lundi 2 mars 2009

"In Praise of More Primitive Finance"



 
 

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via naked capitalism de Yves Smith le 02/03/09

Analysts, regulators, and politicians are beginning to recognize that most if not all of the widely touted benefits of modern finance redounded only to its purveyors. The decidedly retro Canadian banking system, with simple products, high equity requirements, and relatively modest securities operations that focus on domestic customers, is the soundest in the world. As Theresa Tedesco noted in the New York Times:
The five major chartered banks, the few regional banks and handful of large insurance companies are all regulated by the federal government. Canadian banks are relatively constrained in the amounts they can lend. Canadian banks are required to have a bigger cushion to absorb losses than American banks. In addition, Canadian government regulations protect the domestic banks by limiting foreign competition. They also keep banks broadly owned by public shareholders....

Canadian banks are known to be risk-averse, and this has served them well. While their American counterparts were loading up their books with risky mortgages, Canadian banks maintained their lending requirements, largely avoiding subprime mortgages. The buttoned-down banks in Canada also tended to keep these types of securities on their books, rather than packaging them and selling them to investors. This meant that the exposures they did have to weak mortgages were more visible to the marketplace.

The big five Canadian banks — Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Bank of Montreal — survived the recent turmoil relatively unscathed. Their balance sheets remain intact and their capital ratios are comfortably above requirements.

Columbia University professor Amar Bhide, writing at the Berkeley Economic Press, endorses the idea of a reinstitution of simpler banking practices. The first part of his article offers an insightful, in many respects novel, critique of how we got in our mess. Bhide sees it as long in the making:
The financial debacle— the first to implicate the widespread use of complex financial instruments, rather than simple speculation or imprudent lending— isn't just the result of the recent missteps of bankers, rating agencies or mortgage brokers. Rather, finance has been on the wrong trajectory for more than half a century. Its defects derive from the academic theories and regulatory structures that have evolved since the 1930s—dysfunctional foundations that have not drawn the scrutiny they deserve. And without addressing the deep defects, we are likely to lurch from crisis to crisis.

His recommendation is straightforward:
Reversing many age-old dysfunctions isn't likely. We aren't going to retrain business school processors in the art and science of traditional fundamental analysis or due diligence. Nor is repeal of the Securities Acts or the reprivatization of financial firms on the cards.

We could, however, go a long way to limiting future meltdowns by a simpler more primitive regulatory regime that keeps banks from enabling dangerous and opaque schemes.

Let's revive the radical idea of narrow banking and tightly limit what banks (and any other entities that raise short term deposits from the public) can do: nothing besides making loans—after old-fashioned due diligence— and simple hedging transactions. The standard would simply be whether the loan can be monitored by bankers and examiners who do not have PhDs in finance.

Anyone else: investment banks, hedge funds, trusts and the like can innovate and speculate to the utmost, free of any additional oversight. But, they would not be allowed to trade with or secure credit from regulated banks, except through prudent loans whose collateral and terms can be monitored by run-of-the-mill bankers and examiners.5 This simple, "retro" approach—a more stringent Glass-Steagall Act—would protect depositors, limit the risks of financial contagion, allow the FDIC and Fed to focus on their primary responsibilities, and not require new agencies or more regulators. Less, would in fact, be more.

Speculations and bubbles would not be eliminated, but walling off the banking system would limit the extent of collateral damage. When the internet bubble burst, for instance, nearly half a trillion dollars of wealth evaporated. But because very little bank lending was involved the impact on the economy as a whole was modest.

Some would, of course, lose. Money market funds would lose their free ride—the howls of protest emanating from money market funds at proposed rules that they take some responsibility for their investment choices6 are telling. Financial engineers would lose access to cheap credit—alarming those who claim that the "sophistication" of the U.S. financial system is a prime cause of U.S. prosperity. But, although a modern economy does need the effective provision of some financial basics, such as risk capital, credit and insurance, claims that all the bells and whistles that have been developed over the last couple of decades are a net plus are implausible. Can we really believe that a financial sector now receives more than thirty percent of domestic corporate profits—double its share from twenty five years ago7—because it has produced improvements in mobilizing or allocating capital of that magnitude?

More likely, innovators and entrepreneurs in the real economy prospered in spite of the talent and funds that were taken up by the expansion of the financial sector. So if the financial sector shrinks back to the basics, so much the better for long run prosperity.

 
 

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lundi 9 février 2009

Madame Defarge Watch: Pay Disparity in US Exceeds France Under Its Last King



 
 

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via naked capitalism de Yves Smith le 06/02/09

The Wall Street Journal Economics Blog today featured an update of a chart prepared by Alexis de Tocqueville, author of Democracy in America, comparing the compensation of French and American civil servants, with an update (click to enlarge):



The problem is that this comparison is misleading. The intent is to illustrate pay disparities over time.

However, while the President and the King were indeed the highest paid "civil servants", the President than as now was almost certainly not the highest paid individual, while the King most certainly was. And that's before we get into the royal perks: the castles, staff, stables, artwork, the list goes on). Plus the idea of a king as civil servant is a bit strained too. However, this was the Bourbon Restoration, so kings were a bit more mindful of the citizens than in pre-Revolutionary times.

But the King was almost certainly the richest and best paid individual in France. He made 8,000 times the most menial civil worker. Our disparity (minimum wage versus Lloyd Blankfein) at a mere 5,000+ isn't quite as bad, right?

