Thursday
Dec112008

A Ruinous Bias Against Helping Detroit

That's the title to a post in The New York Observer, on which I'll comment but not link because it came to me as an email with Red Alert warnings about "phishing" and "potentially unsafe attachments."

Yes, I think there is a bias, but I would describe it as a bias in favor of Wall Street instead of a bias against Detroit. The financial industry has its money claws deeply into many, many government officials of both parties, and the financial industry is much harder for people to think they understand than is manufacturing. A lot of people understand the importance to the US economy and middle class incomes of the auto industry and its large supply chain, and they can more or less objectively assess the nature of problems and the proposed solutions. But when the financial industry says they must be instantly bailed out, no questions asked, or The Great Depression will recur, very few know enough to push back.

I'm not in favor of bailing out Detroit on the ground that fairness requires equal treatment of finance and manufacturing. Congress was right to send the Big 3 CEOs away with a scolding when they showed up without recovery plans. But if GM, Chrysler, and/or Ford come up with new business plans that show they can restructure their balance sheets, their off-balance-sheet obligations, reduce their overhead, produce vehicles that Americans will buy, and return to profitability in a few years, which I'm pretty sure they can do, then I would favor government acting as the investor of last resort if they are unable to raise private capital now because the financial system is temporarily broken. It would be preferable to do all the necessary restructuring without a bankruptcy filing, but bankruptcy has advantages, such as forcing creditors to accept a fair deal, and I don't think bankruptcy will result in liquidation unless there is no credible recovery plan. On the other hand, if there is no workable plan, they will just burn through whatever taxpayer money we give them and then collapse in a few months anyway.

As best I can tell, my position is like that of most Congressional Democrats and the Obama Administration. The GOP opposition seems to have two sources. Many hold to an ideology about markets that causes them to have a principled objection to government interventions, and many of them also opposed the TARP for the financial industry. The other source of opposition is that a big part of the GOP base is located in the old Confederacy, which has become the host to non-union assembly plants of foreign auto manufactures (Toyota, BMW, Benz and others). Being against a bailout for Detroit allows them to favor local businesses and workers and to stick their thumbs in the eyes of unions, both of which for them are good politics. The rest of the GOP base is in flyover territory where auto manufacturing is not felt to be important to the local economies.

Thanks to Christa for sending the question.

Thursday
Dec112008

“It’s better to have you suspect I’m broke than to have you know I’m broke.”

That's a principle suspected to be influencing financial institution accounting. For example, in the 3rd quarter, large US financial institutions reclassified $610 billion of assets into an accounting category that gives them maximum "flexibility" in assessing values, and that has increased concerns about hidden dangers on balance sheets, according to this Financial Times piece. Specifically, mortgage backed securities and collateralized debt obligations were moved from Level 2 to Level 3.

So-called "fair value" or "mark-to-market" accounting requires a 3-tier approach to placing current values on assets and liabilities. "Level 1" assets are widely traded securities with readily visible market prices. "Level 2" assets are those that lack such price data but have characteristics similar to other instruments ("proxies") for which there are observable price data. "Level 3" assets are not only hard to sell but hard to value because they lack any of those price data and have to be valued using "models." A useful discussion of these issues in an SEC-hosted roundtable in July is reported here. Speakers commented on how different companies have vastly different proportions of Level 1, Level 2, and Level 3 assets, how difficult it is to value companies by predicting earnings that are strongly influenced by revaluations, and whether fair value accounting does or does not result in more useful disclosures about financial condition.

One complaint about fair value accounting is that it makes earnings too volatile when investors want stability. One roundtable participant countered that the prices for these instruments are volatile and the financial statements should reflect that reality. That leads me back to the FT piece, where a financial industry insider is quoted saying, "A lot of banks are saying: 'I am going to move securities to level-three assets because I have more control over, and confidence in, the model used for their valuations'." In other words, securities that in the second quarter were valued by reference to observable proxy prices are now valued by non-standard models controlled by the reporting companies. The suspicion is that the reclassifications are being made in order to report higher and less volatile valuations—not because proxy price data are no longer available but because proxy price data are unwelcome. Nevertheless, the FT piece speculates that the next step after reclassification to Level 3 is further write-downs.

