Tuesday, April 24, 2007

California to Energy Producers: Not in Our State

Irvine, CA—After an intense four-year struggle, Australian energy company BHP Billiton's attempt to build a Liquefied Natural Gas facility off the coast of California has been effectively killed by the state's Lands Commission, which voted 2-1 that its "Environmental Impact Report" was unsatisfactory.

"When we in California experience our next energy crisis—or the next time we complain about our exorbitant gas and electric bills—we should remember the fate of BHP Billiton," said Alex Epstein, a junior fellow at the Ayn Rand Institute. "That company wanted to build a plant that could satisfy up to 15 percent of Californians' energy needs—a plant that did everything possible to maximize safety and minimize pollution. And what did it get in return? Nearly half a decade of obstruction from California's endless constellation of environmental bureaucracies—and seething opposition from environmental groups that oppose every single practical form of energy production, from coal to oil to gas to nuclear power. The message California sends to any would-be producers of plentiful energy is obvious: Not in Our State.

"California and many other states are riddled with laws based on environmentalist hostility toward industrial energy. These laws must be replaced with a respect for property rights and an appreciation for the incomparable value that is industrial energy. Fossil fuels and nuclear power are the lifeblood of our civilization; without them, the average American's food, clothing, shelter, and medical care would be impossible. And, contrary to claims that we must abandon fossil fuels to protect against alleged weather disasters caused by global warming, fossil fuels are vitally necessary to build the buildings and power the technologies that protect us from dangerous weather.

"The anti-industrial mentality of environmentalists must be rejected, in word and in law, by everyone who truly cares about human life."

Copyright © 2007 Ayn Rand® Institute. All rights reserved.


Galileo Blogs comments:

"NIMBY" which stands for "Not In My Back Yard" has entered the lexicon. In very few places do Americans want the industrial machines that power their houses and fuel their cars, that light up the Internet, that keep them warm in the winter, and cool in the summer. Americans want the consequences of capitalism, but not the means. Americans want all of the abundant, comforting, life enhancing things that capitalism makes, but none of the seemingly dirty, noisy, unsightly machines that do the making. I, for one, find an industrial plant beautiful. I salute its role in supplying me with the things that make my life modern and civilized.

Nevertheless, whether you find an industrial plant beautiful or not, you should have no political authority to tell an industrialist whether he should build it. It is his right; it is his property. Of course, by building the plant, the industrialist benefits our lives, whether we like it or not, whether we approved of it or not.

The California Land Commission and all such similar agencies should be abolished immediately. Our survival, our standard of living depends on it.

Monday, April 23, 2007

Ode to the City of the Chicago Spire

This is my ode to the city of the Chicago Spire. Chicago is the probable future home of the Chicago Spire, which will be the tallest building in the United States. It awaits a final approval vote from a Chicago zoning board.

Chicago deserves to get its new 2,000 foot high tower. The city already has some of the greatest skyscrapers in the world. It is the home of architect Louis Sullivan, the father of the skyscraper. Chicago's towers are tall, straight and proud.

I say this as a New Yorker. I love New York's buildings, but they are often hammered by bizarre zoning rules that force flattened pancake shapes on their structures. Many New Yorkers today dislike tall buildings; as a result they clamor for zoning laws that squeeze new buildings ever shorter. It is no wonder that our tallest building and my favorite, the Empire State Building, is over 75 years old. The taller World Trade Center, now gone, wasn't even built by a private developer, but by a state agency that had exempted itself from all of the zoning laws that private builders are forced to obey.

I exult that the new Chicago tower will be residential. Chicago builds gloriously tall residential structures, as a matter of course. It is easy and inexpensive to find rental or condo apartments that are 30, 40 or even 50 stories high, complete with pool on the roof! In New York, new residential towers that tall are almost non-existent. The oppressive height restrictions that afflict our city are especially stringent against tall residential buildings.

