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Financial Finagling Pt. 2
Opening Billboard: Funding for this program is provided by the Bernard and Irene Schwartz Foundation, the Smith Richardson Foundation, and the Lynde and Harry Bradley Foundation.
Hello, Iím Ben Wattenberg.
The financial scandals of the last five years have given many American corporations a bad name. From Enron to Global Crossing, from Arthur Andersen to Merrill Lynch, big firms have been accused and sometimes convicted of financial skullduggery in all its forms.
Federal and state governments have passed new legislation aimed at curbing accounting fraud, but some say the regulations go too far --- others say, not far enough. But in the meantime, the stock market continues to do fairly well ó despite chaotic global conditions. And abroad, America is still seen as a safe haven for investment.
Has Wall Street become over-regulated? Or has recent legislation been the strong medicine big business needs to keep from self-destructing?
To find out, Think Tank is joined this week by Alex Pollock, former President and CEO of the Federal Home Loan Bank of Chicago, a director of Allied Capitol Corporation, of which I am a shareholder, and the Chicago Mercantile Exchange, he is a resident scholar and a colleague of mine at the American Enterprise Institute.
The Topic Before the House: Financial Finagling part 2, This Week on Think Tank.
WATTENBERG: Alex Pollock, welcome back to Think Tank.
POLLOCK: Thank you.
WATTENBERG: So what was the intent of Sarbanes-Oxley? Was there political intent? Was Paul Sarbanes wanting to run for President or something like that?
POLLOCK: Thereís nothing like that as far as I know. It is interesting that he was Chairman of the Senate Banking Committee --
POLLOCK: -- before, just an interim period between two Republican majorities when the Senator Jeffries from Vermont switched parties and got us -- in that sense, got us Sarbanes-Oxley.
I think there was a political intent in the sense for all the politicians involved wanted to show, as they always do in the wake of the bust, then the scandals come out, and they want to show theyíre doing something. 'Have to show that Iím somehow addressing this public problem,' and thatís natural, and so it always happens.
I do think the intent was always -- was, in addition, this notion of confidence -- I put that personally. I put that in quotes -- confidence in financial markets. What you were saying, you want people investing to think theyíre going to get a fair deal, and what that really means is that youíre not going to let the insiders cheat the outsiders.
POLLOCK: The biggest problem with the Sarbanes-Oxley Act -- there are various debates, but the biggest problem is around a section called Section 404, which has unleashed the excessive expense and bureaucracy.
But the problem really isnít the Act itself, the wording of the Act. The problem is how the wording has been implemented by various bureaucracies and assistant bureaucracies which are --
WATTENBERG: Just for the record, it has been criticized, of course, by conservatives for over-regulation. But a lot of cities and states have sort of picked variants of it. And I know some very liberal accountants who I used to work with, even they say itís been too much.
POLLOCK: Too much.
POLLOCK: I think everybody agrees itís been too much. The SEC --
WATTENBERG: Yes, and theyíre in the process of rolling it back somewhat.
POLLOCK: Well, the SEC itself agrees that the implementation bureaucracy has been excessively costly, heavy-handed, focused on the wrong things.
But itís really the implementation, not the wording of the Act itself, an example of the famous unintended consequences --
WATTENBERG: Of all unintended consequences, thatís one of the neoconís marching songs. So go ahead.
POLLOCK: Well, this is a great example of it.
WATTENBERG: What does SOX, Sarbanes-Oxley, actually do?
POLLOCK: It causes senior corporate officers, CEOs, chief executive officers and chief financial officers, to have to certify to the financial statements and the internal control systems under some fairly significant personal liabilities, including potential criminal liability, about -- in a complex company or even a not so complex, but sizable company -- about things they canít possibly personally know. But theyíre the captain of the ship, so theyíre --
WATTENBERG: But it said, I believe, that in some ways, it puts the CPA in the driverís seat rather than the CEO. It says that he has power over the company under Sarbanes-Oxley and that he can tell them what sort of investments to make and not make, what product lines --
POLLOCK: No, no, not that. Not investments to make --
WATTENBERG: Well, I mean, in effect.
POLLOCK: But it does -- it does shift the power between the accountants, the outside auditors, and the management quite significantly. Itís ironic because, on one hand, the accountants are terrified. The accountants themselves --
WATTENBERG: Because they now have so much power --
POLLOCK: No, no, because they have so much liability.
WATTENBERG: Yeah, okay. And power --
POLLOCK: They watched Arthur Andersen be destroyed --
WATTENBERG: Which was one of the Big Seven --
POLLOCK: -- which was one of the Big Five --
WATTENBERG: Big Five.
