The Magic of Math

The Magic of Math

via The Big Picture de Barry Ritholtz le 13/12/08

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via Dilbert

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Trade protection and growth

Il y a encore des abrutis (l'essentiel peuple les facultés d'économie et la presse anglo-saxonne) pour nier l'efficacité, dans certaines ocnditions, de politiques douanières ou assimilées qui s'éloignent du dogme ricardien. A cela il suffirait de répondre "China, 1978/2008" mais cela ne suffit apparemment pas. Heureusement certains économistes gardent une approche empirique et le résultat est intéressant, quoique assez intuitif.

Trade protection and growth

via Dani Rodrik's weblog de Dani Rodrik le 30/11/08

Ugh, yet again! But the question of whether trade liberalization/protection promotes or retards economic growth is one of those venerable topic of discussion in economics that simply refuses to go away. See for example Ha-Joon Chang's recent op-ed in the FT. One reason is that much of the discussion is driven by pre-conceived ideas (on the efficacy of markets versus governments) instead of actual evidence.

Two recent papers represent a significant advance. One, by Lehmann and O'Rourke focuses on the late 19th century, while the other, by Estevadeordal and Taylor, looks at the last thirty years. The chief contribution of these two papers is that they actually differentiate between different types of tariffs. Lehmann and O'Rourke distinguish between tariffs that protected industry, tariffs that protected agriculture, and tariffs intended to simply raise revenue. Their conclusion:

Industrial tariffs were positively correlated with growth. Agricultural tariffs were negatively correlated with growth, although the relationship was often statistically insignificant at conventional levels. There was no relationship between revenue tariffs and growth.

The sample of countries is a group of mostly developed countries over the period of 1875-1913.

Estevadeordal and Taylor, meanwhile, distinguish among tariffs on capital, intermediate, and consumer goods (plus they use an imaginative identification strategy to alleviate reverse-causation concerns). They find that it is mainly tariffs on capital and intermediate goods that retard growth, while tariffs on consumer goods have a much weaker effect.

Now, the two sets of results are somewhat in tension with each other, and it is not clear whether the differences are due to differences in statistical methods, or to the fact that the late 19th and late 20th centuries were inherently different, with the former being a period in which protection of industrial goods was good for growth while the latter was one where, at best, it was not too damaging.

Regardless of reconciliation, the bottom line is this: what matters is the structure of protection (what is being protected). The answer to the age-old question is one that economists should be accustomed to giving: it depends.

And of course one thing that it depends on is the overall state of the global macro-economy. At a time when the world is digging deeper into recession, exporting your problems through trade protection is the last thing that any responsible country should be doing.

Does globalization erode social safety nets?

Does globalization erode social safety nets?

via Dani Rodrik's weblog de Dani Rodrik le 11/12/08

Economic theory and intuition suggest that as economies become more globalized, the ability of governments to undertake redistributive policies and to engage in social spending erodes. After all, a large part of the tax base--corporations, financial intermediaries, and skilled workers in particular--become internationally mobile and can evade taxes needed to finance those public expenditures.

This is important because historically countries that are more exposed to international trade have actually had larger public sectors, in part to insulate their citizens from shocks originating from abroad. This fact, along with the lack of an obvious decline in the overall tax take in major advanced economies, has led many observers to think that the hypothesized decline of the welfare state has not in fact taken place.

Giuseppe Bertola and Anna Lo Prete have now brought new evidence to bear on this question, and their findings bear out the simple intuition. As they put it, "as technological progress and multilateral trade liberalisation have made borders less of a barrier to economic activity, the scope of redistribution policies has become smaller." Here is the chart that goes along with their result:

Another interesting argument Bertola and Prete make is that private finance seems to have partly filled the whole left by public transfers. The claim is that more developed financial markets are able to supply the insurance and consumption-smoothing provided traditionally by the welfare state in very open economies. They use the share of house prices financed by mortgages as an indicator of financial development.

I am sure this argument made a lot more sense a year ago, when the authors were doing their original research, than it does now. It will take a while until we think of finance, and housing finance in particular, as a source of insurance and stability.

Bertola and Prete are aware of this of course. So they conclude thus:

Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity.

Indeed. Welcome back to the political trilemma of the global economy.

Paul Krugman: The Madoff Economy

Paul Krugman: The Madoff Economy

via Economist's View de Mark Thoma le 19/12/08

The costs of "America's Ponzi Era":

The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I'm not the only person to ask the obvious question: How different, really, is Mr. Madoff's tale from the story of the investment industry as a whole?

The financial services industry has claimed an ever-growing share of the nation's income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it's ... had a corrupting effect on our society as a whole.

Let's start with those paychecks. ... The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.

But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.

Consider the hypothetical example of a money manager who leverages up his clients' money..., then invests the bulked-up total in high-yielding but risky assets... For a while — say, as long as a housing bubble continues to inflate — he (it's almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he'll keep those bonuses.

O.K., maybe my example wasn't hypothetical after all.

So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients' money rather than collecting big fees while exposing investors to risks they didn't understand. ... Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.

We're talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America's G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we're talking about $400 billion a year in waste, fraud and abuse.

But the costs of America's Ponzi era surely went beyond the direct waste of dollars and cents.

At the crudest level, Wall Street's ill-gotten gains corrupted and continue to corrupt politics... Meanwhile, how much has our nation's future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?

Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? ... The answer, I believe, is that there's an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they're doing.

After all, that's why so many people trusted Mr. Madoff.

Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we're looking at now are the consequences of a world gone Madoff.

New York Times Pulls Punches On Wall Street Bubble Era Pay

New York Times Pulls Punches On Wall Street Bubble Era Pay

via naked capitalism de Yves Smith le 18/12/08

Why is no one willing to call things by their proper names, and instead resort to euphemism and double-speak?

A New York Times story today, "On Wall Street, Bonuses, Not Profits, Were Real," makes its most important point in its headline, and managed to get some good data points on how rich investment bank compensation was in the peak years, but otherwise glosses over the fundamental nature of what went on.

It was looting, and it is high time the media starts describing it in those terms.

Let us turn the mike over to Nobel Prize winner George Akerlof and Paul Romer. From the abstract of their 1993 Brookings paper:

Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. These arrangements can create a web of companies that operate under soft budget constraints. To enforce discipline and to limit opportunism by shareholders, governments make continued access to the guarantees contingent on meeting specific targets for an accounting measure of net worth. However, because net worth is typically a small fraction of total assets for the insured institutions (this, after all, is why they demand and receive the government guarantees), bankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values...

Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, causing them to produce in a way that helps maximize the looters' current extractions with no regard for future losses...."

Re-read the key phrase: "pay themselves more than their firms are worth and then default on their debt obligations." This has happened en masse in what formerly were investment banks who have now become wards of the state.

