ProfessorBainbridge.com

Reform LIBOR, don't scrap it

In today's WSJ, economist Richard Grossman argues we should scrap the London Interbank Offering benchmark rate (LIBOR). To be sure, as Grossman argues, the LIBOR rate has been plagued by scandal:

Because so much money is riding on Libor, banks have an incentive to alter submissions—up or down, depending on the situation—to improve their bottom lines. Many in the financial community had long known about Libor manipulation. As early as 2008, then-president of the Federal Reserve Bank of New York Timothy Geithnerwarned the Bank of England that Libor's credibility needed to be enhanced. E-mails between bankers that have come to light since the scandal broke almost a year ago prove conclusively that cheating was commonplace.

Instead of fixing LIBOR, however, Grossman wants to scrap it:

The British government should announce that, six months from today, Libor will cease to exist. The British Bankers' Association, which technically owns the interest-rate index, has been so wounded by the scandal that it has been willing to follow the government's lead and will no doubt agree.

And how will markets react? The way they always do. They will adapt.

Financial firms will have six months to devise alternative benchmarks for their floating rate products. Given the low repute in which Libor—and the people responsible for it—are held, it would be logical for one or more market-determined rates to take the place of Libor.

Grossman's argument is fraught with error. First, he far too glibly assumes that markets will easily adjust. But LIBOR is not just used in spot markets, which could adjust in the short term, but is also used in countless long-term contracts. As I explain in my article, Reforming LIBOR, attempting to replace LIBOR with an alternative benchmark likely would have triggered massive dislocation--and, as a result, massive litigation. In addition, the extensive network effects associated with LIBOR suggest that change would be costly due to path dependency.

Second, it's not obvious that there are any plausible alternatives to benchmarks based on interbank lending. Grossman argues that there are at least two:

One often mentioned candidate is the GCF Repo index published by the Depository Trust & Clearing Corp. This index is based on actual repurchase agreement transactions, and is thus a better indicator of the cost of funds than banks' internal estimates—even if those estimates were unbiased. Another option might be some newly constructed index based on credit-default swaps transactions, corporate bonds and commercial paper.

Like other interbank offering rate benchmarks, however, LIBOR submissions combine three components: (1) compensation to the lender for the time value of money, (2) compensation for the risk that the counterparty bank will default, and (3) a liquidity premium reflecting market transaction costs.  This combination has proved highly useful for lenders. It allows lenders to pass on changes in their funding costs to borrowers and thus minimize basis risk, for example, by pegging the borrower’s interest rate to LIBOR plus an appropriate risk premium reflecting the borrower’s creditworthiness.  As such, if the lending bank’s funding rate rises, so too will the rate the borrower must pay, ensuring that the lending bank will continue to receive the full risk premium. Grossman's alternative index based on CDSs etc... lack those characteristics.

The GCF Repo index also differs from bank funding costs, consisting of "the average daily interest rate paid for the most-traded GCF Repo contracts for U.S. Treasury bonds, federal agency paper and mortgage-backed securities [MBS] issued by Fannie Mae and Freddie Mac." The GCF Repo index also is problematic because it's based on US instruments. One of LIBOR’s major advantage is that the London time zone allows it to straddle the Asian and U.S. markets. 

Finally, Grossman ignores the reforms that the UK government has put into place to ensure that the reformed LIBOR benchmark will be less vulnerable to manipulation. Specifically, LIBOR submissions will be based on a hierarchy of transaction types. A panel bank first looks to its own transactions in the inter-bank deposit market, in other deposit markets such as commercial paper, and finally in other related markets such as derivatives. In the absence of good data from such transactions, a panel bank next looks to its observations of third party transactions in those markets. The third tier of the hierarchy consists of third party quotes to panel member banks in those markets. Only in the absence of any such transaction data should a panel member rely on an estimate in making its LIBOR submission.

