Annals of CDS Demonization, Michael Lewis Edition

Posted on January 23, 2009 by Felix

Michael Lewis has a grand theory about the CDS market: it was all one big mechanism for paying traders to take a whole bunch of tail risk which would eventually blow up all of Wall Street.

You know, I have yet to have a financial person persuade me that there’s a really useful reason for a credit default swap. I know why they exist and I know why they’re used. They’re mostly used as speculative instruments. And the people who are selling the insurance are mostly selling it because they don’t pay a price for it until everything goes bad.

This doesn’t even make internal sense. Yes, there are some people who speculated with credit default swaps: bought them when they thought they were going to go higher, and sold them when they thought they were going to go lower. Those people, by definition, were marking to market, and would profit by closing out their positions when the market moved in their favor.

On the other hand, there were the long-term investors — pension funds, insurance companies, that sort of thing — who would sell five-year credit protection with every intention of simply insuring that credit for the full five years, and pocketing the insurance premiums. Those players can’t be considered to be speculators — but it was they, most notably at AIG Financial Products, who refused to mark their positions to market and therefore didn’t "pay a price" until it was far too late.

In any case, you don’t need to look for logical inconsistencies to see that Lewis doesn’t understand credit default swaps as well as he thinks he does. You just need to see him getting the basics of the market upside-down:

Lets take a bond, let’s say a General Electric bond. A General Electric bond trades at some spread over treasuries. So let’s say you get, I dunno, in normal times, 75 basis points over treasuries, or 100 basis points over Treasuries, over the equivalent maturity in Treasury bonds. So you get paid more investing in GE. And what does that represent? You get paid more because you’re taking the risk that GE is going welsh on its debts. That the GE bond is going to default. So the bond market is already pricing the risk of owning General Electric bonds. So then these credit default swaps come along. Someone will sell you a credit default swap — what enables the market is that it’s cheaper than that 75 basis point spread — and he’s saying that in doing this he knows GE is less likely default than the bond market believes.

What Lewis is saying here is that the driving force behind the CDS market — "what enables" it — is the fact that the basis between CDS spreads and bond spreads is negative: CDS spreads were lower than bond spreads on the same credit.

Except, they weren’t. In reality, the CDS-bond basis has nearly always been positive, certainly in the days when the CDS market was growing fastest. Far from implying that GE was less likely to default than the bond market believed, the prices on CDS implied that it was more likely to default than the spreads on GE’s bonds implied. Just to take the most obvious example, the credit default swap on the US government is trading at about 60bp, which is 60bp wide of the risk-free rate as measured by the Treasury market: it’s impossible to have a negative basis on US government CDS.

Now there are lots of technical and fundamental factors behind the CDS-bond basis, which aren’t worth getting into here. But if Lewis really believes that a negative basis was the "enabler" of the market, he really should start talking to more financial people.

And yes, there is "a really useful reason for a credit default swap" — it’s pretty much the same as the really useful reason for the existence of equity markets. In the stock market, there are lots of sellers, and lots of buyers, and the public visibility of the market-clearing price creates a lot of value. The bond market, by contrast, has always been much more illiquid: bond investors tend to be buy-and-hold types (remember those pension funds and insurance companies) who buy up bonds at issue and then hold them to maturity. As a result, it can be very hard to short any given bond, or to get a useful bead on exactly what the market-clearing price on any given company’s debt might be. Unless you have a liquid CDS market, which is very useful indeed when it comes to price discovery.

I’m pretty sure that Lewis understands the importance of short-sellers to the stock market; it’s weird he doesn’t understand that the existence of short-sellers in the credit market can serve an equally useful purpose. But if demonizing short-sellers is a popular and easy sport these days, demonizing the CDS market is easier still. More’s the pity.

(Via Kling, who also demonizes CDS, reiterating the same arguments I addressed last month.)

Posted in derivatives | 1 Comment

US News’s Doomed Subscription PDF

Posted on January 23, 2009 by Felix

Jeff has the news today that US News is launching a $19.95-per-year weekly PDF. The decision comes almost exactly ten years after Slate went free, after a disastrous attempt to charge $19.95 a year for its content:

Bill Bass, an analyst at Forrester Research Inc., said that the issue was one of supply and demand. ”Last year, I said this was the dumbest thing I had ever heard,” he said. ”There is so much free content on the Web that if you try and charge for it people won’t go to you. There is too much substitutable content.”

In the past decade, of course, the amount of free content on the web has increased exponentially, especially when it comes to the "politics and policy" beat of the new PDF.

But US News isn’t simply adopting the failed Slate model of 1998. It’s also adopting the failed Slate model of 1996:

SLATE is basically a weekly: Most articles will appear for a week. But there will be something new to read almost every day. Some elements will change constantly. Other elements will appear and be removed throughout the week. Every article will indicate when it was "posted" and when it will be "composted." As a general rule the Back of the Book, containing cultural reviews and commentary, will be posted Mondays and Tuesdays, the longer Features will be posted Wednesdays and Thursdays, and the front-of-the-book Briefing section will be posted Fridays. If you miss something, you can easily call it up from our archive, "The Compost."

Obviously, that didn’t last long: artificial once-a-week publishing schedules were never going to work online. If a story is written and ready to go, neither its author nor its readers have any interest in sitting and twiddling their thumbs, waiting for the calendar to tick over to whatever day the publisher thinks that the article should appear. This kind of thing just seems funny nowadays:

U.S. News Weekly will have near-instantaneous turnaround: The magazine will close on Thursday night and be made available at noon on Friday.

Er, that’s not "near-instantaneous", it’s a timelag of a good 12 hours, which is a long time in today’s news cycle. But more to the point, many of the stories will have been written long before Thursday night, and the wait until noon on Friday is going to be excruciating for any writer who sees his story growing staler by the hour.

But wait, it gets worse. US News, in going subscription-only, is making a conscious decision to remove itself from the vibrant politics-and-policy debate online. That’s silly, but at least they know they’re doing it. But the decision to go PDF is just crazy: even Slate circa 1996 didn’t make that mistake, and realized that it was ridiculous to give up the freedom to add new content throughout the week, and to offer interactive features.

What’s more, there are two things you can do with a PDF: you can print it out and read it on paper, or you can read it on-screen. US News is going to have subscribers in both camps. But if you’re reading on paper, you want parallel columns and intelligible two-dimensional page layouts; if you’re reading on screen, you want easy scrolling and a much more one-dimensional beginning-to-end format. The two are almost impossible to reconcile.

