lundi 29 septembre 2008
vendredi 26 septembre 2008
Equity Warrants and Asymmetric Information
Equity Warrants and Asymmetric Information
Jonah Gelbach an Economist for Obama, explains why an argument against including equity warrants as part of the bailout proposal doesn't hold in the presence of the type of asymmetric information present in these markets:
"Smart Friend" vs. Asymmetric Information, Economists for Obama: Earlier today, Greg Maniw posted a three-point defense of the Paulson bailout plan from someone to whom he referred only as "a smart friend". I want to address point 2 of Mankiw's friend's argument:
2. "Taxpayers will be better off if Treasury gets warrants."
This is essentially the assertion made in David Leonhart's column in the NY Times on Wednesday. And it again illustrates that we would all be better off if high schools taught the Modigliani-Miller theorem. MM implies that the price of the asset (again, assuming the auction gets it right) will adjust to offset the value of any warrants Treasury receives. In this case of a reverse auction, imagine that the price is set at $10. If Treasury instead demands a warrant for future gains of some sort, then the price will rise in the expected amount of the warrant -- say that's $2. Then the price Treasury pays for the asset will be $12. Some people might prefer to get $12 in cash and give up a warrant worth $2 in expected value. Fine, that's a choice to be made. But the assertion that somehow warrants are needed is simply wrong.
For a smart guy, Mankiw's friend is making a pretty dumb argument. Sure, if everyone has the same information, then an asset with a value of $10 will cost $12 if it's required that a $2 warrant comes with it. But that totally misses the point. Based on what I've read, it appears that if everyone understood what these assets were worth, there wouldn't be any need for a bailout: the bailout is necessary because people with capital are scared witless that anything they buy will just be crud. Folks like Mankiw are constantly reminding us (and they're often right) that there's no reason to think government has better information than private parties. So how will Hank Paulson or his agents know any better than folks risking their own money?
In more concrete terms, the right way to think about the equity issue is as follows. (I'll abstract from debt-deflation spiral issues, which are no doubt important but are beside the point for this discussion.) Suppose a bailee has two assets, each of which has face value of one unit. However, actual value and face value diverge, say because the underlying security may default. The first asset is actually worth $10, and the other is actually worth $9. The Treasury can't tell the difference, but the bailee can.
Now suppose the Treasury declares that it is willing to pay $10 for one asset with a one-unit face value, with no equity transfer required. The bailee will certainly prefer to sell Treasury the $8 asset, as it will profit by $2. The bailee now has $10 in liquid capital, and Treasury books a real, long-term loss of $2.
Now suppose that Treasury insists on getting warrants whose value is an increasing function of the loss Treasury books when it sells off the bailee's assets. Let's suppose for simplicity that the warrants' value have expected value equal to the difference between the price Treasury pays the bailee and the price for which Treasury sells the asset. Now if the bailee hands Treasury the $8 asset for $10, the bailee will expect to pay $2 later in warrants, so the bailee and Treasury each break even, though the bailee gets liquidity in the short run, which is the point. On the other hand, if the bailee hands over the $10 asset, then there will be no warrants issued later, since Treasury won't lose anything on the deal.
In this example, the use of warrants has (1) gotten liquidity to the bailee, (2) made the bailee indifferent between transferring the two types of assets, and (3) ensured that Treasury doesn't get stuck with an adverse selection-induced loss. The moral of the story is that the use of equity claims makes truth-telling incentive compatible.
This is an example of simple mechanism design, a topic that is well understood by many microeconomists, no doubt including many smart friends of Greg Mankiw's. Obviously the real world is much more complicated than the simple example here (which I emphasize I took from Mankiw's smart friend). But the idea that the MM-type argument Mankiw's smart friend makes is at all relevant to a world full of informational asymmetries strikes me as bankrupt, tough to credit, and more than a little deflating.
Bankers are criminals
For many years, Republicans, in particular, have espoused the virtues of "trickle-down economics." This theory holds that "increases in the wealth of the rich are good for the poor because some of such additional wealth will eventually trickle down to the middle class and to the poor." (Wikipedia)
Since the credit bubble began to burst, however, we've seen a malignant variation of this phenomenon. Instead of wealth, red ink has been trickling down from the orifices of badly-run financial companies, undermining the economic wellbeing of a wide range of individuals and firms.
Among the victims, according to a CNNMoney.com report, "Credit Crunch Freezes Hiring, Expansion," are small businesses.
When small businesses can't get loans, job growth and economic expansion stall.
After 41 years in business, Hull Printing shut down its printing presses for good in March, laying off 19 workers and closing one of the oldest family-run businesses in Barre, Vt. The catalyst: Hull Printing's bank slashed its line of credit, kicking off a death spiral that led to the company's collapse.
"All of the equipment's gone and been liquidated," said Jon Hull, 32, whose grandparents started the commercial printing business in 1967. "The bank got all of their money back, but it left a lot of unsecured creditors that will never be paid back, including many other small businesses in town."
