Sunday, May 10, 2009

SNL Nails "Stress" Tests

When it comes to the stress tests, I think SNL's Tim Geithner might have been a tougher negotiator than the real Tim Geithner.

Saturday, May 9, 2009

Stress Test "Negotiations"

When is a stress test not a stress test? If you said when the most "adverse" scenario in the stress test is not as bad as current economic conditions, you would be correct. If you said that the regulators relied on the bankers to report on their firms' financial health using the same models that failed to alert the banks to the impending financial apocalypse, you would also be correct. And if you said when the bankers negotiate with the regulators over how much capital they need to raise due to the stress tests, you would be triply correct. From the Wall Street Journal:
The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

The overall reaction to the stress tests, announced Thursday, has been generally positive. But the haggling between the government and the banks shows the sometimes-tense nature of the negotiations that occurred before the final results were made public.

Government officials defended their handling of the stress tests, saying they were responsive to industry feedback while maintaining the tests' rigor.
When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.

At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.

At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as "asinine," were particularly heated, according to people familiar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings.

The Fed ultimately accepted some of the banks' pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter.
Bank of America's final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations.

A Bank of America spokesman wouldn't comment on how much the previous gap was reduced, though he said it resulted from an adjustment for first-quarter results and errors made by regulators in their analysis. "It wasn't lobbying," he said.
Wells Fargo's capital hole shrank to $13.7 billion, according to people familiar with the matter. Before adjusting for first-quarter results and other factors, the figure was $17.3 billion, according to a federal document.

"In the end we agreed with the number. We didn't necessarily like the number," said Wells Fargo Chief Financial Officer Howard Atkins. He said the company was particularly unhappy with the Fed's assumptions about Wells Fargo's revenue outlook.
This is exactly backwards. Throughout this sham of a process, regulators have bent over backwards, making sure not to offend bankers' sensibilities. Whether bankers are happy with the results of the stress tests is irrelevant - what matter is whether the numbers are accurate. Why would anyone have confidence in these numbers if banks lobbied for them? (Saying that what they were doing was not lobbying is a dead giveaway that they were).

This final nugget from the WSJ piece reveals the underlying problem with the stress tests - the regulators confused the ends and means. From the WSJ:
With the stress tests, government officials were walking a fine line. If the regulators were too tough on banks, they risked angering their constituents and spooking markets. But if they were too soft, the tests could have lost credibility, defeating their basic confidence-building purpose.
The purpose of stress tests should be to reduce opacity. Increased confidence should be a byproduct of this increased transparency. Lying about banks' balance sheets to create a short-term confidence boom in the banks simply puts off the problem, as the administration hopes the banks can earn themselves back to health. And if the banks are still insolvent six months from now? Will we finally get some sort of pre-packaged bankruptcy for systemically important financial firms? Or will we get Tim Geithner to come back and tell us everything is still fine...the banks just need another $500 billion or so.

Wednesday, May 6, 2009

More Stress: Wells Fargo Needs $15 Billion

Bloomberg reports that Wells Fargo will need to raise $15 billion in additional capital as a result of its stress test. If Wells is allowed to play the same accounting games as Citi and BoA, they can simply convert some of the $25 billion of preferred shares the government owns from the TARP to common shares and be done with meddlesome capital requirements. Of course, Wells Fargo may not want the government to be one of its biggest voting shareholders, if not the biggest, so actually issuing new common stock is not out of the question. And, of course, Wells Fargo plans on getting out from under its government shackles by earning its way back to solvency - soon! From Bloomberg:

Chief Executive Officer John Stumpf said last week that Wells Fargo will pay back $25 billion to the Treasury’s Troubled Asset Relief Program and restore its dividend as soon as possible.

“We earn our way out,” Stumpf, said at the company’s annual shareholders’ meeting in San Francisco April 28. “This company has a great capacity to produce wonderful results. That will be the driving force.”

The stress tests were designed to incorporate potential earnings in their assessments of banks’ capital needs.

Translation: with all the direct and indirect government subsidies to banks, even the idiots who ran their firms aground cannot lose money. If new revenues equal losses on "legacy" assets - and there are still huge time bombs on banks' balance sheets like CRE loans- then the banks should not require too much more help. Whether banks can survive and thrive without government training wheels is entirely another question, though.

But forget those concerns. Happy days are back again - right? At the very least, maybe Warren Buffet's favorite banks should unveil a new slogan: Wells Fargo - Not As Crappy As Citi or BoA.

Stressed: BoA Needs $34 Billion

The New York Times reports that Bank of America needs to raise $33.9 billion in additional capital according to the regulators who conducted the stress tests. BoA can either issue new common stock, or convert some of the non-voting preferred shares the government received for the TARP into common shares. And, of course, it's vital to keep in mind that economic conditions today are worse than the most "adverse" scenario regulators used for 2009 in the so-called stress tests. So if Geithner & Co. say BoA needs $34 billion, the actual hole in their balance sheet is likely much, much larger. From the New York Times:
The government has told Bank of America it needs $33.9 billion in capital to withstand any worsening of the economic downturn, according to an executive at the bank.

If the bank is unable to raise the capital cushion by selling assets or stock, it would have to rely on the government, which has provided $45 billion in capital through the Troubled Asset Relief Program.

It could satisfy regulators’ demands simply by converting non-voting preferred shares it gave the government in return for the capital, into common stock.

But that would make the government one of the bank’s largest shareholders.

Executives at the bank, one of the largest being examined, sparred with the government over the amount, which is higher than executives believed the bank needed.

But J. Steele Alphin, the bank’s chief administrative officer, said Bank of America would have plenty of options to raise the capital on its own before it would have to convert any of the taxpayer money into common stock.

“We’re not happy about it because it’s still a big number,” Mr. Alphin said. “We think it should be a bit less at the end of the day.”

The government’s determination that Bank of America doesn’t need as much capital as it has already received from taxpayers is an indication that even some of the most troubled banks may not need more government money than has been allocated to them.
None of the banks may need more capital from the taxpayers - if their bondholders convert debt-to-equity, or otherwise take a haircut on what they are owed. That does not mean the banks are healthy, merely that policymakers finally realize that it is not sustainable for the public to subsidize Bill Gross's portfolio any longer. Also: how reliable is this $34 billion figure if officials from BoA allegedly "sparred" with Treasury officials over this number? Back to the article:
Mr. Alphin noted that the $34 billion figure is well below the $45 billion in capital that the government has already allocated to the bank, although he said the bank has plenty of options to raise the capital on its own.

“There are several ways to deal with this,” Mr. Alphin said. “The company is very healthy.”

Bank executives estimate that the company will generate $30 billion a year in income, once a normal environment returns.
Here's the crux of Geithner's plan: hope something approximating a "normal" environment returns quickly so that banks can earn their way back to health without requiring any further restructuring or government bailouts. This is more or less how the Reagan administration dealt with de facto insolvent banks in 1982. While this approach could work, we won't know for several months. And if banks cannot earn their way back to health, the costs of bailing them out will only rise.

Tuesday, May 5, 2009

Will Fewer Have Jobs When The Economy Is At Full Employment After Recovery?

Some economists are reconsidering what will constitute "full employment" - the unemployment rate at which the inflation rate does not change positively or negatively - after this slump ends. From Bloomberg:
Post-recession America may be saddled with high unemployment even after good times finally return.

Hundreds of thousands of jobs have vanished forever in industries such as auto manufacturing and financial services. Millions of people who were fired or laid off will find it harder to get hired again and for years may have to accept lower earnings than they enjoyed before the slump.

So far, so good. Since unemployment is generally a lagging indicator, it seems likely that even after the economy stops contracting that the unemployment rate will continue to climb. Furthermore, sectors that were overbuilt during the bubble - autos, real estate, and finance - will lose jobs that will not come back. But what does this mean for full employment? Back to the article:

This restructuring -- in what former Federal Reserve Chairman Paul Volcker calls “the Great Recession” -- is causing some economists to reconsider what might be the “natural” rate of unemployment: a level that neither accelerates nor decelerates inflation. This state of equilibrium is often described as “full” employment.

