Category: Articles

Alan Greenspan was arguably the country’s most powerful financial cop in his 18 years as chairman of the Federal Reserve. But Mr. Greenspan’s regulatory record has received far less scrutiny than his management of the economy.

Article Originally Published in The WSJ

That may be changing. A former colleague says Mr. Greenspan blocked a proposal to increase scrutiny of subprime lenders under the Fed’s broad authority. That added scrutiny might have helped curtail questionable lending practices now blamed for soaring defaults by mostly low-income borrowers. Democrats in Congress are now turning up the heat on regulators, especially the Fed, for failing to do more to stamp out those practices, and the Fed appears increasingly likely to overhaul its approach.

Edward Gramlich, who was Fed governor from 1997 to 2005, said he proposed to Mr. Greenspan in or around 2000, when predatory lending was a growing concern, that the Fed use its discretionary authority to send examiners into the offices of consumer-finance lenders that were units of Fed-regulated bank holding companies.

“I would have liked the Fed to be a leader” in cracking down on predatory lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this past week. Knowing it would be controversial with Mr. Greenspan, whose deregulatory philosophy is well known, Mr. Gramlich broached it to him personally rather than take it to the full board.

“He was opposed to it, so I didn’t really pursue it,” says Mr. Gramlich, a Democrat who was one of seven Fed governors.

Greenspan’s Response

Mr. Greenspan, in an interview, says he doesn’t recall a specific discussion of the idea but confirmed his opposition to it.

There is “a very large number of small institutions, some on the margin of scrupulousness and very hard to detect when they are doing something wrong,” says Mr. Greenspan, who retired in February last year. “For us to go in and audit how they act on their mortgage applications would have been a huge effort, and it’s not clear to me we would have found anything that would have been worthwhile without undermining the desired availability of subprime credits.”

Mr. Greenspan adds that borrowers might get a false sense of security from a lender that advertised itself as Fed-inspected.

Ben Bernanke, Mr. Greenspan’s successor, told Congress in March that he has asked his staff for “a complete review of our powers and practices” in examining holding-company units. A Fed spokesman this past week said “that review is under way.” The Fed Thursday will conduct a public meeting on steps it could take to strengthen laws governing subprime lending.

On June 29, the Urban Institute will release a book by Mr. Gramlich, “Subprime Mortgages: America’s Latest Boom and Bust.” It argues, among other points, that all lenders affiliated with banks and thrifts could “be brought under the same supervisory conventions as their parents seemingly without major culture shock.” It wouldn’t be a huge undertaking by policy makers, and it would lead to more uniform, stringent practices.

Mr. Gramlich, who is being treated for cancer, says, “There are certain things that unsupervised lenders do that a Fed supervisor would not let you get away with,” such as not escrowing taxes and insurance, not verifying an applicant’s stated income, or assessing the borrower’s ability to repay based on an introductory “teaser” rate. But he said the proposal’s reach would have been limited by the fact that many lenders would still have no federal supervision.

At the time President Clinton appointed Mr. Gramlich to the Federal Reserve Board, he was a University of Michigan academic who had served on commissions studying Major League Baseball and Social Security. Mr. Greenspan put him in charge of the board’s community and consumer affairs committee.

Mr. Gramlich often pushed the Fed to expand fair-lending and consumer-protection rules, winning the admiration of consumer groups that often accuse the Fed of being too supportive of the financial industry. Despite their differing philosophies, Mr. Gramlich says he got along well with Mr. Greenspan, who supported him on most initiatives, especially those involving increased disclosure.

Nonetheless, his remarks represent a rare insider’s criticism of Mr. Greenspan’s regulatory record. Mr. Greenspan says he didn’t get heavily involved in regulatory matters in part because his laissez-faire philosophy was often at odds with the goals of the laws Congress had tasked the Fed with enforcing.

“I basically listened to the staff and tried as best I could to support the staff’s recommendation,” he says. He notes that with one exception, on a highly technical issue, he always voted with the board majority.

Still, Mr. Greenspan’s views did color the regulatory environment, facilitating growing concentration in banking and a hands-off approach to derivatives and hedge funds. That approach, broadly shared by both the Clinton and Bush administrations, is coming under increased scrutiny.

The Fed has taken heat recently for not more vigorously using its power to write consumer-protection rules for the entire industry, not just the lenders it oversees directly. Before it proposed new standards last month, the Fed hadn’t conducted a broad review of its credit-card disclosure requirements since 1981 — six years before Greenspan took office.

In 2005, 52% of subprime mortgages were originated by companies with no federal supervision, primarily mortgage brokers and stand-alone finance companies; 23% by banks and thrifts; and 25% by finance companies affiliated with banks and thrifts, including units of bank holding companies.