The editor of US News, Brian Kelly, tells Jeff that "if you can get 200,000 people to pay for a product, you’re doing very well". When Slate abandoned its subscription experiment, it had a paid subscriber base in "the high twenty thousands". US News will be hard-pressed to achieve even that number, given the level of competition it faces from the likes of Politico and the print newsweeklies, including the Economist, all of which are free online.

I give this experiment six months to a year before it’s abandoned when the writers for the weekly realise they’re basically shouting into a void, and the publishers realise they’re not making any money off it. It might even last less time than that, if US News print subscribers don’t bother to download the PDF — which is being offered to them for free. This product not only isn’t worth $19.95 a year, it’s not even valuable enough to persuade anybody to subscribe to the print edition of the magazine, or to renew their subscription. It’s doomed, and the only question is when it’s going to die.

Posted in Media | 1 Comment

Using Software to Gauge Hedge Fund Risk

Posted on January 23, 2009 by Felix

I had an interesting chat with Olivier Le Marois, the CEO chairman of Riskdata, a couple of days ago. His company has put out a couple of interesting reports: one on blow-up-prone hedge funds generally, and one on Bernie Madoff in particular. In both cases, Le Marois claims that his software, which looks only at the data that any investor or potential investor has access too, would have raised lots of red flags, without any need for deep forensic analysis or intrusive investigations of operational risk.

Le Marois is the first to admit that red flags can be a false alarm. But if you avoided any funds with his red flags, you would pretty much have avoided all the most spectacular blowups. You might have thereby stayed out of funds which were posting what seemed to be very good risk-adjusted returns, "but risk management has a payoff," he says. "Like an insurance policy, you are very at ease if you never see it materialized. You might slightly underperform your peers. But you get rewarded for that when things go really wrong."

Le Marois says that just by looking at a fund’s published returns and its stated portfolio and strategy, he can tell with surprising reliability when it’s doing something dangerous. Such activity falls into one of three buckets, he says.

The first is simple manipulation of the returns, where managers smooth out their returns by "storing" outperformance from excellent months and applying it to bad months. In that case, you nearly always find a huge discontinuity at zero: there are many more small positive months than there are small negative months. Which is a huge red flag. And there are other indicators, too, which are built into Riskdata’s bias ratio.

Riskdata’s numbers are quite impressive: out of a universe of 2,281 funds, 20 have had a bias ratio of more than 6 on Riskdata’s scale. Those 20 included all six hedge funds — including Fairfield Sentry, the Bayou Superfund, and Beacon Hill’s Safe Harbour fund — which proved to be outright frauds.

The second sort of dangerous behavior involves simply being lucky rather than fraudulent. If you were simply long credit between 2003 and 2006, you made lots of money — but carried much more risk than your volatility numbers would suggest. Most relative-value fund managers, says Le Marois, are playing this game: relative-value trades are generally based on mean-reversion. But as LTCM famously found out, they can blow up spectacularly. Again, this kind of arbitrage-driven management style is quite easy to detect, and often fund managers are happy to say that’s exactly what they’re doing.

Finally, there’s the classic Capital Decimation Partners strategy of simply selling out-of-the-money puts. This is also relativey easy to detect: you look for funds which are short gamma.

Long-gamma funds, says Le Marois, tend to be much safer places to be than short-gamma funds when a blow-up occurs. Many macro and commodity funds are long-gamma: they’re long when markets are going up, and short when markets are going down. That doesn’t necessarily mean they’ll outperform, but it does mean they’re much less prone to disaster.

Of course, there is still operational risk: Riskdata’s system doesn’t capture that. But "it’s easy to diversify operational risk," says Le Marois — simply invest no more than 3-4% of your funds with any single manager.

I don’t for a minute think that Riskdata’s system is a one-stop off-the-shelf alternative to hiring an experienced risk auditor to really take a long, hard look at any given fund. But it’s a hell of a lot better than nothing. And it can be applied not only to individual funds but also to your entire portfolio, so that you can see when you’re overinvested in certain strategies or are taking on more overall blowup risk than you thought. So it sounds like something helpful, which is likely to do relatively little harm so long as you don’t rely on it to the exclusion of anything else.

At the end of our conversation, I asked Le Marois what he thought of the Sharpe ratio. He didn’t need any prompting:

Sharpe ratio is the most stupid way to compare funds, and is a huge incentive to invest in Madoff-like funds. CAPM is absolutely outdated. It makes sense when you have very simple risk patterns, when you have Gaussian distributions, and no derivatives and no illiquid assets. But the current world has nothing to do with that world. People have highly asymmetrical payoff structures. There are plenty of illiquid securities. All this makes it very easy to get around this kind of evaluation ratio. We have to acknowledge that we are living in a complex world, and stay away from an oversimplified systematic view.

All of which makes sense to me. After all, a low high Sharpe ratio is something that both LTCM and Bernie Madoff had in common. Which hardly commends it.

Posted in hedge funds, risk | 1 Comment

Adding Up the White House Pay Freeze

Posted on January 23, 2009 by Felix

The Washington Post reckons that Barack Obama has saved the nation about $443,000 by freezing the salaries of any staffers on six-figure salaries. But the real number is surely much less than that — and could be as low as $17,000.

The reason is the unknowable counterfactual: how much more would staffers be making if it weren’t for the pay freeze? The Post bases its estimate on the average cost-of-living and merit increase over the past five years, which works out at 2.8%. But the cost of living didn’t go up last year: CPI was only 0.1%. And you can’t really get a merit increase on a brand-new job.

If salaries rose only in line with inflation, then, the 120 staffers making more than $100,000 a year — who between them make about $17 million annually — would have seen their pay rise only about $17,000 between them. Which is a savings, but not much of one.

On the other hand, if you gave them all a 2.8% raise, by my calculations that would come to $478,000. So I’m not sure where the $443,000 number comes from.

Posted in pay | 1 Comment

Geithner on China’s Currency Manipulation

Posted on January 23, 2009 by Felix

Tim Geithner’s testimony about China’s currency manipulation is the top story in the world today, judging by the NYT’s front page. And he did indeed say three times in his written responses to the Senate Finance Committee that "President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency."

The general reaction in the blogosphere has been dude, I thought you liked a strong currency. And this isn’t manipulation anyway. And does this mean we’re asking them to sell their dollars now? Etc. But looked at in the context of the full set of responses, I see this answer a bit differently.

The overwhelming impression one gets from reading the full 102 pages is that Geithner never wants to answer a question directly, always wants to leave open the possibility that he might agree with the senator asking the question, and is generally taking a don’t-spook-the-horses approach to the committee. Remember that his answers are key in determining whether his nomination will get voted through by the committee, and in fact that’s their only real purpose.

