Morgan Stanley: Systemic Mistrust or Bad Financials after the Financial Crisis?

"Morgan Stanley by any measure is a safe and solid investment bank. Except for one: The amount of trust people have in the whole financial and political system. It's just about zero,” according to Jesse Eisinger of The New York Times in October 2011. Even as there is undoubtedly an element of hyperbole in his conclusion—for zero trust in the financial system and governments would occasion far greater problems than the world faced at the time of Eisinger’s report—his broader point that bankers would be held accountable one way or the other for not having learned their lesson on derivatives (and risk more generally) is valid. The subtext is that even though banks like Morgan Stanley were in actuality in solid financial shape, they deserved the negative repercussions from the systemic skepticism that the banks themselves brought about by virtually ignoring risk analysis in preference to a run of profits and (not coincidentally) bonuses.

Eisinger points out that, at least as of October 2011, Morgan Stanley “has almost $60 billion in common equity, compared with $36 billion before September 2008, and its ratios are stronger. Its trading book - which is volatile and where any bank can take sudden, large losses - is smaller than it was. Morgan Stanley has more long-term debt and higher deposits, both of which stabilize its finances. The bank has more cash available in case there's a crunch and a smaller amount of Level III assets, which don't have an independently verifiable value and so must be estimated by the bank. Hedge funds have parked a smaller amount of assets at Morgan Stanley. That's good because in the financial crisis, they pulled them from the bank.” But because all of this could be easily wiped out by a run on the bank occasioned or fueled by a wider mistrust of the financial sector, Eisinger brings up the topic of derivatives as a way of showing that the bankers did not in fact learn their lesson (i.e., all the improved stats may be for naught). Accordingly, the bankers deserved the systemic mistrust even at the expense of any effort having resulted in added financial strength.  

According to the reporter, Morgan Stanley had a face value of $56 trillion in derivatives in October 2011. He notes that JP Morgan Chase had more: a face value of $79 trillion. This is the GNP of some countries. Even though the bankers insisted at the time that they had adequately hedged their long positions, the hedges themselves could fail, especially if the derivatives are positively correlated, as in September 2008 when AIG was completely overwhelmed due to the housing-based derivatives caving in virtually all at once.

In other words, those of us capable of learning lessons know that we should not trust hedges in so far as systemic risk is concerned; the system itself can be overwhelmed by the sheer momentum of a really big wave. So we are back to the issue of trust in the entire financial system, which is and ought to be a drag on even stellar financials until the broader lesson is learned. Unfortunately, that lesson may not be in the immediate financial interest of particular banks due to externalities occasioned by moral hazard (e.g., the possibility of being rescued while another bank, such as Lehman, fails).

Even though governments can step in to protect the broader system (unless captured by the regulated), legislators and regulators cannot force bankers to learn their lesson. A mentality to safeguard even one’s own bank as a going concern cannot be imposed; it must be felt and valued from the inside. All too often, bankers are engaged in “managing” regulations as impediments to be minimized rather than stepping back to ask why the regulations exist in the first place. They might exist for the banks’ own good. If so, the banking lobby trying to water down the Volcker Rule might have been working at odds with those institutions that the lobby ostensibly represents. Be careful what you wish for, Wall Street bankers. You might just get it, especially if you have the gold and therefore can make the rules. It would be ironic if the protesters rather than yourselves had your back, even as you ridicule the masses marching below your towering be-windowed edifices of greed.

Source:

Jesse Eisinger, “Between the Lines, Wall St. Banks Face a Deficit of Trust,” The New York Times, October 12, 2011. 

Mitt Romney’s “About-Face" in the 2012 U.S. Presidential Election: A Candidate’s Conflict-of-Interest

As was demonstrated in September 2008 as banks began to stop lending to each other even overnight, trust is the foundation, or grundlagen, of a market. The same is true in relationships between people. I would be surprised were a marriage ever the same after even a contrite spouse has had an extramarital affair. The same is true in politics; once the electorate has been lied to, it is very hesitant to remove the asterisk next to the politician’s name. The relevance of a politician’s extra-marital affair, such as the flowery lapse of Gary Hart or the sordid stains of Bill Clinton, is that the people conclude that they, like the wives, could be betrayed. Once established, a lack of trust tends to spread like an invidious cancer until it has encompassed the entire body politic. The shift is from justice to a lack of harmony on many levels.

