Friday, 29 May 2009

As Transparent as a Cesspool

This Huffington Post piece, "Accountants, Washington Helping Banks Fluff Profits," illustrates why it's so frustrating to watch this financial crisis play out, day after day.

We need greater transparency in the financial system. Nobody -- right, left, center, right of center, left of center, center of right of left of center -- contests that. Nobody has said, "What we need in America are more off-balance-sheet vehicles, derivatives traded in back alleys, murky accounting rules, hard-to-understand securitizations."

If we need more light, we do we keep embracing the darkness? I don't get it.

And if you don't like "mark-to-market rules" (accounting standards that value an asset on a company's books according to what it's worth at that moment, freely traded), then what do you like? Mark-to-whatever-you-feel-like-it rules (these by the way, in their more reputable guise, are known as "mark to model")?

If you're an accountant, the nice thing about a financial asset should be that it's not a friggin' puppy. It doesn't have sentimental value. That CMBS in the back room isn't worth $5 million to me but $10 million to you because you like its big brown eyes and curly cashmere-soft coat.

At day's end (so to speak), it pays out X dollars, and that's what matters. That's how the market prices it. If you claim it's worth $10 million, but Joe Investor will give you only $5 million, but it IS really worth $10 million (assuming reasonable rates of return), guess what? Fred Investor will step in and give you $9.7 million say, recognizing a good deal when he can get one.

But if you can't get anything near $10 million, for God's sake, don't turn purple and start throwing your paperweights around the office, swearing about those "damn accounting rules." I know in America it's always in fashion to blame someone else, not yourself. But in this case, you really need to man up. If you're holding a stinkbomb, deal with it honestly, instead of trying to bend every accounting rule in sight.

Thursday, 28 May 2009

PPIP Deathwatch, May 28 Installment

More evidence, this in the Wall Street Journal, that Geithner's plan to purchase toxic assets from the major banks is hitting the skids: Plan to Buy Banks' Bad Loans Founders.

To be fair, this is only one piece of the public-private partnership effort to buy bank assets through a competitive bidding process. PPIP provides a mechanism for banks to dispose of both (1) loans (the article above) and (2) securities. The Treasury, in charge of the securities auctions, assures us that it's still going full-steam ahead.

Honestly though, I doubt the Treasury's earnest intentions will matter much. The banks will pull out the sharp knives, when Geithner isn't looking, and skewer him. They don't want to sell their impaired loans, their impaired securities, their impaired nothin'. The banks don't want to sell any of this crap at anything near a market price because, to maintain the fiction of solvency, they have to keep pretending it's worth more than its real value.

And what the banks want in this crisis, the banks get. The Obama Team feels most comfortable bullying Detroit and pandering to Wall Street.

Wednesday, 27 May 2009

Mr. Greenspan, Surely You Jest

Jaw dropper of the morning ... did anyone else see this quote below? It was in a Washington Post article on Brooksley Born, the smart lady who was ostracized by Washington's high-powered financial regulators after she (presciently) warned that unregulated derivatives could lead to a huge financial mess:

Greenspan had an unusual take on market fraud, Born recounted: "He explained there wasn't a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him."

Wow. I am just flabbergasted, bumbleboozled, speechless beyond the reach of the confines of the English language. I have one comment: Is Alan Greenspan seriously this stupid? I know he's an unrepentant Ayn Rand acolyte, but ... but ... oh my God.

This reminds me of that line about chimpanzees: sure they may look like cute pets; just remember you're getting an ape who can bend steel but who has the intelligence of a five-year-old. Or in Greenspan's case: sure he may look like a cute Federal Reserve chairman (in the right light); just remember you're getting an ape who can cause markets to tumble with the snap of his fingers but who has the wisdom of a four-year-old.

Tuesday, 26 May 2009

The Interest Rate Problem of the Federal Reserve

The “Bond Fears” in today’s Financial Times could be the epilogue to my 3-part series on the international monetary relations. (I do not provide a link because you need to subscribe to FT to read this particular article.) After pointing out that the yield on 10-year treasuries had gone up 26 basis points in two day, the article asks:
What’s going on? The fall in equities is scary but comprehensible. Not so with the bond sell-off … Fixed-income investors are now genuinely bewildered. The long-term trend, the latest inflation data, not to mention the experience in Japan, all point to lower yields. Buying by the Fed is another reason to favour bonds. But this latest sell-off, taken alongside the weakness of the dollar, suggests something far more terrifying is causing sleepless nights.
What is going on is this: The Fed is trying to resolve an economic crisis by means of technical maneuvers. Whether this is due to an “invincible faith in oneself”, a profound ignorance of economic relations or the absence of any other policy option, matters not. The result is the same. The bond yields are going up (and bond prices down) when the opposite is supposed to happen. That is how you know a force more powerful than the Fed’s is at work.