But Blankfein was far from the best paid American. Forbes told us that the 400 highest earning taxpayers reported $105 billion in adjusted gross income. That averages $262.5 million. $262 million versus the minimum wage level of $13,100 gives a ratio of over 20,000 to one.

Now some will protest that the $105 billion probably includes one time windfalls, like the sale of major businesses. Doesn't wash. We are looking for the disparity top to bottom. I haven't seen any estimates for 2008 yet, and hedge funds had a rougher year, but the Institutional Investor ranking of top hedge fund managers for 2007 showed John Paulson at $3.7 billion, George Soros at $2.9 billion, and James Simons at $2.8 billion.

So the popular perception is right. The super wealthy today are better off than royalty of old. And it's not due to indoor plumbing, either.

 
 

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David Sirota: "Obama's Team of Zombies"

encore sur la déception Obama

 
 

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via naked capitalism de Yves Smith le 07/02/09

David Sirota at Salon gives a concise, brutal assessment of Obama's economic team and its priorities.

We've now had two bait and switch Presidents in succession. Bush promised "compassionate conservatism" and dragged the country far to the right, enriching those at the top of the food chain and leaving everyone else with the empty promise of "trickle down economics." Obama promised change, but his economic team is slavishly loyal to the interests of the financial elite who steered the financial system onto the shoals and now expect all of us to patch the hull and somehow get it back into navigable water. Yes, we have some gestures to appease the downtrodden, like restrictions on private jets and largely meaningless promises of salary caps (Lucien Bebchuk, a Harvard Law professor and expert on corporate governance, described how they do little to restrict total comp). Summers and Geithner are proteges of Robert Rubin, former Goldman co-CEO, and they are proving true to form, promoting even more borrowing in a doomed-to-fail-or-be-counterproductive effort to achieve status quo ante, the very conditions that lead to this shipwreck. Paul Volcker, who is enough of an old-fashioned banker that he might have been able to exert a moderating influence, appears to have been marginalized.

And we also like the fact that he highlights the use of "newspeak", as we did in a post on one of Team Obama's bank rescue trial balloons.

From Sirota:
America was told that finally, after years of yes men running the government, we were getting a president who would follow Abraham Lincoln's lead, fill his administration with varying viewpoints, and glean empirically sound policy from the clash of ideas. Little did we know that "team of rivals" was what George Orwell calls "newspeak": an empty slogan "claiming that black is white, in contradiction of the plain facts."...

Of course, that lockstep [defense policy] uniformity pales in comparison to the White House's economic team -- a squad of corporate lackeys disguised as public servants....

Now, this pinstriped band of brothers is proposing a "cash for trash" scheme that would force the public to guarantee the financial industry's bad loans. It's another ploy "to hand taxpayer dollars to the banks through a variety of complex mechanisms," says economist Dean Baker -- and noticeably absent is anything even resembling a "rival" voice inside the White House.

That's not an oversight. From former federal officials like Robert Reich and Brooksley Born, to Nobel Prize-winning economists like Joseph Stiglitz and Paul Krugman, to business leaders like Leo Hindery, there's no shortage of qualified experts who have challenged market fundamentalism. But they have been barred from an administration focused on ideological purity.

In Hindery's case, the blacklisting was explicit. Despite this venture capitalist establishing a well-respected think tank and serving as a top economic advisor to Obama's campaign, the Politico reports that "Obama's aides appear never to have taken his bid (for an administration post) seriously." Why? Because he "set himself up in opposition" to Wall Street's agenda.

The anecdote highlights how, regardless of election hoopla, Washington is the same one-party town it always has been -- controlled not by Democrats or Republicans, but by Kleptocrats (i.e., thieves). Their ties to money make them the undead zombies in the slash-and-burn horror flick that is American politics: No matter how many times their discredited theologies are stabbed, torched and shot down by verifiable failure, their careers cannot be killed. Somehow, these political immortals are allowed to mindlessly lunge forward, never answering to rivals -- even if that rival is the president himself.

Remember, while Obama said he wants to slash "billions of dollars in wasteful spending" at the Pentagon, his national security team is demanding a $40 billion increase in defense spending (evidently, the "ludicrous" faction got its way). Obama also said he wants to crack down on the financial industry, strengthen laws encouraging the government to purchase American goods, and transform trade policy. Yet, his economic team is not just promising to support more bank bailouts, but also to weaken "Buy America" statutes and make sure new legislation "doesn't signal a change in our overall stance on trade," according to the president's spokesman.

Indeed, if an authentic "rivalry" was going to erupt, it would have been between Obama's promises and his team of zombies. Unfortunately, the latter seems to have won before the competition even started.

Update 2/8, 12:45 AM: An only slightly less caustic take on the Obama economic team comes from the New York Times' Frank Rich:
The new president who vowed to change Washington's culture will have to fight much harder to keep from being co-opted by it instead. There are simply too many major players in the Obama team who are either alumni of the financial bubble's insiders' club or of the somnambulant governmental establishment that presided over the catastrophe.

This includes Timothy Geithner, the Treasury secretary. Washington hands repeatedly observe how "lucky" Geithner was to be the first cabinet nominee with an I.R.S. problem, not the second, and therefore get confirmed by Congress while the getting was good. Whether or not this is "lucky" for him, it is hardly lucky for Obama. Geithner should have left ahead of Daschle.

