Category: Corruption

Rule of Law in Russia

This presentation by Bill Browder at the Stanford Graduate School of Business is a pretty astonishing account of the Russian economy over the past two decades. I am familiar with the usual story of oligarch profiteering, but Browder’s experience shows how even the ostensibly sound legal arrangements of today can quickly unfold into a nightmare for investors. As the Stanford GSB news puts it,

Browder soared to fame and fortune investing in Russian equities amid the chaos and corruption of the post-Soviet economy. His hallmark: finding hidden values in Russian companies and driving up their share prices by exposing corporate malfeasance and mismanagement. His widely publicized campaigns for shareholder rights and corporate governance helped propel the Hermitage Fund from $25 million in 1996 to $4 billion a decade later. But eventually the U.S.-born financier ran afoul of the Russian government, which banned him from the country in 2005 as a threat to national security.

According to Browder, “Anyone who would make a long-term investment in Russia right now, almost at any valuation, is completely out of their mind. . . .My situation is not unusual. For every me, there are 100 others suffering in silence.” And for a “bigger picture” presentation about the “disembedded markets” and the types of forces Browder was a victim of, Nancy Fraser’s Storrs Lecture podcast on “Predatory Protections, Tragic Tradeoffs, and Dangerous Liaisons: Dilemmas of Justice in the Context of Capitalist Crisis” is also well worth listening to.


Compstat and Police Subculture

Last Friday the New York Times reported that a New York City police commander and four officers are facing internal charges stemming from their alleged failure to record criminal complaints.  These charges are just one piece of a larger story about the reliability of information fed into NYC’s Compstat program.  In a study released earlier this year, more than 100 retired high-ranking officers reported that they were aware of “ethically inappropriate” changes to crime complaints that fell into the seven major felony categories tracked by Compstat.  A patrol officer in Brooklyn’s 81st precinct has also reported widespread manipulation of crime statistics in 2008 and 2009.  (You can hear a This American Life episode about that officer here, along with excerpts from surreptitious recordings the officer made on the job.)

These recent revelations raise questions about the extent to which crime has actually fallen in New York City.   But the focus on crime reduction obscures another important issue about the occupational subculture.  For decades, police reformers have written about the importance of bringing down the “blue curtain,” that is, an occupational subculture in which a code of loyalty and secretiveness reign.  This subculture is widely believed to contribute to an “us and them” mentality which, among other harms, encourages police officers to do whatever is necessary to protect themselves and their fellow officers from criticism and administrative and legal penalties.  This mentality ultimately poses risks to those caught up in the criminal justice system and undermines public confidence in police work. 

When success is measured according to statistics, the temptation to manipulate is near irresistible.  Couple this with the dominant occupational subculture and almost anyone could have predicted that the data being fed into Compstat was unreliable.  The more important question is whether Compstat and its progeny are counterproductive to police reform over the long-term because they have the effect of reinforcing the dominant occupational subculture instead of remaking it.

Chris Lehmann, Rich People Things

The late Benoit Mandelbrot was a true polymath, inspiring new ways of thinking far beyond his own field of mathematics. In an interview conducted a few years ago, he made the following point about communication:

Many scientific articles are completely flat because they are written for people who do not have to be convinced. They are part of a small circle within a well-established domain; they write for each other, know more or less everybody, or are introduced by their thesis supervisors or mentors. As a result, style is a very secondary and unimportant thing for them. In my case, the fact that I write for an unknown public necessarily influences and shapes my style. Whether it is opera or Greek drama, one must know how to enter into a subject quickly because one cannot assume that the public will wait to understand. One has to be able to speak to people in their style, motivate and perhaps amuse the reader a little.

Chris Lehmann is a master at drawing people in. Though caustically titled and serious in intent, his Rich People Things made me laugh every few pages. He’s plied his trade on the RPT blog for about a year, but trust me: buy the book. As he notes in a brutal few pages on the Free-deology of Wired guru Chris Anderson, the web is rapidly moving toward a “feudal model of enterprise, whereby managerial rentiers . . . extract fees far upstream” from actual creators.
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Will Charles Ferguson be Our Ferdinand Pecora? (Review of Inside Job)

In his post on Michael Perino’s book Hellhound of Wall Street, Lawrence Cunningham observes that “Our predecessors were fortunate to have someone like Ferdinand Pecora to uncover top-secret financial shenanigans. No such person appears in our midst.”

