Does the ECB/Eurosystem have enough capital?

 

 

Envoyé par guillaume e via Google Reader :

 

 

Does the ECB/Eurosystem have enough capital?

via Willem Buiter's Maverecon de Willem Buiter le 14/05/09

'Enough capital for what?' should be the question prompted by the title of this post. The short answer, amplified below, is "enough capital to be able to engage in effective monetary policy, liquidity policy and credit-enhancing policy (including quantitative easing or QE), without endangering its price stability mandate."

Let's consider the conventional balance sheets of the ECB and of the consolidated Eurosystem (the ECB and the 16 national central banks (NCBs) of the Euro Area.

The most recent publicly available balance sheet of the ECB is in the 2008 Annual Report, published in April 2009.  It is reproduced here:

Balance sheet of the ECB on 31 December 2008 and 31 December 2007

Assets (€ bn)			Liabilities (€ bn)
	2008	2007		2008	2007
Gold & Gold Receivables	10.7	10.3	Bank notes in circulation	61.0	54.1
Claims on non-euro area residents in foreign currency	41.6	29.2	Liabilities to euro area residents in euro	1.0	1.1
Claims on euro area residents in foreign currency	22.2	3.9	Liabilities to non-euro area residents in euro	253.9	14.5
Other assets	14.3	11.3	Liabilities to euro area residents in foreign currency	0.3	0.0
Intra-Eurosystem claims	295.1	71.3	Liabilities to non-euro area residents in foreign currency	1.4	0.7
			Other liabilities	20.5	9.4
			Intra-Eurosystem liabilities	40.1	4.0
			Capital & reserves	4.1	4.1
			Profit for the year	1.3	0
Total	383.9	126.0	Total	383.9	126.0

It is clear that if the ECB were all there is to the Eurosystem, the Euro Area would be in trouble.  The ECB has negligible capital (€ 5 billion subscribed, rather less than that paid in; even if we add capital and reserves to 2008 profits, we only get €5.4 bn.  With assets of €3839, that gives the ECB 71 times leverage at the end of 2008, a number that would impress even Deutsche Bank. The previous year, the ECB had 48 times leverage.  On its own, the ECB looks like an overblown pawn shop.

Fortunately, the balance sheet of the ECB by itself is effectively irrelevant and uninformative as to the financial strength of the Euro Area monetary authority.  In 2008, about 75% of the assets of the ECB consisted of intra-Eurosystem claims (the left hand lending to the right hand).

What is informative is the consolidated balance sheet of the ECB and the 16 NCBs of the Euro Area - the Eurosystem.  This consolidated balance sheet of the Eurosystem is available monthly:

Consolidated financial statement of the Eurosystem as at 8 May 2009

Assets (EUR millions) 1 Gold and gold receivables 240,817 2 Claims on non-euro area residents denominated in foreign currency 159,299 3 Claims on euro area residents denominated in foreign currency 123,101 4 Claims on non-euro area residents denominated in euro 21,359 5 Lending to euro area credit institutions related to monetary policy operations denominated in euro 653,352 6 Other claims on euro area credit institutions denominated in euro 26,453 7 Securities of euro area residents denominated in euro 292,405 8 General government debt denominated in euro 36,790 9 Other assets 241,523 Total assets 1,795,099

Liabilities (EUR millions) Totals/sub-totals may not add up, due to rounding 1 Banknotes in circulation 759,502 2 Liabilities to euro area credit institutions related to monetary policy operations denominated in euro 264,137 3 Other liabilities to euro area credit institutions denominated in euro 436 4 Debt certificates issued 0 5 Liabilities to other euro area residents denominated in euro 139,090 5.1 of which General government 130,717 6 Liabilities to non-euro area residents denominated in euro 177,993 7 Liabilities to euro area residents denominated in foreign currency 1,548 8 Liabilities to non-euro area residents denominated in foreign currency 11,407 9 Counterpart of special drawing rights allocated by the IMF 5,551 10 Other liabilities 159,644 11 Revaluation accounts 202,952 12 Capital and reserves 72,840 Total liabilities 1,795,099

A central bank can go broke (become insolvent) despite its ability to 'print money' (issue currency and/or create (electronically) deposits owned by commercial banks and other eligible counterparties that are generally accepted as final means of payment) if it has a sufficiently large stock of liabilities denominated in foreign currency and/or a sufficiently large stock of index-linked liabilities.  Neither condition would seem to apply to the Eurosystem.

A shortage of foreign exchange assets or credit lines is not going to be a material problem for the Eurosystem. As of May 8, 2009, the net position of the Eurosystem in foreign currency (asset items 2 and 3 minus liability items 7, 8 and 9) was EUR 263.9 billion. The ECB is also able to create reciprocal or one-sided swap arrangements with all other serious central banks. As far as I know, the Eurosystem does not have any significant amount of index-linked liabilities.

No, the Eurosystem will not encounter the 'Iceland problem'. It will always be able to create euro base money (either by issuing additional euro currency or by increasing euro bank reserves and similar deposits held with the Eurosystem by eligible counterparties) by any amount required to maintain its solvency. It is, however, possible that the amount of additional base money that would have to be created to maintain the Eurosystem's solvency could endanger the ECB's price stability mandate, operationalised as a rate of inflation, measured by the HICP, below but close to 2 percent per annum in the medium term.

So the question is: does the Eurosystem have enough capital to be able to risk significant capital losses in its monetary operations, liquidity operations and credit enhancing operations (including quantitative easing), without endangering its price stability mandate?

The Eurosystem already has taken a lot of private sector credit risk exposure on its balance sheet.  It accepts as collateral in repos and at its discount window (the marginal lending facility), most private securities (including most asset-backed securities except those that have derivatives as underlying assets) rated BBB- or better.  That includes a lot of rubbish.  Commercial banks throughout the Eurozone (including subsidiaries of Lehman Brothers and of the now defunct Icelandic banks) have repoed with the ECB.  When three banks went belly-up in late 2008, the Eurosystem was exposed to potentially dodgy collateral to the tune of about €10 bn and provisioned about € 5 bn.

With assets of € 1,795 bn and capital and reserves of € 73 bn, the Eurosystem has 24,6 times leverage.  A decline of just four percent in the value of its assets would wipe out its capital.  That does not look like a terribly comfortable position, as the quality of much of the assets it has accepted as collateral from Euro Area banks is likely to be uncertain at best.