According to Inside Mortgage Finance, an industry publication, in 2006 three of the eight largest subprime mortgage lenders were units of bank holding companies. The Fed is one of four federal regulators that supervises deposit-taking banks and thrifts. It also has oversight over bank holding companies, with the discretion to delegate authority over their operating units to other agencies.

Thus the Fed generally leaves regulation of nationally chartered banks to the Office of the Comptroller of the Currency; of securities-dealer units to the Securities and Exchange Commission; and of consumer-finance companies to the states.

However, state regulation is generally considered inconsistent and usually less rigorous than federal oversight. Moreover, 18 states offer some form of exemption from state regulation to bank holding company units, according to the Conference of State Banking Supervisors.

The Fed periodically examines the finance-company units to ensure that they pose no threat to the “safety and soundness” of their deposit-taking affiliates and to assess their controls for things like money laundering. In special situations, it does scrutinize their practices for compliance with consumer-protection laws. In 2004, it fined Citigroup $70 million for alleged abuses by its CitiFinancial unit.

But Mr. Gramlich fretted that extending those standards to holding-company units would create an unlevel playing field unless stand-alone lenders were subjected to the same thing.

Jim Strother, general counsel for Wells Fargo & Co., said oversight of bank holding company units isn’t “where the need is,” noting the Fed does examine Wells Fargo Financial, a major subprime mortgage lender. “The gap is for companies that aren’t in the banking system at all.”

Abdalla El-Badri, Secretary-General of the Organization of the Petroleum Exporting Countries (OPEC) said the biofuel strategy being pushed by President Bush and European leaders would backfire because “you don’t get the incremental oil and you don’t get the ethanol”. In this scenario, he warned, oil prices would go “through the roof”.

He said OPEC members had so far maintained their investment plans but he warned: “If we are unable to see a security of demand…we may revisit investment in the long-term.” Why the change? In the past OPEC had all but mocked biofuel’s potential. This is the first public expression of concern.

“They are really concerned,” said Julian Lee of the Center for Global Energy Studies in London. “Opec will continue investing, but with biofuels on the horizon, they may not invest enough.”

OPEC is caught between a rock and hard place. On the one hand,if they keep prices high like they have become accustomed to, the rest of the world will continue it’s quest for alternative sources. Should they ramp up production to bring prices down in an attempt to make biofuels cost prohibitive, their wallets suffer. What to do?

I think if anything this is proof positive that oil production is currently at a peak level. If OPEC could, it would flush the world with oil and dampen it’s desire for alternative sources and make them less profitable. The fact that they haven’t means they can’t.

Here is another odd point. With OPEC clearly scared about both the current reality and the future surrounding ethanol, why are US ethanol makers currently nowhere near 52 week highs? When you have the US and Brazil, who between them produce over 10 billion gallons a year of the stuff rushing to partner production practices, shouldn’t that excite us? When the world’s #1 producer of biodiesel, ADM (ADM) has set up shop in Brazil, will produce biodiesel there in August and is aggressively seeking an ethanol partnership, ought we not be more positive about the future of these companies?

Let’s not forget other US Agribusiness companies like Bunge (BG) and Corn Products (CPO) are in the process of producing from South America also.

Here is another miscellaneous thought. If the Dems take the White House (and even possibly if they do not) oil companies like Exxon (XOM), Chevron (CVR), and BP (BP) will once again find them selves in front of congress answering for record profits and high gas prices. Dems have wanted to grab some of these profits for years and may soon be in a position to actually do it. Can you think of anything that would get anyone of them off the hook faster than being able to say “We are also the #1 (or #2) ethanol producer in the US”? With half the ethanol sector near 52 week lows, valuations are ripe for buyouts by big oil flush with cash, looking for some real nice PR in their commercials and as a way to protect their profits from congress’s hands.

When you have the organization that controls 40% of the world’s oil publicly worried about ethanol, I find the current apathy towards companies that produce it odd. Maybe that is what a value investor is, finding the value in what others overlook.

Time for an update of the various lead paint suits winding their way to obscurity throughout the US.
The main defendants are Sherwin Williams (SHW) and NL Inustries (NL). I have taken this post in it’s entirety from Jane Genova’s Law and More since, as I have said here numerous times before, investigating the legal aspect of lead paint litigation begins and ends with Jane’s blog.

“These updates come by way of the monitoring, research and interpretation of LexisNexis [TM] Mealey’s Litigation Report. This Mealey’s briefing is focused totally on the lead issue. I have radically downsized the content of the original report. Also I have added my own commentary.