New York also suffers terribly from another affliction that Chicago does not have: rent control. Rent control has stunted the natural height of the city, and laid waste to square miles of land once teeming with private apartment buildings in the Bronx, Brooklyn, and upper Manhattan. Rent control makes apartments more scarce, so that the available apartments are far more expensive than they are, for example, in Chicago, which has no rent control!

Let Chicago build the tallest building in the United States. Let Chicago again inspire New York as it did in the days of Louis Sullivan. Let it inspire New York to stand up and build the world's tallest buildings as the world's greatest city should!

That's my ode to Chicago, sung by a New Yorker.

[Hat tip to Gus Van Horn's blog, where I posted a version of this as a comment to his post.]

Thursday, April 19, 2007

Becoming Involuntary Parents

Imagine a world with no abortion. Every time a couple has sex, they run the risk of involuntarily becoming parents. Their condom breaks, the woman forgot to take her birth control pill or, simply in the heat of passion, they have sex without using birth control -- all of these situations becomes fraught with risk. The risk is that the woman becomes pregnant and the couple, who may not want a child, is forced to become parents.

That is the world we are moving closer to with yesterday's Supreme Court decision upholding a federal law banning certain second trimester abortions. There is not even an exception for the health of the mother. Justice Kennedy, author of the majority 5-4 decision, contemptuously said that if a doctor is concerned about the health of his patient, he can simply violate the law and perform the illegal abortion anyway, and then challenge the law in court. He is acknowledging that his heinous decision can put the life of the mother in danger, and he suggests that a doctor simply risk jail in order to uphold the Hippocratic Oath and protect his patient.

This is the attitude of the man who defended the magnanimity of Congress in its wise decision to pass its anti-abortion law: "The government may use its voice and its regulatory authority to show its profound respect for the life within the woman." (source for quotes: New York Times)

Just whose life does he want to protect? Certainly not the woman's (and man's).

The anti-abortionists are clear about the meaning of this Supreme Court decision. As Dr. LeRoy H. Carhart, the Nebraska doctor who was the defendant in the case, stated, "those who support this law are trying to outlaw all abortions, one step at a time."

Justice Kennedy's comments and Dr. Carhart's astute observation make it clear. The ban on so-called "partial birth" abortions is really an effort to get abortion banned. The possibility that the religionists will be successful in achieving that goal is now much greater.

A world without joy is what the Christians want. Banning abortion is a step in that direction. The Republicans made this happen.

Tuesday, April 17, 2007

Hedge Fund Q&A

Hedge funds are regularly disparaged in the media. Mostly, this is simple envy of the wealthy. Mostly, it is based on misunderstandings about hedge funds. So, here are my answers to basic questions:

What is a hedge fund? A hedge fund is a private investment partnership. A group of people agree to hire an investment manager to invest their funds on a pooled basis. The agreement is private and it is voluntary.

How do hedge funds invest? Hedge funds invest in the manner specified in the contract agreed upon by the partners. There are as many ways of investing as there are private contracts between people.

How risky are hedge funds? All investments have the risk of loss. The degree of risk is determined by the particular investing strategy of the hedge fund manager, which is agreed upon by the partners. The agreement can specify what type of securities can be invested in, such as stocks, bonds, options and/or commodities. The agreement can specify whether the manager can invest in foreign securities, and to what degree. The agreement can specify whether the manager can use leverage (borrowed funds), and to what degree. It is entirely up to the partners and the manager to agree among themselves the limits on the investing strategy of the manager. The level of risk is agreed upon by the partners.

How are hedge fund managers paid? Managers are paid according to the agreement between the manager and the partners. Typically, a manager is paid an annual maintenance fee of 1% or 2%, and a percentage of the fund’s profits, which can range from 10% to as high as 50%. The fee is contractually set and can be anything that the partners and manager find to be mutually beneficial. One typical provision of a hedge fund contract is a “high water mark” provision. This provision means that a manager cannot be paid a percentage of the fund’s current profits until losses from prior periods are made up.