Hull's story is a familiar one to millions of small business owners across the U.S. who rely on credit lines and loans to fund expansion or help them recover from setbacks. In a National Small Business Association (NSBA) survey released this week, 67% of business owners polled reported being affected by the credit crunch in August, up from 55% in February. Additionally, 32% reported a deterioration in the terms of available bank loans, up from 27% six months earlier.
"If there is a squeeze on banks, even if only large investment banks, the repercussions can easily flow over into commercial bank loans," says NSBA President Todd McCracken. "Based on what history suggests, if banks have to pull back, they'll pull from small business loans first."
A small business cutback will have ripple effects on the larger economy - and on the jobs pool. Small businesses employ about half of all non-government employees in the U.S., according to Small Business Administration estimates. This year, small companies have been crucial in keeping the job-loss numbers from turning even grimmer: While bigger businesses shed workers, companies with fewer than 50 employees have reported a net increase in positions every month this year, according to ADP, which compiles a monthly employment report. In August, when overall employment fell by 33,000 jobs, small companies added 20,000 net new hires, according to ADP's estimates.
A credit crunch can force companies to make hard choices. "Sometimes there may not be enough work for key staff, so they'll face the choice of losing good people or hanging on to them until they catch the next wave," McCracken said.
In D'Iberville, Miss., Fayard's Grocery owner Rusty Quave is waiting to find out if he'll receive a deferral on loan payments that will mean the difference between staying in business and going under for his general store. For now, Quave has shortened the store's operating hours and temporarily stopped selling gas and diesel as he tries to cut his daily operating costs enough to stay afloat.
Stalled growth
Quave is also the mayor of D'Iberville, a town of 6,000. All around, he sees signs of economic development at a standstill. Shattered three years ago by Hurricane Katrina, D'Iberville responded with a comprehensive urban-development plan for rebuilding. The 60-page document is a blueprint for sustainable retail, residential and industrial development, but little ground has been broken because of the credit-market freeze.
"All the major developers can't come up with the financing," Quave said. "We're a district that has legal gaming. We have groups that have bought property and haven't been able to start."
The NSBA's president says Quave's situation is in line with others he's seen. "For a company that has a growth opportunity, you can still get funding, if you take a lot of energy and time and pull from different places. But companies not in a position to expand may lose money," he said.
While officials in Washington hash out the details of a proposed $700 billion bailout to address the financial-system crisis that began unfolding on Wall Street last week, business owners far from the financial markets' epicenter are already feeling the effects of banks' reluctance to risk new loans.
When entrepreneur Tim Trzepacz and his partner sought funding last year to expand their fledgling product-development company, Sprout Creation in Wayland, Mass., they had the benefit of sterling personal credit and years of experience and networking in their industry: Trzepacz is the former merchandising director at consumer-electronics retail giant Brookstone, where his partner, David Laituri, headed up design and engineering. They also had one product already on the market and generating sales, the Vers iPod dock, available at Target.com (TGT, Fortune 500) and other retailers.
Trzepacz pitched almost a dozen banks. One bank executive "told us we'd be approved unless they pulled our credit history and found out we'd committed mass murders," Trzepacz recalled. They were turned down. Over and over, the pattern repeated: Trzepacz and Laituri would meet with a bank and quickly win over their prospective loan officer. But when that advocate pitched the loan further up the bank hierarchy, it would be shot down. Banks wanted 18 to 24 months of cash flow and a demonstrated operating history before they would consider opening their coffers.
Bank of America (BAC, Fortune 500) agreed to extend the company a line of credit for around $80,000, but it was essentially a credit-card line, carrying interest rates of 15% and up. When Trzepacz sought a higher limit, Bank of America told him to look elsewhere.
In the end, Laituri found salvation literally on his doorstep. Laituri walked into a nearby branch of Middlesex Savings Bank, his local community bank, and asked if they'd be interested in talking about financing his business. Two weeks later, Trzepacz and Laituri had a $200,000 line of credit at interest rates less than half those they'd been paying to Bank of America - and they had a promise that as their business grew, their financing would grow with them.
Since getting that financing this spring, Vers Audio has added an employee, introduced new Vers models and created the next extension of its line, a combo iPod dock/alarm clock that will soon be on sale. None of that would have been possible without their line of credit.
"We came within 45 days of D-day," Trzepacz said. "We probably would have had to halt business operations, and our revenues would have been half what they'll be this year."
Other small businesses are stuck at a standstill. Take, for example, Jamaal Oldham of The Cheesecake Experience in Nashville. His four-person operation has been hand-delivering their specialty cheesecakes for years, and the business has been growing locally. The problem is that the team is still working out of Oldham's home kitchen. It needs funding to expand into a larger facility.
"Restaurants both in-state and out are interested in carrying our product, but we can't produce on a mass level because we don't have the facility," Oldham said.
He's confident he'll be able to pay back the $10,000 loan he's seeking. But banks are not budging, including the one that holds his company's accounts. "They told us to consider using credit cards, but with rates as high as 20%, I'm not really willing to go that route," Oldham said.
Oldham is now looking for cheesecake-loving investors, which may mean giving up partial ownership of the company: "I'd rather do that than deal with rates."
Weathering storms
Few entrepreneurs say they're looking for financing and loans to fund ordinary operations; business owners know that debt is expensive. What drives businesses to banks are growth plans or unexpected shocks.