Documents associated with these developments are available from Mealey’s at www.lexisnexis.com/mealeys or James.Cordrey@lexisnexis.com

RHODE ISLAND:

Abatement:

1. Defendants Sherwin-Williams, NL Industries and Millennium Holdings filed a joint objection to the state’s recommendation for special master of Mary Jean Brown, MD of the U.S. Centers for Disease Control and Prevention. The reason, say the defendants, is that it appears “from available information [Brown] has had from any years been involved in reviewing (and to some extent shaping) the evidentiary facts regarding childhood lead poisoning and lead abatement in Rhode Island.” The person functioning as special master, of course, should have no ties to any one party in an adversary proceeding.

2. On June 4, Superior Court Judge Michael Silverstein heard from plaintiff and defendants about their recommendations for a special master. He did not indicate when he would rule on this.

3. On May 16, plaintiff filed proposed abatement schedule indicating it would file a detailed plan by Sept. 15. Defendants have 60 days to file objections to the plan. The plaintiff also proposes defendants shall pay all fees and costs incurred by the function of special master.

Appeal to RI Supreme Court:

Both the plaintiff and the defendants had filed an appeal. On May 21, the RI Supreme Court issued an order and briefing protocol for the defendant paint companies.

The schedule requires the completion of the official transcript, certification of the original papers and exhibits and docketing of the matter in the RI Supreme Court. As we have been informed previously, this could take months. Sources predict this might not be done until early 2008.

After that, there will be a conference with plaintiff and defendants to work up a schedule for filing briefs. When that date is set and the briefs have been actually filed, then a date will be made for oral arguments before the Court.

Since the contingency issue has already been fully briefed, there is no additional filing related to this one matter. The other issues will be briefed in five phases:

* Appellants’ briefs
* Appellees’ briefs
* Amicus briefs
* Reply briefs
* Replies to amicus briefs.

WISCONSIN:

City of Milwaukee v NL Industries. Plaintiff rested its case on June 6. The jury returns June 8. Then the defendant will present its case. Since as part of the defense teams in the RI lead paint trial, NL Industries lead attorney Donald Scott didn’t present a defense, lead-paint watchers are curious who he will call as witnesses and what strategies he will use.

Steven Thomas et al. v. [Many]. On May 10, the judge ruled the defendants could compel Steven Thomas’ guardian ad litem to provide deposition testimony, subject to limitations. Defendants argue exculpation defense should be allowed. Atlantic-Richfield claims no liability since its lead carbonate was not sold in Milwaukee.

Called for short “The Thomas Case,” this upcoming trial is viewed as the most severe test the former lead paint industry and its former trade association Lead Industries Association (LIA) have encountered. Part of the challenge is how the legal concept of liability is being approached because of a WI Supreme Court ruling.

CALIFORNIA:

In County of Santa Clara, et al. v Atlantic Richfield Co, et al. the judge issued an order staying the case until the appellate review.

MISSISSIPPI:

The state Supreme Court denied Sherwin-Williams’ motion for a rehearing and the case [a personal injury one] will go to trial.

OHIO:

SS 117 Veto. The state Supreme Court, which heard oral arguments on May 1 regarding if Senate SS Bill 117 had become a law because of the former Governor’s not vetoing it, will probably rule by the end of June.

Preemptive Strike by Sherwin-Williams. On May 14, the city of Columbus and other cities in OH filed a brief seeking to prevent Sherwin-Williams from being allowed to take “the extraordinary step of prohibiting the defendants from engaging legal counsel of their choosing in pending state court claims.” It also requested a dismissal of Sherwin-Williams’ request for a preliminary injunction against litigation. The cities contend that this filing by Sherwin-Williams represents an attempt to evade responsibility for creating a public nuisance.”

Here are the top 5 sectors YTD ranked by return.

1- Chemicals / Fertilizers +68% (13 stocks)

2- Steel Producers +30% (22 stocks)

3- Trucks & Parts Heavy +45% (13 stocks)

4- Food- Dairy Producers +30% (9 stocks)

5- Transportation / Ships +20% (49 stocks)

Rankings are done by price performance of all stocks in the group. So, a sector that has 5 stocks, one up 100% and 4 up 1% will not be ranked as high as a sector that has 5 stocks all up 15%, thus the differential in rankings vs return.

Here are the top 5 sectors ranked by the percentage of the group reaching new highs

1- Retail- 25%

2- Chemicals / fertilizers- 17%

3- Internet-isp- 13%

4- Apparel-shoes- 12%

5- Electrical, military systems- 12%

Here is a great post that can be found at the blog The Mess That Greenspan Made. I take no credit for this, it is the authors in it’s entirety and it is very good.