I previously commented on the controversy about whether fair value accounting rules should be suspended and, if so, what should take their place.

Wednesday
Dec102008

Perhaps a state law remedy for under-water home buyers in Massachusetts

In Massachusetts, making a loan that a lender could not reasonably expect to be repaid in the absence of steadily increasing real estate prices may be an unfair and deceptive practice under state law, in which event the lender may not be entitled to foreclosure, according to the Supreme Judicial Court in an action brought by the Attorney General in October 2007.

Tuesday
Dec092008

The one fundamental blunder that led to all the other blunders that caused the current financial crisis

Outsourced to Joseph Stiglitz:

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. . . . The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

This is from Stiglitz's article in the current Vanity Fair. For a summary, see this post on Mark Thoma's blog, which is where I got it.

Monday
Dec082008

Grover Norquist, meet Dean Baker.

Dean Baker doesn't want to eliminate the financial industry.  He just wants to shrink it until it's small enough to drag into the bathroom and drown in the tub.  He says the financial industry has become so powerful that it has been politically impossible to regulate it. 

Sunday
Dec072008

It wasn’t even a learning experience for Bush.

Today, 44 days before the end of Bush's term and the start of Obama's, Obama demonstrated in this Meet the Press interview a clearer understanding of the challenges facing the Nation and the President, and what to do about them, than Bush did on his best day in office. Video and transcript here.

Saturday
Dec062008

They’re baaaack! Keynesians to the rescue.

Nobel laureate Joseph Stiglitz says 3 decades of wrong-headed economic policies did great harm in the developing world, but only when we inflicted the same kind of damage at home did neo-liberal economists rediscover their inner Keynes. Stiglitz points out some subtleties in selecting the best Keynesian remedies and worries that the same greedy market fundamentalists who created the crisis will make out like pirates again while flying the Keynesian flag.

Saturday
Dec062008

Our only energy insecurity is exposure to high energy prices.

To suggest, as the Western Governors' Association does in its energy policy recommendations to the Obama-Biden Transition Project, that it makes a difference whether we import oil from "friendly trading partners" or from others is a common misconception that could lead to policy blunders. For example, importing oil from nations X, Y, and Z instead of from A, B, and C would not ameliorate our real energy security problem, and US military occupation of oil producing regions is counterproductive.

Any supply disruptions, such as occurred twice in the 1970s, do not cause the customary buyers of the interrupted supply to be without oil while buyers from uninterrupted supplies are unaffected. Instead, worldwide prices shoot up and tankers are re-directed to different refineries around the world until the reduced worldwide supplies are meeting the highest value needs everywhere. The recent excursion of the benchmark petroleum price to $147 was a worldwide phenomenon, and prices of domestically produced oil increased no less than OPEC prices.

The US now uses 20-21 million barrels per day of petroleum. At $70 per barrel, that is about 3.5% of GDP. When the price doubled to $140 this year, it became 7% of GDP, depressed economic activity in the US, Europe, and Asia, and caused large permanent transfers of wealth to exporting nations. If we were consuming only half as much oil, the impact of the price spike would have been only half as large and would probably have been tolerable.

The only effective solution to our real energy insecurity problem is to make our economy generally more energy efficient and specifically to consume less petroleum from all sources. Increasing efficiency of petroleum use will also ameliorate, if not eliminate, our chronic negative balance of trade, reduce our contribution to global climate change, and boost growth industries employing middle class and working class Americans at good wages.

BTW, ordinary citizens can review and comment here on all(?) written materials submitted by interest groups to the Obama transition team. And there is a video of a guy who says all the comments and submitted materials get considered. Hmmm.

Tuesday
Dec022008

Atmospheric CO2 measurements by satellites start next month.

This ought to settle once and for all the question whether ambient CO2 has anthropogenic sources and help monitor changes in CO2 emissions and concentrations as regulatory programs take effect.

In January, the next frontier of atmospheric CO2 measuring instruments will begin when the National Aeronautics and Space Administration launches the first carbon-scanning satellite, called the Orbiting Carbon Observatory.

Each day, the satellite will orbit Earth 15 times, taking nearly 500,000 measurements of the "fingerprint" that CO2 leaves in the air between the satellite and Earth's surface. The data will be used to create a map of CO2 concentrations that will help scientists determine precisely where the sources and sinks are—showing differences in trace gases down to a 1 part per million precision against a background of 380 parts per million CO2 equivalent.