Fallout from the recession implies a “markedly higher” natural rate of unemployment, says Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel Prize in economics. “It was 5.5 percent; maybe it will be 6.5 percent, maybe 7 percent.”

This is certainly possible, but it seems like an optimistic reading of the situation. An unemployment rate that peaks somewhere around 11-12 percent and then recedes to 7 percent for the foreseeable future could also act as a powerful deflationary force on the economy. If banks begin to lend out some of the gargantuan excess reserves they hold, this could prop the economy out of deflation despite the relatively elevated unemployment level. In this context, the number of people working when the economy is at "full employment" could fall. But if the Fed tightens monetary policy, the inflationary impact of any credit expansion would dissipate, and the US economy could very well teeter along into deflation again.

Let us hope that we get high unemployment and inflation: the alternative is far worse.

Monday, May 4, 2009

Krugman: Absolute Wage Levels Matter Too

Economists usually talk about relative prices. If wages and prices all double in an economy, then an individual's consumption choices will not change. But this view of relative prices ignores the impact of fixed costs, particularly of debt. If wages and prices fall commensurate levels, the purchasing power of an individual should be unchanged - unless that individual wracked up excessive levels of debt when wages and prices were higher. In that case, the individual will need to devote a greater percentage of his income to servicing that debt than he did when his wages were higher. The collateral he used to secure the debt - say a house in the case of a mortgage - might be worth less than the value of the loan with general deflation across the economy, so he cannot sell what he owns to get out from under the debt. This is debt deflation.

Paul Krugman reminds us of the veritable economic horrors of debt deflation and the implicit importance of nominal wages in his latest column. From the New York Times:
And soon we may be facing the paradox of wages: workers at any one company can help save their jobs by accepting lower wages, but when employers across the economy cut wages at the same time, the result is higher unemployment.

Here’s how the paradox works. Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer.

But if everyone takes a pay cut, nobody gains a competitive advantage. So there’s no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy’s problems on other fronts.

In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don’t go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade — but as wages fall, they’re chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed.

Things get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: “The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period.” And a rise in the effective interest rate is the last thing this economy needs.
Just a reminder that as bad as the 1970s were, if we face a choice between stagflation and a deflationary spiral, it's really no choice at all.

Condi Rice Schooled By A 4th Grader

First, college students were too tough for Condi Rice. Now, it's 4th graders who are too much of a challenge. After a speech at a Washington DC elementary school, the Washington Post reports a 4th grade student asked her "What did Rice think about the things President Obama's administration was saying about the methods the Bush administration had used to get information from detainees?" Again, she resorted to the Nixonian "it's-legal-if-the-president-says-it-is" defense.

Lucky for her, the student's question was toned down: he originally wanted to ask her, "If you would work for Obama's administration, would you push for torture?" Is the media paying attention? That's how you ask tough questions.

Sunday, May 3, 2009

"Contrarian" Naivete From TNR

Now that the "Wall-Street-controls-Washington" meme has gained traction, especially among the center-left, the oh-so-contrarian New Republic has taken to arguing that this isn't exactly true. After explaining several weeks ago that Simon Johnson's diagnosis of the United States as an emerging market crisis on steroids disquieted him, Noam Scheiber explains that the idea of Wall Street controlling the levers of power is problematic, since "Wall Street" is not a monolithic entity. To illustrate his case, Scheiber cites the recent controversy over mortgage cram-downs. When cram-down legislation, which would allow bankruptcy judges to renegotiate mortgages, came up in the Senate, lobbyists representing bankers and investors holding securitized mortgages united in opposition to the legislation. From Scheiber's piece:
When Obama unveiled his own housing plan in February, he asked Congress to revive the cram-down idea as part of a carrot-and-stick approach to helping borrowers. The carrot would be cash incentives--a series of $1,000 payments--for banks to perform modifications. Cram-down would serve as the stick.

Almost immediately, investors and banks joined forces to snap that stick like a twig. Investors hated the cram-down idea because they worried judges would force them to accept, say, lower interest payments for the sake of distressed borrowers. The big banks had similar worries for the mortgages they keep. Many also hold on to second liens (basically, second mortgages) after they sell off the first and worried judges would wipe those out entirely. And both groups generally feared the arbitrary ways judges might wield their power.

But then the script got flipped. The banks switched sides. Back to the article:

But a funny thing happened while the big banks and investors were uniting against the cram-down push: The banks cut their own deal. Top executives at four large banks--Citigroup, Bank of America, J.P. Morgan, and Wells Fargo--descended on Congress to proclaim they'd love nothing more than to modify mortgages, just like the president wants. It's just that, with all those greedy investors out there, you never know who's going to sue. The solution, they argued, was a "safe harbor" provision: Give us legal immunity, and we'll modify all the loans you send us.
Different classes of financiers going at each each other! See - Wall Street can't really control Washington if they're busy infighting. Scheiber explains that this conflict between banks and hedge funds is like the Iran -Iraq War: "Where there are no obvious good guys, the next best thing may be two powerful rivals beating each other to a pulp."

But why did the banks change their minds when it came to cramdowns? What were the fissures that led to the split up between banks and hedge funds over this issue? Scheiber explains that it was a matter of political savvy. From the article:

If the fight in Congress was essentially over who would eat hundreds of billions of dollars in housing market losses, the genius of the banks was to realize early on that, given the political environment, it wasn't going to be homeowners. That left them duking it out with investors, even if the latter weren't aware of it....

In the end, the problem for investors was largely sociological. Banking is a heavily regulated industry; in order to succeed, a bank's top executives must be as deft at navigating Washington as they are at lending money. But, with a few important exceptions, most hedge funds live by a meritocratic credo: You make money by having the more sophisticated computer model or arbitrage strategy. "Traditionally, investors aren't lobbyists, they don't have an eye toward Washington".

In short: banks are used to the ways of Washington and did a better job reading the political winds, so they abandoned their opposition to cramdowns. However, this ignores a key fact: the banks rely on the government for survival, both directly via capital infusions and indirectly in the form of FDIC-guaranteed debt. Is it inconceivable that the government, ahem, told the banks that it would be an awful shame if populist rage over cramdowns hamstrung Congress from going back for TARP II? After all, didn't something similar more or less seem to happen back in February when JP Morgan, BofA, and Citgroup agreed to a foreclosure moratorium? Not even considering this possibility smacks of remarkable credulity and naivete. If this is the case, then the degree to which the financial services industry owns our government is even more depressing. Even when the government has enough leverage over the banks to turn them against the hedge funds, the hedge funds still won. This hardly seems cause to break out the champagne.

Friday, May 1, 2009

Krauthammer: Torture Is Impermissible Except Always

This is really a masterpiece of partisan hackery from Charles Krauthammer. Weighing in on the torture debate (how sad is it that there is even a debate about whether the United States should torture) with his trademark sanctimonious liberal-who-has-been-mugged-by reality "toughness", Krauthammer informs us that "torture is an impermissible evil. Except under two circumstances." And what are these exceptions? According to Krauthammer, "the first is the ticking time bomb." Ah, the ticking time bomb. Never mind that this situation has never actually happened outside of 24. Indeed, consider all of the facts an interrogator would need to know to justify torture in this situation: he would need to know that an attack is imminent, he would need to know enough about the plot to capture the suspect without knowing where or when the attack was, and he would need to know that the suspect knew enough to stop the attack. This is the epistemiological aspect of the ticking time bomb scenario. It is extremely unlikely that such a situation would ever occur. Much more plausibly, an interrogator would justify chatter about impending attacks - there is always chatter - to go on a fishing expedition to see what a suspect knows. After all, there might be a ticking bomb! It is a very slippery slope from the ticking time bomb to allowing torture in any case.

