Bernanke’s Unconvincing Confidence

Posted on January 13, 2009 by Felix

Ben Bernanke’s speech in London this morning constitutes a clear overview of the various bullets that the Fed has fired into the onrushing crisis. But he starts off with a bold and puzzling claim:

I believe that the Fed still has powerful tools at its disposal to fight the financial crisis and the economic downturn, even though the overnight federal funds rate cannot be reduced meaningfully further.

The natural response to this is simple: if you still have powerful tools at your disposal, why haven’t you used them already? And why did you enact that final rate cut to zero, which necessarily comes accompanied by all manner of nasty consequences in the repo markets and at money-market funds? That decision certainly made it seem as though the Fed believes a marginal further reduction in the Fed funds rate is still far more effective than any of its other policies.

Bernanke is of course a bank regulator as well as a setter of monetary policy, and so this kind of thing comes as no surprise:

Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively.

I do wonder, though, whether the Fed is making enough of a distinction between the financial system, on the one hand, and the companies which comprise it, on the other. Can’t we build a strong financial system, perhaps through nationalizing failing institutions, in a way which doesn’t reward the people who screwed up the old one? Rather than spinning off bad banks, why not spin off good banks instead, and put them under new ownership and new management?

This, however, is the closest that Bernanke comes:

Particularly pressing is the need to address the problem of financial institutions that are deemed "too big to fail." It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period. The existence of too-big-to-fail firms also violates the presumption of a level playing field among financial institutions. In the future, financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking.

I take this to mean that Goldman Sachs and Morgan Stanley aren’t going to be able to be freewheeling investment banks again, at least not for the foreseeable future: instead, they should expect "especially close regulatory scrutiny" — as should the large commercial banks. But who will be doing the scrutinizing? The New York Fed? The SEC? The OCC? The OTS? Treasury? A new and untested super-regulator?

Color me unconvinced, for the time being, that this will actually work, especially so long as the Fed chairman is generally chosen from the ranks of economists rather than regulators. After all, as Jeff Madrick says, the entire economics profession has garnered itself a big fat F during this crisis. Why should we trust the economists now — even ones from Princeton?

Posted in fiscal and monetary policy, regulation | 1 Comment

Extra Credit, Monday Edition

Posted on January 13, 2009 by Felix

Why You’ll Love Paying for Roads That Used to Be Free

Accountability Time: James Kwak on Warren vs Treasury.

Call It Hurricane Alan: Bush "still seems to view the financial crisis as an act of God — and thus to have given no thought to the role his administration’s policies played in creating it".

Credit Crunch Over? Best Week for Debt Sales in a Year Raises Hopes

Reining in the meltdown’s ‘catastrophic enabler’: A real debate is emerging over whether and how a CDS exchange should be set up. The WSJ has already decided it doesn’t like the idea.

Posted in remainders | 1 Comment

The End of Citigroup

Posted on January 12, 2009 by Felix

Citigroup shares closed today at $5.60 apiece. Only twice in recent memory have they closed lower: on November 20 and 21. Back then, the parlous state of Citigroup’s equity caused Treasury to implement an emergency bailout package. Today, the b-word isn’t bailout, but rather breakup: the Marketwatch headline says that "Citi may be broken up, under government influence". As Roger Ehrenberg says,

We are now seeing the sequel to the original Citigroup drama, As the Stomach Turns.

We know that Rubin and Bischoff are toast; it’s pretty clear that Pandit is toast, too. But Ehrenberg makes it clear that Citi itself is toast, or should be:

It needs to fail. Just not in the haphazard, destructive way that Lehman failed. It can be done much, much better.

Someone needs to take Citigroup out behind the barn and shoot it. Because if we don’t, it just may kill us in the process.

The good news is that if Citi can stagger on for another week, we’ll have a new administration in place which isn’t as ideologically opposed to outright nationalization as the current lot. Citi could easily go the way of RBS, and there’s no reason why it shouldn’t.

But that’s not the only option. The other bit of good news is that Citi’s domestic retail bank is relatively small, by BofA/JPMC/Wells standards. A buyer could be found for it relatively easily; if no US bank wants to step up, there are always the Canadians, or maybe Santander.

The Smith Barney wealth-management operation is already halfway out the door; the investment bank could be sold to its own managers, much like Neuberger Berman. The credit-card operations and Banamex could be IPOed; the Polish bank could go to any number of European banks looking to expand east of Germany.

