Thursday, 17 December 2009
For my readership of 10 to 15 -- you know who you are -- my blogging may be a bit less frequent after I start this new job. It's not that I lack ideas; the rub is simply that blogs suck up time. Maybe I'll try blogging shorter (a la Greg Mankiw, who sometimes just links to stuff he finds interesting, with no comment). I dunno; that's not really my style. But ...
I really, really wanted to do a long entry this week on the maddening futility of regulating banks using capital ratios. The problem is that Basel-type thinking (capital weightings for certain classes of assets) is just so, I don't know, 19th century. Modern financiers will always be a step ahead, using new products to innovate around the rules, so that you have to wonder, "Is this just a failed approach?"
But what in its place? Do we just let banks gamble recklessly, with even less supervision? That seems foolish since the fact that regulators were asleep at the switch during this financial crisis was a huge problem.
I think there may be a better way. I would consider ditching capital ratio requirements altogether (radical idea), but in return, make it easier to prosecute and strip of their wealth Wall Street CEOs and traders who end up running an institution into the ground. What if there were no capital requirements, but someone said, "You bankrupt this company through reckless behavior or negligent oversight and we'll take every penny you have, possibly throw you in jail, cut off your pinky and thumb (okay, I'm exaggerating to make the point), and ensure you never work in the finance industry ever again."
How high do you think the capital ratios would be in that scenario? Say 15, 20 percent, as opposed to the current 8 percent minimum today? Hard to say, but when there are aggressive clawbacks and serious prosecutions, I'm not sure you need a lot of rules about needing this much capital for this kind of asset and this much for the other. What we have now unfortunately is a broken system -- a dense framework of rules that encourages the banks to go diving for loopholes, following the advice of a platoon of securities lawyers.
Wednesday, 16 December 2009
He neither understood nor followed the age-old advice that Clint Eastwood’s Inspector Callahan disdainfully summarized: “A man’s got to know his limitations”. In that, he was a fool. He knowingly and methodically downplayed, dismissed and covered up the contradictions that came into his ken, especially the ones which sprang from his “theories”. For that, he was a knave.
He was a “popularizer”; he stripped the “complexities” from the ideas to make them more palatable to the masses. He explained, according to the New York Times obituary, “what Marx could have meant by a labor theory of value”. (Marx meant what he said!)
He dabbled in everything and left behind “voluminous” writings. To the Times, they are the evidence of his “astonishing array of scientific theorems and conclusions”. What they are is a circular canon of superficiality; they show how one may write million of words on a subject and not advance it one iota forward. His Economics is a case in point. It sold millions of copies. It was a veritable cash cow for the Titan over a half a century. And it reads like a Danielle Steel novel, only with more inconsistencies. It is a hillbilly tune to the grand symphonies of the classical economics.
Here is a sample of the Times’ description of Samuelson’s contribution to economics, beginning with his much touted Neoclassical Synthesis.
Mr. Samuelson wedded Keynesian thought to conventional economics. He developed what he called Neoclassical Synthesis. The neoclassical economists in the late 19th century showed how forces of supply and demand generate equilibrium in the market for apples, shoes and all other consumer goods and services. The standard analysis had held that market economies, left to their own devices, gravitated naturally towards full employment.
Economists clung to this theory even in the wake of the Depression of the 1930s. But the need to explain the market collapse, as well as unemployment rates that soared to 25 percent, gave rise to a contrary strain of thought associated with Keynes.
Mr. Samuelson’s resulting “synthesis” amounted to the notion that economist could use the neoclassical apparatus to analyze economies operating near full employment, but switch over to Keynesian analysis when the economy turned sour.
To summarize: Theory A worked under Condition A, but not Condition B. Theory B worked under Condition B and not Condition A. Paul Samuelson came along and “wedded” the two together to create Theory AB. He suggested using part A under condition A and part B under condition B. This, he called “Neoclassical synthesis” – or “Can’t We Just Get Along?” (He probably got the idea from quantum mechanics, where the light is shown to be both wave and particle at the same time).
His speeches and his voluminous writing had a lucidity and bite not usually found in academic technicians. He tried to give his economic pronouncements a “snap at the end”, he said, “like Mark Twain”. When women began complaining about career and salary inequalities, he said in their defense, “Women are men without money.”So the “Titan of Economics” wanted his comments to have bite, just like Mark Twain! How could have one explained to him that Mark Twain’s comments had a bite because he was conscious of the larger social inequalities. On this topic, he would have probably said: Women are black men.
Mr. Samuelson also formulated the theory of public goods – that is, goods that can be provided effectively only through collective, or government, action. National defense is one such public good. It is nonexclusive; the Navy, for example, exists to protect every citizen. It also eliminates rivalry among its many consumers; that is, the amount of security that any one citizen derives from the Navy subtracts nothing from the amount of security that any other citizen derives.Here, Samuelson compares the U.S. Navy with an apple and “concludes” that no one would voluntarily buy a nuclear attack submarine, no matter how bad the crime situation got in the neighborhood. From this, he draws the further conclusion that the government has to force everyone to pay for the navy. (Notice how he chooses the safely remote Navy and ignores police, a more logical and intuitive example of the “public good”. Some might have questioned the “nonexclusivity” of the police force from their experience.)
The features of public goods, Mr. Samuelson taught, stand in direct contrast to those ordinary goods, like apples. An apple eaten by one consumer is not available to any other. Public goods, he concluded, cannot be sold in private markets because individuals have no incentive to pay for them voluntarily. Instead they hope to get a free ride from the decisions of others to make the public goods available.
Mr. Saber, now, really. You must be exaggerating; having fun at the expense of the dearly departed. There had to be some value to Samuelson’s work. More than half a century of prizes, awards, citations, recognitions; his book being translated to more than twenty languages and now all these posthumous praises. Surely you are not suggesting that all that is due to chicanery and the man fooled most of the people all his life. You, yourself call him an economist of our time. Even with the hint of disapproval that it is there, he had to do something to deserve the designation. No?
Samuelson influenced our world in two ways. Both were destructive. Both set back the cause of science and gave a black eye to civilization.
One is his “introduction” of mathematics to economics and, later, finance. A single sentence in the Times obituary – in code, as usual – captured this sinister deed:
Mr. Samuelson was credited with transforming his discipline from one that ruminates about economic issues to one that solves problems, answering questions about cause and effect with mathematical rigor and clarity.
Here, “mathematical rigor and clarity” means calculation. It is referring to Paul Samuelson taking economics, which was a social and philosophical discipline concerned with discovering the laws of the dynamics of social change, and bringing it down to the service of the businessmen, putting it to use for the calculation of profit and loss. It was the opportunistic seizing of an opportunity by an opportunist. And it was a serious blow. If the war of ideas were fought like wars, Samuelson would be shot for treason. I wrote about this in Vol. 1:
Pursuing mathematical finance along the lines of Portfolio Selection was advantageous in other ways too. It provided a respite from the contentious ideological disputes in economics between the Left and Right that in the era of McCarthyism were beginning to assume an ever sharper, and potentially career-ruining, tone. Research in mathematical finance had no downside risk. It was socially safe, it provided a perfectly respectable line of research and, with luck, it could lead to new discoveries and from there, to fame and fortune.
But, taking the Times’ descriptions, how does one solve problems and answer questions about cause and effect without ruminating about the issues? This question did not concern Samuelson. He was not interested in the larger social issues that resulted from the business decisions. His work on linear programming is the Exhibit A in this regard. From Vol. 1:
Linear programming epitomized the “objective” science. It seemed to be the embodiment of Friedman’s assertion that “positive economics is in principle independent of any particular ethical position.” The solutions it offered were arrived at mathematically and were indisputable. There was only one best way of scheduling oil tankers between a given number of ports if the profits were to be maximized or costs minimized. Democrats and Republicans, capitalists and communists, oil producers and tanker owners, all had to agree on it.It mattered little that Samuelson’s knowledge of mathematics was, like his knowledge of economics and finance, shallow. In Vol. 2 of Speculative Capital, you may recall, I examined a densely mathematical passage he wrote on warrants pricing. I was taken aback by flagrant flaws in calculation and reasoning and, especially the way Samuelson handled a contradiction that his own formulation had created; he simply dismissed it as “prosaic”. I wrote: “The passage, after it ceases to be funny, remains difficult to believe”.
But while mathematics is abstract, it is always applied in the context of given social conditions. And precisely because mathematics is abstract, upon application it assumes the characteristics of the context to which it is applied. If the context is the Battle of Britain, the mathematics of linear programming shows the best way of organizing fighter planes. If the context is the profitability of commercial airlines, it still shows the best arrangement, which is establishing “hubs” and cutting service to low traffic destinations. Both solutions are mathematically correct. In the latter case, because the purpose behind the application of the method has changed–and that purpose is determine by social conditions–the solution leads to a different kind of consequences: medium-sized and small communities become further isolated.