But no one is willing to call this activity for what it was. In fact, some are still urging that we not squelch "financial innovation," which Martin Mayer described as

... a way to find new technology to do what has been forbidden with the old technology....Innovation allows you to go back to some scam that was prohibited under the old regime.

But we digress. Dick Fuld reportedly spends much of his days allegedly wondering why he didn't get a bailout. He should instead be thanking his lucky stars he is not in jail. Bankruptcy fraud is criminal, and fraudulent conveyance is subject to clawbacks. How could Lehman possibly have been producing financials that showed it had a positive net worth, yet have an over $100 billion hole in its balance sheet when it went under? No one has yet given an adequate answer on where the shortfalls were.

Commonwealth countries have a much simpler solution. If a company is "trading insolvent," that is, continuing to do business when it is in fact broke, its directors are personally liable.

We have said repeatedly that one of the triggers for the crisis was permitting investment banks to go public (prior to 1970, no NYSE member firm could be listed). We had dinner with one of our long-standing colleagues who was responsible for Sumitomo Bank's investment in Goldman Sachs and had (and continues to have) close and frequent dealings with the firm. He said that the change in the firm's behavior after it went public was dramatic. Before, it would deliberate (one might say agonize) important business decisions,. Waiting two years to enter a new field was not unheard of. But after the partners cashed in and were playing with other people's money, the firm quickly became aggressive in its use of capital in expanding the size and scope of its activities.

But the New York Times article gives an anodyne portrayal:

As regulators and shareholders sift through the rubble of the financial crisis, questions are being asked about what role lavish bonuses played in the debacle. Scrutiny over pay is intensifying as banks like Merrill prepare to dole out bonuses even after they have had to be propped up with billions of dollars of taxpayers' money. While bonuses are expected to be half of what they were a year ago, some bankers could still collect millions of dollars.

Critics say bonuses never should have been so big in the first place, because they were based on ephemeral earnings. These people contend that Wall Street's pay structure, in which bonuses are based on short-term profits, encouraged employees to act like gamblers at a casino — and let them collect their winnings while the roulette wheel was still spinning...

For Wall Street, much of this decade represented a new Gilded Age. Salaries were merely play money — a pittance compared to bonuses...

While top executives received the biggest bonuses, what is striking is how many employees throughout the ranks took home large paychecks. On Wall Street, the first goal was to make "a buck" — a million dollars. More than 100 people in Merrill's bond unit alone broke the million-dollar mark in 2006. Goldman Sachs paid more than $20 million apiece to more than 50 people that year, according to a person familiar with the matter. Goldman declined to comment.

The bulk of the piece is about Dow Kim, former co-president of Merrill's fixed income business, and does deliver some detail about how Kim and his subordinates were paid. But it fails to delve into how the profits were illusory, the bad decisions made, how the fixed income area in particular lead to the end of Merrill's independence. Perhaps the author, Louise Story, assumed the tale has been well told elsewhere. However one effort to demonstrate the business was on the wrong track, falls woefully short. It discusses a CDO deal that went bad, but fails to establish whether Merrill took losses by virtue of retaining a big interest ("The losses on the investment far exceed the money Merrill collected for putting the deal together" does not clearly say that Merrill, as opposed to investors, suffered. One assumes so, but the drafting is ambiguous).

Even more glaring, the story mentions Merrill's disastrous, end of cycle $1.13 billion acquisition of mortgage originator First Franklin, without mentioning that deal came a cropper (Merrill shut the unit down only a year and a couple of months after it completed the transaction).

Other stories have given some of the sordid details about Merrill's ill fated mortgage expansion (a Wall Street Journal piece, "Merrill Upped Ante as Boom In Mortgage Bonds Fizzled," is one of many examples), Giving short shrift to the staggering level of strategic errors and lax risk oversight means the article fails to pin responsibility clearly for the mess on Kim and his fellow business heads. The article simply assumes the connection, but by talking about the profits without giving sufficient detail on the colossal errors, it makes Kim and his lot seem far more innocent than they really were.

Quantitative Easing

Quantitative Easing

via The Big Picture de Barry Ritholtz le 16/12/08

via Mish

Monkeys Trade Assets I

Monkeys Trade Assets I

via Grasping Reality with Both Hands: The Semi-Daily Journal of Economist Brad DeLong de Brad DeLong le 13/12/08

Virginia Postrel writes:

Pop Psychology: For more than two decades, economists have been running versions of the same experiment. They take a bunch of volunteers, usually undergraduates but sometimes businesspeople or graduate students; divide them into experimental groups of roughly a dozen; give each person money and shares to trade with; and pay dividends of 24 cents at the end of each of 15 rounds, each lasting a few minutes. (Sometimes the 24 cents is a flat amount; more often there's an equal chance of getting 0, 8, 28, or 60 cents, which averages out to 24 cents.) All participants are given the same information, but they can't talk to one another and they interact only through their trading screens. Then the researchers watch what happens.... "The fundamental value is unambiguously defined," says the economist Charles Noussair, a professor at Tilburg University, in the Netherlands, who has run many of these experiments. "It's the expected value of the future dividend stream at any given time": 15 times 24 cents, or $3.60 at the end of the first round; 14 times 24 cents, or $3.36 at the end of the second; $3.12 at the end of the third; and so on down to zero. Participants don't even have to do the math. They can see the total expected dividends on their computer screens....

The trading price should stick close to the expected value. At least that's what economists would have thought before Vernon Smith, who won a 2002 Nobel Prize for developing experimental economics, first ran the test in the mid-1980s. But that's not what happens. Again and again, in experiment after experiment, the trading price runs up way above fundamental value. Then, as the 15th round nears, it crashes. The problem doesn't seem to be that participants are bored and fooling around. The difference between a good trading performance and a bad one is about $80 for a three-hour session, enough to motivate cash-strapped students to do their best....

Experimental bubbles are particularly surprising because in laboratory markets that mimic the production of goods and services, prices rise and fall as economic theory predicts, reaching a neat equilibrium where supply meets demand. But like real-world purchasers of haircuts or refrigerators, buyers in those markets need to know only how much they themselves value the good. If the price is less than the value to you, you buy. If not, you don't, and vice versa for sellers. Financial assets, whether in the lab or the real world, are trickier to judge: Can I flip this security to a buyer who will pay more than I think it's worth?... Based on future dividends, you know for sure that the security's current value is, say, $3.12. But—here's the wrinkle—you don't know that I'm as savvy as you are. Maybe I'm confused. Even if I'm not, you don't know whether I know that you know it's worth $3.12. Besides, as long as a clueless greater fool who might pay $3.50 is out there, we smart people may decide to pay $3.25 in the hope of making a profit.... Noussair... "if you put people in asset markets, the first thing they do is not try to figure out the fundamental value. They try to buy low and sell high." That speculation creates a bubble.

