Juggling Dynamite

James Kidney, 66, a trial attorney from the Securities and Exchange Commission since 1986 offered a honest speech at his March 27 retirement party before a crowd of 70.  According to a copy of his remarks obtained by Bloomberg, Kidney said his bosses were too “tentative and fearful” to go after ” the comfortable and powerful” Wall Street leaders.  Kidney had campaigned internally to bring charges against more executives in the agency’s 2010 case against Goldman Sachs.

He called the SEC “an agency that polices the broken windows on the street level and rarely goes to the penthouse floors… On the rare occasions when enforcement does go to the penthouse, good manners are paramount. Tough enforcement, risky enforcement, is subject to extensive negotiation and weakening.”

Kidney said what many of us have long suspected, that his superiors were more focused on getting high-paying jobs after their government service than on bringing difficult cases. The agency’s penalties, Kidney said, have become “at most a tollbooth on the bankster turnpike.”  SEC spokesman John Nester declined to comment.

Dallas Fed President Richard Fisher, gave a speech to the Asia Society Hong Kong Center last week (read the full text here) where he laid out the glaring concerns and reasons for why the Fed’s QE policies are now in retreat and on track to end by October of this year.  In Fisher’s words:

• By buying copious quantities of longer-term U.S. Treasury bonds and mortgage-backed securities (MBS), our balance sheet has grown from slightly under $900 billion prior to the crisis to $4.3 trillion at present
• Less than a fifth of commercial credit in the highly developed U.S. capital markets is extended through depository institutions. Yet depository institutions alone have accumulated a total of $2.57 trillion in excess reserves—money that is sitting on the sidelines rather than being loaned out into the economy. That’s up from a norm of around $2 billion before the crisis.
• The price – to-earnings (PE) ratio of stocks is among the highest decile of reported values since 1881. Bob Shiller’s inflation- adjusted PE ratio reached 26 this week as the Standard & Poor’s 500 hit yet another record high. For context, the measure hit 30 before Black Tuesday in 1929 and reached an all-time high of 44 before the dot -com implosion at the end of 1999.
• Since bottoming out five years ago, the market capitalization of the U.S. stock market as a percentage of the country’s economic output has more than doubled to 145 percent— the highest reading since the record was set in March 2000.
• Margin debt has been setting historic highs for several months running and, according to data released by the New York Stock Exchange on Monday, now stands at $466 billion.
• Junk-bond yields have declined below 5.5 percent, nearing record low.
• Covenant-lite lending is becoming more widespread.
• In my Federal Reserve District, 96 percent of which is the booming economy of Texas, bankers are reporting that money center banks are lending on terms that are increasingly imprudent.
• At the current reduction in the run rate of accumulation, the exercise known as QE3 will terminate in October (when I project we will hold more than 40 percent of the MBS market and almost a fourth of outstanding Treasuries). We will then be back to managing monetary policy through the more traditional tool of the overnight lending rate that anchors the yield curve.

In other words, “we now interrupt the QE (and HFT-driven) mirage of robust investment markets and return you to the reality of the business cycle….bonne chance.”

In 1982 the U.S. Securities and Exchange Commission (financial firm controlled) used Rule 10b-18 to legalize large-scale buybacks so long as they did not exceed 25% of a company’s average daily trading volume over the previous four weeks. Previously the limit had been 15%. See: Share buybacks let income inequality grow, for an excellent summary of how the counterproductive short-term obsession with share buybacks has enriched executive pay scales beyond reason while stagnating meaningful investment and innovation. Talk about a dumb incentive system.

“A new research paper written by William Lazonick of the University of Massachusetts Lowell, which will be presented at the conference of the Institute of New Economic Thinking in Toronto on April 10 to 12, noted that in 2012, the 500 highest-paid executives in the United States received an average pay of $24.4-million (U.S.) – 52 per cent from stock options and 26 per cent from stock awards.

“The more one delves into the reasons for the huge increase in open-market [share] repurchase since the mid-1980s, the clearer it becomes that the only plausible reason for this mode of resource allocation is that the very executives who make the buyback decisions have much to gain personally through their stock-based pay,” Mr. Lazonick said.

As executive pay soared, workers’ wages stagnated when measured against productivity gains. Between 1948 and 1983, when regulations severely limited the size of buybacks, real compensation per hour and gains in productivity per hour closely tracked one other. That’s no longer the case. In the early 1980s, a significant gap between productivity and wages emerged and kept getting wider…

The rule was a godsend to stock-based pay, and buybacks climbed. Between 2001 and 2012, the S&P 500 companies spent an astounding $3.5-trillion on buybacks, an average of $600-million per company per year (perversely, the buybacks peaked in 2007, the pre-crash year, destroying the boardroom argument that buybacks were launched because executives believed their companies’ shares were fundamentally undervalued).

Some companies practised the art with abandon. Exxon Mobil spent $207-billion buying back shares between 2003 and 2012, equivalent to 60 per cent of its profit over those years. Cisco Systems and Hewlett-Packard spend more than 100 per cent of their profit on buybacks. Canada’s BlackBerry and Finland’s Nokia launched huge buybacks even as their market shares were collapsing. Imagine if they had devoted those fortunes to innovation instead?”