It’s a tragic situation, especially because there are some real truth tellers out there—Yves Smith, Mike Konczal, Michael Greenberger, and many affiliates of the Roosevelt Institute come to mind. The difference between Pecora’s time and ours is a fragmented and manipulated media that a) can barely follow a complex financial story for more than a few hours, and b) fastidiously counterbalances every account of a Wall Street misdeed with some “expert” assuring us that it’s just business as usual in an industry that’s way too complicated for ordinary people to understand.

Charles Ferguson’s compelling film Inside Job steps in for a phantom mass media. Every citizen should be conversant with the basic narrative Ferguson puts together. Andrew Sheng, Chief Advisor to the China Banking Regulatory Commission, puts it in a nutshell: there was massive private gain in the US financial sector leading to massive public loss. Looking back, we might have all been better off if the finance tycoons profiled in the film had simply demanded hundreds of millions of dollars directly from the government back in 2000, and retired to Capri.

Instead, these deci- and centimillionaires helped build up the Rube Goldberg contraption of derivative deregulation, CDO’s, and CDS’s Ferguson describes. Fortunately, the film concisely explains that farrago in a way that will both educate the uninitiated and intrigue those who’ve read some books on the crisis. The film’s real contribution lies in four arguments it makes.
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Rakesh Khurana’s “From Higher Aims to Hired Hands”

Rakesh Khurana’s book From Higher Aims to Hired Hands: The Social Transformation of American Business Schools and the Unfulfilled Promise of Management as a Profession is a profound contribution to sociology and institutional analysis. It is also a persuasive critique of some of the most disturbing trends in the American economy. While B-schools may seem of marginal relevance to the actual conduct of CEOs, Khurana observes in the book that they “occupy the commanding heights of higher education . . . and the kinds of knowledge and skill they purvey [are] now seemingly more essential to the tasks of university—and indeed societal—leadership than anything taught elsewhere on campus” (367). Khurana describes how leading B-Schools gained a world of power, prestige, and influence in the 20th Century, but lost their soul along the way.

The Biblical echo here is intentional: like Weber, Khurana traces the religious origins of the concepts of vocation and higher education. His focus on values—as well as his harsh indictments of business education past and present—could easily lead Khurana to jeremiads or charismatic prophecy, but he skillfully resists both of these temptations. He offers a sober vision for hope in the future of business education. Khurana’s work should inspire legal academics as well as business school professors (as it already has in a conference at the University of St. Thomas Law School (pdf) last year).

Khurana’s book has several points of interest for legal scholars. He focuses on the role of community and norms as sources of values distinct from markets and governmental hierarchies. As post-crisis interventions in the health care, finance, energy, and transport have demonstrated, the old debates over “market vs. government” solutions, or “private vs. public” spending, are of fading relevance for serious social theory in the US (however potent they may be on the campaign trail). Flaws in the “government” are all too often rooted in flaws in the “market,” which are in turn rooted in past flaws in policy, ad infinitum. Recent liberalization of campaign finance rules will only accelerate that dynamic of capture. Institutions that generate values are some of the few entities capable of short-circuiting this pernicious circularity.
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Two Meanings of Corporate Governance

The Harvard Law School Program on Corporate Governance recently issued an important paper entitled “Corporate Political Speech: Who Decides?” Written in response to the Citizens United decision, the paper makes the case for requiring shareholder approval of corporate political expenditures:

Under existing corporate-law rules, corporate political speech decisions are subject to the same rules as ordinary business decisions. Consequently, political speech decisions can be made without input from shareholders, a role for independent directors, or detailed disclosure — the safeguards that corporate law rules establish for special corporate decisions. We argue that the interests of directors and executives may significantly diverge from those of shareholders with respect to political speech decisions, and that these decisions may carry special expressive significance from shareholders. Accordingly, we suggest, political speech decisions are fundamentally different from, and should not be subject to the same rules as, ordinary business decisions.