What mattered is that Samuelson “delivered” the goods, the goods being the nations’ best and brightest to the service of finance. “When today’s associate professor of security analysis is asked, ’Young man, if you’re so smart, why ain’t you rich?’, he replies by laughing all the way to the bank or to his appointment as a high paid consultant to Wall Street”, he wrote in the introduction to Merton’s Continuous-Time Finance. That was the new goal of economics: training highly paid consultant to Wall Street. Looking back at what took place in the business schools and economics departments in the past 30 years, we must, in fairness, acknowledge Samuelson’s service.
When economists “sit down with a piece of paper to calculate or analyze something, you would have to say that no one was more important in providing the tools they use and the ideas that they employ than Paul Samuelson,” said Robert M. Solow, a fellow Nobel laureate and colleague of Mr. Samuelson’s at M.I.T.Exactly. That is the secret of Samuelson’s fame and success: genuflection in the direction of the businessman. What a falling off was there.
Still, this retrogression pales next to the effects of Samuelson’s other deed, whose impact went further and deeper in the society. I do not suppose the man who emptied economics of social elements noticed or appreciated the irony.
Prior to Samuelson – and Friedman – writing and speaking about economics had been in the form of discourse, which is “proceeding from one judgment to another in logical sequence”, according to its dictionary definition. All classical economists were schooled in logic and philosophy. They could disagree with each other – and they often and vehemently did – but each side could answer and refute the opposing arguments point by point. Because there was a logical relation between the points of a case, in this way one could, if he had the logic on his side, refute the core thought of his opponent.
Samuelson, and his partner in crime, Milton Friedman, changed that. The change was violent and disorienting. It had a similar effect on the intellectual terrain that the introduction of the machine gun had brought to the battlefields of WWI. Whilst previously cavalry had charged the enemy lines, now two men behind a machine gun could hold the line against a thousand charging cavalrymen.
Samuelson and Friedman had no core theory, no central point, no logical anchor, only an “astonishing array of scientific theorems and conclusions”, which meant that they could not be nailed down to any particular position; they switched the subject and sides at will. And they were “formidable debaters”, according to the New York Times, precisely because the substitution of the spoken word for the written word created the ideal environment for their style of polemics. They uttered rapid-fire sequence of nonsensical assertions, peppered with false statistics that they knew no one could check.
With the rat-a-tat of their drivel, they killed discourse. They made discussion, and even conversation, impossible. What do you do with a man who goes on and on about the contrast between the U.S. Navy and an apple and cannot be thrown into a madhouse because of his Nobel Prize and M.I.T. tenure?
In this way, the Tweedle Dee and Tweedle Dum of economic scene invented the aggressive in-yourfaceness of unreason that we see today in talk radio hosts, Rush Limbaughs and the public figures. That is the main legacy of Samuelson with which we will have to live for years to come.
The Times obituary mentioned that Samuelson had trained and mentored many “brilliant” economists who went on to occupy important positions in academia, government and the private industry. Looking around at the social and economic landscape, I must say that I could have surmised that on my own.
The Trojan War
is over now; I don’t recall who won it.
The Greeks, no doubt, for only they would leave
so many dead so far from their own homeland.
Tuesday, 15 December 2009
Bankers Support Regulation? Au Contraire?
Only hours after Obama met with Wall Street "fat cat" CEO bankers (about half of whom opted to be patched in by conference call -- how's that for signaling?), JPMorgan put out this media release on its Web site.
The JPMorgan statement of Dec. 14 appears to be guarded support for financial regulation. In other words "yes, let's have some of course, but slowly, slowly ... carefully, carefully."
The details matter, and the stakes are simply too high and the consequences too far-reaching to do this hastily and poorly. While we agree with many of the proposals, we share concerns with others that some regulatory proposals could restrict lending by banks, which will hinder economic growth and job creation.Duncan's analysis:
This press release so quickly after the meeting at the White House today would seem to have no apparent purpose other than to make it clear to the other bankers and lobbyists that nothing has changed with regard to the industry’s passive-aggressive battle against the CFPA. It also appears to be a rather harsh metaphoric middle-finger to the White House given that it is posted less than 24 hours after the President personally asked for Mr. Dimon’s support.Why did I find this amusing? Well, because of my April blog post, JPMorgan Flips Geithner the Bird. At that time, Dimon was saying basically, "Hell no, we're not going to offer up any assets for PPIP (Geithner's plan to relieve banks of toxic assets)."
Since the Geithner Plan was rolled out with all due fanfare, and awaited with baited breath, the Dimon comment was actually pretty explosive, though it got scant coverage. The subtext of Dimon's remarks was clear: "Screw you. Take your PPIP and stick it up your nether regions." And PPIP has been dying a slow death all year long, as other banks decided to shy away from the program as well.
So has JPMorgan (or Dimon, more specifically) now metaphorically flipped off Geithner and Obama too? If so, that would be arrogance seasoned with plenty of chutzpah.
I was listening to Lieberman on TV last night. He sounds like a Jewish Steven Wright. I keep waiting for the punchline. ("I'd kill for a Nobel Peace Prize ... but seriously folks, about health care ...") Lieberman has a flat, uninflected, depressive aspect that apparently the people of Connecticut find irresistible.
Hell hath no fury like a former Democrat scorned.
Sunday, 13 December 2009
Credit the U.S. Treasury with the P.R. job. Its announcement said that JPMorgan’s warrants provided “an additional return to the American taxpayer from Treasury’s investment in the company”.
Additional return. Investment. American Taxpayer. Only Apple Pie and Motherhood were missing from the formal communiqué.
If the “return to U.S. taxpayer” had any meaning, or if the sum involved even matched what Maddoff “investors” are going to get back from the IRS, I would go through the trouble of showing in numbers what this “return” entailed; I know a thing or two about warrants and options.
Still, you can form an informed opinion about the matter from the concluding sentence of the FT article that reported the happy news on its front page:
The Treasury said the price was well above what JPMorgan had offered to buy back the warrants, adding that the auction had been oversubscribed.
The price was well above what JPMorgan had offered. That is called lowballing.
The auction had been oversubscribed. There was nary a word about the buyers, but you could bet your top dollar that they were all professional traders and fund managers. And they were falling over one another to buy the warrants, which is why the auction was oversubscribed.
Bravo, Secretary Geithner – playing one scene of excellent dissembling and letting it look like perfect honor.
The paper said that Prof. Plotkin shines “a Marxist light” on the economic crisis, though Marx is an “uninvited guest,” the professor was quick to add.
What does he know about his uninvited guest?
Marx wrote: “In the analysis of economic forms … neither microscopes nor chemical reagents are of use. The force of abstraction must replace both”.
Prof. Plotkin has substituted dramatization for abstraction. He no doubt thinks that this shows his enthusiasm. And he may well be enthusiastic. But there is a deeper rationale behind his theatrics which makes them appeal to his students and administrators.
Here is an excerpt from the manuscript of Vol. 4 of Speculative Capital. We pick up where the product is produced and must now be sold, i.e. converted into money. Without this conversion, the production process will come to a halt:
Given this centrality of sales and its practically limitless sub-specialties in a Capitalist society– in the U.S., one would find hiring ads for “nuclear waste salesman” – it is natural that the subject is deeply embedded – intertwined, really – with the culture. Often, it is the driver and creator of the culture, especially in the “Anglo-Saxon” U.S. and U.K., where the businessman’s influence goes further than it would in other nations. The culture in these countries could be said to be the culture of a salesman, as it is shaped by the habits, sensibilities, tastes and priorities of a salesman. This point can best be seen by a look at Dale Carnegie’s How to Win Friends and Influence People.Prof. Plotkin’s understanding of economics is shaped by the salesmen, in the same way that Black, Scholes and Merton’s understanding of options was shaped by the traders. Those who have read Vol. 3 know the price one pays for blindly following these agents of circulating capital.
The book’s title is precise. It telegraphs the content, so attention must be paid. Carnegie wants to win friends. Why? Because he wants to influence them. But the purpose of this influence is not bringing new friends to the righteous path. Carnegie is not an Islamic zealot practicing the Prevention of Vice and the Propagation of Virtues. He wants to influence people in order to sell to them. Friendship is a strategy, a mere means, towards that end. Note the word “win” – not finding friends or making friends but winning friends. The purpose is exploitation, after which “friends” become what they always were: people. It is a singularly cold-blooded and cynical title.
A straight line connects Dale Carnegie to the modern financier, Michael Milken who, responding to a minion’s comment that the rate they were charging a friend was too much answered: “Who are we going to make money off of if not our friends?”