In fact, the people who make the most money in these experiments aren't the ones who stick to fundamentals. They're the speculators who buy a lot at the beginning and sell midway through, taking advantage of "momentum traders" who jump in when the market is going up, don't sell until it's going down, and wind up with the least money at the end. ("I have a lot of relatives and friends who are momentum traders," comments Noussair.) Bubbles start to pop when the momentum traders run out of money and can no longer push prices up...

"The Rising Tide Tax System"

En particulier pour le concept, cité à la fin, de "equal marginal sacrifice", qui est une justification moralement intéressante de la progressivité de l'impôt

"The Rising Tide Tax System"

via Economist's View de Mark Thoma le 14/12/08

This is one of the entries in the NY Times Magazine's annual Year in Ideas:

The Rising-Tide Tax System, by Stephen Mihm, NY Times: In the last 20-plus years, overall economic growth in the United States has come at a cost: rising income inequality, which in the past few years has hit levels not seen since the late 1920s. A more progressive income tax, introduced during the New Deal, helped mitigate the problem, and it remains a likely prescription today. Yet a team of economists that includes Robert Shiller of Yale University and Leonard Burman of the Tax Policy Center recently released a paper in which they propose another way of "spreading the wealth"...

Under the proposal, the tax code would automatically be rewritten at the end of each year to reflect any changes in the relative share of national income earned by each income bracket. For example, if one year the nation's top earners saw their share of national income rise while people at the bottom saw their share grow at a slower rate (or decline), the following year's tax rates would be automatically rewritten to compensate for the new inequality. This would keep everyone's share of after-tax income at the earlier level.

The ... proposal would work both ways: if the rich saw their share of the nation's income grow more slowly relative to people lower down the economic ladder, the tax system would become less progressive...

The name of the proposal — the Rising-Tide Tax System — is an allusion to John F. Kennedy's claim in 1962 that "a rising tide lifts all boats," a promise that general economic growth would benefit all members of society. Shiller argues that it's still possible to turn Kennedy's vision into a reality. "It's something we can engineer," he says.

This has attractive properties, and it may help us to avoid the concentration of bubble-inducing excess liquidity in the hands of relatively few people, but how do we know which baseline level of inequality to target?

Also, this approach leads to the idea that the only reason for progressive taxation is redistribution, but that's not the case. Concepts such as equal marginal sacrifice can be used to support a progressive structure, so even if there is no redistribution at all we may still want to have progressive taxes. Thus, before we can use this approach we'd have to decide (at least) two things - what is the level of inequality we are targeting, and what is the base level of progressiveness that we use. For example, if there is no change in inequality from previous years, does that mean taxes should be flat?

Regression to the Mean

Regression to the Mean

via The Big Picture de Barry Ritholtz le 10/12/08

Another interesting chart from Doug Short over at dshort.com
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Here's Doug's commentary:
http://dshort.com/articles/regression-to-the-mean.html

Corporate Logos Remixed for Crisis

Corporate Logos Remixed for Crisis

via The Big Picture de Barry Ritholtz le 10/12/08

Here's a few favorites from Business Pundit:

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There's some more at the link below . . .

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Source:
After The Crisis: A Parody of 15 Corporate Logos
Ryan
Business Pundit December 9, 2008
http://www.businesspundit.com/after-the-crisis-a-parody-of-15-corporate-logos/

Dec. 3, 1984: Bhopal, 'Worst Industrial Accident in History'

Dec. 3, 1984: Bhopal, 'Worst Industrial Accident in History'

via Wired Top Stories de Tony Long le 02/12/08

1984: Poison gas leaks from a Union Carbide pesticide factory in Bhopal, India. It spreads throughout the city, killing thousands of people outright and thousands more subsequently in a disaster often described as the worst industrial accident in history.

Union Carbide chose Bhopal, a city of 900,000 people in the state of Madhya Pradesh, because of its central location and its proximity to a lake and to the country's vast rail system.

The plant opened in 1969 and produced the pesticide carbaryl, which was marketed as Sevin. Ten years later the plant began manufacturing methyl isocyanate, or MIC, a cheaper but more toxic substance used in the making of pesticides.

It was MIC gas that was released when water leaked into one of the storage tanks late on the night of Dec. 2, setting off the disaster. Gas began escaping from Tank 610 around 10:30 p.m. although the main warning siren didn't go off for another two hours.

The first effects were felt almost immediately in the vicinity of the plant. As the gas cloud spread into Bhopal proper, residents were awakened to a blinding, vomiting, lung-searing hell. Panic ensued and hundreds of people died in the chaotic stampede that followed.

An exact death toll has never been established. Union Carbide, not surprisingly, set the toll on the low end at 3,800, while municipal workers claimed to have cleared at least 15,000 bodies in the immediate aftermath of the accident. Thousands have died since and an estimated 50,000 people became invalids or developed chronic respiratory conditions as a result of being poisoned.

Regardless of the numbers, all evidence pointed to Union Carbide and its Indian subsidiary, as well as the Indian government, its partner in the factory, being responsible, mainly through negligence, for what occurred. Despite the extreme volatility and toxicity of the chemicals in use at the factory, safeguards known to be substandard were ignored rather than fixed.

In the subsequent investigations and legal proceedings, it was determined, among other things, that:

• Staffing at the plant had been cut to save money. Workers who complained about codified safety violations were reprimanded, and occasionally fired.

• No plan existed for coping with a disaster of this magnitude.

• Tank alarms that would have alerted personnel to the leak hadn't functioned for at least four years.

• Other backup systems were either not functioning or nonexistent.

• The plant was equipped with a single back-up system, unlike the four-stage system typically found in American plants.

• Tank 610 held 42 tons of MIC, well above the prescribed capacity. (It is believed that 27 tons escaped in the leak.)

• Water sprays designed to dilute escaping gas were poorly installed and proved ineffective.

• Damage known to exist, such as to piping and valves, had not been repaired or replaced because the cost was considered too high. Warnings from U.S. and Indian experts about other shortcomings at the plant were similarly ignored.

The aftermath of the disaster was almost as chaotic. Union Carbide was initially responsive, rushing aid and money to Bhopal. Nevertheless, faced with a $3 billion lawsuit, the company dug in, eventually agreeing to a $470 million settlement, a mere 15 percent of the original claim. In any case, very little money ever reached the victims of the disaster.

Warren Anderson, Union Carbide's CEO, went before Congress in December 1984, pledging his company's renewed commitment to safety, a promise that rang hollow in India (and probably to Congress as well).

Anderson was subsequently charged with manslaughter by Indian prosecutors but managed to evade an international arrest warrant and disappeared. Investigators from Greenpeace, which has kept up an active interest in the case, found Anderson in 2002, alive and well and living comfortably in the Hamptons. The United States has shown no inclination to hand him over to Indian justice, and most of the serious charges against him have been dropped.

Union Carbide, meanwhile, was acquired by the Dow Corporation in 2001, which refused to assume any additional liability for Bhopal, arguing that the debt had already been paid through various court settlements. It did go on to settle another outstanding claim against Union Carbide, this one for $2.2 billion made by asbestos workers in Texas.

