Hedged Bet

SNL Nails "Stress" Tests

2009-05-10T13:16:00.005-04:00

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

Stress Test "Negotiations"

2009-05-09T23:09:00.011-04:00

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.

More Stress: Wells Fargo Needs $15 Billion

2009-05-06T14:40:00.002-04:00

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

2009-05-06T13:37:00.004-04:00

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.

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

2009-05-05T00:53:00.006-04:00

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.

Krugman: Absolute Wage Levels Matter Too

2009-05-04T13:23:00.007-04:00

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

2009-05-04T08:10:00.004-04:00

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.

"Contrarian" Naivete From TNR

2009-05-03T19:17:00.007-04:00

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.

Krauthammer: Torture Is Impermissible Except Always

2009-05-01T19:36:00.002-04:00

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.

GOP Fearmongering

2009-04-30T17:41:00.008-04:00

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...

2009-04-30T17:10:00.005-04:00

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

2009-04-30T17:06:00.004-04:00

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?

Bair: FDIC Can Handle This Crisis

2009-04-28T16:35:00.004-04:00

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.

Geithner Is Wall Street's Guy

2009-04-27T02:55:00.019-04:00

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?

2009-04-27T00:10:00.003-04:00

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.

Meyerson: Simon Johnson is Right

2009-04-26T21:49:00.003-04:00

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

2009-04-26T06:38:00.013-04:00

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?

Feldstein: The Coming Inflation

2009-04-25T14:12:00.011-04:00

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%

2009-04-25T03:25:00.005-04:00

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.

Waterboarding Is Torture

2009-04-24T11:56:00.001-04:00

Visit msnbc.com for Breaking News, World News, and News about the Economy

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

2009-04-24T06:40:00.006-04:00

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?

Ireland: Keynsianism's Worst Nightmare

2009-04-21T12:00:00.011-04:00

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

2009-04-21T06:44:00.000-04:00

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.

A Horse, A Horse, My Kingdom For A Horse

2009-04-20T16:41:00.003-04:00

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

2009-04-20T14:53:00.008-04:00

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.

Rattner Probe

2009-04-18T14:32:00.004-04:00

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."

PPIP DOA?

2009-04-16T15:00:00.002-04:00

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?

Goldman Disappears December

2009-04-15T23:25:00.005-04:00

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

2009-04-15T22:15:00.000-04:00

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

2009-04-15T15:33:00.010-04:00

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?

2009-04-15T15:08:00.004-04:00

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?

2009-04-15T12:49:00.003-04:00

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)

2009-04-15T10:52:00.004-04:00

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.

Deflation Alert

2009-04-15T10:32:00.002-04:00

CPI down 0.1%. In the twelve months ending in March, prices declined 0.4% - the first yearly decline since 1955. How long will goldbugs continue to insist that ending up like Weimar Germany rather than USA circa 1933 is the real danger facing our economy?

Richard Cohen Is Not Very Bright

2009-04-14T22:04:00.002-04:00

In an otherwise unremarkable column about the myriad failures of the Bush presidency, Richard Cohen throws us this brilliant line on foreign policy:

Whether you supported the war or opposed it, you have to concede that it should have ended years ago and, along with the invasion of Grenada, be a fit dissertation subject for a desperate PhD candidate and not, as it remains, a festering debacle.

Does Cohen really think that regime change in a small Caribbean island, and in a much larger, ethnically heterogeneous Middle Eastern state are comparable? Was this the "logic" he used for supporting the invasion of Iraq? Perhaps he should stick to what he knows - serving as a faithful stenographer for our elites - and leave the policy analysis to people who can actually think (the kind of people who understand cultural and historical factors matter when you're talking about toppling a government and occupying a nation indefinitely).

Frank Rich Indicts Finance's Takeover of Higher Education

2009-04-14T21:28:00.007-04:00

As usual, Frank Rich captures the zeitgeist like no other in his column on Larry Summers. While most commentators have focused solely on any potential conflicts of interest Summers might have in his role as chief economic advisor after his comfy job at DE Shaw, Rich draws attention to how finance has effectively hijacked higher education. From Rich:

But perhaps I’ve become numb to the perennial and bipartisan revolving-door incestuousness of Washington and Wall Street. I was less shocked by the White House’s disclosure of Summers’s recent paydays than by a bit of reporting that appeared deep down in the Times follow-up article on that initial news. The reporter Louise Story wrote that Summers had done consulting work for another hedge fund, Taconic Capital Advisors, from 2004 to 2006, while still president of Harvard.
That the highly paid leader of arguably America’s most esteemed educational institution (disclosure: I went there) would simultaneously freelance as a hedge-fund guy might stand as a symbol for the values of our time. At the start of his stormy and short-lived presidency, Summers picked a fight with Cornel West for allegedly neglecting his professorial duties by taking on such extracurricular tasks as cutting a spoken-word CD. Yet Summers saw no conflict with moonlighting in the money racket while running the entire university. The students didn’t even get a CD for his efforts — and Harvard’s deflated endowment, now in a daunting liquidity crisis, didn’t exactly benefit either.
Summers’s dual portfolio in Cambridge has already led to one potential intermingling of private business and public policy in his new White House post. He tried — and, mercifully, failed — to install the co-founder of Taconic in the job of running the TARP bailouts. But again, Summers’s potential conflicts of interest seem less telling than the conflict of values that his Harvard double-résumé exemplifies.
In the bubble decade, making money as an end in itself boomed as a calling among students at elite universities like Harvard, siphoning off gifted undergraduates who might otherwise have been scientists, teachers, doctors, entrepreneurs, artists or inventors. The Harvard Crimson reported that in the class of 2007, 58 percent of the men and 43 percent of the women entering the work force took jobs in the finance and consulting industries. The figures were similar everywhere, from Duke to the University of Pennsylvania. Dan Rather, on his HDNet television program in December, reported that at Penn this was even true of “over half the students who graduated with engineering degrees — not a field commonly associated with Wall Street.”

I couldn't agree more. Maybe now we'll get a more rational allocation of our human capital. Instead of piling all of our best minds into conniving new ways to pile leverage on top of itself, we'll devote more attention to addressing the structural issues we face in energy and healthcare.

Defending Gaming the Geithner Plan

2009-04-14T20:04:00.010-04:00

The inevitable gaming-the-PPIP-backlash backlash is on. After Joseph Stiglitz and Jeffrey Sachs lambasted Geithner's plan as a taxpayer rip-off, Noam Scheiber has taken to TNR with his oh-so-contrarian take that the PPIP being a scam isn't necessarily a bad thing. From TNR:

But is this really such a bad thing [if banks game the PPIP]? It sounds a lot like a good bank/bad bank model, in which we recapitalize Citibank to the tune of $925,000 and take the toxic asset off its books and stick it in another entity--a "bad bank"--created for that purpose. As I've said before, there may be moral objections to such an arrangement. (It is offensive that taxpayers have to bail Citibank out.) And the Geithner plan may not have enough money to recapitalize all the banks this way. But that's different from arguing that it can't work....

The only real difference, so far as I can tell, is who pays. Under Sachs's preferred approach, the bondholders and stockholders take most of the hit, while under his hypothetical gaming approach, the taxpayers do. Again, that's not fair. But being unfair doesn't doom something to fail. And I'd take an unfair success over a fair failure. (Though successful and fair would be ideal, and Sachs's proposal may get us close.)

What's a few trillion dollars between friends? But Scheiber ignores the very real possibility that the PPIP will not be enough - that bank losses will go well beyond the funding Geithner can manufacture with the FDIC and the Fed, and that the administration will have to go back to Congress. In that case, if the entire bailout process is perceived as an indefensible giveaway to Wall Street, then there is little hope of convincing Congress to pony up for more. If that happens we could be back where we were last September - financial panic as too-big-to-fail institutions fail.

Therefore, there is a premium on finding a policy that not only will work, but the public will see as being fair. Geithner seems to understand this, which is likely why he has resurrected the Paulson cash-for-trash plan with a few bells and whistles to distract the public (like any good magician, Geithner knows misdirection is key). But rather than trying to trick the public, wouldn't a much simpler plan that put insolvent banks into some form of receivership-on-steroids and restructured them make more sense? This would not only be good policy, but good politics as well; Axelrod and Emmanuel certainly understand that getting tough on Wall Street would be a popular position.

These are issues that Scheiber completely ignores. He seems to have completely bought the administration/banks' line that we must save the bankers to save the economy. But saving the banks does not mean saving the bankers who got us in this mess. Oops - I guess that makes me a radical populist.

Wells Fargo: Profitable Does Not Mean Solvent

2009-04-14T18:51:00.008-04:00

One week you're announcing "record profits," the next analysts are saying you need $50 billion more in capital. As Matthew Yglesias notes:

This is why nothing you near from the financial sector about how all’s well should be taken too seriously. It’s true that given very bank-friendly monetary policy it’s easy for banks to run an operating profit. But most of these large banks are zombies—insolvent. They’re only able to run an operating profit because they’re not going out of business and being liquidated. And the reason they’re not being liquidated is government guarantees. It’s as if I had a profitable business selling cookies, except I didn’t actually have any cookies to sell and was just putting government-provided cookies in boxes, then bragging about how profitable my company is and how the government should stop hassling me about paying myself a bonus.

How long will it take for banks to earn their way out of insolvency? If the administration thinks the type of hands off approach Volcker took with probably insolvent banks in 1982 will work today, they're most likely wrong. As Krugman points out, any economic recovery probably won't be as steep today as it was then, creating a more difficult environment for lenders and borrowers. Please tell us this isn't really the plan.

Scraping the Bottom of the Barrel...

2009-04-14T01:02:00.011-04:00

with Richard Cohen. Amidst the outcry over Larry Summers' $5 million sinecure at the hedge fund DE Shaw, Cohen takes to the Washington Post to voice his unsurprisingly contrarian dissent from the simmering populist rage. Cohen, after all, has made a career out of defending the prerogatives of the elite - from government officials who lied us into war, to the very journalists (such as himself) who failed to investigate these lies, to financial journalists who couldn't be bothered to ask questions about the housing bubble. But with the Summers-DE Shaw flap, Cohen takes his standard establishment hagiography to new Orwellian heights: we should not censure Summers for his ties to the financial industry, but, rather, lavish praise on him for passing up the riches of our new robber barons to re-enter public service. In other news from Robert Cohen: war is peace; freedom is slavery; ignorace is strength. From Cohen:

The recent headlines about Lawrence Summers had it all wrong. They announced with an implied breathlessness that he earned around $8 million last year -- much of it from the hedge fund D.E. Shaw. Here's what I would have written: "Man Takes More Than $7.9 Million Cut in Pay." Somewhere in the Diagnostic and Statistical Manual of Mental Disorders, the bible of shrinks, there should be an entry for "public servant." They are all, bless their hearts, a little nuts....

In our scandal-soaked culture, it is de rigueur to denigrate public officials and to search for the inevitable conflict of interest. But here are people, such as Summers, who have put aside wealth and lavish perks for government service. They have their reasons, sure, but whatever they are, we -- not they -- are the richer for it.

Unfortunately, Cohen is hardly alone in this establishment defense. Indeed, most of the establishment deign to indulge the masses with bouts of populist fury - AIG bonuses anyone - only to later lead the backlash against the backlash; informing the uneducated and unsophisticated masses why focusing on such details is trivial. The following discussion between Noam Scheiber of TNR and Megan McArdle of the Atlantic typifies this attitude.

This misses the point. For Scheiber, as long as there is no quid pro quo between Summers and DE Shaw, there is no scandal. Maybe. But does anyone believe that Summers will push for oversight or regulation of hedge funds/derivatives if he thinks a very lucrative post-government career at a hedge fund awaits him? The cognitive capture of our government, media, and academic elites by Wall Street is of vital importance. If our elites believe that what is good for Wall Street is good for America, then they will likely try to revive the status quo ante. Beyond whether this is even possible, it should be asked whether it is even desirable. Unfortunately, most establishment figures deem that a silly, unserious question.

Relaxation Tests

2009-04-12T19:10:00.003-04:00

About those "stress" tests...turns out they're not so stressful. From the New York Times:

Regulators say all 19 banks undergoing the exams will pass them. Indeed, they say this is a test that a bank simply will not fail: if the examiners determine that a bank needs “exceptional assistance,” the government, that is, taxpayers, will provide it.

This is beyond farcical. If banks cannot fail the stress test by definition, then it is not a stress test. The notion that banks can both require "exceptional assistance" and "pass" their stress test is so absurd that it boggles the mind that anyone will fall for this. But, of course, some investors and talking heads (read: CNBC) will go bonkers when they see the headlines that the banks all passed, and they will pour into financials. Eventually, once writedowns continue to exceed puffed up earnings, even the slowest investors will realize that the banks are a bad bet. At that point, it will become apparent what an enormous waste of time this entire stress test exercise has been.