Unlike the US banks and the UK banks, Eurozone banks have barely made a start on recognising the toxic and bad assets they are exposed to, on balance sheet or off-balance sheet.  I won't this time single out Iberian banks as likely suppliers of vast quantities collateral consisting of dodgy residential mortgage-backed and commercial-mortgage-backed securities to the Eurosystem.  Being given the evil eye by the Governor of the Central Bank of Iberia is no laughing matter.  And in any case, the Irish banks are likely to have saddled the Eurosystem with collateral that yields to no other Eurozone nation in awfulness.  We know of the dreadful state of most of the German Landesbanken, the fragility of the bailed-out Commerzbank, the opaque balance sheet of Deutsche Bank, the precarious state of the remaining large listed Benelux banks, the exposure of the Austrian banks to Central and Eastern Europe etc. etc.  If any of these banks had good collateral, they would not give it to the Eurosystem.  They would sit on it.

Even before the Eurosystem starts to buy private securities outright (as it is planning to do with high-grade covered bonds, Pfandbriefe, to the tune of € 60 bn), it is certainly within the realm of the possible (or even likely) that it would suffer losses on its assets of €73 bn or more, before this crisis and this contraction are over.

That, of course, would not endanger the solvency of the Eurosystem, which has the present discounted value of current and future seigniorage income (the interest earned (or saved) by being able to borrow at a zero rate of interest through the issuance of currency and through mandatory reserve requirements).

The monetary base issued by the Eurosystem (not all of which is held in the Euro area) is just over a trillion euros.  Eurozone GDP at current market prices in 2008 was about € 9.2 trillion.  So the monetary base is about 11 percent of GDP.  If long-run nominal GDP growth in the Euro Area is four percent per annum (two percent real GDP growth and 2 percent inflation), then, assuming for simplicity that the demand for base money does not depend significantly on the rate of inflation for low rates of inflation), the Eurosystem would be able to issue another 0.43 percent of GDP worth of additional base money each year ($40 bn worth of base money in 2009) withough putting upward pressure on inflation or driving it above the inflation target, assumed to be 2 percent to make the arithmetic easy.

This is likely to be an overstatement of seigniorage revenues at a rate of inflation consistent with the price stability mandate for two reasons.  First, the demand for base money is likely to be boosted significantly and unsustainbly by the extreme liquidity preference of banks and households following the collapse of interbank markets and other ready sources of liquidity.  Also, a large but unknown share of euro notes is held outside the Euro Area, both for legitimate and illegitimate purposes.  This demand for euro currency will not depend on Euro Area income growth, inflation and interest rates.

Even if the 'normal' euro seigniorage as a share of GDP at a 2 percent rate of inflation is only 0.2 percent of GDP, the capitalised value of the current and future stream of seigniorage, assuming that the long-term nomopnal nterest rate exceeds the long-term growth rate of nominal GDP by one percentage point, would be 20 percent of Euro Area annual GDP.  That would allow the ECB to absorb quite massive losses to its balance sheet, which as it happens equals 19.5 percent of Euro Area annual GDP.

A complete blow-out of the balance sheet of the ECB is unlikely, to say the least.  Admittedly, we have to set against the present value of current and future seigniorage the present discounted value of the cost of running the Eurosystem.  The ECB is lean and mean, but many of the NCBs are over-staffed, bloated organisations.  I have not been able to find data on the current and capital costs of the Eurosystem, but it seems unlikely to alter the conclusion that with its monopoly of the issuance of currency in the Euro Area, and its tax on eligible bank deposits (aka reserve requirements), the Eurosystem is so wildly profitable that it can withstand very large capital losses on its conventional financial balance sheet.

Things are different in that regard for the Bank of England and the Fed, where, under normal circumstances, base money is a much smaller fraction of annual GDP than in the Euro Area - typically no more than 4 or 5 percent.  The maximum losses these central banks can sustain without having to either increase base money issuance to a volume that generates inflation above the (implicit or explicit) target, or knock on the door of the Treasury for compensation for their capital losses are therefore less than a quarter of the losses the Eurosystem can tolerate.

That is just as well, since the ECB and the Eurosystem 'swim naked': there is no Euro Area fiscal authority that, explicitly or implicitly, stands ready to act as the recapitalisor of last resort for the Eurosystem.  As the Euro Area develops financially, and as its Southern Fringe becomes less tolerant of tax evasion and the grey and black economies, the demand for base money will shrink as a share of GDP.  This would tighten the intertemporal budget constraint of the Eurosystem and make it more likely that it will have to look for a Euro-Area fiscal indemnity for capital losses incurred in the pursuit of its monetary, liquidity and credit easing objectives.  But that is likely to become an issue only with the next financial crisis, a couple of decades down the road.

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à Willem Buiter's Maverecon à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

Credit Default Swaps Holders Likely to Force GM into Bankruptcy

Mais à part ça l'innovation financière c'est quelque chose de merveilleux... Comme le disait Paul Volcker, le seul exemple "récent" d'innovation financière utile c'est l'ATM.

 

 

Envoyé par guillaume e via Google Reader :

 

 

Credit Default Swaps Holders Likely to Force GM into Bankruptcy

via naked capitalism de Yves Smith le 11/05/09

It only takes opposition by 10% of the bondholders to stymie an out-of-court restructuring of GM. The FT believes that there are enough bondholders who, via being net short GM bonds via credit default swaps, have good reason to block a negotiated outcome and force the automaker into bankruptcy. And that poses risk to the economy, since there are meaningful odds that the fast track solution of a 363 sale will be opposed successfully, producing uncertainty as to when GM will exit bankruptcy and putting further strain on the supply chain. GM is a big actor in its ecosystem, and too much damage to its supply chain will hurt all US based car-makers, including the transplants.

Here we have financial technology trumping what is in the collective best interest. Creditors when possible prefer to avoid bankruptcy court if a settlement can be reached out of court (it saves costs, reduces uncertainty, and minimizes the risk of loss of customers and key employees during the BK process).

From the Financial Times:

Hedge funds and other investors stand to make billions of dollars on credit insurance contracts if GM declares bankruptcy, a prospect that is complicating efforts to persuade creditors to agree to a restructuring plan for the automaker, analysts say.

Holders of $27bn in GM bonds have until June 1 to decide whether to swap their debt for a 10 per cent equity stake in the company as part of an offer that would give the US government 50 per cent of the shares, a United Auto Workers union healthcare fund 39 per cent and existing shareholders 1 per cent.

However, analysts say the chances the proposal will be accepted have been diminished by the large number of credit default swap (CDS) contracts written on GM's debt.

Holders of such swaps would be paid in the event of a default – but would lose money if they agreed to restructure GM's debt. For investors who own bonds and CDS, this could create an incentive to favour a bankruptcy filing.

According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM. Once off-setting positions are considered, the DTCC estimates CDS holders would make a net profit of $2.4bn if GM were to default.

The opposition of 10 per cent of bondholders is enough to derail the proposal, which has already triggered protests from investors who argue it unfairly rewards the UAW at the expense of bondholders.