Are hedge funds regulated? Unfortunately, hedge funds are extensively regulated. Federal law states that only accredited investors are permitted to become hedge fund partners. That limit is currently being raised so that only investors with $2.5 million in liquid funds can invest in hedge funds. Someone with less money is legally forbidden from investing in hedge funds.

Hedge funds can accept no more than either 100 or 500 investors, depending on the applicable regulation.

Hedge funds are not permitted to advertise. They cannot publicly advertise their performance or explain their strategies. They cannot even have websites accessible to the public that explain their funds.

Other rules. Special rules prevent hedge funds from easily investing in both commodities and stocks in the same fund. Special tax rules make it impractical for foreigners to invest in domestic U.S. hedge funds, so hedge fund managers are forced to set up offshore funds for foreigners. Hedge fund managers are required to disclose their positions in securities periodically when those positions are sufficiently large. Hedge fund managers must set up as many as three legal entities in jurisdictions such as New York because of special taxes that target limited liability partnerships. Hedge fund managers cannot accept more than a certain amount of money from pensions and other retirement plans regulated by the federal government.

These are just a few of the rules hedge funds operate under. Hedge funds are private agreements between willing investors and the manager they hire to invest their funds. Nevertheless, they are highly regulated, and the regulations grow every day. Large legal and accounting costs must be borne by any hedge fund to comply with these changing and growing rules.

Are hedge funds less regulated than other business enterprises? How many business enterprises are legally forbidden to advertise? Even tobacco companies still have some legal advertising avenues open to them. Hedge funds cannot even legally advertise with a public website. How many businesses must legally turn away customers who aren’t wealthy enough? How many businesses must stop accepting customers when the number of customers reaches a legal limit? Hedge funds are more regulated than most other businesses.

Despite these rules, investors keep putting money into hedge funds. Globally, investment in hedge funds grew 30% last year to $2.1 trillion dollars under management, $1.4 trillion managed in the United States. This is a faster rate of growth than mutual funds and most other investment classes. Over 9,000 hedge funds operate in the United States today.

Why do investors keep putting their money into hedge funds? One reason is because the other investment alternative, mutual funds, faces different regulations that make them less attractive as investment vehicles for many investors. The differences affect the incentives that mutual fund managers face, and their freedom to invest. In both areas, mutual funds suffer disadvantages relative to hedge funds.

Incentives: Hedge fund investors can pay their manager in whatever manner they mutually agree upon. The method typically used, where the manager gets a percentage of the fund’s profits, provides an enormous incentive for the hedge fund manager to work hard and generate profits. Both he and the fund’s investors share in the fund’s profits proportionately.

Mutual funds are not allowed to pay their managers in the same manner. Under the Investment Company Act of 1940, which regulates mutual funds, mutual fund managers cannot be paid a straight percentage of the fund’s profits. That is why mutual fund managers are typically paid a salary plus a variable bonus that is more loosely connected to the fund’s profitability. A weakened connection to profitability means a weakened incentive to work hard to find profits. Mutual funds are also not allowed to have a “high water mark” provision where they agree to forgo their fee until a prior loss is made up. This also reduces their incentive to achieve profits.

Freedom to invest: Hedge fund managers have few legal limits on what they can invest in. Their limits are those agreed upon by the partners and the manager. A particularly important advantage is that hedge fund managers have the legal ability to take short positions in securities. A short position in a security is one where the investor makes money when the security price goes down, instead of up. Short positions are very advantageous when the stock market is declining, as it did for much of 2000, 2001 and 2002. Because of their ability to invest in short positions, hedge funds as a whole outperformed most other investment categories, such as mutual funds, during those years. If risk of loss is a concern, hedge funds as a whole were less risky than mutual funds during those years. Such a reduction in risk was possible because hedge funds could take short positions.

Mutual funds face regulations that make it very difficult to invest in short positions. Although those rules have been loosened recently, as a practical matter most mutual funds find they can only invest in long positions. Long positions go up in a rising market and decline in value in a falling market. Hedge funds can blunt the loss of value in a falling market through short positions; mutual funds are largely legally precluded from taking the same steps to protect the value of their portfolios.

