Thanks to the editors of the ABA Journal for listing The Conglomerate among the 100 best law blogs. This is the Third Annual ABA Journal Blawg 100, and The Conglomerate has appeared on all three lists. We have never been a top contender in the voting portion of this promotion, but for me the value of the list is that it introduces me to new law blogs.

Apparently, I am not alone. I first learned of the list from a reader who received a hard copy of The ABA Journal, but shortly thereafter I noticed a (small) flurry of subscriptions to our Twitter feeds. I couldn't make sense of that until I saw the entry for us on the Blawg 100 site:

Legal Theory

For those looking for more than just casual musings and rants, these academics provide substance over sensation.

...

Conglomerate, aka The Glom, is a group effort by academics who emphasize, however loosely, business, law, economics and the catchall—society.

Twitter: @GlomPosts, @Glom

Quick Take: The Glom has hosted a Junior Scholars Workshop since 2005 as a way to mentor untenured law professors and those just entering law school teaching.

We take some pride in our promotion of junior business law scholars, so I am happy that the editors noticed. One of these days, I am going to have one of the those junior scholars explain how they follow blogs on Twitter. I am still using Google Reader.

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I was talking about conglomeration (horizontal integration) today in class ... then returned to my email to find Steve Bainbridge's post describing differences between horizontal and vertical integration. Inspired by this W$J article, Steve wonders whether recent moves toward vertical integration mean that George Geis was wrong about outsourcing or whether outsourcing is a management fad. 

My impressionistic take, for what it's worth: George was right about outsourcing, and outsourcing is not a fad. Outsourcing still makes sense in some contexts. As noted in the W$J article:

In the past two years, Boeing bought a factory and a 50% stake in a joint venture that make parts for its troubled 787 Dreamliner jet. The moves partially reversed Boeing's aggressive outsourcing strategy to assemble the Dreamliner from parts made by hundreds of suppliers. Supply and assembly problems have knocked the Dreamliner more than two years behind schedule. Boeing CEO Jim McNerney says the company is still committed to outsourcing.

I don't see any reason to privilege one form of organization over the other in all circumstances. Even if transaction costs were the only motivator of organizational structure -- or perhaps I should say, especially if transaction costs were the only motivator of organizational structure -- we would still expect some institutional diversity to account for different frictions in different contexts.

Oh, and just in case you forgot, transaction costs are not the only motivator of organizational structure.

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It is hard to know, given that the country has acknowledged that it is $59 billion in debt, and its wholly owned firm, Dubai Portsworld, has extended the maturities on its debt for six months.  Here's a nice look at the panic.  If it is the company, that's a matter of international contractual and commercial law.  What happens if countries default on their debt?

There's nothing forbidding such a thing in customary public international law, and debt defaults in the past century, have, of course, been legion.  One buys sovereign bonds at one's own risk, though it could be that Dubai is a party to some exotic investment treaties of which I am not aware.

But what if Dubai is discriminating against foreign investors in the way it treats its creditors?  In the Barcelona Traction case, the ICJ made it difficult for countries to espouse the interests of their investors if they believed their investments were being expropriated by their host country.  The result was a flowering of BITs, or bilateral investment treaties, which provided national treatment obligations and usually the option to take a dispute to a neutral arbitrator.  It meant that foreign investors could claim that they were being discriminated against, and they could do it to a panel of arbitrators in Washington, DC, Paris, or Stockholm.  Dubai itself is not a party to any BITs, according to the World Bank, but the UAE, of which Dubai is a part, is a party to 21 (that's not many - fewer than Venezuela and Vietnam).  There may not be much here for foreign investors to grab onto.  The WTO, which the UAE joined in 1995, is also pretty sparse on investment protections (which have been left to the BITs).

The key to these sorts of claims is to establish that domestic investors are being treated better than are foreign ones.  There's no indication yet that this is the case.  And while some have argued that international law forbids the expropriation of property without paying compensation, I'm not sure that many observers would find that rule to be one carefully observed.  And it could, at any rate, be circumvented by the contractual outs contained in the sovereign debt. 

Finally, sovereigns are generally immune from suit in foreign courts - whether that immunity should extend to purely commercial activities is a matter of debate, but it is worth noting that sovereign debt does not clearly qualify as commercial activity - at least, not in the same way that operating an airline would.

