Parallels

There are several interesting parallels between the concerns and resolutions proffered to address the current Gulf oil spill and the recent financial crisis. Each of these crises has generated significant and, in certain instances, irreversible harms. Financial markets and environmental regulators are working diligently to develop and adopt effective prophylactic measures to prevent a repeat of either disaster.

Regulators, legislators, academics and pundits are now debating whether implementing ex ante rules that require market participants to contribute to a collective disaster relief fund may effectively address these concerns. Under the current financial reform bill passed by the House, ex ante pre-pay rules would require banks to pay into a $150 billion rainy-day reserve fund. The monies collected in the fund would be distributed to an ailing bank whose insolvency threatens to trigger a daisy-chain collapse of multiple systemically significant financial institutions. Pre-paying into a fund is an attractive proposal because it suggests that the need for public funding will not be necessary in the event of a future crisis. Some are skeptical and challenge the presumption that the reserve fund will be sufficient and ask whether developing a pre-pay system is even possible in light of the current market instability and lack of liquidity. As a result, the Senate version of the bill, supported by the White House and Wall Street firms, does not include a pre-payment program.

The use of a superfund is not unprecedented. Following the Exxon Valdez oil spill which involved the release of 250,000 barrels of oil into Alaska's Prince William Sound and $3.5 billion in cleanup costs, Congress adopted the 1990 Oil Pollution Act creating the Oil Spill Liability Trust Fund. In addition to arguments challenging their constitutionality, the Act and the trust fund have also faced practical limitations that leave many unsatisfied. Under the law, BP’s current exposure would be limited to clean up costs and a fine of $75 million. Although BP has waived the $75 million limitation, there are many questions about what BP will legally be required to pay to assist the many communities and businesses economically impacted by the recent oil spill. The long-term losses experienced by many who enjoy the Gulf area, like my family in Texas, may be genuinely immeasurable and will likely fail to be fully captured in any payout.

-- Kristin Johnson

SEC Charged Mickey Mouse Former Employee with Insider Trading

Poor Mickey. He must be appalled that confidential Walt Disney Company information was offered for sale to several investment firms including private equity firms in the U.S. and abroad. Bonnie Hoxie, an executive assistant to the Head of Corporate Communications at Disney, and Yonni Sebbag, Hoxie’s boyfriend, unfortunately offered to sell confidential information to an undercover FBI agent for $15,000. Hoxie and Sebbag were arrested in Los Angeles before they were able to actually sell the confidential Disney information including quarterly earnings, and purported “tips” on alleged efforts to sell the ABC television network to private equity firms. Both Hoxie and Sebbag were charged with one count of wire fraud and one count of conspiracy. The U.S. Securities and Exchange Commission filed civil charges against Hoxie and Sebbag. The complaint alleged that Hoxie and Sebbag sent anonymous letters to more than 20 U.S. and European hedge funds, offering pre-release of Disney second quarter 2010 results in exchange for a fee. The charges carry a maximum sentence of 25 years in prison and a fine of at least $250,000. The developing story is available here.

Lydie Nadia Cabrera Pierre-Louis

ClassCrits Progressive Rhythm

As reported on the Corporate Justice Blog earlier this week, the Rethinking Economics and the Law After the Great Recession Conference was held at the University of Buffalo Law School on Monday and Tuesday, May 17th and 18th, 2010. Conference Organizer Angela Harris had the following to say about the conference (as memorialized at the Salt Law Blog):

"The workshop was organized by the “class-crits,” a small group of American legal scholars (I count myself as one) who bring the insights of critical legal scholarship to the study of the interrelationships among market and state institutions. Sponsored by the Baldy Center for Law and Social Policy, an internationally recognized institute at the University at Buffalo that supports the interdisciplinary study of law and social institutions, this year’s class-crits meeting brought legal scholars together with “heterodox” economists. The results were inspiring, exciting — and subversive.

