Inside Job, the Conflict of Interest

inside-jobInside Job is such an inspiring film with so many issues worth thinking hard and doing further research on. Here I just want to share with you some of my takeaways from the film, mainly focusing on the issue of conflict of interest.

First let’s look at some disturbing facts. First, during the late 1990s, many IB promoted risky stocks of Internet companies that appeared to be very uncertain in terms of financial strength, which resulted in law suits and $1.4 billion settlement. Another fact is that famous credit rating agencies such as Moody’s, S&P, and Fitch provided high-risk CDOs with triple-A credit ratings which attracted numerous investors that ended up losing their shirts. Fact number three: very few academic economists foresaw the financial crisis, and even afterward, some continued to argue against reforms. Fact number four: The SEC claimed that Goldman Sachs had misstated and ignored very important facts when selling CDOs to various investors; the case was settled for $550 million but Goldman Sachs did not admit to any wrongdoing.

The way I see it is that all those facts are caused by the issue—conflict of interest, which, by definition, means that a person has a private or personal interest which is sufficient to influence the objective exercise of his or her official duties as a professional. The film mentioned four types of people that have such issue – analysts of investment banks, credit rating agencies, academic professionals, and of course, executives in Wall Street.

Analysts in investment banks are greatly motivated to report virtual-high ratings for stocks to attract clients because their firms paid them based on the level of business that they brought to the firms but not on how accurately they rate. This wicked compensation system drives the analysts to focus on creating profitable deals instead of creating safe deals. Moreover, they would rather sacrifice safety in order to bring profitable deals. This phenomenon is hard to change as long as the organizational structure doesn’t change.

The rating agencies are expected to provide unbiased professional opinions about investment. Their words are very important references for investors, so being trustworthy should be their top ethical standard. However, according to some journal articles I read, the rating agencies emphasize heavily on immunity to accountability in their operational ideas. As the excerpts from congressional hearing in the film shows, agencies defend their ratings as simply opinions that should not be relied on. In that case, it is obvious that rating agencies may also prioritize profitability over accuracy. It would appear that they are only interested in trading opinions for money.

Academic conflict of interest comes in a similar way. Many leading economists were paid consulting fees by financial service firms to shape public debate and policy. It is unnecessary for them to be accurate, because “accuracy is not something to expect in this fluctuating market anyway”, so why not just take the money from financial service firms and say what they want to hear? An example from the film would be the report written by Mishkin titled Financial Stability in Iceland, which described the exact opposite side of the truth.

wall streetLast but not least, conflict of interest of the executives in Wall Street is a big one. They somehow manipulate the market to their interest so that they could continuously feed their fat wallets, and they could walk away with huge size of bonus when things didn’t go well. Here I will just simply mention their conflict of interest in terms of fiduciary duty. To fulfill such duty, one must put client’s interests first, act in good faith, disclose everything of all materials, remain neutral, and confess if there is a conflict of interest. However, this is only an ethical code but not a requirement, and what’s worse is that, it’s an ethical code that kills income.

In short, humans are greedy. This is an unfortunate but very well-accepted fact. The conservation of resources on the earth decides that when some people get richer, others get worse. With that in mind, my conclusion would be that as long as the conflict of interest exists, which is always true, and as long as it is not regulated by force, which means law that violating will cause huge penalty, investors should always keep in mind that the financial market is full of lies and dark transactions.



Who Moved My Cheese

Three months into 2104, Chinese investors announced they’ve snapped high-tech deals worth more than $6 billion in the U.S. The figure, which is greater than the combined total in the past four years, marks a giant leap in high-tech investments made by private companies from China. But instead of welcoming new jobs and R&D grants, business communities across America are advised to be wary of the innocence of Chinese companies.

A recent report published by The Rhodium Group and Asia Society concludes Chinese buyers may have set out to target high-tech industries in the U.S. While the number of deals has dropped since 2011, the value of China-U.S. high-tech transactions took a jump in the first quarter this year. Overall, Chinese direct investment in the U.S. reached a record high of $14.1 billion last year since taking of in 2008, according to the report.

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The boom can be seen across America and in a variety of sectors. A majority of Chinese investors, as graphic below shows, unsurprisingly struck deals with technological communities in California. There was a lot of Chinese money going into IT equipment when Chinese PC maker Lenovo bought IBM’s personal computer business in 2005. But the appetite for software and IT services has prominently grown in the past few region 00-13

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Setting numbers aside, a primary issue the report addresses is how to react to the rise of Chinese takeover of “valuable” technological brands made in the U.S. At a conference held in L.A. on Thursday, most bankers and lawyers who helped handle high-tech transactions for their Chinese clients in the past voiced their major concerns: American companies should look out for possible technology theft, and the U.S. government should make efforts to beef up cyber security.

The big-ticket sales capture a shift in China’s economic ambition and could be a prelude to the country’s departure from being a global manufacturer. But being on a learning curve doesn’t mean the nation’s transition must be an evil breed. In nature, purchasing IBM’s personal computer business was no different from Facebook’s buying WhatsApp: both indicate the parent company sees some value in the subsidiary, and pays money to learn from it. It is fair bargain as long as both sides shake hands on the price.

The $6-million deals made in the first quarter include three major components: Lenovo, after it purchased IBM’s PC business years ago, is spending another $2.3 billion buying a server unit of IBM. Earlier, it purchased Motorola Mobility from Google for $2.91 billion. China’s Wanxiang Group took in luxury carmaker Fisker in February.

They all have eye-popping price tags, but the health of the three subsidiaries show Chinese buyers are tasked with turning failing American brands around before they move on to harness, if any, new technologies. Fisker had been in huge financial loss and filed for bankruptcy when Asian buyers emerged at the end of last year. Google paid $12.5 billion for the acquisition of Motorola Mobility to obtain the patents it needed to ward off lawsuits from Apple (and they weren’t accused of technology theft), and dumped the “perpetual money-loser” a year later. IBM’s PC unit was, again, losing money when Lenovo bought it in 2005, yet the latter has come back for more. The low-end server business Lenovo is taking from IBM has posted seven quarters of losses.

To the other end, The Committee on Foreign Investment in the United States (CFIUS) has guarded national security well. It guarded it so well that Chinese telecommunication giants had to shift their U.S. business from installing network equipment to selling smartphones to survive in the U.S. market.

In 2011, Huawei Technologies Co., China’s biggest network equipment maker, was barred from participating in building a nationwide emergency network. A year later, the U.S. House Intelligence Committee chairman discouraged U.S. companies from doing business with Huawei and ZTE Corp, for fear of intellectual-property theft and spying. The Committee also noted in a report that CFIUS “must block acquisitions, takeovers, or mergers involving Huawei and ZTE given the threat to U.S. national security interests.”

From selling handsets, ZTE had a market share of 6 percent in the U.S. last year. The CEO of ZTE’s U.S. division touted the company’s decision to drop network business in the U.S. “a strategic move” and “an adaptation to America’s legal framework.”

The second-largest telecommunication manufacturer in China has opened 14 offices and five R&D centers in the U.S. It hires about 380 local employees. It has invested $350 million in its U.S. business. It remains at the mercy of geopolitics.

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