Sense on Cents

Profit over principle. Where does one draw the line?

I worked with some incredibly sharp individuals on Wall Street. In fact, two individuals with whom I worked were banned from casinos in Vegas because of their ability to count cards. While casinos do not appreciate card counters, I would not include that skill as a negative in my thoughts about their personal character. To be perfectly frank, both of these individuals were gracious, charitable, and professional. The overwhelming majority of those with whom I worked were also true professionals.  That said, the very nature of the Wall Street enterprise attracts an element that prioritizes profit over principle. I am reminded of that fact again today. How so?

The Financial Times reports, U.S. Banks Face Insider Trading Probe. While each and every instance of insider trading is an untold cost and burden for free market capitalism, this particular story is less surprising than it is galling. How so? As the FT highlights, the activity is directly related to capital injections into these banks via TARP (Troubled Asset Recovery Program) and the PPIP (Public Private Investment Partnership). As such, the individuals involved are using American taxpayer dollars to drive their own illegal profits.

The FT writes:

Neil Barofsky, the special inspector-general overseeing the US government’s financial rescue efforts, is to probe allegations of insider trading among bank executives and their associates.

Eight of the largest banks in the US received between $2bn and $25bn in October 2008 under a programme to prop up the financial system led by Hank Paulson, then Treasury secretary.

Dozens more institutions followed and Mr Barofsky, who examines the troubled asset relief programme, is looking into whether information improperly made its way to trading rooms during a feverish period in which the government and banks were frequently exchanging information.

“We have pending investigations looking into that – typically into insider trading,” he said. “Once upon a time getting Tarp funds actually meant your stock price would go up and we are looking at specific trading around Tarp announcements by insiders or looking at potential tips from insiders.”

The Treasury is celebrating faster than expected Tarp repayments from the financial sector; it now expects relatively small losses, with some elements generating big profits.

While Mr Barofsky acknowledges this, he said there remained substantial problems with the struc-ture of the public-private investment programme, which is designed to encourage investors to buy troubled assets from banks to clean their balance sheets and stimulate lending.

He said there should be walls between fund managers taking part in PPIP, which co-invests government funds with those of the private sector, and managers at the same firm buying and selling similar securities.

An example of suspicious activity at an unnamed firm showed a manager selling a security from a non-PPIP fund and then buying it back at a slightly higher price with a taxpayer-supported PPIP fund minutes later.

“The rules are insufficient,” said Mr Barofsky. He said even if the behaviour, which Sig-Tarp is investigating, was found to be within the rules “it still creates this credibility issue, this reputational damage, this appearance of fund managers gaming the system”.

Much of Sig-Tarp’s new report is given over to an examination of the housing market and the multitude of government schemes designed to support lending and help homeowners avoid foreclosure.

“The government has done more than simply support the mortgage market,” the report said. “In many ways it has become the mortgage market with the taxpayer shouldering the risk that had once been borne by the private investor.”

What do I see as the common theme here? In an environment where major components of risk are socialized, those who can game the system are in a position to generate outsized rewards.

These behaviors have to be thoroughly exposed and aggressively prosecuted and punished. Will that happen? Regrettably, we have too much evidence over the years indicating that regulators are incompetent, negligent, or complicit in dealing with these activities. I commend Barofsky for his efforts, but I wonder if his colleagues at FINRA and the SEC are equally determined on these fronts. I wish they would prove my concerns wrong.

Card counting looks amazingly mild by comparison.

LD

This entry was posted on Monday, February 1st, 2010 at 1:56 PM and is filed under General, insider trading, PPIP, TARP. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.