Monday, March 30, 2015

(Social Costs Of Capitalism Are Destroying Earth’s Ability To Support Life)  In Which the Would-Be Enforcement Official Cravenly Compliments the Industry He Supposedly Polices and Then Jokingly Puts Forward His Own Son As a Candidate for Job in Private Equity (Financial Feudalism Explained)

What’s Wrong with the Economy — and with Economics?

Wait, you mean the gutting and deading of extreme capitalism has had a few downside social costs?

And WTF are social costs? (And who cares anymore anyway?)

Aren't we the noveau Richie Riches now? (It's good to be king.)

. . . the external cost imposed on the climate by fossil-fuel use is the source of the life-threatening crisis that humanity confronts. Capitalists make money by exploiting labor and by externalizing the costs of the wastes produced by the productive process by imposing the wastes on the environment. It is the short-term time horizon of production organized by selfish private interests focused on quarterly profits that is destroying the livability of the earth.The Social Costs Of Capitalism Are Destroying Earth’s Ability To Support Life

Regulatory Capture, Captured on Video

By Matt Taibbi, "Rolling Stone"

27 March 15

SEC official slobbers over private equity titans, suggests his son might want a job in the field
his is courtesy of Yves Smith over at "Naked Capitalism," who's been following the strange story of SEC Examination chief Andrew Bowden's evolving position on financial corruption for a while.

That story blew up recently in a remarkable public appearance by Bowden, in which the would-be enforcement official cravenly compliments the industry he supposedly polices and then — get this — jokingly puts forward his own son as a candidate for a job in private equity. On video. You won't see a more brazen example of regulatory capture anywhere.

Some brief backstory. Just a little under a year ago, Bowden, the SEC's Director of Compliance Inspections and Examinations, gave a speech that was remarkably, unusually critical of the Private Equity field. Bowden had conducted a study of the Private Equity buSsiness and found that over half of the companies they looked at were guilty of ripping off their clients:

By far, the most common observation our examiners have made when examining private equity firms has to do with the adviser's collection of fees and allocation of expenses. When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50 percent of the time.

To fully explain what Bowden is talking about here would require a much longer article, but the basics go something like this.

Private Equity reptiles like Mitt Romney make their living borrowing huge sums of money, millions and billions, from investors called "limited partners." They then take that borrowed money and acquire companies with that cash, sometimes with the company's consent, sometimes without it.

The ostensible object of the exercise (at least, this is the way folks in the Private Equity business would describe it) is to make money for the limited partners by acquiring flawed firms, turning them around, and channeling the profits from the reborn target firm back to the investors.

However, from another point of view, the more immediate object of the exercise is to make money for the Private Equity firm. This can be achieved in virtually countless ways once these takeover parasite-pirates have latched on to their target. But the most reliable way of making cash is to soak the acquired company for huge masses of fees, both legit and not.

The always-excellent Gretchen Morgensen brought up a great example last year, in a piece about a company called Biomet that had been taken over by a consortium of PE partnerships. She wrote that Biomet will be forced to keep paying about $30 million in "monitoring fees" through 2017, which as Morgensen notes is two years after the deal closes.

In other words, she wrote, "Blackstone, Goldman Sachs, K.K.R. and TPG will be paid for two years of services that Biomet isn't receiving."

Anyway, last year, Andrew Bowden at the SEC found that over half of the PE/LBO firms he looked at were doing something wrong with fees.

One of the most common scams involves the use of something called "Operating Partners." In essence, the PE firm forces the target company to hire their people as independent contracting consultants.

As Bowden put it, these "Operating Partners" are typically Wall Street hotshots whose services "the portfolio companies could not independently afford."

The scam here, as Yves Smith points out, is that the investors think that the Private Equity firm is paying for these managers, while in fact they're being paid for by the acquired company. As Smith says, this scheme essentially robs the investors:

From an economic perspective, every dollar that comes out of a portfolio company this way is effectively stolen from the limited partner investors, since they would otherwise have the first claim on the portfolio companies' cash flows.

All of which is a complicated way of saying the following: Takeover Artist Jerks use hidden fees to rip investors off.