Meanwhile, as Marcy Murningham notes, “Congress faces a decision on the Shareholder Protection Act (HR 4790), which puts a [potential] check on the flood of corporate money into electoral campaigns.” Jennifer Taub makes a compelling case for passing the SPA. Ciara Torres-Spellicsy’s publication “Corporate Campaign Spending: Giving Shareholders A Voice” explains one way the process could work:

Congress should act to protect shareholders by giving them the power, under statute, to authorize political spending by corporations. The voting mechanics would work in the following way: At the annual meeting of shareholders, a corporation that wishes to make political expenditures in the coming year should propose a resolution on political spending which articulates how much the company wishes to spend on politics. If the resolution gains the vote of the majority of the outstanding shares (50% plus 1 share), then the resolution will be effective, and the company will be able to spend corporate treasury funds on political matters in the amount specified in the resolution. However, if the vote fails to garner the necessary majority, then the corporation must refrain from political spending until the shareholders affirmatively vote in favor of a political budget for the compan

Given the extant weakness of corporate governance mechanisms, I can’t guarantee that this will make a substantial difference for our public sphere. I reluctantly began to consider campaign finance reform a “lost cause” even before the opinion in Citizens United was issued. But I do think immediate and full disclosure of the ultimate source of contributions and expenditures is a sine qua non for a legitimate electoral process. New Jersey Senator Robert Menendez worries that “shadow groups [are] putting their thumbs on the scale with undisclosed, unlimited and unregulated donations.” It is deeply troubling to see entities like the US Chamber of Commerce promise “deniability” to donors. Proposals like the SPA and tougher disclosure rules would help put campaign finance back in the limelight it deserves, lest books like David C. Korten’s become the predominant social meaning of “corporate governance.”

The Question Concerning Finance: Party Like It’s 1929? Or Prepare Like It’s 1957?

Another day, another story of Wall Street’s failure to allocate capital responsibly. Today’s installment appears on ProPublica, and describes how “Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history:”

Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses: They created fake demand.

A ProPublica analysis shows for the first time the extent to which banks — primarily Merrill Lynch, but also Citigroup, UBS and others — bought their own products and cranked up an assembly line that otherwise should have flagged. The products they were buying and selling were at the heart of the 2008 meltdown — collections of mortgage bonds known as collateralized debt obligations, or CDOs.

As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created — and ultimately provided most of the money for — new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those. . . .Because of Wall Street’s machinations, more mortgages had been granted to ever-shakier borrowers.

The article explains the details of the deals, whose byzantine structures should be numbingly familiar to anyone who’s read ProPublica’s earlier work on Magnetar, or chapter 9 of Yves Smith’s book Econned. Smith calculated that, “if you look at the non-synthetic component, every dollar in mezz ABS CDO equity that funded cash bonds created $533 in subprime demand” (Econned, 261). (If mezz ABS CDO means nothing to you, I highly recommend Smith’s blog, or John Lanchester’s I.O.U., the most stylishly written of the “crisis” books.)

Behind all the reticulated swaps of risk and reward, in article after article, the crash of 2008 is boiling down to a familiar story: endless leverage designed to support ever more fee-generating deals. Read More

Recommended Viewing: American Casino and Flow

I was recently reading Bloomberg Businessweek’s excellent examination of commodity ETFs. Here’s a taste of the findings of Peter Robison, Asjylyn Loder and Alan Bjerga (which are well worth reading in full):

Lured by the idea of profiting from raw materials, investors put $277 billion into commodity ETFs and related securities by the end of 2009. Then they noticed a problem: When commodities go up, the commodity ETFs often don’t. . .

When the futures contracts that commodity funds own are about to expire, fund managers have to sell them and buy new ones; otherwise they would have to take delivery of billions of dollars’ worth of raw materials. When they buy the more expensive contracts—more expensive thanks to contango—they lose money for their investors. . . . Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks. “You walk into a casino, you expect to lose money,” says Greg Forero, former director of commodities trading at UBS (UBS). “It’s the same with these products. You’re playing a game with a very high rake, a very high house advantage, and you’re not the house.”