For Hull Printing, the tipping point was an expansion gone wrong. About to outgrow a too-small building, the company owners began looking for new real estate. A sales manager pitched a broader expansion: Add new equipment and increase printing capacity, she said, and sales will jump.
That turned out to be inaccurate. Hull Printing added employees and bought advanced new printing presses, but sales stayed flat. Then the company's bank turned the vise tighter: It announced that by expanding without the bank's permission, Hull Printing had violated the terms of its existing loan. Although the company was making all its payments on time, Jon Hull says, the bank placed Hull Printing in default.
"Our banker knew, and chose not to tell us, 'you guys are risking a lot by making this expansion,'" Hull said. "Putting us in default instantly caused the interest rates on our credit lines to double, which only added fuel to the fire. Here we have a struggling company, and they're adding fees."
Hull worked with a business consultant to try to improve the business's cash flow, and he lined up a buyer interested in taking over the business. But as the company's credit dried up, so did its options and its daily operations. Eventually, closing down became inevitable.
Rusty Quave of Fayard's Grocery is trying to stave off that fate. Storms are his problem. Almost 30% of D'Iberville residents who left town after Katrina haven't come back. When Hurricane Gustav blew through last month, D'Iberville evacuated again, and Fayard's Grocery had no customers for several days.
Open every morning at 6 am, the store has temporarily pulled its closing time back from 9 pm to 3 pm. That's still enough time to feed the breakfast and lunch crowds, who gather at Fayard's for buffets of chicken, shrimp, crawfish, and other Gulf Coast specialties. Locked in negotiations this week with the Small Business Administration, which holds the note on the disaster-assistance loan Quave took out after Katrina, Quave is seeking a deferral. A one-year break on repaying his loans will give him the cash flow he needs to keep Fayard's Grocery open and his staff of 10 employed, he believes.
"We're not asking for free money, we're asking for loans and deferrals of payments to allow us to stay in business and keep being productive," Quave said. "My business is struggling but I'm hanging on. I'm not going to quit or file for bankruptcy, which would be the easy way out. You can't give up. We want to live here and keep our businesses going."
jeudi 25 septembre 2008
Latest Bailout Plan Spin: Its a Money Maker!
Most people are unfamiliar with the evolution of financial management over the years. It began as a clubby old boys network, who you knew mattered more than what you knew. It evolved over time. Starting in the late 1970s, retail stock brokerage became a telemarketing sales business. Although that model is clearly changing, there is still trillions of assets under management today that got that way via the cold call.
The cold calling sales approach was developed and refined at Lehman Brothers (perhaps their collapse was Karma). It was encapsulated by a man named Martin D. Shafiroff, who wrote up, refined and perfected various phone techniques. These include the straight line, the first trade, the trust close. All of his various techniques were published in the book "Successful Telephone Selling in the '80s" and subsequent editions ('90s, etc.)
Having worked on the Sell side for the first decade of my Wall Street career, I am intimately familiar with the various pitches the retail world uses to obtain clients and assets. There is not a single retail broker of my acquaintance that does not have Shafiroff's how-to on his bookshelf.
The reason I bring this up today is due to the latest sales pitch from various people, aggressively pushing the bailout plan. The newest spin on the massively expensive plan is "Hey, its a jumbo money maker!"
The spin reminds me of the classic retail stock jockey. The guy has buried his clients in a series of bad trades, bad judgment, poor risk management -- all motivated by his self-interested, commission-generating trades. The only way out of the money losing mess, pitches the broker, is a big, Hail Mary trade.
Sound familiar?
This technique is one of the last ones in the the Shafiroff book. Once an aggressive retail broker is upside down, the plea goes out for raising more money from the mark client. "Believe me, I hate being under water more than you. I pulled in some favors, this is the trade that makes it all back for us and then some. I could even get in trouble telling you this, so don't mention this to your pals. This is the one -- but I need you to send in more capital so we can recoup the prior trades that went bad on us."
I guess Paulson read the book in the early days of his career. That line of bullshit is identical to what the public is now being fed. A series of OpEds in the Washington Post and the Wall Street Journal (and who knows where else) are all pushing the same nonsensical line: The bailout plan is a big money maker:
Andy Kessler in the WSJ:
"My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion dollars and maybe as much as $2.2 trillion -- yes, with a "t" -- for the United States Treasury...
Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.
Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion."
Bill Gross (who just volunteered to manage the bailout for free) in the Washington Post:
"The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that."
Now, I have a few question for Messrs. Kessler & Gross: What does this say about the private sector? Why can't the all of the private equity funds, sovereign wealth funds, and enormous pools of capital do this themselves? There are trillions of dollars sitting around in cash, yet none of it that sees any value here?
I guess that Hank Paulson, George Bush and Ben Bernanke -- all of whom have been been unequivocally, expensively, tyrannically wrong about the entire crisis from the beginning -- are smarter than both the markets, and all of the private equity pools, about this paper?
Does that sound right to you? The guys who missed this from day one -- despite many many admonitions from many people -- only they see the value in this paper, whereas the smart guys who saw the shitstorm coming in advance, and bet against it, don't?
