State-Controlled Capitalism, New York Edition

New York may well be the business capital of the world.  While most of the other original U.S. states began their existence as religious colonies of one sect or another, New York/Amsterdam was a trading center from day one and today stands as the premier world marketplace in finance and many other areas of business.  And yet we overwhelmingly elect politicians who have no comprehension whatsoever of how this works.  Our City also serves as the home to dozens of media outlets that define themselves by incessant bashing of our wealth-generation as somehow evil and immoral.

So, instead of relying on the free-wheeling capitalism that has made us so hugely successful, how about trying some of the state-controlled capital allocation that has done so well by places like Russia, Venezuela, Iran, and Argentina?  There have been multiple examples of that in New York over the last several days.

On Wednesday a state entity called the Gaming Facility Location Board recommended approval of three large new Las Vegas-style casinos in upstate New York.  Here is the report on the approvals from the New York Times.   The three approved locations are: one in relatively remote Sullivan County in the Catskills region (actually next to what once was the famous Concord Hotel); one in the Albany area; and one in the northern Finger Lakes between Syracuse and Rochester.

Now you are undoubtedly asking, why does this require a state "facility location board"?  Why doesn't anyone who wants to open a casino just open one wherever he wants, as we do with, say, laundromats or card stores?  That's a long story that has a lot to do with the unsavory coalition of Baptists and bootleggers, but suffice it to say that once casinos initially got banned, the process of handing out exceptions offers way too many opportunities for graft for the politicians ever to let go.  And thus we have come to a situation where to build a casino you must spend years making the right political contributions and cultivating the pols.  And the investment capital goes where the pols direct it to go and when they direct it to go there.  So after a process of consideration that has extended over decades, we now are getting these three casinos granted to the politically favored.

The timing of these casino approvals couldn't be more ridiculous.  Have they even noticed that Atlantic City is imploding right now before our very eyes?  This research report from UNLV (the Nevadans are rubbing it in!) shows Atlantic City gaming revenues off about 45% since a peak in 2007.   Casinos there are closing left and right.  The same New York Post today that has an op-ed by Bob McManus commenting on the ridiculous New York casino approval also has a news article in the business section reporting on the latest in the "Perils of Pauline" tale of the bankrupt Taj Mahal casino, second largest in Atlantic City, just (maybe? temporarily?) rescued from closure through an investment by Carl Icahn.

Casinos were supposed to be the salvation that would rescue Atlantic City from poverty.  The first casino opened in 1978.  Thirty-six years later, Atlantic City is a one-industry town with the industry collapsing -- remind anyone of Russia?  And it's still poor.  But don't worry, in upstate New York, casinos built by political favor and at political direction are going to bring you economic development!  Here's my favorite line from the Times article reporting on the Location Board approvals:

[The GFLB] rejected six applications in Orange County, the region closest to New York City, in favor of a single resort in neighboring Sullivan County, to the north, citing the need for economic development.     

Got that?  We won't allow these things where they might actually succeed, and instead we're going to duplicate the Atlantic City model of forcing them into economic backwaters because "economic development."

Meanwhile, the economic decline of upstate New York continues, and the experience of Atlantic City (and state-controlled capitalism in general), combined with the high taxes imposed by the City-and-suburban-centric political culture make it highly likely that the decline will continue.  The population declines in upstate New York, and particularly in the triangle defined by these three new casino locations, are really stunning.  Syracuse has declined from a peak of 221,000 people in 1950 to 145,000 (35%); Utica from a peak of 102,000 in 1930 to 62,000 (39%); and Binghamton from a peak of 81,000 in 1950 to 47,000 (41%).  The last person to leave should turn out the lights.

But there is another industry that very much wants to come into this area and create lots of jobs and wealth.  That, of course, would be the industry of "fracking" natural gas out of the shale formation that extends under most of New York's so-called southern tier.  This industry would require no government effort at all -- all the government needs to do is get out of the way and let it happen.  Oh, yesterday our Governor permanently banned it.  A permanent ban on investment in an industry is another example of state-controlled capitalism.  Sorry, upstate New York, but you'll just have to take your chances on the casinos. 