In order to further strengthen the link between LIBOR and actual transaction data, the number of currencies and maturities for which a LIBOR benchmark is quoted are to be reduced by eliminating currencies and maturities traded in particularly thin markets. 

In sum, the case simply has not been made for scrapping LIBOR. Instead, we need to be careful to ensure that the new administrator is well supervised. This is so, because Grossman is right about one thing: NYSE Euronext is a suspect administrator. The BBA failed in large part because it had no skin in the game. NYSE Euronext has the opposite problem; i.e., too much skin in the game:

British authorities earlier this month granted a contract to run the index to NYSE Euronext, a company that owns the New York Stock Exchange, the London International Financial Futures and Options Exchange, and a number of other stock, bond, and derivatives exchanges. NYSE Euronext is scheduled to be taken over by IntercontinentalExchange, a firm which owns even more derivatives markets.

In other words, the company that will be responsible for making sure that Libor is set responsibly and fairly will be in a position to profit like no one else from even the slightest movements in Libor.

The UK regulators will need to closely supervise NYSE Euronext to ensure it doesn't cheat and be prepared to force NYSE Euronext to step aside if necessary. But that's an argument for supervision, not for scrapping the whole project.

Hedge funder Boykin Curry sends email asking for Wall Street support for Spitzer

As one Wall Streeter aptly paraphrased Curry's absurd argument:

“Vote for Spitzer: He may be a whore-monger, but at least he’s an arrogant bully — and doesn’t owe anyone anything, because his daddy set him up just like mine did!”

via www.nypost.com

Leathers tweet of the day

That poor naive girl, with her dreams of one day becoming Sydney Leathers Danger Weiner.

— Molly Ball (@mollyesque) July 24, 2013

Can LoPucki make the DGCL more readable?

My friend and UCLAW colleague Lynn LoPucki argues that:

Although artfully drafted, the Delaware General Corporation Law (DGCL) is unreadable. Sentences are excessively long – one rambles on for nearly two pages. The DGCL sometimes follows the standard convention that divides complex statutory sentences into multiple paragraphs. But more often the DGCL defies convention by burying several sentences on different topics in a single paragraph. Roman numerals denoting list items hide undifferentiated in the midst of long block paragraphs. Although the DGCL’s section headings are informative, sections are sometimes long and subsection headings are non-existent. Add to these problems the inherent difficulty in all statutory interpretation, the complexity of corporate law, and the excruciating explicitness of the Delaware drafters, and the result is an impenetrable law. All but the most determined readers simply bounce off.

It is probably true that the MBCA, to cite but one relevant example, is easier to read than the DGCL, although after 25+ years of dealing with I rarely have trouble with the DGCL. But Lynn thinks he can do better:

This pamphlet presents a readable version of the DGCL (RDGCL). Some readability is through standard typographical techniques. The RDGCL employs running heads, squares and indents entire paragraphs rather than merely the first lines of paragraphs, uses leading to visually separate paragraphs, and bolds paragraph and subparagraph numbers – including those troublesome list denoters.

But what most enhances the RDGCL’s readability is the application of a grammar-based marking system (VisiLaw) to the statutory text. The markings visually separate sentences, and clauses within sentences, making it possible to see where each begins and ends. This ability to see structure at a glance makes it possible to read clauses one at a time without losing orientation in the overall structure. Within each constituent clause, underlining identifies a skeletal sentence – subject, verb, direct object and a few other words. The underlining enables the reader to quickly get the gist, and understand the structure, of the constituent clause. Marks are catalogued in a single-page Key to Visilaw Markings and the system is explained in a lengthier Introduction to the VisiLaw Marking System.

Candidly, I'm not sure the Visilaw system helps all that much, but maybe I just need to play around with it more. And, as always, your mileage may vary. So try it for yourself.