I am not overstating the role of this depression-era salesman. Dale Carnegie did not invent the ways of salesmanship. He merely categorized them – arranged them around a central theme and in doing so, gave them cohesion and focus. His is the authentic voice of a salesman the way braying is the voice of a donkey.
Look at his chapter titles: Three Ways of Handling People; Six Ways to Make People Like You; Twelve Ways of Winning People to Your Way of Thinking; How to Change People Without Giving Offense or Arousing Resentment (in 9 steps, ending with “Making People Glad to Do What You Want”). Little wonder, then, that his book became the manifesto for a country whose “chief business” President Coolidge had declared was “business”.
What Carnegie began has grown into a multi-billion a year “self-improvement” and “interpersonal skills” business. Millions of people have taken courses on dressing, speaking, walking, even sitting – that would be “your silent presence” – to hone in their selling skills.
The graduates have then gone on to quietly instill the culture with the values that they learned and internalized in the classrooms. In this way, the modus operandi of the salesmen has turned into the cultural trait of the society. When the modus operandi changes, the culture changes.
One main change in the past 40 years has been the intensified competition due to the falling rates of profit. That has made selling a far more stressful occupation than it was in the heydays of the U.S. industrial power. The salesman is under constant pressure to be more “productive”, meaning that he has to sell more in less time.
The ensuing stress has darkened his mood. The passive Willy Loman has given way to the obscenities-spewing, conniving and downright criminal salesmen of Mamet’s Glengarry Glen Ross.
In practical terms, efficiency squeeze has necessitated harsher sales tactics. One is that the prospective buyer has to be evaluated quickly: is he/she going to buy or not? There is no time to be wasted on those “just looking”. This could only be done visually, checking the prospective buyer’s car, clothes, shoes – in short, any outward signs of material wealth. Hence, the elevation of the visual and “first impression” above all else. Rorschach test is the “psychological” test of this culture in which the salesman constantly and quickly “sizes up” his prey ...
In this way, the reliance on the visual becomes the norm. The “visual art” rises.
Saturday, 12 December 2009
Here's how everything worked before the financial crisis/meltdown/blowup: A bank -- let's call it "Smitigroup" -- creates an off-balance sheet vehicle; let's give it a sexy name like "Xena." Here's what lil ol' Xena does: it borrows money by issuing short-term securities, then in effect lends money by buying longer-term securities. Now, if you're a Joe Blow reader who's wondering, "Exactly why does, ahem, Smitigroup, want to do this?," let's look at what's going on.
You make the short-term borrowing at say 2.8 percent, then you buy longer-term products at say 3.5 percent. Notice the "spread" between the two. Borrow a million for $28,000, buy a longer-dated asset (like, say, a security backed by mortgages from some fast-appreciating neighborhood of homes in south Florida) that pays $35,000 a year, and you're pocketing a cool $7,000 annually from the difference.
Rinse. Wash. Repeat. (As they say.)
Now, if you're financially savvy, you may be thinking, "Hey, that sounds kind of like what my bank does." And bingo -- you'd be right. Your bank basically "borrows" short term from its depositors (paying them a small amount for their funds) then lends long term (home and business loans). But there is a difference: the structured investment vehicle is more like an invisible bank; it doesn't show up on regulatory radar.
So let's return to that riveting question: Why does Smitigroup want to create an SIV? Well, one reason obviously: the potential profit. But why create the SIV off-balance sheet?
Yes, why oh why? Because Smitigroup operates under capital constraints and other regulations. It must have a certain amount of underlying capital to be able to expand its traditional banking operations. But here's the neat thing about its SIV: Smitigroup waves a magic wand and Xena takes shape and starts operating at arm's length from its creator, so that the business doesn't eat into Smitigroup's capital base. Meanwhile Xena funnels profits back to Smitigroup.
Hey! What's not to like?
But then, you have a liquidity seize up -- those long-term assets Xena is holding become worth less, no one wants to buy its short-term securities, and Xena begins to circle the bathtub drain at an increasingly frenetic clip. So, no problem for Smitigroup right? Smiti won't be on the hook.
Wrong. Suddenly you see the tractor beams appear. Smiti hoovers up Xena, moving the vehicle's operations onto its own books. So much for the fiction that Xena was "independent"!
This is the absurd crap -- sorry, crap is the most polite term I can think of -- that was allowed to persist in the financial industry. Now though, that may be changing, Floyd Norris of the NYT reports in a meandering column:
The issue is a couple of new accounting rules that are forcing banks to put back on their balance sheets some strange creations that bad accounting rules had allowed them to shunt aside in the past.Strange creations indeed! But as weird as these SIVs were, there was an even odder beast out there:
Bank holding companies have been allowed to issue something called “trust preferred securities.” The beauty of those securities was that they were really debt that the holding companies could call capital. Having that “capital” meant the bank could take on more debt. A system that lets a bank borrow more money because it has already borrowed money — rather than because it has sold stock — is hardly a wise one.Got that? As a bank, I'm supposed to hold capital against my assets (mostly loans). The more loans I make, the more the capital ratio shrinks toward my regulatory minimum. But a "trust preferred security" turns that equation upside down. As I make more loans, my capital ratio grows. Ain't bank accounting grand!
Broadly, such tricks fall under the rubric of "capital arbitrage." Ah, if only we could have seen these capital arbitrage tricks at the time. But zee banks, zey are so clever! It would take a man of almost unimaginable perspicacity and intelligence, a man possessing perhaps clairvoyance even, to divine the gravity of the game that was afoot ...
Or maybe not:
In Spain, some smaller banks are in trouble from real estate loans, but the big banks seem to have emerged in good shape. One reason is that Spanish regulators were not fooled by things like SIVs, and insisted that if any bank wanted to create one, it could, but would have to hold reserves anyway. Since there was no business reason — other than capital arbitrage — for a SIV, those banks shied away.Oh well. But at least the Financial Accounting Standards Board is finally getting around to sewing this loophole shut:
The FASB, in an attempt to save face and a degree of integrity, has pushed back on Wall Street by passing FAS 166 and 167 which would require investments in off-balance sheet vehicles to be brought on-balance sheet. The implementation of FAS 166 and 167 is imminent and would require financial institutions to set aside increased capital against selected assets.This seems like a no brainer, a slam dunk. But the banks are squealing, predictably, because they have been hiding operations off balance sheet for a while and are worried about the impact of bringing them back onto the books.
The fact that we're even having this discussion is ridiculous. We need a better regulatory regime. I think capital-based requirements in a rule-based system (See Basel, incarnations I and II, e.g.) may be an obsolete approach, especially in an information-rich age of high-speed computers and financial innovation galore. The banks, with an army of lawyers in tow, will always twist and limbo their way around the requirements.
There is a better way. I'll look at that later this week.
Friday, 11 December 2009
His main points are:
1. Everyone who's senior level on Obama's economic/Treasury team once worked for Robert Rubin, came from Citigroup, came from Goldman Sachs, or some combination of all three. It's rather sobering as he ticks off the names, one by one -- and ties them back to Rubin/Citi/Goldman. And we wonder why we get so much Samethink out of this White House on economic issues?
2. Banking lobbyists right now are busily gutting legislation that would add consumer protections for financial products and force stricter regulation and transparency for derivatives trading. They are of course abetted by our "elected" representatives, who probably should be required to wear logo-plastered jumpsuits, a la racecar drivers, to show which special interests (which major insurers, banks etc.) they really take their marching orders from.
3. Americans on the whole are too dumb to care that the financial sector is hardly being reformed at all, despite the fact financier misdeeds brought us last fall to the brink of Credit Armageddon.
What disappointed me about Taibbi's article was that he catalogs a familiar litany of crimes but doesn't try to answer the underlying question of his piece: Why did Obama sell out? What happened to "Change We Can Believe In?" Is Obama really just another empty suit politician? Did we, American voters, just get duped again?
Here are the possible explanations I have for why Obama sold out. Pick the one, or ones, you like or feel free to add your own in the comments section:
Obama really was a fraud, just like so many other politicians, willing to say whatever he had to to get elected. He has no principles.
Obama talks a good game -- he is a master rhetorician -- but his cojones are about the size of sesame seeds. He does believe in change, but in practice, he all too quickly defaults to dull compromise.
Obama remains very aware of his "blackness," and is so worried about seeming radical to White America that he tacked hard the other way, to the safety of the Wall Street moguls.
Obama to this day doesn't really understand how badly his team screwed up and how much they gave away to the banking interests; economics is his weak suit and he simply isn't very interested in it, preferring on that long flight to Pakistan to read the Urdu poets instead. And he really thinks that, over the long view of history, his team will be lauded for its courage and wisdom in how it tackled the financial mess, and not disparaged for failing to deal directly with so many problems that caused it.