The Curse Of State-Controlled Capitalism

Actually, let's start with the blessing of not having state-controlled capitalism.  Here in the U.S. our free-market economic system erodes little by little with the ongoing expansion of government micromanagement, but we still have the basics in place.   And thus when the price of a major commodity like oil suddenly falls by about half -- as it has over the course of about the past four months -- this is actually a net positive for the economy and very likely for the stock market as well.  Granted, it's not so great if you're an upstream producer of oil who just sank millions of dollars into drilling a few wells and now you're only going to get about half the revenue you expected.  But the smart drillers sold much or all of their output long ago in the derivative markets, at prices that locked in profitability, and they won't be hurt much at all.  Lots of other entities in other parts of the oil business -- like refiners, shippers, and retailers -- don't really care much whether oil prices are high or low.   And throughout the rest of the economy, lower oil prices mean lower costs of energy inputs and therefore increased profitability and/or lower final prices.  Consumers get cheaper gasoline, cheaper electricity, cheaper heating fuel, cheaper everything that has energy as an input -- and that's pretty much everything.  What's not to like?  A few incautious upstream oil producers will likely go bankrupt.  Hey, that's capitalism!

Over in Russia, things don't work quite the same way.  There, if you are an ambitious young risk-taker, don't think that you can just go out buying up oil rights and drilling some wells.  These things are the privileges of the big companies, who need the patronage of the big kahuna to keep away from government predation.  So you can be big in the oil and gas industry if you are Rosneft (69.5% owned by the Russian state) or Gazprom (50.23% owned by the Russian state).  Or you can try being a fully private company like Yukos, by having your chief (Khodorkovsky) be a well-connected ex-member of the Communist Youth League.  But that's only good enough until the day he crosses Putin.  In case you didn't keep track of the story or don't remember, Khodorkovsky, up until then the richest man in Russia through being CEO and part owner of Yukos, was arrested in 2003, charged with fraud, convicted, and then spent 8 years in jail through 2013.  Meanwhile, Yukos was charged with tax crimes and was broken up by the government.  Just a few months ago the former owners of Yukos won an arbitration award of $50 billion against the Russian government.  The basis for the decision was that the alleged tax crimes were not real and the whole government prosecution was just a disguised uncompensated taking.  Good luck collecting on that award!  There are other nominally private oil and gas companies in Russia, but you'd better believe they have learned their lesson about staying on the right side of the big guy.

Anyway, with government functionaries in Russia directing the allocation of capital either overtly or behind the scenes, Russia has done what seemed like the obvious thing of getting deeper and deeper into oil and gas as the sole driver of their economy.  The economy is remarkably undiversified.  According to Bloomberg News here, the oil and gas sector accounts for about 25% of GDP (in the U.S., it's 2.5%),  and for about 50% of government revenues.  On the pure business side, it has seemed like easy printing of money.  On the geopolitical side, it can be loads of fun periodically to use your oil or gas weapon to put the squeeze on a Ukraine or even a Germany.

It all seemed to be working brilliantly until the price of oil suddenly dropped by half.  Now what?  It's not just that GDP is taking a sharp hit.  The biggest immediate problem is that the ruble is collapsing.  The Wall Street Journal reports this morning that the ruble fell a full 20% just yesterday, even after the large declines of the past several months.  The people have cleaned the banks out of all foreign currency.  And it'll be a while before we even learn of the effects on Russia's budget, which can't be pretty.

And it's not just Russia, not by a long shot.  Wouldn't you think that the United States would understand what makes its own economy a success, and after spending hundreds of billions of dollars to liberate and stabilize a country, would at least take the trouble of establishing a real capitalist economy?  Well, Iraq is about as bad a case of state-controlled capitalism as exists.  Of course, this is another country totally dominated by the oil and gas sector, in fact even more so than Russia.  And essentially all of it is government-owned.  And the same state control extends into much of the rest of the economy.  Here are some quotes from a three-year-old article from Megan McArdle.  I can't find newer numbers, but I have no reason to think that things have changed much:

Half of the labor force works for the national government, either directly or indirectly, and another 20 percent or so is unemployed. “Iraqis believe that the only real job is a government job,” [Lehigh University Professor Frank] Gunter says. It “pays more, has benefits, you can’t be fired, and the work intensity is lower than in the private sector.” Gunter estimates that if the price of oil falls below $40 a barrel, the government is in serious trouble: below that price, it will not have enough revenue to pay salaries and pensions, even if no services are provided at all.     