In a recent article, economist James K. Galbraith concludes: “It is . . . pointless to continue with conversations centered on conventional economics. The urgent need is instead to expand the academic space and the public visibility of ongoing work that is of actual value when faced with the many deep problems of economic life in our time.” Galbraith’s conclusion that conventional economics should be abandoned rests in large part on the extraordinary intellectual impoverishment of mainstream economics departments. These departments have largely jettisoned the teaching of history, politics, social theory, and culture in order to pursue what Paul Krugman, in a recent lament titled “How Did Economists Get It So Wrong?” calls their “desire for an all-encompassing, intellectually elegant approach that also [gives them] a chance to show off their mathematical prowess.” This blinkered approach to economics was enthusiastically adopted by the legal academy’s “law and economics” movement, which — thanks to lavish funding by the Olin Foundation and others — produced a generation of Smart White Guys wielding terms like “Pareto optimality” who were uninterested in history, culture, subordination, sociology, psychology, and anything having to do with “distribution.” . . .

For the class-crits, the 2008 crisis offered an opportunity to take Galbraith’s advice and abandon the crumbling edifice of neoclassical economics, along with the rickety shed in its back yard that is “law and economics.” “Rethinking Economics and Law After the Great Recession” invited heterodox economists to sit down with progressive law professors, and the result was a dramatically different conversation. To begin with, the group decided, economics is not “the science of the allocation of scarce resources.” It is the study of social provisioning. Economic activity, therefore, doesn’t take place only in formal markets, but also in families and informal arrangements. Economic activity can’t be made sense of without an understanding of organizations, culture, history, and the state. Our discussion of the financial crisis moved from TARP to massive mortgage fraud to the financial sector’s culture of entitlement to the history of racial discrimination in housing, to the global history of colonialism. And our discussion of the law encompassed a range of state projects, from the regulation of property and corporate personhood to the workings of the administrative state, the economic significance of mass incarceration, the law of the family, immigration law, and questions of access to justice."

To read the entire post by Professor Harris, go here.

Financial Reform and the Conference Committee

Since early May, the Dow Jones Industrial Average has fallen 1200 points and credit markets have tightened dramatically due to the European debt crisis. Counterparty risk is increasing and some analysts now predict a Lehman II type credit crunch.

Against this backdrop, the US Senate finally passed a 1500 page financial reform bill. It seems impossible right now for anyone to say for sure what is in the bill, but I do take comfort in the fact that Elizabeth Warren, a consistent voice in favor of consumer protection and rational regulation, states that:"No bill that deals with big issues is ever perfect, but the Senate's Wall Street reform package will go a long way toward preventing the kinds of abusive practices that brought our economy to its knees."

Still, the next step in the legislative process is critical. The bill is headed to conference committee. This crucial committee has final say on the content of the bill, and they work in secret with zero record of who put in what and therefore zero accountability. I have often posited that the conference committee is tailor made for the exercise of special interest influence. And, early indications suggest that many interests such as credit card firms and auto dealers and Massachusetts financial firms are already poised to have final sway over the bill.

What impact this bill will have on market action is anyone's guess. But it is certainly a wild card factor in a market that is plenty wild already.

Wall Street Culture

As financial reform makes its way through Congress, the media and political observers have justifiably concentrated on the policy proposals and specifics that have been under debate – from the bank tax to the scope of resolution authority. While this debate continues it is important not to miss the forest for the specific trees. In testimony before the financial crisis commission, Goldman Sachs CEO Lloyd Blankfein explained Goldman Sachs business model, in particular in the context of market maker: “We represent the other side of what people want to do. Because we had this risk, because we were accumulating positions which, by the way, we acquired from clients who want to sell them to us, we have to go out ourselves and provide and source the other side of the transactions so that we can manage our risk.” In testimony before Congress, days after Goldman Sachs was charged with fraud by the SEC, it was clear that Blankfein’s defense of Goldman’s business model was falling flat to members of Congress. As Goldman representatives defended themselves from potential criminal charges, Congress seemed to be putting Goldman’s entire business model on trial. While Goldman was talking about their role as “market makers,” many Senators pushed back on the idea that Goldman could engage short positions in a market product at the same time that their clients had long positions and still consider themselves to be providing a service to their clients, on both sides of the deal. In successfully defraying allegations that these deals were illegal Goldman had a much harder time explaining to any member of Congress why these deals are actually needed or even beneficial to their clients or society. The hearings tended to show that Wall Street culture has become to simply profit as much as possible at whatever cost rather than providing valuable service to clients and ultimately service to the national and global economy.