I will return with more on this.

Monday, 25 May 2009

How the Mighty Have Fallen

Alan Greenspan, Master of Snark? The former chairman of the Federal Reserve, whose most trivial utterances were once closely parsed for larger meaning ("Greenspan said some of the cherry trees on his drive to work seemed to be blooming later than usual this year? ... Sell Treasuries! Sell! Sell! Sell!"), appears to have been reduced to ankle-sniping. Richard Posner said he received an e-mail from the Once Great One, complaining about Posner's "rather thin analysis of the source of the current financial crisis."

Follow the link above to read the whole thing. If you want to save yourself some time, here's the version in a nutshell's nutshell:

Greenspan: My monetary policy not to blame for housing bubble; Fed sets only short-term rates which we did raise; trouble is long-term rates on mortgages stayed low and pumped the bubble because the damn Asians were saving too much. Posner: short-term rates do influence long term, the Asians be damned; in any event many homeowners weren't taking out fixed-rate mortgages anyway but rather ARMs, which do track short-term rates, so there.

If I were a ringside judge, I'd give the bout to Posner. Maybe not an outright knockout -- Greenspan lands a light punch to the chin. But that's not the larger point. What I wanted to underscore was what a weird place we've come to in this financial crisis. In the good old days, a surly Greenspan wouldn't have been e-mailing his critics. He towered above all that. He was, well, you know, ALAN FREAKIN' GREENSPAN. He didn't send e-mails to Atlantic magazine writers who run blogs by names such as "The Daily Dish."

Of course now that Greenspan has shown that he's not above chasing heckling fans into the stands, I want to throw down the gauntlet too. That's right, I too want to mix it up with Greenspan. So let's get it on, big guy!

Yep, "Mr." "Greenspan", I too think you SCREWED UP, BIG TIME. Enough namby pamby excuses. Blame the Asians huh? Oh right, the Asians prevented you from regulating the mortgage companies that ran amok. And was that an Asian standing offstage, training a gun on you, warning you to make soothing statements about the housing market or Andrea Mitchell would be dog meat by dawn? Let's see, you warned us about a housing bubble, about, uh, ZERO times?

Okay Greenspan, let's have your best shot. I've cleared out my comment section just for you. Finance Guy awaits your reply. I say what Posner said, only double! Plus I say what I said too! Come on, ya big lug. Take a swing.

Sunday, 24 May 2009

An Analysis of International Monetary Relations – Part 3: Where We Are Going

Hegel famously said that history repeats itself. Marx equally famously said that Hegel should have added: first time as a tragedy, the second time as a farce. Marx should have been more precise. History does not repeat itself only twice. It constantly “repeats” itself, each time at a qualitatively higher plane, corresponding to a progressively more developed stage of the society’s productive forces. Tragedy and farce are always present, farce being a tragedy brought on by the ignorance of self-assured men. That is why Hegel characterized the “invincible faith in oneself” as the chief quality of a comic character. As the societies advance, farce becomes more pronounced because the contradictions become more intensified.


This is an important point which I will take up in detail in Vol. 5 of Speculative Capital. Here, let me try to explain it with an example.

Take Holbein’s oil painting, The Ambassadors, which is a signature art work of the dawn of Capitalism.

What makes this 1533 work so contemporary is the pose and confident gaze of the two characters “at the camera”. The men stand next to the various artifacts – the “stuff”, in modern language – that represent wealth. But this is not the fixed wealth of old social orders. It is a dynamic wealth associated with international commerce – look at the globe and navigation equipment – and ultimately, the power of money. We are way past the barter trader here.

Except for the “distorted” skull in the foreground that was a common code then for the life’s transitory nature, there is no hint of irony in this painting. It is a serious work, as indicated by its title.

Now, look at the 1999 cover of Time Magazine in which Rubin, Greenspan and Summers are introduced as the saviors of the world.

This, too, is a serious picture; it could not be otherwise, portraying the three most eminent men of finance in the U.S. government on the cover of a prestigious weekly.