Plato theorized that justice is the harmony within the rational psyche and polis (city, or country) as well as between the heavenly spheres (planets and stars)—the harmony between the rational and the vibrations of the spheres being in sync, which is justice itself. It follows that a person who lets his or her desires run rampant is in line with a squalid or aggressive city, and that neither of these shares in the musical/mathematic harmonious vibrations of and between the heavenly spheres. Lack of trust at the personal, business, or civic level can be said to be a symptom of the shift from the condition of harmony, and thus justice, to discord.

It follows that in a republic or union thereof, it is vital to maintaining justice (as harmony) that the electorate not be as sheep in taking in that which a politician claims regarding what he or she “really believes.” Once a candidate has stupidly lapsed in terms of trustworthiness, the electorate should be cognizant of the conflict of interest in the candidate later dismissing the substance of his or her real feelings or beliefs. In general, if a candidate’s statement is in line with him or her getting elected, a due dose of salt should be taken with that dish.

I have in mind Mitt Romney’s statement at a closed-door fundraiser in September, 2012 that nearly half of Americans don’t pay income taxes, view themselves as victims, and refuse to take responsibility for their lives, wanting to live off entitlement programs instead. Some seventeen days later, after even prominent office-holders in his own party distanced themselves from his view, the presidential candidate stated publically, “In this case, I said something that’s just completely wrong.” The question is whether this electorally-convenient “change in belief” is believable, given its consistency with electoral victory.

              Mitt Romney and Paul Ryan, in an image tailor-made as "brand image" for generic consumption.  Reuters

For an electorate to be like sheep is to ignore the conflict of interest and take at face value whatever a candidate says. Simply being on television brings with it the veneer of official truth, so it is difficult for a “mere viewer” to discount the veracity of the celebrity’s claims based solely on one’s own subjective judgment. In a democracy, however, such judgments constitute popular sovereignty, under which governmental sovereignty is exercised by public officials. Therefore, the citizenry has a responsibility to place its judgment above the larger-than-life asseverations made by candidates or office-holders at mass rallies or on television. The deck, I fear, is stacked against popular sovereignty in favor of the agents, and television has exacerbated the problem even as the medium has enabled voters in an “extended republic” to “see” more of the candidates (or their marketed “brand” image).

To aid the electorate in its subjective judgment made in the privacy of each mind, a few principles may be helpful. First, as stated above, a candidate’s statement made in contradiction to an earlier one and in line with his or her electoral success on election day is subject to a conflict of interest. In other words, the claim that the candidate had been wrong should not be taken at face value if it, unlike the earlier claim, is in line with getting elected.

Mitt Romney’s statement disparaging nearly half of the electorate can reasonably be assumed to be at odds with him winning the election (even making such a statement privately may be a lapse of judgment effectively disqualifying a candidate from any high office in which using good judgment is crucial).  Romney's later claim that his earlier privately-expressed view had been “just completely wrong” can be taken to be in line with his political interest. This pattern, or "switch" in line with political interest, constitutes a conflict of interest because he could reasonably be assumed to be lying in his later statement in order to improve his chances of winning. That the earlier statement had been made in private whereas he announced his “change of heart” publically involves a second principle.

That which is said privately can be taken to have more credibility than that which is stated publically. This is a less direct way of looking at the conflict of interest. A candidate may express his or her authentic beliefs privately because doing so publically would not be in line with winning the election. The switch from private to public after the private statement is leaked is particularly suspect because it is reasonable to assume that the public statement is not genuine, but, rather, is geared to reducing “political damage.”  For the public to assume that the candidate has recognized his or her error and that the public statement is a sort of contrition ignores the conflict of interest. In other words, the sheep mentality is naïve, more a matter of idealistic projection than in what is actually motivating the candidate.