Looked at in that light, it’s on the face of it a bit weird that he’s taking such a strong view on China when he’s so good at taking no view at all on, say, Cuba. But think about it for a second: which committee member, if any, would actually object to Geithner’s statement that China is manipulating its currency? Politically speaking, as far as the finance committee is concerned, the upside to such a statement is significant, while the downside is limited.

Still, didn’t Geithner know that the Chinese would read his comments, and not just the senators? Of course. But if you’re going to say something which, at the margin, risks weakening the dollar and raising Treasury’s borrowing costs, what better time to do so than a day when the dollar is very strong and Treasury’s borrowing costs are almost zero? Yes, the low interest rates on Treasury bonds will make it much easier to finance the upcoming stimulus package. But Treasury also has a broader interest in pricking the Treasury bubble and getting credit flowing elsewhere.

What’s more, Geithner was careful to take this position only after Barack Obama had personally laid it out first. This is also true of Geithner’s other substantive statement: "President Obama has said that he wants to reform the IMF to increase developing

country representation." Geithner clearly — and understandably — doesn’t feel comfortable taking public positions on issues which Obama hasn’t already nailed down before he’s even been confirmed. But when Obama has nailed down a position, the least Geithner can do is reiterate it: neither the Senate nor China can really blame Geithner for Obama’s previously-announced policies.

So, like Dan Drezner, I’m not sure the China part of Geithner’s testimony was really such a big deal. But I’m clearly in the minority here.

Posted in china, Politics | Comments Off on Geithner on China’s Currency Manipulation

It’s Time for GE to Lose its Triple-A

Posted on January 23, 2009 by Felix

GE’s triple-A credit rating is so important, especially now that it has been threatened by S&P, that it has overshadowed the company’s earnings this morning. But really it’s high time that GE lost the rating, which is a throwback to the pre-crisis era. Why?

  1. The slogan is familiar by now: any company reliant on its triple-A rating shouldn’t have one. GE should by rights be a large industrial company, but over the years, thanks to that rating, GE Capital — essentially an in-house SIV — became a monster which grew to a point where it drives the company’s earnings and success. It became so big, in fact, that it needed its very own Fed bailout. This is not healthy.
  2. Triple-A means risk-free, and GE isn’t that, as one look at its spreads will indicate: five-year GE bonds are trading at 326bp over Treasuries, which, as Eric Falkenstein says, is "a spread that most junk bonds had in 2006". And if we’ve learned one thing over the course of this crisis, it’s that when a triple-A company sees spreads at that kind of level, it won’t keep that rating for long.
  3. If it wasn’t for the Fed stepping in to save the day, GE would have had a massive liquidity crunch already, simply incapable of rolling over its whopping $515 billion in liabilities. In other words, a large part of the triple-A is simply the moral hazard of GE being too big to fail — and since that’s the case, the government should by rights be getting paid for its de facto backstop. Instead, the shareholders are receiving $13.4 billion a year.
  4. GE’s creditors can no longer take solace in the fact that if push came to shove, GE could borrow against its assets in order to pay them off when their debts come due. GE’s unsecured debt is trading at high spreads, but there’s no indication that GE’s secured borrowing costs are any lower. After all, who has a long-term cost of funds low enough to make money lending to GE at low secured rates?
  5. Since it’s not a bank, GE has made zero efforts to mark those assets to market. There’s no doubt they’ve fallen a lot in value, but your guess is as good as mine when it comes to how much they’ve fallen in value. It’s probably not enough — yet — to wipe out GE’s equity, but it might well be enough to make that equity cushion so thin that a triple-A rating is no longer warranted.

The fact that GE reckons it can still pay a $13 billion dividend and be profitable is indication that it’s a relatively safe company, at least unless or until investors start trying to mark its assets to market. Now it’s not clear why they should do that, since those assets were always being held to maturity, and there’s no reason why GE should ever want to sell them off. But on the other hand, there’s also no reason why shareholders should consider those assets to really be worth par — which is what GE is reporting.

In any case, no company with half a trillion dollars of liabilities can sensibly have a triple-A rating in this market: GE is simply too leveraged to justify such a thing. Which is maybe why, at $12.55 a share, the stock is at its lowest level since 1996.

Posted in credit ratings | 1 Comment

Is Nationalization Contagious?

Posted on January 23, 2009 by Felix

Those of us in favor of bank nationalization don’t want to nationalize all banks, just the massively insolvent ones which are too big to fail. But let’s say that the government took over Bank of America and/or Citigroup, wiping out shareholders and probably preferred stockholders as well. What would happen to JP Morgan Chase and Wells Fargo? Would their stocks plunge in fear that they, too, might get nationalized, with their stock going to zero? And would such a plunge end up becoming a self-fulfilling prophecy?

I frankly don’t know the answer to that question, but it is something for those of us in favor of nationalization to think about. If nationalizing Citigroup would constitute a death sentence for JP Morgan and Wells Fargo, such a decision could involve a great deal of wealth destruction, given that those two banks are worth $140 billion between them.

Update: I should mention that this idea obviously comes straight from Tyler Cowen, whom I linked to earlier. But then I went out for drinks with a friend, and talked about these things, and then I watched a documentary about Helvetica, and by the time I posted this entry I knew the idea was in my head but had forgotten exactly where it had come from. Thanks to Jim Surowiecki for working it out for me. In any case, here’s how Tyler put it:

The risk is that nationalization becomes a contagious idea and spreads from one bank to the next, acting as a self-fulfilling prophecy.

Obviously, the contagious-nationalization meme is almost as contagious as nationalization itself!

Posted in banking | 1 Comment

Extra Credit, Thursday Edition

Posted on January 22, 2009 by Felix

Will the Banking Crisis End with Nationalization? A very interesting discussion, if I do say so myself, between Binyamin Appelbaum, Peter Cohan, Simon Johnson, and me. The upshot: nationalization is politically unpalatable, but there are very similar alternatives which can and should be adopted instead. The NYT also joins the debate about Nationalizing the Bank Problem.

Dollar schizophrenia: "Either America is very upset with China for doing something that’s in America’s national interest, or American officials are very much opposed to things which are in the national interest, or quite a bit of Treasury testimony and public statements generally consists of large loads of hooey. Naturally, it’s the latter. On this score, at least, the new boss will be just the same as the old boss."

The Dirt Bag Chronicles: Hank Paulson, Bob Rubin, John Thain… is Goldman’s reputation finally losing its luster?

Book Review: "The Decline and Fall of the British Aristocracy": I’m beginning to think that the best thing to do with money is just spend it. Solves all your long-term investment problems at a stroke.

