Randomly Noted

What’s the primary human trait that governs prices of income-earning instruments?

Risk aversion.

So says former Federal Reserve Chairman Alan Greenspan in his paper delivered today to the Brookings Institution on the origins of the credit crisis.

This risk aversion chat is buried in a  footnote of the paper that more generally concedes that Greenspan and the Fed made some regulatory and judgment mistakes in the pre-credit crisi period but won’t connect a  long period of Fed-induced very low short rates with the housing bubble.

Back to risk aversion. “When people become uncertain or fearful, they disengage from perceived risk,” Greenspan wrote. “When their uncertainty declines, they take on new commitments.”

So risk aversion can range from zero to full, though life itself can’t really take place at the true extremes.

And while market prices gyrate based on what in cruder terms could be called the swings between greed and fear, Greenspan said over long periods of time there’s not much change in the aversion dial.

He mean the really long term.

Greenspan wrote that AAA railroad bonds in the years just after the U.S. civil war were at spreads above U.S. Treasury securities “that are similar to our post-World War II experience.”

For a man noted for the complexity of his speech and writing, Alan Greenspan’s perscription for helping prevent the sort of devastating crisis just experienced is alarmingly straightforward: more capital.

“The primary imperative going forward has to be (1) increased regulatory capital and liquidity requirements on banks and (2) significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutions making the trades,” Greenspan wrote in a paper running 48 pages of text and 18 charts. This retrospective is elegantly titled “The Crisis.”

The paper, for presentation today at the Brookings Institution, will be best remembered for the former Fed chairman’s continued and more complex defense of the low short-term interest rate regime the central bank maintained during the middle years of the prior decade.

Greenspan maintains those low short rates weren’t the cause of the housing bubble, the eventual bursting of which led to all our troubles. He cites various factors, including declining mortgage rates, but sees different causes from Fed monetary policy for that.

And while he’s willing to concede some regulatory and judgment lapses in a world where many now have changed their assessment of him from the near universal view as the iconic central banker, Greenspan won’t give on the Fed’s ability to diffuse an asset price bubble as its inflating.

Given the post-housing bubble damage in the global economy, that hands-off, we’ll help clean up afterwards policy is certainly due for a rethink.

“But why not incremental tightening?” Greenspan writes of a possible bubble-busting strategy. “There are no examples, to my knowledge, of a  successful incremental defusing of a bubble that left prosperity intact.”

He also references his 1996 “irrational exuberance” speech that slowed the dot-com stock boom for a day. It then continued to inflate for four more years, he said, even though the Fed raised the federal funds rate 350 points from 1994 to 2000.

Hindsight is just that, of course, meaning its easy, and Greenspan is understandably fighting for his legacy. But he certainly could have done more in the mid-1990s than make one speech about the dot.com bubble. Perhaps regular and increasingly vigorous warnings about the dot.com irrationality combined with surprise and somewhat steeper rate increases could have achieved the necessary “risk aversion” needed without killing economic growth. We just don’t know.

As for increased capital requirements for banks and other financial entities, it’s hard to argue with that.

It amazes this blogger how often people buy things they just don’t understand.

The ongoing legal saga perpetuated by the city of Milan, Italy, is yet one more example. Milan engaged in interest-rate swaps with the four above banks in 2005 when it sold a 30-year fixed-rate bond. Milan made a bet interest rates would move lower, so, it engaged in a swap that obligated it instead to pay at floating rate.

There seems to be a lot of allegations about the banks misleading Milan – and other municipalities – and they therefore received big fees illegally. (The banks were formally charged yesterday.)  But this quote from Dario Loiacono, a lawyer in Milan, in today’s FT seems to sum it all up: “It is clear that the municipalities did not understand the risks and costs they were taking on.”

Message to Milan city officials: You wasted taxpayer money by spending it on things you don’t understand. You lost millions of Euros by making a bad bet. You should shoulder more of the blame here than the banks.

Jerry York has passed away after being hospitalized earlier in the week with a brain aneurysm. We crossed paths in 1995 when Kirk Kerkorian staged an audacious effort to control and remake Chrysler. Kerkorian couldn’t have done it without Jerry,  who brought guts, operational expertise and straight-talk to the table. Jerry did much, much more in his career, making indelible marks on corporations and corporate governance across industries — but most significantly within the auto industry. He is gone at age 71, which is too soon.

In various way, the leaders of the Securities and Exchange Commission are trying to burnish the agency’s reputation for probity after less-than-stellar performances leading up to the credit crisis and in the Bernard Madoff affiar.

That makes the tone-deaf decision to support a Wall Street request to modify the agreement that separates stock analysis from investment banking all the more baffling.

But there it is on the front page of today’s Wall Street Journal. A judge vetoed the SEC-Wall Street firms’  bid to start allowing investment bankers and research analysts to communicate without the presence of lawyers or compliance officials.