Yet, there is a teasing of sorts going on here. The caption – three men saving the world – is the deliberately exaggerated language of advertisers, like saying that BMW is the ultimate driving machine. It is an ad blurb that a modern reader is expected to recognize. The picture’s background, unlike in The Ambassadors, is austere. In fact, there is no background to speak of. The close-up shot merely makes Greenspan look like a three-headed hydra, albeit a smiling and friendly one. Heads contain brains, intelligence and ideas. All three men are closely associated with the globalization. And all three are at the pinnacle of power and prestige. That is what the picture is selling: the idea of the finance capital as the all-powerful savior of the world.

Of course, the reader does not quite buy that suggestion, in the same way that he does not believe a BMW is the ultimate driving machine even when he owns one. Neither do our “saviors”. Yet, the idea is pushed in earnest. That is a setup for farce. Rubin and Greenspan signal it by their grin; the celebrated genius Summers, by his discomfort and embarrassment at taking part in it.


The instigators a social farce are not harmless clowns. Charlie Chaplin understood this important point. His clowns make you laugh but he never allows you to forget that the buffoon who is amusing you is perfectly capable of doing serious harm. The word farce has a social connotation.


As a result of what has transpired in economic and financial relations between the countries in the past 30 odd years, Chinese are holding just under $2 trillion of USD-denominated assets, with half of that invested in the U.S. treasuries and agencies. These are the liabilities of the U.S. government, and the ability of the U.S. to extinguish them in such a way that Chinese and other creditors would not suffer is now the central issue of international finance.

On the surface, this circumstance appears similar to the late 1960s, when the European and Japanese central banks with large dollar reserves were expressing concern about the dollar’s convertibility to gold.

But setting aside the changed landscape of global politics and economics, there is a critical difference between now and then. The Bretton Woods crisis was about the ability of the U.S. to convert dollars to gold. The current issue is about the ability of the U.S. to “handle” its unsecured debt. Gold is out of the picture.


This is probably the closest I will come in this blog to giving trading and investment advice. But if you are concerned about the rise of inflation and would like to put your money into something “tangible”, stay away from gold. Gold is on its way to shedding its status as the universal money, as the universal depository of value. In coming years, if the price of gold increases, it will do so in its capacity as a metal, the way the price of iron or aluminum might increase.

Lenin said that after the world-wide establishment of Communism, gold would be used for furnishing public lavatories. He had this demonetization of gold in mind, a spectacularly theoretical notion that speculative capital brought to the realm of possible in a little over 30 years. This point is important. Gold is demonetized not because of the decision of this or that authority but as a result of a historical process that gave rise to speculative capital and “globalization”, and, at the same time, set the financial system on a path towards a systemic collapse.

The financial system could somehow be “repaired”, but there is no going back to gold. History does not repeat itself, in the sense of returning to where it was previously.


To prevent a complete meltdown, the U.S. government has pledged about $13 trillion in guarantees and actual payments to various entities, mostly financial institutions.

Then, there are the other, more persistent financial holes the U.S. government also has to plug. The Treasury must finance a $1.8 trillion budget deficit and a $1 trillion trade deficit through issuing bonds.

The tremendous demand for borrowing pushes the interest rates higher. To bring them lower, the Federal Reserve does “quantitative easing”, i.e., it buys the Treasuries. To pay for the purchase, the Fed creates money from thin air through an accounting entry; poof, and there is a trillion dollars.

No currency could withstand such persistent debasing and not lose its value. Hence, the Chinese's lingering unease about the weakness of the dollar.

But it is not the Chinese only. The recent G20 Conference in London this past March was the first economic/financial conference in the past century in which the U.S. not only did not set the agenda and dominate, but it was visibly relegated to the periphery. That more focus was placed on Michelle Obama’s fashion sense than her husband’s conference agenda said all there was to be said about the shape of the future to come.


Macro developments in economics and finance have a long horizon. They certainly do not happen overnight. The eddies of international finance, furthermore, produce transient effects; a weak dollar could temporarily appreciate against one, two or even all currencies. But the writing is on the wall: the dollar is on its way towards a structural depreciation against all major currencies, including yen. From there, the loss of its status as the main reserve currency will necessarily follow.

If this were the only bad news, it would be good news. But this is not your father’s monetary crisis.


The dollar became the world's money through its linkage to gold, which historically had that role. What made the linkage possible was the industrial might of the U.S. Without it, the U.S. could not have been in possession of the sufficient amount of gold – it would not have been in a position, period – to orchestrate the Bretton Woods system. Financial maneuvering and one-upmanship, even of the aggressive kind that Harry Dexter While pulled off at the Bretton Woods Conference, could not by themselves create a new world monetary order.