"You have every incentive not to agree," said one bondholder, a large credit hedge fund. "You would be locking in a loss if you did. It isn't only the 'shark' capital; it will be the mom and pop mutual funds who will oppose this deal. "

Moreover, as we have written at length elsewhere, the idea that GM can have a quick and easy bankruptcy looks like a fantasy. The article continues:

"Chrysler looks like a simple two-car funeral compared to the traffic jam of assets and liabilities and contracts at GM," said the credit research boutique CreditSights. "Chrysler provides limited parallel."

John Dizard, in a separate story, explains why a 363 sale is likely to be blocked:

The "363" plan (a provision under the Bankruptcy Act that allows the company to sell assets) is the means for a "good GM" funded by the government to buy assets from the existing company, or "bad GM". The plan, based on a review of some fairly clear precedents from past cases, is a legally flawed way to disregard the rights of certain creditors – in GM's case, their public bondholders....

The 363 loophole, (really 363(b)), was intended to give a judge the authority to allow for the quick disposal of wasting assets, or assets that are not part of the core business, without waiting for creditors to vote their permission. It was not intended as a way to impose what is called a "sub rosa plan of reorganisation". That is a plan of reorganisation of the entire company on which creditors do not get a vote.

In GM's case, the "sub rosa plan" is to sell the valuable assets, with accompanying union contracts, to a new, "good" GM, and leave the money-losing assets in the original company, which is left in the street to bleed cash and die.

GM's law firm, Weil Gotschal, has attempted to use this section of the bankruptcy code in the past, and had only mixed success in doing so. For example, a bankruptcy judge in New York ruled against a similar Weil Gotschal tactic in the Westpoint Stevens case, saying: "The fact that a transaction including a 363(b) sale of assets may ultimately be in the best economic interests of a debtor's various constituencies does not authorise the court to ignore the creditors' rights and procedural requirements of Chapter 11."

Here's how I believe the GM bankruptcy case will play out. The government, the UAW and GM are in a good position to "forum shop", or find a bankruptcy judge who will be sympathetic to the government-UAW plan. That judge may be in New York (convenient for Weil Gotschal, headquartered in New York's GM building), or Michigan (hometown advantage for GM). That judge will almost certainly grant the request of GM, the union and the government for the 363(b) sale.

Then the bondholders do some forum shopping of their own. They could well find a judge in a Federal district court (one level up from bankruptcy court) willing to grant a temporary restraining order blocking the 363(b) sale.

Given the facts of the case, and the precedent on the side of the bondholders, I think it's quite possible that the judge will issue a TRO, and set a hearing on a motion by the bondholders to enjoin the sale.

That will be the end of the good news for the bondholders. The judge will read through the law, and the facts, and then ask an unpleasant question of the bondholders: what's your alternative?...

Their problem is that the US government will be offering not just working capital for GM during its bankruptcy, but "exit financing" for GM's emergence from Chapter 11. That is hard to get now on commercial terms, even on a smaller scale than would be needed for GM.

There are other problems with the government/union plan. The suppliers to the remaining "good" brands will need to spread their fixed costs over fewer parts, and transferring and revising all the contracts is logistically very difficult. Getting effective, decisive management, when the major shareholders have made unconvincing pledges to be hands off and avoid conflicts... very uncertain.

The bondholders still fight a hard, continuing, rearguard action, since they have little or nothing to lose, and want to preserve their rights and legal precedents for future reorganisations.

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à naked capitalism à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

Upward Mobility: Reality and Illusion

C'est tellement fondamental que personne n'en parle en ces termes, mais la notion d'illusion en matière de mobilité sociale est un élément clé du blocage que connaissent les USA aujourd'hui entre l'échec manifeste de leur modèle social, et l'incapacité à en penser la réforme.

 

 

Envoyé par guillaume e via Google Reader :

 

 

Upward Mobility: Reality and Illusion

via Grasping Reality with Both Hands de Brad DeLong le 04/05/09

Ezra Klein:

Ezra Klein : [Russell] Shorto... [thinks that in] the Netherlands.... [T]here's "a cultural tendency not to stand out or excel...the very antithesis of the American ideal of upward mobility." But... Americans are in the odd position of fervently believing in upward mobility while not actually having very much of it. Eruopeans, conversely, don't really believe in economic mobility but have plenty of it.... Brookings... examined the relative mobility in other Nordic countries. And the United States doesn't come out that well.... The United States believes itself to be uncommonly meritocratic. But compared to European countries who don't believe themselves very meritocratic, it actually exhibits less income mobility....

If you believe that your country is extremely mobile, you're likely to believe the results of the economic competition are relatively fair. As such, you won't want to slap the rich with particularly high tax rates and you won't be terribly concerned about spreading economic opportunity. After all, anyone can make it! On the other hand, if you don't believe your country is terribly mobile, then you're less likely to believe economic outcomes are fair. And if you don't believe the outcomes are fair, you're likely to tax the winners relatively heavily and plow those profits into things like universal health care and free college. Policies, in other words, that spread opportunity more widely and thus make your society more mobile. Put like that, it sort of makes sense. If you believe your society is already economically mobile, you don't spend a lot of time trying to solve the problem of insufficient economic mobility. if you don't believe that, then you implement policies meant to increase mobility. What's odd is that the public perceptions in Europe and America don't seem to be changing much in response to actual outcomes.

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à Grasping Reality with Both Hands à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

"Austrian Business Cycle Theory"

 

 

Envoyé par guillaume e via Google Reader :

 

 

"Austrian Business Cycle Theory"

via Economist's View de Mark Thoma le 02/05/09

John Quiggin explains why Austrian business cycle theory "hasn't developed in any positive way" since the 1920's, and has since become "ossified dogma":

Austrian Business Cycle Theory, by John Quiggin: I've long promised a post on Austrian Business Cycle Theory, and here it is. For those who would rather get straight to the conclusion, it's one I share in broad terms with most of the mainstream economists who've looked at the theory, from Tyler Cowen, Bryan Caplan and Gordon Tullock at the libertarian/Chicago end of the spectrum to Keynesians like Paul Krugman and Brad DeLong.

To sum up, although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn't developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas.

The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma. Like all such dogmatic orthodoxies, it provides believers with the illusion of a complete explanation but ceases to respond in a progressive way to empirical violations of its predictions or to theoretical objections. To the extent that anything positive remains, it is likely to be developed by non-Austrians such as the post-Keynesian followers of Hyman Minsky. ... [...continue reading...]

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à Economist's View à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

The Failed Conservative Revolution

 

 

Envoyé par guillaume e via Google Reader :

 

 

The Failed Conservative Revolution

via Crooked Timber de fabio_rojas le 30/04/09

This essay is cross-posted at Orgtheory.net, the social science and management blog. For earlier discussion of this book, with Steve's responses, click here.