A few outstanding legal claims from Bhopal remain to be settled, both in India and the United States, but most of the court wrangling is over.

The victims of the disaster, those who live on, continue dealing with various health problems — including chronic respiratory problems, vision problems and an increased incidence of cancer and birth defects — and an environment that remains contaminated to this day.

Source: Various

Felix Salmon sur les banquiers

arf arf
Une des grandes blagues de l'actualité récente est l'effort pitoyable que font les banques et leurs séides dans la presse pour justifier les rémunérations délirantes propres à cette industrie. felix Salmon a quelques remarques intéressantes à faire sur le sujet...

Finance Salaries: A Reply

via Portfolio.com: Market Movers de Felix Salmon le 02/12/08

Free Exchange responds to my declaration that finance-sector salaries should be slashed:

The problem, however, is with self-selection. The most talented people in finance would be the ones to go. Even in the worst labour market talent is in demand. Workers may go abroad, where finance jobs still pay well, or into another industry. The finance industry will be left with a less-skilled labour force, which will lead to an unambiguous decline in performance.

First, finance jobs don't pay more abroad than they do in the US. There's always a hot emerging market somewhere where a few lucky bankers are making millions, but they're the exception. Most countries' finance industries are more like Japan, where bankers make a fraction of the going rate in New York or London. (And no, there aren't many jobs in London.)

As for other industries, they pay much less than finance, as a rule. And although bankers flatter themselves that they're so smart they could work anywhere, that's really not the case: the skills needed to run a trading desk don't translate well to a widget manufacturer.

But most importantly, we simply don't know whether a less-skilled labour force would "lead to an unambiguous decline in performance". Especially considering the decline in performance we've seen with today's, ahem, highly-skilled labor force. The "dumb" banks -- the ones which just took in deposits and underwrote loans -- have massively outperformed the smart banks, after all.

The Economist's blogger continues:

It is hard to justify the kind of money Vikram Pandit got as he presided over Citibank this past year. But why else would you become the face and shoulder the responsibility of such an embattled bank, many of whose problems predated your tenure?

I don't buy it. "Vikram, do you want to be CEO?" "How much are you paying?" "$10 million." "Not enough." "$20 million?" "OK, I'll do it." It doesn't work like that. People accept high-profile CEO jobs for lots of reasons, and they decline them for lots of reasons as well. But they don't decline them because they aren't paying enough.

The blogger does concede that she "wondered if salaries in other fields, such as engineering, might not include positive externalities and if high finance salaries therefore constituted a labour market failure". The answer is yes: it's very difficult to come up with a model which explains why financial-sector salaries are so high, given the demand for the jobs in question. But she quickly moves on: "other industries cannot thrive without a burgeoning financial industry", she says. Oh yes they can, very much so. Look at the thriving industries in the BRIC countries: are they built on a burgeoning financial industry? Not at all. And I don't think that Google, say, has relied much on financial technology to get to where it is today.

In fact it's simply not true that the finance industry needs to burgeon (ie, grow) in order for other industries to do well. The finance industry can and should be a modest intermediary, adding a little bit of value here and there, but not always growing so that it takes up an ever-larger proportion of GDP. Right now, few people would disagree that the finance industry, in toto, needs to shrink. That's not "hobbling" it, as Free Exchange would have it. Maybe "optimizing" is a better word. Let's have fewer bankers, making less money. And put all that skilled labor to more productive use.

Sad News: Tanta Passes Away

Tanta et le blog calculated Risk ont été, depuis avant le début de la crise, un exemple accompli de ce que le blog pouvait apporter en termes de qualité d'information et d'analyse, particulièrement dans un contexte où les médias traditionnels avaient totalement failli à leur mission. Sa disparition est une triste nouvelle.

Sad News: Tanta Passes Away

via Calculated Risk de CalculatedRisk le 30/11/08

My dear friend and co-blogger Doris "Tanta" Dungey passed away early this morning. I would like to express my deepest condolences to her family and friends. Photo: Tanta in 2004 (from her sister Cathy).

From David Streitfeld at the NY Times: Doris Dungey, Prescient Finance Blogger, Dies at 47

The blogger Tanta, an influential voice on the mortgage collapse, died Sunday morning in Columbus, Ohio.

Tanta, who wrote for Calculated Risk, a finance and economics blog, was a pseudonym for Doris Dungey, 47, who until recently had lived in Upper Marlboro, Md. The cause of death was ovarian cancer, her sister, Cathy Stickelmaier, said.
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Tanta used her extensive knowledge of the loan industry to comment, castigate and above all instruct. Her fans ranged from the Nobel laureate Paul Krugman, an Op-Ed columnist for The New York Times who cited her in his blog, to analysts at the Federal Reserve, who cited her in a paper on "Understanding the Securitization of Subprime Mortgage Credit."

She wrote under a pseudonym because she hoped some day to go back to work in the mortgage industry, and the increasing renown of Tanta in that world might have precluded that. Tanta was Ms. Dungey's longtime family nickname, Ms. Stickelmaier said.

From CR to Tanta's many readers, fans and internet friends: Tanta enjoyed writing for you, chatting with many of you in the comments, and corresponding with you via email. She told me several times over the last few months how much she enjoyed discussing current events with you.

Tanta worked as a mortgage banker for 20 years, and we started chatting in early 2005 about the housing bubble and the changes in lending practices. In 2006, Tanta was diagnosed with late stage cancer, and she took an extended medical leave while undergoing treatment. At that time I approached her about writing for this blog, and she declined for a simple reason – her prognosis was grim and she didn't expect to live very long. To her surprise, after aggressive treatment, her health started to improve and she accepted my invitation. When she chose an email address, it reflected her surprise: tanta_vive ... Tanta Lives!

Armed with a literary background and extensive knowledge of the mortgage industry, Tanta wrote about current events with deep insight and wit. Here is the introduction to one of her posts in 2006: Let Slip the Dogs of Hell

I still haven't gotten over the fact that there's a "capital management" group out there having named itself "Cerberus". Those of you who were not asleep in Miss Buttkicker's Intro to Western Civ will recognize Cerberus; the rest of you may have picked up the mythological fix from its reprise as "Fluffy" in the first Harry Potter novel. Wherever you get your culture, Cerberus is the three-headed dog who guards the gates of Hell. It takes three heads to do that of course, because it's never clear, in theology or finance, whether the idea is to keep the righteous from falling into the pit or the demons from escaping out of it (the third head is busy meeting with the regulators).