The saddest part is that the stress tests could have been the first step in a viable banking rescue. If Geithner had honestly assessed the banks' books and put hopelessly insolvent banks into receivership, there would be justified public confidence in the remaining banks. This is what FDR's banking holiday accomplished during the Great Depression. Unfortunately, Geithner seems to think that the minimal appearance of transparency and accountability is a good substitute for actual transparency and accountability. He is badly mistaken.

Pretending insolvent banks are healthy, pouring endless subsidies into them to prop zombie institutions up - it's all so Japanese. Weren't we supposed to have learned from their lost decade? And with each dollar siphoned off to Wall Street, Obama is throwing his presidency away...Maybe Obama and his political advisers will wake up and realize that flirting with economic stagnation is not a path to electoral success. We can only hope that they finally admit what an unmitigated disaster Geithner has been, and undo this mistake.

Sachs: PPIP Is A Scam

2009-04-11T20:28:00.005-04:00

Columbia professor Jeffrey Sachs has joined the chorus of those proclaiming Geithner's PPIP a swindle. In the wake of the FT reporting that banks are considering bidding on each others assets, Sachs explains that while most commentators have worried about outsiders profiting at taxpayer expense, the potential for insiders gaming the system is even worse. From Sachs:

Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.

The earlier criticisms of the Geithner-Summers plan showed that even outside bidders generally have the incentive to bid far too much for the toxic assets, since they too get a free ride from the government loans. But once we acknowledge the insider-bidding route, the potential to game the plan at the cost of the taxpayers becomes extraordinary. And the gaming of the system doesn't have to be as crude as Citibank setting up its own CPPIF. There are lots of ways that it can do this indirectly, for example, buying assets of other banks which in turn buy Citi's assets. Or other stakeholders in Citi, such as groups of bondholders and shareholders, could do the same.

Are there any assurances that something like this would not happen? And is there anyone outside the administration willing to defend this plan?

Pinch Me, Thomas Friedman Is Making Sense

2009-04-10T10:33:00.008-04:00

Even a broken clock is right twice a day. Or, when it comes to Thomas Friedman, even Captain Obvious writes a moderately insightful column every few weeks. In his latest column, Friedman makes a fairly persuasive case for preferring a carbon tax to cap-and-trade. The pluses:

a carbon tax is transparent, and easy to understand
cap-and-trade could be gamed by Wall Street, making a simple carbon tax preferable
offsetting a carbon tax with a commensurate payroll tax cut is an easy way to make it revenue neutral, so opponents can't criticize it a regressive burden on working families; whereas the opacity of cap-and-trade is open to this line of political attack (this is the point of cap-and-trade: hide where the tax is coming from)

Of course, the Obama administration is planning on generating some $600 billion in revenue from selling carbon permits, so they probably wouldn't be too keen on a revenue neutral plan.

Taleb: Why Can't Homeowners Mark Houses to Whatever They Want?

2009-04-10T09:31:00.003-04:00

Nassim Taleb has been hammering this point home for weeks now, but it's worth repeating: increasing opacity in our financial markets and institutions will only delay recovery. Investors will, justifiably, not trust financial statements, and keep their money away. Taleb also asks a great question - why do we allow banks to not mark to market, but not homeowners. If homeowners had a fancy formula some quant invented that has little relation to reality and no one understands, would we allow them to mark their homes to whatever they want? Of course, there's a very simple explanation. Bankers contribute huge sums to politicians, and most normal citizens do not, so bankers get to live according to their own fantasy rules. The sense of entitlement manifested in bankers not having to acknowledge the full reality of this crisis, while everyone else suffers never fails to astonish.

Warren Drops A Bomb on Geithner

2009-04-10T08:44:00.003-04:00

While she speaks in a mild-mannered tone, make no mistake: Elizabeth Warren TKOs Tim Geithner. In a measured tone, she lays out the three approaches to dealing with financial crises:

Liquidation, i.e. Chapter 11
Receivership. FDIC seizes the insolvent banks, separates the good and bad assets, recapitalizes the banks/gets bondholders to perform debt-for-equity swaps, and sell back the good bank to private investors
Subsidies. These can either be direct, in the form of capital infusions, or indirect, such as buying toxic assets at inflated prices.

Then Warren examines Treasury's policy of subsidization to date, before concluding

Treasury's overall approach seems based on the premise that the banking problem is temporary - and look, we all hope that's the case. If it is, more aggressive steps may never be needed. It is possible, however, that Treasury's approach fails to acknowledge the depth of the current crisis. The economy may not come roaring back. And the big profits that propped up the banks during the housing boom may not return. For some, that means it is necessary to consider alternate approaches.

Translation: this is not a liquidity crisis, and we're going to have to put insolvent banks into receivership. Hopefully Congress is paying attention.

Half of US Banks Bust?

2009-04-10T06:40:00.003-04:00

Count Andy Beal among those skeptical about Geithner's PPIP. According to Beal

He says Treasury Secretary Timothy Geithner's new plan to guarantee loans to buyers of toxic assets won't lead to many sales because the problem isn't liquidity but price. They are not low enough. Half the country's banks--4,000 in all--would be bust, he says, if they marked their loans to what the loans would fetch in an auction. He says banks are fooling themselves by refusing to mark busted assets down.

"Banks are on a prayer mission that somehow prices will come back and they won't have to face reality," Beal says. And that reality, according to Beal, is going to get a lot worse. "Unemployment is going over 10%, commercial real estate hasn't even begun collapsing and corporate credit defaults are just getting started," he says. His prediction: depression, without bread lines this time, thanks to the government safety net, but with equal cost to society.

Whose judgment do you trust on whether this is a crisis of solvency or liquidity: a banker who noticed all the bad loans being made as this crisis developed, or a regulator who failed to diagnose the problem?

Greenspan's Wet Dream

2009-04-10T06:24:00.003-04:00

Alan Greenspan must have a special place in his heart for Andy Beal. After all, if every banker ran their bank like Andy Beal ran his, then Alan Greenspan would not have had to repudiate his Ayn Rand-style libertarianism. From Forbes:

By September 2004 Beal Bank's assets had climbed to $7.7 billion. Then Beal stopped buying, letting his loans run off. By September 2007 assets had shriveled to $2.9 billion, one-fifth of which was cold cash. He was worried that consumers had taken on too much debt and money was being lent to companies for next to nothing. "Every deal done since 2004 is just stupid," Beal says.

He began by pulling back from home loans--even those guaranteed by Fannie Mae ( FNM - news - people ) and Freddie Mac ( FRE - news - people ). Beal thought the two quasi-government agencies were over-leveraged. When staffers mentioned their guarantees in deal presentations he would fire back that these guarantees were "worthless."

A banker whose perceived self-interest led him to abstain from the housing/credit bubble - I think Alan Greenspan might go all Andy Samberg on us. Unfortunately, Beal was the exception. Still, Beal's prescience shows that for those who cared to ask questions, the fallout from the housing bubble was fairly obvious. Hoocoodanode, indeed.

Boring is the New Sexy In Banking

2009-04-10T05:50:00.006-04:00

It's back to the future in the banking world - that is, if our policymakers are serious about reforming our financial system. The myth that financial "innovation" cannot be stifled, lest the economy stagnate, has now been laid to rest. Financial "innovation" merely allowed bankers to take and spread risks they did not understand, perform regulatory arbitrage, and justify their exorbitant salaries. Paul Krugman and Simon Johnson both make the case that we should end the era of free-for-all casino capitalism, and move back to the type of more stable, boring banking system we had during the postwar period up till 1980. From Krugman:

Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some of which later turned out to have been based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative for those who ran it. Banking became boring, partly because bankers were so conservative about lending: Household debt, which had fallen sharply as a percentage of G.D.P. during the Depression and World War II, stayed far below pre-1930s levels.

Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

As these changes took place, finance again became a high-paying career — spectacularly high-paying for those who built new financial empires. Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age....

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

Simon Johnson strikes a similar note, calling on policymakers to

make banks smaller, less powerful, and much more boring.

Using antitrust laws to break up too-big-to-fail banks into smaller parts, and re-instituting Glass Steagall and the division between commercial banking, which exists as a public utility, and investment banking, which takes on riskier enterprises underwriting securities, would be a good start. Unfortunately, Geithner and Summers seem too enamored with Wall Street to enact these reforms. We can only hope that more politicians can muster the common sense and historical humility that Senator Byron Dorgan did a decade ago, in condemning the repeal of Glass Steagall and deregulatory mania in general as an inevitable step towards a new crash.

If Someone Called Matt Lewis a Homophobe to His Face, Would He Notice?

2009-04-06T13:23:00.004-04:00

Apparently not. But while the wingnuts at Townhall are easy fodder for lampooning, Lewis's incoherence speaks to the disintegration of the conservative movement. Social conservatives are rapidly finding that as the economy falls off a cliff, no one really cares whether gays are allowed to marry. Not even in Iowa. Far right crazies like Lewis have not made their peace with this reality yet. Meanwhile, foreign policy conservatives are busy claiming Obama's policies amount to a continuation of their own. And economic conservatives - Wall Street conservatives - have been completely discredited. Tax cuts for the rich and financial deregulation haven't been this out of vogue since the Kingfish was advocating his "Share Our Wealth" plan.

What's the future of the GOP? Who knows - but it's probably a Republican Party that acknowledges global warming, doesn't bash gays/use race as a wedge issue, and actually commits itself to running the welfare state responsibly. Something like David Cameron's Tories. It's going to take quite awhile for the GOP to modernize itself that much. Let's just hope they let the grownups govern without obstruction (and that the Democrats stop being so beholden to Wall Street too) while they work out their issues.

Switzerland Falls Into Deflation

2009-04-06T11:05:00.012-04:00

As Ambrose Evans-Pritchard notes, Switzerland is the latest country to join the deflation club. Swiss CPI fell 0.4% in March on a year-on-year basis, and is projected to fall to -1% by July. The Swiss franc's status as a currency safe haven has exacerbated this downward pressure, as the franc has gained value, driving the value of imports down, and hence forcing domestic goods to become cheaper as well in order to compete. The Swiss National Bank (SNB) has promised to aggressively move to lower the exchange rate to counter this threat, raising the specter of competitive devaluations. Evans-Pritchard explains:

Yet even the SNB's hard men have thrown away the rule book, taking emergency action to force down the exchange rate of the Swiss franc.

Here lies the danger. If other countries try to export deflation by this means, we will face a second phase of the global crisis. Taiwan is already devaluing. Korea, Singapore, and Sweden all seem tempted to follow. Japan is chomping at the bit.

"We don't fully realise in the West what a catastrophic collapse Japan has suffered," says Albert Edwards, global strategist at Société Générale. "The West has dumped a large part of its economic downturn onto Japan by devaluing against the yen."
This is about to go into reverse as Tokyo hits the ping-pong ball back across the net. "As the unfolding collapse in the yen gathers pace, the West will see its green shoots incinerated to dust," he said.

By devaluing, a country makes imports more expensive, pushing up prices across the economy. There is a concomitant fall in prices abroad, as the country's exports become cheaper, pushing down prices with its trading partners. But this only works if it is pursued individually. If a host of countries try to gain a competitive advantage by devaluing, then there is a race to bottom that nobody wins. Relative prices between exports and imports remain the same, while the prices of real assets - commoditites, real estate, and stocks - jump. This is a path towards mutual ruin. Because wages are sticky, households will find it harder and harder to pay for the basics of housing and energy.

Will world leaders - particularly from trade surplus countries where there is an incentive to export troubles away - be able to organize the type of collective action necessary to avert such disaster? Not likely.

Black Swan Makes Sense

2009-04-05T01:25:00.004-04:00

Here's Nassim Taleb making sense, as usual. On mark-to-market:

mark-to-market makes banks look more dangerous, exactly like a thermometer makes a patient look more sick. Eliminating the mark-to-market is exactly like putting your head in the sand.

On retirement investing:

Have a dual strategy. The first one is hyperconservative. As much as you can - whatever you don't want to lose, don't lose. Don't trust the market with what you cannot afford to lose. Whether 80%, 90%, 20%, whatever it is that you need for your retirement, and the rest is play money....We're going to de-financialize the economy, to what we had in the '50s, '60s, and '70s. People will be fed up with the stock market, and will realize that they cannot rely on financial assets, neither as a reservoir of value, nor as a means to earn a living.

If Taleb is right, and the public does sour on stocks for the long run, putting their money into ultrasafe Treasuries instead, then we could face a secular shift in market activity and salaries. The retirement of the Baby Boomers will certainly exacerbate this problem for stock brokers, as a generation cashes out whatever they have left. It could be a long time before we get back to the October 2007 highs.

And Now Some Bad News: Grim Employment Data

2009-04-04T20:52:00.003-04:00

Another bad month. 663,000 more lost jobs. Unemployment at 8.5%. U-6 - unemployed, underemployed and the discouraged at 15.6%. Robert Reich makes it official: this is a depression.