Steven Teles' The Rise of the Conservative Legal Movement (RCLM) is an important book. It is one of the few studies to thoroughly address the institutionalization of conservative politics. It's also a well motivated account. Using ideas from contemporary sociology, Teles frames the conservative legal movements as an example of resource mobilization. Winning elections isn't enough to implement conservative policy. One must create conservative networks and organizations that can be used to fight and win court battles.

In this response to RCLM, I'd like to argue that conservative legal movement is a failed movement. We have come to view the period from the 1970s to the 2006 Congressional election as an unqualified victory for the American right. Republicans put three of their own in the White House and gained control of the House of Representatives. The 9/11 era allowed a conservative White House to restructure the Federal government and expand its powers.

However, from a larger perspective, the conservative movement has been a failure. The conservative movement has targeted major policy domains for reform, only to win the occasional battle. Repeatedly, conservative activists railed against the New Deal era regulatory regime, but much of it remains. Cases like Kelo show that repeated appeals to property rights can fail even in courts that have been substantially shaped by conservative ideology. Conservatives have fought against Roe v. Wade, yet abortion remains legal in all states with few restrictions. Nearly all attempts to regulate, or re-regulate, private social life have ended in failure. There have been some victories, such as periodic tax code reforms, or the 1996 welfare reform act, but the state that liberals built in the 1930s and 1960s remains with few modifications.

How does the conservative legal movement fit into this picture? I argue that it mirrors the right's general inability to substantially restructure American life. Let me draw on a few themes from RCLM to motivate the argument. In the closing chapters of RCLM, Teles notes that there is a general frustration within the movement because people seem to be attracted to hot button issues. Unlike liberal legal activists, who might tirelessly fight over a modest case like a tenant-landlord dispute, conservative activists appear most willing to donate their time for ideologically sensitive cases like campus speech codes.

Another theme: much of Teles' book is dedicated to the law and economics school of thought, but Teles' discusses how law and economics has now moved toward the academic mainstream. It's no longer the case that law and economics is exclusively done by conservatives, or that it supports conservative policy prescriptions. Law and economics is now one specialty among many.

What do these two examples show? The first shows that the conservative legal movement has grown by leaps and bounds since the 1970s, but it is not yet at the stage where it can reform the legal system through challenging the law at multiple levels. The movement is unable to take the fight to the "ground" and perform a wholesale reconstruction of the law. The second example shows that the academic system has co-opted law and economics. The law and economics movement probably allowed a cohort of conservative law professors to successfully gain tenure, and it might be a standard tool for analysis in a few areas of law (such as anti-trust), but overall, the legal academy remains a politically liberal institution. The average law student is not required to take law and economics, nor does the average judge automatically rely on economics as an analytical tool. At most, one could say that law and economics is a well regarded specialty in the academy and that a notable group of judges use it.

I'll conclude this essay by providing an interpretation of the conservative legal movement's failure. By the late 1960s, liberals had succeeded in many domains: they regulated the economy in the 1930s, they provided extensive social support policies in the 1960s, they liberalized social mores in the 1970s and beyond. This reconstruction of society triggered various push-backs. The radical left claimed that the liberals hadn't gone far enough, while the right claimed these reforms shouldn't have been done at all.

What prevented the radical left and the conservative right from overturning the liberal society was that they were unable to provide an ideology that could act as a foundation for a new political order. Americans couldn't live in a world without state sponsored safety nets and subsidies. At the same time, Americans could not accept the radical left's promise of a state that appropriated the economy and focused on marginalized groups. Similarly, the conservative legal may have helped judges reach market oriented decisions in some cases, but the legal mainstream could not accept it as a new way of doing law. In the end, the RCLM documents the rise of an important movement, but this movement has only produced a niche in the legal academy, not a revolution in the law.

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à Crooked Timber à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

Luck and Taxes

Ce qui est nouveau, ce n'est pas tant la question (à laquelle Rawls et d'autres ont répndu depuis des décennies) que le fait qu'elle soit posée aux USA aujourd'hui.

Fascinant.

 

 

Envoyé par guillaume e via Google Reader :

 

 

Luck and Taxes

via Economist's View de Mark Thoma le 26/04/09

Robert Frank:

Before Tea, Thank Your Lucky Stars, by Robert Frank, Commentary, NY Times: The link between success and luck is stronger than many people think. Analysis of this connection provides a useful framework for weighing ... recent "tea parties," where orators ... bemoaned their "crippling" tax burdens. ...

Contrary to what many parents tell their children, talent and hard work are neither necessary nor sufficient for economic success..., some people enjoy spectacular success despite having neither attribute. (Lip-synching members of boy bands?...)

Far more numerous are talented people who work very hard, only to achieve modest earnings. There are hundreds of them for every skilled, perseverant person who strikes it rich — disparities that often stem from random events. ...

Malcolm Gladwell reports that a disproportionate number of pro hockey players owe their success to the accident of having been born in January, which made them the oldest, most experienced players in every youth league growing up. For that reason alone, they were more likely to make all-star teams, receive special coaching and eventually become professionals.

Although people are often quick to ascribe their own success to skill and hard work, even those qualities entail heavy elements of luck. ... People born with good genes and raised in nurturing families can claim little moral credit for their talent and industriousness. They were just lucky. ...

Even in markets where luck plays no role, minuscule differences in performance often translate into enormous differences in salaries. ... In law, consulting, investment banking, corporate management and a host of other occupations, the ablest performers are often paid hundreds or even thousands of times as much as others who perform nearly as well.

Another important message of recent research is that a person's salary depends far more on where she is born than on her talent and effort.

For example, as a Peace Corps volunteer in Nepal long ago, I hired a cook who had no formal education but was spectacularly intelligent and resourceful. ... Yet his total lifetime earnings were less than even a very lazy, untalented American might earn in a single year. Well-paid Americans owe an enormous, if rarely acknowledged, debt to the social investments that supported their success.

The president's proposal is modest: raising the top marginal tax rate from 35 percent to 39.5 percent, its level when Bill Clinton left office and well below the corresponding level in most other industrial countries. There has never been a shortage of talented people willing to work hard for success... And the president's proposal would not cause such a shortage...

It would, however, promote more efficient provision of public services... For example,... when government levies higher tax rates on the wealthy, we can provide public services that the wealthy and others greatly value but that would otherwise be beyond reach. Under such a tax system, the heavier tax bill becomes payable only if we're lucky enough to end up among life's biggest winners.

Financially successful tax protesters seem blissfully unaware of how incredibly fortunate they are. To borrow from the late Ann Richards and her description of the first President Bush, they were born on third base and thought they'd hit a triple.

See also Hal Varian's Luck, Skill, and Progressive Taxes:

In the debate over tax policy, the power of luck shouldn't be overlooked, by Hal Varian, NY Times, 2001: President Bush's proposed tax cut has rekindled an age-old debate: how progressive or regressive should the income tax be? ...