The question then is whether financial sector reform will play any role in transforming the culture of Wall Street to better align its interests with the interests of the country and "Main Street." As the financial crisis and its aftermath have shown, financial institutions will go to great lengths to avoid regulation and will fight tooth and nail against even modest, common sense regulatory efforts. One former Lehman executive explained after the revelation of Repo 105, “firms clearly shop jurisdictions all the time for the most favorable rule set, and there’s nothing wrong with that.” A managing director in London further explained: “Yeah, yeah, yeah. In London, people just generically talk about it. It’s funny, for nonprofessionals, you can try to make it a smoking gun. I’m like, whatever.” Regulatory arbitrage is a common business strategy and while not illegal, it must be recognized as common. Further, financial innovation will always flow to the least regulated causeway as a business matter. These realities should be addressed and debated in current financial sector reform. Whatever watered down and diluted bill that emerges from the Senate, I am not confident that Wall Street culture or effectively regulating financial innovation will be addressed. This I fear will be a mistake.

Emory University School of Law to Host Transactional Education: What’s Next? Conference

Emory University School of Law’s Center for Transactional Law and Practice is delighted to announce its second biennial conference on the teaching of transactional law and skills, Transactional Education: What’s Next? The conference will be held at Emory Law on Friday, June 4, and Saturday, June 5, 2010.
Emory Law's Center for Transactional Law and Practice is at the forefront of educating students and professionals on topics related to business transactions. Students participate through Emory's Transactional Law Certificate Program, while the center offers a number of workshops and seminars designed specifically for practicing attorneys. The Center regularly hosts a conference for educators in the area of teaching transactional skills.

Registration
The registration fee for the conference is $179.00. It includes a pre-conference lunch, snacks, and the reception on June 4 and breakfast, lunch, and snacks on June 5th. An optional dinner for attendees on Friday evening, June 4, is an additional $40.00. Attendees are responsible for their own hotel accommodations and travel arrangements.

After you register, we would appreciate you completing a short survey about transactional courses at your school. The results of the survey will be available at the Conference.

Registration closes May 25, 2010.
To register, please click here.

Hotel
Special hotel rates for conference participants are available at the Emory Conference Center Hotel less than one mile from the conference site at Emory Law. Subject to availability, rates are $129 per night. Free transportation will be provided between the Emory Conference Center Hotel and Emory Law. To make a reservation, call the Emory Conference Center Hotel at 800.933.6679 and use Group ID Number 20006017399 to obtain the special conference rate.

Learn more about the Emory Conference Center Hotel by visiting their website.

We look forward to seeing you in June.
The Steering Committee
Tina L. Stark, Chair, Emory University School of Law
Danny Bogart, Chapman University School of Law
Deborah Burand, University of Michigan Law School
Joan MacLeod Heminway, The University of Tennessee College of Law
Jeffrey Lipshaw, Suffolk University Law School
Jane Scott, St. John’s University School of Law


Lydie Nadia Cabrera Pierre-Louis

Class Crits Conference: Rethinking Economics and the Law After the Great Recession

The University at Buffalo Law School, Baldy Center for Law and Social Policy will be hosting the Class Crits Conference on Monday and Tuesday, May 17-18, 2010. The Conference subject is "Rethinking Economics and Law After the Great Recession." The workshop will feature presentations and discussion of heterodox economic theory and its implications for law in the wake of the crisis within economic theory. Progressive economics will provide overview of alternative perspectives on theory and policy. The Conference aims to aid in the development of a critical, interdisciplinary analysis of law and economic inequality. Topics that will be covered include:

1. Heterodox Economics

2. Thinking Through How the Market Actually Works

3. Making Sense of the Financial Crisis: Financial Political and Regulatory Institutions

4. Making Sense of the Financial Crisis: Racial, Heteropatriarchal, and Class Dynamics - Insights for an Integrated Theory

5. American Casino and Capitalism: A Love Story

6. Engaging Narratives of Economics and Class in Law

7. Engaging Narratives of Law in Economic Development - Local, National and Global

For more information, see the conference website here.

Eurozone Update: "Meltdown" Ahead?