The linkage to gold provided a built-in frame of reference for the value of the dollar and its quantity in circulation; if the amount of dollars in circulation relative to the supply of gold increased, the dollar would be “weak”.

The breakdown of the Bretton Woods system did away with that frame of reference and, in doing so, set the stage for the expansion and subsequent ascent of finance capital.

The “ascent” meant that finance capital could claim a historically larger share of the country's newly produced value. That could only come at the expense of the industrial capital. So the ascent of finance capital was the beginning of the systematic weakening of industrial capital, that is to say, the systematic attack on the industrial base of the U.S. The destruction we are seeing in all spheres of economic activity is the result of this conceptual and yet very real conflict. The “system” in systemic collapse goes far beyond financial markets and institutions.


A complete analysis of the the relation between finance and industrial capital must await Vol. 4 of Speculative Capital. (That would be the “relation between Wall Street and ‘real economy’”, as it is commonly put because those who put it have no other way of putting it.) For now, an example should suffice.

Take any industrial corporation with a “finance arm”. Take, for example, GM and GM Acceptance Corporation, as the U.S. car companies have been on the news for the past 20 or so years.

The raison d'etre of a car company's finance arm in providing financing to car buyers is so they would not wait weeks for bank financing. Gradually, as this means towards selling cars becomes profitable, it become an end in itself, with the inevitable mission creep that follows. The following story captures this fateful reorientation.
The world’s biggest car company said Tuesday that it earned record second quarter earnings of $1.8 billion US on revenue of $48.7 billion ... General Motors Acceptance Corp., (GMAC), the car maker's financial services arm, contributed $395 million to its income.

The GMAC financial arm pulled in more profit in the second quarter, despite higher interest rates than in 1999 ... GMAC provides a variety of lending and insurance products. It recently became involved in commercial finance, full-service leasing and international mortgages.

We learn that: i) despite a difficult economic environment, the contribution of GMAC to GM's bottom line increased; and ii) GMAC is expanding to new areas, including mortgages.

Here is the result:
GMAC LLC, which provides loans to buyers of General Motors Corp vehicles, said its first-quarter loss grew 15 percent, reflecting an increase in soured mortgage and auto loans as the economy weakens.

But by far, the most pernicious impact of GMAC was in influencing the production cycle of the parent company. GMAC and other sister financing arms created the concept of “leasing” which implicitly assumed that the GM car buyers would get a new car every three years. The production cycle and car design was adjusted around that assumption. This is the ultimate example of production dog wagging the finance arm, with the results plain for everyone to see.

Car companies need not perennially be on verge of bankruptcy. Car companies could be, and the vast majority of them are, profitable.


The most pernicious damage of finance capital is the destruction of the “business model”. It initially creates a binge of easy profits and, in doing so, changes the organization of the enterprise in line with the “new”, finance-oriented model . Over time, the new model proves the instrument of undoing of the enterprise.


The U.S. industrial base remains formidable by any measure. But so is the scale of the destruction of the value. It is astounding how little effect almost $13 trillion in commitments and guarantees have had on the markets.

Meanwhile, the farce continues with clowns calling for the creation of a New American Century, as if bombast could be a substitute for economic might. In this way, they provide the surest evidence to date that the 21st Century is the American Century no more.

Tuesday, 19 May 2009

Krugman Does China

Couldn't resist letting Paul Krugman's China trip slip by without comment, especially since I just moved out of Hong Kong after three years. I found this article by China Stakes (Krugman in China: Stimulating, Controversial, and Expensive) to be amusing.

It appears the Chinese were initially delighted to have Krugman on the Sino-lecture circuit for several reasons. First, he is seen as an economic prophet (and what price can you put on one of those -- oops, looks like $200,000 an appearance, according to the article, making this probably a million-dollar jaunt for PK). He also won the Nobel Prize recently and has been a harsh critic of the U.S. response to the financial crisis.

Everything seemed to be in the cards for a lovely week of high-powered talks and shmooze-fests. You can almost see the dark-suited Chinese officials sitting in the front row and nodding with vigor as Krugman lambastes the Obama team's tepid response to the banking mess. "Why, oh why, are they so frightened of nationalization?" Krugman thunders as an audible murmur of sympathy rises from the audience.

But of course, the trouble with mavericks and independent thinkers is they don't heel and sit up and roll over on command. The article made Krugman sound a bit prickly as he challenged China to take responsibility for the impact of its own huge and persistent trade surpluses. He spoke frankly about the root cause of the surpluses, the country's currency regime.

