The Deadman Night Rider

A forum for evening students of the SMU Dedman School of Law and other outlaws..

Thursday, June 30, 2005

I don’t know who the blogger for Dispatches from the Frozen North is, but I’d like to buy him a beer sometime. Check out this entry regarding an earlier post on the Volokh Conspiracy concerning the increase in interest-only mortgages.

On the Volokh site, Todd Zywicki makes the case I’ve heard a lot of financial planners put forward – that paying down mortgage principal is a dead use of cash that could go toward other investments that generate return. This short, elegant post from Dispatches points out the flaw of focusing too tightly on rate of return and ignoring its context in the full scope of life – we don’t live in a spreadsheet.

Dispatches is correct that most people don’t think of their house as a purely financial asset, but I think that it goes even further than that: most people don’t think about residential real estate in anything resembling a rational way. Sentimentality is the driving force with finances playing the role of limiting factor – as a friend of mine quotes his real-estate agent cousin “Always buy as much house as you can afford”. The recent history of prices has allowed this attitude to masquerade as good fiscal sense, and interest-only mortgages are simply the fullest extension of the concept. And that’s the danger – people aren’t using them in the detached, analytical way Zywicki describes to diversify their assets, they’re using them to load up on house – as Dispatches notes, classic bubble behavior.

If anyone still thinks we’re not due for a correction, count how many of your friends and family are real estate agents…

Sunday, June 26, 2005

If this is quack corporate governance, I'm with the ducks...

For anyone in the corporate world, the word SOX is
dreadfully familiar as the radioactive fallout
emanating from the nuclear crater left by Enron,
Worldcom, Global Crossing, etc. In this article from
the May issue of the Yale Law Journal, Roberta Romano
evaluates the effectiveness of the corporate
governance provisions of the Sarbanes-Oxley Act, and
the political climate that surrounded its passage
(link via It isn’t hard to discern
her opinion on the subject: the title is "The
Sarbanes-Oxley Act and the Making of Quack Corporate

One of the paper’s main assertions is that when
Congress passes ‘emergency legislation’ in the midst
of a crisis climate, the results are often flawed
measures adopted with too little consideration - an
opportunity for interested parties to enact policies
that wouldn’t normally pass into law simply because
they are on hand with ready-made solutions. Congress
sees a bear in the woods and, eager to shoot, doesn’t
stop to scrutinize the first gun handed to them. The
bulk of the paper is devoted to tracing the history of
the corporate governance provisions as they made their
way into law, and I can’t argue with the
premise. In this case, however, I don’t believe the
result is as dire as claimed.

The first section of the article is devoted to
demonstrating that the four governance mandates
provide little or no value to investors, and it is
here that I find the arguments less than persuasive. I obviously don’t pretend that I am in the
same league with Professor Romano, a law professor at
with a list of credentials as long as your arm –
I’m just a CPA who has some experience working as an
auditor and an accountant in public companies. Also,
Professor Romano draws on an impressive array of
quantitative studies, and I am not disputing the value
of that data – I definitely don’t have the resources
or likely the expertise to do that. I do think,
however, that these measures are too narrow to draw
the conclusion that the SOX governance provisions
provide so little value that their costs outweigh on

To begin with, a number of the studies Romano cites
appear to use company performance measured by earnings
as a benchmark, which doesn’t seem like an apt
standard since these provisions are not aimed at
improving profitability or stock prices – a
correlation either way wouldn’t support their value.
The article does break out the number of studies that
use measures that are more to the point
in determining quality of reporting(abnormal
accruals, restatements, earnings conservatism, etc.), which admittedly
also do not show any strong indications of the
provisions’ effectiveness – in other words, the
measured events occur with the same frequency with or
without them. All the same, the thrust of the
corporate governance provisions is to protect an
inherently non-quantifiable attribute: faith in
corporate reporting, and by extension, the equity
market as a whole. To that end, these were necessary
reforms whose worth exceeds their statistical
correlation with any given circumstance.