I’m sure there would be feverish bidding for the hugely valuable Citigold brand globally; once Citi’s Japanese operations were sold off, the rest of Citi’s global presence could either be absorbed into the investment bank or quietly sold off or shut down. I’m sure there are other bits and pieces I’m forgetting about here, but the point is that on a sum-of-the-parts basis, Citi’s actually got some pretty valuable assets; the problem is of course on the liability side of things.

So either the government outright nationalizes Citigroup and then sells it off, or else it provides debtor-in-possession financing within some kind of Chapter 11 proceeding.

Either way, the world would see the failure of a too-big-to-fail bank, and that would in turn be salutary for anybody still trying to make money from the moral hazard trade.

Of course, the trick is to do the break-up in a slow and orderly fashion, and in this environment it’s not clear that that’s really possible. But something much more than a management shake-up is clearly needed: the problems at Citigroup are much too big and pressing for any executive team to solve, especially since there’s no sign the company has a coherent succession plan in place for Pandit’s departure. I’d say p=0.3 right now that Barack Obama’s first major act as POTUS will be the nationalization of Citigroup. Yikes.

Posted in banking | 1 Comment

Explaining US Government CDS Rates

Posted on January 12, 2009 by Felix

What’s going on with credit default swaps on the US government? 5-year CDS are trading in the 50bp to 60bp range these days, which implies a seriously non-negligible risk of default — and the higher the expected recovery value, the higher the implied default risk.

Greg Ip says that "last week, markets pegged the probability of a U.S. default at 6 percent over the next 10 years"; I’m not sure where he got that figure, or why he’s using decidedly rare 10-year CDS prices. But if we take a quick and very dirty look at 5-year CDS, and say they’re being priced at 60bp, then that means total premiums over five years are 300bp, or $30,000 to protect $1 million of debt. If you assume a 50% recovery rate, then you’re basically paying $30,000 to receive $500,000 in the event of default — which implies a default probability of 6% over five years.

It’s hard to see what would trigger such a payout, though. Dean Baker says that "a default event… could include the government temporarily exceeding its debt limit"; I don’t think that’s true. In order for the CDS to be triggered, I think there would have to be not only an actual payment default, but that default would have to continue for longer than the grace period.

Since US government CDS are all denominated in euros, the main loss would be a function of the dollar/euro exchange rate, which would presumably plunge in the event that the US government defaulted. But if we’re assuming that the dollar recovery would be very high, and probably 100%, then it’s hard to see why the US government would ever default in the first place. After all, it’s not like it can’t just print more money.

So I don’t understand why US government CDS are trading at these levels. I don’t think that zero-coupon strips are eligible as cheapest-to-deliver securities, which would definitely change the calculations, and I also don’t see how in any case an event of default is ever going to get triggered. And then, of course, there are all the questions about counterparty risk — your ability to demand collateral from your counterparty in a world where the US government is about to default might well be limited.

That said, anybody who bought protection at, say, 25bp is now sitting on a very nice profit if they close out their position. Maybe this is just a form of black swan insurance: buying US government CDS is a way of making money when everything else plunges in value. You’re not really insuring against an actual default, you’re just betting that if the world starts to implode, the price of your CDS is going to rise even higher.

Posted in derivatives | 2 Comments

Financial Crisis: The Word Count

Posted on January 12, 2009 by Felix

Dear John Thain has a wonderful list of a bunch of the Must-Read Articles that Important Publications have written about the financial crisis. He reckons he really should get around to reading them some time; the scary thing, for me, is that I reckon I’ve actually already read nearly all of them.

Why is that scary? Because if you add them all up, as I just did with the help of my trusty Firefox Word Count plugin, they come to 163,788 words. If you published them all in a standard 250-words-per-page book, it would come to 655 pages.

And that’s just a couple of dozen major features, remember. Any attempt to keep up with the blogs, let alone common-or-garden news coverage, will put some big multipliers on that number. In other words, by the time the first books on the financial crisis start coming out, many of us will have read many, many books’ worth of financial-crisis coverage already. And those of us without the time to read newspapers and magazines and blogs are probably unlikely to have huge amounts of time to read books on the same subject.

Still, the good news is that there are tens of thousands of unemployed former Wall Streeters who have nothing better to do these days than to read all this stuff. For all that the supply of financial-crisis material is overwhelmingly huge, demand for it never seems to slacken. Or that’s what all the book publishers are hoping, anyway.