That JP Morgan picture – official redux: JP Morgan finally gets the area vs diameter thing right.

Christopher Cox Leaves: To zero lamentation.

Did John Thain lose his job because he acted like it’s still 2007? Spending $1.2 million on decorating your office "is all basically stuff that top Wall Street executives do", says Justin Fox. But Thain, says John Gapper, is "unusually low-key, modest and amiable for a Wall Street executive". Which makes one wonder what other Wall Street executives spend on their offices.

Rep. Oberstar: Rail Had to Take a Back Seat to Tax Cuts: It doesn’t make sense to cut stimulus spending on passenger rail.

Obama Will Get His Blackberry: Some good news for 44, he probably needs it.

Posted in remainders | 1 Comment

Welcome to the Atlantic’s Business Channel

Posted on January 22, 2009 by Felix

Finance, it would seem, is hot these days. Four months after Slate launched its spin-off finance site, The Big Money, the Atlantic has followed suit, with its own business channel. Like TBM, there’s lots of green in the color scheme (green=money, geddit?); the main difference would seem to be that the Atlantic’s site is slightly bloggier and wonkier, while Slate’s site tries to appeal to a more generalist audience.

The good news is that both spin-offs now serve up full RSS feeds. That’s in contrast, interestingly enough, to the feeds at the main Slate site.

And the better news is that the Atlantic has managed to persuade Tyler Cowen to contribute to its new business channel; his first entry there makes some important points about the downside of bank nationalizations.

With any luck, this growing proliferation of professionally-run finance sites (see also: Clusterstock, Seeking Alpha, and more that are in the works) will boost the demand for business and finance content across the board, as well as provide some much-needed cash for many of the best bloggers out there. Memo to the Atlantic: get in touch with Abnormal Returns, there’s definitely a mutually-beneficial deal to be done.

Posted in blogonomics | 1 Comment

John Thain, RIP

Posted on January 22, 2009 by Felix

It was always a bit weird that John Thain was going to stay on at Bank of America, but as it turned out, he lasted less than a month before getting fired this morning by the equally-beleaguered Ken Lewis. The important number here is the $15 billion in unexpected losses that Merrill suffered in the fourth quarter, not the $1.2 million that Thain ridiculously spent tarting up his Merrill office. But that’s icing on the cake: the super CEO who worked wonders at both Goldman Sachs and the NYSE — the man whose name was on the shortlist for every financial CEO job in America — is now a national laughingstock.

Thain didn’t get on with his Merrill subordinates, and Gregory Fleming, who left after one too many fights with Thain, is probably wondering right now if there’s any way he can persuade Lewis that he should return. The only real winners in this saga are Merrill’s bondholders, and the employees who got their bonuses before the takeover closed; everybody else is a loser. Including, of course, the taxpayer. Normally it takes at least a few months for disastrous takeovers to be recognized as such; in this case it took only a couple of weeks. Even with Thain gone, Lewis himself is unlikely to last much longer.

Posted in banking, defenestrations | 1 Comment

Geithner’s Written Responses to the Senate Finance Committee

Posted on January 22, 2009 by Felix

Does Kentucky senator Jim Bunning read Market Movers? If not, we’re certainly thinking along very similar lines. If you scroll down to page 45 of the 102 pages (!) of written responses from Tim Geithner to the Senate Finance committee, you’ll find a question from Bunning which is almost identical to the one I wanted to see asked. Geithner’s answer isn’t nearly as contrite as you might expect:

Bunning: The New York Fed oversees the Fed’s Large Financial Institutions regulation.

Therefore, as President of the New York Fed, one of your most important

responsibilities is regulating and preventing the collapse of systemically important

banks. And that has been your job since 2003, which means it was your job to

watch those institutions during the time they acted most irresponsibly and made the

decisions that eventually led to our current crisis. All one has to do is look at the

near-total collapse of Citigroup to see that you failed at that job. Why did you fail

at that job and why should that not disqualify you from overseeing the entire

financial system?

Geithner: There were systematic failures of risk management and supervision across the financial

system, and addressing these failures will require comprehensive changes to financial

regulation here and around the world. As President of the New York Fed, I led a number

of initiatives to strengthen the financial system ahead of this crisis. Those efforts were

important and effective in addressing many of the weaknesses at the center of past

financial crises, and they helped limit the damage caused by the present crisis. But those

efforts were inadequate.

Essentially, Geithner is saying that it wasn’t his fault — he did what he could — but rather the fault of the entire global regulatory set-up. This might be true, but the New York Fed was hardly powerless, and could certainly have done more to constrain Citigroup’s risk-taking. As Geithner himself says elsewhere:

Citigroup’s supervisors, including the Federal Reserve, failed to

identify a number of their risk management shortcomings and to induce appropriate

changes in behavior.

It would have been nice to see a first-person pronoun in that answer somewhere, instead of seeing Geithner blame only the Fed generally, rather than himself specifically.

In general, Geithner’s answers are highly diplomatic and content-free, with lots of stuff like this:

The U.S.-China economic relationship presents significant challenges, but also

opportunities. It is one of our most important relationships. There are many specific

issues in our economic relationship that require our careful and prompt attention.

If confirmed, I am committed to a deep engagement between our senior economic

officials to address differences and effectively resolve problems on these topics.

Geithner’s ability to "answer" numerous questions about Cuba without giving any hint of what he actually believes on the subject is weirdly impressive in its own way, but also makes him look like a politics-as-usual Washington insider. Even his answer to Orrin Hatch’s point-blank question about nationalization is uncomfortably mealy-mouthed:

Hatch: Do you believe that nationalizing our financial institutions is necessary to save our economy?

Geithner: I believe that the best outcome for the economy is a financial system that resides in

private hands, with appropriate and effective oversight and regulation, and strong

incentives for private market participants to invest. We nonetheless face a situation in

which the U.S. government is currently providing extraordinary support to many

financial institutions in order to avoid a catastrophic collapse in the functioning of the

system and in the flow of credit to households and businesses. We believe these

aggressive actions are necessary to prevent the need for an even greater outlay of funds in

the future. However, we will make sure that the support the government is providing

comes with strong, carefully designed conditions to protect the taxpayer, to provide much

greater transparency about how the money is being spent and the results being generated,

and to improve the possibility that private capital comes in and replaces government

capital as quickly as possible.

I, for one, have no idea what that means — which is almost certainly Geithner’s intent. But Geithner must have smiled when he wrote this: it’s a statement which he will surely be called on to repeat, mantra-like, with great regularity.