PPIP Gaming

2009-04-04T14:19:00.006-04:00

It's official: banks will use the non-recourse loans from the PPIP to bid up each others toxic assets. From the FT:

US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.

The plans proved controversial, with critics charging that the government’s public-private partnership - which provide generous loans to investors - are intended to help banks sell, rather than acquire, troubled securities and loans....

But public opinion may not tolerate the idea of banks selling each other their bad assets. Critics say that would leave the same amount of toxic assets in the system as before, but with the government now liable for most of the losses through its provision of non-recourse loans.

This is even worse than the abortive Paulson cash-for-trash scheme. At least under the original version of the TARP, some toxic assets would actually be removed from banks' balance sheets. In trying to resurrect this rejected idea by dressing it up with a bit of financial prestidigitation, Geithner has created a perverse situation where banks have incentives to acquire more toxic assets, gambling that some of this trash will be worth something. Of course, taxpayers are on the hook if the assets are indeed worth as little as current prices imply. Somehow providing huge subsidies to banks for them to buy up worthless pieces of paper from each other does not seem like a fix to the problems plaguing the financial sector. The amount of bad debts the banks hold on their balance sheets is simply too large for the government to buy or subsidize. Debts need to be restructured; insolvent banks need to be put through orderly bankruptcies. Subsidizing failure will only guarantee the existence of zombie banks. Failed banks will eventually be put into receivership anyway - why not do it now when it will cost less?

German Hyperinflation Did NOT Occur During Great Depression

2009-04-03T14:32:00.004-04:00

Here's an example of bad history informing bad policy preferences.

The historical trauma of hyperinflation certainly seems to have contributed to German wariness about aggressive fiscal policy - but the infamous Weimar hyperinflation occurred during 1923, not during the Great Depression. Furthermore, out of control government spending did not cause the German hyperinflation. Rather, the Weimar government printing money to pay reparations, as well as benefits to workers striking against the French occupation of the Ruhr region, caused the runaway inflation. Since German industry ground to a halt with the general strikes, they had no goods to trade for capital. To make up the difference, they printed money, with disastrous consequences. This does not prove the case against Keynsian deficit spending; merely it proves that you cannot print money and pretend you have a real economy when you in fact do not. It would be helpful if our media - and the Germans themselves - understood this difference when debating the merits of fiscal stimulus.

And Now Some Good News...

2009-04-03T12:30:00.005-04:00

This was our last chance. So warned George Soros and Ambrose Evans-Pritchard in rather apocalyptic exhortations to world leaders on the eve of the G20 Summit. According to Soros

If the G20 is nothing but a talking shop then he thinks we are heading for meltdown. “That could push the world into depression. It’s really a make-or-break occasion. That’s why it’s so important.” The chances of a depression are, he says, “quite high” – even if that is averted, the recession will last a long time. “Look, we are not going back to where we came from. In that sense it’s going to last for ever."

With that in mind, the happy news that the G20 actually produced meaningful action on increased funding for the IMF and trade credits, as well as a commitment to crack down on tax havens is especially heartening. World leaders woke up and realized that letting emerging markets go bust - particularly in Eastern Europe - would likely lead to a new round of financial contagion in core countries. There is hope we can avoid a global lost decade.

Sanity From the Wall Street Journal?

2009-04-03T00:49:00.005-04:00

We're not in Kansas anymore. Someone aside from a token liberal is making sense in the Wall Street Journal's opinion pages. Hedge funder Paul Singer takes to Fox News Dead Tree Version, opining that

While many of Mr. Obama's ideas warrant skepticism, conservative opposition to any expanded role for government is a mistake. There is an urgent need for a new global regulatory initiative that addresses the primary cause of the financial collapse: highly leveraged and concentrated positions.

Reform must begin with a regulatory regime focused on "behavior" instead of "systemically important institutions." Today, even small entities that trade complex instruments or are granted sufficient leverage can threaten the global financial system.

It's true that monetary policy was too lax for too long, and the government encouraged lending to people who were unlikely to repay their loans. But this crisis was primarily caused by managements and individuals throughout the financial system who exercised extremely poor judgment. The private sector, not the public sector, is where the biggest mistakes were made.

How did this get by the Journal's editors? No mention of the CRA? Or Fannie and Freddie? And an acknowledgement that crazy levels of leverage, non-existent risk management, and perverse short-term bonus incentives were the key factors in this crisis - it's so...reality-based. What's next, admitting that this is the greatest financial crisis since the Great Depression? Maybe not - but we can hope.

Contrary Indicator?

2009-04-02T19:18:00.005-04:00

Jim Cramer thinks our mini-depression is over (but not the recession). He sees us in a cyclical rather than secular downturn, due to the supposed positive impact of the Geithner plan.

Visit msnbc.com for Breaking News, World News, and News about the Economy

Stiglitz: Wall Street Wins, Taxpayers Lose

2009-04-02T08:01:00.003-04:00

This is now two Nobel prize-winning liberal economists vociferously opposed to Geithner's PPIP. A week after Paul Krugman announced that the leaked reports of Geithner's plan "fills me with a sense of despair," Columbia professor Joseph Stiglitz takes to the New York Tims to voice his own displeasure over the huge taxpayer giveaway the Geithner plan represents for banks and private investors. From the New York Times:

In theory, the administration’s plan is based on letting the market determine the prices of the banks’ “toxic assets” — including outstanding house loans and securities based on those loans. The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.

The two have little to do with each other. The government plan in effect involves insuring almost all losses. Since the private investors are spared most losses, then they primarily “value” their potential gains. This is exactly the same as being given an option.

Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year’s time. The average “value” of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is “worth.” Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!

Stiglitz goes on to attack the claim that the current crisis is simply the result of a lack of liquidity - i.e. panic is driving down asset prices beyond the fundamentals. Again from the New York Times:

The main problem is not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They have lost their capital, and this capital has to be replaced.

Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time....

What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.

Has the Obama economic team rebutted these arguments, aside from saying calls for putting insolvent banks into receivership are "deeply impractical"? If Obama is seen as in Wall Street's pocket, there will be no political will for further bailouts, which will inevitably be necessary. Putting off the day of reckoning, and playing nice with the bakers is a very, very dangerous course.

Which One is the Comedian?

2009-04-02T06:16:00.006-04:00

The Colbert Report

Mon - Thurs 11:30pm / 10:30c

The 10/31 Project

comedycentral.com

Colbert Report Full Episodes

Political Humor

NASA Name Contest

Glenn Beck certainly is wily. How the hell is Colbert supposed to satirize that?

Someone Might Want to Tell the Wall Street Journal There Was a Credit Bubble, Not Just a Housing Bubble

2009-04-02T05:40:00.002-04:00

So, according to Daniel Henninger, we're just suffering from a housing bubble that requires relatively minor fixes. Indeed, Henninger seems so skeptical about the chaos in our financial system and markets, that he puts quotes around the phrase "the greatest financial crisis since the Depression" (if he can name a financial crisis since the Great Depression worse than this one, he neglects to mention it). According to Henninger

The housing bubble that floated into view in 2007 is turning into the blob that ate the world. Real-estate mortgages and their derivative securities are a significant problem. That discrete problem, however, has been pumped up to an historic "crisis of capitalism."

Capitalism didn't tank the U.S. economy. Overbuilt housing did. Overbuilt housing tanked the economies of the U.K. and Ireland and Spain. If little else, we've learned that artificially cheap housing sets loose limitless moral hazard.

Um...what? Maybe he didn't notice that aside from the housing bubble, there was a more generalized credit bubble. Credit cards, auto loans, home equity loans, private equity LBOs, increased financial leverage - they were all symptoms of a massive credit bubble. Housing was the most pernicious part of this bubble, since it was the collateral so many people used to secure loans, and so many banks held so many securitized mortgages on their balance sheets, but it was hardly the only aspect of this crisis. Although give him credit - at least Henninger is actually proposing new regulations in the housing market as part of the fix, instead of just saying Merry Christmas.

Citi: Bank Stocks Will Fall

2009-04-02T05:27:00.003-04:00

A Citigroup strategist advises clients to buy puts on bank stocks, since the recent run-up in bank stocks will likely fade. From Bloomberg:

Investors should buy put options on financial companies because derivatives-market trading suggests the industry will retreat after a 43 percent surge since March 6, Citigroup Inc. said.

Guess that means suspending mark-to-market won't have an effect. Who would have guessed that banks lying about their balance sheets won't make them any sounder?

Conservatives Still Want to Privatize Social Security?

2009-04-02T03:48:00.006-04:00

Bad ideas die hard, apparently. You might think that the whole global financial crisis thing would make conservatives rethink the wisdom of putting even a portion of Social Security into the markets. You would be wrong. Over at AEI, Andrew Biggs, for one, is still trumpeting the supposed superiority of the would-be Bush private accounts over Social Security. Biggs observes that under the Bush scheme

Total Social Security benefits would increase if personal accounts returned more than the interest rate on government bonds.

Is it so hard to imagine a scenario where Treasuries would beat the stock market? Of course not - we're in such a period right now! (note: the below chart compares the S&P 500 vs 3-month Treasuries. Longer term government bonds would obviously look even better).

Over the last five, ten, and twenty-five years, government bonds have beaten the S&P 500. Furthermore, imagine a situation (let's call it Japan), where there's a huge asset and stock bubble. Twenty years later, stock prices are roughly a quarter of their highs. Workers with private accounts who entered the workforce a few years before the crash would have their holdings wiped out and remain depressed. And even if the stock market began to recover after twenty odd years, because the private accounts have a "life-cycle portfolio" that phases out stocks as retirement nears, these workers would not even catch the upside. They would be better off with the guaranteed benefit of Social Security.

Providing a modicum of economic security in old age is the purpose of Social Security. After all, that's why it's called "Social Security". Why scrap a system that successfully does this for one that might do it? Social Security itself does not face nearly the funding problem its critics like to claim it does. All that's required to fix its long term problems is a payroll tax hike and perhaps some sort of benefit cut. This isn't rocket science. You might even say it's bedrock conservatism - after all, it's what Ronald Reagan did in 1983.

Is Reserve Currency Status Worth the Costs of Empire?

2009-04-02T00:46:00.002-04:00

Bill Maher is not entirely correct. We do get something for being an empire: the dollar is the reserve currency of the world. But is being able to borrow cheaply worth the costs of maintaining our empire? (Of course, this won't even be a tradeoff, if Geithner continues to open the door for an IMF world currency to replace the dollar as the reserve currency). Count Roger Cohen among those who think a reduction in American overseas military commitments inevitable as part of a larger retrenchment. America will not be able to afford to be the world's policeman for much longer. In the long run, this is a postive development - the insidious influence of the military-industrial complex on our government has been apparent from the beginning. Hopefully, Cohen will be right, and Asian democracies like India and Japan will embrace greater responsibility for ensuring global security in conjunction with the United States. But in the short run, America is weakest when social and political stability is under the most strain. The Pax Americana could very well go out with a bang. Let us hope not.

Highway To Hell

2009-04-01T23:36:00.003-04:00

What do you do if your neo-Hooverite policies get you booted from office? If you're ex-Czech Prime Minister Mirek Topolanek, you take some inspiration from AC/DC, and claim Keynsian fiscal policy is a "road to hell". From the New York Times:

“AC/DC played here last week,” Mr. Topolanek told the daily Lidové Noviny. “And their cult song ‘Highway to Hell’ might have led me in that very improvised speech to use the phrase ‘road to hell’.” According to the Czech newspaper, Mr. Topolanek’s prepared remarks included the less resonant phrase “the way to destruction.”

On a more serious note, Prime Minister Topolanek's evocation of Keynsian as a road to perdition speaks to the reticence of many European countries to run up more debt when their debt-to-GDP ratios are at generally higher starting points than the United States. But if this slump persists and European governments stick to their fiscal austerity, the crisis could take on a new political dimension, with governments falling, and perhaps resorting to protectionist measures. As Ambrose Evans-Pritchard reports

the Czech crisis has unnerved investors even more because the country has been seen as a rock of stability. It kept a tight rein on credit and avoided the stampede into euro and Swiss franc mortgages that occurred in other parts of Eastern Europe.

The fate of premier Mirek Topolanek – toppled in the middle of the Czech Republic's EU presidency – shows how fast the crisis is moving from finance into the core economy. Czech industrial output fell 23pc in January as car plants moth-balled production lines.

"This is the next leg of the crisis," said Neil Shearing from Capital Economics. "We're seeing the political backlash as this spreads into the labour market. The risk is that we will see a move to populist nationalism in some countries. That could prove dangerous."

So far we have not seen the type of rabidly nationalistic or xenophobic extremist parties gain power in Eastern Europe as did in interwar Europe during the Great Depression. Hopefully, we will be wise enough to avoid repeating that chapter in history.