I am in the same camp as Michal Lewis, who writes at Bloomberg "the Treasury plan also creates this wonderful hidden opportunity for Goldman Sachs to make a killing, and thus preserve its bonus pool for a long time to come."
Put me down as sympatico with Anatole Kaletsky, who writes in the London Times:
"Mr Paulson may be a former chairman of Goldman Sachs, but as US Treasury Secretary he does not know what he is doing. His recent blunders, starting with the "rescue" of Fannie Mae, have triggered unintended consequences around the world, resulting in the death-spiral of financial values. But last Friday Mr Paulson outdid even these Rumsfeldian achievements, when he demanded $700 billion from Congress for a "comprehensive and fundamental" solution to the global financial crisis, without apparently having any idea of what he would actually do."
Agreed.
I have a 10 year bet for those folks now pushing the "Trust me, we will make it all back on this one trade" spin. If you who think the Paulson plan is a money maker, a cash winner, and a net after-fees taxpayer surplus creator, put your money where your mouth is. I bet you one million dollars, to the charity of the winner's choice, that the current plan is ginormous money loser.
Any takers?
>
mardi 23 septembre 2008
Anti-Intellectualism
Jeffrey Sachs says anti-intellectualism "could end up getting us all killed":
The American anti-intellectual threat, by Jeffrey D. Sachs, Commentary, Project Syndicate: In recent years, the United States has been more a source of global instability than a source of global problem-solving.
Examples include the war in Iraq, launched by the US on false premises, obstructionism on efforts to curb climate change, meager development assistance and the violation of international treaties such as the Geneva Conventions. While many factors contributed to America's destabilizing actions, a powerful one is anti-intellectualism...
By anti-intellectualism, I mean especially an aggressively anti-scientific perspective, backed by disdain for those who adhere to science and evidence. The challenges faced by a major power like the US require rigorous analysis of information according to the best scientific principles.
Climate change, for example, poses dire threats... that must be assessed according to prevailing scientific norms... We need scientifically literate politicians adept at evidence-based critical thinking to translate these findings and recommendations into policy and international agreements.
In the US, however, the attitudes of President Bush, [and] leading Republicans ... have been the opposite of scientific. The White House did all it could for eight years to hide the overwhelming scientific consensus that humans are contributing to climate change. It tried to prevent government scientists from speaking honestly to the public. The Wall Street Journal has similarly peddled anti-science and pseudo-science to oppose policies to fight human-induced climate change.
These anti-scientific approaches affected not only climate policy, but also foreign policy. The US went to war in Iraq on the basis of Bush's gut instincts and religious convictions, not rigorous evidence. ...
These are ... powerful individuals out of touch with reality. They reflect the fact that a significant portion of American society, which currently votes mainly Republican, rejects or is simply unaware of basic scientific evidence regarding climate change, biological evolution, human health and other fields. ...
Recent survey data by the Pew Foundation found that while 58 percent of Democrats believe that human beings are causing global warming, only 28 percent of Republicans do. Similarly, a 2005 survey found that 59 percent of self-professed conservative Republicans rejected any theory of evolution, while 67 percent of liberal Democrats accepted some version of evolutionary theory.
To be sure, some of these deniers are simply scientifically ignorant, having been failed by the poor quality of science education in America. But others are biblical fundamentalists... They reject geological evidence of climate change because they reject the science of geology itself.
The issue here is not religion versus science. All of the great religions have traditions of fruitful interchange with -- and, indeed, support for -- scientific inquiry. ...
The problem is an aggressive fundamentalism that denies modern science, and an aggressive anti-intellectualism that views experts and scientists as the enemy. It is those views that could end up getting us all killed. ...
It is difficult to know for sure what is giving rise to fundamentalism in so many parts of the world. ... Fundamentalism seems to emerge in times of far-reaching change, when traditional social arrangements come under threat. The surge of modern American fundamentalism in politics dates to the civil rights era of the 1960s, and at least partly reflects a backlash among whites against the growing political and economic strength of non-white and immigrant minority groups in US society.
Humanity's only hope is that the vicious circle of extremism can be replaced by a shared global understanding of the massive challenges of climate change, food supplies, sustainable energy, water scarcity and poverty. ...
The US must return to the global consensus based on shared science rather than anti-intellectualism. That is the urgent challenge at the heart of American society today.
Extending the Bailout: It's Simple, Sell Us the Company and You're In
Sur la question des compensations en capital de tout plan de sauvetage
The WSJ discusses the puzzling issue of how far the bailout should go. Should it cover auto loan debt, student loan debt, construction loans?
If the bailout were structured correctly, this wouldn't be a problem. The bailout has to be painful, it is not supposed to be a reward for ridiculously overpaid executives who pushed their companies to the edge of bankruptcy. If the government's purchases of bad debt were tied to serious restrictions on executive compensation and the forced sale of equity to the government, then only banks that really needed the money would line up for the bailout. Under these terms, we could include whatever assets the Wall Street boys and girls want to sell.