Self-governance, whether of a psyche or in a republic (or union thereof), includes governing one’s own fantasies and projections in order that one can more accurately assess candidates for office and office-holders. Here again is Plato’s notion of justice in the reason-governed psyche being in line with the reason-governed polis (electorate). Being intellectually honest in one’s assessment of even one’s ideologically-favored candidate can be said to be one of the duties of citizenship if self-governance is to apply both to a person and a republic. Letting candidates get away with double-talk is a case of an undisciplined psyche and electorate of a polity not worthy of government by the people.

Whichever way an electorate leans in its collective judgment in a given election, it is my hope that the judgment illustrates the best in popular sovereignty. It is essential, albeit difficult for a large electorate, to hold the agents (even as candidates) accountable to the will of the people, such that the collective will is rendered as clear as possible and that the agents implement it rather than assume (or presume) a superior position to it.

For more on conflicts of interest in government and business, see Institutional Conflicts of Interest, available at Amazon.

Source:

Colleen Nelson, “Romney Backs Off Remarks About the 47%”, The Wall Street Journal, October 5, 2012.

On Leveraging the U.S. Debt-Ceiling: How the Market Mechanism Handles Trust

On May 9 2011, U.S. House Speaker Boehner insisted “on trillions of dollars in spending cuts, and no tax increases, as the price for rounding up enough votes to allow more borrowing and prevent the country from defaulting on its debt,” according to the Huffington Post. The Ohio Republican had “said failure to increase the borrowing limit [in the summer of 2011] would trigger a financial disaster for the United States and the world.” On May 12^th in Congressional testimony, Ben Bernanke, chairman of the Federal Reserve Bank, cautioned against using raising the debt ceiling as leverage for getting a particular partisan policy-prescription on federal spending enacted into law. Richmond Fed President Jeffrey Lacker had told Reuters, “I do share the chairman’s concern that going up to the edge and playing chicken on the debt ceiling is not a wise strategy.”

Meanwhile, GOP U.S. Senators and House Representatives had been hearing from constituents warning them not to raise the debt ceiling.  “Enough is enough!” such citizens were saying. This pressure was geared to getting the U.S. Government to live closer to its means rather than resorting to its power to increase the debt it can issue without limit. Even so, U.S. Senate Majority Leader Harry Reid said on May 10^th that tax increases may be needed, along with spending cuts, to help rein in the deficit. Moreover, he warned against ultimatums. “We shouldn’t be drawing lines in the sand,” he said according to The Wall Street Journal. This was not stopping Sen. Bob Corker, who was urging an automatic spending cap of 20.6% of GNP (when the fiscal 2011 figure was estimated at 24.3%) as a condition of passing an increase in the federal debt limit.

Given the existence of contending policy prescriptions, using default for leverage on one side is faulty. Aside from the implicit presumption that one side of the debate has a monopoly on truth, playing with fire where the viability of the financial system itself could hang in the balance does not evince much statesmanship and it could imperil the operation of the market mechanism itself.

Trust is vital in the very nature of a market. If trust is up for grabs, the increased volatility can freeze the market mechanism itself. Rather than simply increasing a price to account for the added risk, a market mechanism can simply close down even if trust is questioned. The reason is that the mechanism reflects human nature itself. Trust does not behave along a continuum as does risk/reward. Rather, people trust someone or something only to a point at which an implicit “all or none” mental calculation or feeling occurs. Beyond that point, the picture itself is fundamentally different. A shift in risk/return does not come into play because fear is choking off any action. In other words, human beings in fear or lack of trust freeze up rather than slow down. The market mechanism’s interval of risk/return tradeoffs reflecting in adjusting price is inconsistent with this feature of human nature as manifested even in a market mechanism. There is thus a fundamental flaw in the mechanism where it diverges from how human nature reacts to fear as lack of trust.