So these are the sort of questions that might form the basis for a beginning of research - but it would be a beginning; I'm not holding myself out as an expert on sovereign defaults, who have their own well versed followers in the halls of academe.

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Thanks to Christine for her interest in my work, and for suggesting to Gordon that I take some time to share my research interests with the Glom readership. Thanks also to Gordon for agreeing to have me. I’m thrilled for the opportunity to make the (temporary) leap from Glom reader to Glom contributor!

I hate to admit this, but as a child I was particularly susceptible to certain forms of advertising— particularly ads for sugary, chocolatey cereals (though my mother was, sadly, much less vulnerable). It’s no surprise, then, that the tremendous surge of interest in contingent convertible bonds (CoCo Bonds) over the past several weeks calls to mind one of my favorite sugary cereal ad characters: Sonny the Cuckoo Bird, who tried to no avail to perform simple tasks without being distracted by the “munchy, crunchy, chocolatey” goodness of Cocoa Puffs. Poor Sonny never could get on with his business, as temptation invariably overcame him and drove him “Cuckoo for Cocoa Puffs!”

Like Sonny, some in the financial world appear to have gone cuckoo, but for CoCo Bonds, a type of convertible debt instrument with a history, but also a new, potentially game-changing use. Though they are not new, CoCos owe their new lease on life to their recently-discovered potential to provide banks an automatic capital cushion during times of stress. This new brand of CoCo will provide that cushion by converting from debt to equity when a bank crosses a predetermined threshold that indicates the bank is in trouble—exactly the time when it will need capital, but have a difficult time raising it. The argument goes that this conversion will provide banks a soft landing, thus making government capital injections unnecessary. The equity conversion also ensures that bondholders get some value for their investments, but eliminates the moral hazard issues associated with “too big to fail” policies that bail them out. Regulators have thus far been unable to constrain these moral hazards; CoCo Bonds offer a promising and (because taxpayer money is not involved) politically desirable solution.

Critics warn, however, that CoCo Bonds are not “a panacea for banks,” stressing that it is difficult to set conversion triggers at the proper levels and uncertain investor appetite may make pricing infeasible. Some go so far as to call these instruments “CoCo the Clown Notes” and their proponents “CoCo nuts.”

Over the next few days, I will introduce Glom readers to CoCos, explain how they work and identify how they appeal to bankers and bank regulators. I will also highlight the practical difficulties that may limit the CoCo's effectiveness as a capital cushion, such as the difficulty in ascertaining the proper trigger point, pricing constraints, and equity dilution. I will further explore how CoCos alter the conflict between shareholders, bondholders, and management. Finally, I will investigate how regulators appear to be creating and shaping the early market for these products, and query whether CoCos would have legs without government intervention. Today's entry introduces the traditional CoCo Bond concept.

Merrill Lynch and Tyco International introduced CoCos to the world in 2000. CoCos are convertible securities, but unlike most convertibles, they cannot be converted into shares of common stock until the issuer reaches a pre-conversion threshold. For example, a holder may only convert a contingent convertible note with a $10 stock price at issue, a 25% conversion premium, and a 120% contingent conversion trigger if the stock trades above $15.00 ($12.50 x 120%) over a predetermined period. The holder would convert at $12.50. Like most equity-linked debt, CoCos were attractive to issuers because the issuer could issue debt with a lower coupon than it would have to pay on a traditional fixed income security. CoCos, however, offered issuers an additional benefit: the equity securities underlying them were not included in the issuer’s diluted EPS calculation (because accounting rules at the time provided that if the right to convert was subject to a meaningful contingency that did not disappear through the passage of time, the underlying equity securities did not have to be included in diluted EPS until the contingency had been satisfied).

CoCos were extremely popular from their introduction to July 2004; investors snapped up more than 360 CoCo issues, valued at more than $125 billion, in less than four years. CoCos became much less attractive beginning in the fall of 2004, however, when the FASB’s Emerging Issues Task Force sought to standardize the accounting treatment of all convertible bonds by requiring issuers to include all underlying securities in EPS calculations when the conversion trigger depended on market prices. The FASB did not grandfather in the more than $125 billion in outstanding CoCos, forcing many companies to quickly pay down the CoCos they issued to avoid massive EPS reductions.