That part greatly interested me. In Hong Kong, studying China's exchange rate policy became one of my pet projects. I became convinced it was the keyhole to understanding the country's larger economy.

This is what Krugman had to say on the subject, according to the article:
Krugman also hinted that China's massive trade surplus is the result of manipulating its currency's exchange rate. He said: “The U.S. Congress will review China's currency each year, and the Treasury will report whether some countries are manipulating currency or not. The answer each time is that China doesn't manipulate, but everybody knows this is not an honest assessment, it's a decision made to avoid conflicts.”

Does China manipulate the rate at which the renminbi (or yuan) trades against the currencies of other nations? Absolutely. I know China fumes and stamps its feet whenever the U.S. hints at this, but that's all theater.

Don't be fooled by that move back in the summer of 2005. Remember? China switched to an exchange rate that floated against a basket of currencies, within a narrow band (that itself is periodically adjusted). It sounds like they freed up their currency somewhat.

Not really. Theater, all theater.

The Chinese made the change, cleverly, to outfox their opponents in the U.S. who complained about the country's fixed rate policy that undervalued the yuan. The Chinese stood accused of dumping low-cost goods and stoking their economy through exports. Beijing answered with a "managed currency" that would "float." Of course it floats in the same way that a dog on a four-inch leash runs.

Actually it's even worse. The semblance of a sort of-floating currency gives the Chinese cover to monkey around with the exchange rate as they wish. While living in Hong Kong, I noticed sometimes it moves opposite the way news would indicate, as the Chinese tweak it down or up to try to discourage currency speculators.

The best evidence that the "basket of currencies peg" is a fiction appears in Jonathan Anderson's wonderful look at the currency, "The RMB Handbook." A graph shows the RMB, after the peg, making a slow but steady increase against the dollar for the next year or so. Anderson, a UBS economist, found that the slow, linear creep of the RMB versus the dollar couldn't be mathematically explained, no matter how creatively you composed that basket of currencies. It was too precise, lacking normal volatility. It was ...

Manipulated (my language, not his). Totally. Indeed you can reasonably draw no other conclusion (note: for semantic reasons, you may prefer the word "managed" to "manipulated" -- I know that James Fallows of the Atlantic, an excellent observer of the China scene, doesn't like the emotional freight carried by "manipulated.")

I'd be the first to say, "Of course China manipulates its currency." But I'd argue that's usually a good thing. Essentially they're selling us stuff for 20, 30 percent off (or however much the currency is undervalued). If Macy's has a clearance sale, do you go outside the store and picket in protest? Hell no. You limber up your wallet and get a parking spot early. Of course the trouble is there's a dark side to this, as we're seeing now. Our unrestrained consumerism in the U.S. coupled with bad policy led to huge trade imbalances that cause global stress.

If I'm scoring this, I place most of the blame with the United States for not recognizing the implications of the undervalued currency and not reacting accordingly. Even if someone offers you all the half-price donuts you want, you don't have to eat yourself into a stupor. But China, as Krugman observes, doesn't escape scot free. They were complicit. They need to make changes too.

Wednesday, 13 May 2009

Finance Blogs: What I Read

I looked over my last couple of blog entries and found them, er, somewhat lacking (ahem: boring), so I thought I'd mix things up a little today. My pet project of late of course is tracking PPIP (as readers can tell, I've solidly thrown my weight behind the "it will fail because the banks won't play" theme, a la Roger Ehrenberg). A quick observation here: the ever-cantankerous banks, mewling and whining about the onerous provisions of TARP as they feast at the Fed's trough of cheap funds, seem to be bearing out my prediction. Their attempted smackdown of their regulator during the "stress tests," arguing downwards the amount of capital they had to raise, showed them to be typically uncowed in the face of Washington power. These refractory banks won't be nudged into participating in the Geithner plan. So stay tuned for "Whatever happened to PPIP?" stories. I expect them in, let's say, early June when it becomes clear that nothing is moving forward on the Geithner plan.

But meanwhile ... time for something completely different. Below are the blogs I'm reading now with quick comments about each. My reading is predictably skewed toward the financial crisis, which I think is a once-in-a-lifetime event that we are not ("green shoot" talk notwithstanding) out of at all, but rather as with a roller coaster, we have simply hit one of those short uphill rises before another plunge.

So here's my rundown, in order of preference:

Naked capitalism: Take my food. Water. Roof. But not this blog. Yves Smith is smart and spunky and WON'T be getting invited to the White House as an Obama critic (as Krugman was) because she punches so hard. This blog has meaty, insightful, well-reasoned commentary. Must read.