According to Alan Greenberg, former Chair and CEO of Bear Stearns, “Without reciprocal trust between the parties to any securities transaction, the money stops. Doubt fills the vacuum, and credit and liquidity are the chief casualties. Bad news . . . has an alarming capacity to become contagious and self-perpetuating. No problem is an isolated problem” (Greenberg, p. 3). Money simply stopping trumps price adjusting to reflect the increased risk from less trust because trust in human terms does not function as intervals of degrees. Accordingly, market theory itself, specifically in its risk/return tradeoff running the gambit, contains a flaw with respect to increased levels of volatility due to “trust issues.”

In using the debt ceiling as a bargaining chip for political leverage, the Republican lawmakers in the U.S. Government were risking the flaw being triggered. In other words, those politicians were implicitly assuming that the market would simply adjust to the added risk rather than shut down. Besides the problem in the lack of statesmanship—a political problem—the market mechanism itself contains a fundamental flaw in need of being addressed. Specifically, higher risk that kicks in even just close to the lack-of-trust-threshold can freeze the mechanism itself due to how human nature handles trust as a more of an “all or none” than “matter of degrees” phenomenon even as we wrongly suppose the market handles trust along an interval of prices. Unfortunately, we love the beauty of the latter even after having realized in September of 2008 that it does not hold.

Sources:

Alan C. Greenberg, The Rise and Fall of Bear Stearns (NY: Simon & Schuster, 2010).

Janet Hock and Carol E. Lee, “Democrats Oppose Spending Cap Plan,” The Wall Street Journal, May 11, 2011, p. A4.

The Huffington Post, “John Boehner, GOP Seek Leverage in Talks Over Raising Debt Ceiling,” May 12, 2011.

The American City: A Police State in the Making

Crime in 2017 was down the 30 largest cities in the U.S, but police levels remained robust. Specifically, less crime did not result in fewer cops on the street. “In 2016, there were slightly more officers per capita than in 1991, when violent crime peaked,” according to the FBI.[1] American cities were on a trajectory toward becoming police states. A mentality of excessive dominance, I submit, lies behind the excessive show of force.

The notion that pruning a police force “inevitably raises the specter of more crime” does not hold, given the evidence of a more complex relationship.[2] For one thing, the actual size of a police force can be distinguished from the amount of police presence in the streets and in the air on a daily basis. I submit that the notion that a constant, ubiquitous police presence discourages crime is also problematic. In fact, blanketing a constant show of force can send the message of total societal distrust, which in turn can lead to crime as the social contract unravels. “The answer to fixing trust inside the community is to not put more distrust into it,” said Tre Murphy, a community organizer in Baltimore, Maryland. The sheer presence of police with guns implies distrust, and even a primitiveness in terms of aggression. “The answer to violence is not to put more violence into the community,” Murphy explains, “and that’s what they’re doing by increasing the police force.”[3] The additional violence here is mostly the passive aggressiveness of an excessive show of force, but also the incidents of police brutality. The latent passive and active aggression in an excessive police presence may be explained by the power vested in a police employee being too much for human nature to control.

It bears mentioning that quality of life also suffers for law-abiding citizens as a city becomes a de facto police state. When I lived in Tucson, Arizona, I was stunned to see low-flying police helicopters on a daily basis, even during weekdays, and this was on top of a myriad of police cars constantly on the major roads. Seeing a low-flying helicopter flying nearby in tight circles with a spotlight dotting here and there is downright creepy, and thus unnerving, especially on nearly a nightly basis. The city’s mayor’s office was oblivious. At the local university, both city and campus police, plus police aides, regularly circled within the campus, giving students and faculty the sense that they were being continuously monitored. The distrust in the air on that campus was so palpable I avoided it. It was not uncommon to see a campus policeman wearing a bullet-proof vest perpetually circling on a bike around the library and campus green, while police vehicles slowly pass by as if also necessary during the day.  