Advantages of mutual funds. Mutual funds have some advantages that hedge funds do not have. The biggest are that they can legally advertise and they can accept money from anyone. There are also no limits on the number of investors they can have. So, their role in the financial world is assured. While only rich people (those with more than $2.5 million in liquid assets) are allowed to invest in “secretive” hedge funds (which are secretive largely because they are forbidden by law from discussing their performance), the so-called little guy can invest in mutual funds which he can study and learn about from advertisements, websites, etc.

There are other investment vehicles that are alternatives to hedge funds, such as exchange traded funds and closed-end funds. Each of them is a product of the peculiar regulations that govern it. Each has advantages and disadvantages, many of which are solely a consequence of differences in regulation.

Conclusion. In a world where everyone had the freedom to invest his money as he saw fit, without facing Depression-era rules designed to “help” the so-called little guy (but really just close off certain investment opportunities from him), there would be no legal distinction among investment pools. The distinction between hedge funds and mutual funds is a creature of regulation. To escape from the rules limiting mutual funds, hedge funds agreed to operate under a different set of rules that limit who they can accept as investors. By accepting one set of rules, they are freed from others, including those that limit investing in short securities, and how managers are paid.

Quite often, the history of financial innovation is a history of creatively finding ways around government edicts. The rise of the hedge fund industry is an example of that phenomenon. I look forward to the day when all those rules are repealed, when everyone’s inherent property right to contract with whom they please on whatever terms they choose is acknowledged in the law. When that happens, the creativity of investment managers, lawyers and accountants will be spent solely on developing the best investment vehicles for their willing clients, instead of having to destroy a portion of their time complying with the growing, changing and arbitrary rules emanating from Washington.

The larger issue is that all individuals can manage their own lives and should have complete freedom to do so. This includes the freedom to manage all aspects of their financial affairs. The only role for government is as protector of property rights. Governments exist to enforce the terms of contracts and punish those who commit fraud. The current hostility against hedge funds is of similar ilk as the hostility toward the “robber baron” industrialists of the late 1800s and early 1900s, and the junk bond and other financial innovators of the 1980s and 1990s. It is envy of the successful for being the successful, and resentment of the rich. The current hedge fund rules do nothing other than close off that investment vehicle from the masses, keeping them with their faces pressed to the glass looking in on a world that they enviously want and can’t have. Therefore, they will use the power of government to throttle and destroy that world.

Monday, April 16, 2007

Antitrust Smackdown

In today's New York Times:

Internet and media rivals to Google Inc. (GOOG.O), fearing an unprecedented consolidation of power in the online advertising market, are expected to urge regulators to closely scrutinize the Web search leader's $3.1 billion deal to buy DoubleClick Inc.

Google on Friday beat out Microsoft Corp. (MSFT.O) and Yahoo Inc. (YHOO.O) to buy Web ad supplier DoubleClick, securing a leadership position as the Internet's top advertising business.

Microsoft, the world's largest software maker, said the deal would allow Google to corner the online advertising market and provide them access to a huge amount of information on consumer behavior on the Internet.

``This proposed acquisition raises serious competition and privacy concerns,'' said Brad Smith, Microsoft senior vice president and general counsel in an e-mail statement.

``We think this merger deserves close scrutiny from regulatory authorities to ensure a competitive online advertising market.''

Microsoft does not see the irony in pursuing antitrust to throttle its competitors, when it is one of the greatest victims in the history of antitrust, and remains a victim to this day.

Microsoft has pandered to the level of its less successful competitors in attacking Google. Like Sun Microsystems, Oracle, Novell, Netscape and sundry others who hamstrung Microsoft at every turn with harassing antitrust lawsuits over the past 15 years, Microsoft now does the same to Google.