The banking lobby basically does own our capital: they own the Senate, the House, and the White House too. Of course that includes owning Obama, who felt the sting when Wall Street moneybaggers began to tighten their pocketbooks and said they weren't going to donate as much funds to Democrats because of his constant bashing of their industry.
Wednesday, 9 December 2009
Yesterday I blogged that OPM ("Other People's Money") and IBG ("I'll Be Gone") were meta-reasons for the financial crisis. Of course that didn't quite square with part of the accepted storyline of the collapse: namely, as Bebchuk notes, "according to the standard narrative, the meltdown of Bear Stearns and Lehman Brothers largely wiped out the wealth of their top executives."
In which case, IBG thinking ("I'll Be Gone when this stinker of a product/strategy blows sky high") would have afflicted the junior traders, but not the senior leaders, it would appear. And, accordingly, one would expect a furious flurry of pay reform taking place now as angry CEOs, their wallets and their stock portfolios scorched once, vow to never let such an orgy of risk-taking ever occur again.
Except ... except ... the top brass apparently made out like bandits too. They were IBG beneficiaries, if not quite direct practitioners. From Bebchuk:
In 2000-07, the top five executives at Bear and Lehman pocketed cash bonuses exceeding $300m and $150m respectively (adjusted to 2009 dollars). Although the financial results on which bonus payments were based were sharply reversed in 2008, pay arrangements allowed executives to keep past bonuses.So you have those traders practicing IBG, and those supervising them who are incentivized to turn a blind eye to IBG.
Which leads us to the number of the day.
Chances of Wall Street spontaneously reforming compensation practices: approximately 0.
Tuesday, 8 December 2009
1. OPM ("Other People's Money)
What does it mean to make bets with other people's money? I think the answer is obvious. When I'm betting my house on an outcome, you can be assured that my thinking moves down a different decision tree than when I'm betting your house.
How was Wall Street betting with "Other People's Money"? Largely, this came about because of a shift in ownership models. The old wingtipped investment bankers worked at firms owned by partners. The oft-repeated joke about partners is that they live poor, but die rich. Their wealth is tied up in the worth of the firm. Under this type of model, you can bet that Wall Street CEOs over the past decade would have known exactly what types of risky wagers their traders were making each day. But they didn't.
Because they were using "Other People's Money."
"Other People's Money" is what you get from the new ownership model: becoming a public company. You sell shares to a vast swathe of investors, everyone from Aunt Edna to Fireman Joe's Pension Fund, to raise capital. And so when your company starts trading for itself in credit default swaps or liquidity puts, you as CEO don't risk losing your house if the bets go bad. You risk losing Aunt Edna's house. (Note: even with CEO "incentives" that try to align your pay with performance, you still tend to capture the upside of your company's gains and escape most of the pain of the losses.)
Big difference. And a slew of Wall Street banks went public in the 1980s and 1990s (Goldman was late to the party, making the jump in 1999).
Yves Smith at naked capitalism and the always incisive (and often acerbic) business journalist Michael Lewis have noted repeatedly the significance of changed ownership models, re: this financial crisis. And they're right: This constitutes a huge meta-reason for the meltdown. On top of all this, once you really start to leverage up other people's money, the danger of excessive risk-taking compounds fast.
2. IBG (I'll Be Gone)
If you were to use this in a sentence, it would sound something like: "IBG (I'll Be Gone) by the time that trading strategy blows up." The prevalence of short-term thinking -- trying to make the numbers for quarterly earnings reports to satisfy investors and analysts (that's a consequence of playing with "OPM;" you're always performing for the stockholders), trying to hit yearly targets for that fat bonus -- it all tends to focus the mind on the end of the money-seeking nose, and not much farther out.
"I'll Be Gone" actually represents the convergence of two bad trends: one, this short-term thinking that reflects in part the stunting of our attention spans, and two, the abdication of personal responsibility ("Hey, my trades went south? So they went south ... that's life, seeya.").
So think about it: if you've got a financial industry with a belief system centered around "get mine, get out, and use other people's money to do it" ... well, why are you surprised that a lot of big reckless bets were made and everyone got out with their bags of gold and no one's being prosecuted?
Tuesday, 1 December 2009
Why didn’t Treasury announce a more detailed proposal including a Fed role limited to bridge financing? Why didn’t the Fed require it as a condition for supplying “liquidity” to the capital-impaired AIG? Why didn’t the Fed require a commitment from Treasury to assume AIG assets it acquired subject to legislation being enacted? Why didn’t the Fed leave the responsibility for management of AIG with Treasury? Why did the Fed permit itself to be used as an off-balance sheet slush fund by Treasury? Why did the Fed permit itself to be put in a position wherein it would have to pay out public monies on behalf of a capital impaired-institution? Why did the Fed turn itself in to a political punching bag?Indeed. Why, why, why? Perhaps Bernanke's a leading academic economist, but he certainly lacks a Phd. in "cover your ass"-ology. He's the Gomer you get to sign all the room service bills during one of those crazy guys-go-wild weekends at some luxury hotel. He's the kid you hand the freshly lit stink bomb to, then say, "Listen, Ben, we have to duck outside for just a minute, but you just hold this thing, don't let it go, and we'll be right back. Promise." And earnest Ben says, "Sure, Hank. Sure, Tim."
Yup, Ben Bernanke's confirmation as Fed chairman is now in danger because it looks like he got played as a patsy. Bernanke let the Fed be drawn outside of its proper sphere of influence. It appears he got pushed and he didn't bother to push back.
If there's a lesson to be abstracted from this I'd say: any agency clueless enough to be duped by a bunch of Treasury bureaucrats, who were in turn duped by the Wall Street pros, shouldn't be christened "super regulator" of our entire financial system.
Monday, 30 November 2009
1. His kid-glove handling of the banks that caused the financial crisis. There was too much "please" and "if you don't mind" and mucho foot-dragging on reforming a broken system and rooting out wrongdoers. The president expressed a little outrage, maybe once or twice, then drew back into his shell. Meanwhile the government has handed over billions to the banking industry, very few strings attached, as unemployment soars. The perception on Main Street: the Obama administration is beholden to a plutocracy that really runs the U.S. of A.
There is much anger about the bailouts that's on a steady simmer right below the surface, I think. It will cripple Obama's future ability to be effective. Paul Krugman really nailed it with his recent op-ed piece pointing out the great tragedy in how the White House played patty cake with the bankers: our leaders have blown a load of credibility with the American public. Obama an agent for change? Yeah, right.
2. His ramping up of the war in Afghanistan. Public sentiment is already turning hard against this war. We're tired of wars in distant lands that half of us can't locate on a globe; we're tired of the burden they place on our groaning budget deficits; we're tired of the open-endedness of these conflicts.
Obama will buck popular opinion, it appears, by sending 30,000 more troops to Afghanistan. And we should all recognize that poker play: I call you and raise you 30,000 troops. This puts him 30,000 soldiers farther from extricating America from what will probably turn into a quagmire. I think it's a very dumb move from a very smart man. His decision puts me in mind of Hannah Arendt's wonderful book, "The March of Folly." Why do wise men persist in hopeless courses of action?
Anyway, before I get sidetracked too much, the central point: What do both of these blunders share? What's the common element? What weakness do they expose of Barack Obama -- by all accounts a highly intelligent man of a reflective nature, someone who can appreciate nuance, who has the native smarts to master any issue out there, no matter its complexity?
I would submit it's this: Obama has a weakness when it comes to bucking the system. He eagerly seeks compromise, tends to be conflict averse, and falls short on courage of conviction. With Wall Street, he didn't dare face down the banking industry. He expressed a little indignation and backed off. With the war in Afghanistan, he didn't dare to face down the military brass, who have sold him a bill of goods on what's achievable over there. He didn't want to be the guy who lost Afghanistan.
Someone might rebut: Well, what about health care? Someone who's wedded to the status quo wouldn't be trying to overhaul the health care system. That's true, and I think Obama dreams big. But look at how he's behaved with health care: He's introduced reform and made the soaring rhetorical speeches, then backed off to let Congress thrash out the actual bills. Public option? No public option? He's easy. Whatever.
Lyndon Johnson, by all accounts, was an arm twister. Barack Obama appears to be more a speechmaker -- and the words are starting to ring hollow.
Perhaps the question is too vague. So let me give a hint:
- after the collapse of the financial system in the U.S.;
- after the collapse of the financial system in the U.K.;
- after the collapse of the financial system in much of the Western Europe;
- after the collapse of the financial system in the Eastern Europe;
- after the collapse of the financial system in the emerging countries;
- after the collapse of the Russian economy in 1998;
- after the collapse of the Mexican economy in 1994;
- after the collapse of the financial system in Argentina in 2001;
- after the collapse of the “Asian” economies in 1998 – that would be Hong Kong, Indonesia, Malaysia, Singapore, Thailand, The Philippines, South Korea, Taiwan;
- after the economic and financial crisis in 1998 in Latin America – that would be Brazil, Argentina, Chile, Bolivia, Ecuador, Columbia, Uruguay;
- after the collapse of the Japanese economy that has been going on for almost two decades;
- after the protracted economic and financial crisis in Turkey in 1980s and 1990s and the 2000s that saw Turkish lira lose its value 1,000,000 times;
After all these crises, what should you conclude when you hear of the crisis in Dubai?