About 10 days ago I warned people to fasten their seat belts in preparation for turbulence arising from the Greek debt crisis. Events have accelerated dramatically over there since that post and another warning of a brewing financial crisis. Since then the EU has announced a $1 trillion bailout of the PIIGS nations and the ECB announced it would begin buying sovereign debt--a move that certainly smacks of quantitative easing (printing money)--although the entire operation is cloaked in secrecy.

Now deep austerity is taking hold throughout Europe as the Greeks, the Spanish, the Irish and others slash spending and raise taxes in order to control debt loads and qualify for bailouts. Naturally, civil unrest is on the upswing and the unions in Spain are calling for a general strike on June 2. Spain already is on the brink of deflation and this austerity will worsen deflationary pressure throughout Europe. Spain's largest bank fell ten percent today in European trading. In fact, Euro banks fell across the board.

Meanwhile the flight from the Euro is now bordering on a panic as it has fallen below 1.24. Interbank credit markets are freezing again, though not yet as nearly bad as in late September of 2008. The EU seems to be between a rock and a hard place, and no matter what they do the markets seem deeply skeptical.

As I mentioned in an earlier post, the big US banks have enormous exposure to the Eurozone, and the derivatives casino is not apt to mitigate that exposure rather than amplify it. In fact, American Bankers magazine quotes a high profile bank analyst who estimates that the big US banks have hundreds of billions, even trillions, in exposure to the Eurozone through derivatives.

Further, the austerity measures are already taking a toll on growth as financial markets over there brace for a fiscal shock. As shown on the graphic below (click to enlarge), the entire continent is pursuing sharp fiscal austerity:
So what does this all mean? Nothing good I fear. The deflationary shock over there will be felt over here, to an unknown and difficult to predict extent. Any bank losses over there will expose our banks over here to potential insolvency--thanks in no small part to the very opaque exposures held through the unregulated derivatives market.

Worse, policymakers seem clueless on the dangers of precipitous debt deflation from massive deleveraging. A debt crisis arises from two problems: too much debt; and, too little income.

Governments must embark upon massive investment programs right now to grow out of this morass. I have argued since the beginning of this fiasco that every dollar spent must yield maximum payback from investment and growth. Instead, here in the US, we have literally pissed away trillions in wealth bailing out reckless bankers and persisting in maintaining patently reckless tax cuts.

So, now we face austerity measures in the face of too much debt. The IMF counsels that these measures are needed. Even President Obama apparently counseled Spain to pursue austerity.

What if this conventional wisdom is wrong, and this Eurofiasco triggers massive deleveraging and debt deflation? Recall, that monetary policy is already impotent, and implicit in the above discussion is that there is a massive withdrawal of fiscal stimulus rather than any looming fiscal stimulus.

Time will tell. But I do not think this will play out over an extended period of time. Financial markets can move quickly and decisively towards massive risk aversion. The CEO of Deutsche Bank has gone on record that Greece is likely to default, and he was involved in trying to engineer a private bailout. He sees the prospect of a "meltdown." Markets will react long before actual default--indeed, the markets themselves can cause the default by raising Greek debt costs to punitive levels.

This was not a good week. Let's hope next week is somehow better.

Enron on Broadway – “Once You Bury a Dead Dog You Don’t Dig It Up to Smell It”

Last Friday I saw a play about Enron on Broadway. The play closed last Sunday – not even three weeks after it opened. The same play has been a hit in London since last January and is still running.

I’m no theater critic but I enjoyed the play. It was a thorough and entertaining presentation of Enron’s rise and fall. Everything was covered – the Enron culture in good times, the definition of hedging, the company’s downfall, the Senate hearings, the criminal cases brought against Skilling, Fastow and Lay. I didn’t learn anything new about the debacle, but the presentation of the events was fun and interesting. For example, one of the actors played an analyst explaining why she recommended Enron stock to investors without truly understanding how the company made money. The analyst asked the audience to think about air travel. She observed that we fly in airplanes without really understanding how the airplane works. And, the actor who played Ken Lay, attempting to keep Enron’s troubles quiet before the truth was unearthed, gave this advice – “Once you bury a dead dog you don’t dig it up to smell it.”