Tanta wrote a number of posts detailing the inner workings of the mortgage industry. These posts covered a wide range of topics, from mortgage servicing, to everything you want to know about mortgage backed securities (MBS), to reverse mortgages. She called these posts "The Compleat UberNerd" and in typical fashion she noted:

An "UberNerd" is someone who is compelled to understand how things work in grim detail, even if the things in question are tedious in the extreme …"

Tanta liked to ferret out the details. She was inquisitive and had a passion for getting the story right. Sometimes she wouldn't post for a few days, not because she wasn't feeling well, but because she was reading through volumes of court rulings, or industry data, to get the facts correct. She respected her readers, and people noticed.

Felix Salmon at Condé Nast Portfolio.com, wrote on Nov 7, 2007 wrote:

"Tanta is one of the best financial writers in the world, and explains complex ideas with wit and great clarity."

Paul Krugman at the NY Times complemented Tanta several times, recently writing:

"The great thing about this age of blogs is the way people who really know something about a subject can quickly weigh in, without being filtered through Authority."

Even researchers at the Federal Reserve referenced Tanta's work: From Adam Ashcraft and Til Schuermann: Understanding the Securitization of Subprime Mortgage Credit, credit on page 13:

Several point raised in this section were first raised in a 20 February 2007 post on the blog http://calculatedrisk.blogspot.com/ entitled "Mortgage Servicing for Ubernerds."

Tanta was also extremely funny. She introduced the Muddled Metaphor Index (MMI) and Excel Art featuring the Mortgage Pig, and she was the originator of a number of phrases in use today, like "We're all subprime now!"

This is a very sad day and I know many of you are in shock. Tanta was our teacher. She generously shared her knowledge with all of us. I doubt she knew how many lives she touched; her insights, spirit and passion lives on in her writings – and in all of you.

Tanta Vive!

P.S. please post or email me your thoughts and remembrances, and I'll post some of them. Please no tips - I'll post a charity of Tanta's choice soon. All my best to everyone on this very difficult day.

Sur le rôle de Big Pharma dans le marketing des médicaments inefficaces

NYT Has Good Piece on Drug Trials

via Beat the Press le 27/11/08

The NYT reported on a study showing that cheap diuretics were more effective than expensive patent protected drugs in combating hypertension. The article reports on the drug industry's efforts to limit the impact of the study.

--Dean Baker

If you only read one thing on China this fall …

Encore une superbe analyse de la situation chinoise (un peu en contradiction avec la précédente). Le point 1 est essentiel, et confirme que le rôle de la Chine dans les échanges mondiaux pose un problème différent de celui que posèrent, en leur temps, le Japon et les dragons asiatiques : la nature particulière du système totalitaire chinois empêche le marché de faire son travail, et de laisser s'apprécier progressivement le pouvoir d'achat des travailleurs. Cela maintient artificiellement bas les coûts de production, et rend caduques les analyses classiques en faveur d'échanges libres avec la Chine.

Bien sûr, les apologues d'un libre échange sans limite ou contrôle avec la Chine appartiennent à la même caste d'imbéciles qui nous vantaient il y a peu les mérites du marché dans la régulation du système financier. Quand cette bande de crétins reconnaîtra enfin son erreur, il reste à espérer que l'industrie des pays occidentaux sera en meilleur état que leur système financier aujourd'hui...

If you only read one thing on China this fall …

via Brad Setser: Follow the Money de bsetser le 26/11/08

Make sure it is the latest World Bank China Quarterly.

David Dollar, Louis Kuijs and their colleagues have outdone themselves – and in the process provided a clear assessment of the sources of China's current slowdown and the risks that lie ahead. I won't try to summarize the entire report. Read it. The whole thing. No summary can do it justice.

Here though are seven points that jumped out at me.

1. China was no workers' paradise during the boom years.

GDP growth has been quite strong. But wages have fallen from around 50% of China's GDP at the start of the decade to around 40% of GDP. That – not a high rate of household savings – is the main reason why consumption is a very low share of GDP (See Figure 15 of the World Bank Quarterly). If China's workers had secured a bigger share of China's output, they could be better off now even if China had grown somewhat less rapidly. There is good reason to think that a world where China subsidies US borrowing (and consumption) isn't the best of all possible worlds. The fruits of the recent boom weren't shared broadly in either the capital-exporting countries or the capital-importing countries.

2. China really is a manufacturing and investment driven economy.

Even when compared to Korea in 1990 or Japan in 1980, China stands out. Investment accounts for a large share of GDP than it ever did for the smaller Asian miracles and manufacturing accounts for a higher share of China's GDP than it ever did in other Asian manufacturing economies (Figure 14). Given China's size, it is pretty clear that China cannot continue to grow by investing ever more and manufacturing ever more. China ultimately has to produce for Chinese demand not world demand.

3. China's current slowdown was made in China, not in the world.

Yes, growth in "light manufacturing" (toys, shoes and textiles) has slowed. But electronics and machinery exports are still doing very well – even if they don't get the press (Figure 3). Or perhaps I should say were still doing well in the third quarter; must has changed recently. China' problem this year is simple: labor intensive export sectors have slowed more than capital intensive export sectors. Overall though China's real exports grew at a 10-15% y/y clip in 08 – far faster than the overall growth in world imports. China's real export growth is forecast to outpace its real import growth in 2008 – which implies that net exports will still contribute positive to China's GDP growth. True, the net exports won't provide as much of a positive contribution as in 07, 06 or 05. But they are still adding to growth not subtracting from it.

Why then is China slowing so sharply? Simple, real estate investment has hit a wall. After growing at 20% y/y for a long time, real estate investment stalled – with a y/y growth rate of around 0% (Figure 5). That means that China is in turn producing more steel and cement than it needs, and producers of steel and cement are cutting back. That in turns hurts iron ore exporters …

This though is very much a result of China's own policy choices. Rather than allowing the real exchange rate to appreciate back when China was truly booming (05-late 07/ early 08), China's policy makers opted to rely on administrative curbs on credit growth. That left China more exposed to global slump in demand – as it kept exports up by limiting real appreciation even as it credit curbs limited the amount of froth in the real estate market back when China was booming and real interest rates were negative. China invested a lot in real estate, but it is no Dubai. But China's policy makers still look to have slammed the brakes on a bit too hard. Rather than slowing gradually, real estate investment fell off a cliff (Figure 5).

4. There is more bad news ahead.

While real exports contributed positive to GDP growth in 2008, they won't contribute in 09. The World Bank forecasts that for the first time in a long time, 2009 real import growth will exceed real export growth. In 2005, real exports grew about 10% faster than real imports (23.6% v 13.4%). Many economists remain – for reasons that to be honest elude me – reluctant to draw the obvious connection: the most likely explanation for China's strong real export growth is the large depreciation the RMB in 2003 and 2004. That combined with administrative controls – which limited lending, investment and ultimately imports – to create China's large current account surplus. Real export growth exceeded real import growth by 5 percentage points in 2006 and 2007 – and by 4 percentage points in 2008.

The positive contribution of net exports to GDP is forecast to end in 2009: real import growth will exceed real export growth by 3 percentage points.