You must conclude that theses economic and financial crises cannot, by definition, be aberrations or exceptions. They are more like a natural phase of the system, the inevitable and necessary aspect of its operation.
That is the subject of the Vols. 4 and 5 of of Speculative Capital: the crisis as the “property” of the financial system currently in place in much of the world, with all the social, economic and financial implications that follow.
Saturday, 28 November 2009
So I offer up this article in US Banker (a little late, but it's been a hectic month): PPIP Finally Ready, But Who's Selling?
For me, the impact paragraph comes at the very end (bold mine):
Ron Glancz, a partner at Venable LLP who has clients with toxic assets, agreed. "It's not created a lot of stir," he says. "We have banks that have a lot of toxic assets, and they are not selling to PPIP. It doesn't deal with the fundamental problem that banks can't book these losses, because that's a depletion of capital."The official storyline is something rather different though. The Treasury Department claims that PPIP is no longer needed, as the economy has improved and major banks have been posting profits. But what's the truth? Here's a quick and dirty rundown:
1. Bank profitability: Well, duh. Banks were given much greater leeway in valuing their assets, back in April. If you can claim multiple pieces of junk worth 40 cents on the dollar are actually worth 80, that's going to boost profits considerably. That, and if you're a major bank, you get to borrow super-cheap from the Fed through an alphabet soup of lending facilities.
2. The economy has improved: The meaningful indicators, such as the rates for unemployment and foreclosures, as well as gauges of consumer sentiment, still look pretty grim. A less meaningful indicator -- the stock market -- of course shows an impressive little runup. Quarterly GDP made an expansionary spurt, but how much of that is temporary stimulus (Cash for Clunkers etc.)?
Which brings us to ...
3. Have the Fed's "cash for trash" emergency backstop programs sopped up a lot of the toxic securities: To me this is a really intriguing question. We know that "Helicopter Ben" is eager to flood the financial system with easy money. The Fed takes collateral from the major banks, and in exchange hands out good ol' dollar bills, usable anywhere. Talk about a jolt of liquidity!
Of course the Fed won't take any ol' piece of crap as collateral. It has to be rated AAA. But ... oops ... weren't Moody's et al rating practically everything AAA, even if it stunk to high heaven? Well, yeah. So one might wonder: how much "AAA" collateral is at the Federal Reserve, and what kind of assets does it represent, and who is it from? The answer: we don't know. The reason: the Fed refuses to tell us. We know that because Bloomberg is chasing the agency through the U.S. court system right now, seeking some details. And the Fed is stonewalling like crazy.
But here's an interesting question: How does the bank that has posted collateral at the Fed account for the value of that security on its books? Because, when you come right down to it, if "A" (the value of that security, as parked at the Fed and exchanged for good hard cash) exceeds "B" (what the bank can get for that security through a PPIP auction, even assuming there will be a little overpaying by the PPIP buyer), the bank will prefer to stick the money with the Fed. And PPIP will fail.
Of course the irony -- which one can spot from a good ways off -- is that the Fed, eager to restore liquidity and restart markets, is actually hampering the necessary clearing activity and proper restarting of the securities markets for dodgy assets, thanks to all its meddling. But then again, what's a good financial crisis without an abundance of irony?
Update: To be fair, I should note that lesser quality securities (below AAA) can be submitted for the PPIP auctions. So, obviously, a bank holding these lower-rated assets can't weigh "what is their value as collateral through the Fed vs. what is their value sold through PPIP"? The Fed, after all, only takes triple A (well, for what that's worth, and it would be interesting to know how much AAA the Fed has scooped up that has then been downgraded). But dodgier securities may not be great candidates for PPIP either, because they can be harder to value, and a bank may want to exploit this uncertainty by carrying them at inflated prices on its books (and conversely, because of the problem of adverse selection, PPIP bidders may penalize such securities, so it's a lose-lose for the bank). That may convince the bank to hold onto these assets and not risk having to do a writedown.
Thursday, 26 November 2009
(1) When did passengers turn into "customers"? I noticed this on the Continental flights I took. Had it been only one flight, I would have just written off the incident as someone on the flight crew remembering some half-digested bit of marketing political correctness. But this practice was apparently part of some memo because the "customers" references came up on different legs of my journey. "Customers, please be seated." "We thank our customers for flying with us." That sort of thing.
One thing you gotta understand about me: I love the English language. I love it on a number of levels, right down to the sound of words knocking together. Further, I believe in simple, direct, effective communication. I grit my teeth when corporate America keeps trying to put lip gloss on the fact that they're terminating workers. We have gone from "firings" to "layoffs" to "downsizing" to -- a particularly odiously bland term -- "rightsizing."
Who the hell came up with "rightsizing"? It sounds so laudable. As in: "We were wrongsized before, and when we realized this, we rightsized, and now as a company we feel soooo much better." Compare that to: "We just fired 200 workers." The trouble is, "rightsize," besides having that fuzzy feel-goodness of Newspeak, is maddeningly imprecise. "Rightsize" could mean that you added 200 workers, if your company felt it was too small. Or it could mean you opened another plant, or acquired a rival. I think there should be Useless Euphemism jars, like swear jars, for awful euphemisms. Every time a flack tells you his company "rightsized," he should have to put a buck in the Useless Euphemism jar.
But back to the customers sitting on the airplane, waiting an hour on the tarmac twice on delayed Continental flights (whoops, wrong peeve) ... why not just ditch the marketing PC and call us what we are, most accurately, in our current role? Maybe when we're buying the ticket at the counter, we deserve to be referred to as "customers." But once we're on the plane, we become passengers. There's no shame in that. And the word best reflects our role at that moment.
Say the plane smacks into the side of the mountain, killing 230 people aboard. When Continental holds a media conference on the disaster, are they going to say, "We lost 6 members of the flight crew and 224 customers."
Of course not.
(2) China, tear down this wall! By "this wall," I am referring to the Chinese firewall of censorship on the Internet. While on vacation, I looked forward to keeping current on my favorite blogs only to find the large blogging communities -- WordPress, blogger -- blocked.
Why? Because China, despite its emergence as a global power to be reckoned with, is still a politically immature country, its leaders fearful of independent thought, criticism and debate. As far as they are concerned, the state news service (Xinhua) tells its citizens what they need to know, with an appropriate viewpoint. "Question Authority" is not a fashionable slogan over there.
I'm not trying to China-bash here. Often the Chinese look at Westerners and protest, "You don't understand our country." And I respect that point of view. There is much that we don't understand. I think the U.S. makes its worst blunders abroad when it assumes that the yearnings in the hearts of our citizens are exactly the yearnings of men and women everywhere, and that what is good for our country must be good for any country. It is hubris bordering on madness to think that we can neatly and simply transplant a Jeffersonian democracy to the harsh sands of Iraq for example or to the desolate strife-torn mountainous region of Afghanistan. America would do better with a little more humility.
Yet -- yet -- at some kind of baseline, there should be principles that reasonable men can agree on that make for a better society. One is the open, independent, vigorous sharing of ideas and opinions, I strongly believe. In America, I think we have open and independent sharing, though its vigor has somewhat been sapped by a culture narcotized by entertainment. In China, they have none of the above. I wonder sometimes if they realize the cost.
There is a real cost in lost innovation, across so many spheres: not only economic, but social and cultural too. There is a cost as well in human development of one's citizens (I am sometimes surprised at the number of very smart Chinese I have met who are not particularly nuanced thinkers or debaters; they have never been taught to question and examine things). Then there is the most ludicrous of costs -- the tangible cost of repression: of maintaining the spy networks, of paying the censors' salaries, of having to constantly screen what is acceptable and not -- a cost akin to buying the bullet that you then use to shoot yourself in the foot.
I think China contains the seeds of greatness, but first must have the courage to let a thousand flowers bloom ... from within.
Thursday, 19 November 2009
My aim is not to offer a blow-by-blow critique of the speech. What I want to focus on, rather, is Dudley’s perspective, the way he sees things. I wrote about this seeing-things-through-the-eye-of-finance-capital in here and here. So the focus is not on Dudley. He is merely a Rumian part that adequately reflects the whole.
The technical description of markets and processes in the speech are generally accurate. But look at the circumlocution and the child-like narrative when the speaker explains the tri-party repo market.