A strong dollar is in America’s national interest.

I’m not entirely sure why it’s such an important part of the Treasury secretary’s job to recite those exact words, but Geithner clearly understands that it’s one thing he has to do.

There are a few more areas where Geithner’s answers provide a bit of real substance: he says explicitly, for instance, that "China is manipulating its currency", and he also says that he’s going to start forcing banks getting government assistance to lend:

As a condition of federal assistance, healthy banks without major capital shortfalls will

increase lending above baseline levels.

But the weirdest bit of the testimony, for me, is the way in which Geithner recused himself from the negotiations with Citigroup. Was that because of his status as a former underling of Bob Rubin?

As part of my responsibilities as President of the New York Fed, I had a number of discussions with senior Citigroup executives and Board members in the weeks leading up

to the most recent package of support. I did not, however, participate in the negotiations

with this firm…

I participated in internal discussions with the Secretary of the Treasury, the Chairman of

the Federal Reserve and the other heads of agencies on broad options, but I removed

myself from any direct role in discussions with the firm on Friday evening, November 21,

2008.

Or maybe Geithner just felt like grabbing a movie that night. We’ll probably never know.

Posted in Politics | 1 Comment

Citicorp to Keep Banamex

Posted on January 22, 2009 by Felix

Lede of the day comes from Reuters:

Citigroup Inc views its Mexican banking unit Banamex as a solid business and has no plans to sell it, sources familiar with the matter said.

And here was me thinking that Citi’s few remaining solid businesses were the ones they were most likely to sell.

It’s an interesting decision, given that Banamex has been operated largely at arm’s length since its acquisition; that it’s the one arm of the Citi empire which has stubbornly refused to adopt the Citi name; and that it was never part of the old Citicorp. But you do need to be in truly dire straits before you decide to sell off a powerful monopoly like Banamex.

Posted in banking | 1 Comment

Bank Regulation Datapoint of the Day

Posted on January 22, 2009 by Felix

From Binyamin Appelbaum:

Since 2000, about 240 banks have converted from federal to state charters…

About 12 percent of the banks that moved to state charters escaped federal regulatory actions, and experts on bank oversight say such cases are the tip of a broader pattern. They note that some banks convert in anticipation of a public enforcement action, or after persuading federal regulators to terminate an action.

If the Feds are barely qualified to regulate this nation’s banks, the chances of every state being able to do so are exactly zero. The first order of regulatory reform should be to abolish state regulation of lenders and insurers: it’s a recipe for lax oversight and enormous loopholes.

(Via Chittum)

Posted in banking, regulation | 1 Comment

Extra Credit, Wednesday Edition

Posted on January 22, 2009 by Felix

Wind down the market in five-legged dogs: A clear and simple argument against securitization.

Nominees and double standards: A woman in Tim Geithner’s position might have had a much harder time.

We’re all nationalizers now: "The question does not seem to be whether we nationalize, but what we nationalize".

Parsons Named Citigroup Chairman: Another for the deckchair-rearrangement annals.

After Sure-Bet Investment Fails, a Bank Contends It Was Duped: When a bank with $65 billion in assets claims to be an unsophisticated investor, taken advantage of by the duplicitous Deutsche Bank, it can’t expect much sympathy.

Sforzian Backlog: "Yay, Obama, &c. &c., and the new robots.txt file is a transparent joy, but the dude just broke every inbound link to whitehouse.gov of the last eight years."

Posted in remainders | 1 Comment

Citigroup Chart of the Day

Posted on January 22, 2009 by Felix

citibook.jpg

Many thanks to David Sunstrum, who put this chart together for me. The blue bar is Citi’s book value per share, as reported in the bank’s quarterly reports. It reached a high of $25.53 in the second quarter of 2007, and since then has fallen by 42% to $14.70. The fact that it’s still positive is what Jim Surowiecki is referring to when he says that Citi is "at the moment solvent from an accounting perspective".

The orange bar is where Citi’s share price closed on the day that the quarterly report came out. The ratio of the orange bar to the blue bar is Citi’s price-to-book ratio, and if the orange bar is smaller than the blue bar, that means the market is expecting further losses, and further erosion of the blue bar.

The problem is that the blue bar can’t fall much further, without Citigroup breaking minimum capital adequacy requirements. In fact, Citi is skating so close to its regulatory minimums right now that it’s almost impossible not to suspect that a large part of where it’s marking its assets is a function of where the CFO needs the company’s book value to be. (Which could also explain Merrill Lynch’s monster loss in Q4: since Merrill clearly couldn’t survive as an independent entity anyway, at that point it didn’t matter if it ran out of shareholders’ equity.)

And obviously the orange bar can’t fall much further, since share prices have a zero bound.

So what happens if this trend continues for just one more quarter? Maybe Tim Geithner knows; I have no idea.

Posted in banking | 1 Comment

How Do You Recapitalize $1.8 Trillion in Bank Loan Losses?

Posted on January 21, 2009 by Felix

I’ve been having a look at Nouriel Roubini’s estimate of a total of $1.8 trillion of losses in the US banking system, compared to just $230 billion in TARP recapitalizations to date and $200 billion of new money from private-sector sources. And while I might niggle with a few of the numbers he uses to reach that $1.8 trillion number, there’s nothing there which is obviously crazy: it’s very much within the realm of possibility.

There’s no one huge number which accounts for most of the $1.8 trillion, although the single scariest one is probably the $295 billion that Nouriel reckons banks are going to lose on their commercial and industrial loans — a number which doesn’t even include another $35 billion in leveraged loan losses or $127 billion in mark-to-market losses on high-grade and high-yield corporate debt which ended up on US banks’ balance sheets despite the fact that it was securitized.

Nouriel uses a naive view of the Markit ABX, TABX, and CMBX indices to work out the mark-to-market value of asset-backed bonds; I’d quibble with that. On the other hand, there are lots of potentially dodgy assets which Nouriel isn’t including in his calculations, including sovereign debt, municipal debt, and — biggest of all — loans extended by US banks to foreign companies and individuals. We’ve already been through a round of European banks taking big losses on their US assets; we haven’t even begun to see US banks take losses on their European assets, or their loans to formerly-flush companies in commodity-rich countries like Russia, Brazil, and Australia.

It’s worth bearing Nouriel’s numbers in mind when reading Tim Geithner’s testimony from this morning:

The tragic history of financial crises is a history of failures by governments to act with the speed and force commensurate with the severity of the crisis. If our policy response is tentative and incrementalist, if we do not demonstrate by our actions a clear and consistent commitment to do what is necessary to solve the problem, then we risk greater damage to living standards, to the economy’s productive potential, and to the fabric of our financial system.