Microsoft failed fair and square in trying to buy DoubleClick. Microsoft wanted it and it was outbid. Now Microsoft wants to use the antitrust hammer to forcefully gain what it wants, which it failed to do in the market.

Long ago, Microsoft undercut its own moral rightness in its antitrust battles. The company did this by never challenging the premise of antitrust. Bill Gates went on record repeatedly saying he thought antitrust laws were fine, just that they shouldn't be used this time against Microsoft.

Now Microsoft uses the same weapon against a competitor. Its action must put a
spring in the step of Ms. Neelie Kroes as she continues to square off against Microsoft in the European antitrust courts. The director of the European Community's Directorate General for Competition (Orwellian sounding, huh?) knows that Microsoft barely stands before her, having already gnawed off most of the moral leg it stood on.

My advice to Microsoft's accountant is: beef up your reserve against an adverse judgment in the European antitrust case against you.

Friday, April 06, 2007

Regulatory Braggadocio

Today's morning news report breathlessly announced that the U.S. Department of Transportation is mandating the installation of a life-saving new technology in cars. The new technology allows computers to individually control the brakes on each car tire in order to prevent roll-overs and out-of-control skids.

I could feel myself momentarily feeling gratitude toward the wise regulatory mother who protected us with this life-saving rule. Then I thought about it for a moment. Wait a second; the television report went on to parenthetically mention that this technology has already been deployed in half of all new cars. The new regulation will mandate its installation in all new cars in five years. By that time, car manufacturers would have already voluntarily chosen to put it in all new cars anyway.

What is going on here is regulatory braggadocio. The regulator claims credit for a product she did not invent, one which private automobile manufacturers were going to implement anyway. The regulator stole the spotlight from the engineers and automobile executives who, acting out of self-interest, were making their product better by making it safer.

All regulations work this way. The technology behind a safety innovation is always created in the market by profit-seeking businessmen. They implement it, sooner or later, depending on the market demand for such a safety innovation. All technologies are costly and the market will determine whether and when it pays to implement a particular technology. It is estimated that this particular braking technology would add $110 to the price of a car. Would it be worth it if it cost $5,000 per car? Only a car maker and its customers can determine that, which is why costly safety improvements are typically installed in luxury vehicles first before they are mass-produced for cheaper cars.

The regulator co-opts this natural market process that makes products safer over time. In some cases, such as this one, the regulator merely steals the limelight from a safety enhancement that was being instituted anyway. In other cases, he forces on an unwilling manufacturer and customer a safety mechanism that is too expensive. Either way, the public gets a clear message. The regulator is beneficent and is the only reason products are safe. You can't trust profit-making corporations to make safe products. Because of regulation, those greedy businessmen are forced to make safer products.

As I thought through this, that fleeting feeling of thankfulness to the beneficent regulator was replaced by another feeling: contempt. And in my mind I thanked those who do get the credit: the engineers and software designers and executives who developed this life-saving technology at the world's automobile companies.

Thursday, April 05, 2007

The Antitrust Hammer

This week Europe announced yet another antitrust action against an American company. Regulators are investigating Apple's iTunes for violation of European antitrust laws. They are claiming that because Apple offers music downloading on a country-by-country basis, they are violating rules against territorial restrictions on sales. Apple, for its part, says that it originally wanted to sell its songs Europe-wide, but found that copyrights were handled nationally and continental distribution was not feasible. Apple is being squeezed between one set of laws (copyrights) and another (antitrust). Although it is a problem of conflicting laws, the regulators do not seek to eliminate the legal contradiction. Instead, they punish the American company caught in the middle.

Apple has done nothing wrong here. As an exercise of their commercial freedom, they can sell to whomever they want on whatever terms they seek. To restrict that in any way is to violate the property rights of Apple's owners.