The four provisions are:

1) Mandatory independence of
Board directors serving on audit committees

2) Prohibition of certain consulting services on the part of accounting firms conducting an

3) A ban on corporate loans to executive officers
or directors

4) Executive certification of financial

The spirit behind these provisions is clearly qualitative rather than quantitative. In positions of public trust, it is just as important to avoid the simple appearance of impropriety and reduce opportunities for abuse as it is merely to refrain from illegal acts. These reforms are the law’s attempt to alter the mindset of the high-level players on both
sides of the reporting process, what auditors call the ‘tone at
the top’. The cold, hard truth (one that accountants freely admit) is that there are no true safeguards that will prevent or detect a determined fraud – in the end all we have to rely on is good faith. In my experience, the attitude shift these provisions are aimed at is taking place.

Romano cannot find any evidence that independent audit committees are more effective, but clearly they now take their duties much more seriously as a result of the legislation. Have a look at this survey of public and private companies conducted by the law firm Foley & Lardner (also via, particularly the ‘Verbatims’ section concerning audit committees. Respondents note that frequency of meetings and requests for information from management have increased, and one even notes the appointment of a ‘Lead Audit Director’. It begs the question, what were they doing before? The honest answer is not much other than being a reviewing committee for the external auditors. In the NYSE-listed company where I worked, the internal audit function didn’t even report to the audit committee before SOX, making their function all but ceremonial.

In her section on prohibiting accounting firms from providing specified consulting services to audit clients, Romano concludes this is a solution to a non-existent problem. Again, this is definitely an area where perception is as important as reality. There is an inherent conflict of interest in the audit function because the audited firm is the paying client – an arrangement that exists simply because there aren’t any good alternatives. A surprising number of investors, especially since the huge spread of participation in the market, are not aware of how this system works. But at least one commentator in the New York Times is questioning its validity this week, a sentiment that will only spread if continued abuses occur. If anyone truly doubts that firms weren’t being compromised by the fear of losing consulting work, consider the big jumps in audit fees since SOX. Some of that increase is due to the new internal control requirements, but not all of it – the truth is that audit fees had been beaten down too far to be profitable on their own. If nothing else, the reform has redirected firms’ attention to providing audit quality – again, note the tone of the comments in the ‘Verbatims’ section of the survey mentioned above. Every entry indicates that he tenor of the relationship has changed, strengthening the auditors’ position. This change simply had to occur if we were to maintain public faith in the audit function.

The ban on executive loans comes in for criticism in the paper since it removes a tool used to align the interests of shareholders and officers, since many of these loans were used to purchase company stock. If there is any non-problem listed in the article, though, it is this. Is there really any public company out there that has a big problem with a divergence of interests between management and shareholders? Have we seen lots of reports of rogue CEO’s out there not trying to maximize shareholder value? There are so many other instruments available to tie executive compensation to performance with much less opportunity for abuse that opposition to this provision doesn’t seem reasonable. This just removes one huge area for potential abuse or at the very least an appearance of impropriety.

Executive certification of financial statements is the most important of the four provisions, and was noted by one of the Foley & Lardner respondents as one of the reforms providing the most value for the least cost. This provision reseats responsibility for corporate reporting where it belongs – with the corporation. For too long, CEO’s have abdicated their duty in this regard. The most famous, of course, is Bernard Ebbers, who claimed on the stand an ignorance of accounting in general and the state of his own company in particular that is simply embarrassing. As with the other three CG provisions, Romano suggests stripping this reform of its mandatory force, allowing companies to weigh the costs and benefits of compliance. Presumably, the market would then award an appropriate value to those in compliance due to increased confidence in their reporting.

The flaw in that reasoning, however, is that the market is not entirely rational (as in ‘irrational exuberance’). Right up until the instant it melted down, everybody loved Enron – it was supposed to be the model for the next generation of the corporation. If there were a market incentive for following these practices, it would have existed before the crisis as well and we wouldn’t have witnessed the race to the bottom that we did.

There are a lot of things not to like about SOX and a lot that needs to be amended – particularly the internal control documentation requirements and other high-cost, low-value items– but the corporate governance provisions are the real heart of the reforms. Regardless of the truth of Professor Romano’s observations about the legislative process under crisis conditions, ‘quack’ is too harsh a term to apply to these provisions. Sometimes, in spite of itself, Congress does make good law.

Wednesday, June 22, 2005

The Deadman gets a plug!