That though doesn't mean that China's currency isn't undervalued. China's exports are forecast to grow faster than the world's imports, meaning China's global market share is still increasing (see Figure 2). And if 2008 and 2009 are taken together, China will still be drawing on the world for its growth: the drag from net exports in 09 will be smaller than the contribution from net exports in 08 (see Table 1)

I fully realize that China is appreciating quite significantly now in real terms – just global demand for China's goods is falling (Figure 11). The tragedy is that this appreciation is coming now – not two or three years ago when domestic Chinese demand was booming and China didn't need to draw on the rest of the world to sustain strong growth.

5. The fiscal stimulus is real, but modest. China's fiscal balance is expected to swing from a 0.7% of GDP surplus in 07 to a 2.6% of GDP deficit in 09. That is a 3.3% of GDP swing. In 2009 alone, China's deficit is forecast to rise by 2.2% of GDP. See Table 1. That shift is important and will help to support China's growth– but it will likely lag the swing in the US fiscal deficit. Hopes that surplus countries will end doing more than deficit countries seem unlikely to be ratified.

6. The last thing anyone needs to worry about is fall in Chinese demand for US treasuries.

The Treasury market obviously isn't worried - not it 10 year Treasury yields are under 3%. And there is little reason for the bond market to be worried if current trends continue.

The World Bank forecasts that China's current account surplus will RISE not fall in 2009, going from an estimated $385 billion to $425 billion. How is that possible if real imports are forecast to grow faster than real exports? Easy – the terms of trade moved in China's favor. The price of the raw materials China imports will fall faster than the value of China's exports. China's oil and iron bill will fall dramatically.

In macroeconomic terms, China's fiscal stimulus will offset a fall in domestic investment leaving China's current account (i.e. savings) surplus unchanged. The 2009 surplus is expected to be roughly the same share of China's GDP (9%) as the 2008 surplus.

In dollar terms, the World Bank forecasts that China will add almost as much to its reserves in 2009 than in 2008. That is a bit misleading: the 2008 reserve growth number leaves out the funds shifted to the CIC (ballpark, $100b in 08) and the rise in the foreign exchange reserve requirement of the state banks (ballpark, another $100b). But it captures a basis truth. Even if a fall in hot money inflows means that China will be adding $500b rather than $700b to its foreign assets, its foreign assets will still be growing incredibly rapidly. China already has – counting its hidden reserves – well over a $2 trillion. It is now rapidly heading for $3 trillion.

In broad terms – if oil stays at its current levels – China will be the only large surplus country in the world, and it will essentially be financing a US deficit of roughly equal magnitude to China's reserve growth. It makes everything plain to see.

7. The way China manages its reserves matters immensely for the world not just China

China shifted from buying Agencies to buying Treasuries in July. Others did too, but no one has quite the market impact of China. China doesn't disclose what it is doing with its reserves, but the recent shift in Chinese demand isn't really in doubt. The market knows it. The TIC data for August showed it. And the latest Fed data strongly suggest large ongoing migration from Agencies to Treasuries.

China now accounts for such a large share of the world's reserves that it is hard to see how the FRBNY's custodial data doesn't reflect, at least in part, a shift in Chinese demand.

A key themes of this blog has been how the internal imbalances of China's economy are a reflection of its undervalued exchange rate – and that China's surplus has implications for the world. It has to be balanced by large deficits elsewhere. Another key theme has been that the Fed has been pushed to absorb risks that other central bank reserve managers now shun. Nothing illustrates this more clearly than the Agencies. Foreign central banks are scaling back their Agency holdings. The Fed is gearing up to buy. Big Time.

One last note: I am taking a few days off for Thanksgiving – I'll be posting again next week.

China's Economic Slowdown Accelerated in November

Une analyse intéressante sur la situation de la Chine

China's Economic Slowdown Accelerated in November

via naked capitalism de Yves Smith le 26/11/08

Even though the markets took cheer from China's rate cut today, the move appears to be in response to an intensification of its economic woes. From Bloomberg:

Some economic indicators in China showed a "faster decline" in November, the nation's top economic planner said, underlining the urgency of government measures to support growth and employment.

"Some economic indicators weakened further in November, showing a faster decline," Zhang Ping, chairman of the National Development and Reform Commission, told a briefing in Beijing today. "Employment is being impacted by factory closures and many migrant workers are returning to their home towns."

The central bank yesterday cut borrowing costs by the most in over a decade to encourage lending and ease the financial burden on thousands of companies that are laying off workers as they struggle to cope with falling orders. Premier Wen Jiabao wants consumers at home to spend more to offset the impact of slowing demand from overseas and prevent unemployment spiraling.

The government will take more measures to boost domestic consumption and bolster growth, the commission, the nation's top economic planning agency, said in a statement yesterday. Farmers' incomes must be raised and small businesses facing difficulties must be helped, the statement said.

Reader Michael forwarded a piece from Newsweek that provides a grim forecast for China:

Notwithstanding all the hoopla about the rise of China's billion consumers, the body blow that's now landing in the industrial heartland will debunk the notion that China has already begun transitioning toward a new growth model based less on exports and investment and more on household consumption. "We would love to believe it too, but it just ain't so," wrote Standard Chartered bank's highly respected China economist, Stephen Green, last month. He says expecting Chinese spending to save the world from recession is "a pipe dream."

With China at the vanguard, Asia as a whole stands dangerously exposed to external shock. Since the late 1990s, household consumption as a share of China's GDP has fallen from roughly half to 35 percent. On the flip side, the share of Asia ex-Japan's output devoted to exports is now more than 45 percent, or roughly 10 points higher than it was on the eve of the 1997–98 Asian financial crisis...."We are where we are because of massive imbalances that policymakers and politicians have allowed to build up over the last decade," argues Stephen Roach, chairman of Morgan Stanley Asia. "Those imbalances were never sustainable, but the longer they went on the more they seduced people. And now we're paying the ultimate price for that seduction."...

China's rebalancing act is actually much tougher than America's...in China, where total household consumption is just 5 percent of America's by value, the challenge is to sustain an economy that's largely investment- and export-driven, which means finding ways to perpetuate industrial overproduction. Michael Pettis, a professor of finance at Peking University, says America found itself in the same bind back in 1929. "The U.S. in the 1920s ran a huge trade surplus and had the largest reserves in history to that point," he says. "So was the U.S. immune to the global crisis? No. It was the country that suffered the most. In that sense it is exactly like China today."

Beijing realizes the growth trap it's in. Why else would it unveil on Nov. 10 a $590 billion stimulus plan—a package nearly as large as Washington's $700 billion financial bailout—just days after it announced that China's economy expanded by 9 percent in the July–September quarter?...

Beijing's stimulus plan has won plaudits internationally not least because it indicates that Chinese leaders won't stand idly by as the crisis deepens....