Such over-the-top policing especially during weekdays raises the problem of the culprits being wholly unaware that their conduct is excessive—more specifically excessively passive aggressive. It is precisely such being oblivious that prevents police forces from accepting the very notion of less rather than more. Downsizing is not in a police force’s DNA, according to Meghan Hollis, a criminologist. “Police departments, as long as they have the funds, they’re going to keep their force size the way it is or grow it, regardless of the crime rate. They can always adjust their statistics to make it look like they need the officers they have.”[4] Likewise, police forces can rationalize even what is an excessive daily police presence on the street and in the air such that the excessive amount can become normalized as the default. Hence even citizens feeling constantly monitored out in public spaces and even on their property can come to accept the fait accompli. The passive aggression inherent in the excessive show of force is, I submit, in the DNA of a police force. Perhaps mayors and university managers are afraid to reel in their respective police forces.  

Perhaps it bears mentioning that the quality of life in a city suffers from a constant police presence. This point is perhaps as obvious as the obliviousness of police forces regarding their own excessive show of force is hidden from the public as well as the police themselves. I submit that America is on the road to a police state, rendering “land of the free” into a farce. To deem oneself to have great liberty and yet live in—and implicitly tolerate!—a police state is to live in a state of denial: oblivious. This may have become the American unconsciousness.

---

[1] Jose Del Real, “Crime Is Falling, But Police Levels Remain Robust,” The New York Times, January 8, 2018.

[2] Ibid.

[3] Ibid.

[4] Ibid.

Betraying an Electorate: On President Obama's Deal with Drug Companies

While campaigning for the U.S. presidency in 2008, Barak Obama decried the greedy Republican lawmakers acting at the behest of the drug companies to keep drug prices artificially high. A year later, those same drug companies wanted Obama to oppose a Democratic proposal that was intended to bring down the prices of medicine. Beyond betraying those voters who voted for him based on his campaign rhetoric on drug prices, Obama belied the trust that is necessary for a viable republic to function democratically.

 “On June 3, 2009,” according to the New York Times, “one of the lobbyists e-mailed Nancy-Ann DeParle, the president’s top health care adviser. Ms. DeParle sent a message back reassuring the lobbyist. Although Mr. Obama was overseas, she wrote, she and other top officials had ‘made decision, based on how constructive you guys have been, to oppose importation on the bill.’ Just like that, Mr. Obama’s staff abandoned his support for the reimportation of prescription medicines at lower prices and with it solidified a growing compact with an industry he had vilified on the campaign trail the year before.” 

As per the quid pro quo, the industry sponsored its own advertising campaign in favor of Obama’s health-insurance proposal. It was not just the guys’ constructiveness that had convinced Obama’s staff to “make the deal.” To be sure, the staff could have been supposing that the subsidies enabling middle-income Americans to afford health insurance and the expansion of Medicaid to cover 30 million uninsured Americans would relieve people from having to pay high prices for medicine (though everyone, even if only as payers of higher taxes, would be paying the price in the form of higher insurance premiums). However, there would be no guarantee that the government would pick up the tab when needed. Furthermore, the higher prices could widen government deficits.

Beyond health-care and budget policy, moreover, is the contradiction between Obama’s campaign speeches and his staff’s decision to oppose the bill. The implication is that Obama went back on his word, essentially betraying anyone who voted for him because he promised to support lower drug prices. Beyond Obama’s public credibility lies the mechanism of democracy wherein voters trust that a candidate’s campaign bears some relation to the candidate’s governance. Otherwise, the “will of the people” breaks down and mistrust sets in on a societal basis. In other words, when representatives say one thing on the trail and quietly do the opposite behind their desks, democracy itself suffers.

In the wake of the financial crisis of 2008, it was said that trust is vital to the financial system. The same can be said of a viable republic. The question, therefore, is how candidates can be held accountable for the assumed congruence when so much of governance is done behind closed doors. In an electoral system where not voting for one candidate benefits the candidate even further from the voter’s preferences, it can be difficult indeed to hold an office-holder accountable at the ballot box. 

Source:

Peter Baker, “LobbyE-Mails Show Depth of Obama Ties to Drug Industry,” The New York Times, June 8, 2012.