And you could really go on all day listing the countries getting terribly burned by going the route of state-controlled capitalism:  Iran, Venezuela, Argentina . . . .  Quite a collection of rogues!  It's really hard to feel too sorry for them.  Oh, and did I mention that the U.S. has recently gone into state-controlled capitalism in the health care sector?


Looks Like Bharara Will Definitely Not Do The Right Thing

In my post Wednesday I asked whether SDNY U.S. Attorney Preet Bharara would now "do the right thing" with respect to the dozens of innocent people out of whom he has improperly coerced guilty pleas in his multi-year jihad against non-insider insider trading.  Well, it only took Bharara a few hours to put out his own statement telling the world that doing the right thing is just not part of his make-up.  Since the statement is short, I'll quote the whole thing:

Today’s decision by the Court of Appeals interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information. The decision affects only a subset of our recent cases, and in those cases – as in all our criminal cases – we investigated and prosecuted misconduct based on our good faith assessment and understanding of the facts and the law that existed at the time. We are still assessing the Court’s decision, which appears in our view to narrow what has constituted illegal insider trading, and are considering our options for further appellate review.

Wow -- Don't they realize that they are dealing with the criminal law and that peoples' lives are at stake?  They have put legitimate companies out of business, put hundreds of people out of jobs, conducted midnight FBI raids over conduct that we now know was wholly legal all along, put dozens of honest hard-working people who committed no crime in jail, forced the expenditure of hundreds of millions if not billions of dollars to defend against their prosecutions, seized billions of dollars of fines and forfeitures without legal basis, and all they now have to say is they are "considering [their] options for further appellate review"?  Well, I predict that their appeal is going nowhere in the Supreme Court, but meanwhile they are keeping these innocent people in limbo for another year while we wait for the denial of cert and they work on landing their next job.

I find it amazing how long this travesty has continued.  As Charles Gasparino points out in this morning's New York Post, there never was any theory under which this non-insider insider trading had anything to do with causing the recent financial crisis.  But in our prosecutors' thirst to produce scapegoats, somehow we have without thinking completely lost track of the principle that you can't be sent to jail for a federal crime unless you violate a statute passed by both houses of Congress and signed by the President and that clearly prohibits what you did.

And thus we have endless amounts written about this non-insider "insider" trading program by people who refuse to acknowledge this fundamental issue.  Start with the headline in the New York Times yesterday in their front-page article about the Second Circuit reversal:  "Appeals Court Deals Setback to Crackdown on Insider Trading."  Just no.  This is not about a crackdown on insider trading, but rather about a crackdown on trading by non-insiders that the feds would like to make illegal without statutory basis because they think they can get a jury angry that somebody made too much money.  Or consider former AUSA Patrick Cotter quoted by CNBC:

"The stunning decision ... has the potential to rewrite the book on insider trading, while also dealing a body blow" to Justice Department and the Securities and Exchange Commission efforts, former assistant U.S. attorney Patrick Cotter said in a statement to CNBC.

Well, isn't dealing a "body blow" to government lawlessness the whole reason we have courts?

I haven't seen any article give a short clear statement of the law on this subject, and the Second Circuit's opinion itself really makes the whole thing seem far more complicated than it actually is.  So for those who want to understand the basics, I'm going to tell you what you need to know about the application of insider trading law to non-insiders in the next fourteen sentences:

The underlying common law of fraud in the United States in general applies to false statements and not to omissions.  That is, if you say nothing to your counterparty in a business transaction, you have not committed fraud, even if you know something important that your counterparty does not know; sometimes this is phrased as there being no "general duty to speak" to your counterparty. There are some exceptions, but very limited.  The federal securities laws then have their own obligations, which do include a general duty to speak, which applies to the issuer of the securities.  In the massive text of the federal securities laws, going on for mind-numbing hundreds of pages, you will not find anything about a general duty to speak applying to those other than the issuer, including those who trade in the security.  Corporate insiders of issuers, who could include officers and directors at the top end down to the lowliest messenger or clerk, are then their own special case.  While there could well be exceptions, assume for these purposes that insiders of the corporate issuer are subject to the issuer's general duty to speak.  But now consider non-insiders, such as investment professionals who do not work for the company: the statutes do not mention anything specific about a duty to speak by such people.   And yet the government criminally prosecutes dozens of them for trading without first disclosing everything they know to the marketplace.  How?  The entire basis for criminal prosecutions, out of all the hundreds of pages of statutes, consists of the following in Section 10(b) of the Securities Exchange Act of 1934:

It shall be unlawful for any person . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance . . . .

Can you find a general duty to speak in there when it does not exist anywhere else in our common law or in our normal understanding of the words "manipulative or deceptive device or contrivance"?   We're talking here about criminal law, where people who violate it go to jail.  The fact is, it's not there, and certainly not in a form specific enough to give anybody reasonable notice of what is and is not legal.

The government starts with a position that if you bribe a corporate insider -- hand over a bag of money -- for information on which to trade, you thereby become subject to his and the corporation's duty to speak, and thus can be prosecuted for insider trading.  My view is that this position  is wrong:  this being a criminal law, if Congress wants to prohibit such conduct, they need to say so specifically.  It's not that hard to do.  If I were on the Second Circuit, the government would lose on the bag of money non-insider insider trading prosecution.  But actually, the Second Circuit has specifically bought into that one.  You can look at the statutory text above and form your own opinion as to whether the government's position on the "bag of money" case is reasonable.  You don't need to be some kind of fancy lawyer to form an opinion on this.  There is nothing about it any more complicated than the statutory text quoted above and the underlying fact that there is no "general duty to speak" in our society, certainly not in a criminal context,  unless a statute specifically imposes it on you.

And anyway, in Newman/Chiasson and many others of the current round of non-insider insider trading cases, we are way, way past the bag of money.  In fact the government's position is effectively that if you know anything sourced from an insider of the company and you make too much money trading, you are going to jail.  They have even phrased their position as being that "friendship" alone constitutes a sufficient "quid pro quo" to make any trader take on the issuer's duty of disclosure.  Is it "friendship" if you once had dinner with the guy, or if you talked to him one time before this time?  Suppose (like Newman and Chiasson) you don't even know the insider who provided the information or anything about the relationship between him and the guy he first gave the information to?  Too bad, you're guilty too.  And now we have thousands of Wall Street professionals who make what they think is an honest living casting about among friends and acquaintances for tidbits of information and tips, with no way to know or find out about the circumstances by which the information was first obtained, and the government's position is, if you made enough money it's a crime if we want it to be.

We find then on the website of Cornell Law School the following statement of the current state of the law on insider trading:

Because friends do not satisfy the definition of an insider, a problem arose regarding how to prosecute these individuals.  Today, a friend who receives such a tip becomes imputed with the same duty as the insider.  In other words, a friend must not make a trade based upon that privileged information.  Failure to abide by the duty constitutes insider trading and creates grounds for prosecution.        

Well, that was never more than the government's phony position and was completely wrong, and as of two days ago the Second Circuit has told us why.  (Cornell has not yet taken its statement down.)  Shame on them for unquestioningly buying into the government's outrageous position without taking a critical look at whether there was any basis for it in the underlying statutes.

Even the Second Circuit in my view does not go far enough.  The Second Circuit opinion says that non-insider insider trading liability will now be limited to situations where the corporate insider received "something of consequence" in return for the information.  Well, what is that?  Forgive me for being soft on Wall Street, but I think that people trying to earn an honest living are entitled to fair notice of what conduct is criminal and what is not.  And that fair notice cannot be something made up by a prosecutor's or regulator's whim, but must get through majorities of two houses of Congress and a signature by the President.  Is that so complicated?  This "something of consequence" standard still gives the government plenty of room for abusive conduct, and we have no reason to believe that the current crop of people occupying the prosecutors' offices will not abuse every bit of power that they are given.










OK Mr. Bharara, Will You Now Do The Right Thing?

Back in July, in a post titled "The Impending Demise Of The Insider Trading Jihad," I predicted that the convictions of Messrs. Newman and Chiasson for alleged insider trading in the stock of Dell and NVIDIA would be reversed by the Second Circuit.  It took a while, but several hours ago, that occurred.  Here is the unanimous decision.