What about Krauthammer's exception? Again, from Krauthammer's column:

The second exception to the no-torture rule is the extraction of information from a high-value enemy in possession of high-value information likely to save lives. This case lacks the black-and-white clarity of the ticking time bomb scenario. We know less about the length of the fuse or the nature of the next attack. But we do know the danger is great. (One of the "torture memos" noted that the CIA had warned that terrorist "chatter" had reached pre-9/11 levels.) We know we must act but have no idea where or how -- and we can't know that until we have information. Catch-22.

This is not an exception; this is a license to torture any suspect at any time. In fact, this is an exact description of the slippery slope entailed in allowing torture under the ticking time bomb scenario. So, per Krauthammer, torture is an "impermissible evil" except whenever we decide to do it. Sadly, this is about on par with the legal "reasoning" in the Bybee and Yoo torture memos. If this is the best defense torture apologists can marshal, they should move to countries that do not have extradition.

Thursday, April 30, 2009

GOP Fearmongering

Remember those heady days after 9/11 when all the Republicans had to do to win an election was invoke Osama Bin Laden or the Twin Towers? Well, John Boehner certainly does.

This is Exhibit A in the intellectual bankruptcy of the GOP. On the major questions of the day - the banking/economic crisis, the healthcare crisis, the energy/climate crisis - they have no answers. They quite literally have nothing to say except for no. Well, that's not entirely true: they still recycle their old talking points, insisting that cutting corporate and capital gains taxes will be an economic panacea; that every American has adequate healthcare since they can go the ER; and that despite all scientific evidence to the contrary, global warming is not man-made.

So what's left for the Republican party? Answer: trying to scare the crap out of people. Unfortunately for them, it's not 2002 anymore. Voters by and large rejected this type of crass fearmongering during the past election, when conservatives played on fears that Barack Hussein Obama was a Muslim-terrorist-communist. But Boehner & Co. did not get the memo. Either did not notice that these scare tactics have lost their effectiveness, or it's simply all they know or have left at this point. It's a sad commentary on a pathetic political movement.

Condi Rice Needs A Lawyer...

Because the "it's-not-illegal-if-the-president-tells-you-to-do-it" defense does not work. Ask Nixon officials.

There's a lot of BS and specious reasoning to unpack here. The three points that really stand out, though, are her implication that Al Qaeda was a more significant threat after 9/11 than Nazi Germany was during World War II because Al Qaeda attacked our "homeland", that the Guantanamo was a model prison, and that waterboarding is not torture because the President said it would not be so defined.

As to the first point: yes, Nazi Germany did not attack the "homeland", but her ally Imperial Japan did. Or is Hawaii too exotic to count? The Nazis also tried to develop nuclear weapons, and would have used them given the opportunity. Oh, and between the two of them, Germany and Japan controlled nearly half the world, not a few caves in an ungovernable corner of the world. The Axis really did pose an existential threat to the United States; Al Qaeda does not. Frankly, this is an embarrassing argument for a professor of international relations to make.

Her claim that Guantanamo was a model prison is laughably disingenuous. As Scott Horton points out, the OSCE report Rice cited that described Guantanamo as a "model medium security prison" referred only to the physical facilities. The same report referred to the treatment of the prisoners as torture.

Reviving the Nixonion "it's-not-illegal-when-the-president-does-it" defense is pathetic. That the president got unscrupulous lawyers to write a memo saying that torture is not torture does not make it legal. If this is the best justification she has for assenting to the torture archipelago the Bush administration instituted, then she needs a lawyer. And she should probably stop giving interviews - especially to non-media people who will actually ask tough questions.

Durbin: Banks Own Capitol Hill

It's official: Wall Street still runs Washington. The latest example of how our bankrupt oligarchs continue to shape policy is the recently defeated mortgage cramdown amendment. Cramdowns, which would allow bankruptcy judges to renegotiate the value of mortgages, are understandably unpopular with banks and investors who hold securitized mortgages. But as foreclosures mount, driving home prices further down, leaving more and more households underwater on their mortgages, there's certainly a compelling argument to be made for trying to put a floor on housing prices by renegotiating existing mortgages. Households - like banks - need debt reduction. Simply reducing the interest owed via refinancing likely won't be enough to seriously mitigate spiking foreclosures.

Given financiers' deep unpopularity, cramdowns would seem to be a - apologies to George Tenet - political slam dunk: looking out for Main Street rather than Wall Street. But this naive view ignores the enduring power of the banking lobby despite the ongoing banking crisis. And so cramdowns went down. Senator Dick Durbin, who championed the cramdown legislation, was particulary galled by how much influence the bankers retain. Durbin bluntly admitted that:
"the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place".
Is that enough evidence for the New Republic that Wall Street has captured our government?

Tuesday, April 28, 2009

Bair: FDIC Can Handle This Crisis

On the heels of the New York Times profile of Geithner that repeatedly juxtaposed his apparent affinity for the bankers he was supposed to be monitoring with Sheila Bair's reported concern about protecting the taxpayers comes this speech from Bair calling for greater power for the FDIC to deal with troubled financial institutions. Was this timing a coincidence? With all the behind the scenes jockeying going on between the different agencies, it is certainly not implausible that FDIC officials anonymously leaked unflattering anecdotes about Geithner to set the stage for their boss' big speech.

Regardless, the substance of Bair's speech deserves attention. Rather than promoting endless subsidies for the banks, Bair suggests closing down failed financial institutions. Imagine that! Failure being punished - it's so...capitalist. The main points of her proposal:
  • Allow the FDIC to shut down bank-holding companies and other financial institutions (read: AIG) in addition to commercial banks
  • Use a good bank-bad bank model for seized firms. Equityholders and unsecured creditors would take the losses for the bad bank, which would be either be sold off to private investors or held by the government. The healthy assets of the company would go into the good bank.
Unsecured creditors taking losses before the taxpayers? It's almost as if Bair has been listening to Joe Stiglitz. There may yet be hope that Bill Gross won't continue to shamelessly gorge himself at the public trough. Still, the bankers are predictably against inflicting such harm on the banks, and they still rather unfathomably seem to call the shots on Capitol Hill. From Bloomberg:
The American Bankers Association has challenged the idea of giving the authority to the FDIC, saying the agency’s mission would be jeopardized and banks may bear unnecessary costs.

“The direct use of the FDIC for resolutions of non-banks would severely confuse the public about FDIC deposit insurance,” Edward Yingling, the Washington-based industry group’s president, wrote in an April 14 letter. He suggested instead giving the authority to a council of the FDIC, Fed and Treasury to avoid giving too much power to the FDIC.
No doubt a Treasury department seemingly staffed exclusively by ex-Wall Streeters and the clubby Fed would serve as powerful checks on the FDIC taking a firm stand against too-big-to-fail financial institutions. We can only hope that Bair wins the backroom political game for control over this process. At least she gets it, that taxpayers should not be used to make bondholders whole on their bad investments - a point which certainly seems to elude Geithner.

Monday, April 27, 2009

Geithner Is Wall Street's Guy

Should we bring back the Geithner Death Watch? This New York Times profile in regulatory capture certainly sets up the it-was-Geithner's-fault narrative if the economy dramatically worsens. Some of the highlights from the article, with between the lines translations:
Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.

Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary.

The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars.
People thought, ‘Wow, that’s kind of out there,’ ” said John C. Dugan, the comptroller of the currency, who heard about the idea afterward.
Translation: Geithner wanted to put taxpayers on the hook for all the mistakes bankers, their counterparties, and their bondholders made, with no real upside for the public. Is a more bank-friendly proposal possible? Back to the piece:
Mr. Geithner was particularly close to executives of Citigroup, the largest bank under his supervision. Robert E. Rubin, a senior Citi executive and a former Treasury secretary, was Mr. Geithner’s mentor from his years in the Clinton administration, and the two kept in close touch in New York.

