was SEC assistant inspections director Eric Swanson who, according to CNBC reporter Charles Gasparino, “was part of the team that examined Madoff’s brokerage firm” in 1999 and again in 2004. “During those exams, the SEC team said it found almost nothing wrong,” Gasparino writes in The Daily Beast. In 2007, after leaving the SEC, Swanson married Madoff’s niece Shana, who is the regulatory compliance attorney at her uncle’s firm

While there is no evidence of wrongdoing with regard to Madoff by either Levitt or Swanson, SEC officials, for whatever reason, looked the other way, despite numerous allegations and “red flags,” some received as early as 1992. And since 1999, rival investment manager Harry Markopolos had sent the agency detailed analysis of why he though Madoff consistent postive returns were mathematically impossible without running a Ponzi scheme or insider trading. In a 2005 submission he made to the SEC that was recently made public by the Wall Street Journal, Markopolos charged that it was “highly likely” that “Madoff Securities is the world’s largest Ponzi scheme.”

But despite the SEC’s incompetence in heeding these warnings, many are still arguing that to prevent future Madoff-type frauds, we need more regulations that give more power to the SEC. But it’s hard to see how any additional powers could have made a difference in this case, given that the SEC almost seemed determined to look the other way for violations of the most basic rules against securities fraud that had long been in place.

Since hedge funds were among Madoff’s clients (and biggest victims, as this WSJ editorial points out), calls are again being intensified for further hedge fund regulation to bring them under the cumbersome registration process for investment advisers. (The SEC already has full authority to investigate hedge funds and other unregistered investment entitities if there are suspicions of fraud.) This is what the agency tried to do a few years ago, only to have a three-judge federal appeals court panel throw out the rule in 2006 in a unanimous finding that the agency had stretched the law.

But the SEC can’t argue that this would have helped them prevent Madoff’s fraud, because, as noted above, Madoff had registered as an investment adviser in 2006, and was registered as a broker-dealer for decades.

This broker-dealer registration gave the SEC full power to investigate all affiliated businesses. As MarketWatch commentator David Weidner pointed out (in a column with a curious headline about “lack of regulation” that is the exact opposite of the author’s point — often columnists, unlike bloggers, don’t wite their own headlines), “Broker-dealers are supposed to be the most scrutinized of the investment community. If Madoff was running separate businesses, the SEC and FINRA should have been looking at all of them as a whole.”

In fact, the fact that Madoff was under such heavy regulation probably helped him in constructing the alleged facade. As business reporters Binyamin Appelbaum and David S. Hilzenrath wrote in their perceptive Washington Post article, “the fraud Madoff allegedly constructed was successful in part because it avoided the appearance of risk.” The article quoted an expert as saying that SEC regulators “had to make judgments, and they decided to look at derivatives, short sales, insider trading, all the things that Madoff never had.”

So The SEC was too busy hounding unregistered hedge funds, short-sellers, and entrepreneurial companies for trivial minutiae from Sarbanes-Oxley and other mandates to notice the fraud right in front of them. The regulators didn’t just “drop the ball,” as President-Elect Barack Obama recently asserted. They lost focus on where the most important “ball” was.

Getting that “ball” back by paying attention to warning signs about where the real fraud is, and rolling back the mounds of red tape on honest investors and entrepreneurs that also wastes the time the agency has to go after the real problems, must be the number one priority of newly designated SEC chairman Mary Schapiro.

In mortgage modifications, property rights of investors must be respected

by John Berlau on November 12, 2008 · 3 comments

in Bailout Watch, Economy, Legal, Personal Liberty, Politics as Usual

Today, in addition to Treasury Secretary Henry Paulson’s expected announcement of a major mortgage modification plan through the $700 billion TARP, Barney Frank’s House Financial Services Committee is holding a hearing entitled “Private Sector Cooperation with Mortgage Modification.” However, despite the word “cooperation” in its title, it’s clear from letters Frank and others sent out that the hearing will be confrontational rather than cooperative. Specifically, Frank and some fellow committee members seek to villify investors in mortgage-backed secuties who assert their property rights under contracts with banks servicing the mortgages.

The harsh tone was set in a letter that Frank and fellow committee Democrats, including Carolyn Maloney, D-N.Y., and Maxine Waters, D-Ca., sent to investor William Frey. The representative wrote that they were “outraged” the Frey was opposing their “voluntary efforts” to “achieve a dimuntion in foreclosures” through the Federal Housing Administration refinancing plan mortgage bailout passed this summer. They then urged him to “reverse his position of trying to obstruct the operation of the bill.” So much for “voluntary,” huh.

But all Frey was doing was asserting the basic American property right of having a contract upheld. Because of securitization, many mortgages are not the banks to modify. Instead they are owned by investors, including pension funds holding the savings of the very middle-class families Frank and others are trying to help. In my OpenMarket post a few months ago, “Abrogating Peter’s Contract to Pay Paul,” I noted that according to investment bank Credit Suisse, 14 percent of MBS are owned by pensions and mutual funds that serve middle-class savers. So a big bailout, I wrote, “not only ‘robs Peter to Pay Paul,’ through taxpayers’ bailout of bad loans by banks and borrowers. It can also be said to ‘abrogate Paul’s contract to Peter.’”

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