Samuelson: Assets Just Need Some Love-erage

2009-03-30T08:14:00.011-04:00

Count Robert Samuelson among those who insist that "there are no bad assets; only misunderstood assets". Per Samuelson:

"Deleveraging" has caused prices to plunge to lows that may be as unrealistic as previous highs.

Grasping this, you can understand the idea behind Geithner's hedge fund. It is to inject more leverage into the economy -- not to previous giddy levels but enough to reverse the panic-driven price collapse.

But has the collapse in assets prices been the result of panic or fundamentals? One study has shown that some CDOs are actually worth even less than what many pessimists thought. To counter the notion that the fundamentals justify the current depressed prices, Samuelson cites

one mortgage bond whose market value has dropped by roughly 40 percent even though all promised payments have been made and, based on the performance of the underlying mortgage borrowers, seem likely to continue.

Unfortunately, this description omits two key details: are the borrowers underwater on their mortgages, and do the mortgages reset in the near future? If borrowers owe substantially more than their homes are worth, then they have a powerful incentive to post jingle mail, and walk away from their mortgages, even if they could afford to pay it. And as the real economy continues to deteriorate, with unemployment rising and wages lowering, increasing numbers of underwater borrowers will likely be under greater financial strain; paying off a mortgage that dwarfs the value of one's house will make less and less sense. Likewise, if these are option ARM mortgages, then they will likely reset within the next year. Borrowers who can make their payments today may not be able to make the higher, reset rates. If either of these scenarios is the case, then discounting this particular mortgage bond 40% seems fairly reasonable.

Samuelson does hedge a bit, admitting that these current lows "may be as unrealistic as previous highs." Perhaps he realizes that losses in mortgages, in commercial real estate, and in credit card debt are all real. There is nothing panic-driven about these losses. And unfortunately, the wizards of Wall Street multiplied these losses several times over with synthetic CDOs and CDS bets. No, our major banks are very insolvent. And no amount of financial engineering - no matter how clever - will change that.

AIG Money Laundering Made Banks Profitable in Q1?

2009-03-30T07:14:00.003-04:00

AIG is the scandal that never dies. There was the first bailout for $85 billion. The second bailout for $65 billion. The third bailout for $30 billion. The $165 million in bonuses to the employees in the Financial Products division responsible for bankrupting the company. And, of course, the revelation that AIG has been the conduit for a backdoor bailout of its creditors, particularly Goldman Sachs. However, the latest report concerning AIG is even more outrageous. AIG has not been simply paying its creditors back in full - it has essentially overpaid them on purpose. This is looting.

Remember when Citigroup CEO Vikram Pandit proclaimed his bank had been profitable through the first two months of 2009 in an "internal" memo released to the press? Bank of America CEO Ken Lewis and JP Morgan CEO Jamie Dimon followed suit the next day, claiming that they too had been profitable through February. While some dismissed these pronouncements as misleading at best, the beleaguered markets took off, rebounding from twelve year lows at any hint of good news. This rally has continued for nearly three weeks now, despite Jamie Dimon and other bank CEOs admitting that March has been "a little tough" - read: they are losing money hand over fist again.

What changed between February and March? According to an email financial blogger Zero Hedge received from a trader at a major bank, the explanation is that in the first two months of the year, AIG unwound trades on extremely favorable terms for the banks. In other words, AIG deliberately overpaid on what it owed. According to the trader

During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever"....

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period."

That AIG's counterparties have been made whole at taxpayers' expense was scandalous enough. After all, companies took a risk when they entered into CDS contracts with AIG that AIG would not be able to make good on the payments. Why should taxpayers foot the entire bill for Wall Street's mistakes? (That's a rhetorical question - the obvious answer is that the financial sector controls the levers of power inside the Beltway). But words fail when AIG more or less launders money directly onto bank balance sheets. As Zero Hedge summarizes

AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam....

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

Our democratic system is in jeopardy. Sadly, this is not hyperbole. The pernicious influence of Wall Street - which has spent some $5 billion over the last decade lobbying both parties for increased deregulation - has made the government responsive to the moneyed interests rather than to the people. As MIT professor and former IMF chief economist Simon Johnson argues, we risk turning into Argentina or Russia, in the sense that crony capitalists have captured the government, and are blocking reform after crashing the economy. Demanding transparency in the bailouts, and an honest accounting of where our money is going is the first step towards reclaiming our government. Absent such clarity - and replacing bank CEOs and boards - Congress should not authorize any further bailouts, because, clearly, Wall Streeters paying off their pals with public money cannot be acceptable. Hopefully, President Obama will realize that a little populist rage is warranted, and is actually not such a bad thing. His presidency may depend on it.

Math Can Do Anything?

2009-03-30T02:34:00.004-04:00

Can math better predict financial markets? IBM seems to think so. Maybe they've missed this whole global financial meltdown thing. Or haven't had time to read Nassim Taleb's Black Swan. If they had, maybe they would have noticed that an over-reliance on financial models that turned out to have little predictive value played a key role in helping traders justify the insane bets they were making both to themselves and to their shockingly negligent risk managers. Floyd Norris nails it: this commerical makes IBM look really stupid.

Is There Even Demand For New Debt?

2009-03-29T20:18:00.004-04:00

If only we could just get banks lending again, we could go back to those heady pre-Lehman days of credit-fueled consumption growth - that seems to be the rationale animating the Geithner banking plan. If we get these toxic assets - er, I mean "legacy assets" - off of banks' balance sheets, then they'll be sound enough to extend credit again. Economic recovery will follow soon thereafter. But can we return to the status quo ante? Or has the deleveraging process gathered such momentum that even if households could take out new loans, they'd choose not to, as they instead try to pay off their existing onerous debt obligations?

Count James Galbraith among those skeptical that even a successful bank bailout would reverse the economy's death spiral. Rather, restoring household solvency is the key issue. Indeed, in a piece in the Washington Monthly, Galbraith makes the case that until households are made creditworthy again, lending will not resume at anything close to normal levels. Galbraith begins by noting that:

For the first time since the 1930s, millions of American households are financially ruined. Families that two years ago enjoyed wealth in stocks and in their homes now have neither. Their 401(k)s have fallen by half, their mortgages are a burden, and their homes are an albatross. For many the best strategy is to mail the keys to the bank. This practically assures that excess supply and collapsed prices in housing will continue for years.

Simply put, American households are drowning in debt. As unemployment rises, wages fall, and option ARM mortgage rates reset to higher levels, increasing numbers of households will not be able to service their debts. Furthermore, now that the game of debt musical chairs is over, and many households have by and large lost access to credit, they must save more to pay off their debts. This means less money for consumption. Businesses in turn will face declining profits, necessitating further layoffs and wage cuts. And of course, all of these losses will reverberate on bank balance sheets, since they hold securitized mortgages, credit card debt, auto loans, student loans, etc. And on and on it goes. Throughout this downward spiral, only debt levels do not fall, posing a rising real burden. This is debt deflation - or a "d-process".

Making the banks solvent again is necessary but not sufficient to resume normal credit expansion. If banks remain de facto insolvent, as the credit losses pile up in both the real and financial economies, then the creditworthiness of American households will be irrelevant - there will be no lending. But this is not to say that fixing the financial system will remedy this collapse in credit. If there is a dearth of creditworthy borrowers, or creditworthy borrowers lose their appetite for new debt - either because they want to pay off their old debts or economic uncertainty makes new business investments seem risky - then the soundness of the banks will be irrelevant. In short, credit depends on both lender and borrower. Both must be solvent and willing to extend or accept a loan for normal credit expansion to occur. But this simple point often gets lost in policy discussions about the banking system. Galbraith points out that

In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal....But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank.

The obvious question is whether there is any reason to expect American households to fix their balance sheets in the near future so that they are creditworthy?

Unfortunately, the answer seems to be no. The wealth effect of vanishing stock portfolios and plummeting housing values not only makes households less willing to spend, but it also leaves them with no collateral with which to take out a loan. Indeed, creditworthiness depends on

a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can’t qualify for loans.

Here, the especially pernicious effect of falling house prices becomes clear. And unhappily, housing prices still have roughly another 20% to fall from their peak just to revert to historic norms, as the following chart shows.

With foreclosures flooding the market, compounding the problem of a housing glut, the chance that housing prices will overshoot on the downside - and possibly stay there for a prolonged period - is very real. Most American households simply will not have the collateral to secure a loan for quite a few years at the least.

There is also the question of "animal spirits" - will creditworthy individuals want to take out loans? Again, the answer seems to be no. The psychology of this crisis has frozen economic activity. As consumer spending has collapsed, there is little incentive to invest in expanding business operations. The future seems so uncertain that people only want to hold cash or liquid assets like Treasuries. Fear rules the scene. A recent New York Times profile of individuals and businesses in Portland, Oregon captures this sentiment well. Writing about the local Portland economy, the New York times reports that

Even banks that are eager to lend find some of their best customers reluctant to extend themselves.

“The problem is trying to get qualified people to borrow,” said Raymond P. Davis, president and chief executive of Umpqua Bank, a regional lender based in Portland....

“The people that want the money don’t deserve it, and the people that deserve it don’t want it,” said John B. Satterberg, president of Community Financial Corporation. “Everybody’s sitting on the fence.”

This is a liquidity trap. The bank-centric economic rescue plans oftentimes lead us to think of a liquidity trap as a supply problem; the banks will not lend because there is no incentive to lend. As Paul Krugman explains

Here’s one way to think about the liquidity trap — a situation in which conventional monetary policy loses all traction. When short-term interest rates are close to zero, open-market operations in which the central bank prints money and buys government debt don’t do anything, because you’re just swapping one more or less zero-interest rate asset for another. Alternatively, you can say that there’s no incentive to lend out any increase in the monetary base, because the interest rate you get isn’t enough to make it worth bothering.

This could be certainly be true, and perhaps even was true early on in this crisis, but as fear has gripped the real economy, and households scramble to save every penny they can in guaranteed assets - i.e., cash and Treasuries - it seems clear that there is no longer any demand for debt. This situation will likely continue until insolvent households fix their balance sheets, at which point they will be creditworthy again, and already solvent households will stop putting off taking out new loans, as the fear strangling the economy subsides.

What is to be done to hasten recovery? Absent government intervention, the economy will eventually recover, to be sure. As households cut back, saving to pay down their debts, pent up demand builds throughout the economy. Once households reestablish their financial footing, this pent up demand will cause a new credit expansion and virtuous circle of economic growth. As Paul Krugman explains, this is how nineteenth century panics resolved themselves. The problem is that this can take years - or longer. Economic growth can stagnate for decades, as it did between 1873 and 1897, when the economy was in recession more often than not. An economy depressed over the mid-to-long term means lower tax revenues, and consequently likely increased deficits (absent large spending cuts, which would only exacerbate the downturn). Given that deficits will increase even without aggressive action, the case for proactive deficit spending to get us out of this economic slump becomes strong. But what should our priorities be?

Fixing balance sheets. That is the short answer. Banks and households. Doing one without the other is pointless. Regarding the banks, Nouriel Roubini has made a convincing argument that the Geithner plan is appropriate for solvent but illiquid banks, but not for outright insolvent ones. Of course, distinguishing between illiquid and insolvent banks can be quite difficult. But paying insolvent banks for toxic assets will be like AIG bailout fiasco on a grand scale: black holes sucking in taxpayer money across the economy. For truly hopeless banks, FDIC-style receivership and restructuring is the best answer. This means bondholders, who have heretofore not taken any losses, will not be made whole. Taxpayers will still be on the hook for enormous losses, but they will get all of the upside from selling these institutions back to private investors, and the total bill will be less, since bondholders will chip in. This is not, however, a free lunch. It is fraught with risk. Bondholders could panic, and pull their money out of banks. But it is the least bad option at this point. Just like banks, households need financial restructuring as well. This means writing down debts, particularly the principals on underwater mortgages. Roubini has proposed reviving the Depression-era HOLC, with the government buying up mortgages, and then renegotiating the principal owed, not just the interest payments as the Obama Administration has already done.

Aside from restructuring bank and household balance sheets, we must increase the buying power of the middle class to boost aggregate demand. This means creating jobs and strengthening social safety nets. The stimulus bill is a good first step towards putting the unemployed back to work, but the talk of cutting Social Security or Medicare benefits out of a sense of "fiscal discipline" seems dangerously wrongheaded. Again, from Galbraith

The prospect of future cuts in this modest but vital source of retirement security can only prompt worried prime-age workers to spend less and save more today. And that will make the present economic crisis deeper. In reality, there is no Social Security "financing problem" at all. There is a health care problem, but that can be dealt with only by deciding what health services to provide, and how to pay for them, for the whole population. It cannot be dealt with, responsibly or ethically, by cutting care for the old.

