Sunday, January 04, 2009

Michael Lewis in today's New York Times --- a reputation damaged

Michael Lewis's "Sunday Opinion" in the New York Times today, an article co-penned with hedge fund manager David Einhorn, is roughly 80% well written, informative, and at times insightful, and 20% a disgrace to Lewis's reputation. As a financial journalist with a widely admired style, it's almost impossible to conceive of how he decided to work with Einhorn and compromise his objectivity.

The lengthy piece has constructive observations and opinions about the SEC, credit rating agencies, the Madoff swindle, the corrosive impact of compensation practices at investment banks, and the failure of Treasury Secretary Paulson to use the TARP funds as advertised. It goes badly off track and becomes self-serving to the Einhorns of the financial world in other respects.

Take for example the call to regulate credit default swaps. The conclusion is that "the most critical role for regulation is to make sure that sellers of risk have the capital to support their bets". That sounds right at first glance and it is certainly the case for traditional securities and lending. Credit default swaps, however, are anything but traditional. The role for regulators here is unequivocally to require that a buyer of the swaps have exposure to the security underlying the derivative. That is a requirement in the short selling of equities(though it is not always enforced). This fix would eliminate the possibility that $50 billion of bets could be made against $2 billion of U.S. based subprime mortgage securities(numbers are an estimate). Lewis and Einhorn's solution seems to have the goal of making sure that Einhorn and hedge funds similar to his get paid out regardless of how extreme these smart players see the market's behavior. Analyzing and assuming counterparty risk is a normal responsibility of financial market professionals.

Then there is the comment on the opinions and efforts of some to adjust mark to market accounting rules. Lewis and Einhorn use the phrase "suspend mark to market accounting" in their characterization of these efforts and say "this means that banks will not have to account for the actual value of the assets on their books but can claim instead that they are worth whatever they paid for them". This is a complete mis-characterization of the issue and there is no one credible that is advocating throwing out all mark to market accounting. The focus is on periods of no liquidity when prices are forced by current rules to be set at unreasonable levels, levels that made Einhorn and his crowd billions in the last year.

Of course, as Lewis is being scammed by the type of people that he once parodied, there certainly needs to be a comment on short selling. In discussing the deservedly maligned SEC he faults their actions on limiting short selling for brief periods during the financial crisis. It is this SEC that he criticizes that eliminated the uptick rule in 2005 with the rationale that current technology and market theory made it unnecessary. The SEC has not yet budged on this mistake which no doubt pleases Einhorn. They opine that the SEC's limitations on short selling at times "protected financial predators with political clout" and the purpose was to "intimidate and impose rules on short-sellers --- the only market players with the financial incentive to expose fraud and abuse". We have the short selling community depicted as the Robin Hoods of the market so we certainly wouldn't want to "impose rules" on them? While there are definitely some short-sellers, like Jim Chanos, with long term reputations in the field for integrity and rigorous analysis, there are also a significant number who are a uniquely amoral type, exaggerating and distorting information with impunity in their rumor-mongering and loosely coordinated market manipulation.

This final example cannot be excluded from this comment. It's too choice. In their comment on what should have been the solution to this overall financial crisis(nationalization of major financial firms deemed too big to fail and the subsequent sale and liquidation of their assets) Lewis and Einhorn suggest a model used by Sweden in 1992. Yes that's Sweden, not exactly a financial behemoth, and yes that's 1992, when the only major derivatives markets were in fx and interest rates and when the globalization of securities markets was only at its beginning relative to today. Whether the solution is any more intelligent than what has been done during this extended financial crisis, the fact that it worked in Sweden 16 years ago seems beyond irrelevant.

With their comments on regulating securities firms and banks, overhauling the SEC, and neutering the credit rating agencies, there is one area of the financial markets that Lewis and Einhorn somehow forgot to mention --- the regulation of hedge funds.


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