LoPucki, Lynn M., The Readable Delaware General Corporation Law (July 10, 2013). UCLA School of Law Research Paper No. 2013-14. Available at SSRN: http://ssrn.com/abstract=2292236

It's not laxness that's the problem

Matthew Yglesias tries to tell us not to worry about the revolving foor problem when SEC enforcement lawyers take the big bucks from private practice:

Robert Khuzami stepped down as director of the Enforcement Division at the Securities and Exchange Commission about six months ago, which naturally prompted speculation about where he would land. Today's New York Times has the story from Ben Protess and Peter Lattman about his new gig at Kirkland & Ellis, a major corporate law firm, complete with all the gory details about the pay package ("more than $5 million a year"), the benefits, the other big firms that wanted to recruit him, and most of all "the quintessential Washington script: an influential government insider becoming a paid advocate for industries he once policied."

And here's where I think it's important to step in with the realization that the news media has, for various professional and economic reasons, a tendency toward a systematic negativity bias. Imagine a scenario in which S.E.C. lawyers had a really hard time getting private sector jobs and almost invariably ended up needing to take a pay cut to obtain a position outside of the government. Then we'd get lots of stories about overpaid and incompetent federal bureaucrats, living high on posh government salaries (S.E.C. lawyers don't earn much compared to top private sector attorneys, but they definitely earn more than the average American) despite a lack of viable skills or job prospects. You're damned if you do and damned if you don't because "Longstanding Practice Is Basically OK" is not very a good story pitch to your editors. But there's actually specific academic research on the question of how the revolving door impacts S.E.C. enforcement actions and it concludes that S.E.C. lawyers who rotate out into the private sector are more aggressive in their enforcement efforts than those who don't.

If you manage to unplug from the revolving door narrative for a second, you can see why this makes sense—if you spend your time as a government lawyer being extremely lackadaisical in your prosecutorial efforts that's going to make you look like a bad lawyer who people don't want to hire. If you want to cash in some day, you want to have the reputation of being someone who's really smart and tough and effective and who understands how to make cases. That's the kind of lawyer who the private sector wants to hire.

As Yglesias essentially admits by his reference to the stdy by Ed Dehaan et al., this is neither new nor novel. Of course, career laxness will do you no good. But so what?

The revolving door problem for enforcement lawyers isn't about encouraging laxness. It's partly about final period problems. Once an enforcement lawyer is reasonably sure where he'll land, he has an incentive to take it easy on that firm's clients.

But the revolving door problem also is partly about the precise opposite of laxness:

Underlying the revolving door is a pernicious underbelly of overzealous and often unfairprosecutions, juked conviction stats, and a culture of plea-bargaining that is spiraling out of control, all in order to bring down some of the biggies in the business world. In short, the revolving door is facilitated by a federal criminal justice system geared more for making prosecutors’ reputations on the scalps of private sector companies and executives, than for achieving true justice.

What is true of DOJ prosecutors is equally true for SEC lawyers.

In addition, of course, Yglesias' argument only works for enforcement lawyers. As far as regulatiory lawyers (such as those in the SEC's Corporate Finance or Market Regulation divisions), the revolving door does create perverse career incentives to generate unnecessary red tape.

Stephen Diamond spanks Paul Campos

Is law school a positive NPV capital investment? Diamond schools Campos on the question.

Executive compensation panel

Jim Barrall and other executive compensation experts participated in a spreecast at the WSJ.

Telemarketers: I want a way to hit back ... very, very hard

The LAT tells us the obvious, namely phone scammers are ignoring the do not call registry:

Regardless of having registered a phone line with the Federal Trade Commission as a telemarketer-free zone, a growing number of consumers are saying that some businesses are ignoring their stated preference and calling anyway.

A particular annoyance: automated robocalls that get you on the line before looping in a human telemarketer. Such calls frequently use "spoofed" lines that hide their origin or make it look as if the call is from someone you know.

"I've given up answering the land line," said Rory Johnston, 67, of Hollywood. "They're nearly all robocalls."