Mr. Geithner met frequently with Sanford I. Weill, one of Citi’s largest individual shareholders and its former chairman, serving on the board of a charity Mr. Weill led. As the bank was entering a financial tailspin, Mr. Weill approached Mr. Geithner about taking over as Citi’s chief executive.
But for all his ties to Citi, Mr. Geithner repeatedly missed or overlooked signs that the bank — along with the rest of the financial system — was falling apart. When he did spot trouble, analysts say, his responses were too measured, or too late.
Translation: Despite being so close to Citi officials that they wanted him as CEO, he was clueless as to how much trouble there were in. This is a nice double whammy: show that Geithner was close - too close - to the bankers he was supposed to be supervising, and then that he was ineffective at supervising them. Was he unaware because his closeness compromised his judgment, or simply because he was not good at his job? Back to the article:
To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic of the bailout, Mr. Geithner’s actions suggest that he came to share Wall Street’s regulatory philosophy and world view.
“I don’t think that Tim Geithner was motivated by anything other than concern to get the financial system working again,” Mr. Stiglitz said. “But I think that mindsets can be shaped by people you associate with, and you come to think that what’s good for Wall Street is good for America.”
Translation: Geithner is a textbook example of regulatory capture. Back to the article:
In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, Mr. Geithner praised the strength of the nation’s top financial institutions, saying that innovations like derivatives had “improved the capacity to measure and manage risk” and declaring that “the larger global financial institutions are generally stronger in terms of capital relative to risk.”

Two days later, interviews and records show, he lobbied behind the scenes for a plan that a government study said could lead banks to reduce the amount of capital they kept on hand.

While waiting for a breakfast meeting with Mr. Weill at the Four Seasons Hotel in Manhattan, Mr. Geithner phoned Mr. Dugan, the comptroller of the currency, according to both men’s calendars. Both Citigroup and JPMorgan Chase were pushing for the new standards, which they said would make them more competitive. Records show that earlier that week, Mr. Geithner had discussed the issue with JPMorgan’s chief, Mr. Dimon.

At the Federal Deposit Insurance Corporation, which insures bank deposits, the chairwoman, Sheila C. Bair, argued that the new standards were tantamount to letting the banks set their own capital levels. Taxpayers, she warned, could be left “holding the bag” in a downturn. But Mr. Geithner believed that the standards would make the banks more sensitive to risk, Mr. Dugan recalled. The standards were adopted but have yet to go into effect.
Translation: Geithner is a fool - perhaps what Rubin would call a useful idiot - who shilled for the bankers. While Geithner was hardly alone in believing that derivatives helped manage risk by spreading it to those most able to bear it, pointing out that he still trumpeted their virtures in 2007 makes him look rather clueless. And if Geithner really believed that lowering bank capital levels would make them more cautious and sensitive to risk, rather than simply more vulnerable to any downturn, then I have a Nigerian friend for him who can help him score big if he'll just send a check. Back to the piece:
In making the Bear deal, the New York Fed agreed to accept Bear’s own calculation of the value of assets acquired with taxpayer money, even though those values were almost certain to decline as the economy deteriorated. Although Fed officials argue that they can hold onto those assets until they increase in value, to date taxpayers have lost $3.4 billion. Even these losses are probably understated, given how the Federal Reserve priced the holdings, said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “You can assume that it has used magical thinking in valuing these assets,” she said.
Translation: This paragraph doesn't even require any between the lines reading; it explicitly says that Geithner accepted Bear Stearns' fake values for assets, with the taxpayers making up the difference. Back to the article:
Over Columbus Day weekend last fall, with the market gripped by fear and banks refusing to lend to one another, a somber group gathered in an ornate conference room across from Mr. Paulson’s office at the Treasury.

Mr. Paulson, Mr. Bernanke, Ms. Bair and others listened as Mr. Geithner made his pitch, according to four participants. Mr. Geithner, in the words of one participant, was “hell bent” on a plan to use the Federal Deposit Insurance Corporation to guarantee debt issued by bank holding companies.
It was a variation on Mr. Geithner’s once-unthinkable plan to have the government guarantee all bank debt.

The idea of putting the government behind debt issued by banking and investment companies was a momentous shift, an assistant Treasury secretary, David G. Nason, argued. Mr. Geithner wanted to give the banks the guarantee free, saying in a recent interview that he felt that charging them would be “counterproductive.” But Ms. Bair worried that her agency — and ultimately taxpayers — would be left vulnerable in the event of a default.

Mr. Geithner’s program was enacted and to date has guaranteed $340 billion in loans to banks. But Ms. Bair prevailed on taking fees for the guarantees, and the government so far has collected $7 billion.
Translation: The vast guarantees of bank debts were Geithner's brainchild. Time and again, the article poses Sheila Bair and the FDIC as unsuccessfully trying to thwart Geithner's plans, worrying that they put the taxpayers at too much risk. It's certainly not good for his image that Geithner is repeatedly depicted as standing up for the banks' interests, while other government officials, usually from the FDIC, stand up for the taxpayers (although this does seem to be a fairly accurate description). Might the unnamed "others" in the room have been FDIC officials with an axe to grind, hoping to make their boss Bair look better? Back to the article:
Mr. Geithner has also faced scrutiny over how well taxpayers were served by his handling of another aspect of the bailout: three no-bid contracts the New York Fed awarded to BlackRock, a money management firm, to oversee troubled assets acquired by the bank.

BlackRock was well known to the Fed. Mr. Geithner socialized with Ralph L. Schlosstein, who founded the company and remains a large shareholder, and has dined at his Manhattan home. Peter R. Fisher, who was a senior official at the New York Fed until 2001, is a managing director at BlackRock....

For months, New York Fed officials declined to make public details of the contract, which has become a flash point with some lawmakers who say the Fed’s handling of the bailout is too secretive. New York Fed officials initially said in interviews that they could not disclose the fees because they had agreed with BlackRock to keep them confidential in exchange for a discount.

The contract terms they subsequently disclosed to The New York Times show that the contract is worth at least $71.3 million over three years. While that rate is largely in keeping with comparable fees for such services, analysts say it is hardly discounted.
Translation: Geithner gave lucrative contracts to close acquaintances. Even if this is not a case of clear cut corruption, there is an appearance of impropriety.

The obvious question this article raises is why publish it now? The populist fervor over the AIG bonuses has died down, and the market rebound over the last six weeks has quieted other (read: CNBC and their ilk) critics. Several possibilities jump out:
  • FDIC officials are wary of being implicated in the PPIP scheme, and want to separate themselves from Geithner.
  • Officials are worried not enough banks are willing to participate in the PPIP since the prices the leverage the government will provide will not be enough to prevent banks from taking large losses, so they want to lay the groundwork for blaming Geithner.
  • Administration officials are jockeying for Geithner's job (yes, that means you Larry), and are setting him up as the fall guy once it becomes clear the green shoots are just a blip on our downward trajectory.
  • The politicos like Rahm and Axelrod - who already distanced themselves from Geithner when he rolled out the PPIP - are positioning themselves to take a much tougher line on the banks, and need to scapegoat Geithner first (though is it really scapegoating if the blame is justified?). The fact that the article quotes several liberal critics of the bailouts - Stiglitz, Buiter, and Roubini - suggests that their ideas are gaining currency with whoever pushed this story. This would be a very positive development.
We can only hope that Geithner is feeling the heat within the administration and that Obama will reconsider whether he wants to tie himself to these unpopular bailouts Geithner has championed. Now if we could just someone besides Summer or Rattner to become Treasury Secretary, we might avoid a lost decade. Would Roubini give up his hard partying ways to take the job?

Bamboo Shoots?

China bulls have pointed to its large stimulus package, the surge in credit over the past months, and the sharp rebound in the stock exchange as signs that China may lead the world out of this global slump. But the latest data on power usage and generation - a leading indicator of economic activity - belies these sanguine predictions of an imminent turnaround in China. From China Stakes:
A February bounce in power generation that continued in the first half of March was welcomed by economic policy makers, not least Premier Wen Jiabao, as a sign of recovery. It was, perhaps, a false hope as power generation again declined in late March. China Electricity Regulatory Commission officials predict a 4% decline in power generation in April....