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Nike just reported some pretty strong financial results – net income up 104% to $496 million and revenues up 7%. But the breakdown of the numbers tell a different story, one of how certain markets have begun to recover, others haven’t and yet others are going gangbusters. Shoes are the biggest part of Nike’s business, so, it’s worth looking at those sales in different regions. In the U.S., footwear sales are actually down 1%. And even worse in Japan where they are down 6%. So, where are more kids today looking to become the next Air Jordan (and wear Michael’s brand of basketball shoes)? China (shoe sales up 12%) and in emerging markets (show sales up 53%).

Maybe this is also telling us about how different countries will fare in basketball in the next summer olympics…

The largest U.S. public pension fund has launched a well-aimed campaign to get more public companies to adopt a “majority” rules policy for uncontested election of directors.

Indeed, the effort by the California Public Employees’ Retirement System is the proper use of this institutional investor’s heft to strike a better balance between shareholders and the boards of directors that are supposed to represent them.

Simply stated, too many companies have stuck with a “plurality” system when a director runs unopposed. Essentially, the plurality has to only be one vote, even if all other holders “withhold” their votes from the director.

“Majority” processes vary but they are pretty much what they sound like and should be familiar to anyone who has sat through a grade school civics class. Essentially, you have to get more “for” votes than those withheld or you have to at least offer to resign.

In this blogger’s previously expressed view, universal acceptance among U.S. publicly traded companies of the majority vote for directors makes unnecessary some of the other investor power pushes in which CalPERS and others have been active.

One of those is the so-called say on pay. It’s a misnomer on its face since most of those proposals for shareholders to have an after-the-fact vote on executive compensation are non-binding. Not much of a say. In majority voting, shareholder votes for directors have real power and can be used against directors at companies where shareholders think CEO compensation is too high.

Also unneeded is the ability of some large holders to nominate directors whose candidacy would be included and voting materials distributed by the company. It’s fascinating that this long-standing governance issue, referred to in short hand as “proxy access,” has now arisen in Senate deliberations about much broader financial regulatory reform, according to today’s Wall Street Journal.

Although I support regulatory or legislative oomph behind adoption of majority voting, it’s a trend that seems to be taking off without official edict. Maybe it’s the undeniable lack of fairness in the “plurality” system.

CalPERs said in a  press release that as of September 2009 about 71% of the S&P 500 companies and 50% of the Russell 1000 had come around to the majority rules concept.

CalPERS specifically said it would ask 58 of the top U.S. companies in its equities portfolio to adopt the majority rules standard. Said George Diehr, chair of the CalPERS investment committee, “The policy should include the required resignation of any director that receives a withhold vote greater than 50% of the votes cast. “

Brazil’s central bank meets today and there’s some sense it might raise interest rates for the first time since July 2008. Chances appear to be 50-50 based on what economists have been saying in the run-up to the meeting. But the fact that it’s even a possibility speaks volumes about Brazil’s economy and the potential for inflation – even as other major economies continue easing monetary policy (Bank of Japan just did so overnight.)  Win Thin at Brown Brothers Harriman argues, in fact, that the only reason NOT to hike rates is political: this may be the last meeting run by Henrique Meirelles, the central bank governor mulling a run for political office in the fall elections. Meirelles may not want to tighten liquidity ahead of a campaign. The pro-tightening camp points out that Brazilian inflationary expectations are rising – and the bank can’t wait too long to take action. Stay tuned!

The Rio Tinto four will go on trial next week – finally – after sitting in jail since last summer without due process, without any clarity about their alleged misdeeds. This is how China operates, and as a result multi-national corporations are finally starting to wise up. I’ve long been amazed at the slavish way in which Western businessmen deal with Beijing. Chinese business and political interests trample all over multi-nationals – and yet their CEOs keep coming back for more. “But China’s HUGE, companies can’t afford NOT to be in China, the Chinese economy is growing FAST even as the West stagnates”  - so goes the conventional wisdom dating back 15 or so years. Perhaps the sobering reality circa 2010, as freshly reported in today’s WSJ, is a sign of a new sobriety about China. Maybe companies will now start looking at China as it really is: an economy with limited opportunities for certain companies and industries, with an awful lot of risk for many.

The U.K.’s biggest mortgage lender is wanting its money back.

Certainly that’s one possible message of the ads that appeared in the U.K. papers this morning from Lloyds TSB, a unit of Lloyds banking Group PLC, which has about a quarter of the U.K. mortgages on its books.

Lloyds is advertising that “Now’s a great time to reduce how much you owe on your mortgage” because of low interest rates. To help nudge homebuyers along it’s doubling the size of mortgage overpayments that can be made without incurring penalties on variable rate mortgages.

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