We must not confuse reforming the health care system - expanding coverage and lowering costs - with reducing benefits. Stronger safety nets ensure everyone a minimum living standard, and act as automatic stablizers in a downturn. The challenge Obama faces is incorporating the best aspects of the welfare state, without importing the rigidity in the labor markets that European countries face. This is a fundamental pivot away from the deregulatory, private-sector mania of the last thirty years, and instead imagining a system where not just the rich and connected win, but all share in the benefits; where the government does more to reduce economic uncertainty without choking off economic opportunity. It means creating an economy that grows from the bottom up, rather than the top down. Let us hope Obama is sufficiently bold to meet these opportunities.

Hey Paul Krugman

2009-03-29T19:47:00.002-04:00

It's a good question: why aren't people who saw the housing bubble and the financial crisis developing - Krugman, Roubini, Shiller, Stiglitz - in the Obama Administration? And what does it say that someone on Youtube has to point this out, rather than the media?

Kristof Calls for Expert Accountability

2009-03-29T07:33:00.005-04:00

A few weeks ago I lamented the disturbing lack of accountability among our political and media elites. For the supposed experts who hyped WMDs in Iraq and the bubble economy of the last decade, there have been precious little consequences. They are mostly still treated as serious commentators - at least by their fellow elites - and seem to feel no sense of chagrin over their manifest errors. Bill Kristol is the poster child for this phenomenon.

Nicholas Kristof at least deserves credit for bringing this issue to the forefront. From the New York Times:

The marketplace of ideas for now doesn’t clear out bad pundits and bad ideas partly because there’s no accountability. We trumpet our successes and ignore failures — or else attempt to explain that the failure doesn’t count because the situation changed or that we were basically right but the timing was off.

For example, I boast about having warned in 2002 and 2003 that Iraq would be a violent mess after we invaded. But I tend to make excuses for my own incorrect forecast in early 2007 that the troop “surge” would fail.

This is obviously but a single column, but raising this issue of the unaccountability of our often wrong experts is a good first step. Of course, this is not to say that if someone makes a bad prediction they should be barred from offering their opinions. Rather, that chronically bad prognosticators - some might say propagandists - should be discredited, and not continued to be treated as Serious People due to the clubby nature of elite media.

AIG Bonus Outrage=Fascism?

2009-03-27T05:55:00.003-04:00

We have a winner for most hyperbolic defense of AIG: Holman Jenkins of the Wall Street Journal. While many Very Serious People in the establishment media have taken to print and the airwaves to lecture the public on how pointless, unproductive, and even counterproductive rage over the retention bonuses paid to AIG's Financial Products employees (some of whom no longer even work at AIG), Holman Jenkins is the first to nearly break Godwin's Law. At the conclusion of his jeremiad chronicling the veritable slings and arrows of outrageous fortune befalling AIGFP's employees, Jenkins informs us that Andrew Cuomo's investigation into AIG reminds us that "It can happen here." This is a reference to Sinclair Lewis' 1935 work It Can't Happen Here, imagining a fascist takover of the United States at the hands of a charismatic Huey Long-style pol. So anger over the employees of a bankrupt company on government life support receiving millions of dollars of bonuses in taxpayer money is the first step on the road to serfdom? Will Andrew Cuomo ask President Obama to set up FEMA concentration camps in the AIG building? And could the right wing be any more detached from reality?

Kinsley: Obfuscation is the Point of the Geithner Plan

2009-03-27T04:31:00.005-04:00

Finally, someone from the establishment media (aside from Paul Krugman) speaks the obvious truth about the Geithner giveaway-to-banks-and-hedge-funds-and-private-equity-at-taxpayers'-expense-orgy: it is deliberately opaque, so as to mask how large a subsidy it is to the financial sector. Just as our erstwhile wizards on Wall Street seem to create intentionally abstruse financial instruments in order to keep the masses from questioning their financial hanky panky, Kinsely argues that the difficulty in deciphering the exact workings of the Geithner public-private plan seems similary motivated: to keep the public out. Indeed, Geithner has merely recycled Paulson's TARP idea of buying up toxic assets, which was rejected for being too transparent a giveaway to bankers, and added an extra step - launder the money through hedge funds and private equity firms. Perhaps the success of keeping the identity of AIG's counterparties secret for six months inspired this new scheme. Geithner has explained that partnering with these financiers will tap into the "expertise of the market" in pricing these so-called toxic assets, when in fact, this amounts to passing out lottery tickets to hedge funds and private equity firms, as they siphon off a percentage of any potential gains from the bailout. And, of course, public money will continue to flow into the banks, except this time via hedge funds and private equity firms instead of through AIG. This is the coup de grace of our kleptocratic system: everyone on Wall Street wins, and everyone on Main Street loses.

Of course, once it becomes clear that already rich financiers are becoming even richer thanks to the largesse of the Treasury, there will be public outrage that could potentially dwarf the AIG bonus flap. Maybe then our political class will pay more than lip service to the righteous anger spewing over the transfer of wealth from the masses to the politically connected who have brought the system down.

Fair and Mentally Unbalanced

2009-03-18T10:13:00.002-04:00

These reports that Glenn Beck is a neo-Nazi vampire-zombie who feasts on the blood of illegal immigrants - I'm tired of hearing about them. I wanted to debunk them. Well, I've now for several days done research on them. I can't debunk them.

See how difficult it is to prove a negative? It's impossible, really. Maybe that's why Glenn Beck is having such a hard time debunking the absurd talk of FEMA camps around the country (or maybe it's because Glenn Beck is an idiot playing to the tinfoil hat crowd). For those of you not keeping up with your right-wing conspiracies, Beck is referring to the rumor that Obama is using FEMA to set up concentration camps across the country where political dissidents will be sent. Sane conservatives like David Frum are reduced to saying WTF?

With the nation facing the economic equivalent of war, the Republicans - who still have enough votes to block major initiatives/bailouts due to the unreliability of Evan Bayh's Blue Dogs - are going off the deep end. Of course, Glenn Beck is just an entertainer - but he's the highest rated talking head on the Republican channel. And as we've seen with Rush Limbaugh, the Republican leadership is unwilling to stand up to the crazy folks in their base. So if Glenn Beck tells his viewers to call their representatives and tell them to boycott any Obama economic agenda, because it's the first step on the road to serfdom...well, you can guess what John Boehner, Eric Cantor and the rest of the A-Team will do. Now they'd almost certainly obstruct Obama's agenda regardless, but having a minority party that has clearly lost its mind that can still block legislation is a tremendous obstacle to getting the right policies in place. At a time of national peril, the Republicans are arguing about realities that only exist within their heads. Bush would be proud.

Clawbacks, Taxes and Prosecution: Oh My!

2009-03-18T08:03:00.003-04:00

Angry Bear captures the zeitgeist of the moment: we need prosecutions of Wall Streeters. Put insolvent firms into pre-packaged bankruptcy, and go after past bonuses as fraudulent conveyance. Or pass punitive, retroactive taxes on all firms that received TARP funds. It could just be the fixed income idiots who spawned this crisis (they accounted for nearly half of Wall Street profits at the peak of the bubble). Or, if Andrew Cuomo is really ambitious, start going after these firms with RICO cases. Get creative. Make arrests. Put the worst of them in jail, where they belong. Show them they are not above the law.

A Modest Proposal: Jim Baker to Treasury

2009-03-18T04:18:00.003-04:00

If Paul Volcker can serve as an economic advisor at the ripe old age of 81, then Jim Baker should be more than spry enough to reprise his role as Treasury Secretary for a year. At this point, it only seems like a matter of time before Tim Geithner gets canned/decides to spend more time with his family. Geithner's stunning inability or unwillingness to use the government's leverage over AIG to prevent them from paying out absurd bonuses is the final straw. The larger issue is his failure to come up with a bank rescue plan that doesn't amount to a giveaway to the bankers. Apparently, nationalization is too unthinkable or scary (picking on Geithner is like hitting a ball off a tee, but Harold Meyerson hits one out of the park with his latest column).

To his credit, Baker recognizes that we face a crisis of solvency, not of liquidity. He has called for FDIC-style receivership of insolvent banks, so that they can be closed and sold back to private investors. This would admitedly be a difficult process, fraught with risk, but it is much, much better than the alternative of creating zombie banks. If anyone can pull this off well, it is Baker; throughout his career he has demonstrated a knack for simply getting things done. He is a doer. Most appealingly, he is a Republican - and one with close ties to Reagan to boot. If he were to be in charge of temporarily nationalizing the banks, it would insulate Obama from any political heat Republicans might gin up about him being a "socialist" for taking over the banks. This would be a political and policy coup. What are the odds of it actually happening?

AIG: All Your Billions Are Belong To Us (And Our Counterparties)

2009-03-17T23:14:00.008-04:00

This is the definition of looting. It would be one thing if employees who had good years despite AIG's implosion were receiving bonuses. Even that is hard case though. After all, taxpayers don't want their money going to pay for bankers/insurers' bonuses; the point of the bailouts was to stabilize the financial system, not bankers' lifestyles. But AIG is an entirely different story. They're giving $150 million to the wizards at Financial Products responsible for burning down the house (or, at the very least, pouring gasoline onto the burning house) - and by house, I mean the global financial system.

AIG has, of course, offered up all sorts of specious arguments about why they need to dole out these "retention" bonuses. The oldie-but-goodie is that the world will end if we don't give them every cent they demand. This is simply extortion. It is sociopathic behavior. The other spurious defenses of these payments - which Aaron Ross Sorkin the New York Times bought hook, line, and sinker in his column yesterday - are that if the government begins abrogating contracts, our entire system of rule of law will crumble, bringing - once again - the world to an end; as well as the claim that AIG needs to keep its supposedly in-demand employees in house to unwind their CDS positions. Here's Sorkin on Hardball reiterating his position.

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However, as John Carney notes, there are holes in these arguments large enough for any half-clever lawyer to push Rush Limbaugh through. AIG would not exist today were it not for its taxpayer-financed bailout, and if AIG had been allowed to go into bankruptcy, its employees, as unsecured creditors, certainly would not be receiving any bonuses. Renegotiating the bonus contracts in this case would not be an abrogation of contracts, but merely reflect the changed status of AIG as a ward of the state. As to the assertion that AIG needs to pay out these bonuses to retain its "top talent" - well, as Andrew Cuomo points out, paying "retention" bonuses to people who no longer work at AIG makes a mockery of that claim.

While the public has attached onto the bonus issue, the real outrage, of course, has been the billions funneled into AIG through the frontdoor going out the backdoor to Goldman Sachs and the rest. Eliot Spitzer nails it: why are taxpayers on the hook to make counterparties whole - especially at a time when people on Main Street are all taking a little bit less so that everyone can get by? That Goldman CEO Lloyd Blankfein was the only bank executive in the room when Paulson and Geithner decided to bail out AIG always reeked of pure cronyism, but amidst the warpspeed nature of the crisis in September, it did not receive the scrutiny it deserved. But in an environment where a senator suggests AIG executives should commit seppuku, perhaps we'll finally begin to demand the type of transparency we should have had from the beginning. We can only hope.

Is Harvard A Hedge Fund?

2009-03-14T07:23:00.009-04:00

Harvard has problems. Billion dollar problems. Exactly how many billions of dollars remains in dispute. What is beyond dispute, however, is that Harvard has lost around a quarter of its endowment in the last nine months, and a large part of the remaining funds are tied up in illiquid investments. This is quite a reversal. Indeed, only a year ago endowments at Harvard and other elite schools had swollen to such gargantuan sums that they were busy devising ways to spend enough to maintain their tax-exempt statuses. There was even talk of using the endowment to make Harvard free for all students. Ah, those heady pre-Lehman days. Of course, it is hardly surprising that Harvard's endowment has not been immune to the global financial turmoil. Markets everywhere have cratered. But the nature of Harvard's losses illustrates the extent to which the university has aggressively moved into nontraditional investments - "real" assets like forests and oil, as well as stakes in private equity. Harvard has become a hedge fund. But why did Harvard transform itself, as Jim Manzi wryly opined, into a "tax-free hedge fund with a very large marketing and PR arm called Harvard University"? And what does this tell us about how the bubble economy skewed our perspectives, and created perverse incentives to join the speculative crowd?

Because it was lucrative. Very lucrative. This is the short answer to why Harvard began managing its endowment like an amped up Wall Streeter trying to max out just before bonus season. This is not hyperbole. Ex-Wall Street alums ran the endowment, and were compensated along the same bonus system (although the Harvard Management Corporation did wisely include clawback provisions). As Edward Jay Epstein notes, they moved out of the types of assets endowments had traditionally held, such as Treasuries and other bonds, and into a broad range of often obscure, illiquid investments. After all, there were oversized fortunes to be made in these exotic bets. And Harvard made them. Under Jack Meyer's stewardship, Harvard's endowment ballooned from $4.7 billion in 1990 to $22.6 billion in 2005. Aggressive management accounted for at least $12 billion of this growth; 15% annual returns will do that.
Of course, it was not simply a Scrooge McDuck hoarding instinct that motivated this shift in investment strategy. The scorched earth competition that is elite higher education demanded it. As colleges entered an arms race in the last fifteen years to attract the best faculty and students, costs skyrocketed. There was an education bubble. And even a school with as strong a brand as Harvard could not afford to let its near peer institutions outspend it on research facilities, dorms, and professors. As former Citigroup CEO Chuck Prince remarked nearly two years ago about the credit boom (in a statement that retrospectively highlights the collective cluelessness of our erstwhile financial titans), "as long as the music is playing, you've got to get up and dance." So Harvard danced.