This decision completely undermines the basis on which literally dozens of financial professionals have been wrongly convicted of non-crimes and had their lives ruined by the overreaching prosecutors of the Southern District of New York, led by one Preet Bharara.   Find yourself the subject of one of these prosecutions and first you get fired from your job; then you face unbelievably huge legal fees that start at about $5 million and can go as high as $20 million, which your former employer may or may not pay (with the government constantly putting on the pressure not to pay); and on conviction you get sentenced to something like 54 months in jail (Newman) or 78 months (Chiasson), and fined another million dollars (Newman) or five (Chiasson), and then hit with "forfeitures" of another almost million (Newman) or two (Chiasson).  And you did absolutely nothing wrong.

Among the cognoscenti, the betting for a long time has been that the Second Circuit would reverse these convictions, but it was not known exactly how they would reverse.   For example, if the court of appeals finds what it believes is a relatively minor defect in the jury instructions, it can direct that the jury instructions be changed and send the case back to the district court, where the prosecutors can proceed to re-try the case with the new instructions.   Well, not this one.  Here the court of appeals also found that the prosecutors "failed to present sufficient evidence" to get to a jury at all, and they remanded "with instructions to dismiss the indictment as it pertains to [Newman and Chiasson] with prejudice."  Ouch!

How could the prosecutors have gone so badly off the rails?  The broad answer is that the prosecutors in our current regime believe that the job of ferreting out information and then making money by trading on that information in the financial markets is wrong, and if you make too much money doing it they will put you in jail whether they have a statute to back them up or not.  The particular subject of this "insider trading" prosecution was what the court of appeals calls "remote tippees," that is, people who were not corporate insiders at all but rather financial professionals who make a living by trolling around in the marketplace for tidbits of information on which to trade.  Here the tidbits of information originally came from corporate insiders, but the defendants were several levels removed from the insiders, had not compensated the insiders in any way, and knew nothing about whether the insiders had been compensated or not.  And in fact, the insiders had not been compensated at all, although the government had a theory, appropriately ridiculed by the court of appeals, that there was "compensation" in the form of sharing information about possible job openings, or something like that.

Here are some key quotes of the court of appeals very appropriately putting the government in its place:

The Government’s overreliance on our prior dicta merely highlights the doctrinal novelty of its recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders. . . .   [W]e find no support for the Government’s contention that knowledge of a breach of the duty of confidentiality without  knowledge of the  personal benefit is sufficient to impose criminal liability.  Although the Government might like  the law to be different, nothing in the law requires a symmetry of information in the nation’s  securities markets.

So let's tote up where the government's so-called insider trading jihad stands today.  Just a few months ago when I wrote my prior post in July, the SDNY was claiming a string of 85 straight "insider" trading convictions, a large number of them, as the court of appeals notes, not involving insiders at all, but rather these "remote tippees."   Oh, and approximately 79 of the government's 85 convictions were guilty pleas, while only approximately 6 were convictions after trial.  The July post was inspired by the first loss after this string, in the prosecution of Rengan Rajaratnam, another "remote tippee."  That prosecution crumbled when the district judge refused to buy the government's remote tippee theory, dismissed two counts, let the third go to the jury on a jury instruction unfavorable to the government, and the jury promptly completed the acquittal.  That put the government at 1 acquittal and 6 convictions at trial.  With today's reversal that record goes to 3 and 4.  Oh wait, another on the convicted-at-trial list is a guy named Steinberg who is an even more remote tippee in the same information chain as Newman and Chiasson.  His conviction is finished.  That makes it 4 acquittals to 3 convictions.

And how about those 79 guilty pleas, Preet?  How many of those are remote tippees who did nothing wrong under the law?  How many completely innocent people have you had frog-marched into court and forced to falsely admit guilt and feign contrition in order to avoid 5 year (or more) prison terms and $5 million fines and another $5 million of legal fees, while you get yourself some big headlines in the paper as the "sheriff of Wall Street"?  Are you now going to do the right thing for these people?  I for one am not counting on it.    




Response To Comments On "Letter To A Manhattan Resident"

A post I wrote a couple of weeks ago titled "Letter To A Manhattan Resident" has drawn a large number of comments (more than 50 to date), most of them over at the City Journal website where the article was first posted.  Some of the comments raised points that I thought deserved a response, so here goes.