In the case of the tri-party repo market, the stress on repo borrowers was exacerbated by the design of the underlying market infrastructure. In this market, investors provide cash each afternoon to dealers in the form of an overnight loan backed by securities collateral.These words are simultaneously convoluted and simplistic. When the speaker says that in the tri-party market “investors provide cash each afternoon to dealers in the form of an overnight loan backed by securities collateral”, it is as if a 5th-grader is explaining the market. And he has the order wrong. The drivers of the tri-party repo market are not investors who provide cash but the broker dealers who seek money to buy an asset that they themselves could not otherwise afford. If you miss this point, you will not understand the tri-party repo market.
Each morning, under normal circumstances, the two clearing banks that operate tri-party repo systems permit dealers to return the cash to their investors and to retake possession of their securities portfolios by overdrawing their accounts at the clearing banks. During the day, the clearing banks finance the dealers’ securities inventories.
Usually, this arrangement works well. However, when a securities dealer becomes troubled or is perceived to be troubled, the tri-party repo market can become unstable. In particular, if there is a material risk that a dealer could default during the day, the clearing bank may not want to return the cash to the tri-party investors in the morning because the bank does not want to risk being stuck with a very large collateralized exposure that could run into the hundreds of billions of dollars. Overnight investors, in turn, don’t want to be stuck with the collateral. So to avoid such an outcome, they may decide not to invest in the first place. These self-protective reactions on the part of the clearing banks and the investors can cause the tri-party funding mechanism to rapidly unravel. This dynamic explains the speed with which Bear Stearns lost funding as tri-party repo investors pulled away quickly.
The result was a widespread loss of confidence throughout the money market and interbank funding market. Investors became unwilling to lend even to institutions that they perceived to be solvent because of worries that others might not share the same opinion. Rollover risk—the risk that an investor’s funds might not be repaid in a timely way—became extremely high.
Dudley’s language reflects his thought process, the ways he see things. But the language is not only a passive reflector. It has an active, pernicious side as well: It hinders thinking by creating the impression that something new was told and learned while in fact nothing of the sort happened. So the real cause remains unexplored. Look at this explanation of the crisis:
At its most fundamental level, this crisis was caused by the rapid growth of the so-called shadow banking system over the past few decades and its remarkable collapse over the past two years.But why was there a remarkable growth of shadow banking? Why did it collapse? Mr. Dudley is giving as the explanation of the crisis the very things that he is called upon to explain.
With such muddled thinking, his “framework” to fix the problem naturally degenerates into a discussion of the “psychology” of lender and borrowers, as in this gem:
This second cause of liquidity runs—the risk of untimely repayment—is significant because it means that expectations about the behavior of others, or their “psychology”, can be important. This is a classic coordination problem. Even if a particular lender judges a firm to be solvent, it might decide not to lend to that firm for fear that others might not share the same assessment.This is the nonsense that he must have heard from some CEO or one his minions as the cause of the crisis.
I wrote about the role of the tri-party repo market in fermenting the crisis here and here. Read them to see why I emphasize, and mean by, the perspective, the “angle of vision on reality”; it liberates the language and allows for imparting knowledge.
On the larger question of the cause of crisis, I have already pointed out that only two issues matter: the structure of the financial system which develops naturally and could be said to be imposed onto the system, and the fall in the value of the securities due to the transformation of values to prices. Most of this blog has been about the first issue. The question of transformation I will take up in Vols. 4 and 5 of Speculative Capital.
Wednesday, 11 November 2009
Lately, Wall Street's head honchos have opened up a bit more, even going on "charm" offensives. And now, you understand why they were silent before. Because these guys radiate arrogance, even when they think they're striking a humble pose. You have Lord Blankfein over at Goldman Sachs, telling us the firm is doing God's work (shades of noblesse oblige) and that a certain amount of income inequality just has to be tolerated.
And then you have AIG's Robert Benmosche, who's threatening to walk off the job after only three months. I love the brutal Huffington Post headline and subhead:
AIG Chief Threatening to Jump Yacht
New CEO Benmosche Spent First Two Weeks on Job Vacationing on the Adriatic ... Now Claims He's Done, Angry About Pay Restrictions
(Note: the pictured yacht is not his, I suspect -- it appears far too small.)
Okay, Benmosche -- who I have yet to see a photograph of, but I imagine most images portray him with foot lodged firmly in mouth, as that's where it appears to have been since his hiring -- is fuming about pay restrictions on AIG executives. Remember, AIG was on the brink of self-immolation last fall when the U.S. government discovered that the company was actually a hedge fund grafted atop a sedate-looking insurer, and was about to go up in flames in a very messy way. And so the government (using our taxpayer dollars) interceded.
So now the U.S. government has the audacity to make rules about how the top executives are compensated, which has a funny sort of logic about it because we own the damn company. AIG is a ward of the state: we purchased four-fifths of this wrong-way bet colossus. Of course we have a say. Don't sell me a hair-covered lollipop then tell me I can't clean it up.
And the top 25 executives at AIG are being forced to work at starvation wages. Anyone want to guess what their annual salary is capped at? $100,000 a year? Well, no -- not that starvation. Any self-respecting AIG top executive is still going to have golf club dues and such. We can't airbrush all that away. Okay, then $200,000 a year? Nah, not that bad. $300,000 a year? Oops, not that low. Not even what the U.S. president makes: $400,000 a year.
Here's the answer: Benmosche is bitching because he can't pay them more than $500,000. By the way, how rich are you if you make a cool half a million? Check this out: you happen to be the richest 107,565th person on the planet. No, actually, you're even richer than that, because the Global Rich List calculator tops out at 107,565 at $201,000 of income. So let's just say you're pretty stinkin' well off.
Benmosche, by throwing a hissy fit about the inability to lavishly compensate his key executives, is displaying a level of Tin Ear-edness that may just win him top honors this year. Since he has no clue about how to run a company without a fat-salaried caste of big bosses, I hereby offer up a few bits of advice (free, because I know he's on a, ahem, budget these days).
1. Grow your own executives, dammit. Surely there are people -- strivers; check the backs of their co-workers for claw marks -- within the relevant divisions, at lower levels, who dream of running the world someday. They're probably not happy with their pittance salaries of $250,000 to $300,000. $500,000 would be a big salary bump. Find them. Mentor them. Put them in place.
2. Split job responsibilities. Okay, if you can't find one guy to run your fire insurance or whatever division for $500,000, find two guys. Better yet, find two women. And a couple of minorities to boot. Use this as an opportunity to introduce a few new faces and spread duties a bit more widely. Checks and balances, right? Maybe, next time, Betty will say to Financial Products co-head Flo Bassano, "Hey, do you really think we ought to be loaded up with so many of these darn CDS things? They look sort of volatile."
In short, be creative. And for God's sake, talk to your PR department. They may, in so many words, tell you what the rest of the world wants to: Stop yer bitchin'.
Tuesday, 10 November 2009
How do you think, in such a world, air would be "regulated"? With the same light hand we would use for regulating the sale of frivolous items, such as lawn gnomes and chia pets? Ah, dumb question. Of course not. Air would be the most regulated commodity mankind has ever known. There would be frequent quality checks for air contamination, strict rules about pipes that carried the critical air supply, regulations about every aspect of the portable air tanks that we depended on.
Why? Simple. Without air, we die. This is a life and death matter.
Abstractable principle: the amount of regulation appropriate for an activity (or commodity, or whatever) should be in some direct proportion to how vital it is. Without breathable air, the entire human race perishes. So clearly, there will arise a lot of rules surrounding the proper reserves of air, how it will be supplied to the population at large, what quality is acceptable, and so on.
By this same argument, Goldman Sachs CEO Lloyd Blankfein believes that the financial industry should be heavily regulated. Because, well, it is the vital lifeblood for our economy. Credit is the "air" that businesses, large and small, need to survive. If you don't believe me, here he is, hotly telling a reporter that you can't compare bonus-seeking bankers to coal miners striking for better wages in the 1970s. Because the bankers happen to be involved in something much, much more important:
"I’ve got news for you," he shoots back, eyes narrowing. "If the financial system goes down, our business is going down and, trust me, yours and everyone else’s is going down, too."Sounds pretty grim. Sounds like an industry that's really, really vital to our economic health. Sounds like a pretty convincing argument for a new, much more intrusive, regulatory regime. U.S. Congress, all you guys have to do is connect the dots for Mr. Blankfein now. He's made the argument for you.