Harvard needed little cajoling to get up on the metaphorical dance floor. This unreserved jump into heretofore abstruse markets hints at the final dimension of the Harvard endowment's metamorphosis into a speculative enterprise: the school's changing culture. Beginning in the 1980s, increasing number of Harvard graduates flocked to Wall Street to get rich. According to Harvard economists Claudia Goldin and Lawrence Katz, the number of graduates going into finance grew from 5% in 1970 to 15% in 1990. A survey of the class of 2007 revealed that 20% of the men were headed for Wall Street. And who could blame all these wannabe Masters of the Universe - alumni in finance earned on average three times more than their former classmates in other fields. What explained this explosion in financial sector salaries? No one is quite sure. If anyone could explain, it would almost certainly be business journalist Michael Lewis, who had a firsthand view of the genesis of this brave new financial world while at Salomon Brothers. However, even he is slightly flummoxed. As Lewis explains in Liar's Poker, the money was just there. In terms of supply and demand it made little intuitive sense. Some confluence of new freedom from regulatory strictures and a generational forgetting of the toxicity of excess debt created a frenzied era of seemingly exponential growth for Wall Street. It certainly seems that by the early 1990s, recent alums and current students had so bought into the Wall Street way that maximizing the endowment's returns seemed obvious; following a conservative strategy would be an inefficient use of capital, after all. Now it is certainly possible that the changing career choices of Harvard alums had little or no impact on the investment strategy of the HMC. The fact that hosts of grads descended on the investment houses and the endowment reoriented towards higher-yielding (read: riskier) assets could both merely have reflected the immense profitability of the Great Bull Market.

Without large parts of the Harvard community internalizing the Wall Street ethos, it seems unlikely that the HMC would have been able to justify its shift in investment philosophy. Indeed, even this was not enough once HMC remuneration peaked in 2004. To some alumni who came of age before the go-go 1980s, the outsized paychecks HMC handed out to the endowment's managers were disquieting. Several members of the class of 1969 began a letter-writing campaign, and ultimately succeeded in pressuring the administration to establish pay caps. The student newspaper the Harvard Crimson, however, was not impressed. They told alumni to "stop calling for salary cuts" and end the "excessive scrutiny" of HMC - otherwise the university would be unable to retain its top financial talent. Besides, HMC did not pay its employees nearly as much as a hedge fund with identical returns would receive. Don't kill the goose that laid the golden nest egg.

They had a point. While paying a combined $70 million to two bond traders in 2004 stoked outrage, this was a pittance compared to what Harvard would have had to pay to an outside firm for the same results. However, arguing that capping pay was short-sighted presupposed a key issue: that Harvard was a hedge fund. During the boom years, this might have seemed a pedantic point, but the current downturn has demonstrated the downside of running an endowment like George Soros runs his hedge fund. Like colleges everywhere, Harvard has instituted a hiring freeze, halted construction on new projects, and fired staff to cut costs in response to the global financial crisis. These austere measures have prompted a torrent of criticism. Despite its losses, Harvard's endowment still dwarfs those of other schools; indeed, Harvard has lost more than most ever had. Given the university's relative wealth, shouldn't they use the endowment to maintain services? Some contended the university was acting as if capital preservation mattered more than the students. Such are the dangers of turning a university into an investment vehicle.

Harvard is hardly alone in transforming itself into a hedge fund. The trend began with Wall Street itself in the 1980s. It is easy to forget now, but investment banks did not always trade on their own books. They advised companies on mergers and acquisitions; they underwrote securities; they executed trades for clients. But as Michael Lewis chronicles in Liar's Poker, the trading culture quickly spread from Salomon Brothers throughout Wall Street once it became clear what kinds of fortunes stood to be made. Institutional investors - university endowments, pension funds, and insurance companies - followed suit. Big ticket manufacturers - GE and GM - got in on the act as well, turning their financing arms into cogs in the larger banking system. At the bubble's peak, entire countries - yes, that means you Iceland - effectively leveraged themselves up and became de facto private equity firms and hedge funds. Why did everyone and their aunt borrow to speculate in the markets? Because they were afraid of being left out. They saw their relatives and neighbors and rivals making a quick buck, and they didn't want to be the sucker who didn't get rich. They let social pressure cloud their judgment. Their early "successes" in the markets only reinforced these pressures, and warped their values, sending them into self-congratulatory fits about how brilliant they were for doing so well.

But now that the age of leverage is over, never to return in our lifetimes, we must all go back to doing what it is that we did before the markets made us crazy. Iceland needs to go back to fishing; GE and GM need to go back to building wind turbines and cars; pension funds and insurance companies need to invest in safe, boring assets; and Harvard has to go back to just educating its students. A new age of responsibility is most certainly upon us.

Welch: Ignore Everything I've Ever Said (Except For This)

2009-03-13T18:56:00.004-04:00

Remember maximizing shareholder value? Remember beating quarterly earnings expectations being the be-all-and-end-all of a CEO's job? Well forget it - at least according to Jack Welch, the deified former GE CEO credited with ushering in the shareholder value gospel. From the FT:

Jack Welch, who is regarded as father of the "shareholder value" movement, has said the obsession with short-term profits and share price gains that has dominated the corporate world for over 20 years was "a dumb idea"....

"On the face of it, shareholder value is the dumbest idea in the world," he said. "Shareholder value is a result, not a strategy...your main constituencies are your employees, your customers and your products."

Now he tells us. No doubt Welch feels chagrined about the sorry state in which he left GE. While Welch managed to leave near the top, the accounting gimmicks he regularly employed to beat quarterly earnings expectations - particularly with the opaque GE Capital - have shredded investor confidence in GE's financial statements today. Oops.

It's worth noting that not everyone has bought into the shareholder value gospel. In the Washington Post, Harold Meyerson calls attention to the stakeholder model in Germany, where workers have meaningful representation on company boards, and long-term goals are prioritized over short-term ones, since German companies rely on retained earnings and banks rather than the markets for funding. It might be a model worth copying.

Down Goes Cramer! Down Goes Cramer!

2009-03-13T17:58:00.006-04:00

Here's the video of Jon Stewart completely eviscerating Jim Cramer last night. Cramer truly got crossfired. Hopefully reporters around the country took notes on what real journalism looks like. Glenn Greenwald hits all the right notes about the financial media's complicity in hyping the bubble mirroring the national media's obsequious "reporting" in the run-up to the Iraq War. Sadly, the proliferation of media has reduced the quality of journalism. Reporters worry so much about losing access to their sources that they never ask the tough questions. Landing the big interview, rather than breaking the big story, has become the measure of a journalist. And sadder still, a comedian has to show them how it should be done.

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Markets Forcing Nationalization?

2009-03-12T04:34:00.003-04:00

Will the bond markets force the administration's hand when it comes to nationalizing banks? Bloomberg reports that:

Citigroup Inc. and Bank of America Corp.’s bond prices are sliding on concern that owners of debt issued by U.S. financial firms will be forced to swallow losses if the industry needs another bailout.

While there has been speculation for some time now that unsecured bondholders might take a loss in any future bailout, analysts are now openly questioning just how safe supposedly ultrasafe senior debt is as well. Again from Bloomberg:

“We’re seeing the start of the next leg of the crisis and that’s going to be financial bondholders taking a haircut as lenders default,” Mehernosh Engineer, a London-based strategist at BNP Paribas SA, said this week. “There’s been a perception that banks’ senior bondholders are untouchable, but that’s going to change.”

James Kwak over at Baseline Scenario observes that

this perception decreases confidence in the banking sector as a whole, because of the potential ripple effects of shorting creditors.

There is the potential for this fear to become self-justifying. Since Citi and BoA are more or less insolvent, loans to them are only worth as much as investors think the government will guarantee. If investors become convinced that some sort of government receivership is inevitable, despite the government's protestations to the contrary, then not only will bank bonds trade at distressed levels, but the banks themselves will have a harder time raising private capital than they already do. Cut off from private capital, the government will then be forced to nationalize the banks.

The risk, of course, is that a panic develops beyond merely Citi and BoA, and that solvent banks find themselves unable to finance themselves, as investors flee from all bank debt. To avoid this, the government must decide who needs to be nationalized rather than the markets. To this point the Treasury has tried to encourage private capital to flow back into the banks to no avail. It has not worked. The markets are not buying it. Treasury needs to finish its stress tests, determine which banks cannot be saved, and then nationalize them all at once. It will be messy and enormously challenging. But it's better to proactively address the problem, rather than have policy reacting to panic.

They Say It Like It's a Bad Thing

2009-03-12T02:10:00.005-04:00

According to the Wall Street Journal, "the exodus" out of finance is in full force. As politicians have tried to attach more strings to bailout packages to appease angry voters, and anemic (if that) earnings have drastically cut into Wall Street bonuses, more and more bankers are leaving the business. What a shock - investment bankers were only it for the money. But the Wall Street Journal says this as if it were bad. It is not. Just as there was massive misallocation of capital into bubbles over the last decade and a half, there has been massive misallocation of human capital into banking. If our best and brightest physicists and MBAs turn their attention to solving real problems rather than inventing new ways to pile leverage on top of itself, I think our society will manage to keep going. We might even prosper again, as opposed to merely creating an illusion of wealth. Indeed, the sooner we can turn our top minds towards developing green tech or making healthcare more efficient, and away from mastering market manipulation, as Jim Cramer explains below, the better we will be.

Accountability

2009-03-11T13:57:00.005-04:00

What happened to accountability? There's a disturbing lack of it among our elites today. If you're a politician or pundit who told the public we'd be "greeted as liberators" or needed to go to war in Iraq so that Arabs would learn to "suck on this," then you are still considered a credible commentator - by other elites - on what we should do in Iraq today. If you're a bank executive and you've mismanaged things so badly that your bank needs a bailout to avoid bankruptcy, then you are just the person to navigate your firm back to health (while still shelling out million dollar bonuses to yourself and employees, of course). If you're a financial news channel that constantly hyped up the bubble and had its anchors simply repeat whatever CEOs told them, then you are still considered the first stop for financial analysis.

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And if you're a conservative think tank that touted countries that embraced the type of laissez-faire reforms you champion, only to watch those countries self-immolate two years later...then you are still the go-to source on economic policy for Republicans. From Krugman:

And wide-open, loosely regulated financial systems characterized many of the other recipients of large capital inflows. This may explain the almost eerie correlation between conservative praise two or three years ago and economic disaster today. “Reforms have made Iceland a Nordic tiger,” declared a paper from the Cato Institute. “How Ireland Became the Celtic Tiger” was the title of one Heritage Foundation article; “The Estonian Economic Miracle” was the title of another. All three nations are in deep crisis now.

If you thought Iceland, Ireland, and Estonia were model economies, why should anyone take your economic advice seriously? It would be as if liberals hyped the success of central planning in communist economies...in 1988.

Greenspan: Don't Blame Me; Blame China

2009-03-11T02:47:00.009-04:00

Alan Greenspan takes to the pages of the Wall Street Journal today to defend whatever is left of his tarnished legacy. His message: the housing bubble wasn't my fault; it was China's. Of course, there is a savings glut, and it certainly contributed to the credit and asset bubbles in large part. But doesn't this miss the point? Greenspan could have raised short-term interest rates to higher levels; if the 2004 hikes did not bring down long-term mortgage rates, Greenspan should have continued to raise rates (if he was truly worried about the housing bubble). It strains credulity that there was nothing the Fed could have done to pop the bubble. Doing so obviously would have meant sending a weak economy into recession - likely even a fairly nasty one - but in retrospect, it would have been better. It's easy to fall into hindsight bias, but Greenspan's own understanding of the role of the Fed as designated driver surely prevented him from taking action that at the time seemed reasonable.

Dean Baker does a good job laying out the case for the Fed targeting asset price stability in addition to its historically understood role of managing inflation. Alan Greenspan, are you listening?

Friedman: Toxic Assets Just Need Some Love

2009-03-11T00:26:00.008-04:00

Another day, another gem from Thomas Friedman. While Friedman correctly identifies fixing the banking crisis as fundamental to turning the economy around, he seems to have embraced the "toxic assets are not bad; they are simply misunderstood" fallacy. From the New York Times:

we need to get a market going that would bring fair value and clarity to the "toxic assets" crippling the balance sheets of our major banks. This will likely require some degree of government subsidy to private equity groups and hedge funds to get them to make the first bids for these toxic assets by guaranteeing they will not lose.