--Dean Baker
Financial One-Liner of the Day
As shared with David Altig:
"The problem with financial institution balance sheets is that on the left hand side nothing is right and on the right hand side nothing is left."
lundi 22 septembre 2008
The collapsing American middle class
Surfing over to Charles Dodgson's site yesterday, I happened upon Elizabeth Warren's lecture on the squeeze on the American middle class since the 1970s. Then you could bring up a family on one income; now you can't. Then non-discretionary spending made up a smaller proportion of household spending; now, it dominates. Result: if a parent loses their job or gets sick, bankruptcy looms. I didn't expect to sit watching a YouTube video for whole hour but I was riveted by the story Warren tells with the consumption statistics.
I was kind of reluctant to blog this too. After all, there are others at CT who do sociology or economics or family policy and I don't do those things. And I'm not an American resident either. Still, it struck me as pretty compelling. I wonder how similar the change has been in the other OECD countries?
Paul Krugman: Cash for Trash
The Paulson plan is not acceptable in its present form:
Cash for Trash, by Paul Krugman, Commentary, NY Times: ...Henry Paulson's $700 billion rescue plan for the U.S. financial system..., as far as I can see, doesn't make sense. ...[And] what, exactly, in the experience of the past year and a half — a period during which Mr. Paulson repeatedly declared the financial crisis "contained," and then offered a series of unsuccessful fixes — justifies the belief that he knows what he's doing? ...
So let's try to think this through for ourselves. I have a four-step view of the financial crisis:
1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities...
2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. ...
3. Because financial institutions have too little capital relative to their debt, they haven't been able or willing to provide the credit the economy needs.
4. Financial institutions have been trying to pay down their debt by selling assets,... but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the "paradox of deleveraging."
The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets... How does this resolve the crisis?
Well, it might — might — break the vicious circle of deleveraging, step 4... Even that isn't clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.
Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I'm not happy with this plan?
The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital..., it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don't go to the people who made the mess in the first place. That's what happened in the savings and loan crisis... It's also what happened with Fannie and Freddie. ...
But Mr. Paulson insists that he wants a "clean" plan. "Clean," in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? Add to this ... that Mr. Paulson is also demanding dictatorial authority, plus immunity from review "by any court of law or any administrative agency," and this adds up to an unacceptable proposal.
I'm aware that Congress is under enormous pressure to agree to the Paulson plan in the next few days, with at most a few modifications... Basically, after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now now now.
But I'd urge Congress to pause for a minute, take a deep breath, and try to seriously rework the structure of the plan, making it a plan that addresses the real problem. Don't let yourself be railroaded — if this plan goes through in anything like its current form, we'll all be very sorry in the not-too-distant future.
The Source for Insights?
Many mainstream media types aren't all that happy with what goes on in the blogosphere. Among other things, they argue that there is too much unvetted commentary and that many bloggers don't adhere to standard journalistic practices. Yet the following post by Interfluidity's Steve Randy Waldman, "Bad," is a good example of why I find myself spending more and more of my time getting insights about what is happening on Wall Street and Main Street in the online world.
Okay. Let's leave no room for ambiguity here. The Treasury's draft plan for saving the world is breathtakingly awful. It would give the Secretary of the Treasury entirely unchecked discretion over up to 700B dollars. Even that "limit" has a loophole big enough that you could drive a truck through it, so the Secretary could in effect spend up to 1.8T dollars, right up to the newly raised Federal debt ceiling, without further Congressional action. This act would be such a wholesale delegation of the power of the purse that I wonder whether it is even constitutional. Of course, the act explicitly puts the Secretary's actions beyond any judicial review, so perhaps questions of legality or constitutionality are merely academic. (Paul Campos shares these concerns.)
As Paul Krugman has pointed out, for the plan to help insolvent institutions, the Treasury would have to overpay for these assets. Yves Smith unearths an account that Secretary Paulson has acknowledged this fact in private, although he won't cop to it on the Sunday talk shows. It is almost old-fashioned to raise questions about whether or not the former Wall Street banker will offer sweetheart deals to his industry (an industry that has harmed the American economy more deeply than most people realize). Just as big lies boldly asserted can trump plausible untruths nervously defended, overt corruption on a massive scale (but "in the public interest") might leave a lot of naysayers dumbstruck. It becomes the way we do business. Of course, none of Dean Baker's progressive conditions, none of Brad DeLong's dealbreakers, not even my plea for a little transparency are incorporated into the proposal.
The oldest technique for the usurpation of power by the executive from the legislative is the manufacture of a state of emergency. That is not to say the present financial crisis is not actually an emergency. But the how the crisis is understood by legislators and the range of options by which it might be addressed have been set by Messrs Paulson and Bernanke. They have presented a single option, one more radical than seemed reasonable even at the height of the depression. (ht Brad DeLong)
It is worth noting that Paulson and Bernanke have thus far proven themselves to be capable technocrats. (Although, as Dean Baker points out, they've been awful prognosticators.) There's a lot to disagree with in how the dynamic duo have handled the torrent of crises that began last August. But they have acted aggressively and creatively, and in their ad hoc interventions so far, they've gone to some lengths to create upside for taxpayers and to squeeze miscreants at least a bit. Until reading on the text of the Treasury's proposal and stewing on it overnight, I was inclined not to fight too hard. I saw things as I'm sure legislators see things: Something must be done, a megabailout is disagreeable and imperfect, but it's something that we can be do quickly, and it's what our experts, whom we trust, recommend. Let's fiddle at the margins to get it done as best we can.