The Post:

If you’ve been wondering why gasoline prices have been so high lately with crude oil trading at only $66 per barrel, the answer can be found at the refineries.

This week’s TWIP (This Week in Petroleum) from the Energy Information Administration has some interesting commentary and, as always, abundant charts to tell the story of how retail gasoline prices have fallen for the second consecutive week, down five cents to $3.16 per gallon.

First, it should be clear that this is not an oil problem. U.S. oil inventories, the biggest raw material cost for gasoline (duh!) have been at or above the range considered normal for this time of year. There is no oil problem – that will occur sometime in the future, maybe soon, we’ll see.

Yet, prices at the pump remain near record highs, particularly here on the West Coast where special formulation requirements and higher taxes almost always result in higher prices.

Lucky us – at least there’s no big brown cloud hanging over the Western U.S. (except sometimes in Phoenix) like the one hanging over parts of developing Asia .

Gasoline stocks are way down, though they’ve been recovering dramatically in recent weeks as indicated by the current slope of the red-dotted line below. It turned ultra-steep last week in an attempt to make up for lost time and keep up with demand from the summer driving season that just started.

Have the refineries suddenly finished all their yearly maintenance work and flipped all the right switches to boost production?

Production has improved in recent weeks but it remains below levels from December of last year – refinery utilization for this time of the year is still below the levels of the last three years.

The downward price pressure (if you can call retail prices falling from $3.30 per gallon to $3.16 per gallon price pressure) comes largely from an increase in gasoline imports which have reached new multi-year highs.

And of course demand continues to increase, current levels of consumption for this time of year again at all time highs despite the higher prices.

Remember what a big deal it was a couple years ago when when gasoline stations couldn’t find enough number 3s to put up on their signs out at the curb?

With the precarious balance between the supply and demand for crude oil combined with aging refineries, it seems only a matter of time before there is a new crisis – finding enough number 4s.

Procter & Gamble (PG) was downgraded to equal-weight from overweight at Lehman Brothers, which said it will be “tough” for the Dow industrials component to deliver above-average returns. “As we see it, P&G’s business is healthy, but without much upside to fiscal 2008 margins versus our estimates nor likelihood of sustained re-acceleration in revenue growth,” the broker said. On Monday

I posted the very same sentiment is less esoteric terms. It is simple, huge discounts are a sign of slowing sales. If the discounting produces the sales, it does so at the expense of margins. Either scenario mean profits will come under pressure..

And yes that makes it “tough”, although I did not know it is usually “easy”

You have probably heard the saying before that high tax rates cause people to engage in behavior that enables them to avoid paying those taxes. Some of it illegal, some legal. When you do business in the US, with our 40% average corporate tax rate being the world’s second highest, those efforts become pervasive. Take the recent case of IBM (IBM).

Why?:

It involves “Repatriation” of profits. The simplest way to describe that is foreign subsidiaries of US companies, if their earning are included in the results of the parent company, have profits taxed here is the US at US corporate tax rates in addition to taxes they may be paying in the country they are based.

To Avoid This:

IBM formed a new IBM subsidiary in the Netherlands. The unit spent $1 billion in cash and $11.5 billion in borrowed funds to buy 118.8 million shares — 8% of shares outstanding. They did this from a group of investment banks that had borrowed the shares from institutional investors. The investment banks will then return the borrowed shares with shares they buy on the open market over the next nine months. If its stock rises and the investment banks suffer losses, IBM will cover them.

The transaction was structured to let IBM buy back stock without repatriating retained earnings from its foreign units to the U.S.

IBM does not have cash hidden overseas. It plans to repay the loans to the banks used for the stock repurchase with future earnings from international subsidiaries in different countries. The estimated tax rate after various credits would be 22%. That would result in saving about $1.6 billion, compared to the taxes it would have incurred by repatriating the sums to the U.S. the person said.

Very sneaky, and until the IRS caught on and issued a notice on May 31st, very legal. Now let’s not get all upset at IBM. People behave in ways based on the conditions they find themselves in. Now, had we had the EU taxes rate of 26%, IBM may not have even investigated this. Were we in the US taxed at the 12.5% those companies in Ireland are, the topic would not have come up. When you tax folks the most, they will find ways around it. Management at IBM has a fiduciary responsibility to their shareholder and a move like this only show they take that seriously.

Rather than giving IBM a “tisk-tisk”, I am trying to find out if the multinationals in my portfolio have done the same thing and if not, ask, “who was sleeping in accounting?”