Last May, Bowden, a senior SEC official, described this problem as almost epidemic. The SEC looked at 150 companies and over half were guilty of something.

A year later? They're not so worried.

It raised some eyebrows over the course of last summer and fall when the SEC did not follow up on Bowden's remarks.

Even some Private Equity trade publications began to wonder aloud where the beef was, noting that "there hasn't been much additional commentary" from the SEC since Bowden's aggressive speech last May.

Bowden himself seemed to walk back some of his comments in an interview last September. "Anecdotally," he said, "I would say there have been some changes in the behavior on the part of funds and investors and that's all for the good."

Anecdotally? It is a very odd thing to hear a regulator in the middle of a granular, industry-wide examination say that he's heard that things are getting better.

Regulation by

rumor is not your typical enforcement MO.

By this month, Bowden had achieved a complete 180, telling a conference of PE professionals that their business was just "the greatest."

This is Bowden on March 5th, on a panel for PE and Venture Capital issues at Stanford. Check out how he pooh-poohs the fact that his SEC has seen "some misconduct," before he goes on to grovel before his audience:

Like what, who else out there is in a business that's that good? And I reckon, it's sort of interesting for me for private equity in terms of all we've seen, and what we have seen, where we have seen some misconduct and things like that, 'cause I always think like, to my simple mind, that the people in private equity, they're the greatest, they're actually adding value to their clients, they're getting paid really really well, you know...

Not the usual posture you'd expect from an enforcement official. He likes the Private Equity business! They make a lot of money! They help people! And that thing about half of those businesses committing fee abuses, that's just "some misconduct" we found last year. No big deal!

It got worse, though:

Bowden: And so my view on the small ones is, I still think this is one of…I tell my son, I have a teenaged son, I tell him, “Cole, you want to be in private equity. That's where to go, that's a great business, that's a really good business. That'll be good for you.”

So for me personally, as we share our opinions…

Questioner [interrupting] I'd love to hire your son, by the way. That's a deal.

Bowden's comments certainly raised a few eyebrows. The LA Times wrote quite critically about them, as did a few other outlets.

There are some people who will say it's easy to overreact to something like this. If you listen to the tape, Bowden makes his comments in a joking manner, and everyone laughs. It's not like he brought his son onstage and had him hand out resumes after the speech.

But no government regulator with his or her head screwed on correctly would ever go near a joke like that in public. Even if it's not what it very much appears to be, it sounds incredibly bad.

And, worse, it reveals an attitude that's absolutely poisonous among regulators, this fawning worship of people on Wall Street who maybe break a few rules, but that's okay, because they make tons of money! Can you imagine Elliott Ness giving a speech gushing over what nice cars Al Capone drives? It's revolting.

It's not necessary for regulators to hate the greedy bottom-liners who go around toying with peoples' jobs and livelihoods using borrowed money.

It's not even necessary for regulators to hate those same rich takeover artists for paying half the taxes of most ordinary people, because our bought-off government refuses to close the loophole that allows Mitt Romney to call the money he makes "carried interest" instead of income.

We don't need regulators to be out to get anyone. But is a healthy indifference too much to ask? Do we really need for even the regulators to slobber over these people?


+19 # PCPrincess 2015-03-27 09:38
I am now quite certain that the portion of human beings that do not possess a large level of empathy (a vast majority) are not capable of self-regulation . Hence, capitalism is NOT possible in any form or sense. My only hope for human-kind are the empathy-bearing progressives. May we find the strength and will to fight even though the oligarchs have ensured we are stressed to the limit just making ends meet.
+10 # wrknight 2015-03-27 10:14
The most important and hardest job of a president is the selection of qualified personnel to carry out the day to day functions of his administration. As a president, Obama has been the greatest disappointment I could ever imagine. His one great achievement was the passing of Obamacare which accomplished only half what he promised. But his greatest failure was in the selection of his staff and cabinet, many of whom were hold-overs from the worst administration ever. How any president, who was fully aware of the sins of his predecessor, could retain those subordinates who were most guilty of executing those sins is simply beyond me. While he may be a great orator, he has been a complete failure as an administrator. Bowden is just one of many examples.