But the proposed text flipped a switch in my brain. This is not, as Senator Schumer put it, "a good foundation of a plan that can stabilize markets quickly". It is a raw arrogation of power. My trust, my willingness to extend the benefit of the doubt, has evaporated.
This is overreach. This is bad.
vendredi 19 septembre 2008
Devenez ceinture noire de Powerpoint (suite)
Powerpoint… rien que d'entendre ce nom j'ai déjà les poils qui se dressent sur ma tête. J'avais déjà abordé le sujet il y a près de 4 ans (cf. Devenez ceinture noire de Powerpoint), mais je reviens à la charge car les dérives sont de plus en plus nombreuses.
Démonstration :
En fait l'erreur la plus classique est de vouloir faire un diaporama qui sert à la fois de support de présentation et de rapport à apporter (les spécialistes appellent ça des "presentument", contraction de "presentation" et de "document"). Grosse erreur car le support est généralement trop chargé pour être utile comme support de projection et incomplet comme rapport à lire à tête reposée. J'irais même plus loin en disant que l'on peut en apprendre beaucoup sur la manière de travailler et de se comporter d'un collaborateur en analysant ses diaporamas…
Bref, pour vous remettre dans le droit chemin (ou vos collègues à qui vous pouvez les offrir) je vous propose ces trois livres :
- Presentation Zen (qui existe aussi en français) ;
- Slide:ology (par le patron de l'agence Duarte, une agence spécialisée dans la réalisation de diaporamas) ;
- Advanced Presentations by Design (à paraitre bientôt).
Et pour celles et ceux qui souhaitent perfectionner l'art de la présentation, je vous recommande vivement les soirées Pecha Kutcha des Designers Interactifs : Pecha Kucha Paris Vol. 6.
The Great Unwind Has Begun
Three month T-bills finished at a two basis point yield, and may even have traded at negative yields. Signs of ZIRP.
Gold rose $68 and is still going up in Asia. The dollar fell against the yen, a sign of continued carry trade unwinds.
Credit default swaps on financials blew out, with Morgan Stanley hard hit: Spreads on protection for its bonds rose 220 basis points to over 900.
The TED spread, an indicator of stress in the interbank lending markets, shot upwards to 238 basis points.
CDS spreads on Treasuries rose to 30 basis points. Nine months ago, CDS on Treasuries were an oddity rather than an actively written contract, and the spread was 2 basis points.
Swap spreads widened considerably.
Today's TSLf auction was, as Alea put it, a "disaster" with prices and bid to cover up big time.
And the commentary was far from cheery. Kenneth Rogoff, in a Financial Times commentary, said that the US needed a trillon to two trillion dollar bailout. That may seem like a made-up number, and any estimate of the outcomes of an eruption this large is bound to be plenty approximate. However, Rogoff has made an extensive study of financial crises, so it would be a mistake to assume that he made this estimate casually. From the Financial Times:
Were the financial crisis to end today, the costs would be painful but manageable.... Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.....
It is hard to predict exactly how and when the mega-bail-out will evolve. At some point, we are likely to see a broadening and deepening of deposit insurance, much as the UK did in the case of Northern Rock. Probably, at some point, the government will aim to have a better established algorithm for making bridge loans and for triggering the effective liquidation of troubled firms and assets, although the task is far more difficult than was the case in the 1980s, when the Resolution Trust Corporation was formed to help clean up the saving and loan mess.
Of course, there also needs to be better regulation. It is incredible that the transparency-challenged credit default swap market was allowed to swell to a notional value of $6,200bn during 2008 even as it became obvious that any collapse of this market could lead to an even bigger mess than the fallout from subprime mortgage debt.
It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.
Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.
An interesting observation in comments at Nouriel Roubini (hat tip Megan):
....the situation in the markets right now reminds me a lot of the time back in 1987 before the big October crash. At that time, during Sep and Oct there were some big swings in volatility in the Dow. The swings came about because investors were very nervous about a possible collapse, then every so often the market would decide that "everything is alright" and bounce up again. We're seeing that phenomenon again now. Back in 1987 one of the big drivers of the crash was "portfolio insurance". Brokers had implemented a scheme whereby stock portfolio's were supposedly insured in value through hedging transactions in the futures markets. Of course, the whole scheme only works if losses can be kept modest and predictable in nature. The market tore apart initially in the Chicago futures markets when the scheme began to break down. This time in 2008 the issue is not stock insurance ... it's bond insurance. The market is now very nervous about a possible collapse in the CDS market. Different asset - but the same underlying issue. The insurance on bond values just can't be paid up when losses become large and unpredictable in the system. (Pete)CA)
From Ambrose Evans-Pritchard at the Telegraph:
Bernard Connolly, global strategist at Banque AIG, said the Fed and the Treasury were doing too little, too late, to stave off disaster. Interest rates need to be cut immediately and dramatically, while Washington must prepare for a wholesale takeover of large parts of the lending system along the lines of the Scandinavian bank rescues in the early 1990s.