The FASB rule change all but killed off the CoCo until earlier this fall, when Lloyds Banking Group, plc, perhaps at the behest of the Bank of England and the FSA, resurrected it in a different form. Tomorrow we’ll explore the new form, and discover why regulators are so attracted to it.

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No, Cyber Monday didn't make me late with Monday introductions!  I am very excited to welcome Rob Beard, a visiting assistant professor at the University of Illinois College of Law, as a guest blogger at the Conglomerate.  I won't embarrass Rob by telling stories about how amazing a research assistant he was or how wonderful it was to have him in class, because that would just make me look like an old geezer.  Rob clerked last year on the Ninth Circuit, and we're excited to have him back at Illinois as a colleague.  Rob is doing some really interesting research on corporate law topics -- so stay tuned.  Welcome, Rob!

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Last weekend, The New York Times reported that internships are again en vogue and offer a welcomed path out of the recession for many seeking to transition between careers or aiming to take advantage of employment opportunities complementary to their areas of expertise. The premise of the article seems reminiscent of an article that you may have read last summer in the National Law Journal regarding Howrey Simon’s law apprenticeship program. For better or worse, Big Law seems to be setting the business trends this time around.

The article from last summer describes Howrey Simon’s intentions to create an apprentice program for their incoming associate classes. Compared to medical residency or secondment of a young accountant at a client’s offices, the apprenticeship program intends to focus on skills developing opportunities such as legal writing and research through pro bono and similar opportunities. While seen as a maverick by some, Howrey is only breaking ground locally. Internationally, other jurisdictions already require a kind of apprenticeship. England and Wales have an article requirement and Scotland has a traineeship requirement. The idea already has a well-established track record in the Americas. In Canada, “articling” is a prerequisite to being called to the bar; bar candidates take bar exams after they  article for one year. A “principal” or admitted lawyer must agree to be responsible for an articling bar candidate’s training during the articling year. How’s that for forced bonding and mentorship! Though, in practice, bar candidates’ experiences are likely quite varied based upon the principal with whom they spend the year working.

Interestingly, articling, is a requirement of the provincial bars and offers firms an opportunity to expand the “trial period” of their courtship with bar candidates for a longer and more substantive period than the three month summer associate program common in the U.S. A bit of regulatory capture there by the bars(?)–reinforcing the notion that young lawyers are still in training and are economically less productive (and therefore, justifiably paid less, a Howrey program proponent might add).  

Three observations about the introduction of the apprenticeship model. First, the introduction of the Howrey model facilitates a broader market reversal in associate compensation and reduces the reputational threat for firms who dare allege that students who completed three years at Big Law Schools still lack lawyering skills. Cravathand others’ bonus announcements this winter parallel the $25,000 discretionary bonus described in Howrey’s apprentice program. Second, while the Howrey apprenticeship announcement every-so-carefully declared no further reductions in pay levels, I expect that we will see creative explanations regarding decisions to reduce Big Law first year salaries from their current historic high of $160,000. Third, while Gordon rightly notes the record numbers of LSAT takers in the current period, perhaps the shift in the structure of compensation and the lengthening of the timeline for eligibility for Big Law associateship (5 years if including 3 years of law school and a clerkship or two year apprenticeship at the firm) may influence, if not dissuade, future LSAT takers.

Whether or not the Howrey program represents a good business model, it's a great idea for a pilot: The Apprentice: Big Law, a reality show that depicts junior lawyers competing for a place as an associate at a large New York/Chicago/San Fran law firm. We have seen many lawyers on television and lawerly television shows, but never a survivor-for-junior-lawyers. Should I start working on the script?

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I posted this in October, but I am moving it up as a reminder ...

Darian Ibrahim, Brian Broughman, and I are organizing a "conference within a conference" for the next Law & Society Association Annual Meeting in Chicago, Illinois on May 27-30, 2010. The LSA's call for papers is here. Our goal is to assemble several paper panels of scholars who are doing work relating to law and entrepreneurship (broadly defined). We welcome not only legal scholars, but also scholars in other disciplines.