According to statistics from the State Grid, power generation dropped 0.7% year on year in March, after a rise of 5.9% in February and a fall of 12.3% in January. Experts believe the fallback indicates economic uncertainties. State Grid figures also show that power generation in the first quarter of this year dropped 2.25%, year on year.

Sunday, April 26, 2009

Meyerson: Simon Johnson is Right

Harold Meyerson certainly seems to agree with Simon Johnson's argument that the financial sector has become both too large economically and too powerful politically. In his last column, Meyerson essentially paraphrases Johnson's recommendations for dealing with this crisis. From the Washington Post:
The Democrat in the White House and the Democrats on the Hill are committed to legislation that regulates our dysfunctional wards in the banking industry, but regulations by themselves won't solve the problem of the banks being too big to fail -- and so big that they dominate campaign finance and, with it, much of the business of lawmaking. We need to amend our antitrust laws so we can scale down banks to the point that they no longer imperil our economic and political systems. As things stand now, it's we who are serving their needs, not they who are serving ours. It's time to turn that around.
While many in the media have been quick to dismiss Johnson as a radical, it is certainly encouraging to see his ideas gain some currency among more mainstream voices. Because if we do not build a consensus about checking the outsized influence of Wall Street, we will only set ourselves up for an even bigger crisis in the future, assuming we make it through this one over the next year or two.

Our Broken System

Most of the public understands that the legalized bribery known euphemistically as lobbying has to a great extent made our government unresponsive to actual citizens - except, of course, when we demand that members of Congress grandstand against AIG bonuses without actually doing anything substantive. Obama ran against this acceptable corruption in large part, and this line of attack certainly resonated with a sizable segment of the electorate (whether reality matches the rhetoric is another matter entirely). Indeed, we wouldn't need change we can believe in if we didn't think the system was rotten, with inside-dealing and kickbacks being the rule.

Given this, the recent report in the New York Times that a consortium of some of the country's largest companies lobbied Congress against taking action to mitigate global warming despite their own scientists' reports that human activity had unequivocally contributed to global warming should not be shocking. As the Times reports:
For more than a decade the Global Climate Coalition, a group representing industries with profits tied to fossil fuels, led an aggressive lobbying and public relations campaign against the idea that emissions of heat-trapping gases could lead to global warming.

“The role of greenhouse gases in climate change is not well understood,” the coalition said in a scientific “backgrounder” provided to lawmakers and journalists through the early 1990s, adding that “scientists differ” on the issue.

But a document filed in a federal lawsuit demonstrates that even as the coalition worked to sway opinion, its own scientific and technical experts were advising that the science backing the role of greenhouse gases in global warming could not be refuted.

“The scientific basis for the Greenhouse Effect and the potential impact of human emissions of greenhouse gases such as CO2 on climate is well established and cannot be denied,” the experts wrote in an internal report compiled for the coalition in 1995.

The coalition was financed by fees from large corporations and trade groups representing the oil, coal and auto industries, among others. In 1997, the year an international climate agreement that came to be known as the Kyoto Protocol was negotiated, its budget totaled $1.68 million, according to tax records obtained by environmental groups.

Throughout the 1990s, when the coalition conducted a multimillion-dollar advertising campaign challenging the merits of an international agreement, policy makers and pundits were fiercely debating whether humans could dangerously warm the planet.
I am shocked, shocked that oil and automobile companies would misrepresent the science of global warming! And yet on some level this latest revelation is somewhat surprising. This is not cigarette companies lying about smoking causing cancer. This is worse. Much worse. Smoking (mostly) only effects smokers; global warming will effect everyone. That such short-sighted business interests so effectively controlled government policy brings to mind Mancur Olson's theory about how great nations decline: economic interests capture the government, maximizing their own interests at the expense of the common good. This eventually leads to economic stagnation. Is this how a great nation ends? Not with a bang but with a bailout - and tax breaks?

Saturday, April 25, 2009

Feldstein: The Coming Inflation

Harvard professor and former Reagan chief economic adviser has been making the rounds warning that sharp inflation threatens to choke off any economic recovery on the horizon. Here he is on Bloomberg explaining the case he made in a recent op-ed in the Financial Times. From the FT:
The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.
This is slightly misleading. Yes, excluding food and energy, consumer prices were up 1.8% from last year, but almost all of that increase came from price increases in tobacco products due to new taxes. Deflation is still the most immediate threat to the economy. Back to the piece:
The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.
In short: fiscal deficits alone will not cause inflation; loose monetary policy is the key issue. As Mark Thoma and Scott Sumner recently explained, expansionary fiscal policy need not lead to the economy overheating if monetary policy counteracts it (this is why our multiplier estimates are largely questions of theory rather than empirical fact). Since the Fed normally tries to meet its inflation targets, it normally acts as such a countervailing force. In this deflationary environment, however, Bernanke & Co. have been so desperately trying to induce inflation that they risk unleashing it on a much larger scale than they want. As Feldstein explains:
But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now....

The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.
Once the economy begins to recover - something Feldstein doesn't see happening until 2010 - banks will likely begin putting these excess reserves to work. The Fed's ability to pull back the money supply will be hampered by not only a lack of T-bills to sell, but also by the fact that so much of the collateral it has to sell are toxic assets of dubious value. From a deflationary spiral to stagflation, here we come!

Given these considerations, it is difficult to see what alternative policies Feldstein wishes Bernanke would pursue. Feldstein readily admits that the banks will be struggling to survive for the next two years, and that aggregate demand will remain weak. In this context, the Fed's massive injections of liquidity certainly seem defensible. And yet if the Fed succeeds in mitigating this downward pressure on the economy, the chances of them successfully pulling back the massive liquidity it has injected look negligible. Do we have any other options? And isn't stagflation preferrable to a deflationary spiral? At least the Fed can easily cure stagflation - pull a Volcker and raise short-term rates until the inflation is wrung out of the economy. Deflation is an altogether different beast. Whether the Fed actually can get us out of this liquidity trap and halt the downard pressure on prices is more a matter of theory than fact. We seem to only have bad and less bad choices ahead.

Rogoff: Unemployment to 11%

Here's Harvard professor and former IMF Chief Economist Ken Rogoff on Bloomberg talking about the prospects of an economic turnaround. Rogoff is still bearish - his analysis of past financial crises shows that these types of slumps tend to last longer than typical recessions, and the recoveries are weaker - and he sees unemployment rising to 11% by 2011. If this prediction turns out to be correct, there are two immediately obvious implications: the farcical stress tests will be even more inadequate than pessimists have pointed out, and Obama will go into the reelection cycle with the cratering economy weighing him down. If the Republicans can manage to pick a credible candidate and shed their current craziness, they might be able to win by default. Of course, if the public perceives the Obama administration as generally being on their side, and trying to alleviate economic suffering, while the Republicans continue to shill for the top 1%, Obama might get a pass for a crummy economy he inherited. But by not biting the financial bullet and getting all of the worst news out of the way - putting insolvent banks into receivership and realizing all financial sector losses - Obama risks extending this downturn, and opening himself up to an electoral challenge. It is baffling that a politician as savvy as Obama does not seem to appreciate this possibility.

Friday, April 24, 2009

Waterboarding Is Torture

Keith Olbermann at his sanctimonious best. Yes: waterboarding is torture. It always has and it always will be. Getting a lawyer to write a speciously reasoned memo asserting that waterboarding is not torture does not change this fact. Sadly, this needs to be said.

Update: As usual, Andrew Sullivan forcefully argues that waterboarding is torture, and the failure of the media to speak its name as such is an abdication of their responsibilities. Money quote:
In the face of this, are there any legal decisions, judgments or trials in the last five centuries in which waterboarding has not been deemed torture? None that I am aware of. And this is not surprising. If waterboarding someone 183 times is not torture, then nothing is torture.

Shiller: Against Market Fundamentalism

Far too often, debates devolve into black-and-white affairs, with strawmen on both sides taking a pummeling. Robert Shiller's latest piece in the Wall Street Journal takes on this type of Manichean thinking, as he adopts the Herculean task of convincing economic conservatives that not all financial regulation is bad. From the WSJ:
The principal long-term result of the current financial crisis should be improved financial regulation. After the immediate crisis is over, we need to restructure our fragmented system. This process will take years to complete since, if properly done, it should get at the heart of the regulatory structure.