There is a great deal of speculation about why the play closed. Some think that American audiences were not thrilled about criticism of American corporate and political culture coming from a British playwright. Others thought that the play was short-lived because the Enron story is an old story that pales in comparison to the most recent events relating to the 2008/2009/2010 economic downturn. A New York Times critic called the play a “flashy but labored economics lesson”. This is probably the biggest cause of the play’s failure.

The premature closing of the play worries me. The playwright’s criticism of our political and corporate culture should engage us, not repel us. We should be more critical about these events ourselves. We should expect better behavior from corporate and political leaders. And when they fail to live up to our expectations, we should keep talking about it. The Enron story is still relevant. The excessive risk-taking, the greed, the arrogance that led to Enron’s demise ignited corporate governance failures that led to the recent economic collapse.

Moody's Sings the Blues: Securities & Exchange Commission Issued Wells Notice to Moody's Back in March for False and Misleading Statements

Many have been blasting the credit rating agencies for sometime now. The three major agencies Standards & Poors, Moody's and Fitch have jointly and severally been blamed for being as responsible as the banking industry for the financial meltdown, and current deep recession. The link between credit rating agencies and the financial crisis continues to be analyzed. A flow chart illustrating the link is available here. Surprisingly, the credit rating agencies have managed to retain their government-mandated oligopoly status, and there has not been much regulatory action taken against the credit rating agencies. All of that is about change. Moody’s disclosed late Friday afternoon, in its 10Q that the SEC has issued a Wells Notice, which means that the SEC has decided that it “may” bring a civil action against Moody's. The Wells Notice provides the recipient an opportunity to say why enforcement shouldn’t take place. Although, it is not a formal allegation or finding of wrongdoing, it basically means that the SEC intends to file a formal complaint against Moody's for providing false and misleading information to the SEC.

As it turns out Moody’s disclosure of the Wells Notice to investors was fairly tardy. The SEC issued a Wells Notice to Moody’s back on March 18th and Moody’s simply declined to disclose to investors that it may be under a pending investigation by the SEC. What was Moody's thinking? Where is Moody's securities legal counsel? As a publicly traded company, Moody’s has an affirmative on-going financial reporting duty to inform the public of “Other Events” that the company considers to be of importance to security holders in Section 8 of Form 8K "within four days of the occurrence of the event." Arguably a two-month lag is a very long time not to inform investors that Moody’s had been issued a Wells Notice for providing false and misleading information to regulators. To make matters even more interesting, Moody’s CEO Raymond McDaniel sold one hundred thousand shares of Moody’s stock during Moody's failure to disclose period. McDaniel was allegedly unaware that Moody’s had been issued a Wells Notice. Even more interesting, Berkshire Hathaway, a la Warren Buffet, is Moody’s largest investor with approximately a 36 percent ownership interest. However, Berkshire Hathaway sold nearly one million shares of Moody’s stock, reducing its ownership position to approximately 28% almost immediately after Moody’s received the Wells Notice back in March, but prior to Moody’s disclosing the information to the public months later in May. Does the Securities Exchange Act Section 10(b) and Rule 10b5 insider trading violation mean nothing anymore? But I digress.


The real story is that Moody’s received a Wells Notice from the SEC, which is an administrative civil charge alleging that Moody’s may have provided false and misleading statements to regulators when Moody’s filed its registration statement under the Credit Rating Agency Reform Act of 2006 to receive a credit rating agency license back in 2007. Credit rating agencies have been criticized recently for giving “high investments grade credit ratings” to financial instruments that were used to “enhance”—that is to say, lower the "perceived" riskiness of securities, collateralized by subprime mortgages only to have these "enhanced high investment grade credit ratings" investments emplode within a matter of months, which in part, assisted in creating the current financial crisis. Moody’s registration statement detailed how Moody’s determines credit ratings of particularly risky investments. The SEC alleged that Moody’s registration statement “was rendered false and misleading” by a subsequent admission that the company’s credit coding policy was violated.” Moody’s disagrees with the SEC and “believes an enforcement action is unwarranted.” The Wells Notice also stated that the SEC is considering cease-and-desist proceedings against Moody’s.


