Business Law Prof Blog

Outsourcing and Fuel Costs

There is strong evidence that high fuel costs have stopped outsourcing of American jobs to foreign factories.  Ohio unions should welcome the high cost of crude.

First Quarter GDP Figures: No Recession

The final figures are in for the first quarter of the year and the estimate was low.  The final figure is a GDP growth of .9 percent; the estimate was .6 percent.  So once again, we are not in a recession and those who have claimed, and profited from the claim, that we are in a recession were just polemics or suckered by polemics. 

US Auto Companies

On Friday, General Motors Corp.'s stock dropped 5 percent after the company reported that strikes at some of its own plants and parts supplier American Axle will cost the automaker about $2 billion, before taxes, in the second quarter.  This drop came on top of a substantial drop in stock value at Ford after it announced that it would cut back the production of its best selling vehicle, the F-150 pickup.  Ford's situation is precarious.  The company's profits have, for years, depended on the sales of the F-150 and the truck platform SUVs.  The sales of both are well down due to high gas prices.  Neither GM nor Ford is a profitable company right now and both companies are running on cash reserves.  The blame game is on in force as to who is at fault.  One thing that all agree on; the country will suffer if we do not make competitive autos and trucks for the national and world markets   

Student Loans

Educators have long been concerned over the heavy loan debt carried by students once they leave school.  Their primary concern is that the loans constrain the work choices the students have once they graduate.  In other words, students cannot take "public interest" jobs and must, horrors, go to work in private industry to pay back their loans.  Like most redistributive arguments from the left, the argument assumes the existence of the loans.  That assumption is now in question.  One of the largest student loan agencies, the Penn. Higher Educating Assistance Agency, is suspending student loans, even if backed by the federal guarantees.  The collapse of the securitization market makes it impossible to cash flow the business.  In the past the loans were packages and resold and the new money was used for new loans.  Now the loans cannot be resold at reasonable rates and there is little new cash for new loans. 

So now students may not have to worry about repaying loans; they may not be any.  Students that do not have the cash to go to school must work before school in, I daresay, private industry, to raise cash to go to school.  Public service jobs will not support future tuition just as they did not support past tuition. 

Educational institutions could attempt to take up the slack by turning into loan companies, a task for which they are not designed and will not do well, but the amount available will be slight compared to the amounts that were available in the private market.  Government could step in the loans and we would have another huge, very expensive government system to fund and monitor all in a time when government budgets are stretched to the breaking point.  Higher taxes anyone?. 

Another hard lesson for the left--be careful what you complain about you may lose it.

Ohio's Economy

The debate last night in Cleveland Ohio between Barack Obama and Hillary Clinton featured a discussion about the Ohio economy.  Apparently both candidates blame NAFTA and other free trade agreements for the decline in manufacturing jobs in Ohio.  Both candidates featured, therefore, promised to "re-negotiate NAFTA" in the debate in an effort to win votes in Ohio.  Yes the Ohio economy is struggling:  Unemployment last measured in December was at 6%, a full percentage point higher than the national average;  mortgage defaults in the fourth quarter of 2007 were at a 1.44% rate, compared to a national average of .87%; over the last eight years, real median income has dropped from over the national average to $2,300 below the national average (a drop of around 10%); and over the last eight years Ohio has lost over 275,000 manufacturing jobs (a drop of about 25%).  But some other facts are notable:  1) Nafta took effect in 1994 and from 1994 to 2000 there was income and job growth in Ohio. Nafta is not the cause of the recent drop, which dates from 2000.  2) Nafta did not greatly reduce tariffs on Mexican goods, they were already low.  The inevitable conclusion is that trade with China (and India and other emerging Eastern Europe economies), which grew dramatically after 2000 (China's admission into the WTO dates from 2001) is a more likely cause.  Indeed, the stump speeches of both candidates now routinely attack China.  Any long-term solution for Ohio, however, has to involve investment incentives that induce private companies to locate or grow here.  This takes time and careful planning.  However, the other routine parts of the candidates stump speeches -- Attacking corporate profits or the pay of corporate executives or the decrying the pay and benefits of workers is not consistent with a plea for corporations to locate or grow businesses here.  Ohio needs to invest in infrastructure (roads, power sources, and cleanup of abandoned factories) and to invest in education and incentives for local talent to stay in the state; the state and the federal government need to reduce corporate taxes and dividend taxes (to eliminate once and for all any double tax on earnings); and the state needs to give up protectionist support (in its many forms) of industries that are not competitive.  We need to drop our takeover protections, for example.  We could also follow Indiana's example and privatize some of our government functions (Indiana sold its northern toll road to Australians who overpaid a whopping $6 B and used the money to attract three new Japanese car manufacturing plants).       