The RiskProf mentions the Deadman Night Rider in his blog today, thanking us for perma-linking to him. This marks the first time the Deadman appears in print in the wider blogosphere - thank you, Risk Prof - May your marginal revenue always equal your marginal cost!

He describes us a group blog - a more accurate description would of course be that we are intended to be a group blog, but so far our reach exceeds our grasp...

Tuesday, June 21, 2005

Several other bloggers have linked to this report from the Tax Foundation on the rising percentage of tax return filers that have zero tax liability – 32.4% in 2004 - due largely to increases in the child tax credit and the earned income tax credit. The report highlights a point many media stories on the 2003 tax cuts ignore: these two credits are refundable, meaning that if the credit exceeds total tax liability, the government pays out the difference.

The purpose of this is to offset the regressivity of sales taxes and other state and local levies on lower income families, and the President’s policy definitely hasn’t gotten enough credit for expanding them. According to the IRS data here, in 2004 over 22 million tax-filers received more money than they paid in, putting them in the “negative” tax bracket. The total amount disbursed between these two credits was $42 billion.

Another area where W. never got any credit was for dropping the lowest tax bracket from 15% to 10% - which not only cut income taxes but simultaneously lowered the capital gains rate for low income earners. The ‘Air America’ crowd takes it as an article of faith that any benefit of the tax cuts for lower income families has been canceled out by increased state and local taxes, but I haven’t seen one set of hard numbers to back up that claim. By focusing on the aggregate amounts of the cuts, which favored the top brackets precisely because they pay such an inordinate amount of the total tax revenue, they have been able to deflect attention from how much more money was put into the pockets of the people they claim to represent.

Meanwhile, it looks like overall tax revenues are increasing. I’m not sure this is the vindication of the vaunted Laffer Curve the writer here claims, but correlation between the cuts and the economic recovery is tough to dispute.

Monday, June 20, 2005

In a post last week, Eugene Volokh (a UCLA law professor and 2nd gen Russian émigré) was taken to task by one of his readers for applying an economic analysis to the decision to have children and how technological developments impact that decision. The accusation was this:

I cannot help but think that you are treating people like a commodity (reduce costs and increase demand). I think a big barrier to childbirth is actually our culture, which cannot see why investing into another is more important than investing in one's self.

As part of his response, Prof Volokh noted:

Perhaps I'm mistaken, but my sense is that many people resist economic analysis because they find it distasteful: People shouldn't be treated like commodities (as if I'm suggesting that I be able to sell my wife on the open market). We should be paying attention to the grand plan of making people more unselfish rather than to technocratic matters such as cost and incentive (as if campaigns to make people unselfish have enjoyed notable success).

I can definitely relate to this sentiment. I’ll never forget a fellow student in my first-year econ course, a young lady named Kat who was getting a degree in social work and had a tattoo of a parrot that covered her entire thigh – she was the first woman I ever saw with a nose ring (it was ’89). Kat carried on a semester-long debate with the prof because she could never come to grips with the law of supply and demand. To suggest that a seller would demand a higher price just because they could was barbaric, it just wasn’t right, how could anyone be so cruel, and so on. It just didn’t sit right with her – possibly because as an aspiring social worker, she was used to thinking about people as people, not disembodied, rational actors. Obviously, though, if you have a problem with supply and demand, you’re not going to find too many economic arguments persuasive.

I think this same bias informs politics as well. Some people resist or reject conservative arguments because they just aren’t nice. It’s not nice to turn away illegal aliens, or cut welfare benefits that disincentivize work, or oppose raising the minimum wage. But unfortunately, we don’t live in Kat’s world.

Friday, June 17, 2005

Check out the Legal Affairs debate this week (link is over at the left hand side) – this week’s topic is the legality/validity of school voucher programs. Laura Underkuffler, a professor at Duke Law School, writes in opposition to vouchers, while Clint Bolick, president and general counsel of a voucher advocacy group, defends them.

Underkuffler still has one rebuttal hanging out there left to post, but it’s clear that she’s gotten the worst of this exchange. She has repeatedly resorted to conflating vouchers with full public funding of religious schools as the basis of her argument in order to bring in problems encountered in the UK with Islamic schools teaching radical ideals. She breezes past the argument that voucher programs would require participating private schools to accept all comers so that she can get on to her worst-case scenario – public education being reduced to a marketplace for vouchers.