It's not people's imagination that telemarketers are stepping up their game.

"We're definitely seeing an uptick in consumer complaints," acknowledged Lois Greisman, associate director of the FTC's division of marketing practices, which oversees enforcement of the do-not-call list.

Here at PB.com, we get about 5-10 calls a week from some outfit that calls itself various versions of the Home Improvemt Center. (It seems I'm not alone.)

It's an obvious scam, as they claim to have done work for us in the past, which is a bald faced lie (how dumb do they think we are). I assume they want to set us up for some sort of robbery (or maybe just fraudulent home repairs). As the LAT observes, the phone companies charge you an arm and a leg (well, a couple of toes, anyway) for "solutions" that don't work:

In California, Verizon charges $2.50 a month to block calls from anonymous numbers, although this won't stop spoofed numbers. The company also charges $4 a month to block calls from up to a dozen local numbers, but this will still allow "800" numbers to get through.

AT&T charges $7.50 a month for each of the same services, though the company says some customers may have them included in their calling plans.

If it doesn't stop 800 numbers or spoofed numbers, what good is it?

So I've tried being polite, hanging up, yelling, and nothing works. Now I want a way to hit back. Maybe some sort of computer virus that one could send back down the phone lines or something. Where's a public spirited hacker when you need one?

 

Eliot Spitzer - The Poster Child for Shareholder Activism

Compared with governor, city comptroller is obviously a downwardly mobile plunge, but Spitzer said he has long appreciated the ability of the office to shape public policy, impose accountability on the budgetary process, and, with its critical role in managing more than $100 billion in public employee-pension funds, wield influence on Wall Street and how large corporations govern themselves.

Asked about reports that his time in the wilderness has made him more mature since he resigned as governor in March 2008, he laughed and said, “That may have been a low threshold.”

Spitzer told me he would be an activist comptroller who would attend stockholder meetings on occasion and offer his two cents, whether solicited or not, on who should be appointed to the boards of various corporations in which New York City’s pension funds hold stock. “In my book, I say that ownership trumps regulation and ownership trumps prosecution as a way to get good governance in corporate America,” Spitzer said.

via www.thedailybeast.com

When Spitzer gets elected and gets to run the NYC pension funds, the people (you know who they are) who claim that state and local pension funds are run by saints--not union thugs and Democrat pols--will have some explaining to do. Spitzer will be the highest profile political hack running a pension fund, but he's hardly alone. Spitzer will be the highest profile politician running a pension fund to benefit the Democrat Party, but he won't be the only one.

Spitzer Reveals Income, but Not the Tax Returns a Rival Sought

The Stringer campaign pointed out that Mr. Spitzer used to release his full returns every year.

In 2006, when he was the state attorney general and running for governor, Mr. Spitzer described it as “the right thing to do.” Last year, as a television political pundit, he asked why Mitt Romney, the Republican presidential nominee, would not release his tax returns.

“The old Eliot Spitzer supported stringent financial disclosure,” Mr. Stringer’s spokeswoman, Audrey Gelman, said. “Just as we’ve seen on his decision to abandon campaign spending limits he once supported, it’s increasingly clear that Eliot Spitzer believes there are two standards in public life — one for him, and one for everyone else.”

via www.nytimes.com

Gordon Crovitz on the NY AG's absurd suit to block Thomson from selling its own property

Since World War II, University of Michigan economists have produced the definitive research on consumer sentiment. Their twice-monthly surveys of household spending are used by everyone from policy makers at the Federal Reserve to Wall Street traders.

But thanks to an arbitrary threat of prosecution by the attorney general of New York, Eric Schneiderman, this high-quality research is no longer going to be available to anyone, any time.

Mr. Schneiderman proudly announced earlier this month that the hedge funds that had covered the costs of the Thomson Reuters/University of Michigan Surveys of Consumers will no longer get a two-second advanced feed of these data. He claimed he was striking a blow for a "level playing field." Instead, he struck a blow against research and information. ...

