Wednesday, April 21, 2010

Will California Default Bring Goldman-like Lawsuits?

It seems everyone has an opinion on the Goldman case, as though there's some really big principle here. Lawsuits have very little to do with principle, as these are merely pretexts to get lucre. Think of ambulance chasing attorneys jumping on Toyota based on dubious claims that accelerators were 'stuck': supposedly they just want a safe public. Yeah sure.

In my lawsuit with Telluride Asset Management, they asserted I violated a confidentiality agreement. They claimed that any usage by me of certain base ingredients for portfolio selection was a violation, because it was necassarily informed by their sage stewardship at Telluride. Yet, I had used these criteria before Telluride as a portfolio manager, and they weren't exactly secret ingredients: profits, momentum, volatility, mean-variance optimization. After the judge noted I did not invent these while at Telluride, she then asked the simple question: "what's your end game? What do you want?" I would have loved an end game. Telluride's lawyers merely said 'to protect our property!' Later, a new judge came in, and asked the same question, and again an unassailable answer: 'to enforce a confidentiality agreement!' Well, the judge couldn't say he was against that, these are bedrock principles!

The key key issue was 'what is your property?' or 'what is your view of the scope of the confidentiality agreement?' It's hard to clear yourself when you've been accused of something to be defined later. Principles are great things in courts, or rhetoric in general, because its so easy to find one that supports whatever you want to do, and so impossible to argue against.

Anyway, if the principle here is that a large complex financial institution should not service issuers that seem certain to default, California should just declare bankruptcy today. Currently , one-third of their revenue is in deficit, an unsustainable cash-burn rate. Legislators are puppets of basically three unions, that make money based on laws passed by those same legislators: the SEIU (janitors, hospital workers), the Teacher's union, and the public safety workers (cops, firemen). California already has high taxes and people are out-migrating for the first time in a century, so they face the downward portion of the Laffer Curve (ie, higher tax rates → lower revenue). It seems pretty clear they need to cut costs, but why wouldn't the unions push for bankruptcy as opposed to benefit cuts? The city of Vallejo recently went bankrupt, and it's still to be determined whether the pensions and union contract have priority in their bankruptcy the way they did for General Motors and Chrysler. Bondholders should not anticipate priority.

I bet all of the major investment banks are facilitating debt issuance by the State of California and its various agencies, counties, and municipalities. I bet also there is a small but spirited set of shorts, trying to make money off of the inevitable bankruptcy. With hindsight it will be obvious, and everyone currently buying California-related debt will develop amnesia and claim they never liked California debt, and were hoodwinked by greedy bankers.

At that point, should all the investment banks be liable? If so, is every bank facilitating California debt issuance committing fraud right now?


Anonymous said...

Nice post. Point of information: California cannot declare bankruptcy, even if it defaults. It's a sovereign entity, and therefore does not have bankruptcy as an option. That's what Walter Wriston meant when he said that countries don't go bankrupt.

Anonymous said...

Good post.

Recently discovered your blog.

I had a small legal snafu in 2005 with Telluride.

It was an particularly unimportant matter and yet the barristers were summoned. So silly.

Smart blog sir.


Anonymous said...

Unfortunately for us Californians, you're forgetting about the prison guards union. The reason we're spending more on prisons than on education.

Anonymous said...

It's a sovereign entity, and therefore does not have bankruptcy as an option.

What does that mean? California can default and creditors can't sue to recover their principal? Even secured creditors like bondholders (that's what distinguishes a bond from a debenture), who have collateral they can repossess? If that's the case, at least California will never be able to run a deficit ever again, since nobody of sound mind will lend money to a borrower who can repudiate its debt at will.

That brings to mind another question: if California is sovereign, why can't they tear up union contracts and benefits at will? What makes the unions sacrosanct and the creditors not?

Anonymous said...

California does not have access to the bankruptcy courts to legally discharge debt. They can stop servicing the debt, but unlike a business or individual they cannot go into bankruptcy court to get rid of it.

Technically, as a soveriegn, California is also immune from lawsuits, but it's a pretty safe assumption that bondholders insisted on a waiver of SI as part of the deal(s) - I suspect the unions did as well.

newt0311 said...


That brings to mind another question: if California is sovereign, why can't they tear up union contracts and benefits at will? What makes the unions sacrosanct and the creditors not?

The same way the unions got their current cushy contracts in the first place: the unions have organized voting pools and funding circles.

RPB said...

This post partially misses the point on Goldman. If Paulson was able to hand pick the mortgage with the expressed purpose of shorting them and Goldman told investors he was buying certain tranches(and not disclosing the short) then the SEC may have a case.

I have not closely examined the materials - I have better things to do. What I do know is that Goldman is being very arrogant at the least prudent of times. The SEC is like a state trooper that pulls you over when you are driving out of state - if you piss him off he's going to find something to nail you for.

J said...

Good question.

California's fiscal situation is not exactly a secret. Anyone consuming California debt has been duely warned (read the small letters below...).

Anonymous said...

California is sovereign, why can't they tear up union contracts and benefits at will?

The contract clause in the federal constitution and supreme court precedent declare that state gov'ts can not ex post tear up contracts they have entered into.

The Fed gov't can, but states can't.