Now more than ever, the president must inspire confidence and stave off panic. As Friday's new unemployment figures showed, the economy kept plummeting while Congress postured. Though Obama is a genius at building public support, he is not Jesus and he can't do it all alone. On Monday, it's Geithner who will unveil the thorniest piece of the economic recovery plan to date — phase two of a bank rescue. The public face of this inevitably controversial package is now best known as the guy who escaped the tax reckoning that brought Daschle down.

Even before the revelation of his tax delinquency, the new Treasury secretary was a dubious choice to make this pitch. Geithner was present at the creation of the first, ineffectual and opaque bank bailout — TARP, today the most radioactive acronym in American politics. Now the double standard that allowed him to wriggle out of his tax mess is a metaphor for the double standard of the policy he must sell: Most "ordinary Americans" still don't understand why banks got billions while nothing was done (and still isn't being done) to bail out those who lost their homes, jobs and retirement savings.

As with Daschle, the political problems caused by Geithner's tax infraction are secondary to the larger questions raised by his past interaction with the corporations now under his purview. To his credit, Geithner, like Obama, has devoted his career to public service, not buckraking. But he still has not satisfactorily explained why, as president of the New York Fed, he failed in his oversight of the teetering Wall Street institutions. Nor has he told us why, in his first major move in his new job, he secured a waiver from Obama to hire a Goldman Sachs lobbyist as his chief of staff. Nor, in his confirmation hearings, did he prove any more credible than the Bush Treasury secretary, the Goldman Sachs alumnus Hank Paulson, in explaining why Lehman Brothers was allowed to fail while A.I.G. and Citigroup were spared.

Citigroup had one highly visible asset that Lehman did not: Robert Rubin, the former Clinton Treasury secretary who sat passively (though lucratively) in its executive suite as Citi gorged on reckless risk. Geithner, as a Rubin protégé from the Clinton years, might have recused himself from rescuing Citi, which so far has devoured $45 billion in bailout money.

Key players in the Obama economic team beyond Geithner are also tied to Rubin or Citigroup or both, from Larry Summers, the administration's top economic adviser, to Gary Gensler, the newly named nominee to run the Commodity Futures Trading Commission and a Treasury undersecretary in the Clinton administration. Back then, Summers and Gensler joined hands with Phil Gramm to ward off regulation of the derivative markets that have since brought the banking system to ruin. We must take it on faith that they have subsequently had judgment transplants.

Obama's brilliant appointees, we keep being told, are irreplaceable. But as de Gaulle said, "The cemeteries of the world are full of indispensable men." You have to wonder if this team is really a meritocracy or merely a stacked deck. Not only did Rubin himself serve on the Obama economic transition team, but two of the transition's headhunters were Michael Froman, Rubin's chief of staff at Treasury and later a Citigroup executive, and James S. Rubin, an investor who is Robert Rubin's son.

A welcome outlier to this club is Paul Volcker, the former Federal Reserve chairman chosen to direct Obama's Economic Recovery Advisory Board. But Bloomberg reported last week that Summers is already freezing Volcker out of many of his deliberations on economic policy. This sounds like the arrogant Summers who was fired as president of Harvard, not the chastened new Summers advertised at the time of his appointment. A team of rivals is not his thing.

Americans have had enough of such arrogance, whether in the public or private sectors, whether Democrat or Republican. Voters turned on Sarah Palin not just because of her manifest unfitness for office but because her claims of being a regular hockey mom were contradicted by her Evita shopping sprees. John McCain's sanctification of Joe the Plumber (himself a tax delinquent) never could be squared with his inability to remember how many houses he owned. A graphic act of entitlement also stripped naked that faux populist John Edwards.

The public's revulsion isn't mindless class hatred. As Obama said on Wednesday of his fellow citizens: "We don't disparage wealth. We don't begrudge anybody for achieving success." But we do know that the system has been fixed for too long. The gaping income inequality of the past decade — the top 1 percent of America's earners received more than 20 percent of the total national income — has not been seen since the run-up to the Great Depression....

The neo-Hoover Republicans in Congress, who think government can put Americans back to work with corporate tax cuts but without any "spending," are tone deaf to this rage. Obama is not. It's a good thing he's getting out of Washington this week to barnstorm the country about the crisis at hand. Once back home, he's got to make certain that the insiders in his own White House know who's the boss.

 
 

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mercredi 4 février 2009

"The Populist Revolt"



 
 

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via Economist's View de Mark Thoma le 03/02/09

Wake up and smell the populism:

Tom Daschle and the Populist Revolt, by Robert Reich: Tom Daschle's surprise withdrawal today shocked most Washington insiders... So what happened? My guess is that official Washington underestimated the public's pique at what appeared to be the old ways of Washington. Hill staffers tell me that many offices have been inundated with telephone calls, emails, letters and faxes expressing concern (to put it mildly) about Daschle -- not only his failure to pay back taxes but his relationships with major players in the health care industry and rich consulting contracts with the private sector since leaving the Senate, and even the fact that he was given a car and driver by one of them.

What's going on here? Maybe official Washington, much like most of Wall Street, is still not quite getting it.