Who told Friedman this was a good plan? Could it have been...private equity guys and hedge fund managers? And what is "fair value" for the so-called toxic assets? Is it the price at which selling them will make banks solvent? Friedman has adopted the transparently untrue belief that toxic assets still have some fundamental value, but are being artificially depressed because of panic. Unfortunately, our Treasury Secretary seems to believe this as well. But facts are stubborn things. And the facts indicate that toxic assets are worth even less than what pessimists have projected. This is a solvency crisis. Insolvent, too-big-to-fail institutions need to be put into receivership, broken up into smaller pieces, and sold back to private investors. This will pose numerous technical challenges. It is not a free lunch. But it's the most cost effective way to create public trust that the financial system is healthy.

Black Swan Bait

2009-03-10T04:58:00.004-04:00

This piece in the New York Times on the rise of quants on Wall Street seems a bit too kind. Of course, it contains the now obligatory Nassim Taleb quote - he never misses an opportunity to herald the dangers of financial models - but this sentence misses the point:

Another consequence is that when you need financial models the most - on days like Black Monday in 1987 when the Dow dropped 20 percent - they might break down.

No - they will break down. This is Taleb's point. Models only work when you don't need them. And, as we have seen, in the hands of unsophisticated traders, these models become the intellectual justification for taking on unknown risks. So to recap: financial models do not help traders anticipate future shocks, but they do give traders a false sense of confidence. Why exactly is Wall Street in a rush to hire ever more quants now?

Repeat After Me: It's A Solvency, Not A Liquidity, Crisis

2009-03-10T04:16:00.005-04:00

Give Russell Roberts and Arnold Kling credit for at least being able to identity the current crisis as one of solvency rather than one of liquidity.

A liquidity crisis means assets lose value because of panic and distressed selling. The assets themselves are still inherently valuable, and given enough capital to tide the banks over, they should be able to survive and sell off the assets at something close to full value once the "market dislocation" ends. A solvency crisis means assets are actually worthless, or close to it. Insolvent banks become black holes (see Citi and AIG, which is a quasi-bank), as they pour capital into the gaping holes in their balance sheets. FDIC receivership is the best option for insolvent banks.

This is a distinction our government officials have apparently been unable to make. Bernanke and Geithner have both publicly stated that our financial system is suffering from a lack of liquidity. If this were true, the unprecedented liquidity the Fed and Treasury have injected into the system over the last six months would have ended the crisis.

I see three possible explanations for Bernanke and Geithner's apparent disconnect from other informed observers when it comes to assessing the banks: 1) they have honestly misdiagnosed this as a liquidity crisis, 2) they are afraid of the politics of nationalization, or 3) they wish to extinguish all alternatives before turning to nationalization because of the technical challeneges it poses. If the first explanation is true, they should both be replaced. If the second is the case, then David Axelrod should explain that given that conservatives from Alan Greenspan to Lindsey Graham have endorsed some form of temporary nationalization, there is more than enough political cover. And if the third is true, then I have two questions: why will the TALF work better than the TARP, and how much more expensive will nationalization be in six months time than it is now?

Shanty Towns

2009-03-10T02:03:00.006-04:00

As foreclosures continue to devastate communities, and unemployment mounts, it seems like more stories like this one from the Today show about the rise of shanty towns - or Bushvilles - in Sacramento, Seattle, Reno, and Nashville will become more commonplace.

Any governor who has threatened to reject any stimulus money, particularly extended unemployment benefits, should be forced to go visit these encampments.

Now what can we do to prevent these settlements from exploding in size? Creating jobs is the obvious first step. Hopefully, the stimulus and the benefits aimed at the most at risk within society will help. But we also need debt reduction for insolvent households, primarily by writing down the face value of mortgages to reflect current prices. With so many borrowers underwater on their mortgage - and many more likely to find themselves there over the next few years, as housing prices most likely still have 20-30% to fall - there will be a terrible incentive to do jingle mail, and simply walk away. This will cause housing prices to overshoot on the downside. Reducing mortgage debt will not only mitigate foreclosures, but boost aggregate demand. Nouriel Roubini has long called for a reincarnation of the HOLC of the Great Depression to buy up mortgages, in order to refinance/renegotiate the terms. Roubini elaborated on this point on CNBC yesterday.

Why can't we find a job in the Treasury department for Roubini? And Krugman, Stiglitz, Shiller, and Simon Johnson as well, for that matter?

Can the Government Stimulate the Economy?

2009-03-09T14:18:00.004-04:00

If two conservative economists discussed whether fiscal stimulus can ever work, and one exposed the debate as irrelevant to our current crisis, would the other even notice?

The answer seems to be no. Russell Roberts gives what he apparently believes is a deep and philosophical critique of Keynsian spending, arguing that government spending (G) effects consumption (C) and investment (I), such that an increase in G will lead to a decrease in C and I; they are more or less zero sum. Robert's argument rests on the assumption that an increase in G necessitates higher taxes, which individuals and businesses will factor into their spending and investment decisions, offsetting the effect of any higher government spending. This is recycled Treasury view masquerading as insight.

But then Arnold Kling exposes one of the fundamental flaws of the Treasury view: it assumes something close to full employment. When the economy is near full capacity, government deficits more or less would crowd out private investment. But when resources are being unemployed, this does not apply. And today we certainly have idles resources, between private capital sitting on the sidelines, pouring into short-term Treasuries, and unemployment itself rising above the equilibrium level.

Roberts seems oblivious to the implications of Kling's argument. The Dark Ages are quite dark, indeed.

Buffet Channels Taleb

2009-03-09T13:41:00.005-04:00

In another segment of his never-ending interview on CNBC, Warren Buffet gave advice Nassim Taleb would be proud of: don't stress about the day-to-day changes in the markets.

Who would have guessed - the key to investing for the long term is identifying well-performing businesses. Forget the quotes; look at the business. Or, in other words, look at companies that create real wealth, not those that merely seem like good speculative bets. Or, to rephrase once again, invest in companies Paul Graham of Y Combinator would endorse - companies that make something people want.

The Banking Lobby

2009-03-09T13:19:00.005-04:00

The banking lobby is digging in to make sure that we learn nothing from this crisis, so they can keep playing their heads-we-win-tails-you-lose game. From Bloomberg:

Alan “Ace” Greenberg, the former Bear Stearns Cos. chief executive officer, said he sees a “very small” chance the Great Depression-era Glass-Steagall Act that separated banking and investment banking could be reinstated.

“Practically you can forget about it, it’s not going to happen,” Greenberg, 81, said today in an interview on Bloomberg Television. “The people who lobbied so extensively for the extinction of Glass-Steagall are still around.”

This is why Simon Johnson talks about the only obstacle to effectively fixing our financial system, since most economists agree temporary nationalization is the best option, is the power of the banking lobby. They really do control the levers of government. If the seemingly endless stream of cash Wall Street has siphoned off from the taxpayers isn't going to be a total waste, we need to put preventive measures in place to guarantee this type of crisis never happens again (at least in our lifetimes, until our children and grandchildren forget our lessons, as we did with the lessons of the Greatest Generation).

Buffet Hints at Geithner's Plan

2009-03-09T11:36:00.003-04:00

During a marathon interview on CNBC this morning, Warren Buffet had a surprisingly upbeat take on the banks.

Buffet claimed that banking has never been more lucrative than it is now do to historically low interest rates and wide bond spreads. While he admitted some of the worst capitalized banks will likely not make it through this crisis, Buffet did say he expected most banks to earn their way out of the holes they are in.

And this is essentially the Geithner plan: give banks enough capital to keep them alive, and hope that they can earn their way back to health. Of course as a major shareholder in Wells Fargo, Buffet favors letting the, according to its own fair-value accounting, insolvent bank try to rebound. But why is Geithner apparently so willing to just cross his fingers and hope for the best? The politics would certainly be easier if the banks did not require massive injections of capital, but instead just needed enough to tide them over till they returned to profitability. But what about banks' increasingly toxic balance sheets makes this likely? Even if banks return to robust earnings, a whole host of mortgages, commercial real estate loans, auto loans, student loans, and credit card loans made at the peak of the bubble that have yet to go bust threaten to overwhelm any new revenue streams, and send banks further into insolvency. This seems like a repeat of Japan.

Alan Blinder: Clueless or a Liar

2009-03-09T10:38:00.004-04:00

Yves at Naked Capitalism says most of what needs to be said about this Alan Blinder op-ed in the New York Times. But it's worth reiterating just how much Blinder misrepresents the terms of the debate. The most glaring example is when Blinder writes that:

Another argument is that banks’ dodgy assets are hard to value, making it impossible to know how much capital they need — and probably very expensive to provide it. True again. But nationalization doesn’t make these problems disappear.

If the government takes over a bank, the taxpayers tacitly acquire its assets, thereby inheriting all the uncertainties over valuation. And if a bank has negative net worth when it is nationalized, who do you think fills the hole?

This is patently untrue. The entire point of temporary nationalization is that regulators don't have to price toxic assets; they can simply buy the bank, and then split it into good and bad halves. This is why Alan Greenspan came out in favor of putting insolvent banks into receivership. The good half can be sold back to private investors rather quickly. The bad assets can be held indefinitely, and sold to investors, hopefully as the market for them recovers, like was done with the RTC during the S&L crisis. Of course, if these assets really are worthless, as seems likely, then the taxpayers will end up eating the losses. But at least the taxpayers will have gotten the upside from selling the good half of the bank, and we won't have merely subsidized bankers by giving them cash for trash.

Alan Blinder either does not know what he is talking about, or is intellectually dishonest. Which is worse?

Creditanstalt II?

2009-03-09T09:37:00.004-04:00

Over the weekend in the New York Times, Liaquat Ahamed sounded the alarm on Europe's potential for catastrophe. Quick version: Eastern Europe borrowed huge sums in foreign currencies from Western European banks; once lending died in September, Eastern European countries found themselves with massive short-term liabilities they could no longer roll over; the exodus of capital from Eastern Europe, in conjunction with massive current accounts deficits, has caused currency crises across the region, raising the real cost of debts; because of difficulties organizing collective action, particulalry on the part of France and Germany, Western Europe has been unable to agree on a bailout of its Eastern neighbors despite the risks Eastern European defaults pose to Western Europe's banks.

Ahamed concludes:

The response of the American government to the financial crisis has been criticized for being too slow and inadequate. But at least we have a federal budget, the national cohesion and the political machinery to get New Yorkers and Midwesterners to pay for the mistakes of homeowners in California and Florida, or to bail out a bank based in North Carolina. There is no such mechanism in Europe. It is going to require leadership of the highest order from officials in Germany and France to persuade their thrifty and prudent taxpayers to bail out foolhardy Austrian banks or Hungarian homeowners.

The Great Depression was largely caused by a failure of intellectual will. In other words, the men in charge simply did not understand how the economy worked. Now, it is the failure of political will that could lead to economic cataclysm. Nowhere is this danger more real than in Europe.

I couldn't agree more.

Volcano Insurance

2009-03-09T08:56:00.004-04:00

Let's say you live next to a volcano. Let's also say you run an insurance company. You make all sorts of bet with all sorts of people, collecting premiums. You do well. Then one day you come up with a way to make huge profits: you'll sell volcano insurance. After all, the volcano hasn't erupted in ages. This is money for nothing - right?

Fast forward three years. The volcano erupts. You're on the hook for hundreds of billions in insurance policies you have no way of paying. And your clients will go bankrupt themselves if you don't pay them. In this case, you're AIG, the volcano insurance was CDS, and your clients were major US and European banks. Now you go hat in hand to the government, telling the Feds that if they don't bail you out, the world will end. From Bloomberg:

What happens to AIG has the potential to trigger a cascading set of further failures which cannot be stopped except by extraordinary means. Insurance is the oxygen of the free enterprise system. Without the promise of protection against life's adversities, the fundamentals of capitalism are undermined.

This is extortion. And what is the point of indirectly bailing out AIG's counterparties? Why not do so explicitly? Many of them are European banks, and we would certainly stop bailing them out. As for the American banks, if they are so desperate for capital that taking a hit on their payout from AIG would push them into insolvency, then they should probably be in some form of government receivership. AIG should go through an orderly bankruptcy where creditors agree to write down debts to some levels to make a continuing bailout at least a little cheaper. The taxpayers should not simply pump money into the system to make Goldman whole.

Ken Lewis: We're Not Insolvent! We Promise!

2009-03-09T06:50:00.005-04:00

Ken Lewis takes to the Wall Street Journal to tell us to pay no attention to that man behind the curtain.

Lewis assures us that "the vast majority of banks will weather this storm" and that nationalization is misguided, because its "announcement would undermine confidence in the financial system and send shudders through the investment community."