While much of the work at LSA is empirical -- and we encourage the submission of such proposals -- we also encourage other proposals.

This year the LSA is soliciting proposals for projects in the early stage of development that could be presented at work-in-progress sessions. We would be interested in developing a proposal for such a session focused on law and entrepreneurship, so please feel free to submit such projects to us.

You may submit a proposal to any of us via email, but as a default matter, please send your proposal to Gordon Smith by November 30, 2009.

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The NYT has a fascinating set of slides based on searches entered on Allrecipes.com,. The most common search? “Sweet potato casserole” ... by a country mile. But my favorite from the Top 50 was #16:

 

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On this Thanksgiving Day, I am grateful for the same sort of things mentioned by random people on the streets of New York ...

But reading a fascinating interview with Umberto Eco, I was reminded that I am also thankful for the ability to learn and grow and change:

I was fascinated with Stendhal at 13 and with Thomas Mann at 15 and, at 16, I loved Chopin. Then I spent my life getting to know the rest. Right now, Chopin is at the very top once again. If you interact with things in your life, everything is constantly changing.

Perhaps as important as the ability to change, I am grateful to be a companion to a woman who encourages me to change for the better. And I am thankful for a God who guides me and supports me in my quest to change. A God who tells me that my trials are of temporary duration but have eternal significance. A God who loves me even more than I love my own children, a fact that, on most days, is almost inconceivable to me. 

Happy Thanksgiving!

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Robert Pozen is currently chairman of MFS Investment Management and is also a senior lecturer at Harvard Business School. Pozen was President and Vice Chairman of Fidelity Investments until 2001. He served as a Democratic appointee to President Bush's bi-partisan Commission to Strengthen Social Security. Pozen then served as Secretary of Economic Affairs in 2003 under Governor Mitt Romney. In 2007, Pozen served as chairman of the SEC's Committee to Improve Financial Reporting. Working closely with both private and public sector experts, the committee made several actionable recommendations to improve the U.S. financial reporting system, many of which have been implemented.

Robert Pozen's Response Follows:

Let me begin by thanking Jay and Satya for their thoughtful reviews of my book.   I also want to thank Gordon Smith for facilitating these online book reviews.  They are a great tool for learning and discussion.

I appreciate that both reviews focus on the distinguishing characteristic of my book -- that I bite the bullet and make specific recommendations about how to deal with each aspect of the financial crisis.  As Satya says, many other books "devolve into mealy-mouthed platitudes and vagaries."

Given the number of recommendations in the book, I was glad to see that the reviewers agreed with many but not all of my suggestions.  I think Jay is right to point out that there is no easy solution to the problems of credit rating agencies.  I am skeptical that reputation effects will mitigate forum shopping -- issuers kept going to the Big Three credit rating agencies even after most of their ratings blew up.   But my preferred solution -- that investors hire and pay for the credit rating agencies -- is not workable because the big investors look down upon the rating analysts and will not pay.   My final proposal is definitely a compromise -- interpose a third party to select the credit agency and then let the issuer pay the bill.

Satya is correct in pointing out that I am deeply a pragmatist in my approach to reform.   That probably comes from actually getting legislation passed while at the SEC and later at Fidelity.   But I do believe as a matter of principle that loan securitization is very useful to both banks and investors so it is worthwhile to reform the securitization process.   By selling loans to be securitized, banks can significantly increase their loan volume -- which is desperately needed to revive the US economy. They can also buy more diversified portfolios of securitized loans than they could possible originate. Similarly, investors can achieve more diversified portfolios of mortgage-related instruments.  In addition, by choosing a particular tranche issued by a pool of securitized mortgages, investors can target the risk-return relationship they desire.

I liked that both reviewers warmed to my concerns about increasing FDIC limits for deposit insurance despite the fact that 98% of depositors are already covered by the $100,000 limit.  This increase is getting lots of political support with little analysis.  I was not surprised to be taken to task for my partial support of the Consumer Financial Products Commission ( CFPC ), since my position is ambivalent.  I tried to support the CFPC to the extent it was focused on products issued mainly by nonbanking firms to low-income clients like subprime mortgages and payday loans.   However, I took a pretty strong line against the expansion of the CFPC into standard bank deposits and insurance annuities, which are already well regulated.  I also argued against letting states add their rules to national regulations on credit cards.