The article brought to mind two outstanding documentaries I recently watched on finance and the “real economy.”

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Louisiana as Petro-State

Here is an interesting take on the role of oil companies in Louisiana:

Long before the oil spill, [Louisiana]’s embrace of the petroleum industry cast it under what economists call “the resource curse”: the paradox that countries rich in minerals or petroleum tend to grow more slowly and have lower living standards than other nations. Simply put, Louisiana is the closest thing America has to a petro-state.

Instead of blessing Louisiana with prosperity, the oil industry fostered dependency, corruption and an indifference to environmental damage. Our Cajun sheikdom’s oil and gas riches — like those of the Niger Delta, the Orinoco belt in Venezuela and the Iraqi marshes — also stunted its development, leaving it far behind states with fewer natural resources. . . . “We’ve always been a plantation state,” said Oliver Houck, an environmental law professor at Tulane University. “What oil and gas did is replace the agricultural plantation culture with an oil and gas plantation culture.”

Just as plantation culture had an impact in Texas, it appears to leave a lingering legacy in Louisiana as well. When many judges and scientists appear to be dependent on an industry, accountability is a long way off.

In the Venal Colony

Paul Romer is an accomplished man; as he puts it, “I revived growth theory. I made technology work in higher ed. I am two for two, and I think the impossible can be done.” His new idea is to promote economic growth in poor countries by establishing zones within them that are administered by business-friendly foreign governments:

Romer is peddling a radical vision: that dysfunctional nations can kick-start their own development by creating new cities with new rules—. . . centers of progress that Romer calls “charter cities.” By building urban oases of technocratic sanity, struggling nations could attract investment and jobs; private capital would flood in and foreign aid would not be needed. . . . [To run the cities,] Romer looks to the chief source of legitimate coercion that exists today—the governments that preside over the world’s more successful countries. To launch new charter cities, he says, poor countries should lease chunks of territory to enlightened foreign powers, which would take charge as though presiding over some imperial protectorate. Romer’s prescription is not merely neo-medieval, in other words. It is also neo-colonial. . . .

When Romer explains charter cities, he likes to invoke Hong Kong. For much of the 20th century, Hong Kong’s economy left mainland China’s in the dust, proving that enlightened rules can make a world of difference. By an accident of history, Hong Kong essentially had its own charter—a set of laws and institutions imposed by its British colonial overseers—and the charter served as a magnet for go-getters. At a time when much of East Asia was ruled by nationalist or Communist strongmen, Hong Kong’s colonial authorities put in place low taxes, minimal regulation, and legal protections for property rights and contracts; between 1913 and 1980, the city’s inflation-adjusted output per person jumped more than eightfold, making the average Hong Kong resident 10 times as rich as the average mainland Chinese, and about four-fifths as rich as the average Briton.

The idea of a “charter city” brings to mind some of Diane Ravitch’s critiques of charter schools:

The media like to focus on a star charter school, as though one extraordinary school is typical. The teachers are young and enthusiastic; the children are in uniforms and well behaved, and they all plan to go to college. But such stories often overlook important factors about charters: one, the good charters select students by lottery, and thus attract motivated students and families; two, charters tend to enroll a smaller proportion of students who are limited–English proficient, students with disabilities and homeless students, which gives them an edge over neighborhood public schools; and three, charters can remove students who are “not a good fit” and send them back to the neighborhood school. These factors give charters an edge, which makes it surprising that their performance is not any better than it is.

It would likely be very difficult to prove that a “charter city” succeeded on the basis of its “better laws,” rather than its attractiveness to the most ambitious workers. The questions of legitimacy raised by Romer’s proposal are difficult, too. US landlords may attempt to contract into their own “private Idahos” in Greenwich Village, but will international law smile on charter city arrangements? What happens when there is a regime change in the country that originally controlled the city space, and the new regime wants it back?

In any event, for further discussion of the idea, check out Russ Roberts’s interview with Romer, which is very substantive.