Why are the Europeans so concerned about such a bizarre, picayune issue? The answer is that they seek to bring down Apple because it is a successful American corporation. Observe the European regulators' continuing crusade against Microsoft, America's leading computer software company. To this day, even after Microsoft painfully settled American antitrust actions and lawsuits, the Europeans continue to punish Microsoft with ever-changing and constantly-growing demands. Lilliputian style, Microsoft is tied down under threat of more fines (after paying a record $613 million fine several years ago), and is forced to change its software, turn over programming code to competitors, adhere to government-set marketing rules and product specifications, etc.

Not so long ago, the Europeans were quiescent in antitrust enforcement. In fact, in countries such as Germany private cartels were legal (as they should be). Governments often encouraged cartelization (which they should not do; it is a private matter). However, about 15 years ago, the Europeans got antitrust fervor. They appointed a Europe-wide antitrust enforcer and set to work. A partial list of companies attacked by the European antitrust enforcers since then reads like a who's who roster of American business success stories:

  • Apple
  • America Online
  • Boeing
  • General Electric
  • Honeywell
  • McDonnell-Douglas
  • MCI
  • Microsoft
  • TimeWarner
  • Sprint
  • WorldCom
Many of these companies who wanted to merge primarily to achieve efficiencies in the United States could not do so because the European regulators would not allow the companies to combine their European subsidiaries. Two examples were the intended General Electric/Honeywell and WorldCom/Sprint mergers. Both of these mergers of American companies were thwarted by the European antitrust regulators. In other cases, mergers between American companies were permitted only after costly concessions were extracted that favored local, European competitors. Two examples were the TimeWarner/AmericaOnline and Boeing/McDonnell-Douglas mergers.

Interestingly, Europe's antitrust fervor began around the same time as the American government's antitrust assault on Microsoft began in the early 1990s. Now, after nearly two decades of America barely uttering a word in protest, the Europeans believe it is open season on American corporations. With regard to Apple, France actually tried to pass a law a year ago that would have forced Apple to allow iPods to accept music downloads from services other than iTunes. Eventually, France backed down after Apple threatened to pull its popular iTunes service out of France.

The Europeans are not just being anti-American. They target plenty of European companies with antitrust enforcement. Their reach across the Atlantic into the boardrooms of American companies has more to do with punishing the successful to protect the mediocre and politically-connected local companies in Europe. Many of the world's most successful companies are American. Therefore, the Europeans hammer them with antitrust.

Monday, April 02, 2007

Protection Racket

The Wall Street Journal today reports that U.S. shrimpers are using so-called "anti-dumping" laws to extort cash payments from foreign shrimpers. Under the anti-dumping law, U.S. producers request and get tariffs imposed on importers they compete with. They only have to complain that the prices the importers sell their products at are unfairly low. Unfair to whom? Certainly not to the customers of shrimp, steel, paper and sundry other products against which anti-dumping tariffs have been imposed. No, they just have to show that it is unfair to them, the producers. So, American producers who compete for a living with all other producers, foreign and domestic, get to claim that their competitors' prices are too low.

It is a politicized, non-objective process and rewards selected American businesses to the tune of billions of dollars every year. All American consumers of these products pay more money for imported and domestic goods that are "protected" this way. Much of the extra profit that the domestic producers make gets passed around to thousands of lobbyists, lawyers, trade associations, regulators and politicians, all of whom make this racket work.

The most recent anti-dumping tariff, imposed in 2003 by the Bush Administration, raised shrimp tariffs by $100 million. Today, that process has become much more efficient and direct. The foreign producers now make cash payments directly to an association of U.S. shrimpers who, in turn, pass much of that money around to the domestic players that support the racket. The money is paid under threat that the U.S. shrimpers will call their political buddies to slap another punitive tariff on them. It was an offer the foreign shrimpers could not refuse.

When the Mob extorts money from businesses, it has to pay off judges, policemen and sometimes senators and congressmen. Today's legalized mobsters do the same thing, paying off many of the same people. All of us pay. We pay higher prices for goods and we suffer from an impaired division of labor. Less efficient and less successful producers of goods are rewarded at the expense of the more able.

Sunday, April 01, 2007

Press the Red Button

This was too good not to share.