Senators, the ultimate costs of this crisis will be greater, if we do not act with sufficient strength now.

In a crisis of this magnitude, the most prudent course is the most forceful course.

"The most forceful course" is clearly not the incrementalist one of adding to Paulson’s TARP here, throwing in a few tax cuts there, announcing some big public works, and hoping for the best. The cost of recapitalizing the banking system alone — to say nothing of the losses elsewhere within the shadow banking system — might well be larger than Obama’s entire stimulus plan.

Now those costs don’t need to be paid for in cash dollars. Government guarantees, whether they arrive implicitly, through nationalization, or explicitly, through loan acquisition and the creation of a ring-fenced "bad bank", can do a lot of good at zero up-front cost. But given the commitment that both Obama and Geithner have made to transparency, I do hope that they’re very clear about the real present value of such guarantees — a sum of money which could easily run into the hundreds of billions of dollars.

But most of all, given the implosion in the Citigroup and Bank of America share prices after they got bailed out with government loan guarantees, I hope that Geithner has learned that ad hoc solutions are a recipe for disaster. I look forward to an announcement, soon, of something big, coherent, consistent, and transparent. Not that Geithner gave any hint of having any such thing in mind during today’s testimony.

Posted in bailouts, banking | 1 Comment

How Not to Fix the New York Times

Posted on January 21, 2009 by Felix

When Michael Hirschorn talks nonsense about the New York Times, it’s silly, but at least it’s understood that he’s not a stock analyst by trading, and that he’s more interested in making waves than being helpful. Henry Blodget, by contrast, really is a stock analyst by training — and what’s more, he’s an internet publisher himself, so the errors he’s making in today’s analysis of the NYT are far less forgivable. I suspect that he, too, is just being a provocateur, but it’s still worth pointing out the many areas where he’s wrong.

First, Blodget wants the NYT to cut costs by 40% across the board, including in the newsroom. Since there have been fewer job losses at the NYT than at many other papers, this is not quite as ludicrous as it seems at first blush — but it is still very silly.

Blodget’s first idea for cutting costs is to cut editors rather than writers: maybe he thinks that since his blogs manage to get by perfectly well without editors, then the NYT should be able to as well. But the NYT’s editors are its most important employees: as a paper of record, it’s vastly more important that the NYT bends over backwards to be error-free than it is that Blodget, say, not make any mistakes. The New York Times is the most scrutinized newspaper in the world: it needs its editors.

But Henry’s only getting started. Next he starts going down the pay-per-view road:

Productive writers can be retained and unproductive ones can be released (thanks to the web stats, this can be determined scientifically: look at a several years of click data and it will be crystal clear).

Got that? If you don’t have the "click data", fear for your job! If you snark about the president, or how to analyze your husband "the way a trainer considers an exotic animal", then you’re probably fine. If you’re an investigative reporter who spends months at a time uncovering secrets, not so much. And if you’re a war correspondent putting your life on the line to cover important conflicts around the world, well, remember to include lots of pictures of kittens to boost that all-important click data.

"Yes," says Blodget, "some sections that some readers love might disappear". But those kind of fluffy, feature-driven sections — the ones that might be cut — aren’t expensive: by contrast, they’re profitable. That’s why they exist: they subsidize the important news hole, which is less attractive to advertisers.

Next, Blodget decrees that "management needs to make certain that printing and distributing papers is a highly profitable business". Never mind that printing and distributing papers has never been a highly profitable business for any newspaper: Blodget seems to think that the selling-news-to-readers business model, which has never worked in the past, can somehow manage to supplant the selling-readers-to-advertisers business model on which newspapers have always historically been based.

If you’re running a print newspaper, the single best way of maximizing your revenue is to maximize your readership. Most newspapers lose money on printing and distribution, and are happy to do so. Does Blodget have a clue how much the NYT would have to charge, per paper, in order to turn a profit on printing and distribution? His plan would cut the NYT’s circulation even further — probably to the point at which the NYT could no longer even come close to competing with the WSJ and USA Today outside the New York metropolitan area. The NYT’s one great hope is to become a truly national newspaper: Blodget’s plan would kill that hope dead.

And then Blodget completely loses it, saying that the NYT’s first-rate website should be artificially crippled with the introduction of subscriber firewalls.

"Some people consider NYT content worth paying for," he writes, pointing to the paper’s print subscribers. But he doesn’t stop to realise that those people aren’t paying for content, they’re paying for their newspaper. You’re welcome to try to print out the NYT’s daily content from your web browser — I can assure you that no matter how efficient your printer, it’ll cost you much more than just buying the paper. Reading the physical paper in the morning is something millions of people love to do — including myself. But the people who do that don’t tend to kid themselves that they’re paying for content. And a huge number of them are commuters who want something to read on their way in to work — where a newspaper is a wonderful source of easily-accessed content, and the internet just isn’t.

Blodget also seems to have deluded himself that people stop subscribing to the print edition of the newspaper because they can read the same content online for free. But newspapers aren’t competing with their own websites: they’re competing with everybody else’s websites. If I read a physical newspaper, I’m vastly more likely to visit that newspaper’s website than someone who doesn’t. Similarly, if I read a certain newspaper’s website regularly, then that’s the newspaper I’m likely to pick up at the airport newsstand when I need something to read on my flight. It’s called synergy. If you cripple your website, people will just go elsewhere.

Over the course of the day, I put together links for my "extra credit" link round-up blog entry. Sometimes there’s important news which I feel needs a link, but which I haven’t devoted a whole blog entry to; today, for instance, it’s the fact that Dick Parsons is taking over as chairman of Citigroup. For that kind of thing I’ll always link to the NYT when I can, because I have faith that the page will look good in perpetuity and that it won’t break or disappear behind a firewall. I often get the news first from the FT or WSJ, but I’m much more hesitant to link to them, because there’s a good chance that link won’t work for many of my readers, and those websites make it pretty much impossible for me to tell which stories are linkable and which will result in readers reaching a firewall instead.

Blodget’s proposed hybrid subscription model is silly for all the same reasons that the FT’s current model is silly, or that any subscription model is silly. People don’t understand such things, and they avoid sites they don’t understand. No one likes visiting a website, clicking on a link, and bumping into a subscription firewall. And so people tend to avoid such sites, given the choice. With the WSJ, they often have no choice: the WSJ has much less competition, for most of its coverage, than than the NYT has. But with the NYT, there’s pretty much always a choice: it deals in news, and news is a commodity.