The underlying false and misleading statements in Moody’s registration statement arise out of Moody’s incorrectly rating certain European investments. Back in 2008, Moody's acknowledged that a computer error resulted in employees incorrectly rating 11 fixed-income investments worth about $1 billion. Moody's also admitted that employees failed to cure the errors after discovering them. When Moody’s discovered a fault in its credit rating model, it fired the head of its structured finance unit when it determined that employees did not comply with internal rules by failing to change the “coding” related to the way “constant proportion debt obligations” were analyzed for certain European securities. As a result, Moody’s erroneously awarded its highest “Aaa” rating to at least $4 billion of European securities whose liquidity were backed by credit-default swaps, within weeks the European securities had lost as much as 90 percent of their "rated" value. Two months later, Moody’s revealed a second error in the way it assessed the risk of certain securities, which were sold to investors by banks including ABN Amro, JPMorgan Chase, and the investment firm formerly known as Lehman Brothers. Despite these credit rating errors, Moody’s is adamant that its licensing registration statement was accurate. Executives from Moody's and S&P testified before Congress last month about their role in rating risky collateral debt investments that were, in part, responsible for the financial crisis. Some critics argue that credit ratings agencies were too close to the companies whose debt issuance they were evaluating to be able to provide fair, and accurate credit rating assessments. It is the classic conflict of interest dichotomy inherent with every credit rating analysis.

Separately but in connection with Moody's credit rating errors, Moody’s rated the financial instruments that are currently at the crux of the SEC's civil fraud investigation against Goldman Sachs who packaged billions of mortgage-backed securities, and other complex derivative investments which also collapsed under the weight of their own erroneously rated collateralized debt valuation. Not surprisingly, all three major credit ratings agencies have been sued by investors who relied on Moody’s “high investment grade credit ratings” when they decided to invest in particular securities to their detriment.

In the current climate of increased financial regulation, Moody’s, Standard & Poor’s and Fitch face enhanced scrutiny by Congress and state insurance regulators after their “high investment grade credit ratings” to subprime-mortgage bonds issued just before the market collapsed in 2007. Professor Elizabeth Nowicki, a former lawyer with the SEC, and currently a visiting professor at Boston University School of Law stated that “the SEC doesn’t usually go after the ratings agencies…It’s impossible to ignore the fact that folks at the SEC have indicated they’re concerned with the role the credit ratings agencies had in supporting the crisis.” Several members of Congress have stated that they want to overhaul the credit-rating industry. The House Financial Services Committee passed a measure in October 2009 that would make it easier to sue credit-rating companies while aiming to rein in conflicts of interest concerns.

In the interim, state regulators are actively pursuing litigation against credit rating agencies. Ohio Attorney General Richard Cordray sued Moody’s, S&P and Fitch in November 2009 on behalf of five state retirement funds, alleging that “improper” credit ratings cost the State of Ohio more than $457 million. State insurance regulators, led by New York and Illinois, are seeking to reduce their reliance on credit ratings firms, and in November they hired Pacific Investment Management Co., manager of the world’s largest bond fund, to replace Moody’s and S&P analysis on home-loan investments held by insurers in New York and Illinois. We may be witnessing the death of the credit rating agency oligopoly.

Lydie Nadia Cabrera Pierre-Louis

President Obama Makes A Supreme Choice: Elena Kagan Nominated To The United States Supreme Court

I try to keep my promises--earlier on this blog I posted a piece on Associate Justice John Paul Stevens' retirement from the United States Supreme Court. I promised to update you when President Obama picked a nominee to replace Justice Stevens. Well, just today, President Obama held a press conference to announce that Elena Kagan was his pick to succeed Justice Stevens. President Obama described Kagan as a "consensus builder." If the Kagan nomination is successful we shall see.

In my earlier post I suggested that President Obama should do two (2)things to refresh the Supreme Court. First, I suggested that President Obama should pick a moderate to liberal leaning candidate to balance the Supreme Court's seeming conservative to right movement. Second, I advocated for a selection that exhibited a measure of diversity--namely a candidate who wasn't a sitting federal appellate judge.

Elena Kagan is fifty (50) years young. So, based on the odds, she will likely shape the law for a generation, assuming she enjoys good health. Kagan is preeminently qualified. Kagan is currently the Solicitor General of the United States. She is the former dean of the Harvard Law School. In a past life, she served as associate White House counsel during the Clinton Administration.