Typical Americans are hurting very badly right now. They resent people who appear to be living high off a system dominated by insiders with the right connections. They've become increasingly suspicious of the conflicts of interest, cozy relationships, and payoffs that seem to pervade not only official Washington but our biggest banks and corporations. In short, many Americans who have worked hard, saved as much as they can, bought a home, obeyed the law, and paid every cent of taxes that were due are beginning to feel like chumps. Their jobs are disappearing, their savings are disappearing, their homes are worth far less than they thought they were, their tax bills are as high as ever if not higher -- but people at the top seem to be living far different lives in a different universe. They're the executives and traders on Wall Street who have lived like kings for years off a bubble of their own making while ripping off small investors, the financial louts who are now taking hundreds of billions of taxpayer bailout money while awarding themselves huge bonuses and throwing lavish parties, the corporate CEOs who are earning seven figures while laying off thousands of workers, the billionaire hedge-fund and private-equity managers who are paying a marginal tax rate of 15 percent on what they say are capital gains while people who earn a fraction of that are paying a higher rate, and, not the least, the Washington insiders who have served on the Hill or in an administration and then gone on to pocket millions as lobbyists for the same companies they once regulated or subsidized. To the American who's outside the power centers ... the entire system seems rotten. ...

[T]he public wants change, real change, big change. There's no tolerance any longer for the way things used to be done.

The new administration was supposed to bring about real change, not chump change. As much as possible, we need a clean break from the past, and if dropping Daschle helps with that, great -- with all the incrdibly talented people in this country I don't think anyone is indispensable, they only seem that way to the old boys. But in many important areas, a break from the past doesn't seem to be what we are getting.


 
 

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The Bad Bank Assets Proposal: Even Worse Than You Imagined

L'administration Obama n'a pas tardé à décevoir, mais son plan de sauvetage des banques américaines va au-delà de la simple déception.
Yves Smith en donne une bonne synthèse

 
 

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via naked capitalism de Yves Smith le 04/02/09

Dear God, let's just kiss the US economy goodbye. It may take a few years before the loyalists and permabulls throw in the towel, but the handwriting is on the wall.

The Obama Administration, if the Washington Post's latest report is accurate, is about to embark on a hugely expensive "save the banking industry at all costs" experiment that:
1. Has nothing substantive in common with any of the "deemed as successful" financial crisis programs

2. Has key elements that studies of financial crises have recommended against

3. Consumes considerable resources, thus competing with other, in many cases better, uses of fiscal firepower.

The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was. We have no new thinking, no willingness to take measures that are completely defensible (in fact not doing them takes some creative positioning) like wiping out shareholders at obviously dud banks (Citi is top of the list), forcing bondholder haircuts and/or equity swaps, replacing management, writing off and/or restructuring bad loans, and deciding whether and how to reorganize and restructure the company. Instead, the banks are now getting the AIG treatment: every demand is being met, no tough questions asked, no probing of the accounts (or more important, the accounting).

Why is this a bad idea? Let's turn to a study by the IMF of 124 banking crises. Their conclusion:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

In case you had any doubts, propping up dud asset values is a form of forbearance. Japan had a different way of going about it, but the philosophy was similar, and the last 15 year illustrates how well that worked.

What we have from Team Obama is a bigger abortion of a :"throw money at bad bank assets" plan that I feared in my worst nightmare. And (when we get to the Post preview), they have the temerity to invoke triage to make what they are doing sound surgical and limited.

Those who remember the origin know that triage means focusing on the middle third of the wounded on the battlefield : leaving the goners to die, leaving those wounded but stable to fend for themselves for the moment (they were in good enough shape to wait to be transported or hold on to be treated later). The middle third, those in immediate danger but who might nevertheless be salvaged, got top priority.

The concept of "triage" recognizes that resources are limited, tough decision need to be made, and some are beyond any hope. But in Team Obama Newspeak, triage means everyone can be saved because resources are presumed to be unlimited:
The basic problem confronting the government is that banks hold large quantities of assets that they value on their books for much more than investors are willing to pay...

Yves here. The spin is so thick I have to interject after one sentence. Note how the problem is that the investors don't want to pay enough, not that the assets are in most cases fetid? Back to the article:
Since the early days of the financial crisis, officials have struggled to unwind that knot. If the government buys the assets at prices that banks consider fair, the Treasury would take a huge loss when it ultimately sells the assets for much less. If, instead, the government insists on paying market prices, the banks may not survive their losses.

Yves here. See how saving the banks in their current form is presumed to be necessary? This is the phony policy constraint that is leading to all the distortions. The savings and loan crisis' Resolution Trust Corporation is touted as a good "bad bank" model (it's far from the only one). But guess what? It got those bad assets from banks that died. That little detail seems to be neglected in modern accounts.

Back to the article:
Instead of taking a single approach, the Obama administration plans to divide assets and other loans into three categories, each with its own solution, according to sources familiar with the discussions, speaking on condition of anonymity because the details are not finalized.

The government would buy and hold on to those assets whose falling prices are putting banks under the most pressure. Officials want to limit these purchases because of the vast expense.

The centerpiece of the plan would be a guarantee to limit losses on a second group of troubled assets that can be kept by the banks because they have more stable prices.

And it would allow banks to retain and profit from their healthiest assets.

Beyond these initiatives, the government also is likely to inject more capital into troubled institutions.

Yves again. This sounds completely arbitrary, despite the pretense of faux science. Do they want to buy the assets most underwater? The assets most at risk of further price declines? The assets with that are the hardest to value (like lower rated CDO tranches?). It may simply be that the Post reporter doesn't appreciate the issues at work, but I wonder if the extreme vagueness reflects instead failure to come to grips with the real objectives (which means Wall Street will be able to manipulate them) or that they don't want the public to know what is going on (per the persistent stonewalling of efforts to find out what securities the Fed has bought and taken as collateral).

