Is Crowdfunding a good model for capital formation?

Soon you will be able to raise capital and float shares using sites like Kickstarter. The effective date for the SEC’s Reg Crowdfunding (they gave up on finding a single letter) is close upon us. I’ve funded things on Kickstarter, but color me skeptical about using it for capital.

Like many things, it sounds good in theory. Going back to Michael Millken and the junk bond empire of Drexel Burnham Lambert, there is a theory that backing lots of risky businesses will succeed because the few winners will more than make up for the many losers. For example, I could have invested in every PC maker from 1977 onwards and made up for all the losses with one winner, Apple.

Wash, Shrink, Repeat.

If it worked for small and risky companies, the theory goes, it will work eversomuchmoreso for even smaller, riskier companies. Never mind survivor effects that have already winnowed the field, etc.

Also running in favor of the idea is the desire to even out income inequality. Very large fortunes are made today by being in on the start of small companies that grow big. Crowdfunding capital formation would spread that opportunity across many more individuals than have it today. This is a very positive and valuable goal.

The SEC stripped me of investor protection, and all I got was this lousy T-shirt

The fly in this ointment is that capital formation has historically been a way to rip people off. It is easy to forget that the SEC set up all the rules about floating shares in the first place to protect potential investors, not prop up investment banks. (Full disclosure, I used to work for one.)

Go public without audited financial statements? Fine! Who needs independent confirmation of facts when we want rampant speculation?

No. No. No. The rules are there for a reason. We learned our lesson, and I would rather not unlearn it.



Half the story and no punchline

Marketwatch recently published a piece on the sad history of the Central States Pension Fund of the Teamsters union. As a quick update for those that do not know why there are jokes about Jimmy Hoffa being buried at the fifty-yard line of Giants Stadium in New Jersey, the Teamsters were a very powerful union in 20th century America, covering the trucking industry and related trades. It fell under mob influence and union leader Hoffa is widely believed to have been murdered by the Mob to keep him from cooperating with the FBI investigation.

The Central States fund is a classic underfunded pension. Many truckers today are not union members, so the ratio of working to retired is 1 to 5.2, according to the article. Investment management of the fund was taken away from corrupt union officials in 1982 and put in the hands of Wall Street firms such as Morgan Stanley, Goldman Sachs (a former employer of the author), and Northern Trust.

The Marketwatch article opines that Wall Street did worse for Central States than the mob did. But is that true? It appears that part of the strategy to deal with the underfunded pension was to invest in higher risk/reward assets than the typical pension. When the financial crisis hit in 2008, this strategy means that the fund’s losses were also magnified.

That’s all the story tells us, but that is only half the story. Yes, the downside in stocks was worse than bonds in 2008, but the rebound was also better. The long-term outperformance of equities of all other asset classes has persisted after the crisis of 2008. And if the mob was still in charge and heavily invested in Vegas casinos – that would have been better for Central States? Of course not.

The real problems here are two, in my opinion. Did the investment managers abandon their equity-heavy allocation at the bottom of the market? That would be a tragic misstep. Did the investment managers consider the average retirement age of the members in their asset allocation decisions? This should have driven concerns for generating cash vs growth. There is a tension between these two, but that is why GS and NT were getting paid the big bucks.

As a piece of financial journalism, this article doesn’t close out the issue it raises in the headline. A stock-heavy allocation does make sense (in my opinion). That in itself is not the problem. Changing strategy at the bottom – now that is a problem. But the article doesn’t document that that actually happened. We have only half the story and no punchline.

Who Audits the Quality of Credit Ratings?

In the wake of the Standard & Poor’s deal to pay a fine but avoid admission of wrong-doing, some questions arise.

  • The fine is more than the amount of profits made from the bad ratings, but is it actually going to change corporate behavior?
  • The really big stick is enjoining the firm from rating certain kinds of bonds, their core business, for a certain period of time. Why not? Is the ratings business really so concentrated in a few firms that S&P is ‘too big to fail’ not in a monetary sense, but in a process sense?
  • Another remedy is increased disclosure. The SEC already expects the ratings agencies to disclose some information on their sites, for public scrutiny. This could have been ratcheted up for a time. Why not?

Money isn’t everything. Changing behavior is much more difficult, but much more important, than a fine.

And finally, who does audit ratings quality? Nobody? We audit food quality, drug quality. If you sell a product that can hurt the public, shouldn’t it be inspected at some point?

Putin Rides the Tiger

There was an interesting misalignment in Putin’s clownish attempt to disguise his takeover of Crimea, and it tells us something about what is going to happen next. Thousands of troops show up in unmarked uniforms, but they are using trucks with Russian military license plates. One is an attempt to disguise (in the most threadbare fashion) the origin of these soldiers, the other plainly tells everyone who they are. Here is how I see it. Continue reading Putin Rides the Tiger

The New Rules of Writing Regulations

One side effect of the recent government shutdown in the US was a lack of information upon which to base decisions. As soon as the doors opened, the government itself starting feeling the pain. What to do about interest rates? Well, we stopped collecting economic statistics, so you’ll have to wait a while. What does that tell us about writing regulations and legislation that requires data? Continue reading The New Rules of Writing Regulations

H.R. 1105 – What’s In A Name? Nothing.

Legislation is often named in an utterly pretentious style, as if every subparagraph is the second coming of the Constitution. Other bills are named like advertising slogans, The Whiter Teeth and Job Creation Act. Still others are named like the Holy Roman Empire, which we all know was not Holy, nor Roman, nor an empire. H.R. 1105, the Small Business Capital Access and Jobs Preservation Act probably hits the trifecta. Continue reading H.R. 1105 – What’s In A Name? Nothing.