Elena Kagan would be the third woman to sit on the current Supreme Court bench--joining Associate Justices Ruth Bader Ginsburg and Sonia Sotomayor. Overall, Kagan would be the fourth woman to serve, if confirmed, over the course of the Surpeme Court's history.

Personally, I think Elena Kagan is a wonderful choice. What do you think? Did President Obama get this selection right?

Latest Laissez Faire Market Collapse Belies Far Right Rhetoric re Fannie, Etc.

The graphs at left are the picture of a debt crisis in the so-called PIIGS (Portugal, Italy, Ireland, Greece, Spain) countries. As you can see the PIIGS are facing a huge increase in their funding costs and their budget deficits mean that they will either have to impose severe austerity or face default. This is the root of a brewing global financial crisis.

As I posted earlier this week we seem to be spinning into another risk aversion credit market collapse that is wrecking havoc on global financial markets. Essentially we seem headed for a Lehman moment but instead of subprime mortgages it involves European debt. I feel like I have seen this movie before and it does not end well.

The main plot is this: banks gorged on risky credits in search of yields above no-risk U.S. Treasury obligations; easy credit meant borrowers overextended themselves; the unregulated derivatives markets spread the risky credit throughout the entire global financial system; now creditors do not trust even creditworthy borrowers; the system is now poised for a deflationary shock; and credit spreads are exploding globally. Here is how legendary bond guru Mohamed El-Erian sees it playing out: "The Greek crisis has already morphed into a regional Eurozone shock. It now stands on the verge of morphing into a more global phenomenon." According to high-profile European bankers the European Central Bank needs to bailout the banking system over there or we face a freeze up that could be "worse" then Lehman. Noble laureate Joseph Stiglitz sees "the very survival of the Euro at stake." I personally do not how this ends or how long we get to the endgame. Events this weekend will play a huge role in market action next week. I fear Americans are largely oblivious to events over there, but that may change next week, if markets give the thumbs down to the latest ECB and Eurozone actions.

I do know this however: these transnational banks gorged on excessive sovereign debt all on their own. Like commercial real estate, there simply was zero argument that some vague government policy or law caused the banks to gorge on risk that led to millions in payout for CEOs and a crash of global capitalism. Fannie and Freddie bought no Greek debt. Yet, the unregulated global financial system and the very lightly regulated global banks took these risks on board anyhow. In the US our top ten banks threw $176 billion at PIIGS debt.

So let's stop with the delusional laissez faire rhetoric. These transnational banks took these risks because they wanted these risks. These ultra-sophisticated banks with armies of quants armed with PhD.s took these risks because they wanted fatter profits than prudent banking would yield. The CEOs of these massive banks took these risks because they got huge bonuses on the front end and golden parachute payouts on the back end when their firms failed. Fannie and Freddie played a bit role at best in this still unfurling mega-drama.

President Obama’s Speech Before the Business Council

President Obama made a speech before the Business Council last Tuesday, making his pitch for financial regulation reform. One of the President’s key points was the importance of building and maintaining a working partnership between business and government in order to stabilize the economy. “I believe the success of the American economy depends not on the efforts of government, but on the innovation and enterprise of American businesses. And it will be American businesses that will help us emerge from this period of economic crisis and economic turmoil.” In discussing government’s role in rebuilding our economy, the President made clear that he believes in free markets. The President spoke of the importance of “markets that are free and open to all who are willing to work hard”. But, he continued, “that doesn’t relieve government of its responsibility to help foster sustained economic growth and to ensure that our markets are functioning freely.”

President Obama spoke of the importance of governmental rulemaking for a well-functioning market. Rules that will help to prevent dishonest market participants from “gaming the system” are essential. But the President’s speech, and the discourse about financial reform in general, fail to emphasize a change in business culture that would make ethics central to any discussion about business and finance. In other words, elected officials, regulators and business leaders should focus on the fundamental principles of responsible corporate leadership – not just the rules. Individuals can always get around the rules. What we need is a change in the business climate itself.

Nigeria's New President

Early this morning, one of Africa’s most populous and wealthiest countries swore in a new president. Goodluck Jonathan, former Vice President of Nigeria, assumed the role of president upon the death of Umaru Yar’Adua. Former President Yar’Adua had long suffered a number of significant health issues including heart inflammation and kidney ailments. President Jonathan, in assuming the position of acting President, pledged to focus on good governance and electoral reform. The nation’s April 2011 elections will offer a chance to measure the success of President Jonathan’s efforts.