As John Paulson pointed out, a lot of poor quality paper is trading. The idea that it is illiquid is a myth.

The problem is not a lack of price discovery, as the discussion above pretends, it's a lack of investor willingness or ability to take losses. And readers have said if a particular piece of paper doesn't fetch a bid, that's because its real value is not materially above zero. But per above, that's the sort of dreck that Team Obama would buy.

And what, pray tell, is the point of the guarantee? The loss exposure on a guarantee (versus a purchase) at the same nominal price is the same, although the initial cash outlay is considerably different. Ah, but if the paper is guaranteed, then your friendly bank welfare recipient can bring the junk to the Fed and get nice cash back.

So we the taxpayers are going to eat a ton of bank losses that should instead be borne first by stockholders and bondholders This program should be labeled the Pimco bailout plan, since the giant bond fund holds a lot of bank debt. That show what a fiction Obama's populism is. It's mere posturing and empty phrases. Look at where the dough goes, and it is going first and foremost to the big money end of town.

Now I do no labor under the delusion that there are cheap or easy ways out of our financial sinkhole. People are suffering, and we are only partway through the process of contraction and writeoffs. I heard of a suicide today, a jewelry dealer who was $400,000 in debt (also owed a lot of money but unable to collect) who threw himself off 10 West 47th Street (from someone else in the building, this is no urban legend). A tragedy, and a visible one, and there is plenty of less acute but no less real trauma afoot.

But Team Obama is taking the cowardly approach of distributing the costs among the most disenfranchised group in the process, namely the taxpayer, when there far more obvious and logical groups to take the hits. Shareholders and bondholders bought securities KNOWING there was the possibility of loss. A lot of big financial institutions have been on the ropes for over a year. A security holding is not a marriage. When conditions change, prudent investors reassess and adjust course accordingly. If anyone is long a lot of dodgy bank paper now, they have only themselves to blame. Any why are rank and file bankers still exempt from pay cuts when the workers in another failing US industry, autos, expected to take big hits?

This is the most roundabout and probably the most costly way to not solve this problem. Another warning from the IMF paper:
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government's fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

The most amazing bit is the government acts as if it has no leverage. Look how Paulson sent teams in to inspect the accounts of Fannie and Freddie and put them into conservatorship. The reason it is obvious that this program is a crock is that it has ben cooked up in the complete and utter absence of any serious due diligence on the toxic holdings of the big banks.
As we discuss in a separate post, the one punitive element, executive comp restrictions, are mere window-dressing. Welcome to change you can believe in.

 
 

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mercredi 21 janvier 2009

Is Sterling About to Tank?

Il faut bien reconnaître que le seul aspect positif de cette crise est le renversement d'image du royaume uni. Que de chemin parcouru depuis la victoire de Londres dans la sélection des villes olympiques, quand l'on n'avait entendu que louanges du modèle anglais et de son incontestable supériorité.
Yark Yark Yark


via naked capitalism de Yves Smith le 20/01/09

Willem Buiter, who had a ringside seat at the Iceland meltdown, warned that the UK could follow back in November:
With the pound sterling dropping like a stone against most other currencies and credit default swap rates on long-term UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland.

The risk of a triple crisis - a banking crisis, a currency crisis and a sovereign debt default crisis - is always there for countries that are afflicted with the inconsistent quartet identified by Anne Sibert and myself in our work on Iceland: (1) a small country with (2) a large internationally exposed banking sector, (3) a currency that is not a global reserve currency and (4) limited fiscal capacity.

In the rest of a quite long and detailed post he shows how the UK is indeed at risk.

Fast forward, today we have a post from Ambrose Evans-Pritchard on the plight of the pound. Even by his standards (he has a great fondness for apocalyptic views), he is, as he warns, "Seriously Alarmed":
The slide in sterling has turned "disorderly"....

For the first time since this crisis began eighteen months ago, I am seriously worried that British government is losing control.

The currency has fallen five cents today to $1.39 against the dollar. It is now perched precariously on a two-decade support line -- the levels tested in 2001 and 1992. If it breaks that line, traders may send it crashing down towards dollar parity.

The danger is blindingly obvious. The $4.4 trillion of foreign liabilities accumulated by UK banks are twice the size of the British economy. UK foreign reserves are virtually nothing at $60.6bn. (on this, more later in a piece I'm writing today)

If the Government is forced to nationalise RBS and perhaps Barclays with their vast exposure in dollars, euros, and yen, it risks being submerged. It is one thing for a sovereign state to let its national debt jump in a crisis -- or a war -- perhaps even to 100pc of GDP. It is another to take on foreign debts on such a scale with no reserves. Yes, the banks have foreign assets as well to match the debts. But how much are these assets really worth?

This is the moment when the "rubber hits the road" -- to borrow from American argot -- the moment when the reckless debt experiment of our economic and political leaders comes back to haunt.

We cannot even do what Iceland did to save its skin. Reykjavik refused to honour the foreign debts of its buccaneering banks. It let them default, parking the losses in Resolution Committees. Small islands can do that. Iceland has fish instead, and lots of metals.

Britain cannot follow suit. The debts are too big. If London takes such disastrous action it will set off global panic and lead to an asset death spiral, drawing the entire world into deep depression.

What have our leaders wrought? The reckless conduct of City, the fiscal incontinence of Gordon Brown (3pc deficit at the top of the cycle), and the pitiful regulation of the UK housing boom have all combined to bring the country to the brink of disaster.