This is not as radical as it sounds, for while many observers equate U.S.-style capitalism with unconstrained free markets, the story is more complicated. Americans have long understood that for the economy to work well, government must play an important supporting role. They've also long understood the important role that self-regulatory organizations (SROs), such as trade associations and exchanges, play in cooperation with government regulation.

An understanding of animal spirits -- the human psychology and culture at the heart of economic activity -- confirms the need for restoring the role of regulators as guiding hands in a healthy, productive free-enterprise system. History -- including recent history -- shows that without regulation, animal spirits will drive economic activity to extremes....

Such a world of animal spirits justifies the economic intervention of government. Its role is not to harness animal spirits but really to set them free, to allow them to be maximally creative. A brilliant player wants a referee, for only when the game has appropriate rules can he really show his talents. While the sports of baseball and football haven't changed much in the last century, the economy has -- and American financial regulation hasn't had an overhaul in 70 years. The challenge for the Obama administration, along with the U.S. Congress and our SROs, is to invent a new and better American version of the capitalist game.
You might think this is an uncontroversial point. Unfortunately, it is not. What was that about Dark Ages again?

Tuesday, April 21, 2009

Ireland: Keynsianism's Worst Nightmare

Question: what keeps Paul Krugman up at night? Answer: not being able to perform fiscal stimulus because of a skittish bond market. Unfortunately for the Irish, this is the situation they now find themselves in. As Krugman explains:
to satisfy nervous lenders, Ireland is being forced to raise taxes and slash government spending in the face of an economic slump — policies that will further deepen the slump.

And it’s that closing off of policy options that I’m afraid might happen to the rest of us.
And how did the Irish get in this predicament? Again back to Krugman:
On the eve of the crisis Ireland seemed to be in good shape, fiscally speaking, with a balanced budget and a low level of public debt. But the government’s revenue — which had become strongly dependent on the housing boom — collapsed along with the bubble.

Even more important, the Irish government found itself having to take responsibility for the mistakes of private bankers. Last September Ireland moved to shore up confidence in its banks by offering a government guarantee on their liabilities — thereby putting taxpayers on the hook for potential losses of more than twice the country’s G.D.P., equivalent to $30 trillion for the United States.

The combination of deficits and exposure to bank losses raised doubts about Ireland’s long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies.

Hence the harsh new policies. Earlier this month the Irish government simultaneously announced a plan to purchase many of the banks’ bad assets — putting taxpayers even further on the hook — while raising taxes and cutting spending, to reassure lenders.

Luckily for the United States, our banking sector isn't so outsized that our too-big-to-fail institutions are too-big-to-save. Small comfort. And the United States' government debt-to-GDP ratio is at a lower starting point than that of most European nations, so we have quite a bit more runway than our friends across the pond. Still, if the PPIP is as inefficient and ineffective as its critics fear, then every day could seem like St. Paddy's Day: we'll have run up too much debt to save the banks to commit to any other spending, cutting vital counter-cyclical programs at the worst moment. Again, back to Krugman:
For now, the United States isn’t confined by an Irish-type fiscal straitjacket: the financial markets still consider U.S. government debt safer than anything else.

But we can’t assume that this will always be true. Unfortunately, we didn’t save for a rainy day: thanks to tax cuts and the war in Iraq, America came out of the “Bush boom” with a higher ratio of government debt to G.D.P. than it had going in. And if we push that ratio another 30 or 40 points higher — not out of the question if economic policy is mishandled over the next few years — we might start facing our own problems with the bond market.

Not to put too fine a point on it, that’s one reason I’m so concerned about the Obama administration’s bank plan. If, as some of us fear, taxpayer funds end up providing windfalls to financial operators instead of fixing what needs to be fixed, we might not have the money to go back and do it right.

And the lesson of Ireland is that you really, really don’t want to put yourself in a position where you have to punish your economy in order to save your banks.
The brouhaha over the AIG bonuses will be remembered fondly as a time of sober judgment if we turn Irish, and bail out the bankers, while cutting services for the public at large. But even this obvious political reality seems unlikely to change policy towards the banks - after all, it's much easier to simply cross your fingers and hope the banks can earn their way out of this crisis a la 1982, than take serious steps to restructure them. Japan circa 1995, here we come!

Some of Life Has To Be Mysterious

It's difficult to imagine a more embarrassing, intellectually vapid defense of war crimes than this. Magic acts need to be mysterious. Authorizing torture at the highest levels of government is the type of criminality we must investigate. No one is above the law. Wishing this abhorrent period away, out of the recesses of our collective memories, only tacitly endorses this abominable behavior, and sets the precedent that a president can break the law with impunity. This is a pathetic, partisan defense of the indefensible in the name of "bipartisan" comity.

I suspect this cringeworthy performance will be remembered as the coda of a dark era. At the end, torture apologists could only plea for us "keep on walking" rather than investigate any abuses. Claims that torture, and only torture, could keep us safe have been debunked. And so Republican loyalists are only left to describe torture prosecutions as a "partisan witchhunt" and call on us to be "forward-looking." I wonder how that defense would have worked at Nuremberg.

Monday, April 20, 2009

A Horse, A Horse, My Kingdom For A Horse

You know things are bad when a racehorse is the only glimmer of hope. From the New York Times:
A racehorse bought for a pittance has turned into a national hero in crisis-stricken Hungary.

The thoroughbred known as Overdose pounded down the stretch here at Kincsem Park on Sunday to extend his record to 12 wins in 12 races, his jockey clad in the red, white and green of the Hungarian flag.

And for an afternoon at least, the crowd of more than 20,000 in the grandstand and lining the rail, along with all the Hungarians watching at home, could forget about the resignation of the prime minister and their currency’s nosedive.

As times have gotten tougher here, the 4-year-old Overdose has become the Hungarian Seabiscuit, a symbol of hope for Americans during the Great Depression. He appears to remind Hungarians of themselves: undervalued and underestimated....

The horse’s popularity has even attracted politicians. On Friday, Viktor Orban, chairman of the center-right Fidesz Party and a former prime minister who hopes to reclaim the job in next year’s election, turned up with a crowd of television cameras to pose with the star.

“Failure is the most often heard expression in Hungary today — failure, mistake, pessimism. When even a horse is able to make a miracle from nowhere, it’s a sign of hope that we can get out from the desperate situation we are now in,” Mr. Orban said.

“If I were a politician, I would do the same, because Overdose is one of the most famous persons in Hungary,” said Mr. Horvath, “even though he is a horse.”

How long before the US looks for its own modern Seabiscuit?

Ukraine Time Bomb Exploding

Remember last summer after Russia invaded Georgia, and neoconservatives hyperventilated, declaring it the most significant development in world history since the fall of the Berlin Wall? Yeah - oops. If Georgia was the Sudetenland in Robert Kagan's wet dream about the reemergence of a Nazi state, then Ukraine was Austria - the next domino to fall. Turns out that the greatest threat to Ukraine's stability and territorial sovereignty didn't come from the Russian bear next door, but rather from the ravages of economic depression the financial crisis has unleashed. From the New York Times:
Few areas of Europe have taken such a body blow from the world economic crisis as the industrial heartland of eastern Ukraine, home to giant enterprises in the steel and metals industry in which orders have dried up nearly completely and prices have plummeted.

In the Donetsk region, home to 4.6 million people, around 80 percent of the economy is tied to the metals industry. In January, when industrial production dropped by a precipitous one-third throughout Ukraine as a whole, in Donetsk it fell by half against the previous year....

In the absence of a galvanizing voice rallying the workers, or a politician in the Ukrainian capital, Kiev, to marshal the popular anger, Mr. Yeryomin and many others are focusing their unhappiness on the borders of this part of Europe, sliced and diced in countless wars through the centuries.