Those who argue for a more progressive income tax emphasize equity: a tax dollar paid by a rich person causes less pain than a tax dollar paid by a poor person. Those who argue for a less progressive system emphasize efficiency: the most productive people should face lower tax rates to give them strong incentives to work harder and produce more.

These trade-offs have been examined in the economic literature... This formulation of the optimal income tax problem was first examined by the economist James Mirrlees... In the simplest version of the Mirrlees model, taxpayers differ only in their ability: how much they can produce with a given amount of effort. One striking result of this model is that those at the very top of the income scale should face low marginal rates.

This result emerges from a detailed mathematical analysis, but the intuition is not hard to explain. Let us assume, for the sake of argument, that Bill Gates made $1 billion in 2000, an amount larger than any other American taxpayer. Suppose further that despite the best efforts of his accountants, he ended up paying 40 cents of the last dollar he earned to the Internal Revenue Service.

Consider the following thought experiment: drop the marginal tax rate from 40 percent to zero for all incomes above a billion dollars. The I.R.S. won't lose any revenue from this reduction, since no one has an income larger than $1 billion. And who knows -- the lower marginal rate might encourage Mr. Gates to work a little harder in 2001, producing new products that would make him, and the rest of us, better off.

Of course, the fact that it pays to reduce the marginal tax rate for billionaires doesn't say much about what tax rates should be like for mere millionaires, a point that has been emphasized by Professor Mirrlees himself and confirmed by subsequent researchers, like Peter Diamond ... and Emmanuel Saez... But the intuitive argument presented above is pretty compelling: if income depends only on ability, those at the very top of the income-ability distribution should face low marginal tax rates.

But perhaps this model is too simple. One might well argue that Mr. Gates, as productive as he is, doesn't owe his success entirely to ability: there was a lot of luck involved, too. And, if truth be told, that's probably true even for mere millionaires.

So let's consider a different model: one in which differences in income are a result only of luck and have nothing to do with ability. In this case, the optimal income tax may well involve taxing billionaires at very high marginal rates. True, aspiring billionaires won't work quite as hard, since the after-tax reward from hitting $1 billion has been reduced. But the chances of becoming a billionaire are pretty low anyway, so taxing billionaires at a high rate won't really discourage much effort by those hoping to become one.

Thus a model where luck is the driving force tends to yield a more progressive optimal tax than a model where ability is the driving force. This is about as far as theory can take us, but it highlights the critical question: How much income results from ability and how much from luck?

It is safe to say that this question has not yet been completely resolved by the economics profession. Still, everyone seems to have an opinion about it: if you want to determine whether someone is a Republican or a Democrat, just ask that person whether differences in income come mostly from luck or from ability.

The preliminary evidence available from in-depth surveys like the Panel Study for Income Dynamics at the University of Michigan shows that income varies a lot from year to year for many households. Economists have found that random events like episodes of bad health, accidents, marital dissolutions and family emergencies play a large role in short-run year-to-year fluctuations in income.

A Harvard social policy professor, Christopher Jencks, and his collaborators pointed out many years ago that income inequality among brothers, who share similar genetic and environmental characteristics, is almost as great as for the population as a whole. This suggests that luck is an important factor in the long run as well.

If luck plays a substantial role in the determination of income, it makes sense to have a progressive income tax, creating a form of social insurance in which the lucky subsidize the unlucky. Perhaps the folk singer Phil Ochs had the best answer for why the upper half of the income distribution should pay so much more in taxes than the lower half: ''And there but for fortune, may go you or I.''

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à Economist's View à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

Dark musings, 2009-03-24

 

 

Envoyé par guillaume e via Google Reader :

 

 

Dark musings, 2009-03-24

via The Big Picture de Barry Ritholtz le 24/03/09

Steve Randy Waldman writes the blog interfluidity. His take is usually away from the mainstream, and always interesting.