However, she holds up a Minnesota program that opens access to all public schools to students from any district in the state as an ideal – which sets up just such a marketplace and concedes all of the anti-voucher arguments about taking away vital funds from already-failing districts, etc. She just doesn’t want to include private schools in the market for fear they will teach values and ideas she doesn’t like, ignoring the fact that to qualify for the voucher funding those schools would have to play by rules that would make it impossible to teach narrow, extreme curriculums.

Consider the private Jewish primary schools here in Dallas. They are great schools, but they devote most of their day to classes taught in Hebrew. To qualify for voucher funding would mean accepting non-Hebrew speakers and a corresponding duty to accommodate them – a choice between retaining their character as a Jewish school or accepting public funds. Any school sufficiently out of the mainstream is not going to find it rational to participate, just like many private companies find the disadvantages of being a public company (reporting, regulation, etc.) outweigh the benefits of the access to public capital markets.

The only way institutions like this would become publicly funded in a true sense is if vouchers were expanded from low-income families to everyone, an open, free market in education that is Underkuffler’s straw man. As a society, however, we have a pretty good record of controlling this kind of slippery slope – all sorts of public assistance programs from food stamps to Social Security (currently via taxation of benefits, but soon even more explicitly) are means-tested with little difficulty.

Wednesday, June 15, 2005

Christopher Hitchens is, not to put too fine a point on it, the man. Aside from George Will, there is no other pundit that I admire more for simple command of language. In his Slate piece this week, he writes of Al Qaeda and similar groups in response to the Amnesty International charge that Guantanamo Bay is the “gulag of our times”:

In Afghanistan and Iraq, they sought to destroy the electoral process that alone can confer true legitimacy, and they are in many, if not most, cases not even citizens of the countries concerned. Their announced aim is the destruction of all nonbelievers, and their avowed method is indiscriminate and random murder. They are more like pirates, hijackers, or torturers—three categories of people who have in the past been declared outside the protection of any law.

The administration therefore deserves at least some sympathy in its confrontation with an enemy of a new type. I should very much like to know how a Gore administration would have dealt with the hundreds of foreign sadists taken in arms in Afghanistan.

I have often wondered that myself (leaving aside the question of whether Gore would have invaded Afghanistan at all, or succumbed to the calls from some in his party to cast the 9/11 attack as a law enforcement issue under the purview of the International Criminal Court). It begs the question, what else can be done?

The grim reality is that most alternatives are tantamount to doing nothing – simply letting the 300 or so still in custody walk out the front door. Legally we can’t justify keeping them, but morally, realistically we can’t countenance releasing them. In many cases, extending them even some of the protections we afford citizens and non-citizens alike would be too dangerous or destroy the value of holding them. In the end, they’ll probably be split up and farmed out to more remote locations as the name Guantanamo acquires more and more negative connotation.

That’s why most of the attacks on the President on this front are irresponsible. His critics are more than happy to let the administration twist in the wind, knowing the next Koran-flushing incident or naked human pyramid photo to come along is only a matter of time.

It may be anathema to the philosophies that underlie our system, but in one sense it is not so unjust for these men to suffer a mild form of outlawry considering how thoroughly they have renounced modern civilization – though even so, they are not without some basic protections. The Guantanamo Bay prisoners enjoy the level of care they receive now if for no other reason than fear of bad publicity from our free press. In the abuses that have occurred – documented in excruciating detail in a manner virtually no other government would allow - the perpetrators have been held to account, even up to senior levels in the military. Detainees are issued Korans, religious literature, and adequate, appropriate diets. If anyone thinks their state is inhumane, consider for a moment how long 300 Chechen militants would last under the tender mercies of Vladimir Putin and the Russian Army, many of whose impressed soldiers routinely endure far harsher conditions.

Thomas Friedman calls for doubling the amount of troops we have in Iraq in today’s NY Times editorials (this link requires a login, but it’s still free for the time being!). I’ve been impressed by Friedman’s principled stand on the war, among other things – he definitely hasn’t done his cocktail-party circuit stock any favors lately. He admits that sending more troops is the last thing anyone wants to hear – true enough, especially since no one knows where they would come from.