 

Mr. Schneiderman's legal theory would have banned Paul Julius Reuter from using carrier pigeons in the 1850s to get news to his subscribers in Europe faster than anyone else. Charles Dow and Edward Jones wouldn't have been able to use the new ticker machine in the 1880s to sell brokers real-time Dow Jones news. Michael Bloomberg would be banned from delivering his financial data only to people who can afford $20,000 a year for a terminal. Tens of thousands of business publications, trade associations and private research firms that charge for content would also fail a level-playing-field test. ...

A final point: The Wall Street Journal is not available free, which is another violation of Mr. Schneiderman's mythical level playing field. If that's really a crime, this columnist pleads guilty.

via online.wsj.com

Tweaking pay for performance measures

One of the big problems with the whole idea of pay for performance is how you measure both pay and performance. Because executives receive many different forms of compensation, much of it deferred in various ways and some of it in kind (e.g., various perks), there are serious problems with figuring out exactly how much they are being paid. Conversely, because there are many ways of measuring performance, there are at least as many problems at that end.

In light of the rising influence of proxy advisory services, such as ISS, which purport to use pay for performance metrics in making various voting recommendations, the question of whether outfits like ISS are getting it right has become quite important. A recent paper by Stephen O'Byrne offers some very pertinent criticisms and suggestions in that regard:

Institutional Shareholder Services (ISS) announced a new approach to evaluating pay for performance in late 2011. This paper explains the new approach, highlights four significant weaknesses of the new approach and explains how ISS could substantially improve its Pay for Performance Model, now and in the future. Without making any change in the data it collects, ISS could improve its assessment of pay for performance by: (1) adopting more meaningful measures of the three basic dimensions of pay for performance – pay leverage, pay alignment and pay premium at industry average performance, (2) defining reasonable trade-offs between leverage, alignment and cost, (3) changing its peer group selection methodology so it’s selecting labor market peers, not companies that fall in the same sector but don’t compete for the same talent, and (4) giving examples of simple compensation programs that provide perfect pay for performance. In the future, ISS could provide more value to investors by using "mark to market" pay to calculate better measures of pay leverage and alignment and by using stock ownership and mark to market pay to calculate a more comprehensive measure of the CEO’s shareholder value incentive ("wealth leverage").

CITE: The ISS Pay for Performance Model (May 24, 2012). Available at SSRN: http://ssrn.com/abstract=2289360

Dear SEC and NY AG: When it comes to regulating the capital markets, please screw us little guys

In the article discussed in the post below, NY Times columnist James Stewart opines that:

A vast network of laws and regulations is aimed at creating a more level playing field for investors, like criminal laws that ban securities fraud and the S.E.C.’s Regulation Fair Disclosure, which requires companies to widely disseminate market-moving information about themselves. Consider also the simultaneous public release of government information like employment data and the Federal Reserve minutes.

The goal is not just fairness, but to make capital markets more robust by encouraging the public — not just professional speculators — to invest.

“The reason America’s markets are the best and strongest markets in the world is that individuals always believed they could get a fair trade,” Mr. Schneiderman told me this week. “If you did your research well, you weren’t at a disadvantage because of information you couldn’t possibly access. It wasn’t a rigged casino.”

Bullshit.

I've been thinking about this for a long time (since about 1988) and I've concluded that retail investors who have the common sense God gave gravel know they have no business playing in the fast lane of individual stock trading. Instead, their money is safey tucked away in a small but diverse portfolio of no-load, low expense, passively maanged index funds, as Burton Malkiel has been telling us for decades in multiple editions of A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing. As an investing little guy myself, I've advocated that strategy for years on this blog and I put my money where my mouth is. Every dime of my savings is in such a fund.

Regulators do investors no favor when they encourage them to compete with the big boys. Instead, regulators should be doing everything they can to persuade us little guys to flock to index funds.