America's self-defeating mistake was to cut off world trade, particularly in the Smoot-Hawley Tariff Act.... the mistake Beijing must avoid is moving too hard to sell more manufactured exports at the risk of flooding an already weak market, and triggering a protectionist backlash.....

The doubts about China's stimulus plan arise in part because it's all broad strokes with no fine print..... Economists estimate that only a quarter of the $590 billion is new money as opposed to previously announced spending, future tax cuts and unfunded mandates passed down to local governments. There's reason to expect that much of the promised social spending—and the consumer empowerment it represents—may not materialize. One warning signal is that Beijing has entrusted much of the safety net stuff to the provinces, which historically have put a low priority on building schools, unless the order to do so comes with earmarked funding from Beijing...

To understand the linkage between social services and household consumption, visit a Chinese hospital. At check-in, patients are required to deposit money up-front, and when that funding runs dry they're tossed out onto the street....Likewise, poor kids can't attend school without paying fees, and most migrants are uninsured against job-site accidents at any price. Families cope by saving an estimated 25 percent of their disposable income, just in case....

The prescription for change has been obvious since the late 1990s. It includes balanced growth between booming east and lagging west; efforts to narrow the yawning income gap between China's superrich and everyone else; and policies that channel the massive earnings logged by the state-owned conglomerates that dominate China Inc. back into government coffers to fund social spending. Yet campaigns with names like Go West meant to spur investment in the hinterland never amounted to more than propaganda exercises, and a long-mulled plan for the government to charge state companies dividend on their huge profits remains a small-scale experiment. In October, Standard Chartered noted a "gulf between aspirations and actual policies" illustrated by Beijing's long-standing bias toward investment and exports, and support for "state-protected oligopolies." Pettis argues that Beijing's persistent mercantilism has prepared it for the wrong crisis—specifically, an external debt shock akin to the one that ravaged Asia in 1997-98, against which China's huge savings and foreign reserve pools would make it "superbly protected." Yet as with America in 1929, China is the nation most exposed in the world to a collapse in global demand today.

As such, Beijing finds itself in a fix as 2008 winds to an ignominious close. Export promotion offers a viable short-term means of keeping the factories of China running—yet grabbing more market share amid a global downturn is the surest way to incite protectionism. During the recent gathering of G20 leaders in Washington, much public emphasis was placed on shoring up the global financial architecture and defending free trade. Yet former New Zealand prime minister Mike Moore, who headed the World Trade Organization from 1999 to 2002, believes the backroom talks focused on the imperative that Asia not try to export its way out of today's crisis. It was "the elephant in the room; how China, and to a lesser extent India and the Southeast Asians, must become consuming countries," he says. "It's overwhelmingly in [their] interest to become a lot less reliant on exports, and it also does right by the people they represent. Not to do it could trigger something that's very, very unpleasant." Global trade slumped 70 percent in the 1930s, and any return to the virulent economic nationalism of that era "would turn crisis into catastrophe," warns Moore.

That presents Beijing with a leadership challenge very different from the one it confronted with tanks and soldiers in 1989. Today, it must work to maintain enough harmony in the global trade arena so as not to lose access to vital overseas markets, while telling the Chinese people that fast growth isn't their birthright. In essence, Beijing must offer a new social contract in which consumption bolstered with a social safety net replaces the export-driven growth engine that has powered China's economy for 30 years. FDR did that in America in the 1930s, but it took a decade. Might China's leaders fare any better? In the late 1990s, then Premier Zhu Rongji refrained from devaluing China's currency when many of its neighbors did so; the decision lost China some export momentum but gained its leadership a reputation for responsible global action. Today's leaders have maintained that reputation, but given the enormity of the economic challenges at hand, the only safe bet is that their helmsmanship will be tested to the extreme in 2009. Especially if the pessimists are correct and China's economy grinds to a halt.

The Citigroup Bailout

le sauvetage de citi (ou son effondrement final) restera sans doute dans le mémoires. Autant commencer à conserver des notes sur le sujet. A ajouter dans le chapitre "je suis content de ne pas être un contribuable américain"

The Citigroup Bailout

via Economist's View de Mark Thoma le 24/11/08

It's bailout time. Let's start with Paul Kedrosky:

Good Bank, Bad Bank, and F---ed Bank: Apparently Citibank and the U.S. government (i.e., we taxpayers) have reached a deal whereby we will backstop something like $300-billion in screwed assets on Citi's balance sheet. ... Here is the gist:

• Citi will carve out $300-billion in troubled assets, which will remain on its balance sheet
  • The first $37-$40-billion in losses on those assets will go to Citi
  • The next $5-billion in losses will hit Treasury
  • The next $10-billion in losses will go to the FDIC
  • Any more losses will go to the Fed
• There will be no management changes at Citi, because, you know, they are all fine and upstanding people who have done nothing wrong
• There will be some compensation limitations, but those have not yet been made clear

To be clear, this is not a "bad bank" model. Assets are not, apparently, being taken off the Citi balance sheet and put into another entity walled off from the Citi biological host. Instead, they are being left on the Citi balance sheet, but tagged and bagged for eventual disposal via taxpayers. ...

I'll have more when there is more, and I know the equity futures markets like it -- it's admittedly less terrifying that letting Citi fail -- but so far I'm not impressed. ...

Yves Smith:

WSJ: US Agrees to Bail Out Citi (Updated): ...Note key element of the deal is that the Federal government will guarantee $300 billion of Citi assets, a much bigger number than had been leaked earlier, with a rather convoluted loss-sharing arrangement, but the bottom line is that Citi is at risk for at most $40 billion. Citi also gets a $20 billion equity injection, on slightly more onerous terms than the initial TARP investments, but still more favorable than Warren Buffett's investment in Goldman. Oh, and it appears there will be NO management changes.

I do not see how GM can be denied a rescue now (not that that outcome is really in doubt, merely how much pain will be inflicted on management and the UAW). ...

Update 12:50 AM: Bloomberg's story puts the bad asset program slightly higher, at $306 billion. ...

Calculated Risk has the Joint Statement by Treasury, Federal Reserve, and the FDIC on Citigroup, while James Kwak says the bailout is "Weak, Arbitrary, Incomprehensible." I think he has it right:

Citigroup Bailout: Weak, Arbitrary, Incomprehensible: According to the Wall Street Journal, the deal is done. Here are the terms. In short: (a) Citi gets another $27 billion on the same terms as the first $25 billion, except that the interest rate is now 8% instead of 5%, and there is a cap on dividends of $0.01 per share per quarter; and (b) the government (Treasury, FDIC, Fed) agrees to absorb 90% of losses above $29 billion on a $306 billion slice of Citi's assets, made up of residential and commercial mortgage-backed securities. (If triggered, some of that guarantee will be provided as a loan from the Fed.) There is also a warrant to buy up to $2.7 billion worth of common stock (I presume) at a staggeringly silly price of $10.61 per share (Citi closed at $3.77 on Friday).