I have to admit to having some mixed feelings and not a little guilt on this subject – I’ve been a strong supporter of the war from the beginning, and now that manpower appears to be getting tight, I feel like I should pull my weight. Physically, nothing is stopping me – I know for a certainty I can run fast enough and do enough pull-ups and sit-ups. At 34, I’m at the top end of the scale but still qualify for both regular and reserve Army. I don’t feel joining the Army now would be any more dangerous than some of the things I’ve done in the past, traipsing around Central Asia. What’s stopping me is naked self-interest – I’ve got a family, I’m starting law school, etc. All that would be put on hold – which is really saying that I’m valuing all of that over my country – not a pretty admission.

Two years ago they told me they didn’t need me. I talked to probably five different recruiters - online, on the phone, and in person – who told me that I’d never get a waiver to go to Officer Candidate School because of my age, since it was full for the next few years. (More self-interest – military pay even at junior officer levels would be a hell of a paycut, and enlisted would be like a 75% drop) Now they’re missing recruiting targets even after lowering the goals. Meanwhile, I sit here counting chile peppers waiting for August 16, and the Deadman.

Sunday, June 12, 2005

John Kenneth Galbraith - too square to be hip

I just finished watching author Richard Parker on CSPAN2 talking about his new biography - John Kenneth Galbraith: His Life, His Politics, His Economics. I was eager to see the interview after reading this review of the book in Foreign Affairs by J. Bradford DeLong, an economics professor from the University of California at Berkeley.

Both Parker and DeLong are troubled by the fact that Galbraith’s legacy seems so tenuous given how great a figure they (and evidently, Professor Galbraith himself) consider him to be. They note with chagrin how the field of economics has dropped him from their list of luminaries, while the Democratic party has similarly abandoned the policies he espoused – a repudiation of both his politics and his scholarship. Parker blames weak resolve on the part of the Democrats and an ivory tower focus on mathematical models and quantifiable equations on the part of economists for this neglect. I think these are fair assessments.

I believe, though, there is another dimension he is missing: the radicalization of the academics and intellectuals who should be Galbraith’s natural constituency. As Parker noted in his talk today, Galbraith is basically a neo-Keynesian who believes in free markets and the intrinsic value of the capitalist system – he simply thinks there are ways to make it work better. Unfortunately for him, the people who would be most receptive to his economics and politics today have moved beyond that basic premise, and the last thing they want is for capitalism to work better.

My experience as an Econ undergrad at UT Austin (late 80’s early 90’2) tracks mostly with what DeLong describes in his review, but with some important differences. The basic theoretical models taught were Keynesian and Monetarist, but the Economics Department resided in the College of Liberal Arts, not in the Business School, which was in line with the basically non-mechanistic focus of the curriculum. After the basics, though, upper level courses that weren’t devoted to specific geographic regions or industries were explicit critiques of the free market system. The most well-known professor in the department was an openly Marxist economist who taught several courses in socialist and communist theory. If you were far enough to the left to believe in Galbraith-esque price controls and government intervention, you normally then slid right on down the slope to full-on socialism or further. Tinkering with the system was akin to making peace with violence.

I recently read an example of this attitude and a realization of its effect on the Left politically in this interview with a professor of economic sociology from Princeton. The academic here exhorts liberals to come to grips with their “lingering hostility toward market mechanisms” and use them to advance their political and social goals – a reasonable position. Even so, he retains a steadfastly anti-capitalist view by declaring that markets are not “free”, but social constructs. Command economies, he claims, aren’t merely perversions of natural-state markets, but equally valid alternative systems that simply produce different results. While he can see the benefits of using the market as a tool to reach his social goals, he still can’t quite bring himself to accept that they exist independently of government. I imagine that for him, Galbraith must seem like someone with good ideas, but lacking the courage of his convictions.

I see the same situation among liberal commentators. Being too big a booster for the wonders of the free market invites some rather pointed criticism from their colleagues. Note the drubbing Thomas Friedman is taking from the Left for his writing about the positive effects of globalism. This reviewer from The Nation of Friedman’s new book betrays a telling attitude when pooh-poohing claims of increased productivity:

"In fact, virtually the only industry in which information technology has made an unquestioned and substantial contribution to productivity is financial services. And that, from society's point of view, may well be no more beneficial than gains in the gaming industry would be--of which, arguably, the capital markets deserve to be considered a part."