England has not defaulted since the Middle Ages. There is a real risk it may do so now.

And no -- just so there is no misuderstanding -- it would not have been any better if Britain had joined the euro ten years ago. The bubble would have been just as bad, or worse, as Ireland and Spain can attest. We have our disaster. They have their disaster. When the dust has settled in five years we can make a proper judgement on the sterling-EMU issue. Not now.

The Baby Boomers have had their moment in power. The most spoilt generation in history has handled affairs with its characteristic hedonism. The results are coming in.

The blithering idiots.

The one cheery bit of news is I haven't seen this line of thinking elsewhere....

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vendredi 16 janvier 2009

Central Banks, Markets and Economists: Perpetual Unreadyness

via Paul Kedrosky's Infectious Greed de pk le 15/01/09

I liked this quote from a recent book:

It is a strange paradox that today's central banks are generally staffed by economists, who by and large profess a belief in a theory which says their jobs are, at the very best, unnecessary and more likely wealthy-destroying…

If central banks are necessary because of an inherent instability financial markets, then manning these institutions with efficient market disciplines is a little like putting a conscientious objector in charge of the military; the result will be a state of perpetual unreadyness.
-- Source: The Origin of Financial Crisis. George Cooper (2008)

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mercredi 14 janvier 2009

Sur Keynes et Bastiat, destruction de richesse et stimulus

via Economist's View de Mark Thoma le 14/01/09

Someone from the Cato Institute sent me this with the message "I've been reading your blog posts on the Obama stimulus plan, and I wanted to bring this to your attention, something I think you'll find interesting." I interpret "interesting" to mean "you are mistaken to think fiscal policy can benefit the economy":

Making Work, Destroying Wealth, by David Boaz: Journalists are telling us that John Maynard Keynes, the intellectual inspiration of the New Deal and its tax-and-spend philosophy, is all the rage again. The Wall Street Journal offers an interesting vignette on Keynes's view of how to create jobs:

Drama was a Keynes tool. During a 1934 dinner in the U.S., after one economist carefully removed a towel from a stack to dry his hands, Mr. Keynes swept the whole pile of towels on the floor and crumpled them up, explaining that his way of using towels did more to stimulate employment among restaurant workers.

Now I should say that various people report this story, including Ludwig von Mises, but no one cites an original source. Assuming it's true, though, it just seems to underline the absurdity of the whole "make-work" theory that is back in vogue. Keynes's vandalism is just a variant of the broken-window fallacy that was exposed by Frederic Bastiat, Henry Hazlitt, and many other economists: A boy breaks a shop window. Villagers gather around and deplore the boy's vandalism. But then one of the more sophisticated townspeople, perhaps one who has been to college and read Keynes, says, "Maybe the boy isn't so destructive after all. Now the shopkeeper will have to buy a new window. The glassmaker will then have money to buy a table. The furniture maker will be able to hire an assistant or buy a new suit. And so on. The boy has actually benefited our town!"

But as Bastiat noted, "Your theory stops at what is seen. It does not take account of what is not seen." If the shopkeeper has to buy a new window, then he can't hire a delivery boy or buy a new suit. Money is shuffled around, but it isn't created. And indeed, wealth has been destroyed. The village now has one less window than it did, and it must spend resources to get back to the position it was in before the window broke. As Bastiat said, "Society loses the value of objects unnecessarily destroyed."

And the story of Keynes at the sink is the story of an educated, professional man intentionally acting like the village vandal. By adding to the costs of running a restaurant, he may well create additional jobs for janitors. But the restaurant owner will then have less money with which to hire another waiter, expand his business, or invest in other businesses. Before Keynes showed up in town, let us say, the town had three restaurants among its businesses, each with neatly stacked towels for guests. After Keynes's triumphant speaking tour to all the Rotary Clubs in town, the town is exactly as it was, except the three restaurants are left to clean up the disarray. The town is very slightly less wealthy, and some people in town must spend scarce resources to restore the previous conditions. ...

Now we are told that "Keynes is back," and we need a new New Deal, and the Obama administration is going to create millions of jobs by shuffling money through the federal government. And the theoretical underpinning of this plan comes from a man who thought you could stimulate employment by breaking things. ...

President-elect Obama proposes that the federal government "create or save" jobs by spending upwards of $600 billion. Where would this money come from? If it comes from taxes, it will be taken out of the more efficient private sector to be spent in the less efficient government sector, and the higher tax rates will discourage work and investment. If it is borrowed, it will again simply be transferred from market allocation to political allocation, and our debt burden will grow even greater. And if the money is simply created out of thin air on the balance sheets of the Federal Reserve, then it will surely lead to inflation. ...

You ... can't get economic growth back by breaking windows, throwing towels on the floor, or spending money you don't have.

It's easy enough to dispense with this by simply mentioning public goods, i.e. goods with high social value that, because of market failure, will not be produced without government intervention. Producing these goods is just the opposite of "throwing towels on the floor," and the net benefits from these projects are particularly high now since input costs have fallen so much as the economy has weakened. There are other easy counterarguments as well, but rather than rehashing those, I want to play the window game.

Suppose there is an economy that is humming along at full employment. Then, all of a sudden, out of nowhere, a giant, extremely rare windstorm - it's like nothing anyone can remember - comes along and blows out many of the windows in town's homes and businesses. The windows are broken.