Finally, I did take a flyer with the parable at the beginning -- trying to attract the non-expert by a novelistic tale.   Furthermore, I tried to make the book accessible to the nonexpert by including diagrams and chapter summaries as well as a glossary.   But it is challenging to write hard-nosed analysis and specific recommendations in a riveting style, so I am not planning to be invited on the Oprah Winfrey show.

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Satya Thallam is the Director of the Financial Markets Working Group at the Mercatus Center at George Mason University, an interdisciplinary group of scholars who conduct research and advise policymakers on financial regulatory reform efforts. He was previously the 2007 Hernando de Soto Fellow where he conducted research into issues of comparative property rights, and has also written on issues of technology regulation, fiscal policy, and urban planning. He completed coursework towards a Ph.D in economics at Emory University and is a contributing editor to the site FinReg21 and the journal Lombard Street.

Before we get started, I'd like to thank The Glom for inviting me to participate in this book club. I've been reading with great interest posts here for a while, but find the book club posts to be among the most interesting. Let's hope I don't drag down the team average too far. 

 

Robert Pozen’s new book Too Big to Save? How to Fix the U.S. Financial System begins with the usual rigamarole of pre-textual text. After the obligatory Foreword and Acknowledgements, Pozen inserts an instructive but slightly weird parable about the financial crisis. It’s unusual because it includes a cast of characters both familiar and fictional, mixed together in a straightforward telling of the financial crisis story. Real participants in the story like Standard & Poor’s and AIG exist alongside made-up entities like Wall Street Dealer, FinCredit and hedge fund manager Joe Engler. His mission is to create a brief narrative account of what happened before diving into the details. In this sense Pozen accomplishes his mission, but the effect of the fact/fictional mixture is to lead the reader to believe some parts of the actual story is unknowable and ultimately the parable loses some credibility. If there is one flaw in this book (among its many virtues) its that Pozen lacks the flare of a Gillian Tett or Andrew Ross Sorkin, which leaves his chapter-by-chapter historical narratives (especially in the first part) dry and straightforward. Then again, to some people that may be an advantage of the book.

 

To comprehensively address the claims in this book would itself require another book. There are literally hundreds of concrete and specific policy recommendations, conveniently highlighted in bold throughout the text. It should be said that Pozen’s stance is one of unapologetic pragmatism. He doesn’t try to remake the country’s financial system as it would be in a perfect world. He does not even really try to remake it as it would be in a decidedly better world. He starts from the world in which we live and makes allowances for marginal improvements given typical industry and political obstructionism. In an event last week I hosted with the author, the primary disagreement between many of my colleagues and Pozen was on this point – is where we are a useful starting point for reform? Whereas Pozen offers suggestions to restart and make more robust the now dormant securitization process for mortgage financing, other commentators question whether such a system is useful in the first place.

 

Pozen may also be too quick draw conclusions where there are none, or the evidence is unclear. At the risk of sounding obtuse, let me provide an analogy. Pretend we’re looking at a picture of two children playing on a see-saw. The see-saw itself is in mid swing, with both children an equal distance from the ground. How would we know which child just pushed off? Throughout Too Big to Save? Pozen looks at a similar snapshot of the financial crisis and then makes in inference as to who was doing the pushing and who was consequently pushed. For instance, while acknowledging that some homeowners knowingly took advantage of unscrupulous underwriting standards, he concludes that the primary cause of mortgages likely to default were mortgage brokers subject to too little consumer protection oversight. His recommendation is that consumer protection be consolidated into one agency as put forward in proposals for a new Consumer Financial Protection Agency. To be fair, Pozen uses credible sources of data throughout, but jumps from apparent correlations to causation. On the flipside, there is evidence that consumers simply responded to the incentives laid out by monetary policy and anti-deficiency laws. No doubt his many years in the industry, as well as turns in academia and public service brings with it a considerable amount of tacit knowledge that inform his conclusions, but they’re not always clear to the reader.