+6 # Edwina 2015-03-27 10:29
The WSJ today states that Elliot Spitzer did untold damage in his attempts to regulate Wall Street. While I am not sophisticated about the ins-and-outs of the SEC and Wall Street, it seems to me that the WSJ is becoming openly propagandistic, rather subtly representing its "natural" interests.
+2 # wrknight 2015-03-27 10:34
Quoting Edwina: 
The WSJ today states that Elliot Spitzer did untold damage in his attempts to regulate Wall Street. While I am not sophisticated about the ins-and-outs of the SEC and Wall Street, it seems to me that the WSJ is becoming openly propagandistic, rather subtly representing its "natural" interests.

When has it not been?
0 # Floridatexan 2015-03-27 11:38
Before Rupert Murdoch bought it.
+3 # BuzzDavis 2015-03-27 10:39
Thank you Matt & Yves Smith. Enforcement of laws at the Fed. level is extreemly had to follow for citizens. We expect that the thousands of workers hired to conduct enforcement do just that. But the bureaucracy has always put gatekeepers in control. The success in enforcement work is to be able to circumvent the gatekeepers. Bowden is an example of how slime politicians put gatekeepers at the head of almost all enforcement so the politicians are in control of the enforcement not the professionals. Without reporting like this the slime forever wins!
_ _ _ _ _ _ _

Wherein, we learn from incredibly prosaic sources the truth:   that the move of big business to shale oil, tar sands, the mining of the earth for black gold (not to mention the melting of the glaciers) for the last bit of big profit was the end game.

For us all.

March 24, 2015

Financial Feudalism

Once upon a time — and a fairly long time it was — most of the thickly settled parts of the world had something called feudalism. It was a way of organizing society hierarchically. Typically, at the very top there was a sovereign (king, prince, emperor, pharaoh, along with some high priests). Below the sovereign were several ranks of noblemen, with hereditary titles. Below the noblemen were commoners, who likewise inherited their stations in life, be it by being bound to a piece of land upon which they toiled, or by being granted the right to engage in a certain type of production or trade, in case of craftsmen and merchants. Everybody was locked into position through permanent relationships of allegiance, tribute and customary duties:  tribute and customary duties flowed up through the ranks, while favors, privileges and protection flowed down.

It was a remarkably resilient, self-perpetuating system, based largely on the use of land and other renewable resources, all ultimately powered by sunlight. Wealth was primarily derived from land and the various uses of land. Here is a simplified org chart showing the pecking order of a medieval society.

Feudalism was essentially a steady-state system. Population pressures were relieved primarily through emigration, war, pestilence and, failing all of the above, periodic famine. Wars of conquest sometimes opened up temporary new venues for economic growth, but since land and sunlight are finite, this amounted to a zero-sum game.

But all of that changed when feudalism was replaced with capitalism. What made the change possible was the exploitation of nonrenewable resources, the most important of which was energy from burning fossilized hydrocarbons:  first peat and coal, then oil and natural gas. Suddenly, productive capacity was decoupled from the availability of land and sunlight, and could be ramped up almost, but not quite, ad infinitum, simply by burning more hydrocarbons.
Energy use, industry and population all started going up exponentially. A new system of economic relations was brought into being, based on money that could be generated at will, in the form of debt, which could be repaid with interest using the products of ever-increasing future production.
Compared with the previous, steady-state system, the change amounted to a new assumption:  that the future will always be bigger and richer — rich enough to afford to pay back both principal and interest.

With this new, capitalistic arrangement, the old, feudal relationships and customs fell into disuse, replaced by a new system in which the ever-richer owners of capital squared off against increasingly dispossessed labor. The trade union movement and collective bargaining allowed labor to hold its own for a while, but eventually a number of factors, such as automation and globalization, undermined the labor movement, leaving the owners of capital with all the leverage they could want over a demoralized surplus population of former industrial workers.
In the meantime, the owners of capital formed their own pseudo-aristocracy, but without the titles or the hereditary duties and privileges. Their new pecking order was predicated on just one thing:  net worth. How many dollar signs people have next to their name is all that's necessary to determine their position in society.