Zero Hedge: Technical, wonky, but thrilling ... reading it, sometimes you feel like the fly on the wall of a Wall Street trading room. This blog breaks news. Occasionally makes mistakes. But shy it is not (and the authors are so prolific that a grazer can always find something to chew on, amid the scads of technical analysis).

Rortybomb: I really like Mike's style (disclosure: he did compliment my blog once, but that in no way influenced me here because he's just REALLY good). He delightfully mixes wide-ranging subjects (comic books, baseball cards and a whole ton of other stuff) to draw analogies and make financial topics simpler to understand. His posting is a little spotty, but hey: he's probably got a job (or a girlfriend, or a life), so go easy on him.

The Conscience of a Liberal: I like Krugman's writing a lot. He's often devastatingly simple when he argues points: he's like a knuckleballer who throws only 65 miles an hour but the opposing batters all miss the pitch, baffled. I'd rank him higher except his blogging has gotten a bit more lightweight and infrequent and subject to more "warmed-over" pet peeves as opposed to original thinking.

Economist's View: I generally agree with Mark Thoma's thinking and he's on top of the issues of the day. He tends to quote chunks of columns or articles without comment (or with light comment) -- not my favorite blogging style. He also tends to lapse into econ-speak more than seems to be necessary (to be fair, his audience appears more to be academic economists like himself).

Calculated Risk: The go-to blog for the quick number round up: the latest figures on unemployment, retail sales, GDP, housing starts. Of course its forte is the housing market. The author tends to maintain a relatively neutral voice, with a few stinging asides that show where his contempt lies.

Greg Mankiw's Blog: I want to like this blog more than I do. Sure, pilosophically, I disagree with Greg more than with any of the others (he skews conservative, having worked for past Republican administrations). He is an undeniably smart guy though and an effective spokesman for the conservative viewpoint. But he has no comment section (double boo -- no triple boo) and sometimes feels a bit smug, as when he plugs the world's best economics textbook (three guesses who wrote that and the first two don't count).

Friday, 8 May 2009

Stress Test Math Makes Absolutely No Sense

I just can't get too excited about these stress test results. It's the mathematician in me.

Sure, it sounds great: the 19 largest banks need only $75 billion, total. They emerged from their Geithner shakedown cruise not in tip-top shape, but looking far better than anyone thought.

Sure, it sounds great, if you don't think too hard about the numbers.

It's simple really. New York University Professor Nouriel Roubini, one of the few economists who was eerily prescient about the magnitude of this crisis, forecasts $3.6 trillion of losses to come on U.S. loans and securities, more than half of that coming from banks and broker-dealers.

What do the stress test results imply about losses to come? The 19 banks that were examined control two-thirds of the banking system's assets. If you assume for simplicity that they hold two-thirds of the "losses to come" (though in truth they probably hold more, having dabbled in riskier assets more recklessly), that seems to imply the U.S. banking system will lose no more than $113 billion (since these banks total must raise no more than $75 billion).

And that makes absolutely no sense. Roubini's math (and not just his -- but the calculations of others as well, including the International Monetary Fund) suggests the U.S. banking system is looking at another trillion dollars or so of value evaporating off the books. If these stress-tested banks shoulder about $700 billion of that -- at least -- how does $75 billion in capital stuff that hole?

And who is dumb enough to provide that capital, knowing this?

We already know the answer to that last question. Look for more government aid, probably through the backdoor, to prop up the banks. This seems to be the Obama Team's strategy for 2009 for dealing with the financial crisis: try to minimize problems, paper over gaping holes, and silently slip the banks (through cheap funds, multiple lending facilities, bailouts galore) enough money to keep them tottering along.

Wednesday, 6 May 2009

The Fault, Dear Brutus ...

Today, the Center for Public Integrity, a journalistic watchdog, published the results of its investigation into the causes of the subprime mortgage meltdown which precipitated the larger meltdown. The Financial Times headline summed up the gist of the report: Few escape blame over subprime explosion. The paper went on to say, quoting the report, that “almost every US power centre had a hand in lighting the fuse to the global meltdown”, and that:
Most of the top 25 originators, most of which are now bankrupt, were either owned or heavily financed by the nation’s largest banks, including Citigroup, Goldman Sachs, Wells Fargo, JPMorgan and Bank of America. Together, they originated $1,000bn in subprime mortgages in 2005-07, almost three quarters of the total.
These supposedly hard hitting reports are a monumental waste of time. If everyone is guilty, then no one is guilty. We learn nothing from them except a back-handed confirmation of our prejudice about the human fallibility. We are being preached an antisocial sermon.

