Saturday, July 17, 2010

Government sponsored blackmail

It has been quite a while since my last post. For the first month that I was writing blog posts I was recuperating from a surgery which allowed me numerous hours to read up on various subjects. Since then, however, I got a job and because they do not pay me to read news articles, I haven't written any new blog posts. This past week has been great in terms of material.

To begin, a mere two hours after the Senate approved the financial regulation this past Thursday, the SEC and Goldman Sachs settled the lawsuit I discussed here and here. A quick summary of my arguments: Goldman Sachs didn't do anything illegal (there's a distinction here between legally wrong and providing markets in products with a negative social utility), the SEC case was politically motivated, and finally, Goldman and the SEC would settle after the financial regulation was signed into law. The framework of my assessment appears to be correct, though the SEC didn't drive an industry wide settlement which is strange and they didn't wait until the President officially signed the legislation which doesn't matter. In exchange for a payment of $300 million, Goldman Sachs seems to have exempted itself from further mortgage backed security investigations. A recent article in the NY Times insinuates that settlement discussions began immediately following the filing of the civil suit on April 16th. The fact that the SEC is involved in politically motivated investigations is unsurprising and certainly not confined to the current administration. The larger lesson that Americans should take from this is the danger of relying on regulators to monitor the financial health of corporations and the country as a whole. They are generally not as smart as their opposition and attuned to the desires of their political masters rather than reality. At some point I'd like to write a blog post on the financial regulation and why I think Paul Volcker might have had the right solution, however messy it is to impliment.

Finally, BP appears to have capped the well and is weeks away from permanently plugging it. This may yet prove untrue (the last time I made this assertion was in June with the "top-kill"). The share price has risen dramatically within the past two weeks, swinging from a low of 26.75 during the last week of June to close at 37.10 on Friday. That's a nearly 39% increase in  three weeks of trading. While I didn't buy all my shares at 26.75, the weeks where it traded around 30 allowed me to get the cost basis for the entire position fairly low. This whole episode has confirmed for me that markets are not efficient in the short term. It seems safe to assert that market participants (those who buy and sell assets such as stocks) tend to be very irrational on the margins, when they are either excessively fearful or happy. I would argue that there was not a significant change from the last week of June to the present in terms of the future liability that BP faces. They may have prevented 3-4 weeks of oil from spilling into the Gulf of Mexico, but my belief is that each incremental barrel of oil spilled has less financial impact than the last. Whether you clean 1 ton of tarballs off of the beach in Pensacola, FL or 1.5 tons, you'll pay roughly the same in total cleanup costs. The actual fines from spilling oil are a much smaller component of the overall liability.

BP did get a surprising helping hand from the government in the form of Kenneth Feinburg. For most of May and June the media and political figures assailed the Obama administration for not taking control from BP. Well they did, and now the blessedly short attention span of the American public has moved on and the government is stuck with the mess. At this point BP can deflect blame for those upset with the size of their claims check to the man hired by the President. Because the spill affected what was already a economically depressed area, it should not be surprising that there will still be an awful lot of upset people 2 yrs from now. Their livelihoods weren't exactly doing well to begin with and Kenneth Feinburg won't be quite the sympathetic cash cow that many were hoping for.