Saturday, 7 November 2009
Still, that blog entry dropped to second place on my "must read" list after I found this, over at naked capitalism: First, Let's Kill all the Credit Default Swaps. Yves Smith, who has gotten pretty smart about CDS products while researching and writing her soon-to-be-released book related to the financial crisis, says:
Credit default swaps have no redeeming social value. They are a fee machine for Wall Street and their supposed value is considerably overstated (the world pre credit default swaps functioned perfectly well) and their costs, which are considerable, are not given the attention they warrant.She lists their sins, including their "anti-social" nature. A credit default swap, remember, is basically insurance in case bad stuff happens to a company and renders its bonds worthless or impaired. When you buy this protection though, the only way to cash in is for the bad stuff (a so-called "credit event") to occur. So, like cash-strapped homeowners who have a tendency to play with flames around heavily insured items, a holder of say an IBM credit default swap might prefer that the computer maker declare bankruptcy (a triggering credit event) rather than restructure its debt -- even if restructuring the debt is a smarter move for the company that in the end does more economic good.
Yves also notes that simply moving credit default swaps onto an exchange may simply create a "too big to fail" exchange -- and not extricate us from this mess at all. It's a good point and indicates that the CDS may be too neutron-bomblike to allow in the financial arsenal of weapons.
A casual observer might wonder about this. After all, a CDS is basically insurance, and we have well-capitalized insurers that do just fine. Well, first the insurance industry is well-regulated, unlike the CDS market, but even if the swaps were highly regulated they differ from standard insurance in two big, troubling ways:
1. Unlike with, say, home insurance, you can buy a CDS repeatedly for the same bond. This would be the equivalent of being able to insure someone's house, say, 50 times over -- or even more. Further, you don't have to have any underlying ownership interest whatsoever in the insured bond. So this is a perfect tool for highly leveraged, out-of-control speculation.
2. You can set aside a stockpile of reserves for insurance more effectively, because correlations are weaker. A national insurer may suffer losses from a hurricane in Florida, but chances are good that its claims elsewhere in the country will run at about the same pace as usual (the probabilities of damage events occurring at separate locations, over a wide enough area, are uncorrelated). That makes it easier to absorb the loss from the hurricane. Unfortunately, when the economy tanks, bankruptcies rise in all sectors. It's like a hurricane that sweeps the length and breadth of the U.S. What's worse, with a credit default swap, the hurricane can strengthen off its own destruction, like some evil black hole that becomes more powerful as it draws in more matter. Namely: as we saw in this last crisis, collateral requirements against credit default swaps start to suck liquidity out of the system as the credit markets spiral downward, which in turn exacerbates the plunge.
I don't think our lawmakers are brave enough to try to get rid of credit default swaps, but I find it interesting that a fair number of smart people who know how these products work, in an intricate way, are suggesting such a thing.
Thursday, 5 November 2009
What put me in mind of this subject: this paper over at Zero Hedge, allegedly by a "Nathan Jerome Burchfield," that claims the Fed may have accepted crappy CMBS (commercial mortgage-backed security) collateral against loans it made. This occurred through the TALF, or the Term Asset-Backed Securities Facility. And then, after the Fed accepted this stuff as top notch collateral (AAA rated, creme de la creme), the ratings agencies -- interestingly enough -- turned around and downgraded the products.
I'll get to that oddity in a second, but first, let's pause for a moment to look at where we are in this financial mess. Ostensibly, things are going pretty well -- the troubled credit markets seem to have taken a magic calming pill -- but if you whisk back the curtain (which few Americans are inclined to do), you are treated to a crutch-like monstrosity of money-rigged supports that brings to mind that old poster "Building a Rainbow." It's hard to tell what asset prices for securities are really worth, because the Fed is swallowing them up at an astonishing rate, as long as they're bearing a AAA rating from one or two of our not-very-trustworthy credit raters. The securities (most likely generously graded) are accepted by the Fed as collateral, giving them value that they ordinarily would not have. So you give the Fed these "AAA" securities, it gives you dollar bills in exchange -- yee hah! -- then sits on your collateral.
But what's this collateral really worth? And what happens when the Fed takes collateral that then is downgraded to something less desirable -- to a rating that the Fed wouldn't have accepted in the first place?
If the Fed were smart, like say Goldman Sachs -- believe you me, it would start hoovering up more collateral, or insist on $x dollars to compensate for the downgrade. But remember: the Fed's agenda is less about protecting the taxpayer than about invisibly bailing out Wall Street. In fact, a critic might even wonder if the Fed, the credit agencies and the holders of the CMBS have in some way colluded so that the ratings hit occurs only AFTER the Fed accepts the securities. That way, the CMBS owner has already got his cash -- bye bye, so long sucker.
Certainly, at the very least, the Fed seems like the "mark" in the "market" these days. Consider: the Fed announces that, starting in July, it will accept CMBS as collateral ... meanwhile, everyone has been predicting all year that commercial real estate will be the next market to fall flat on its face. So the Fed has accumulated billions in CMBS collateral -- I think the latest figure is $6 billion -- in a sector that's prime for collapse. Dumb or really dumb?
A true-blue capitalist might argue that this is precisely the kind of sector the Fed should avoid -- let the upheaval come, the prices drop, the readjustment occur. Let the free market sort out things. But the Fed, gently intervening through its invisible bailout, helps keep asset prices artificially high.
Outraged about this example? Save some outrage. The Fed is rife with lending programs like TALF. The organization's balance sheet has become an alphabet soup of crutch-supports. And these programs have gotten pretty darn fat. Anyone recall this Yves Smith blog entry, Term Auction Facility: Confirmation of Financial Stress?, from Feb. 19, 2008 (the bold is mine)? God, seems like a lifetime ago huh?
To give a quick overview of the TAF: it was launched December 17, with two $20 billion actions, one for 28 days (the one conducted on the 17th) and a second for the 20th for 35 days. The reason for the program was that the gap between the Fed funds rate and interbank rates had become very large, suggesting that banks were reluctant to lend to each other. That was even more acute in December, since banks customarily curtail their short term lending then so they can tidy up their books for year end.
We’ve called the TAF a discount window without stigma (and in fact, the Fed implemented the TAF because banks weren’t using the discount window even when they should have). Banks can post a wide range of collateral, borrow on a non-disclosed basis, and can hold on to the cash for a while (by contrast, the discount window is overnight)
And what would you expect when you allow "a wide range of collateral"? Probably a rapidly expanding program, as banks shovel in all sorts of junk and get dollars in return. And sure enough:
The Financial Times today raises some concerns, noting that banks are indeed using the TAF to use crappy collateral for borrowing.
And note that, with no announcement I can recall, the facility has been increased to $50 billion even though the year end crunch has passed. That too is not a good sign.
So whatever happened to good 'ol TAF? By the end of June of this year, the Fed said that the value of collateral pledged through TAF was $1,570 billion (edit: actually, to be fair, only $899 billion of that was against current loans). Big, bad and bloated.
And so, the larger questions: where does all this massive intervention end? Does the Fed really think there's an easy way to just quietly and painlessly withdraw such huge levels of support? And what if that collateral turns out to be worth not very much? Who's stuck with the tab?
Wednesday, 4 November 2009
A couple of weeks ago, The New York Times had an interview with William Clay Ford Jr., “perhaps the most seasoned auto executive in Detroit.” He has more than 30 years on the job at Ford Motor Company which was founded by his great grandfather. He is presently the executive chairman of the board. A Q&A and the follow-up went as follows:
Q: Is the financial support given by taxpayers to G.M. and Chrysler a positive development for the American economy?The interview was published in a special section about cars and not in the business section.
A: The biggest concern that we had all through this was the collapse of the supply base. I believe that if G.M. and Chrysler had gone into free-fall bankruptcies, it could have devastated the entire industrial base of this country.
Q: Does the average American value the domestic auto industry?
A: They should. One cannot find a healthy economy anywhere in the world that does not have a strong industrial base, period. We seem to be the only country in the world that doesn't strongly value that. Everywhere else Ford does business in the world the government and people understand it, and do everything they can to enhance it. The notion that we can just simply become an information-age data provider as a nation is ludicrous.
If I were conducting the interview, I would note that Ford Jr. was lamenting the lack of an industrial policy, although he did not dare/care/want to mention that phrase. I would also note that he was lamenting the lack of an industrial policy the way one would lament the lack of, say, good beaches in the country.
I would gently push him on the subject, encouraging him to continue with his thoughts.
“Mr. Ford”, I would ask, “as a high ranking executive of Ford Motor Company and a powerful business executive, your views carry tremendous weight on the subject of manufacturing. You have the ear of every Fortune 500 executive and every policymaker in this country, including the president of the U.S. Since you maintain that without an industrial policy a nation is doomed, “period”, why is it that you have not pushed for the creation and adoption of just such a policy? More importantly, given the critical role of such policy, one would expect it to be the playbook of the business and the government activities. But it is not. Who and what stand in the way? Please take your time.”
I would then go to Larry Summers, the wunderkind working from the While House, and ask him the flip side of the question.