"Unless there is a very rapid change of mind, depression - with all its horrors and consequences - will be inevitable. The judgment that letting Lehmans go would not create systemic risk depended, if it was ever going to be anything other than ludicrous, on very rapid action to shore up the financial system. Instead, Hank Paulson seems to be adding to the risk in the system," he said.
"We fear that a virtual nationalisation of the financial system will now be necessary," he said....
Albert Edwards, global strategist at Société Générale, said Washington's serial bail-outs are the inevitable result of the credit bubble of preceding years. "This was all baked in the cake long ago. What we have seen so far is just a dress rehearsal for the deep recession that is coming. America is going to be losing 500,000 jobs a months. That is when we will see interest rates go to zero. The deficit will be covered with printed money as it was in Japan. The endgame will be helicopters full of cash dropped by Ben Bernanke," he said.
And from the Financial Times:
Andrew Brenner, co-head of structured products and emerging markets at MF Global, said: "It feels like no one wants to take anyone's credit...it feels like we are on a precipice."
vendredi 12 septembre 2008
"Wages are Falling for Just about Everybody"
This is the type of issue the election should be about. The conversation has been steered elsewhere, the focus is no longer on the economy, and that's to the detriment of those who need help, especially if the connection between the economic policies of the Bush administration, policies that will continue under McCain-Palin, and the economic outcomes people have experienced are not fully recognized:
Wages are falling for just about everybody, by Kathy G.:
Chart from the Wall Street JournalToday, the Wall Street Journal reports the sobering news that, since 2000, real wages have fallen for every educational group in America except folks with professional degrees (doctors, lawyers, and the like). All other groups, even those with master's degrees and Ph.D.'s, saw declining wages over this period. The WSJ piece is based on recently released Census data (you can find the most recent Census Bureau report on income and earnings here).
In recent years, the college earnings premium has decreased substantially. As the Journal points out:
In 1975, for instance, workers with college degrees earned 60% more per year on average than workers with high-school diplomas only, according to the 2006 Economic Report of the President.
Workers with a college degree saw their earnings premium grow steadily over the next quarter century, and by 2000 their average earnings were roughly double what workers with a high-school diploma made. Over the next four years the trend reversed: By 2004, workers with a college diploma only were earning about 80% more than high-school grads, on average.
The Journal article identifies globalization (including the outsourcing of both blue- and white-collar jobs) and rising health costs as possible causes for the decline in wages. One reason workers' wages aren't keeping up with inflation is that health care costs have risen dramatically in recent years, so employers are shelling out more for health coverage, and less in wages.
For most Americans, these data paint a fairly bleak picture of their economic prospects. About the only good thing I can say about this is that, given this economic climate, I find it almost impossible to believe that the Republicans triumph this November. The seven-year period during which wages have been in freefall just happen to be seven years in which a Republican was president and Republicans, for the most part, controlled Congress. There's no way in hell that the Republicans should be able to get away with this. If, in spite of everything, they end up winning this fall, it will be the con job of the century.
I'm guilty of this too with recent side trips to discuss elitism and other cultural issues, but can we steer the conversation back to the issues that are important? Can the press and everyone else stop fanning the flames of side issues that are nothing but a distraction from what matters to struggling households? It's time to change to conversation, to go on the offensive with these kinds of issues, but how? My opinion is that there's only so much we can do, it's up to the campaigns to set the national conversation, and right now the Democrats are in response mode - playing defense - rather than setting the conversation by aggressive attacks on Republican economic policy, attacks that make it clear how those policies have worked to the detriment or simply ignored the needs of typical households. You can win playing defense, especially if you are already way ahead, but most of the time it's offense that scores the big points.
Michigan (And Maybe Ohio): Lose Your Home, Lose Your Vote
Michigan (And Maybe Ohio): Lose Your Home, Lose Your Vote
From Michigan Messenger (hat tip Credit Slips):
The chairman of the Republican Party in Macomb County Michigan, a key swing county in a key swing state, is planning to use a list of foreclosed homes to block people from voting in the upcoming election as part of the state GOP's effort to challenge some voters on Election Day.
"We will have a list of foreclosed homes and will make sure people aren't voting from those addresses," party chairman James Carabelli told Michigan Messenger in a telephone interview earlier this week. He said the local party wanted to make sure that proper electoral procedures were followed.
State election rules allow parties to assign "election challengers" to polls to monitor the election. In addition to observing the poll workers, these volunteers can challenge the eligibility of any voter provided they "have a good reason to believe" that the person is not eligible to vote. One allowable reason is that the person is not a "true resident of the city or township."
The Michigan Republicans' planned use of foreclosure lists is apparently an attempt to challenge ineligible voters as not being "true residents."....
The Macomb County party's plans to challenge voters who have defaulted on their house payments is likely to disproportionately affect African-Americans who are overwhelmingly Democratic voters. More than 60 percent of all sub-prime loans — the most likely kind of loan to go into default — were made to African-Americans in Michigan, according to a report issued last year by the state's Department of Labor and Economic Growth...