Several commenters somehow came away with the impression that I was describing a New York in "shambles" where the people are miserable.  For example, here is Ed Johnson:

I get out often, and not many of them [New Yorkers] look miserable to me. Come, enjoy the smell of Pretzels roasting over live charcoal by Rockefeller Center while you look at the windows at Saks, Macy's and Lord and Taylor.  This image you've been sold of a NYC in shambles full of violent homeless and Liberals is, well, you know. A stupid lie.

Well, you won't find anything about New York being a "shambles" or the people miserable in the article he's commenting on, or for that matter elsewhere on this website.  Actually, over on my "About" page my summary of living in New York over the past 40 or so years is "All in all, it has been a great place to live and raise a family."  My criticism is not that things aren't pretty good,  particularly after 20 years of Republican mayors who did great work in bringing the City back from the brink.  Rather, my criticism is that it could be so much better.  We fall far below our potential, mostly due to the drag of way over-expensive progressive policies that completely fail to accomplish their stated goals of ameliorating poverty, income inequality, homelessness and the like.

On a closely related subject, a number of commenters point out what appears to them to be a contradiction between the obvious wealth in Manhattan and my contention that high taxes and expensive redistributionist policies are a drag on the economy.  For example, a commenter calling himself "I love NY" writes:

You point out that we live in the richest county in the country and that we have the highest taxes. By the simplistic logic your favorite news channel often employs does this not prove that high taxes are not a problem for wealth creation?

Another commenter named Nancy Groutsis collects some data on per capita GDP by state, grouped Red and Blue:

Gallup’s top red states (Utah, Wyoming, Idaho, North Dakota, Nebraska, Kansas, Alabama, Montana, Alaska) had an average state GDP of $43,738 which is less than the $48,843 per capita GDP of its top blue states (Hawaii, Maryland, Rhode Island, New York, Massachusetts, Connecticut, Vermont, Illinois, Delaware) (Real Per Capita Gross Domestic Product by State, University of New Mexico, 2013).

The fallacy here is looking at a snapshot rather than at rates of growth and change.  High taxes and overly-expensive government do not bring about economic devastation overnight.  As I have written many times, for example here, the consequence of high taxes and overly-expensive government is a slow, gradual decline relative to other areas that have lower taxes and less expensive government.  New York (state) does have higher GDP per capita today than most of the most-Red states (however, not Alaska, North Dakota or Wyoming), but the recent trend is that most of the Red states are growing solidly and some rapidly, while in New York the economy of the City is growing a little and the economy upstate is somewhere between stagnation and absolute decline.

Go back to the 1920s, and New York was enormously dominant in the national economy.  Check out this IRS publication of income data from 1920:  New York State represented about 17% of the national total.  Today it's down to about 7%.  Slow, gradual, relative decline.  Per capita taxable income in New York was about two and a half times that of Texas in the 1920 data, and at least 50% higher than even "rich" states of the time like Pennsylvania; today, we're hanging on to about a 15% edge in per capita GDP over Texas.  How much longer will that last?  The decade of the 1920s was before New York's taxes and spending got way out of line, and for a time its growth and economic dominance continued.  In just the ten years from 1920 to 1930, New York City's population grew from 5.6 million to 6.9 million, reaching about 5.7% of the entire population of the U.S., with over 23% growth in one decade.  But in the 1950s and 60s New York adopted the model of government spending as the solution to all human problems, to be financed by ever-accelerating taxes.  By the early 1970s combined New York State and City income taxes for the top bracket had reached about 19% -- and the City lost about 800,000 people, about 10% of its population, in the decade of the 70s.  Today, we've gotten the combined top state + city tax rate back to about 12%, and all of our neighboring states have helped our competitive position by adopting their own income taxes.  That plus 20 years of decreased crime and competent management in City Hall, and New York City's population has grown from about 8.0 million to 8.4 million since 2000, 5% growth in 14 years.  But our taxes are still the highest in the country, if not by so much, and the relative decline continues.  Our population of 8.4 million people is now only about 2.3% of national population, and low tax jurisdictions like Texas and Florida are far outgrowing us.  It is only a question of time until they overtake us in per capita income as well.

But don't get me wrong -- it can be a lot of fun hanging around in a decadent, very slow-growing, but very civilized place.  Can anybody say "Europe"?