Sweet Irony

A piece in the New York Times by Andrew Ross Sorkin today castigates CEOs for not doing more M&A deals in the current, volatile stock market.  Sorkin notes that many deals fail and that those that are successful are often at the beginning of a "deal" cycle.  Deals that are done in "follow the leader" markets are most likely to not be successful. His conclusion?  CEOs should do more deals now, when the market is unsettled and M&A volume is down.  This from the paper that in the past has routinely lambasted deal makers.  While I am on this tack one should note that after the paper's many attacks on the dangers of hedge funds last year it is the main line investment banks and brokerage houses (and often their internal hedge funds) that have disgraced themselves in the sub-prime loan mess.  The main line banks have inadequate risk controls on a process that separated incentives from long term quality; the private hedge funds have, as a group, done somewhat better.      

Potter v Bailey: The Wrong Debate

Several opinion writers, Floyd Norris is the latest, have noted the application of the movie "Its a Wonderful Life" to the sub-prime mess.  Bailey, the idealist, versus Potter, the cold hearted investor, in evaluating the plight of sub-prime borrowers who cannot face their mortgage payments in ARM resets.   Should we show compassion or be tough?  "We can't [foreclose]. These families have children." [Bailey]  "They're not my children" [Potter]  So Congress and the Fed are ready to pass laws that look silly on their face:  1) Banks cannot loan money to those who cannot pay it back.  2) Banks must verify income figures from those presented by borrowers (stopping "liars loans") 3) Banks must check the objectivity of appraisals on property that is collateral to loans.  They might as well pass a law that states 4) Banks should be profitable.  The laws restate bank's obvious business incentives and perversely given borrowers the incentive to try and hook wink banks so they can sue under the new statutes.  The most rational borrower under the new rules is now one that goes to a bank purposely ignorant, hoping a bank will make a mistake, so the borrower can get something for nothing.  The fallout, no more sub-prime loans to anyone anywhere anytime, will hurt people with poor credit ratings the most, the sub-prime borrower. 

The core of the problem in internal bank controls (whether as investor in SIVs or as originator/underwriter of SIVs) and banks are suffering huge losses because of it. We do not need legislation to correct this; banks will correct it themselves.  The market has its own penalties -- CEO are getting fired, financial stock is swooning, new owners (China and Abu Dhabi) are buying stakes in our banks, investors will not longer buy any securities backed by mortgage loans -- the correction is already in place.  We do not need new legislation.  Prosecutions should sue those it can find who lied to people and plaintiff attorneys should be class actions against banks that did not disclose problems with internal control fast enough.  The system is working the way it is.

This is another classic case of government overcorrection, fueled by bleeding-heart columnists.   

Income Inequality

The new CBO report on IRS data from 2005 shows that the richest 5% had the largest percentage gain in income from 2000 levels.  It also shows that all levels gained to some degree.  What we are unhappy about is the percentage gain was not spread out more evenly.  First, we should be delighted that all levels gained. We take this for granted.  It may be that it is more likely than not that all levels gain if the top gains rather than the reverse.  Second, the top levels pain a higher percentage of total tax.  The richest 1% pay 39% of all income taxes (a gain of 2% since 2000); the richest 5% pay 60% of all income tax (a gain of 4% since 2000); the richest 10% paid 70% of all income taxes.  It is hard to imagine a more progressive tax system than we have already.

The Home Foreclosure Mess

The top three states in home foreclosures are California, Florida and Ohio.  In California and Florida there was a spike in real estate values that attracted speculators, many of whom were flippers.  The speculators who took risks and lost do not deserve much sympathy.  In Ohio, however, the housing market did not show substantial price spikes.  The situation is very different.  Those losing their homes were cause by rising unemployment rates in their income sectors and by the false hope (lured by low teaser initial rates) that many in the lower income sectors could afford homes that were beyond their means.  Should government money bail them out? Should the government force "renegotiation of rates" (should SIV trustees be prohibited from foreclosing)? The argument is more complicated.  One has to balance long-term injury to the home lending market (caused by disabling execution on loan; loans with be more expensive in the future and less available to lower income earners) with short-term relief for those who are facing the lose of their homes.  The moral questions are much tougher.  Since the government, if empowered will probably make a mess of things, I would let the market clear on its own.   