His most recent discussion on Bank Nationalization is quite interesting

~~~

I often wish I were Mark Thoma. If I were Mark Thoma, I could be smart and paying attention without being bitter.

So I am not wedded to a particular plan, I think they all have good and bad points, and that (with the proper tweaks) each could work. Sure, some seem better than others, but none — to me — is so off the mark that I am filled with despair because we are following a particular course of action.

Unfortunately, I have a darker temperament, a spirit less generous and optimistic than Mark's. I am filled with despair, not because what we are doing cannot "work", but because it is too unjust. This is not my country.

The news of today is the Geithner plan. I think this plan might work very well in terms of repairing bank balance sheets.

Of course the whole notion of repairing bank balance sheet is a lie and misdirection. The balance sheets we should want to see repaired are household balance sheets. Banks have failed us profoundly. We want them reorganized, not repaired. A world in which the banks are all fixed but households are still broken is worse than what we have right now. Too-big-to-fail banks restored to health are too-big-to-fail banks restored to power. The idea that fixing legacy banks is prerequisite to fixing the broad economy is a lie perpetrated by legacy bankers.

I think that critics of the Geithner plan are missing some of its tactical brilliance. My guess is that behind the scenes, Geithner has arranged a kind of J.P. Morgan moment. You know the story. During the Panic of 1907, J.P. Morgan locked a bunch of bankers in a room and insisted they lend to stave a panic. We've already seen one twisted parody of this event, when Henry Paulson locked a bunch of bankers in a room and insisted they borrow money from the Treasury. This second one is more clever. I don't think the scandal of the Geithner plan is going to turn out to be the subsidy to well-connected investors embedded in the non-recourse loan put option. On the contrary, I think that Treasury has already lined up participants for the "Legacy Loans Public-Private Investment Fund" and persuaded them to offer prices so high that despite the put, investors will expect to take a major loss. My little conspiracy theory is that the Blackrocks and PIMCOs of the world, the asset managers who do well by "shaking hands with the government", will agree to take a hit on relatively small investments in order first to help make banks smell solvent, and then to compel and provide "good optics" for a maximal transfer from government to key financial institutions.

Consider a hypothetical asset manager, PIMROCK. PIMROCK reviews a pool of loans held by the bank J.P. Citi of America, and its analysts determine they are worth 30¢ of par value. The bank holds them at 80¢ on its book. PIMROCK agrees to put down $10B to purchase loans from the pool at 82¢ thrilling stock markets everywhere. It was all just a bad dream!

Under Geithner's plan, PIMROCK's $10B permits a $10B equity investment from the Treasury. Then the FDIC levers the whole thing up, providing $6 of debt for every one dollar of equity. So, $140B of bad loans are lifted from J.P. Citi of America, nearly $90B of which is sheer overpayment to the bank.

Of course, as cash flows evolve, PIMROCK's $10B is wiped out entirely, as is the Treasury's investment. The FDIC gets repaid in a bunch of securities worth about $50B, taking a $70B loss. But, as Calculated Risk, likes to say "Hoocoodanode?" These were real market prices, Geithner or his successor will argue. Our private partners lost everything. There was no subsidy here.

Meanwhile, taxpayers will be out around $80B.

Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.

Welcome to America, 2009. Change we can believe in.

The scenario I've presented is a variation on this by Karl Denninger (ht Tyler Cowen).

I liked this post today by Matt Yglesias:

My biggest concern about the PPIP approach to the banking system is that even if it works, what it does essentially is return us to the pre-crisis status quo — banks that are so large that they're too politically powerful to regulate effective and too systemically important to be allowed to fail. That's a recipe for dishonest transactions that produce short-term profits at the cost of blowups. One appealing element of nationalization is that it can easily be made to end in a world in which there is no institution named "Bank of America" or "Citi" and no such gigantic institution.

On the bright side, I'm thankful that we have people like Paul Krugman, Simon Johnson, and Willem Buiter, who fight the good fight while being too eminent to ignore.

On the dark side, try here, here, and here.

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à The Big Picture à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader

 

 

Guest Post: Hedge Fund Socialism?

 

 

Envoyé par guillaume e via Google Reader :

 

 

Guest Post: Hedge Fund Socialism?

via naked capitalism de Leo Kolivakis le 24/03/09

Submitted by Leo Kolivakis, publisher of Pension Pulse.


Wall Street got the news it wanted on the economy's biggest problems -- banks and housing -- and celebrated by hurtling the Dow Jones industrials up nearly 500 points:

Investors added rocket fuel Monday to a two-week-old advance, cheering the government's plan to help banks remove bad assets from their books and also welcoming a report showing a surprising increase in home sales. Major stock indicators surged about 7 percent, including the Dow, which had its biggest percentage gain since October.

Analysts who have seen the market's recent false starts are still hesitant to say Wall Street is indeed recovering from the collapse that began last fall. But the day's banking and housing news bolstered the growing belief that the economy is starting to heal, and that is what had investors buying.

"It's just hard to argue that there isn't an improvement in economic activity on the horizon," said Jim Dunigan, executive vice president at PNC Wealth Management.

The market began turning around two weeks ago on news that Citigroup Inc. was operating at a profit in January and February. A spate of more upbeat economic reports helped the market build on its gains, although the rally stalled last Thursday and Friday.

Analysts said they saw more fundamental strength in Monday's buying than they saw at the start of the rally. Dave Rovelli, managing director of trading at brokerage Canaccord Adams, said there appeared to be less short covering, which occurs when traders are forced to buy to cover misplaced bets that stocks would fall. Short covering contributed to the market's surge after the Citigroup news.

"There is definitely new buying," he said. Rovelli also said the approaching end of the quarter can make money managers eager to buy into a market to make the statements they send to clients look stronger.

Stocks shot higher at the opening and kept going. The Treasury Department said its bad asset cleanup program would tap money from the government's $700 billion financial rescue fund and involve help from the Federal Reserve, the Federal Deposit Insurance Corp. and the participation of private investors.

The market had been waiting for weeks to hear details of the government's plan for helping banks get rid of bad assets. Treasury Secretary Timothy Geithner announced an outline of the program last month but provided few details then about how it would work, leading to a stock plunge that sliced 380 points from the Dow.

But while analysts were pleased with the market's performance Monday, they were also still cautious; Wall Street more than gave back its big yearend rally and continued falling during January and February.

Subodh Kumar, an independent investment strategist in Toronto, said the Fed's announcement that it would buy government debt and the details on plans to help banks are giving traders hope for recovery.

"The market is shedding some of its excess pessimism. That doesn't mean the market goes straight up," he said.

The National Association of Realtors' existing home sales report was overwhelmingly positive for investors although it showed a decline in home prices in February.

Investors are embracing any sign that a glut in homes for sale may be easing. Monday's data followed a dose of good housing news last week as housing starts for February came in much better than expected.

The Dow rose 497.48, or 6.8 percent, to 7,775.86, its highest finish since Feb. 13. It was the biggest point gain for the blue chips since Nov. 13 when they rose 552 points and the biggest percentage gain since Oct. 28, when they rose 10.9 percent. It was the fifth-biggest point gain in the Dow's history.

Broader stock indicators also surged. The Standard & Poor's 500 index rose 54.38, or 7.1 percent, to 822.92, crossing the psychological milepost of 800. The Nasdaq composite index rose 98.50, or 6.8 percent, to 1,555.77.

The Russell 2000 index of smaller companies rose 33.61, or 8.4 percent, to 433.72.

The Dow Jones Wilshire 5000 index, which reflects nearly all stocks traded in America, jumped 7 percent. That's a paper gain of about $700 billion.

More than 10 stocks rose for every one that fell on the New York Stock Exchange, where consolidated volume came to nearly 7.5 billion shares, about even with Friday's pace.