This is unfortunate. The town specializes in delicate goods that cannot be exposed to the weather, and when the windows were broken and the weather rushed in all of the inventory, or much of it anyway, was destroyed. In addition, since all of the town's wealth was invested in the inventory, and then some (i.e. they had borrowed to finance some of the inventory), the people of the town lost both their wealth and their ability to borrow from residents of other towns.

So they are wiped out. With all of their wealth gone and no way to borrow, there is no way to rebuild the town and go on as before. Most people are struggling just to get by each day, they don't have time to repair the windows, let alone the resources to finance the repairs and then restock the shelves.

Or maybe there is a way. Suppose the government steps in and hires people to replace the broken windows, and then makes loans as needed (or makes loan guarantees, with an appropriate allowance for risk, or even outright grants in some cases) to recapitalize the businesses and cover the cost of the repairs. That way, the business owners can purchase new inventory and go on as before (well, not exactly as before, one condition of the government loan is that windows of a certain strength are installed, by regulation if necessary, so that the government financed inventory is safe from another disaster).

Thus, instead of destroying wealth, the government is essential in creating it. After the economy-wide window disaster, the government ignores the advice to turn its back in a time of need, and instead steps in and provides the help that is needed to get the economy up and running again. Because of the government action, the economy is revived, and they all live happily ever after.


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lundi 5 janvier 2009

Risk Management

via Economist's View de Mark Thoma le 04/01/09

I probably should have done more to highlight the article on risk management by Joe Nocera that appeared in the NY Times Magazine this weekend. Fortunately, James Kwak and others have it covered:

Risk Management for Beginners, by James Kwak: Joe Nocera has an article ... about Value at Risk (VaR), a risk management technique used by financial institutions to measure the risk of individual trading desks or aggregate portfolios. ...

VaR is a way of measuring the likelihood that a portfolio will suffer a large loss in some period of time, or the maximum amount that you are likely to lose with some probability (say, 99%). It does this by: (1) looking at historical data about asset price changes and correlations; (2) using that data to estimate the probability distributions of those asset prices and correlations; and (3) using those estimated distributions to calculate the maximum amount you will lose 99% of the time. At a high level, Nocera's conclusion is that VaR is a useful tool even though it doesn't tell you what happens the other 1% of the time.

naked capitalism already has one withering critique of the article out. There, Yves Smith focuses on the assumption, mentioned but not explored by Nocera, that the ... changes in asset prices ... are normally distributed. To summarize, for decades people have known that financial events are not normally distributed.... Yet ... VaR modelers continue to assume normal distributions..., which leads to results that are simply incorrect. It's a good article, and you'll probably learn something.

While Smith focuses on the problem of using the wrong mathematical tools, and Nocera mentions the problem of not using enough historical data - "...VaR didn't see the risk because it generally relied on a two-year data history" - I want to focus on another weakness of VaR: the fact that the real world changes.

Even leaving aside the question of which distribution (normal or otherwise) to use, VaR assumes the likelihood of future events is dictated by some distribution, and that that distribution can be estimated using past data. A simple example is a weighted coin that you find on the street. You flip it 1,000 times and it comes up heads 600 times, tails 400 times. You infer that it has a 60% likelihood of coming up heads; from that, you can calculate the probability distribution for how many heads will come up if you flip it 10 more times, and if you want to bet on those coin flips you can calculate your VaR. Your 60% is just an estimate - you don't know that the true probability is 60% - but you can safely assume that the physical properties of the coin are not going to change, and you can use statistics to estimate how accurate your estimate is. ...

By contrast, imagine you have two basketball teams, the Bulls and the Knicks, who have played 1,000 games, and the Knicks have won 600. You follow the same methodology, bet a lot of money that the Knicks will win at least 5 of the next 10 games - and then the Bulls draft Michael Jordan. See the problem?

Now, are asset prices more like coin flips or like basketball times? On an empirical level, they may be more like coin flips; their probability distributions aren't likely to change as dramatically as when the Bulls draft Jordan.... But on a fundamental level, they are more like basketball teams. The outcome of a coin flip is dictated by physical processes, governed by the laws of mechanics, that we know are going to operate the same way time after time. Asset prices, by contrast, are the product of individual decisions by thousands, millions, or even billions of people... We have little idea what underlying mechanisms produce those prices, and all the simplifying assumptions we make (like rational profit-maximizing agents) are pure fiction.

Whatever the underlying function for price changes is,... importantly, no one tells us when the function changes. Going back to asset prices: To estimate the probability distribution of price changes, you need a sample that reflects your population of interest as closely as possible. Unfortunately, your sample can only be drawn from the past, and your population of interest is the future. So you really face two different risks. You face the risk that, in the current state of the world (assuming you can estimate that perfectly), an unlikely event will occur. You also face the risk that the state of the world will change. VaR, at best (assuming solutions to Smith's criticisms), can quantify the first risk, not the second. ...

There was one part of Nocera's article that I liked a lot:

At the height of the bubble, there was so much money to be made that any firm that pulled back because it was nervous about risk would forsake huge short-term gains and lose out to less cautious rivals. The fact that VaR didn't measure the possibility of an extreme event was a blessing to the executives. It made black swans [unlikely events] all the easier to ignore. All the incentives — profits, compensation, glory, even job security — went in the direction of taking on more and more risk, even if you half suspected it would end badly. After all, it would end badly for everyone else too. As the former Citigroup chief executive Charles Prince famously put it, "As long as the music is playing, you've got to get up and dance." Or, as John Maynard Keynes once wrote, a "sound banker" is one who, "when he is ruined, is ruined in a conventional and orthodox way."