Carabelli is not the only Republican Party official to suggest the targeting of foreclosed voters. In Ohio, Doug Preisse, director of elections in Franklin County (around the city of Columbus) and the chair of the local GOP, told The Columbus Dispatch that he has not ruled out challenging voters before the election due to foreclosure-related address issues.....
Challenging all voters registered to foreclosed homes could disrupt some polling places, especially in the Detroit metropolitan area. According to the real estate Web site RealtyTrac, one in every 176 households in Wayne County, metropolitan Detroit, received a foreclosure filing during the month of July. In Macomb County, the figure was one household in every 285, meaning that 1,834 homeowners received the bad news in just one month. The Macomb County foreclosure rate puts it in the top three percent of all U.S. counties in the number of distressed homeowners.
jeudi 11 septembre 2008
the USSRA (United Sociali...
The now inevitable nationalization of Fannie and Freddie is the most radical regime change in global economic and financial affairs in decades. For the last twenty years after the collapse of the USSR, the fall of the Iron Curtain and the economic reforms in China and other emerging market economies the world economy has moved away from state ownership of the economy and towards privatization of previously stated owned enterprises. This trend was aggressively supported the United States that preached right and left the benefits of free markets and free private enterprise.
Today instead the US has performed the greatest nationalization in the history of humanity. By nationalizing Fannie and Freddie the US has increased its public assets by almost $6 trillion and has increased its public debt/liabilities by another $6 trillion. The US has also turned itself into the largest government-owned hedge fund in the world: by injecting a likely $200 billion of capital into Fannie and Freddie and taking on almost $6 trillion of liabilities of such GSEs the US has also undertaken the biggest and most levered LBO ("leveraged buy-out") in human history that has a debt to equity ratio of 30 ($6,000 billion of debt against $200 billion of equity).
So now Comrades Bush, Paulson and Bernanke (as originally nicknamed by Willem Buiter) have now turned the USA into the USSRA (the United Socialist State Republic of America). Socialism is indeed alive and well in America; but this is socialism for the rich, the well connected and Wall Street. A socialism where profits are privatized and losses are socialized with the US tax-payer being charged the bill of $300 billion.
This biggest bailout and nationalization in human history comes from the most fanatically and ideologically zealot free-market laissez-faire administration in US history. These are the folks who for years spewed the rhetoric of free markets and cutting down government intervention in economic affairs. But they were so fanatically ideological about free markets that they did not realize that financial and other markets without proper rules, supervision and regulation are like a jungle where greed – untempered by fear of loss or of punishment – leads to credit bubbles and asset bubbles and manias and eventual bust and panics.
The ideologue "regulators" who literally held a chain saw at a public event to smash "unnecessary regulations" are now communists nationalizing private firms and socializing their losses: the bailout of the Bear Stearns creditors, the bailout of Fannie and Freddie, the use of the Fed balance sheet (hundreds of billions of safe US Treasuries swapped for junk toxic illiquid private securities), the use of the other GSEs (the Federal Home Loan Bank system) to provide hundreds of billions of dollars of "liquidity" to distressed, illiquid and insolvent mortgage lenders, the use of the SEC to manipulate the stock market (restrictions on short sales), the use of the US Treasury to manipulate the mortgage market (Treasury will now for the first time outright buy agency MBS to manipulate and prop up this market), the creation of a whole host of new bailout facilities (TAF, TSLF, PDCF) to prop and rescue banks and, for the first time since the Great Depression,to bail out non-bank financial institutions, and a whole range of other executive and legislative actions (including the recent bill to provide a public guarantee to mortgage for banks willing to reduce their face value).
This is the biggest and most socialist government intervention in economic affairs since the formation of the Soviet Union and Communist China. So foreign investors are now welcome to the USSRA (the United Socialist State Republic of America) where they can earn fat spreads relative to Treasuries on agency debt and never face any credit risks (not even the subordinated debt holders who made a fortune yesterday as those claims were also made whole).
Like scores of evangelists and hypocrites and moralists who spew and praise family values and pretend to be holier than thou and are then regularly caught cheating or cross dressing or found to be perverts these Bush hypocrites who spewed for years the glory of unfettered wild west laissez faire jungle capitalism (and never believed in any sensible and appropriate regulation and supervision of financial markets) allowed the biggest debt bubble ever to fester without any control, have caused the biggest financial crisis since the Great Depression and are now forced to perform the biggest government intervention and nationalizations in the recent history of humanity, all for the benefit of the rich and the well connected. So Comrades Bush and Paulson and Bernanke will rightly pass to the history books as a troika of Bolsheviks who turned the USA into the USSRA. Fanatic zealots of any religion are always pests that cause havoc and destruction with their inflexible fanaticism; but they usually don't run the biggest economy in the world. But these laissez faire voodoo-economics zealots in charge of the USA have now caused the biggest financial crisis since the Great Depression and the nastiest economic crisis in decades. So let them be shamed in public for their hypocrisy and zealotry that has caused so much financial and economic damage.