 

That being said, Pozen’s book is probably the most measured and comprehensive of its peers. In addition to the usual inclusion of discussions on derivatives, the bailout, corporate governance, and short-selling, the book includes a sober assessment of the oft-overlooked increase in the FDIC insurance limit, the often emotionally debated use of mathematical modeling (including a clear graphical explanation of distribution curves), and a lucid, though borrowed, example of how small mistakes in estimating the risk of underlying mortgage securities lead to catastrophic changes in the risks associated with CDOs.

 

As mentioned above, Pozen’s book is rather comprehensive and it would be silly to try to address all of his points, or even to select a subgroup of the “most important” ones. Suffice it to say the book does a fine job of elucidating the chain of finance which ultimately led us to where we are. While readers may take issue with the lessons he draws, they would be hard-pressed to accuse him of cherry-picking his data or evidence. Notwithstanding the difficulties I have with the book outlined above, it is an eminently readable and useful resource on the subject. And Pozen should be further commended for offering discrete and refutable policy choices on nearly every page where other writers often devolve into mealy-mouthed platitudes and vagaries.

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I am pleased to return to the Conglomerate today to host another in the successful line of Conglomerate Book Clubs.  Today we will be taking a look at Too Big to Save?  How To Fix the U.S. Financial System by Robert Pozen.  I will also be joined by Satya Thallam, Director of the Mercatus Center Financial Markets Working Group.

Bob's book is a fascinating read, and it is informed by his wealth of experience in financial markets.  Bob was the President of Fidelity Investments and presided over an unprecedented era of growth for Fidelity. From the non-partisan, clear cut compromises the book develops for fixing the financial system, we also get the sense that the book is informed by Bob's work on a number of bi-partisan projects, from the Social Security Blue Ribbon Commission to Chairing the SEC Advisory Committee on Financial Reporting.  For example, the book provides an excellent play by play of the Treasury Department's TARP program to inject capital into failing banks and provides a useful running critique of the Bush administration's approach.  Yet it also runs counter to many of the reform initiatives in the current Dodd Bill.  It is a breath of fresh air to read an analysis of financial regulatory reform that isn't motivated by partisanship or regulatory turf wars.

One appealing feature of the book is its accessibility.  The novice will find in it a concise summary of the events leading up to the financial crisis of 2008-2009 and a clear explanation of some very complicated financial engineering.  The book really hits its stride in the chapter on Credit Default Swaps, where it first made me question my understanding of instruments I thought I understood, and then resolved each of my questions in turn.  Each chapter also closes with a short list of recommendations for solving the regulatory challenges that the chapter addresses.  

I found I agreed with probably 2/3 of the recommendations in the book.  For instance, incorporating liquidity risk into financial models in a more conservative way seems like a great idea, and regulation designed around a "comply or explain" format for banks incorporating liquidity risk into their reserve requirements is something I can support.  But I also found that some of Bob's recommendations ran counter to my views.  For instance, I don't think that breaking the credit ratings oligopoly by allowing more competition for ratings will lead to forum shopping for ratings.  I think reputational effects will mitigate forum shopping.  So I thought that most of his ideas were brilliant, and many of them made me uncomfortable, but I suspect that this is what bi-partisan compromise feels like when it actually occurs.

Bob picks his battles carefully.  In his analysis of Fannie, Freddie, and the Federal Housing Administration, he doesn't take much of a position on the larger question of how much the government should subsidize housing.  He does recommend, however, that housing subsidies take place on the federal budget, rather than continuing the smoke and mirrors game of implicit (but unrecognized for budget purposes) government backing for mortgage intermediaries.  He also gets into the weeds to offer some useful mechanical solutions, like limiting tax credits to half the down payment on a house and requiring hard down payments (not tax credits or exemptions) for FHA housing.

One of Bob's conclusions that I think could be better supported is found in the chapter on hedge funds. Bob is suspicious of over-leveraged and unregistered hedge funds, but his recommendation that hedge funds register with the SEC isn't well supported.  Many hedge funds voluntarily registered with the SEC, hoping to use registration as a selling point to clients, have complained that the Commission doesn't have the resources to conduct many compliance audits.  Let's not also forget that Madoff was a registered investment adviser. 