The new president will face a myriad of issues, including the challenge of maintaining peace and stability in the deep oil-rich pockets of the nation’s delta. Former President Yar’Adua was celebrated by many for bringing peace to the Niger Delta region. Rich in oil deposits, the Niger Delta region, has generated significant wealth for the country. With one of the most developed economies in Africa, Nigeria’s growth depends heavily on the export of oil; revenues from oil account for 80% of the country’s GDP and 90% of its total exports. Nigeria is the 12th largest producer of petroleum in the world. After struggling through losses last year related to the global financial crisis, a Nigerian central banker reports that the country’s economy is poised to grow 7% this year.

The resilience of a number of emerging market countries following the recession has ignited an interesting discussion regarding a shift in the global balance of economic power in the decades to come. According to a special report in this week’s Economist, four particular countries - Brazil, Russia, India and China- stand poised to set the agenda for economic reform. Hopefully, Nigeria will attain the good governance goals that the President Jonathan has set out and maintain peace in the Niger Delta region. President Jonathan’s given name suggests that fortune may already be on his side.

Not Quite Ready to Damn Derivatives

As a result of their role generating significant economic losses during the recent financial crisis, it is not surprising that there is a dearth of credit derivatives defenders. Few publicly disagree with demands for increased regulation of credit derivatives or dismiss as populism cries for increased transparency and oversight. Republicans, in a reversal of strategy, have hitched their efforts to thwart adoption of financial regulation to a “We-Want- Even-More-Regulation” battlewagon.

Interestingly, last week, a senior bank regulator and appointee of the Democratic administration expressed concerns that regulation as currently proposed threatens to drive use of derivatives into the shadows, an approach that may present more of a threat to future economic stability than structuring regulation in a manner that maintains a spotlight on the use of these instruments. In her letter to Senate Banking Committee chairman Christopher Dodd, D-Conn., and Agriculture Committee Chairwoman Blanche Lincoln, D-Ark., Sheila Bair urged caution in the Senate’s approach to regulating derivatives.

According to Ms. Bair, the chairwoman of the Federal Deposit Insurance Corp., Inc., legislators should tighten the reins on derivatives but avoid choking the industry. The current proposal for regulation of derivatives requires standardization of derivatives and compels exchange trading or trading these instruments through clearinghouses. By failing to include provisions for a broad enough range of alternatives or regulator flexibility in addressing customized derivatives products, Ms. Bair argued, “the underlying premise” of the proposed legislation suggests “that the best way to protect the deposit insurance fund is to push higher risk activities into the so-called shadow sector.” Ms. Bair argued against overly restrictive regulation on two grounds; first, derivatives offer an important risk management tool for banks and second, not all derivatives are created equal. After expressing “strong support for enhanced regulation of ‘over-the-counter’ (‘OTC’) derivatives and the provisions of the bill which would require centralized clearing and exchange trading of standardized products,” Ms. Bair explained that certain uses of OTC derivatives, such as bank’s use of derivatives for interest rate hedging, offer valuable tools for banks to manage risk in an environment where “uncertainty surround[s] future movements in interest rates” and failure to hedge may have detrimental effects on “unhedged banks.”

Is it that simple to distinguish among parties’ varied uses of derivatives? Distinguishing “good” and “bad” uses of these instruments may be more elusive than Ms. Bair suggests. The recent crisis illustrates that banks and bank holding companies should not be permitted to engage in activities that create substantial risks of solvency-threatening liquidity crises. The difficulty with Ms. Bair’s position and most other voices offering direction on how to regulate derivatives centers on the challenge of identifying “speculative trading.” Many point to naked credit default swaps as an example of the type of speculation that should be banned. The agreements are described as a mechanism for gambling. Is this characterization completely accurate? Are there any uses of credit default swaps or naked credit default swaps that offer strategic value beyond hedging against risk? Is risk-reduction the litmus test for determining the social value of investment products? If there is a distinction between hedging and speculation, can we articulately describe it? It seems we must agree on broader national questions about the social value of investing in order to reach acceptable answers to several of these questions.