The Dow is now up 1,228 points, or 18.8 percent, from March 9, when it finished at its lowest point in nearly 12 years, although it's still down 1,000 points in 2009. The S&P 500 is up 21.6 percent in that time.

The Dow and the S&P 500 index remain more than 45 percent below their peak in October 2007.

So what should you make out of this rally? It basically confirms that the big banks were waiting for Treasury Secretary Geithner's plan to shore up their balance sheets. Citigroup (C), Bank of America (BAC), Wells fargo (WFC), JP Morgan (JPM) and Goldman Sachs (GS) were all up big today.

Hedge funds and prop traders who wanted more "juice" were out buying the Direxion Financial Bull 3X Shares (FAS), up a whopping 41% today as the financial orgy gripped Wall Street.

Why shouldn't the Masters of the Universe party? Geithner's new plan needs hedge fund and private equity backing:

President Barack Obama and Treasury Secretary Timothy Geithner today unveiled an ambitious plan for a public-private partnership to buy up the toxic assets that have caused bank lending to grind to a halt. But the hedge funds and private equity firms needed to make the Public Private Investment Program work are expressing misgivings amidst Congressional action to restrict bonuses at companies receiving bailout money.

Geithner's plan would use up to $100 billion in bailout money to back private investors that buy some of the hundreds of billions of dollars of illiquid assets and loans that have thus far proven resistant to a solution.

"Our judgment is that the best way to get through this is if we can work with the markets," Geithner told The Wall Street Journal. "We don't want the government to assume all the risk. We want the private sector to work with us."

Some alternative investment executives were briefed on Geithner's plan yesterday. They expressed their concern, not about PIPP, but about the American International Group bonus outcry, and legislation that would tax at a 90% rate any bonuses handed out by firms receiving more than $5 billion in government bailout money.

According to The New York Times, those executives said they would only participate in PIPP if Treasury sets no compensation limits. The Journal says Geithner agrees that they should not be subject to the terms of the AIG legislation, should it pass the Senate and receive the president's assent.

Now that they are not subject to compensation limits, they can focus on scamming the TALF:

Today's new public-private partnership bailout scheme is very similar to the TALF, the Fed program that will let hedge funds lever up their purchases of distressed assets. It's the same deal: The banks get to dump "toxic" assets, the hedge funds set a price, and taxpayers get their money back if anyone makes a profit.

But it looks like the TALF could easily be scammed, resulting in huge losses for the taxpayer.

Zero Hedge explains the process.

1. First the hedge fund buys an asset with a face value of $100 for $80. The hedge fund puts up $2.40, while the Fed contributes the rest, $77.60. Huge leverage.
2. The next day, the hedge fund re-runs the model and realizes that they overpaid the bank. Turns out, it was only worth $20 -- which was where the market had been, sans-government leverage.
3. The hedge fund loses it entire $2.40, and the taxpayer loses its entire $77.60.
4. BUT! The bank buys the asset back from the hedge fund at $20, while paying it a $5 million fee for its trouble.
5. The upshot: The banks sells high, buys low. The hedge fund collects a fee for holding the asset. And the taxpayer is screwed.
   

Good deal, eh!?

It's a great deal for everyone but the chumps footing the bill. And some very smart people are not convinced this plan will succeed.

Nobel-prize winning economist Paul Krugman said in remarks published on Monday that the latest U.S. Treasury bailout program is nearly certain to fail, triggering a sense of personal despair:

U.S. Treasury Secretary Timothy Geithner on Monday unveiled a plan aimed at persuading private investors to help rid banks up to $1 trillion in toxic assets that that are seen as a roadblock to economic recovery.

"This is more than disappointing," Krugman wrote in The New York Times. ""In fact it fills me with a sense of despair."

"The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt," the Princeton University economist said, citing weekend reports outlining the plan.

"This isn't really about letting markets work. It's just an indirect, disguised way to subsidize purchases of bad assets," he added.

Krugman called it a recycled idea of former Treasury Secretary Henry Paulson, who later abandoned the "cash for trash" proposal.

"But the real problem with this plan is that it won't work," he says, adding that bad loans may be undervalued because there is too much fear in the current climate.

"But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus -- for that is what the Geithner plan amounts to -- will change that fact," Krugman wrote.

While the real economy is being hurt by the meltdown of the financial system itself, Krugman says this is not the first or the last time this has happened. And there are lots of roadmaps to get us out.

"It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books," Krugman said.

Time is running out on the Obama administration to take control of the banks - and the crisis.

"If this plan fails - as it almost surely will - it's unlikely that he'll be able to persuade Congress to come up with more funds to do what he should have done in the first place," he wrote.

The White House strongly disagreed with Krugman's assessment, defending the administration plans on the morning talk shows.

"I think Paul's just wrong on this one," Christina Romer, head of the White House Council of Economic Advisers, said on ABC's "Good Morning America" show just ahead of the plan's release.

"This is really tails both the government and the private sector win, heads both the government and the private sector lose. We both are going to have, as the saying goes, skin in the game."

Those same thoughts were expressed by James Galbraith who called Geither's plan "extremely dangerous":

In short, because the plan is yet another massive, ineffective gift to banks and Wall Street. Taxpayers, of course, will take the hit Why does Tim Geithner keep repackaging the same trash-asset-removal plan that he has been trying to get approved since last fall?

In our opinion, because Tim Geithner formed his view of this crisis last fall, while sitting across the table from his constituents at the New York Fed: The CEOs of the big Wall Street firms. He views the crisis the same way Wall Street does--as a temporary liquidity problem--and his plans to fix it are designed with the best interests of Wall Street in mind.

If Geithner's plan to fix the banks would also fix the economy, this would be tolerable. But no smart economist we know of thinks that it will.

We think Geithner is suffering from five fundamental misconceptions about what is wrong with the economy. Here they are:

The trouble with the economy is that the banks aren't lending. The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it. As consumers retrench, companies that sell to them are retrenching, thus exacerbating the problem. The banks, meanwhile, are lending. They just aren't lending as much as they used to. Also the shadow banking system (securitization markets), which actually provided more funding to the economy than the banks, has collapsed.

The banks aren't lending because their balance sheets are loaded with "bad assets" that the market has temporarily mispriced. The reality: The banks aren't lending (much) because they have decided to stop making loans to people and companies who can't pay them back. And because the banks are scared that future writedowns on their old loans will lead to future losses that will wipe out their equity.

Bad assets are "bad" because the market doesn't understand how much they are really worth. The reality: The bad assets are bad because they are worth less than the banks say they are. House prices have dropped by nearly 30% nationwide. That has created something in the neighborhood of $5+ trillion of losses in residential real estate alone (off a peak market value of housing about $20+ trillion). The banks don't want to take their share of those losses because doing so will wipe them out. So they, and Geithner, are doing everything they can to pawn the losses off on the taxpayer.

Once we get the "bad assets" off bank balance sheets, the banks will start lending again. The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they'll sit there and say they are lending while waiting for the economy to bottom.

Once the banks start lending, the economy will recover. The reality: American consumers still have debt coming out of their ears, and they'll be working it off for years. House prices are still falling. Retirement savings have been crushed. Americans need to increase their savings rate from today's 5% (a vast improvement from the 0% rate of two years ago) to the 10% long-term average. Consumers don't have room to take on more debt, even if the banks are willing to give it to them.

Importantly, Galbraith thinks the plan is flawed because it does not deal with the collateral of the borrowers. "Banks will sit there and they will not come back and start a new credit expansion".