But eventually almost all the good, local sources of hydrocarbon-based energy became depleted, and had to be replaced using lower-quality, more remote, harder-to-produce, more expensive ones.
This took a big bite out of economic growth, because with each passing year more and more of it had to be plowed right back into producing the energy needed to simply sustain, never mind grow, the system.
At the same time, industry produced a lot of unpleasant byproducts: environmental pollution and degradation, climate destabilization and other externalities. Eventually these started showing up as high insurance premiums and remediation costs for natural and man-made disasters, and these too put a damper on economic growth.

Population growth has its penalties too. You see, bigger populations translate to bigger population centers, and research results show that the bigger the city, the higher is its energy use per capita. Unlike biological organisms, where the larger the animal, the slower is its metabolism, the intensity of activity needed to sustain a population center increases along with population. Observe that in big cities people talk faster, walk faster, and generally have to live more intensely and operate on a tighter schedule just to stay alive.
All of this hectic activity takes energy away from constructing a bigger, richer future. Yes, the future may be ever more populous (for now) but the fastest-growing form of human settlement on the planet is the urban slum—lacking in social services, sanitation, rife with crime and generally unsafe.

What all of this means is that growth is self-limiting. Next, observe that we have already reached these limits, and have in some cases gone far beyond them. The currently failing fad of hydraulic fracturing of shale deposits and steaming oil out of tar sands is indicative of the advanced state of depletion of fossil fuel sources.
Climate destabilization is producing ever more violent storms, ever more severe droughts (California now has just a year's worth of water left) and is predicted to wipe out entire countries because of rising ocean levels, failing monsoon seasons and dwindling irrigation water from glacial melt.
Pollution has likewise reached its limits in many areas:  urban smog, be it in Paris, Beijing, Moscow or Teheran, has become so bad that industrial activities are being curtailed simply so that people can breathe. Radioactivity from the melted-down nuclear reactors at Fukushima in Japan is showing up in fish caught on the other side of the Pacific Ocean.

All of these problems are causing a very strange thing to happen to money. In the previous, growth phase of capitalism, money was borrowed into existence in order to bring consumption forward and by so doing to stimulate economic growth.
But a few years ago a threshold was reached in the US, which was at the time still the epicenter of global economic activity (since eclipsed by China), where a unit of new debt produced less than one unit of economic growth. This made borrowing from the future with interest no longer possible.

Whereas before money was borrowed in order to produce growth, now it had to be borrowed, in ever-larger amounts, simply to prevent financial and industrial collapse. Consequently, interest rates on new debt were reduced all the way to zero, in something that came to be known as ZIRP, for Zero Interest Rate Policy. To make it even sweeter, central banks accepted the money they loaned out at 0% interest as deposits, which earned a tiny bit of interest, allowing banks to make a profit by doing absolutely nothing.

Unsurprisingly, doing absolutely nothing proved to be rather ineffective, and around the world economies started to shrink. Many countries resorted to forging their statistics to paint a rosier picture, but one statistic that doesn't lie is energy consumption.
It is indicative of the overall level of economic activity, and it is down across the entire world. A glut of oil, and a much lower oil price, is what we are currently witnessing as a result. Another indicator that doesn't lie is the Baltic Dry Index, which tracks the level of shipping activity, and it has plummeted too.

And so ZIRP set the stage for the latest, most queer development:  interest rates have started to go negative, both on loans and deposits. Good bye, ZIRP, hello, NIRP!
Central banks around the world are starting to make loans at small negative rates of interest. That's right, certain central banks now pay certain financial institutions to borrow money! In the meantime, interest rates on bank deposits have gone negative as well: keeping your money in the bank is now a privilege, for which one must pay.

But interest rates are certainly not negative for everyone. Access to free money is a privilege, and those who are privileged are the bankers, and the industrialists they fund.
Those who have to borrow to finance housing are less privileged; those who borrow to pay for education even less so. Those not privileged at all are those who are forced to buy food using credit cards, or take out payday loans to pay rent.