“I look with pride at Russia,” said Mr. Yeryomin, who lived in Russia as a child and counts himself among the 40 percent of inhabitants of the Donetsk region who are considered ethnically Russian. “We should cut Ukraine in two, and give half to Poland and half to Russia.”

This part of eastern Ukraine has always felt more attached to Russia than to western Ukraine and neighboring Poland. For many here, the fraying economy is accompanied by a sense that officials in Kiev, where the government is paralyzed by political infighting, have abandoned Ukrainians to their fate.

Just last week, more than 10,000 protesters gathered in Kiev to demand a change of government, prompting President Viktor A. Yushchenko to issue a surprise announcement that he was considering early presidential and parliamentary elections.

Whether any politician can allay both the global and the homegrown troubles of the metals industry in Ukraine is unclear. For now, the national currency, the hryvnia, has lost 40 percent of its value against the dollar from its high last year, and the reforms demanded by the International Monetary Fund as a condition for receiving a life-giving $16.4 billion loan are the subject of endless wrangles in an argumentative Parliament.
Economic volatility, ethnic divisions, and the frontier of a former empire: sounds like Niall Ferguson's recipe for upheaval.

Saturday, April 18, 2009

Rattner Probe

Is anyone in the administration working on the bailouts clean? The latest revelation that car czar Steve Rattner is being investigated for his potential role in a kickback scheme with the New York state pension fund does little to contradict the perception that political and financial insiders play by a different set of rules, and have gamed the system at the public's expense. From the WSJ:
A Securities and Exchange Commission complaint says a "senior executive" of Mr. Rattner's investment firm met in 2004 with a politically connected consultant about a finder's fee. Later, the complaint says, the firm received an investment from the state pension fund and paid $1.1 million in fees.

The "senior executive," not named in the complaint, is Mr. Rattner, according to the person familiar with the matter. He is co-founder of the investment firm, Quadrangle Group, which he left to join the Treasury Department to oversee the auto task force earlier this year....

In the long-running pay-to-play case, authorities allege that about 20 investment firms made payments in exchange for investments from the $122 billion New York State Common Retirement Fund....

The main legal issue for the investment firms turns on whether they knew, or should have known, that fees they paid to certain entities for access to the New York fund were legitimate or were improper kickbacks, and whether they were properly disclosed, according to people familiar with the matter.
Even if there was no wrongdoing, this appearance of impropriety and insider dealing is horrible press. Nothing galvanizes populist rage like financial and political elites playing the system for themselves. I guess this will take Rattner out of the running as potential Treasury Secretary-in-waiting, should Geithner ultimately "decide to spend more time with his family."

Thursday, April 16, 2009


Is the Geithner PPIP already over? Clusterstock reports that Jamie Dimon announced that he does not foresee JP Morgan participating in the PPIP, either as a buyer or a seller. From Clusterstock:
Speaking on the company's just-concluded conference call, JP Morgan (JPM) CEO Jamie Dimon downplayed the PPIP, saying the bank had nothing to sell into it, and that it certainly had no interest in partnering with the government as a buyer.

What's more, he said, he didn't consider the PPIP to be that big of a deal, suggesting that it's just one small piece of what Treasury is doing to prop up the system.

Remember, this is coming from the bank that has 10% of all mortgages. They're saying they have nothing to sell and that toxic asset prices aren't the problem.
I guess 6X leverage isn't enough to bid up the prices of toxic assets high enough for banks to still not take enormous losses. This was fairly predictable. Now what's the plan?

Wednesday, April 15, 2009

Goldman Disappears December

Gone. Vanished. Kaput. That's what the boy (and girl) wonders at Goldman did to the month of December - they disappeared it Pablo Escobar-style. Via Floyd Norris, we learn that when Goldman Sachs switched from being an investment bank to a bank holding company, it changed its fiscal year from beginning in December to January. So its Q4 2008 earnings go through November 30, 2008, and its Q1 2009 earnings begin on January 1, 2009.

What happened in December then? Write-downs. Lots of write-downs. Over a billion dollars worth, pre-tax. So much for that $1.8 billion first quarter profit. But now we know why they pay them the big bucks. They turn financial chicanery into an art.

Ireland Takes One for Germany

Here's Ambrose Evans-Pritchard at his gloomy, apocalyptic best describing the danger of Ireland falling into a debt deflation cycle not seen since the 1930s. As Evans-Pritchard notes, the most tragic part of this slow-motion trainwreck is that it does not have to happen: if the ECB aggressively cut rates, and Ireland had monetary sovereignty to devalue its currency, then they could perhaps settle for a lost decade instead of an outright depression. Unfortunately for the Celts, the Germans exert de facto control over the ECB, and the Germans are far too worried about the potential inflationary pressures of quantitative easing to pursue such heterodox monetary policies. Apparently memories of needing a wheelbarrow of cash to pay for a loaf of bread scar a nation's collective psyche for generations. From the Telegraph:
If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system.

The Irish central bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.

Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.

Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone....

Brian Lenihan, Ireland's finance minister, said the economy would contract 8pc this year on top of the terrifying 7.1pc drop in the final quarter of last year.

But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing.

This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.

Don't blame the victim. Ireland has been betrayed twice in this saga. Once by New Labour, which led Dublin to believe that Britain would join EMU at the same time – covering Ireland's dangerously exposed flank of Sterling trade.

It was betrayed again by the European Central Bank, which opened the monetary floodgates early this decade to nurse Germany through a slump, holding rates at 2pc until late 2005, despite flagrant breach of the ECB's own M3 money targets. Fast-growing Ireland and the Club Med over-heaters were sacrificed to help Germany. They were left to cope with credit bubbles as best they could.

Ireland struggled. Construction reached 21pc of GDP – a world record? – compared with 11pc in the US at the peak. Mr Lenihan hopes to shield banks from the calamitous consequences by creating a buffer agency. It will soak up €80bn to €90bn in toxic debt – or 50pc of GDP.
He borrowed the plan from Sweden's bank rescues in the early 1990s, but overlooks the key point – it was not the bail-out that saved Sweden's financial system, the country recovered only by ditching its exchange peg and regaining its freedom of action.

Without that sort of liberation, Ireland's property slump will grind on for years and more multinationals will join Dell in decamping to cheaper plants in Poland. Ireland risks a deflationary slide into bankruptcy.

Of course, it is not the job of the ECB to set policy for Dublin's needs. But it would at least help if Frankfurt began to set policy for Europe's needs. Has the ECB noticed the collapse of industrial output in Spain (-24pc), Germany (-23pc), Italy (-21pc), France (-14pc)?
If Europe fell into depression, would the ECB notice? Don't answer.

Macro-Economists Have No Good Multiplier Estimates

This discussion between Mark Thoma and Scott Sumner touches on two key issues: first, this is a balance sheet recession; and second, macro-economists do not have good multiplier estimates for fiscal policy in a depressed economy.

Regarding the difference between the current downturn and garden variety business cycle recessions, Thoma explains that insolvency is the distinguishing characteristic. While policymakers have mostly focused on the banks, household balance sheets are in bad shape as well, as the following chart of household debt-to-GDP shows.

Since households are still more or less swamped in debt, they will likely use any tax cuts to save or pay down debts. While this won't prop up aggregate demand, it should speed up recovery. Indeed, since consumer spending makes up such a large part of the American economy - some 70% at the peak of the bubble - there will not be a sustained recovery until households regain their financial footing. And as tax cuts will help households pay off what they owe quicker, there is a compelling argument for including them in any stimulus. Nonetheless, to prevent aggregate demand from completing collapsing into a deflationary spiral, Thoma argues for the necessity of fiscal stimulus.