Then Blodget runs the numbers, and reckons, improbably, that the NYT could find 750,000 people willing to pay $80 per year for a subscription. That’s $60 million a year, which compares to current advertising revenue at nytimes.com of double that. Blodget reckons that net-net the NYT wouldn’t lose money by moving to a subscription model — but even if it didn’t lose money, it would certainly lose an enormous amount of goodwill and brand value. All for the sake of a few million dollars a year in extra revenue: it’s just not conceivably worth it.

More than anything else, Blodget’s plan would be an admission of defeat. All of his ideas destroy brand value and the iconic New York Times franchise: the really smart thing to do would be to build that up instead. Is that possible as a publicly-listed company? Maybe not: and if it’s not, then the Sulzbergers should find a way to go private, or non-profit, or something along those lines. But a slash-and-burn approach where you fire your most important reporters for lack of "productivity" and make it as hard as possible for your most loyal and valuable readers to read your content? That’s just idiotic.

Posted in Media | 1 Comment

The Economics of Liquidation

Posted on January 21, 2009 by Felix

Andrea Chang has a story about Circuit City shoppers being angry that liquidation discounts aren’t larger:

"What happened to 30%? Lies!" shouted customer Gabriel Ifrah, 52, at the Circuit City on La Cienega Boulevard in Los Angeles on Monday, where most items were priced at 10% off.

Jim Surowiecki has no sympathy for such people — and neither do I, frankly. But I can understand where the confusion comes from, and it’s not the "up to 30%" discounts promised in the ads. Rather, it’s the message implied by big "Going Out of Business" signs, as well as news articles saying that Circuit City’s merchandise is being "liquidated".

Such signs carry a clear implication of bargain-basement fire-sale prices, and it’s easy to see how shoppers might be disappointed to turn up to a fire sale, only to find most items marked down by no more than 10% — especially when the store’s own pre-liquidation sale prices might well have been lower still.

The fact is that liquidations tend to be pretty bad places to find a bargain. It’s worth remembering that a liquidation isn’t the kind of sale put on by a store which needs to clear out their shelves in order to make space for new merchandise: there’s no new high-margin merchandise coming in for shoppers to buy, and so the opportunity cost of keeping the old merchandise on the shelves is actually very low. Circuit City stores are going to be open through March: there’s little point in having them simply sit there empty thanks to too-big early discounts.

What’s more, liquidators only get one shot at maximizing their revenues. They don’t care about mindshare or anything like that: there’s no benefit to them from people fondly remembering the great discount they got at a certain store, and therefore being more likely to return in future. Quite the opposite, in fact: they’re in the business of getting people into the store for one final shopping trip, never to return. In that business, it doesn’t really matter if your customers are angry. If liquidators could legally promise a free pony with every patch cable, they probably would.

The lesson of this story is quite simple: treat liquidation sales with extreme prejudice, and pay attention only to price levels, not to headline discounts. Things like the Amazon iPhone app can come in very handy to get an idea of what real market prices are. If you’re looking for something specific at a great price, don’t expect to find it at a liquidation sale. And if you’re just looking for fire-sale bargains, wait until a few days before the stores are going to close. The pickings might be slim, but at that point, at least, you know that they’ll be cheap.

Posted in consumption, economics | 3 Comments

Bank Capitalization Chart of the Day

Posted on January 21, 2009 by Felix

bankchart2small.jpg

Here are the capitalizations of the biggest banks in the world: the blue circles dark blue bars correspond to how much they were worth in the second quarter of 2007, while the green circles light blue bars are the capitalizations as of yesterday. (I’ve updated the chart since this blog entry was first posted; see below for details.) The second circle from the left on the top row (RBS) does honestly have a tiny green circle — it’s just hard to see at this scale. Click for a bigger version.

Update: Alphaville had this earlier, and says that JP Morgan might be fudging things a little.

Update 2: Oh dear, my commenters are right and I am blind: JP Morgan here made the unforgivable error of making the diameter, not the area, of the circles correspond to the market capitalization. I’ve replaced the chart with a much better one from Matthew Turner. Apologies to all, and many thanks to Matt.

Posted in banking | 1 Comment

Pirate Datapoint of the Day

Posted on January 21, 2009 by Felix

Peter Leeson, pirate economist, reports:

Only one sailor has lost his life at Somali pirate hands. This represents less than two-tenths of one percent of crewmembers taken hostage by Somali pirates between January and October and an even smaller percentage of the total number of sailors these pirates have attempted to capture.

Even a single death is a tragedy. But the number of confirmed, Somali pirate killings is surprisingly small–especially for a band of Kalashnikov-toting criminals. This hardly comports with our image of pirates as fiendish, blood-lusting curs.

Leeson gives good economic reasons why pirates wouldn’t be killing their captives — and says that in this respect they’re actually entirely in line with their 18th-century forebears such as Blackbeard and Calico Jack Rackham. But do they light slow-burning fuse matches in their dreadlocks?

Posted in pirates | 1 Comment

Does Geithner Know What He’s Going To Do?

Posted on January 21, 2009 by Felix

I’ve been keeping an eye on Tim Geithner’s confirmation hearings this morning: they seem to be going pretty much according to plan — a ritual hazing followed by a certain confirmation. (The NYT and WSJ are live-blogging.) Geithner is suitably contrite about both his tax problems and his role as a top bank supervisor during the biggest financial-sector meltdown in living memory. But he’s also being very vague about what he intends to actually do if and when he goes to Treasury.

Tactically, the decision to say little of substance might well make sense, in terms of maximizing his chances of getting confirmed: there’s no point in giving the lawmakers something really substantive to object to. But I also get the feeling that Geithner genuinely doesn’t know what he’s going to do: this isn’t like a Supreme Court nominee pretending that he hasn’t ever thought about Roe vs Wade. It might be nice if one of the assembled senators simply asked the nominee what kind of timetable he’s working on, in terms of when he’s going to make up his mind and actually implement new policies.

Posted in Politics | 1 Comment

Newspaper Datapoint of the Day

Posted on January 21, 2009 by Felix

From Andrew Edgecliffe-Johnson:

The $5.6bn Rupert Murdoch’s News Corp paid in 2007 for Dow Jones, owner of the Wall Street Journal and several local papers, would now be sufficient to buy Gannett, the New York Times, McClatchy, Media General, Belo and Lee Enterprises, even at twice their current share prices.

Of course, Dow Jones included much more than just newspapers. And the New York Times, for one, is not for sale at any price, let alone its current (non-voting) share price. But this is definitely proof, if proof be needed, that the for-profit newspaper model seems to be irreparably broken.