That’s not hyperbole – that’s outright disdain for one of the central drivers of the capitalist system itself. At least once a week I see this kind of antipathy for markets in general in print, and the demise of the command economies in China and the Former Soviet Union have only seemed to make it more prevalent – perhaps because there are no concrete examples to ruin idealized, airy notions of socialism. These statements almost always come from people whose goals and values are closely aligned with Galbraith’s – but it seems he doesn’t cut close enough to the bone for them.

In his Foreign Affairs article, DeLong writes that Galbraith is “a guilt-inducing reminder of how much broader and more relevant economics can be.” If the reach and influence of academic economics were truly that limited, the work of others he names – James Tobin, Milton Friedman – would not have the impact they do today. Galbraith’s problem is that he’s preaching to an empty choir box – too far out to be mainstream, but not radical enough to be chic.

Friday, June 10, 2005

A little Friday fun...

I read this article on Slate yesterday about the painting American Gothic - the picture of the farmer holding a pitchfork standing with his wife in front of a farmhouse. It is obviously one of the most famous paintings in the world and almost everybody recognizes it, regardless of how little they know about art. According to the article, when a Harvard professor showed it to his class of 59 sophomores, they all recognized it, but only about half knew the name, and only 5 knew the artist. It turns out that there is an interesting backstory to the painting, and even some controversy, but almost no one knows anything about that (I certainly didn't). Knowing the history of the painting actually changes the way you look at it, though - even the artist evidently came to feel differently about it as time went on.

While I was reading the article, I thought about how the law is alot like that - everybody knows something about the law, some know a little more, and finally a smaller group are experts down to the minutia-level, and that level of familiarity has to influence their views. Also, both are produced by a relatively tiny, self-contained group of specialists that effect a large number of people, which entails certain risks. The art world draws alot of criticism for being insular and too far removed from the rest of society to really produce the kind of work they should - a sentiment I hope to keep in mind as I go through this process.

Thursday, June 09, 2005

This week’s Debate Club blog on Legal Affairs magazine’s website focuses on the validity of the concept of judicial review, as established in Marbury v. Madison. I’m going to put up a permanent link to this feature since it is usually pretty interesting.

Every week there is a new subject, and the participants are usually well-known academics or practicing attorneys. Defending judicial review in this exchange is Erwin Chemerinsky, the attorney who took the challenge to a Ten Commandments monument standing on the Texas State Capitol grounds brought by a homeless man in Austin to the Supreme Court. He definitely has the easier job, since he’s advocating a status quo that has been in place for over 200 years. It’s a little irritating, though, that when he goes through his roster of causes he repeatedly refers to a man sentenced to 50 years to life for stealing $153 of videotapes. That is absolutely not what he was sentenced 50 yrs to life for – it was for doing that after committing two other crimes serious enough to qualify for the 3 Strikes rule. I’m going into law school with an open mind, but if I can’t see coming out on the other end with a different opinion on that.

The main value in this debate is probably educational, since as a practical matter judicial review isn’t going anywhere – regardless of the merits or flaws of the practice, I can’t see judges voluntarily giving up that much power and it would take a Constitutional amendment to take it away from them.

Wednesday, June 01, 2005

Everyone knows by now the Arthur Andersen verdict has been reversed by the Supreme Court. Here is a link to the opinion.

It's interesting that this reversal boils down to arguments about the grammatical construction of one sentence, and that the function of the Supreme Court is to parse out the meaning of ten or fifteen words. I guess this is just a preview of what's to come over the next three years...

From my time doing audit and tax work, the additional nexus problem cited by the Court was particularly familiar. The main reason firms have document retention policies is to cull out any extraneous information that could be used against them or their clients later on. For example, we were constantly reminded never to let partner review notes remain in tax files, since they would be a road map to the problem points in a return for an IRS auditor. Under the position taken by the government, and rejected by the Court here, those notes would have had to have been preserved, since an audit of any one return was foreseeable.

Another lesson from this to take into law school: justice may eventually be served, but simply too late to do anyone any good. For good or ill, AA is dead and buried - and there is nothing this ruling can do to bring it back.