The NY AG brings socialism to the capital markets

If I build a better mousetrap, I am free to sell it to whoever I want at whatever price I want (setting aside invidious discrimination). Right? I mean, this is a free society, right?

Not according to folks like New York Attorney general (and general all-around busy body) Eric T. Schneiderman, the pinkos at the NY Times, and Columbia law professor John Coffee, all of whom think I should have to give it to anybody who wants it:

On Friday morning, Thomson Reuters released the latest University of Michigan Consumer Sentiment Index, as it does twice a month. But this time was different. As a result of a settlement Thomson Reuters reached this week with New York’s attorney general, Eric T. Schneiderman, a select group of its customers didn’t get the two-second advance release they’d been buying. ...

While Thomson Reuters agreed to suspend the two-second advantage while his investigation continues, its regular clients get a five-minute jump on the general public, which gets the data at 10 a.m. Thomson Reuters pays the University of Michigan close to $1 million a year for the right to distribute the data.

The five-minute edge may well be the next target, since either everyone gets the information at the same time, or they don’t, whether the gap is seconds, minutes or hours. ...

For some market experts, the attorney general’s move is long overdue. Mr. Schneiderman is “a mile ahead of the Securities and Exchange Commission, which has to be dragged slowly and grudgingly toward raising the standard of behavior,” said John Coffee, a professor and expert on securities law at Columbia Law School.

Apparently, expending effort to develop valuable information and then selling it to the highest bidder is a standard of behavior to which Professor Coffee does not stoop. But this is the same guy who thinks I belong to the tea party caucus of the corporate law academy.

Astonishingly, the author of the Times article eventually manages (it's buried at the end of the article) to point out that reasonable people might have a different view:

Legal standards aside, many market experts worry that the attorney general’s crackdown may go too far and discourage the kind of enterprising research that has long made markets more efficient, whether undertaken by short-sellers hoping to profit directly on it, Wall Street investment banks that sell research to their clients, or investigative journalists.

“The notion of a level playing field is important, and it’s important to aim for it,” said Harvey Pitt, a former S.E.C. chairman and now the chief executive of the consulting firm Kalorama Partners. “But a level playing field can’t mean everyone has the same information. People need financial incentives to dig up information, and the marketplace benefits.”

It's a simple idea: "People need financial incentives to dig up information, and the marketplace benefits.” But apparently great NY minds just can't seem to grasp it.

Regular readers of this space, however, may recall that I made much the same point back in June in a post that explained why it's perfectly legal to do what Thomson is doing (as a matter of federal securities law, which may be why the SEC isn't rushing to turn Coffee's preferences into law) and which concluded that:

If this so-called "blind spot" were to be patched with legislation banning such transactions, the effect will not be to ensure that all investors have equal access to this sort of information. Instead, the effect will be that nobody will have access to it because such information simply won't be produced:

Richard Curtin, an economist who runs the university's survey, said he knows the deal gives an advantage to select investors.

"Hardly anyone would pay for it if they didn't see a profit motive," Mr. Curtin said. Later, he added: "This research is totally funded by private sources for the benefit of scientific analysis, to assess public policy, and to advance business interests. Without a source of revenue, the project would cease to exist and the benefits would disappear."

And that would help nobody.

 

 

 

Richard Epstein: “The Myth of a ProBusiness SCOTUS” - Overlawyered

Left-leaning lawprofs like Erwin Chemerinsky and Arthur Miller regularly flog the idea that decisions they disagree with — such as Twombly and Iqbal on pleading, AT&T v. Concepcion and AmEx v. Italian Colors on arbitration, and Vance v. Ball State and Ledbetter v. Goodyear Tire on workplace liability — show the Supreme Court to be biased in favor of business defendants. Richard Epstein rebuts.

via overlawyered.com

Don't forget left-leaning judges like Richard Posner.