“Dr. Summers”, I’d ask. “The Wall Street Journal of February 13, 1998 carried an incredible news story on page A2 pertaining to your testimony in front of a congressional committee in the context of the Asian financial crisis that was then raging. Here is what you said:
There has been more progress in scaling back the industrial policy programs in these countries in the last several months than there has been in a decade or more of negotiations.“In your testimony, you expressed satisfaction at the scaling back, or even the destruction of, the industrial policies in Asian countries. Is it now or has it ever been the policy of the U.S. to dismantle the industrial policies anywhere it finds them, including within the U.S.? If so, how and where is this policy set? If there is no coordinated opposition, why do you think that there has not been any such policy despite the conviction of manufacturing executives that it is absolutely needed?”
These are the questions I would ask if I were a financial journalist.
Sunday, 1 November 2009
Answering that question has become a hot niche topic for debate. The latest contribution by William Sterling is here: Looking Back at Lehman. It's a rather tedious read, so I'll just cut to the chase:
In contrast to the analysis of Lehman skeptics such as John Taylor (2008, 2009) and John Cochrane and Luigi Zingales (2009), the evidence we present supports the view of many practitioners that the decision not to rescue Lehman represented an immediate and massive shock to the financial system that was larger by an order of magnitude than anything seen over nearly two decades.First, if you examine the day-by-day, blow-by-blow data, I think it's obvious that the Lehman bankruptcy did matter hugely. But if you look at the larger picture, I don't think Lehman mattered much at all. The long historical view: we were poised on the tip of a teetering Seussian-type credit edifice, creaking with hidden risk and towering with high leverage. It was bound to collapse in an ugly way sooner or later.
The "micro" analyses that focus on how the credit markets reacted in the immediate aftermath of Lehman's collapse largely miss the point. Which is: Lehman's failure revealed the Seussian-type credit edifice in all its terrifying precariousness for the first time. There were at least two big problems that came to the forefront with Lehman:
1. The shadow banking system was shown to be extremely fragile.
First, check out this primer on shadow banking; it's what I consider a great introduction to the subject. It's an interview between Mike Konczal (the creator of the always-smart Rortybomb blog) and a Barnard College professor, Perry Mehrling.
Shadow banking was (still is, I imagine) HUGE. This MarketWatch story claims that the shadow banking system had $10 TRILLION in assets in early 2007, making it the same size as the traditional banking system. Just ponder that for a second. That's a tremendous amount of money sloshing about that's meeting demand for funds in the economy, while doing so outside of the reach of regulators.
Big brokers such as -- ta da -- Lehman Brothers were supposedly the largest players in the shadow bank network. How does shadow banking work? An investment bank such as Lehman arranges to sell some securities to what we'll call a "pseudo-bank", then buy them back say a day later for more money (that extra bit of money providing an interest rate on funds, if you will, for the lender). James Kwak at Baseline Scenario breaks it down well here.
Those securities may be AAA-rated, making them appear pretty safe. That's important because the pseudo-bank has to juggle two risks here: (1) That it will get stuck with the securities (2) That, if it is stuck with them, it will have to make enough money selling them to be made whole. Who are the pseudo-banks? Largely, it appears, money market mutual funds swimming in cash, looking for better yields.
So Lehman gets to de facto borrow against high-rated securities (that serve as collateral). Once this collateral looks suspect, or Lehman begins to falter financially, the mutual fund may refuse to "roll over" the buy-resell contract. Then, since these are very short-term agreements, Lehman can very quickly find itself pretty much screwed, unable to raise money that it desperately needs.
Which is what happened when Lehman stumbled. Its financial footing was rapidly whisked away and, because this is a "shadow" banking system, there was nowhere to turn for emergency liquidity (see Mike at Rortybomb for a longer discussion of this gaping weakness).
Now, if you're a pseudo-bank providing funds to this shadow banking system, and you observe Lehman staggering about, badly wounded, what do you think? It's not, "Well, that must be a problem isolated to Lehman." No, it's more like, "Holy crap, almost any of these investment banks could be in similarly rough shape, and how do I know these 'AAA' securities are really worth as much as anyone says."
Meanwhile, the U.S. government begins to realize that it can't let all the investment banks go belly up, en masse, because the Lehmans and Morgan Stanleys have got a million tentacles reaching into many corners of the global financial system, such as through their derivative operations. These guys have been at ground zero in the efforts to launder risk.
So Lehman's failure was about more than Lehman. I think we could've rushed in and bailed out Lehman, sure, but eventually the sprawling, frail shadow banking system would have blown up somewhere else.
2. Lehman was shown to be worth a lot less than it claimed, further scaring the hell out of everyone. Everyone starts to wonder, "How solid are the counterparties I'm doing business with?"; nervousness sets in; credit flow ices over.
September 15, Lehman Brothers Holdings says it will file for bankruptcy. It cites bank debt of $613 billion, $155 billion in bond debt, and assets worth $639 billion. Doesn't sound too bad huh? Assets of $639 billion, liabilities of $768 billion?
Now take a guess how much Lehman's bondholders recovered on the dollar. 50 cents? 40 cents?
Recovery rates for defaulted bonds have declined in the U.S., true. Moody's said they fell, on average, from 61.8 percent on senior unsecured bonds in 2007 to 33 percent in 2008. But Lehman bonds crapped out spectacularly. They fetched less than 10 cents on the dollar. That's pretty awful.
So there you have it.
Here's my takeaway point: Lehman's bankruptcy was a proximate cause of the credit freeze, but that doesn't necessarily mean rescuing Lehman would have been the wise thing to do. Perhaps if we had saved Lehman, that would have only delayed the breakdown of the financial markets to the fall of 2009, and it would have been twice as bad.
I worry about the "No More Lehmans" crowd because they're the ideological heirs of "Bailout Nation," the hopeless model of propping up Too Big To Fail banks. And I'm concerned they don't even seem to realize it.
Thursday, 29 October 2009
First, a disclaimer on my recommendation for this Huffington Post investigation: a version of this story has been done before; it's not exactly anything new. To wit: Moody's and friends like to scurry behind the First Amendment when outraged investors seek recompense for losses after believing their inflated ratings.
I know the argument the credit raters are trying to make, but it always has offended me somewhat. You think of the great figures of American history who have invoked the First Amendment, and how it has been this core, unassailable principle that makes our democracy so powerful. And then Moody's ... well, subverts it to this end. I suppose my reaction is akin to the reaction you'd expect from a Fox commentator who discovered footage of a beatnik casually wiping his butt with the American flag.
For now the lesson we must learn is to treat the credit-rating agencies as untrustworthy, unfortunately, as they consider their ratings to be basically on par with an opinion column in a NAMBLA newsletter. It's all just free speech, right? But remember what motivates their "free speech." They can in effect "sell" good ratings, as they are paid by the company that issues the product they're rating.
Even if prostitution is deemed legal (as it is in some places), a whore is a whore is a whore. To some degree, credit-rating agencies will continue to be whores (or have pronounced whore-like tendencies, at the least) as long as they are paid by the people whose products they're judging. So investors, caveat emptor.
2. Naming Systemically Dangerous Firms
This guest post by David Moss at The Baseline Scenario left me clutching my head and moaning. Apparently the systemic risk legislation for the financial industry that's beginning to wend its way through Congress would identify "Too Big to Fail" institutions and then NOT make their names public. The stated reason: identifying them would encourage "moral hazard."
No. No. No. No. No. (Draw picture of me here, repeatedly banging my head against a brick wall.)
Sometimes I wonder what kind of chowderheads we have drafting laws in this country (actually, I should know by now: they're not the men and women we elected; they're the lobbyists that paid for their campaigns). Assuming that we decide to allow "Too Big to Fail" institutions to exist (believe me, there are many Americans who question the wisdom of this), why the hell should we keep their identities in the closet? Remember, one big pillar on which regulatory reform needs to be built:
One more time:
The truth is, there will be enough leaking of this "Too Big to Fail" list that plenty of people will know who's on it. The market will make adjustments; you'll get your damn moral hazard anyway. What you may not get is the open and vigorous debate that we need about the TBTF's that appear on the list. Any bank that merits a Too Big to Fail should be regulated within an inch of its life, like a common utility. And it should be watched really, really closely, because when it blows up, it can blow a gaping hole in the side of the good ship the U.S. Economy.
And for all of us to be super-vigilant about these Too Big to Fails, we all need to know who they are.
"Too Big to Fail" shouldn't be some neat little merit badge you get at a moonlit ceremony in the heart of the dark woods. It needs to be a stamp, hopefully more akin to a scarlet letter, that gets planted on your forehead in full view of the public (which has to pay for your Too Big to Fail-ness, if you do screw up, so believe me, there's plenty of justice here).