The functions which borrowing once played in capitalist economies have been all but abandoned. Once upon a time, the idea was that access to capital could be obtained based on a good business plan, and that this allowed entrepreneurship to flourish and many new businesses to be formed. Since anybody, and not just the privileged, could take out a loan and start a business, this meant that economic success depended, at least to some extent, on merit.
But now business formation has gone in reverse, with many more enterprises going out of business than are being formed, and social mobility has become largely a thing of the past.
What is left is a rigidly stratified society, with privileges dispensed based on hereditary wealth:   those at the top get paid to borrow, and get to surf on a wave of free money, while those at the bottom are driven ever further into debt servitude and destitution.

Can NIRP underpin a new feudalism? It certainly cannot reverse the downward slide, because the factors that are putting limits on growth are not amenable to financial manipulation, being physical in nature.
You see, no amount of free money can make new natural resources spring into existence. What it can do, however, is freeze the social hierarchy among the owners of capital — for a while, but not forever.

Everywhere you care to look, the ever-shrinking economy eventually results in populist revolt, war and national bankruptcy, and these cause money to stop working in a number of ways.
There is usually devaluation, bank failures, inability to finance imports, and the demise of pensions and of the public sector. The desire to survive causes people to focus on getting direct access to physical resources, distributing them among friends and family.

In turn, this causes market mechanisms to become extremely opaque and distorted, and often to stop functioning altogether. Under these circumstances, how many dollar signs someone has next to their name becomes rather a moot point, and we should expect the social hierarchy among the owners of capital to become unstable and capsize.
A few among them have the talents to become warlords, and these few fleece the rest out of existence. But overall, in a situation where financial institutions have failed, where factories and other enterprises are no longer functioning, and where real estate holdings have been overrun by marauding mobs and/or invaded by squatters, one's net worth becomes rather difficult to compute. And so we should expect the org chart of the post-capitalist society, in spreadsheet terms, to look like this. (“#REF!” is what Excel displays when it encounters an invalid cell reference in a formula.)

A good, precise term for this state of affairs is “anarchy.” Once a new, low level of steady-state subsistence is reached, the process of aristocratic formation can begin anew. But unless a new source of cheap fossil fuels is somehow magically discovered, this process would have to proceed along the traditional, feudal lines.

John Stuart Mill may well be the most important liberal thinker of the nineteenth century. In countless respects, his once-revolutionary arguments have become familiar, even part of the conventional wisdom. Certainly this is so for his great 1869 essay The Subjection of Women, which offered a systematic argument for sex equality at a time when the inferior status of women was widely taken for granted. It is also true for On Liberty, published in 1859, which famously argued that unless there is harm to others, people should have the freedom to do as they like. A strong advocate for freedom of speech, Mill offered enduring arguments against censorship. He also had a great deal to say about, and on behalf of, representative government.

Friedrich Hayek was the twentieth century’s greatest critic of socialism, and he won the Nobel Prize in economics. A lifelong defender of individual liberty, he argued that central planning is bound to fail, even if the planners are well motivated, because they cannot possibly assemble the information that is ultimately incorporated in the price system. Hayek described that system as a “marvel,” because it registers the knowledge, the preferences, and the values of countless people. Hayek used this insight as the foundation for a series of works on freedom and liberalism. Committed to free markets and deeply skeptical of the idea of “social justice,” he is a far more polarizing figure than Mill, beloved on the political right but regarded with ambivalence by many others. Nonetheless, Hayek belongs on any list of the most important liberal thinkers of the twentieth century.

Mill and Hayek help to define the liberal tradition, but in both temperament and orientation, they could not be further apart. Mill was a progressive, a social reformer, an optimist about change, in some ways a radical. He believed that, properly understood, liberalism calls for significant revisions in the existing economic order, which he saw as palpably unjust: “The most powerful of all the determining circumstances is birth. The great majority are what they were born to be.” Hayek was not exactly a conservative—in fact he was sharply critical of conservatism on the ground that it was largely oppositional and did not offer an affirmative position—but he generally venerated traditions and long-standing practices, seeing them as embodying the views and knowledge of countless people over long periods. Hayek admired Edmund Burke, who attacked the idea that self-styled reformers, equipped with an abstract theory, should feel free to override social practices that had stood the test of time. Mill had an abstract theory, one based on a conception of liberty from both government and oppressive social customs, and he thought that society could be evaluated by reference to it.


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