POLLOCK: -- theyíre now four. Itís a very uncompetitive industry. Thatís another problem. They watched Arthur Andersen be destroyed as a firm by the Government for auditing mistakes.
They watched the people not only lose their jobs, but lose their pensions. We talked about pensions before if you were with Arthur Andersen. And theyíre terrified at the penalties that they might possibly have, at the lawsuits that they might attract for malpractice of accounting.
So one hand, theyíre scared, and the fact that theyíre running scared makes them willing to do a lot of things to protect themselves. And the company doesnít really have a lot of choice because, under Sarbanes-Oxley, you must have the accountants attest or certify to the fact that theyíre happy with your internal controls. So --
WATTENBERG: Alex --
POLLOCK: Just one final thought.
WATTENBERG: Go ahead.
POLLOCK: So think that Iím scared, I can do anything, either more bureaucracy and routines and memos and looseleaf folders full of stuff that I create, the safer I am personally. And I can do all this by charging you; you pay for it all. And in fact, the more bureaucracy I create as the auditor, the bigger my profits are. Thatís Sarbanes- Oxley.
WATTENBERG: maybe we would agree on this and maybe we wouldnít. I think that certain kinds of Federal regulation, which some Conservatives decry -- I mean, there are people in this town that say taxation is theft; neoconservatives like myself do not believe that.
We think the Federal governments, State governments, local governments, complex as they may be, often do good things. And you will find the political heirs of Social Security and Medicare who bitterly opposed those programs now say, 'I wouldnít touch a hair on the head of Social Security.'
POLLOCK: Thatís true. Okay.
WATTENBERG: So you think the idea of certain forms of big government make some sense?
POLLOCK: Certain forms. Iím very fond of the saying of Charles Kindleberger, the great economic and financial historian, who said -- and thereís an eternal debate -- should you be an Adam Smithian free marketer or should you be a Keynesian interventionalist? Kindleberger said, 'Every rational man has to answer both depending on the circumstances.' Thatís --
WATTENBERG: And what did they say --
POLLOCK: Thatís what I think too --
WATTENBERG: I mean, Keynes, I know -- well, you told me what Keynes -- I mean --
POLLOCK: Well, Keynes was in favor, when the circumstances warranted it, of having Government programs intervene to try to fix problems.
WATTENBERG: Okay. What do you think of the new Chairman of the Fed, said to be the second most powerful man in Washington after the President, Ben Bernanke, who, it is said, speaks in American where Alan Greenspan spoke 'Greenspeak' or 'Alanspeak' or whatever it was called, very complexified? Howís he doing?
POLLOCK: I think thereís no doubt that Mr. Bernanke is very brilliant. Seems to me to be doing fine.
WATTENBERG: Heís got a beard like mine --
POLLOCK: A tough job --
WATTENBERG: -- but darker. Yeah.
POLLOCK: Well, there are interesting historical cycles in beards and cleanshavenness as well.
WATTENBERG: Great waste of time shaving. Go ahead.
POLLOCK: Thereís a great strategic decision, it seems to me, you would have to make, as Chairman of the Fed; that is the strategy of clearer communication versus unclear, mysterious communication. In general, in life itís better to be clear, succinct and let people know what you want to happen, especially if, say, youíre a manager of a company. Thatís a great -- a great virtue. Youíve got to let people know what you want and what youíre trying to do and what theyíre supposed to do.
On the other hand, I think thereís a strategical argument to be made for mystery and lack of clarity or even call it obfuscation in what seems to be the Greenspan style if youíre the Central Bank.
WATTENBERG: You know, it was at an AEI annual dinner where Alan Greenspan -- and the Dow was about 6000 or so -- said there was an irrational exuberance in the market, and I didnít understand it. I happened to be sitting next to Herb Steiner, who was the former Chairman of the Council of Economic Advisors, and he understood what it meant. It meant that he would raise interest rates to slow it down, right? And all the Japanese journalists ran like hell for the phones to get it up there.
But the Dow then proceeded from 6000 to about 9000 before -- so no one knows nothiní when you get right down to it.
POLLOCK: Thatís the point I was about to make.
POLLOCK: You really donít know no matter who you are or how brilliant, how much data, how much staff. So thereís some advantage to not being very clear.
WATTENBERG: Let me bring up a somewhat ancillary topic. The United States and its script called the dollar, which is no longer even backed by gold, and they closed the gold window --
WATTENBERG: 1971 -- as if that made any difference -- is now the --
POLLOCK: Actually, I think it did make a difference, but anyway...
WATTENBERG: Well, why is gold of any particular value?
POLLOCK: Itís not of any particular value. Itís whether you have any control on the central banks of the world. And after they closed the gold window, remember we had runaway inflation in the whole world for a decade.
WATTENBERG: And you think that was the reason?