Sunday
Nov302008

Risk management means taking the risks your competitors take.

It is frequently said nowadays that the risk management function in Wall Street firms failed because of lack of accurate and credible information and/or executive incompetence. However, the piece of information that generally overwhelms all other information about the riskiness of an investment is whether competitors are taking the risk. Consider this reflection of completely ordinary business behavior from Rubin's Teflon Finally Wears Off:

Mr. Rubin was deeply involved in a decision in late 2004 and early 2005 to take on more risk to boost flagging profit growth, according to people familiar with the discussions. They say he would comment that Citigroup's competitors were taking more risks, leading to higher profits.

The problem isn't limited to investments, of course. Businesses everywhere are having frequent and agonizing meetings of their credit committees to decide whether to accept, for example, the next order for parts from GM or Acme Widget when they have been refused COD, credit insurance, and factoring. Or whether to ship to a large retailer with disturbing credit scores and rumored to be on the edge of BK. If they don't take the order, the consequences for their business may be dire, permanent loss of the customer, for example. Usually, they will wring their hands and take the risk.

Credible technical information about risk is not enough. There must be prudential regulation to keep financial firms "too big to fail" from following the herd onto dangerous ground. I am much more upset about Rubin's failings as a government official than I am about his performance at Citi. The scandal of the subprime mortgage meltdown is not that a few bad apples committed crimes or deceit but that practically everything that happened was perfectly legal.

Sunday
Nov302008

Who will tell Obama about the flaws in his advisors’ core economic beliefs?

Bob Kuttner reflects on Obama's economic policy challenges and is "a little nervous about who he's listening to." He's referring to Robert Rubin and his protégés, Summers and Geithner, and other gatekeepers who embraced the failed mainstream economics of the last 25 years. Obama correctly says the Administration needs people with actual government experience in key positions, but he also says he wants new ideas. How do impressive heterodox people like Kuttner, who got right what the gatekeepers got wrong, get heard?

Friday
Nov282008

President Washington’s first Thanksgiving Day proclamation. It wasn’t about the harvest.

Whereas it is the duty of all Nations to acknowledge the providence of Almighty God, to obey his will, to be grateful for his benefits, and humbly to implore his protection and favor -- and whereas both Houses of Congress have by their joint Committee requested me "to recommend to the People of the United States a day of public thanksgiving and prayer to be observed by acknowledging with grateful hearts the many signal favors of Almighty God especially by affording them an opportunity peaceably to establish a form of government for their safety and happiness."

Now therefore I do recommend and assign Thursday the 26th day of November next to be devoted by the People of these States to the service of that great and glorious Being, who is the beneficent Author of all the good that was, that is, or that will be -- That we may then all unite in rendering unto him our sincere and humble thanks -- for his kind care and protection of the People of this Country previous to their becoming a Nation -- for the signal and manifold mercies, and the favorable interpositions of his Providence which we experienced in the tranquility, union, and plenty, which we have since enjoyed -- for the peaceable and rational manner, in which we have been enabled to establish constitutions of government for our safety and happiness, and particularly the national One now lately instituted -- for the civil and religious liberty with which we are blessed; and the means we have of acquiring and diffusing useful knowledge; and in general for all the great and various favors which he hath been pleased to confer upon us.

And also that we may then unite in most humbly offering our prayers and supplications to the great Lord and Ruler of Nations and beseech him to pardon our national and other transgressions -- to enable us all, whether in public or private stations, to perform our several and relative duties properly and punctually -- to render our national government a blessing to all the people, by constantly being a Government of wise, just, and constitutional laws, discreetly and faithfully executed and obeyed -- to protect and guide all Sovereigns and Nations (especially such as have shewn kindness onto us) and to bless them with good government, peace, and concord -- To promote the knowledge and practice of true religion and virtue, and the encrease of science among them and us -- and generally to grant unto all Mankind such a degree of temporal prosperity as he alone knows to be best.

Given under my hand at the City of New York
the third day of October in the year of our Lord 1789.

George Washington

(Thanks to Lynda C. for sending this.)