Here is what I wrote in the opening paragraph of the 10-part Credit Woes series early in 2008 that began this blog.
The events leading to this seizure have been covered in detail from many perspectives but always within the same prescribed framework: the crisis as the culmination of a series of unfortunate events set in motion by (choose your emphasis) greedy traders, irresponsible lenders, foolish borrowers, sleeping-at-the-switch rating agencies and feeble regulators.

The focus on human element makes for good storytelling and has an evangelically uplifting bend that is appealing: If only the bad guys were to be replaced with good guys – something definitely in the realm of possible – the wrongs will be set right. The fault, dear Brutus, is not in our stars, but in ourselves!

Such takes on the crisis are not inaccurate; they are irrelevant. The subject matter of finance is not people; it is capital in circulation.
Go back and read the full series again. You will notice that against a background that shattered the most cherished beliefs, it has aged well. In fact, it has even improved with time, as all its “forward looking” statements have come to pass. That is the power of a correct theory, which is derived from the power of the truth. It is that relation, that correspondence, that stands the test of time.

Tuesday, 5 May 2009

A Humble Proposal For Reducing Speculation

“Of our time” description, when used for a poet, a writer or a philosopher, could have two distinct and opposite meanings. One is that of a fool who struts and frets his hour upon the stage but is nevertheless useful, the way an inanimate archeological object is useful, because in deciphering what he uncomprehendingly recorded we could learn about his time. The other is that of a knowing, perceptive observer who is conscious of the goings on around him and can therefore add to our knowledge with his observations and insights.

T.S. Eliot is a poet of our time strictly in the latter sense. He has an eye for the social ills as they affect individuals. Of particular interest to him is a large class of hollow men. Hollow man, as competently elaborated by Craig Raine in his study of T.S. Eliot, is “a physically damaged, confined soul, corroded by its own caution, a life disfigured and distorted, rusty with reluctance”.

This phenomenon, which is present at every age, especially stands out in modern times because it stands in contrast to, and in mockery of, the slogans of free men. The commonness and its uncomfortable implications are politely hidden in a neutral word: pragmatist. The pragmatist keeps a respectful distance from established prejudices and relations, follows the consensus and never, ever rocks the boat, no matter how urgently the boat might need a shakeup.

I thought of all this as I read last Thursday that the Federal Reserve was considering imposing a 3 percent penalty on failed treasury trades.

A fail trade is a trade that a short-seller fails to deliver. I wrote about short selling in detail last year in relation with the unraveling of money markets:
The sec lending market is driven by short selling, or shorting, which is selling something you do not have. Outside the financial markets, the practice amounts to fraud; if you sell a house, or a car, or a farm you do not have, you would probably go to jail. In the financial markets, the practice is legal and very common. With the ownership requirement eliminated, the buy-sell sequence could be reversed; instead of buying first and selling later, you could sell first and buy later.
In all events, the seller must deliver. Confronting him is a buyer who demands the security he just purchased. Since he himself does not have the security, the short-seller must borrow it or somehow find it in the market. When he fails to do so, in consequence of which he could not deliver the security to the buyer, we have a fail-to-deliver. It is this failure on which the Fed is imposing a 3% penalty. Here is part of the original story:
A Fed-endorsed industry recommendation will require traders to pay a three-percentage-point penalty on uncompleted trades, known as fails, starting tomorrow ... While the new recommendations are meant to curb disruptions caused when traders fail to meet their obligations, some strategists are concerned it may do more harm than good in the $7 trillion-a-day repurchase market, where dealers finance their holdings. A reduction in trading would be a setback for the Fed as it seeks to lower borrowing costs by pumping cash into the banking system and purchasing as much as $1.75 trillion in Treasuries and mortgage securities.
Let us set aside all distracting technical points and focus only on the core issue: short-selling U.S. treasury securities.

Buying treasuries is lending money to the U.S. government; you get an interest bearing security from the government, the government gets your cash. Selling treasuries you own is calling back your loan. You get your money back and a new lender to the government (who bought you treasuries) replaces you and your capital.