POLLOCK: I think itís related.
WATTENBERG: Well --
POLLOCK: Anyway --
WATTENBERG: All right. Anyway, the United States is what -- the dollar is what called the reserve currency --
WATTENBERG: -- which means what?
POLLOCK: Which means that other countries, central banks, monetary bodies or even private companies or citizens hold assets denominated in dollars in other countries as their savings.
So that if you look, for example, at the Chinese Investment Authority of the Chinese Government, it has an investment portfolio, a very significant amount of which is held in assets denominated in dollars.
WATTENBERG: Now, Alex, this reserve currency idea, I donít want to be mean-spirited or overstated, but itís sort of a racket in a way, very beneficial to the United States. We issue script which we call dollars. People, in return for that paper unbacked by gold bars in Fort Knox, people send us goods and services, and then they hold on to these pieces of paper.
So we are getting one of the great free rides in the history of the world. I mean, it is -- I donít want to put too fine a point on it -- a racket.
POLLOCK: Itís a great advantage for our country. Thereís no doubt about it. To be the one who issues -- itís like the Government being able to issue paper money domestically.
POLLOCK: The United States is like the issuer of paper money to the whole world in the form of dollars, and itís a huge advantage to the authority that can do that.
WATTENBERG: Okay. Alex, what do you think about the criminalization aspect? I mean, I know perfectly honest and decent people, or at least I think they are, some with Fannie Mae and with others, who are facing, I guess, now civil crimes, but which may be criminalized, and may have to spend slammer time.
WATTENBERG: And in Ken Layís case, he was looking -- who I donít think quite got what was going on; maybe he did -- spend their life in prison, men with families, wives, children and all that kind of stuff. Have we overdone that?
POLLOCK: I think so. I think itís very distressing where ex post facto we turn what might have been mistakes or even stupidity, although itís --
WATTENBERG: The Constitution said there will be no
ex post facto laws.
POLLOCK: Yes. But it looks like what happens is that the distinction between mistakes which end up costing people money and something criminal gets very unclear. I mean, itís a big problem.
WATTENBERG: What do you think of these things that are principally vehicles for the wealthy only?
POLLOCK: The hedge funds?
WATTENBERG: Hedge funds. Now, little guys, for the most part, canít get into them. I guess they can buy --
POLLOCK: Oh, thatís not true.
WATTENBERG: They can buy pieces of it --
POLLOCK: Oh, no. The way that we talked before about the average people, the way that they are in hedge funds is through their pension funds. Pension funds, in fact, are becoming big investors in hedge funds. So you have average employees who are, in fact, invested in these hedge --
WATTENBERG: -- trade currencies --
POLLOCK: They do --
POLLOCK: -- anything. They invest in stocks, both long and short stock --
WATTENBERG: -- billions of dollars trading currencies --POLLOCK: Trade currencies. They trade derivatives, options, swaps. They trade fixed income, bond positions of various kinds. They deal --
WATTENBERG: Let me just interrupt. No, no. I just canít stress enough that that language, for most people, is Greek. I mean --
POLLOCK: Iím sure.
WATTENBERG: There are not a lot of people, including yours truly, who really understand it. But you have to trust your Rabbi and a lot better broker. Heís quite cautious. I like to risk a little bit, and so we sort of blend a little bit. Itís worked so far.
POLLOCK: I think a cautious broker is a consummation devoutly to be wished.
WATTENBERG: We have some interesting financial situations that have come about. It used to be that Social Security kicked in at age 65, and if, in any quarter until you were age 72 you earned money, you didnít get your Social Security.
Now you can retire as early as 62, and when I was, I think, 67, a few years ago, they paid me back taxes -- back disbursements of everything that I would have gotten had I called for it when I was age 65. And the amounts have gone way up.
When I worked on President Johnsonís staff, it didnít receive much attention at the time, but he, working with Wilbur Mills, who was the Chairman of the House Ways and Means Committee, I think, they raised the Social Security benefit from $50 to $100. A hundred-dollars in those days would probably be --
WATTENBERG: -- four or five hundred dollars today. And if you look at the lines on the chart, if you wanted to look at property in the United States, you looked under the line that said elderly. And now they have higher than the average income, and thatís a great step forward, isnít it? Itís big government.
POLLOCK: It is. Itís a forced savings. In one sense, itís a forced --
WATTENBERG: I mean --
POLLOCK: -- savings for --
WATTENBERG: -- thinks itís scandalous that the Government should help you save. But I must tell you that if it wasnít for that, I donít think I would feel as at ease as I do about my financial situation.
POLLOCK: Yes. We did a bunch of numbers recently trying to look at various cases, thinking of Social Security as a forced savings program where you and your employer pay in each year a certain amount over your life, and then you get a certain amount back, making guesses about how long you live.