Ohio Court Stops Foreclosures by SIVs

A federal judge in Ohio, Judge Boyko in Cleveland, asked a straightforward question of Deutsche Bank National Trust Company, a trustee for securitization pools of mortgage backed securities.  The bank was attempting to foreclose on 14 homes in Ohio. "Prove that you own the loan and the mortgage."  he asked.  The Bank could not.  The legal papers had not kept up with the multiple assignments that created the securitization pools.  This is a new and serious wrinkle for the already hammered SIVs who have pooled subprime mortgages and sold securities in the pools to others.  The default rates on the mortgages are up and the value of the securities is, corresponding, down, causing major banks, who had purchased the securities to take massive write-downs.  Now the potential defaults will be augmented by the possibility that the SIVs cannot  execute on the homes.  Loans that were worth 40% to 60% of their face value (due to the underlying collateral, the home) are suddenly worth nothing, nadda, zero.  The write downs will get bigger unless the lawyers can figure out how to find the appropriate legal documents that demonstrate ownership. 

GM 3rd Quarter Loss

General Motors reported a third quarter loss of $39 billion dollars. GM attributed the loss to a $38.6 billion non-cash charge largely related to the write-off of accumulated deferred tax credits. The loss is the second largest quarterly corporate deficit in the history of the United States. According to Standard and Poor’s, the largest quarterly deficit belongs to AOL, who wrote down $45.5 billion following its troubled merger with Time Warner in 2002.   The reported loss is larger than GM's total market capitilization.  Those who admire unions might ask themselves whether any unionized industry in the United States is doing well at the moment. A serious question for management is whether the shareholders would be better off if the company were liquidated and the cash reserves just distributed to shareholders in a liquidation dividend.

Credit Suisse Case on the IPO Market

The Supreme Court held In Credit Suisse Securities v Billing, consistent with its past history, that securities laws cede jurisdiction over market structure of the securities markets to the SEC, pre-empting the federal antitrust laws.  The ruling was not a surprise.  I agree with the holding but not he SEC use of its power; the SEC has favored antifraud enforcement over competitive concerns and, in my view, overly micro-structured the securities markets to limit otherwise healthy competition.  Justice Stevens concurring opinion reminds me that judges, when they step out from making jurisdictional decisions and decide to comment on market forces, are often, well, just out of their league.  Justice Stevens pronouncement that underwriting syndicates cannot fix prices and the suggestion that they can is "frivolous" is a laugher.  The market for underwriting has very few players (there are five or six large investment banks) and underwriting fees for stock are an amazingly stable 7% across time, across types of companies, across size of offerings.  To say that the few underwriters, participating in each others offerings, have informally or formally colluded to fix a 7% rate is not frivolous; it is plausible, even probable.  Then there is the "underpricing problem."  Watch the Blackstone IPO on its first day.  Why do American IPOs average, 15% or more underpricing on the first day?  There are competing theories, some are market based and some are not (they are based on the market power of investment banks).  Stevens is way out of his league in his pronouncements in his concurrence and he was sanctimonious in tone when he wrote them.  Why make such statements without an adequate record or investigation?  Put on the robe and some judges get instant smarts.       

The SEC and Global Uniformity

I am consistently buffaloed by the SEC's strategy on global integration of our legal standards.  We are told by the SEC that the Sarbanes Oxley Act of 2002 will put American markets ahead of other markets, give us a competitive advantage, because our markets will have more integrity due to stronger rules against fraud. Then, in the next breath, we are told that we will accept international accounting rules rather than use our own so we can integrate with the global disclosure standards.  Should not, using the SEC's logic on SOX, our rules be better or stronger??  Accounting rules are at the core of the disclosure system; if we brag about having the best regulatory system to differential ourselves from other world markets should not our accounting rules be unique and better.  Pick a strategy or explain why SOX (on accounting rules, by the way) is different than FASBs (v IFRA). 