Selling treasuries you do not have is borrowing money as U.S. government. Only the U.S. government can borrow money as the U.S. government, in the same way that only the U.S government can print money. I discussed this point in Vol. 3 of Speculative Capital:
Yet another critical point went unnoticed: how could we short a riskless bond? Shorting a bond means borrowing money. In the yin yang of borrowing and lending, risk is defined with reference to lender only. As borrowers, we face no risk; we could take the lender’s money and run. Risklessness of the US Treasuries, likewise, refers to risklessness of these securities to their buyer – those who lend to the US government. The securities are riskless because the US government would not default. It then follows that only the US government can short a riskless bond, in the same way that only the US government can print money; we, as individuals cannot. It is astounding how often the difference between buying and selling, lending and borrowing escapes the attention of the finance scholars.

The closest equivalent to shorting treasuries is counterfeiting money. Failing to deliver short is selling counterfeit money that you do not even have! Yet everyone in the market treats it as a birthright.

Imposing 3% penalty on a small part of the market – the fails – is a timid and irresolute act. It will do nothing by way of improving markets no matter how you measure it.

The correct policy action would be to warn the “market participants” that a complete ban on short selling treasuries will be implemented in a few months and then on the designated day, pull the trigger. You will be surprised how quickly and extensively the speculative element will be flushed out of the markets.

Looking around, I expect this policy to be implemented in the morning after the Judgment Day.

The Dance of the Seven Veils

I'm back in the U.S. (to live), having traversed too many time zones in too short a period of time. The planes did feel like airborne virus cages, with the phlegmy cough in seat 14C recirculating a few dozen times, and I did appear to contract something but -- keep the CDC off my doorstep -- it appears not to be swine flu but rather a garden-variety head cold. In Tokyo (layover), there was an interesting scene of unknown conclusion: a phalanx of surgical mask-wearing health workers shot past a bunch of us deplaning passengers, followed by a hustling man carrying a videocamera. Where they were headed, and what they were doing, was unclear though ominous. So I'm back in the good ol' U.S. at last, which brings me to this first (short) entry, as I de-jetlag ...

The leakapalooza surrounding the Bank Stress Tests (why not capitalize? It feels like this has been with us for, oh, a few decades by now) has been interesting to observe. It is almost like watching a pilot (I'm in an aviation metaphor mood for obvious reasons) feather down a wide-body aircraft. With all the delays and all the leaks hinting at how the banks fared, all of which has been mulled and chewed over by bloggers and other media chattering heads at some length, you really REALLY get the sense that Geithner and crew don't want any bad surprises here.

Consider: (1) You can't exactly fail the test, as the government has made clear it will give inadequately capitalized institutions a chance to raise funds, or failing that, will supply money itself. (2) The leaks look very much packaged by the White House -- we haven't after all heard anything particularly damning about a given bank, but rather vagueness and broad hints of what's to come: e.g. "10 of 19 of the stress-tested companies need to raise capital." If these leaks hadn't been orchestrated by Team Obama, I'd expect to see more names and hard numbers. (3) The banks themselves are apparently actively negotiating what the final disclosure will say.

#3 is yet more evidence of the topsy-turvy state of what passes for U.S. capitalism, early 21st century. It has become obvious to even a casual observer that the financial institutions run the government and not the other way around. Imagine if you're a code inspector and you visit Tom's Lobster Shack and his electrical wiring is a jury-rigged abomination. You tell Tom, "Hey, I'm going to write this up; it's all wrong," and Tom says, "Wait a minute, let's negotiate this, it's not as bad as it looks -- the reason the dog got electrocuted was because his tail was wet, not because that's a bare wire." How often do you think this happens? Maybe, like, never? But the banks have made it clear in this crisis they don't bow and scrape to nobody, pal. Regulator, shmegulator.

What I'm interested in watching is how the stress test results affect PPIP, Geithner's planned public-private partnership to buy dodgy legacy securities and loans. Once again, I think the program is virtually dead -- I read an interesting NYT piece on the plane about how the big banks are giving Washington the cold shoulder, and several have made clear they are NOT interested in being part of PPIP, in any way, shape or fashion. The program is dead because the big banks want to earn their way out of this crisis, as is becoming clear from the Potemkin first-quarter profits they posted and changes in fair-value accounting that remove the teeth from mark-to-market rules, thus allowing them to postpone declaring losses on impaired assets.

I see Roger Ehrenberg is also a pessimist about the Geithner plan. He thinks PPIP is DOA too. The only saving grace for Geithner's proposal would be if he finds a way to muscle the banks into participating, whether they like it or not. If he was smart, he'd use the stress tests to do that and outfox his recalcitrant opponents. But in this crisis, the government has shown no instincts for cunning, only for rolling over.