And in general -- of course, if you die early, itís a terrible savings program because you lose it all. But in general --
WATTENBERG: You mean in theory, the SSA people in Baltimore are pro-death?
POLLOCK: Yes, right.
WATTENBERG: But I donít think thatís the way they really behave, but go ahead.
POLLOCK: Well, in theory, any writer of annuities is pro-early death.
POLLOCK: The implied rate of return to all your forced savings with average life expectancy turns out to be around two-percent real. And if you --
WATTENBERG: Real meaning after --
POLLOCK: -- real meaning --
WATTENBERG: -- after inflation?
POLLOCK: -- after inflation, which is not a great investment, but itís not dissimilar from owning Government bonds.
POLLOCK: Thatís why Iíd rather give people --
WATTENBERG: But it is inflation-indexed.
POLLOCK: It is inflation-indexed.
WATTENBERG: Thatís very important.
POLLOCK: And thatís why I would rather give people personal accounts that have Government bonds which are inflation-indexed; that is to say, Treasury inflation protected securities that they actually own. I think youíd have a better result all around.
WATTENBERG: Give me one other verdict, if you would, on what is euphemistically called the death tax, the estate tax. What do you think about that?
POLLOCK: I donít have a strong view one way or the other except I think that wherever the estate tax starts it ought to be high enough so that most people are not touched by it, and they can leave their assets, their businesses --
WATTENBERG: Most people like myself think it ought to begin about a dollar higher what their estate is worth. So that --
POLLOCK: I would say should miss 99-percent of the population.
WATTENBERG: We ought to be able to pass wealth on to our children or philanthropies and that that is a good thing, and if you let that money accrue and accrue and accrue, while there are some very public-spirited families -- I mean, the Rockefellers in some instances and others, the Kennedys in certain instances -- we also have some wastrels in our society.
And we have examples of five and six generations of really landed aristocracy with three or four homes and the yachts.
POLLOCK: I must say that idea doesnít bother me. An aristocracy of privilege bothers me. An aristocracy of political power you wouldnít want to have. But the aristocracy of wealth, if somebody made it honestly, it doesnít bother me.
But I think the motive to accumulate assets and save and build either a business or an art collection or whatever you may want to be building to pass through a family is a good motive. I will say --
WATTENBERG: And you donít think it can create wastrels?
POLLOCK: I think it can create wastrels, and wastrels are -- just like fraud, weíll always have with us.
A friend of mine who is an economics professor in Colorado wrote a wonderful paper about the American tradition of the combination of entrepreneurship and philanthropy; that he thinks this paper argues that the American emphasis on the importance of entrepreneurial risk-taking and thereby the ability to become rich is tightly linked in our culture with the fact that you then want to give it away to worthy causes where you can do things with concentrations of wealth that could never be done if the wealth were all divided up in little pieces.
WATTENBERG: Alex, letís wind this down. Bottom line, are you generally optimistic about the American economy now?
POLLOCK: I am absolutely optimistic on the long-term trend.
WATTENBERG: Okay, and --
POLLOCK: That doesnít mean we donít have short-term problems.
WATTENBERG: Oh, I understand. Well, what sort of short-term problems would you --
POLLOCK: Well, weíre about to have a housing finance bust, for example. Weíre started on --
WATTENBERG: I donít believe that, but thatís all right.
POLLOCK: I mean --
WATTENBERG: Well, if youíre going to grow from 300-million to 400-million to 500-million people, where are they going to live?
POLLOCK: Youíre talking about the long-term trend?
WATTENBERG: Yes, sir.
POLLOCK: I agree with you on the long-term trend.
WATTENBERG: Okay. Now, what would, in your judgment, be the biggest challenge for our economy? Is it the real estate bubble, the allegedly stagnant wages, deficits, inflation fears, all that? You know the litany.
POLLOCK: I would say itís maintaining competitive advantages in social -- what I talked about before -- the infrastructure of the society, not letting ourselves drown in our own bureaucracy and maintaining the competitive advantage in the creation of knowledge and its offspring in science, technology, those two things.
WATTENBERG: The role of immigration in bringing knowledge to the United States has been -- the so-called brain drain
-- has been win-win for us, hasnít it?
POLLOCK: It has, and thatís something that historically has gone back a long way --
WATTENBERG: Oh, yes.
POLLOCK: -- European intellectuals coming to America.
WATTENBERG: Okay. Alex Pollock, on that note we will have to end our discussion. Thank you very much for joining us on Think Tank. And thank you. Please donít forget to send us your comments via email. We think that makes our program better. For Think Tank, Iím Ben Wattenberg.
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