"The [Public] Corporation Will Disappear"

Holman W. Jenkins, Jr., of the Wall Street Journal quote Nobel laureate Myron Scholes in the Weekend edition that "the [public] corporation will disappear."  His point:  the move from public markets in favor of private equity markets is caused by risk management contracts (derivatives) competing with equity.  He also notes the impact of regulation has affecting the trend.  His point only makes sense if one does not "look through" investors.  A public corporation has over 500 shareholders (300 on the way out).  We are calling corporations private is they have less than 300 shareholders even if each of those shareholders is itself a pool of multiple investors.  If we "looked through" the funds and counted individual investors, the 300 shareholder limit would be shaky for many newly converted "private companies."  In other words, his argument does not rest on risk management as much as it rests on a legal rule that does not permit "look through" judgments.  [ Recall the ill fated hedge funds rules which do use "look throughs"]  It suggests to me that an old, old standard, the 300 shareholder rule should be reconsidered and SEC regulation (for IPOs and for periodic reporting requirements, including Section 404 of SOX ) should scaled with the total capitalization of the firm.  This is the primary request of the Small Business Advisory Committee that reported to the SEC last year.  The SEC rejected the request out of hand; it should look at the scaling regulation question again. 

Westar Energy Convictions Reversed

The criminal convictions of Wittig and Lake, convicted of looting Wester Energy of Topeka, were reversed by the tenth circuit.  The opinion joins the list of other several circuit court opinions that have reversed convictions in major trials over financial scandals that were disclosed in 2002.  Here is the pattern. Prosecutors discover widespread financial fraud can be very technical -- so they pick what they see as a clean, focused instance of abuse.  At trial, the prosecutors cannot resist attempting to throw in all the bad conduct, most of it irrelevant to the specific charge, and they find that the charge they have chosen, in the heat of the moment, is itself a very technical claim.  In the Witting and Lake case they chose to feature the executives personal use of company aircraft.  The prosecutors came to realize late, apparently, that there is an SEC rule on the issue and the defendants may not have violated the rule.  It makes sense to choose a specific part of the fraud to try but -- prosecutors must choose, as the saying goes, wisel and then stick to the strategy, try the case narrowly to match the claim

Judge Kaplan and the KPMG case

The Wall Street Journal editorial page today called the KPMG tax fraud case in New York a "fiasco" and suggested that the Justice Department "reconsider" the case at its "senior levels."  The behavior of the Justice Department attorneys has been less than exemplary but there is another problem here.  We are watching a Judge over control a complex case.  And there is no normal relief for this until an appeal.  Kaplan has written a scathing opinion in June over the government's use of the Thompson Memo.  Judge's should rarely write "scathing" opinions; this should be reserved for a once in a decade case.  A Judge has the awsome power to decide the fate of the people before her; she rarely needs angry words -- a decision is enough. The Judge does not like the policy of the memo (I do not either) but wrote a nutty legal analysis about its unconstitutionality.  The Judge continues to "exchange barbs" with prosecutors.  Judges should not "exchange barbs" with anyone (again, perhaps, with a one in a decade exception).  Now the Judge has delayed trial, trial Judges should normally do the opposite and facilitate and push for a speedy trial on the merits, except in very unusual circumstances.  This case is not that unusual .  A Texas judge has ruled on the merits that the KPMG tax shelters are legal; a speedy trial may even benefit the defendants here.

I suspect that the Wall Street Journal may get its way and the Justice Department will drop the case.  The Judge's decisions and conduct will not get reviewed.  Indeed, it may be vindicated.  Pity.

Federal district court judges are an admirable bunch, but a few, a very few, are not.  They sit alone in important cases and can, with self-righteous sanctimony, lose patience and focus.  I have been there and seen it.  I have not been in this courtroom to watch this case and therefore cannot say.  From long distance ... 

Kerkorian and GM

The push by Kerkorian to join GM with Nissan and Renault is the subject of much speculation on whether it will work and whether the GM board will buy it.  Kerkorian's motives have also been dissected.  See Paul Ingrassia, Kerkorian Motors, WST today (Kerkorian wants new managers and likes Ghosn of Nissan).  Many are missing the boat.  GM's problem is an operating deficient caused by overpaying its workers, masking by a stash of cash.  The company must wait for the cash to run out, sucked away by operating losses, before it can restructure in bankruptcy.  An alternative is a merger.  The GM shareholders, Kerkorian included, can use the merger to take cash out of the company and the new owners can restructure.  It is a brilliant use of a well known acquisitions strategy. The GM board should go along. 

Not for Profit Troubles

Not for Profit Corporations (or nonprofit corporations) have been repeatedly in the news recently for scams.  Some are overpaying their CEOs (NYSE), some are making political contributions (churches), some are not doing what they promised in exchange for their status (hospitals that do not treat the indigent), and some are in illegal tying arrangements with for profit business (home down payment charities).  Without oversight by private owners, we must rely on the IRS and state attorney generals for regulation of not for profits.  Charities are not high on their list of concerns.  Abuse is the inevitable consequence. 