"Furthermore, the structural problem of banking system will remain which is that the financial system as a whole is much too large relative to the economy, so the shrinking of the financial system which has to occur to restore its health will not have occured."

For those who think there is no alternative to the public-private investment fund, professor Galbraith says that is "hogwash":

Aside from being legally proscribed, the upside of FDIC receivership is the banks are restructured and reorganized for potential sale (either in whole or parts), Galbraith says. Such was the fate in 2008 of, most notably, Washington Mutual and IndyMac.

Crucially, FDIC receivership also means new management teams for insolvent banks; and Galbraith notes new leaders will have no incentive to cover up the fraudulent or predatory lending practices of their predecessors. Given the entire system was "massively corrupted by the subprime debacle," the professor believes criminal prosecutions on par with the aftermath of the S&L crisis - when hundreds of insiders went to jail - is a likely (and necessary) outcome of the current crisis.

But don't expect to see many "perp walks" if Geithner's current plan comes to fruition. That's one reason Galbraith called the plan "extremely dangerous" in part one of our interview.

So why isn't the Obama administration pushing for FDIC receivership? "Political influence of big banks," the economist says.

One person who enthusiastically supports the new public-private plan is Bill Gross of PIMCO. Mr. Gross was on the Nightly Business Report on Monday calling it a "win- win-win" and stating that the plan will allow buyers and sellers of toxic assets to meet find common pricing levels:

GHARIB: Another prickly area is pricing. The banks are going to want to sell these assets as, at as high a price as possible and the private investors are going to want to buy them at a low a price as possible. So there is a big gap. Could that pricing issue derail the plan?

GROSS: I think it's still a problem. We're just going to have to find out, probably in 30 to 60 days when all of this comes together. I mean the banks up until this point for a typical loan have wanted $0.70 or higher, the private market in terms of buyers have wanted $0.40 or lower and that a huge gap. What this financing does though, this leverage, this availability of money at 1 to 1 1/2 percent financing, in other words, the ability to borrow money at a cheap rate, what that does is make it possible for the 40 percent price to move up to $0.60 or $0.65 and still be on a comparable basis. So buyers and sellers have moved much closer together based upon this particular plan.

GHARIB: All right so if the buyers and sellers finally can work something out, how soon do you think that this could get the credit flowing in the economy?

GROSS: Well, it will take some time. You know, I mentioned it will take 30 to 60 days to implement or to begin to implement this particular plan. And then once the toxic waste so to speak is cleared off the balance sheets if it is, then you know, the new lending will begin and that will take six to 12 months. So this not a situation by any means where the U.S. economy or the global economy is out of the woods. We expect further deterioration in terms of unemployment, further deterioration in terms of economic growth but this is a major step to cushion that process.

GHARIB: But today President Obama was saying that he sees glimmers of hope in the economy and last week we also got some very optimistic comments from Fed chief Ben Bernanke. Are you beginning to see a turn at all in the economy?

GROSS: Not yet. You know, I think that's still six to 12 months out and I think ultimately Susie that when the economy does turn, that those that are expecting it to turn and to move back up to normal levels, to levels of growth of 3 to 4 percent, unemployment rates back to 4 1/2 to 5 percent, that they are sadly mistaken. We are moving to what we call a new normal which reflects a very subdued level of economic growth and a very subdued rate basically of growth for economic assets and financial assets.

GHARIB: Just have a little time left and I hate to leave it on a down note. But worst-case scenario, what if this Treasury plan doesn't work? What does that mean for the economy and for reviving the financial system?

GROSS: Well, if it doesn't work, it means that the basically the $5 trillion hole that Pimco estimates that the U.S. economy has to fill back in, that the Fed, the Treasury, that the fiscal stimulation plan in terms of the budget deficit has to fill in, it means that that would be a tremendous, tremendous effort going forward. Basically this program has to work.

Late tonight, Charlie Rose invited Andrew Ross Sorkin, Joe Nocera and Paul Krugman to discuss the public-private plan (click here to view this interview but it might not be available until tomorrow on the website).

Joe Nocera stated that you can't use the stock market as a barometer of the financial system's health because it too volatile. He said the credit markets hardly flinched on Monday (read this Bloomberg article on bank bond spreads). He was also concerned about the populist backlash, saying it could be profoundly "destabilizing".

Andrew Ross Sorkin mentioned his New York Times article, If Goldman Returns Aid, Will Others?, where he states that Goldman is planning to give back its TARP money soon. On Charlie Rose, he agreed with Joe Nocera's concerns about the populist backlash because it could engender a "domino effect" where weaker banks also want to return TARP funds.

I quote from the article:

It remains possible that Treasury could try to persuade Goldman to hold off on paying the money back until the economy stabilizes. That could stir up a new flavor of public outrage.

For his part, Krugman once again made the most sense, stating that the plan is ensuring another Japanese-style lost decade of "zombie banks". He went over the Geithner plan arithmetic and he said that it's basically trying to "bribe" private funds into buying these assets using government subsidies.

Krugman thinks we need to adopt the Swedish model and bring back the Resolution Trust solution that was used to work through the S&L crisis. He said that he finds it ironic when people say "we are not like the Japanese because we moved faster". In his eyes, we are only prolonging the agony. I couldn't agree more.

Finally, I leave you with this Harper's Magazine article by Ken Silverstein, Hedge Fund Socialism:

There's already much debate about the merits of the administration's plan to clean up toxic assets, but one person I spoke with—a well-connected Democrat representing a big investment firm — was absolutely crystal-eyed about the fundamentals:

Even as details are being worked out, he saw ample opportunities for his firm to make huge profits. Banks, hedge funds and other investors that take part in the plan cannot lose money, thanks to the government's support and guarantees. Taxpayers, he said with a mix of regret and satisfaction, were getting shafted again.

Paul Krugman has it just right:

For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn't, that's someone else's problem.

Incidentally, try to imagine if the Bush Administration had floated this plan. Is there anyone from the liberal blogosphere who wouldn't be denouncing this as a Wall Street giveaway? Particularly given the architects of the Obama administration's plan? As Frank Rich wrote:

"Given that Summers worked for a secretive hedge fund, D. E. Shaw, after he was pushed out of Harvard's presidency at the bubble's height, you have to wonder how he can now sell the administration's plan for buying up toxic assets with the help of hedge funds. It will look like another giveaway to his own insiders' club. As for Geithner, people might take him more seriously if he gave a credible account of why, while at the New York Fed, he and the Goldman alumnus Hank Paulson let Lehman Brothers fail but saved the Goldman-trading ally A.I.G.

I want you to think about something else. Who funds hedge funds and private equity funds? Pension funds, insurance companies, endowment funds, and some banks.

I find it perverse that pension funds will pay 2% management fee and 20% performance fee to some hedge fund or P.E. fund that will then get a government subsidy to buy these assets at 30 or 40 cents on the dollar hoping to sell them to a greater fool at a higher price.

I got a better idea (call it the 'Kolivakis Pension Plan'). Why don't the world's largest pension funds band together to create a "Pension Resolution Trust" taking these assets off the banks' books and then selling them off slowly over many years as the global economy eventually recovers?

Why pay fees to hedge funds, private equity funds or the PIMCOs of this world when you can band together and use your financial clout and deep pockets to make money by directly taking ownership of these assets?

Admittedly, this will require some serious planning, some changes in individual investment policies and some resources to make it work, but it can also help pensions deal with their deficits while they help the credit system get going again.

I think it's time we start thinking "outside the box" and start implementing some long-term solutions to deal with a virulent financial crisis that threatens global peace and prosperity.

 

 

Ce que vous pouvez faire à partir de cette page :

• Vous abonner à naked capitalism à l'aide de Google Reader
• Suivre l'actualité de tous vos sites favoris avec Google Reader