The government (should have) had two goals for this bailout. First, since everyone assumes Citi is too big to fail, the bailout had to be big enough that it would settle the matter once and for all. Second, it had to define a standard set of terms that other banks could rely on and, more importantly, the market could rely on being there for other banks. This plan fails on both counts.

The arithmetic on this deal doesn't seem to work for me (feel free to help me out). Citi has over $2 trillion in assets and several hundred billions of dollars in off-balance sheet liabilities. $27 billion is a drop in the bucket. Friedman Billings Ramsey last week estimated that Citi needed $160 billion in new capital. (I'm not sure I agree with the exact number, but that's the ballpark.) Yes, there is a guarantee on $306 billion in assets (which will not get triggered until that $27 billion is wiped out), but that leaves another $2 trillion in other assets, many of which are not looking particularly healthy. If I'm an investor, I'm thinking that Citi is going to have to come back again for more money.

In addition, the plan is arbitrary and cannot possibly set an expectation for future deals. In particular, by saying that the government will back some of Citi's assets but not others, it doesn't even establish a principle that can be followed in future bailouts. In effect, the message to the market was and has been: "We will protect some (unnamed) large banks from failing, but we won't tell you how and we'll decide at the last minute.)" As long as that's the message, investors will continue to worry about all U.S. banks.

The third goal should have been getting a good deal for the U.S. taxpayer, but instead Citi got the same generous terms as the original recapitalization. 8% is still less than the 10% Buffett got from Goldman; a cap on dividends is a nice touch but shouldn't affect the value of equity any. By refusing to ask for convertible shares, the government achieved its goal of not diluting shareholders and limiting its influence over the bank. And an exercise price of $10.61 for the warrants? It is justified as the average closing price for the preceding 20 days, but basically that amounts to substituting what people really would like to believe the stock is worth for what it really is worth ($3.77).

How does this kind of thing happen? A weekend is really just not that much time to work out a deal. Maybe next time Treasury and the Fed should have a plan before going into the weekend?

What, and ruin a perfect record? Robert Reich:

Citigroup Scores: If you had any doubt at all about the primacy of Wall Street over Main Street; the utter lack of transparency behind the biggest government giveaway in history to financial executives, and their shareholders, directors, and creditors; and the intimate connections the lie between Administrations -- both Republican and Democratic -- and the heavyweights on Wall Street, your doubts should be laid to rest. Today it was decided the government will guarantee more than $300 billion of troubled mortgages and other assets of Citigroup under a federal plan to stabilize the lender after its stock fell 60 percent last week. The company will also will get a $20 billion cash infusion from the Treasury Department, adding to the $25 billion the bank received last month under the Troubled Asset Relief Program.

This is not a particularly good deal for American taxpayers, but it is a marvelous deal for Citi. In return for all the cash and guarantees they are giving away, taxpayers will get only $27 billion of preferred shares paying an 8 percent dividend. No other strings are attached. The senior executives of Citi, including those who have served at the highest levels in the US government, have done their jobs exceedingly well. The American public, including the media, have not the slightest clue what just happened.

Meanwhile, more than a million workers in the automobile industry, along with six million mortgagees, and a millions of Americans who depend on small businesses and retailers for paychecks, are getting nothing at all.

As I noted the other day, the difference in urgency between saving wall street and saving main street is apparent.

John Jansen says somebody will pay for this:

Reaction to the Bailout: Tokyo is closed so there is no US Treasury trading this evening. We will have to wait for Europe to arrive to get a reaction.

Stocks are higher. That also seems ludicrous. I do not care what they call this but Citibank is effectively acknowledging that they did not have the resources to survive alone without government assistance. I did not use the words bankrupt or insolvent.

I think that when participants think about this soberly they will be very disturbed and I am saddened to say that the markets will line up one of the remaining survivors for a pre holiday turkey shoot. It has been the history of this rolling crisis since August 2007 that the worst outcome ensues. The market will seek another prey and relentlessly pursue it.

Update: Paul Krugman:

A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more.

Amazing how much damage the lame ducks can do in the time remaining.

Update: More from Arnold Kling

For all of the Depression Mania, there is a lot of the U.S. economy that does not have to shrink. Manufacturing is pretty lean to begin with. Housing construction is already much lower than it has been in years. Unlike the 1930's, we have some very big sectors (health care, education, other government employment) that are unlikely to develop massive layoffs.

The one sector that definitely needs to contract is the financial sector. Maintaining Citi as a zombie bank is not really constructive. I would feel better if it were carved up, with the viable pieces sold to other firms and the remainder wound down by government. In my view, getting the financial sector down to the right size ought to be done sooner, rather than later.

From my perspective, the whole TARP/bailout concept is misconceived. The priority should not be saving firms. The priority should be pruning the industry. Get rid of the weak firms, and make good on deposit insurance. Then let the remaining firms provide the lending that the economy needs.

Update: Felix Salmon says the bailout is underwhelming.

Update: John Hempton:

The consensus is that the Citigroup bailout was bad...I am going to differ here. The bailout was well designed...

except

1). The Government should have taken a much larger fee - at least 20 percent ownership of Citigroup - and arguably more. Shareholders should be punished.

2). The attachment point of the excess of loss policy is too high. If the attachment point had been 80 billion Citigroup would survive. There was no need for a 40 billion dollar attachment point.

The problem with the bailout was not the design - it was the amount extracted from Citigroup shareholders. The government took too much risk for too little reward.

I am surprised that the shareholders were not effectively wiped out as per Fannie, Freddie, AIG.

Not displeased - but somewhere I wish the government would get a happy medium somewhere - rather than one rule Citigroup and one rule for Fannie.

Update: Andrew Samwick:

The technical term for this is a joke.

Citigroup has plenty of assets. It has just written too many claims on those assets. Those holding those claims need to face the reality that their claims are worth less than they were promised and adjust to that reality. That means either liquidating the firm, selling off the assets to the highest bidders, or becoming the new equity holders of the firm. The FDIC can get involved as needed to manage its contingent liabilities to insured depositors.

If the government is to get involved beyond that, it should be senior debt to the restructured entity, not preferred equity (i.e. junior to the most junior debt) to the existing entity.

Update: Barry Ritholtz:

Un-fricking-believable.

The US is guaranteeing $306 billion on bad investments (So much for Capitalism without failure). For Citi, its a great deal — but its a terrible one for taxpayers.

The dividend payment has been restricted to one cent per quarter for 3 years. Can someone explain why even a penny is allowed?

Where is the "Protection" for the taxpayers? Where are the clawbacks? How about going after the idiots that bought a third of a trillion dollars worth of junk, and then got paid large on it? Where is the sense of outrage and justice?

At what point do taxpayers demand that the people responsible for creating this mess must pay their pound of flesh?

Update: Brad DeLong:

It is unclear to me why they aren't just buying common stock. As it is, they're endangering their own reputations to an extraordinary degree...