(HT: Chittum)

Posted in Media | 1 Comment

Fragmented Bondholders

Posted on January 21, 2009 by Felix

During the Great Moderation, institutional fixed-income investors had boring, if lucrative, lives. They’d buy paper, clip coupons, and make money. Now, however, faced with a stream of high-profile defaults, they’re going to have to start justifying their former paychecks by getting down in the trenches with the distressed companies they lent money to, and negotiating hard to maximize their eventual payout.

Or not. The biggest bond investor of all, Pimco, has resigned from the investor committee negotiating with General Motors, despite being one of GM’s largest bondholders. And I don’t like the way that Pimco’s Bill Gross is trying to paint this as some kind of win for the little people:

“We’re just not good committee members,” Bill Gross, Pimco’s co-chief investment officer, said in an interview yesterday from his Newport Beach, California-based office. “We have the interests of our clients more at heart than the interests of particular corporations or even the government, I guess, so it’s best that we simply look at the situation from afar as opposed to from inside.”

Of course bondholders will represent their clients’ interests in negotiations. No one’s expecting anything else. But that doesn’t mean they shouldn’t talk at all. Creditor committees exist for a reason: they allow companies and their creditors to gauge which solutions are likely to be mutually acceptable, and move on past a debt restructuring to a period of profitability and growth. After all, neither company nor creditor likes it when bonds are in default, and they both have an interest in ending that state of affairs as soon as possible.

Interestingly, the news of Pimco’s resignation from the GM committee arrives just as Ecuador announces that it has managed to find a bank to advise it on its own debt restructuring: Lazard. The last time that Ecuador defaulted, back in 2000, the country evinced very little interest in meeting or negotiating with its creditors, and Ecuador bondholders were furious. They set up the Emerging Market Creditors Association, or EMCA: a forum where the biggest holders of emerging-market bonds could get together and try to force countries to come in good faith to the negotiating table.

And who was the co-founder of, and single largest bondholder within, EMCA? None other than Pimco’s very own Mohamed El-Erian. Back then, El-Erian fought hard for the right of bondholders to sit down and negotiate with distressed debtors; now, he seems happy for Pimco to unilaterally resign from such negotiations, citing vague reasons about just not being good on committees.

EMCA no longer exists, which is a shame, since it’s needed now more than ever, in the wake of Ecuador’s default and as emerging-market bond spreads price in a massive wave of further defaults in the future. But maybe that’s symptomatic of a broader problem: bondholders compete against each other, to see who can get the highest returns, and are never very comfortable when they try to cooperate. Which means that they fragment — as the GM bondholders just did with Pimco’s departure from the negotiating table — and leave debtors in a more powerful position.

Clearly, Lazard wasn’t scared enough of its buy-side clients to refuse the Ecuador mandate. What that says to me is that bondholders don’t have teeth these days. You’d think that Pimco would be worried about that state of affairs, but evidently not.

Update: Notwithstanding the fact that the only above-the-jump link in this blog entry was to the Bloomberg article I quoted, and notwithstanding the fact that I put the quotation in <blockquote> tags to make it quite clear that I was quoting another news source, I received the following nastygram this morning from Bloomberg:

I am in-house intellectual property counsel for Bloomberg L.P. and its affiliates, which together form one of the largest providers worldwide of financial news and information and related goods and services.

It has come to my attention that the recent, January 21, 2009 "Market Movers" blog article entitled “Fragmented Bondholders” includes a direct quote from Bill Gross which was obtained by Caroline Salas for Bloomberg News. As there is no attribution to Bloomberg News, there is an implication that the quote included in the Market Movers blog article originated with the author of the article. We ask that the article be updated with the proper attributions.

Now that you are aware of the issue, Bloomberg News expects a higher level of respect for the copyright law and greater editorial integrity going forward.

Regards,

Joanne St. Gerard

Does a direct link to the article in question really not constitute an attribution? How on earth can something which is explicitly tagged as a quotation from an outside source be read as an implication that I got the quote? Does Joanne St. Gerard ever read blogs? And why does she think that impugning my "editorial integrity" is a sensible way of initiating contact with me? I have no idea. But for the record, yes, the quotation in this article came from the Bloomberg article I linked to. I trust she’s happy now.

Posted in bonds and loans | 1 Comment

Extra Credit, Tuesday Edition

Posted on January 20, 2009 by Felix

Four questions for Tim Geithner: To add to my one.

Obama’s shout-out to John Maynard Keynes: Who was no rhetorical slouch himself.

Roubini Predicts U.S. Losses May Reach $3.6 Trillion

Saudi’s Kingdom Holding posts $8.3 bln Q4 loss

French carmakers to receive €6bn bailout

The mystery meaning of sovereign CDS: No one seems to be able to satisfactorily explain what’s going on.

How Contango Affects Crude Oil ETF’s and ETN’s: In a word, badly.

Ben Stein: Please eat your hat

Before & After: WhiteHouse.gov

Posted in remainders | 1 Comment

Geithner’s Baptism of Fire

Posted on January 20, 2009 by Felix

On Monday, when US markets were closed, Royal Bank of Scotland announced it lost something in the region of £28 billion last year, and the FT ran a column with the headline "Shoot the bankers, nationalise the banks". On Tuesday, when US markets opened, there was carnage in the financials, with RBS down a whopping 70% in dollar terms and State Street finally going the Way of All Banks (rapidly towards zero).

This isn’t all bad. The markets are waking up to the fact that most of the banking system is both insolvent and losing money: a lethal combination. With future write-offs larger than the present value of any (distant) future profits, it’s really hard to see how there’s much if any equity value in the banks at all. And given the massive and unexpected fourth-quarter losses from the likes of RBS, Merrill, and Citigroup, it stands to reason that the XLF financial-sector index ETF should trade lower than its previous low in November. Plus, markets abhor a power vacuum.

Tomorrow, Tim Geithner’s confirmation hearings will begin — and if the Senate Finance Committee improbably starts giving him a hard time, expect another brutal day in the markets. This is no time for a Bush administration hold-over like Stuart Levey to be running Treasury: we need someone in there who is able to speak for the Obama administration and take some tough decisions.

Much more likely is that Geithner will get through the Senate with a slap on the wrist for his tax problems; I hope that as soon as he’s confirmed he lays out with great clarity both the principles underlying his future treatment of the financial sector and the way in which he intends to put those principles into practice. For Geithner, there will be no honeymoon period: he’s getting thrown straight into a shark-infested deep end. And the decisions he makes in his first days in office will set the tone for his whole tenure at Treasury. I hope he’s worked out already what they’re going to be.

Posted in banking | 1 Comment