Focusing on the Wrong “Special Master”

Good Evening: The capital markets absorbed a flurry of news today and came away with only some minor indigestion. Stocks and bonds were on the defensive before each market made comebacks of varying degrees, while the dollar and commodities were firm before giving up some of their gains. Aside from a surprising drop in crude oil inventories, most of the economic data releases were not compelling as market drivers today. One of the more interesting stories, however, centered on an attempt by the Obama administration to appoint a paymaster to oversee executive compensation among firms receiving taxpayer funding. But if the latest threat from the overseers of Russia’s sovereign reserve assets is at all credible, then we here in the U.S. might be focusing on the wrong “special master”.

Markets around the world were quite peppy last night, though this strength didn’t translate into much of a rally for U.S. stock index futures. As for the economic data out today, mortgage purchase applications ticked up a hair during the latest reporting week. Our nation’s trade deficit widened about as much as expected when exports fell faster than imports in April, while energy inventories were drawn down. The amount of crude, gasoline, and distillates in storage during the most recent week substantially fell, and the news kited energy prices.

The Census Bureau releases a quarterly “services survey”, one which is intended to capture information about the health of the technology industry. While this survey fell shy of estimates, few cared since it’s a Q1 number. The Treasury’s budget shortfall for May was in keeping with the other horrendous deficit figures piled up during fiscal ’09; May’s deficit set a new record for the month. Some did find release of the Fed’s Beige Book of mild interest. Trying to please both equity and bond investors at the same time, the Fed districts painted a picture mixed enough to allow a myriad of interpretations. For a nice summary of the Beige Book, see BAC-MER’s piece below.

Stocks opened more than 0.5% higher before the story that Russia and Brazil would seek to buy $20 billion worth of IMF bonds in lieu of U.S. government obligations started to take its toll. Defecting customers are never good news for a sovereign bond market, and ours was no exception today as interest rates rose. The psychological impact of this move by nations like Russia is larger than its physical impact, and this effect was seen when the Treasury’s 10 year note auction results were released. 3.99% was the higher than expected winning yield, and though the depth and quality of bids was decent, the fact that the auction scraped the 4% mark harmed the rest of the bond market. Equities took notice and were soon down 1.5% for the day when a late rally cut into most of those losses. The Russell 2000’s 0.8% drop lagged the rest, but the Dow Transports managed to squeak out a fractional gain. As noted above, Treasury yields headed higher, though they, too, finished with a bit of a bid. Yields ticked up between 5 and 11 bps as the curve once again steepened. The dollar rose along with these higher yields, but it faded somewhat into the close. Commodities benefited from the strength in the energy complex, and the CRB index managed to hold on to a 0.2% gain by day’s end.

The U.S. government is seeking to appoint a “Special Master”. His job will be to review and then opine upon the compensation packages of any company receiving “extraordinary” U.S. government funding (see both stories below). The kindest interpretation of this move is that this special overseer will safeguard U.S. taxpayers by making sure those who run the companies we all now have a stake in from running up the tab too much. It’s not a very effective way to attempt regulatory reform, an issue I addressed back in May. Rather than having our government trying to micromanage things like union contracts and executive pay levels, it seems to me the best approach is avoid letting the regulatory pendulum from swinging too far in either direction.

Perhaps the best financial regulation is not the “all or none” debate into which the major political parties so often descend. Smarter regulation would involve a hybrid of both philosophies. If the thesis of “little or no regulation” held by those on the right leads to systemic risk, and if the antithesis of “regulate everything down to the paychecks” held by those on the left leads to systemic sclerosis, then perhaps my concept of “freedom to operate within set boundaries” represents a common sense synthesis. The concept I propose is to set up boundaries within which financial firms can then operate purely at their own discretion. As long as they don’t leave the reservation (e.g. take on too much leverage, or push CDS on retired widows), our government should leave them alone. Here’s the comment I wrote in May, and below it is an excerpt that touches on what I’m proposing:

<a href=”“>May Commentary, Jack McHugh

“In short, I’m proposing large and well enforced boundary fence type of regulatory framework inside which banks and other financial institutions can more or less freely operate. Government intervention (as with Chrysler) and rule making on a micro scale is just as wrong-headed as letting the banks do whatever they want. Placing visible and enforceable borders around financial institutions will work precisely because it acknowledges both human dimensions so common to capitalism — the freedom of choice that allows Adam Smith’s Invisible Hand to operate, and the Visible Fist of government that tries to prevent the greedy from gaming the system in ways dangerous to us all. Though the Rio Grande river gets more attention, this is the type of “border security” legislators should focus upon. I know it’s a lot to ask of our elected leaders to want them to enact smarter regulation, but it sure would be nice if they at least tried.”

As we saw with today’s record budget deficit for May, Washington can’t get its own house in order, so how can they be expected to know how to micromanage complex banks? Thus, appointing a “Special Master” misses the mark in terms of both philosophy and pragmatism. According to our Constitution, government should be the servant and not the master. And, as Russia reminded us all today, our foreign creditors increasingly aspire to the role of “Special Master” with each passing Treasury auction. Maintaining a global fiat currency standard with the dollar as the world’s reserve currency only encourages our dependence on the kindness of strangers whose interests may or may not be in keeping with ours. If we had smarter regulation and more responsible government at all levels, then we the people would have no need of a special master of any kind — foreign or domestic.

— Jack McHugh

BAC Research: Sector improvement in the Beige Book
Russia, Brazil Plan to Buy $20 Billion IMF Bonds
Treasuries Fall After Auction, Russian Threat to Cut Holdings
Obama Seeks Powers for SEC on Executive Pay, No Caps
Feinberg Will Review Executive Pay as Special Master

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