Friday
Nov282008

Lessons from The Great Depression--Part 2

Keynes or Friedman? Monetary policy became an impotent tool, or the Fed caused The Great Depression by not expanding the money supply enough fast enough and rescuing banks? Paul Krugman points out that in the current crisis the Fed and Treasury have been aggressively implementing the Friedman cure, and it isn't working.

I hope Obama's economic policy team can get beyond this academic cat fight, recognize that neither Keynes nor Friedman nor any other economist has the whole "truth" about this, and make some sound pragmatic judgments--and be ready to adjust based on results and changing circumstances. 

Part 1 is here.

Friday
Nov282008

Atlas Shrugged updated for the current financial crisis

Friday
Nov282008

How cartels lose control—Part 3

Free riders. Russia's budget, current account, and exchange rate are all hurting with crude oil prices below $70, and they have to worry that OPEC might keep production high just to discipline Russia for its refusal to share the pain of production cuts. So now Russia says it will "coordinate" with OPEC, but not "collude." Don't you admire Russia's principled stand? FT story here.

Friday
Nov282008

How cartels lose control—Part 2

With petroleum prices lower than probably any OPEC member wants them, $52 this morning, member nations are split between those who want to agree on further production cuts and those who want to have everybody comply with the already-agreed cuts. The difference between the production cuts announced by OPEC and the actual reductions by OPEC members is often considerable and always a source of distrust amongst the members. Because of rampant cupidity and incompetence, nobody trusts official production figures like these.

For example, Venezuela has to adjust its official production figures periodically when the amount of cash coming into the treasury gets out of whack with the volumes claimed by the production people. Consequently, even OPEC members rely on data from third party networks of spies and from the anti-cartel, International Energy Agency. Financial Times has the story here. Part 1 of this n-part series is here.

Thursday
Nov272008

The Financial System: Proudly bringing you disasters since 1720.

The author of The First Crash: Lessons from the South Sea Bubble asks why few if any of the 4000 university professors of finance didn't see the dangers in the recent credit bubble or in the recombination of commercial banks and investment banks into universal banks and financial services firms.

Tuesday
Nov252008

Nobody coulda foreseen the subprime mortgage meltdown—except for a lot a people who blew the whistle years ago.

This is an absolutely riveting account of the inflating subprime bubble told mainly from the perspective of industry insiders who understood there was no there there and bet heavily against these securities and the equities of firms that created, rated, and owned them. It describes how the volume of credit default swaps exploded because they were the "side bets" that allowed speculators to short mortgage backed securities and other collateralized debt obligations at much lower cost than borrowing and shorting the actual securities. Then the sellers of credit insurance packaged and subdivided the swap contracts to mirror the "shorted" securities. Normally the longs hate the shorts, but in this case people who were long on the MBSs and CDOs loved the short sellers because it increased the volume of activity on which they earned large fees while their clients were being walked over a cliff. Not only is the piece informative, it's a fun read by the author of Liar's Poker and has names and dialogs of knaves and fools as well as truth-tellers.

Tuesday
Nov252008

Lessons from The Great Depression

What are top economists saying about what lessons should have been learned from The Great Depression and what we should and should not do now? Mark Thoma has collected and republished diverse views in a forum going on right now here. Not surprisingly, one focus of attention is what Christina Romer (to be head of Obama's Council of Economic Advisors) may think about certain policy options. Something I had not heard before is that in the late 1930s there was a large influx of foreign money into the US as Europeans sought safe investments, and that this was an important stimulus to the US economy before 1942.

Monday
Nov242008

Some of what you wanted to know about the instruments at the heart of the financial crisis

Here is a good explanation of how mortgage backed securities and other collateralized debt obligations work and why the individual tranches can be impossible to value. For example, the value of middle and lower tranches depends not only on default rates and recovery ratios but on whether the defaults occur in a big spike, especially early in the term, or at the same rate throughout the term. Thus, ultimate payouts may depend greatly on whether housing values are at the bottom now or will decline another 15%, whether the current recession in the real economy is nearly over or will get deeper and last a long time, whether adjustable mortgage interest rates go up or down, and on anything else that affects whether large numbers of people will pay their debts or default.

BTW, this explanation was posted in March 2007, so nobody in responsible positions in financial institutions or government should have been surprised by the public emergence of big problems more than year later.