Mr. Ellison... Where's our money??

Posted by Jason R. Job

That's what Harvard is saying to Oracle Corp. founder, Larry Ellison.  According to Sarah Duxbury at the San Francisco Business Times, Mr. Ellison has failed to pay any of the $115 million pledge to Harvard to create The Ellison Institute for World Health. (See link here).  According to the article, Ellison's pledge would have been the largest single give in Harvard's history.

Additionally, Ellison still owes the $100 million that he was ordered to pay to charity as a part of a settlement which he proposed back in September and was approved in November.  (See Prof. Oesterle's discussion of the settlement in his related post Ellison Settlement Questions).

Having worked a bit with the Ohio State Foundation when I was in school, I am sure that many parties are working long and hard to obtain Mr. Ellison's pledge.  However, more importantly, this story will become a PR nightmare for both Oracle Corp. and Mr. Ellison.

Wal-Mart

Wal-Mart is the world’s biggest company by sales.  Its sales for fiscal year 2005 were over $312.4 billion.  Wal-Mart now has over 3,800 stores nationwide. In America there are more Wal-Mart employees (1.3 million) than high school teachers.   

The company’s competitive advantage is its sheer efficiency – it is a superbly run organization that sells products for less than anybody else can. 

Why is such a successful company, an employer of millions, so controversial?

    Several communities have voted to keep Wal-Mart stores out on the grounds that the stores destroy local shopkeepers.  Others claim that Wal-Mart pays parsimonious wages. The State of Maryland has passed legislation, aimed at specifically at Wal-Mart, that requires large, non-unionized retailers to spend a minimum amount on health-care benefits.  Banks are fighting Wal-Mart’s request to offer its own, inexpensive personal credit card.

The rhetoric gets heated. In the language of the street, Wal-Mart is a “modern day plantation” paying “slave wages.”

The “Wal-Mart effect” is the subject of three new books and a documentary film.  Two of the books and the film are harshly critical.  The title of the book by Anthony Bianco, The Bully of Bentonville: How the High Cost of Wal-Mart’s Everyday Low Prices is Hurting American, sets the tone of the criticism.  There is a high social cost to Wal-Mart’s low prices.   

Behind the charges, data is scarce.  Here is what we know to date.  A typical Wal-Mart store employs 150 to 350 people; the bigger “superstores”, which also sell groceries, employ 400 to 500.  The arrival of a store in a typical county destroys 180 to 270 retail jobs over what it employs.  A Wal-Mart associate does the job of 1.5 to 1.75 people at any rival. 

Yet a Wal-Mart attracts new retailers that take advantage of the increased customer traffic and the new retailers create new jobs.  The retailers set up across the street and put out “workers needed” signs.  Estimates of the average new job creation around a single new Wal-Mart store exceed the number of jobs destroyed by the store by close to 100.  In other words, there is a net gain in jobs, not a net loss.

Do Wal-Mart’s pay “slave wages”? A new study by David Neusmark and co-authors (Public Policy Institute of California) estimates that a Wal-Mart store reduces per worker retail wages by only about 1 percent. 

On the positive side, what Wal-Mart saves in efficiency, lower payrolls, it passes on to consumers in prices.  A Wal-Mart store in the area slashes one’s shopping bills, even if a shopper never shops there. 

Emek Basker, an economist, estimates that the price of goods such as toothpaste, shampoo, aspirin and laundry detergent fall by 7 to 13 percent in the five years after Wal-Mart’s arrival in a city.  The Economist, the world’s best news magazine, reports that superstores return 25 cents back for every dollar spent on groceries, a average savings of $450 a year for a family.  The numbers on other merchandise, clothing, are larger still. 

The numbers will not silence the critics.  They know consumers save at Wal-Mart and the total employment and wage numbers will not satisfy. 

Wal-Mart is a lightning rod for a diverse body of social critics.  Some are suspicious of the deeply religious, white Protestant culture of the company’s leadership.  Others dislike capitalism, the profit motive, and the regimen of financial efficiency.  Yet others fear size or the “not from around here” nature of the business.  There is an odd “do they really care about us” uneasiness about a business designed to give costumers’ exactly what they want at the lowest price.

Wal-Mart’s success has inevitably attracted social critics of American culture and economic system.  Wal-Mart is best, the most successful, at prospering in this system and therefore the most obvious target.  Wal-Mart will find no relief from such critics – until a better retailer comes along.