Undermine confidence in the financial system? Really? As Paul Krugman would ask, what's the weather like on his planet? Trillions of dollars of credit losses worldwide has destroyed confidence in the financial system. Paying billions of dollars for the right to absorb Countrywide and Merrill Lynch's billions of dollars of losses has crippled confidence in Lewis's BoA. Nationalization only raises the specter that creditors won't be made whole. That could create a renewed panic among holders of unsecured bank debt, but if there's an orderly process it should be a tractable problem. At this point, nationalization might be the only way to convince the public that banks are actually healthy.

So nice try Ken. But you're not distracting anyone from the real question at hand: why do you still have a job?

What Does Nationalizing the Banks Mean?

2009-03-09T00:01:00.007-04:00

Here's Chuck Schumer and Lindsey Graham on Meet the Press talking about possibly nationalizing insolvent banks.

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Schumer does a good job explaining the differences between what he calls "good" and "bad" nationalization. Good nationalization is essentially FDIC receivership on steroids - the government seizes the bank, separates good and bad assets, sells the good parts back to private investors quickly, and holds the bad assets to sell back over a longer time frame. This is more or less what the government did during the S&L crisis. Bad nationalization means the government permanently running the banks, with political connections determining who does and does not get loans. It is crony capitalism. Think Mexico in the 1980s.

Schumer did neglect one key, though technical, question: what to do with unsecured bondholders? Within any corporation, the capital structure flows up from common stock to preferred stock to unsecured debt to senior debt. If the government puts a bank into receivership, the common stock is automatically wiped out (not that the markets haven't more or less done that to troubled banks already). But who else should take a loss? Simon Johnson has argued that CDS spreads on financials peaked last week in response to the government converting its Citigroup preferred stock to common. Johnson speculates that the markets have interpreted this action as the harbinger of a move up the food chain to eventually include unsecured debt. If there were debt-for-equity swaps, or even outright haircuts, there could be a run on unsecured bank debt. This is the nightmare scenario Bill Gross of PIMCO describes. While Gross obviously is obviously not impartial on this issue, his point is valid. While forcing bondholders to share some of these losses with taxpayers certainly makes the package cheaper, it must be done transparently and simultaneously so that there is not a generalized panic.

Still, even without addressing these thornier issues, it's certainly encouraging to see a bipartisan consensus emerging around temporary nationalization (or receivership or pre-privatization if the N-word is still too taboo). Of course, the administration is still dragging its feet on a banking fix, preferring instead to put lipstick on a pig, and trot out TARP 2.0. But the fact that Wall Street's senator himself admits that putting failed banks into receivership might be our best option should prod Geithner and Summers to reconsider their non-plan plan.

Update: E.J. Dionne and Paul Krugman both summon the appropriate level of concern over the Obama administration's timidity in dealing with the economic crisis.

Washington Post: Healthcare=Iraq

2009-03-08T17:59:00.002-04:00

From the annals of journalistic equivalence, comes this tendentious editorial from Jackson Diehl in the Washington Post. The Very Serious Diehl informs us that in actually attempting to follow through on his campaign promises, President Obama risks following his predecessor George W. Bush into presidential oblivion. Indeed, Diehl finds it "odd" that most of the punditocracy has spent the last few weeks comparing Obama's transformative potential to that of FDR or Reagan, while to Diehl the parallels to Bush are so apparently obvious.

David Broder would be proud. After all, while this "pox on both your houses" style of journalism seems easy to write, it often requires a great deal of intellectual dexterity to argue that up is down. Being this vapid is hard. And so in a rather breathtaking display of equivalence, Diehl argues that healthcare reform is Obama's Iraq. Bravura performance.

Diehl claims Obama mirrors Bush's trajectory first in not asking people to sacrifice in the face of crisis. I suppose the question could be asked, sacrifice what exactly? Their homes? Their jobs? Their retirement investments? People are already losing everything in this economic crisis. Asking them to give something else up now makes no sense. And it would be counterproductive to recovery. Once the economy is on stronger footing, and we know how much we spent to plug the holes in the banking sector and to stimulate growth, it would make sense to talk about broader based tax increases. I suspect President Obama will be forced to do just that, particularly with the payroll tax to make Social Security solvent over the longer term. But criticizing him for not talking about the hard choices we will have to make when we don't know what they are exactly is a cheap shot.

Second, Diehl argues that, like Bush, Obama has not made serious efforts at bipartisanship, and has instead used a crisis to push through a partisan agenda. This makes so many mistakes, it's hard to keep track of them all. First, it assumes that bipartisanship is in itself desirable. This is always the starting point for Very Serious centrists like Diehl; they see both sides of the issues and understand that compromise is always the best solution. This is simply untrue. There are right answers. Now there will always be disagreement, but a lack of unanimity does not make a policy incorrect. Sometimes the price of watering down a correct policy to appease the minority is disastrous. Now is one of those times. If you think we should have a government spending freeze during a depression and I think we should aggressively spend to use the excess capacity in the economy, we should not simply split the difference. Diehl complains that Obama has not done that. Indeed, according to Diehl, President Obama:

has been unapologetic about using emergency measures like the stimulus bill to press polarizing Democratic priorities, such as the expansion of Medicaid benefits to the unemployed and union-friendly contracting provisions.

Perhaps Diehl should become economically literate. Does he really believe President Obama pushed for increased aid to the unemployed because those are Democratic priorities, or because spending targeted at those most in need is the most stimulative? Mark Zandi, a middle of the road economist who advised Senator McCain's campaign, has estimated that spending is much more stimulative than tax cuts during a recession. Aid such as food stamps and extended unemployment benefits give the greatest bang for the buck in terms of stimulus. But for Diehl, how successful a policy is irrelevant in judging its merits. Whether Republicans and Democrats agree on it is the only factor that matters. This is the final fallacy Diehl adheres to: all disagreements are equal. Democrats voting against an intrusive infringement of our civil rights is equivalent to Republicans reverting to neo-Hooverism as the economy collapses (and, of course, the Very Serious people always blame the Democrats for any failure to agree; they had to give in to President Bush on the Patriot Act, and they must be willing to include more bad ideas in the stimulus to get Republicans to sign on).

To conclude this stunning tour de force of intellectual vapidity, Diehl tells us that President Obama's efforts at healthcare reform are analogous to the war in Iraq. Really. Both, according to Diehl, are "divisive and risky." Both, in a rather telling admission, have "lurked in the background of the national agenda for years." And both threaten to divide the set off "an enormous domestic battle," while the real problems besieging us - in this case the war in Afghanistan and the financial crisis - continue unsolved. Credit Diehl with this one point: he is correct that the Obama team needs to do more vis-a-vis the banks. Tim Geithner's performance and lack of a coherent plan thus far has been troubling. But comparing healthcare reform to the Iraq war is insane. Obama ran on a platform of healthcare, energy, and education. Now he is trying to make good on his campaign promises. He is not using this crisis to try to enact a secret agenda. He ran on this agenda, and won on it. People want dramatic change in all of these areas. Conversely, Bush misled us into war in Iraq for reasons still unknown. It was a complete non sequitur from 9/11. It never made any sense. This is why half the country vociferously opposed the war from the beginning. Furthermore, the war in Iraq directly took away resources from the real fight in Afghanistan. Reforming healthcare is not similarly zero sum when it comes to fixing financial crisis. And bringing down the costs and expanding coverage will put our economy on more competitive ground so that we can have real, sustainable growth in the future, not the purely speculative, illusory growth we have had for the last decade and a half. But never mind that - for Diehl and the organs of the conventional wisdom, Democrats and Republicans are always equally to blame. Especially Democrats. As Brad DeLong laments, why, oh why, can't we have a better press corps?

Time to Buy Stocks?

2009-03-06T00:45:00.005-05:00

Um, no. While Buttonhood at the Economist cites research claiming "the US market has only been cheaper for 26 months in the last 140 years," conventional measures like Robert Shiller's 10 year cyclically adjusted P/E ratio suggest that stocks still have a ways to fall. Shiller's method uses ten years of earning data to mute the effect of short term earnings swings either up or down in valuing a stock. Applying this method to historical data gives an average stock price of 16X earnings. Today, the S&P 500 just dipped below 12X. So stocks are cheap, right? Not necessarily. Looking at past big bear markets, stocks typically overshoot on the downside and go to 5-8X. By this measure, there is a nontrivial chance stocks could go down 50% from present day value. James Glassman was right all along - if you erase a zero. Dow 3600!

But it gets worse. As Henry Blodget notes, we are exiting a fifteen year period where stocks have been enormously overvalued. At the peak of the dot com bubble, stocks were 45X. This was unprecedented. Even after the tech bubble collapsed, stocks remained elevated by historical standards, at roughly 25X. Considering we just witnessed the greatest speculative boom in US stock market history, it is certainly possible, as Blodget hypothesizes, that we could well have a longer and deeper trough in the markets than there were after past bubbles.

And this brings us to the notion that the Dow is somehow President Obama's "scorecard." Yes, Obama's economic team could have been much clearer with their plans for fixing the financial system. Their vagueness has certainly contributed to the uncertainty in the markets. But the markets declining from their New Year highs in the 9000s has nothing to do with Obama, and everything to do with the fact that there was a bear market sucker's rally that has since ended. We are exiting a credit bubble that overinflated asset prices across the board - these prices must fall. The president can not artificially inflate the Dow, just as he cannot artificially inflate home prices. Too much of the debate surrounding Obama's housing plan was whether this would "fix the housing market" and "stem the decline in home prices." This is nonsense. Home prices were a bubble; they were much higher than the fundamentals of supply and demand would dictate. Now they are falling, as they must. However, the Obama administration is correct in trying to help homeowners avoid foreclosure. That is where the focus should be, first with refinancing and ultimately writing down the principal for underwater borrowers. This will mitigate any overshooting on the downside with home prices, and ease the devastating social blow foreclosures have on families and communities.

For families facing trillions in lost wealth in the stock market and in home values, this is not welcome news. But it is the truth. That paper wealth is gone and is not coming back. We must get back to actually making things, and lay the foundation for real, sustainable growth in the future with investments in energy and infrastructure.

Update: For what it's worth, CNBC had Louise Yamada on today, talking about the possibility of the Dow going to 4000.

Who Needs Stress Tests?

2009-03-05T17:39:00.004-05:00

Can we just put our major banks into receivership and be done with it? According to banks' own estimates of the fair market value of their financial instruments, Bank of America and Wells Fargo are insolvent. Citi is clearly there too (no wonder they never sleep). And it's hard to imagine JPMorgan won't join them, as more commercial real estate, auto loans, and credit card debt go bust as the real economy deteriorates over the coming months.

Yes, a temporary nationalization will be ugly. Wiping out management and shareholders is easy. But dealing with bondholders will be harder. Some will have their holdings converted to equity; others will have to take significant haircuts. Furthermore, to prevent a run on unsecured debt at other banks, all nationalizations should take place at the same time so that there is no uncertainty about whether a bank might be taken over. Simultaneity and transparency should prevent panic from engulfing the markets. Again, this is not a free lunch. In most cases, the bondholders who will take a hit are pension funds, money market accounts, and insurance companies. This will be painful for ordinary people. But the alternative - pouring potentially trillions of dollars into zombie banks - is far, far worse. If the IndyMac experience is any guide, where a group including John Paulson and George Soros bought the troubled lender six months after the government seized it, the four major banks could be back in private hands within a year. That's about the best we can hope for at this point.

CNBC: Hardhitting, Insightful Journalism

2009-03-05T16:34:00.006-05:00

Fish, meet barrel. Jon Stewart blows them away.

The Daily Show With Jon StewartM - Th 11p / 10c

CNBC Gives Financial Advice

Daily Show Full Episodes
Important Things With Demetri Martin

Political Humor
Joke of the Day

Robert Barro: Stock Market Crashes Are Bad

2009-03-03T22:46:00.005-05:00

So get this: stock market crashes are bad. Don't believe me? Well don't take my word for it - listen to Harvard professor Robert Barro, who recently studied the correlation between stock market crashes and depressions (defined as at least a 10% drop in GDP or consumption). Barro's conclusion:

In the end, we learned two things. Periods without stock-market crashes are very safe, in the sense that depressions are extremely unlikely. However, periods experiencing stock-market crashes, such as 2008-09 in U.S., represent a serious threat.

I'm glad Robert Barro is here to tell us these things. Really, I am. But here's a tip: his study might actually be meaningful if he included debt levels as a variable. Debt deflation - a d-process - is the real culprit when it comes to depressions. As Irving Fisher described, when assets used as collateral for loans undergo price deflation, economies can fall into a downward spiral of deleveraging, leading to further falls in asset prices, and then even more deleveraging, as the two processes feed on each other in a negative feedback loop. I suspect if Barro redid his study and considered debt levels as well that the odds of today's crisis spiraling down into a depression would be significantly higher than the 20% figure he gave. I doubt he would compare our current situation to the crashes in 1974 and 2001. What does it say about the state of academic economics that "stock market crashes are bad" passes for insight from a professor at our nation's top university? Dark Ages, indeed.