The book does a masterful job of considering the banking regulators and provides some well supported recommendations in that regard.  Most importantly, Bob notes that the Fed needs to adopt an explicit inflation target to help minimize the specter of inflation on the horizon.  He also argues that the Fed should stick to what it does best, monetary policy, and get out of the business of regulating consumer protection or financing the purchase of corporate assets.  With respect to the FDIC, Bob argues that charging the same insurance premiums to all banks and thrifts regardless of their risk doesn't make any sense, and he's right. 

The book also signs on to the new Consumer Financial Protection Agency, but doesn't acknowledge that there is a growing debate over whether it will be effective in achieving its objective (for more on the debate see Zywicki and Wright).  Regulators didn't do a very good job in predicting problem spots in this crisis.  Bob mentions that OFHEO ruled Fannie and Freddie's books "accurate and reliable" just days before a scathing audit report.  The PCAOB is criticized for mark-to-market accounting, and the SEC takes a hit for its Consolidated Supervised Entity program overseeing the investment banks.  One is left to wonder whether new agencies are going to offer much benefit.

Bob's book is a must read, not only because it presents a clear picture of how we got into this mess but also because it provides the most independent, non-biased roadmap available of how to get us out.  Buy your copy here.

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Oprah Winfrey interviewed Sarah Palin last week and hinted that the former VP candidate may be in talks to launch a talk show. “Should I be worried?” Oprah asked with a coy smile (she would announce retirement days later).  If Oprah is not above paranoia about job security, who are we to rest on our laurels? Admit it. Even as the financial markets show signs of stabilization, some of us are still keeping an eye trained on our competition.

The NYSE may want to watch the competition closely. Last week’s edition of the Economist featured a replica of Cristo Redentor (Christ the Redeemer) atop Corcovado Mountain in Rio de Janeiro rocketing into the heavens. According to President Luiz Inácio Lula da Silva, "[i]t is Brazil's time." Should we really be surprised by Brazil’s success? Maybe. Maybe not. But I think we should be thoughtful about what Brazil’s success means for competition among international stock exchanges for listings of publicly offered securities.

Brazil is silencing critics and earning its place in Jim O’Neil of Goldman Sachs’s creative acronym “BRIC.”  Economists use the term BRIC to describe the fastest-growing developing economies in the world, Brazil, Russia, India and China. In the recent financial crisis, Brazil stunned economist and pundits with strong performance - making it one of the last in and first out of the crisis. Brazil’s economy seems poised to experience continued positive growth despite the crisis.

Brazilian companies are active in the currently ripe mergers and acquisitions market. Two deals that indicate that Brazil companies are strong contenders on the mergers and acquisitions dealbook map-  InBev’s acquisition of Anheuser-Busch and Vale’s acquisition of Canada mining company Inco (much to the chagrin of North American competing bidders Falconbridge and Phelps Dodge). Last year, rating agencies awarded the country’s sovereign debt an investment grade rating; impressive for a nation that nearly defaulted on its sovereign debt less than a decade ago. Rising real wages have lifted 24 million Brazilians above the poverty line in the last seven years. Record prices on commodities such as soy, iron ore, and steel exports contributed to the government amassing a healthy a $224.2 billion stock pile of international reserves. Yes, real problems persist. While its record 6.8% growth in the third quarter of 2008 will not be sustainable, economists do expect that Brazil will enjoy a healthy growth rate of 4-5%. The real (Brazilian currency) has enjoyed strong appreciation in the last year. During the same period foreign direct investment rose 30% (presenting some concerns explored in an interesting piece by Rachel Anderson).

Foreign issuers have historically chosen to list on an international stock exchange such as the NYSE because international exchanges offer lower costs of capital, increased liquidity, access to a deeper, more diversified shareholder base and higher visibility. In recent years, scholars like John Coffee have debated foreign issuers’ preference for listing their publicly traded securities on domestic exchanges in lieu of listing on a national exchange and cross-listing on an international exchange such as the New York Stock Exchange. In a forthcoming piece, I examine Brazilian and other emerging market issuers’ increasing share in the global capital markets listing race. These issuers’ smart use of depositary receipts to gain access to American and European capital without undertaking the onerous and expensive listing process and on-going reporting requirements is noteworthy. While in private practice, I had the privilege of working on Regulation S and Rule 144 exempt offerings of American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs) by a number of Brazilian issuers launching IPOs on Brazil’s national stock exchange (BOVESPA) and listing ADRs or GDRs in Luxembourg or a similar jurisdiction. The growing use of ADR and GDR markets challenges arguments that U.S. capital markets will sustain their competitive edge as developing economies present increasingly present interesting capital investment opportunities. Another interesting issue that is changing the competitive landscape is corporate governance reform initiated by stock exchanges emerging market countries.