This, I think, is an accurate picture of what was going on. If you were a senior executive at an investment bank, even if you knew you were in a bubble that was going to collapse, it was still in your interests to play along, for at least two reasons: the enormity of the short-term compensation to be made outweighed the relatively paltry financial risk of being fired in a bust (given severance packages, and the fact that in a downturn all CEO compensation would plummet); and bucking the trend incurs resume risk in a way that playing along doesn't. ... Or, in the brilliant words of John Dizard (cited in the naked capitalism article):

A once-in-10-years-comet-wiping-out-the-dinosaurs disaster is a problem for the investor, not the manager-mammal who collects his compensation annually, in cash, thank you. He has what they call a "résumé put", not a term you will find in offering memoranda, and nine years of bonuses.

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vendredi 2 janvier 2009

Qui aurait pu deviner ?

J'aurais dû écrire la même chose

via Grasping Reality de Brad DeLong le 01/01/09

Why oh why can't we have a better press corps?

Hilzoy: "I take the point of [Robert Samuelson's] op-ed to be that he is not competent in his alleged area of expertise, and moreover lacks one of the basic skills that a PhD in a discipline almost always provides: the ability to spot good arguments in that discipline made by other people, and to decide who is worth listening to and who is not":

Obsidian Wings: What Do You Mean 'We', White Man?: Robert Samuelson has an infuriating op-ed in today's Washington Post. It's called "Humbled By Our Ignorance":

"It's the end of an era. We know that 2008, much like 1932 or 1980, marks a dividing line for the American economy and society. But what lies on the other side is hazy at best. The great lesson of the past year is how little we understand and can control the economy. This ignorance has bred today's insecurity, which in turn is now a governing reality of the crisis.

The entire column is devoted to explaining all these things that "we" were ignorant of. But who, specifically, are "we"? It's hard to say. Mostly, it seems to be the nameless subject of the passive voice:

"It was once believed that the crisis of "subprime" mortgages -- loans to weaker borrowers -- would be limited, because these loans represent only 12 percent of all home mortgages. (...)

It was once believed that American consumers could borrow and spend more, because higher home values and stock prices substituted for annual savings. Ed.: Apparently, it was also believed that stocks and home prices always went up.

It was once believed that the rest of the world would "decouple" from the United States.

And so on, and so forth. All these beliefs, and no believers in sight. All this bustle and commotion, and there's nobody around!

The closest Samuelson gets to identifying people who actually believed these things is at the beginning of his piece ("The great lesson of the past year is how little we understand and can control the economy"), and at the end ("Our ignorance is humbling.") Which is to say: it's "us".

And yet, strange to say, I did not believe these things. I'm almost sure I wrote about this in 2006, but I can't recall where, so this from March 2007 will have to do. In it I predict that the mortgage meltdown will knock the legs out from under consumer spending, create a serious credit crunch, and slam the many investors who own CDOs based on mortgages; and that the combination of these three things will be very, very bad, even without taking into account the possibility of systemic risk.

Apparently, I did better than Robert Samuelson. I'm not saying this because I think I deserve credit for that. I don't. That's the point. I'm not especially astute about the housing market, or an expert in economics. I do tend to be common-sensical and cautious about economics -- I do not, for instance, tend to believe such things as: that houses will go up in value indefinitely, or: that we can keep living way beyond our means forever. But that shouldn't exactly set me apart from anyone.

The only reason I saw this one coming was that I read people who know a lot more than I do: people like Paul Krugman, Dean Baker, Tanta at Calculated Risk, Stephen Roach at Morgan Stanley, and Nouriel Roubini. They all challenged one or another of the myths Samuelson lists, and they did so years ago. Moreover, they had arguments to back up their claims, and I found these arguments much more persuasive than the arguments of the people who disagreed with them.

There were very smart people who did predict this. Their writings were not arcane or hard to find -- I mean, I found them, and this is not my area of expertise. Nor was their basic point that hard to grasp. If I could grasp it, then anyone remotely worthy of having an economics column in the Washington Post should have.

Whether or not Samuelson realizes it, I take the point of his op-ed to be that he is not competent in his alleged area of expertise, and moreover lacks one of the basic skills that a PhD in a discipline almost always provides: the ability to spot good arguments in that discipline made by other people, and to decide who is worth listening to and who is not. In his shoes, I would ask myself what, in the absence of competence or the ability to learn from the writings of others, could possibly justify my continuing to take up valuable space in the Post. It's certainly not obvious to me.

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Cool SF illustrations

http://www.conceptships.blogspot.com/
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3 Smart Things About Sleeping Late

via Wired Top Stories de Daniel Dumas le 31/12/07

1 // You may need more sleep than you think.
Research by Henry Ford Hospital Sleep Disorders Center found that people who slept eight hours and then claimed they were "well rested" actually performed better and were more alert if they slept another two hours. That figures. Until the invention of the lightbulb (damn you, Edison!), the average person slumbered 10 hours a night.

2 // Night owls are more creative.
Artists, writers, and coders typically fire on all cylinders by crashing near dawn and awakening at the crack of noon. In one study, "evening people" almost universally slam-dunked a standardized creativity test. Their early-bird brethren struggled for passing scores.

3 // Rising early is stressful.
The stress hormone cortisol peaks in your blood around 7 am. So if you get up then, you may experience tension. Grab some extra Zs! You'll wake up feeling less like Bert, more like Ernie.

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