And here's where things get interesting. Sumner and Thoma agree that macro-economists have no good estimates for fiscal multipliers. As Sumner explains, under normal economic conditions, if fiscal policy created an inflationary pressure, the Fed would raise rates in order to meet its inflation targets. In other words, monetary policy would counteract fiscal policy to prevent the economy from heating up too much. Consequently, we don't have good estimates of what the multipliers of fiscal policy would be, holding all else equal. Of course, today we are in a situation where the Fed is desperately trying to create inflation, so we do not have to worry about fiscal and monetary policies working at cross purposes. But when economists argue about the different multipliers of different types of tax cuts or spending, they are largely flying blind, relying on theory rather than empirical tests. In other words, economics is much, much less a science than its adherents usually like to pretend.

And Now You Find Yourself In '82?

As Simon Johnson notes, the administration seems to be following a different script for dealing with the banks from the liquidation/receivership/subsidization troika Elizabeth Warren outlined in her last TARP oversight report. This fourth option - what Simon Johnson calls "forebearance" - is essentially hoping banks can earn their way out of insolvency. By relaxing accounting rules on mark-to-market and providing just enough capital to keep banks operating, the administration hopes that a rebounding economy along with cheap money will provide enough earnings opportunities for banks to work their way back to health. Johnson points out that this is more or less the approach Volcker took with the banks after the 1982 Latin American debt crisis likely pushed many into de facto insolvency. But Johnson sees three factors that make such a policy succeeding today unlikely:
  • this is a global slump
  • the real economy will probably keep deteriorating, unlike the 1982 recession when there was a sharp turnaround after the Fed lowered rates
  • there are more speculative attacks on banks today
Hedged Bet argued that forebearance was the real Geithner plan after Warren Buffet hinted as much on CNBC last month. It seemed like a plan to emulate Japan's zombie banks then, and it still does now. Let's hope this really isn't the plan.

Hungary On The Brink?

As Eastern European governments fall victim to the global financial crisis, the issue of social and political instability gets injected into what is already a Gordian knot of an economic crisis. The specter of economic nationalism and sovereign defaults haunts the international system. While the G20's steps to shore up the financing of the IMF undoubtedly mark a positive step in the direction of global stability, the question of what to do with countries such as Ukraine and Hungary that cannot or will not enact IMF fiscal austerity measures still looms. This concern is even more acute given that Hungary's prime minister stepped down a few weeks ago, amidst the political fallout that trying to follow the IMF's spending restrictions generated. From the New York Times:

As for Hungary, the $25 billion agreement it signed with the monetary fund last year has put it in an awful policy vise. Mandated to squeeze its budget deficit below 3 percent of gross domestic product, the government is in no position to stimulate an economy estimated to sink by as much as 6 percent this year.

There is no painless path to recovery.

“Hungary has an uphill struggle, but we know that,” Gordon Bajnai, the economy minister, said in an interview in late March. “We need a reform-minded government.”

On Monday, Prime Minister Ferenc Gyurcsany, the former Communist who has led the country since 2004, appointed Mr. Bajnai, a 41-year-old former businessman, to lead that effort as his successor.

But furious opposition from Hungary’s right wing — which has called for elections — may limit the scope of his ambitions.

Lajos Bokros, a former finance minister, says that the alternative to not meeting the monetary fund’s conditions is bankruptcy. He worries that the forint will fall even further amid the political uncertainty — a concern underscored by downgrades of Hungary’s credit rating by Standard & Poor’s and Moody’s this week.
The social dimensions of this crisis are only beginning to be felt. Hopefully this climate of political and economic fear will not usher in a new era of extremism.

Establishment Media: We Hope Liberal Critics Are Wrong (Though We Doubt It)

Liberal critics of the Paulson/Geithner bailouts have levied three main criticisms to date: first, subsidies to banks represent highly costly transfers of wealth from taxpayers to bankers; second, insolvent banks need to be put into receivership, rather than subsidized; and third, policymakers have avoided restructuring banks because of they are still enthralled in the ideology of market worship/the banking lobby has captured the government. Paul Krugman and Joseph Stiglitz have popularized the first two points, while former IMF chief economist Simon Johnson provocatively advanced the third point in his recent piece in the Atantic.

What has been the response from the administration and the establishment media to these fairly devastating critiques? Government officials have suggested those calling for temporary nationalization are either naive or simply wrong; leading media voices, meanwhile, have expressed unease - unease because they hope these liberal critics are wrong, but they're not confident of it. From Newsweek:

If you are of the establishment persuasion (and I am), reading Krugman makes you uneasy. You hope he's wrong, and you sense he's being a little harsh (especially about Geithner), but you have a creeping feeling that he knows something that others cannot, or will not, see. By definition, establishments believe in propping up the existing order. Members of the ruling class have a vested interest in keeping things pretty much the way they are. Safeguarding the status quo, protecting traditional institutions, can be healthy and useful, stabilizing and reassuring. But sometimes, beneath the pleasant murmur and tinkle of cocktails, the old guard cannot hear the sound of ice cracking. The in crowd of any age can be deceived by self-confidence, as Liaquat Ahamed has shown in "Lords of Finance," his new book about the folly of central bankers before the Great Depression, and David Halberstam revealed in his Vietnam War classic, "The Best and the Brightest." Krugman may be exaggerating the decay of the financial system or the devotion of Obama's team to preserving it. But what if he's right, or part right? What if President Obama is squandering his only chance to step in and nationalize—well, maybe not nationalize, that loaded word—but restructure the banks before they collapse altogether?
And this from a New Republic piece on Simon Johnson:

there's something that bothers me ever-so-slightly about the piece. It turns up as Johnson shifts from the political economy of an emerging-market financial crisis to the political economy of American finance over the last 25 years to the political economy of this particular crisis....

In the United States, Johnson argues, the situation is even more insidious in some ways. Our own financial elites have not only been politically ascendant for the last generation, but intellectually ascendant, too. Policymakers blithely adopted the view that vast unregulated flows of capital were in the national interest--a view that just happened to overlap with Wall Street's self-interest. "A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true," Simon writes. A bit hyperbolic, I'd say, but definitely a kernel of truth here.

It's the last pivot where Johnson loses me. Well, he doesn't exactly lose me, because I worry he may be right. But he certainly leaves me a little cold. Johnson concludes that American financial elites "are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive." He adds that we're afflicted by "a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support." Johnson's preferred solution--one I'm sympathetic to--is that the government seize weak banks, recapitalize them, and sell them off in pieces. But he thinks this is next-to-impossible so long as Wall Street stays so powerful.

Now, certainly there are a lot of data points consistent with the financial sector having a veto over public policy. As Johnson notes, a lot of the bailouts the Fed and Treasury have arranged left the banks basically intact. By most reasonable measures, the terms have been more favorable to bankers than to taxpayers, which raises questions about who controls whom. Likewise, the Geithner plan certainly goes to elaborate lengths to avoid seizing banks, which also looks on its face like the work of an overly-solicitous policy mind.

On the other hand ... we just don't know. Johnson has performed a service by marshalling the available data points and drawing some provocative connections, but he's not great at establishing what's driving what....

The point is that figuring out whether financial interests control public policy is a question that needs to be answered directly--with documents and testimony. You can't just infer it from a bunch of circumstantial evidence.

This unease comes from fear that populists may be right. For our elites, populism is a knee-jerk reaction on the part of the uneducated, unsophisticated masses. It is almost always wrong. But today, as Simon Johnson points out below, some of the most respected members of the economics profession - along with members of the educated classes spanning the political spectrum - could easily be mistaken for full-blown populists.

This creates cognitive dissonance within establishment circles, especially traditional left-of-center publications that place great weight in the opinions of experts such as Krugman, Stiglitz and Johnson. They would seem to have only two choices: either claim that such denunciations are wrongheaded, or admit that the critics are right. Instead, they have hedged their bets, explaining that the critics make compelling cases, but perhaps they go too far; these critics can't prove what they're saying in a court of law, after all. This is nothing more than a craven refusal to perform their roles as journalists. Instead of investigating the claims of critics, they try to assuage the public's anger at the bailouts with flimsy defenses of the establishment, while acknowledging that something might be rotten in the District of Columbia. Their ostensible role as public watchdogs demands that they do more than simply cross their fingers that we don't live in a banana republic.


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