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With all the investors in distress news in today's Times, I'm just glad that we're somewhat close to Thanksgiving.  This Madoff motion by the investors who think their losses ought to include some of the scheme's paper profits is pretty cheeky, and completely antithetical to the way the trustee has been doing things.  It could also, it seems to me, put the SIPC - the securities industry FDIC - on the hook for the whole fictional $50 billion originally thrown around with regard to the affair, it seems to me.  For that reason alone, it seems like a stretch, but one increasingly thinks knowledge of bankruptcy and its cognates would be of real assistance these days.  Also in distress - Raj Rajaratnam's defense, ably analyzed by Peter Henning here.

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In connection with a story I was reading about the SEC’s outreach efforts to promote financial literacy among elementary students, I stumbled across a pretty depressing survey on financial literacy in young Americans.   Last Friday, officials from the SEC, FINRA and the Jump$tart Coalition for Personal Financial Literacy visited 18 elementary schools throughout the county to teach a class on financial literacy.  The program is part of a joint partnership among the organizations called Project C.H.A.N.G.E: Creating Habits and Awareness for the Next Generation’s Economy.  In talking about Project C.H.A.N.G.E, Chairman Schapiro noted “Teaching children about money is an investment in the future, because an investment in financial literacy can pay a lifetime of dividends.” And apparently young Americans are in dire need of such an investment. 

A 2008 national Jump$tart survey found that the financial literacy of high school students had fallen to its lowest level ever, with students scoring an average of 48.3%--that would be a failing grade.  The survey notes that basic and critical financial concepts are simply not getting through to the next generation.  To be sure, college students fare better on the survey and hence, the survey concludes that “American college graduates are close to being financially literate and probably will be so with more life experience.”  However, because only 25% of our youth graduate from college, the survey's results mean that 75% of young American adults “are likely to lack the skills necessary to make beneficial financial decisions.”

As the survey notes, these numbers are particularly troubling because they have emerged despite concerted efforts over the last decade to improve financial literacy.  Indeed, when Jump$start first began measuring financial literacy eleven years ago, the average financial literacy score for high school students was 57.3%.  Since then, the numbers actually have declined falling to 51.9% and then rebounding to 52.4%, but the latest numbers reflect a new low.  And this low comes even though, since the organization’s inception, hundreds of efforts and initiatives at the state and federal level have emerged aimed at promoting financial literacy.   In some cases, these actions have proved beneficial.  Interestingly, early surveys found that students from families in the top income range fared worse than students from lower income ranges.  This result was attributed to the thought that "students from more affluent homes did not have to be as financially literate as their less affluent counterparts since they were almost universally college-bound and would probably be "cocooned" from most financial responsibilities for at least four more years." However, student scores from families in these higher income brackets have now improved.  The survey hypothesizes that this improvement stems not only from the financial literacy movement, but also from the fact that such students are in environments most capable of offering them a solution. By stark contrast, students in other income brackets have not seen similar success.  Instead, sometimes educational efforts appear to be having the opposite effect.  Hence, the survey found that students who take high school courses in personal finance tend to fare no better than those who do not take such a course.  The overall result is that student scores remain low and there is now an increasing divide between the financial literacy of students.

The survey's executive summary ends with this thought:

<="<" li="li">Since standard of living is a multiplicative function of both financial resources (income and wealth) and the ability to use those resources efficiently (financial literacy), we find it increasingly disturbing that those with less income and education are saddled with the additional disadvantage of not possessing the ability to spend what they have efficiently.  It is no great surprise to learn that the current financial crisis began with the sub-prime mortgages that were marketed primarily to those with less income, education, and presumably less financial literacy than those who were eligible for prime mortgages.  Financial literacy clearly has ongoing macroeconomic ramifications.

In the end, the survey is a sobering commentary on the financial literacy of all young Americans.  And I certainly finished the survey convinced that we need to do significantly more work in this area.

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