Posted in Media | Comments Off on Financial Crisis: The Word Count

When Stimulus Doesn’t Scale

Posted on January 12, 2009 by Felix

Barack Obama wants ideas from Paul Krugman, who of course is happy to oblige — and to make the good point that "we don’t have many specifics from the Obama people themselves". But hidden in the respectful joshing is a profound and interesting point of agreement. Here’s Krugman:

The Romer-Bernstein report acknowledges that “a dollar of infrastructure spending is more effective in creating jobs than a dollar of tax cuts.” It argues, however, that “there is a limit on how much government investment can be carried out efficiently in a short time frame.” But why does the time frame have to be short?

As far as I can tell, Mr. Obama’s planners have focused on investment projects that will deliver their main jobs boost over the next two years. But since unemployment is likely to remain high well beyond that two-year window, the plan should also include longer-term investment projects.

What Obama-Romer-Bernstein and Krugman are all saying here is that stimulus doesn’t easily scale. There’s only so much money that can be spent immediately, to "jump-start" the economy; beyond that, you’re forced to look for longer-range investments. So in terms of immediate bang for the buck, the first stimulus dollar has a lot more effect than the trillionth.

Krugman does his best to make the case that the trillionth dollar is still worth spending, but clearly even he agrees that at some point there are diminishing returns.

On the other hand, given that the main metric being looked at by both Obama and Krugman is jobs, I’ll just reiterate my point that you can create a huge amount of jobs, very cheaply, with arts subsidies — and arts subsidies do scale. Yes, it’s hard to get Republican support for such things, but we did just elect a Democrat to the presidency.

Posted in fiscal and monetary policy | 1 Comment

Vikram Pandit, Dead Man Walking

Posted on January 12, 2009 by Felix

Remember Jack Flack’s five levels of CEO hell? The fourth ("On The Ropes") is when the board starts expressing confidence in the CEO; the fifth ("Dead Man Walking") is "when the corporate flacks, who are typically the staunchest of the palace guard, refuse to comment instead of denying the fragility of their CEO’s job". At that point, says Mr Flack, "the game is over".

Which brings us, naturally enough, to Vikram Pandit:

"We have confidence in the current management and leadership of Vikram," Richard Parsons, a former CEO of Time Warner Inc., said in an interview Sunday. "There’s no truth" to rumors that Mr. Pandit’s job is in jeopardy barely a year after he took the reins, he added. Mr. Parsons is expected to be named Citigroup’s chairman this month, replacing Sir Win Bischoff, say people familiar with the company.

A Citigroup spokeswoman declined to comment.

Posted in banking | 2 Comments

A Deaccessioning Thought Experiment

Posted on January 11, 2009 by Felix

This is for Tyler Green, who hates the idea of museums "deaccessioning" (ie selling) art in order to pay their operating expenses. And it’s based around an imaginary institution I’m calling the Museum of Underappreciated Art, or MUA.

MUA is run by a board of living artists; it’s expected that artists on the board will donate some of their work to the museum. It puts on shows of underappreciated American artists, both living and dead; to do so it relies partly but not wholly on its own art collection. When an artist has a show at MUA, he or she, like the board, is expected to donate works to the museum.

MUA is widely respected yet perenially cash-poor, and operates out of a grand and expensive uptown building. Over the years, it has been instrumental in building or rehabilitating the reputations of many important American artists who otherwise might never have received a major museum show.

In order to cover its substantial annual operating expenses, MUA regularly sells off works of art which have been donated to it. By design, it sells off some of its most valuable works — works by artists who are now being collected by major museums around the country and the world. MUA, in full concordance with the Adrian Ellis rule, restricts all sales to museums and public collections — thereby ensuring that even its deaccessioning helps to build the value and reputation of the artists concerned.

As a result, artists — especially the underappreciated artists for whom MUA exists — are generally very happy to donate art to the institution, and the number of works in MUA’s collection goes up every year, even as it sells off its most valuable works to fund its own operations.

This is an entirely sustainable business model: by selling off a few paintings a year and receiving many more, MUA supports itself and builds up a substantial and enviable collection of American art, sans endowment, fundraising campaigns, or any other non-deaccessioning means of raising cash. Far from being a regrettable necessity, deaccessioning is in many ways the lifeblood of the institution — the practice which proves that MUA has been successful in its mission.

All is well, until the Association of Art Museum Directors, appalled at the fact that MUA is selling off art to fund its operating expenses, bans its members from lending any work at all to MUA. Without access to loaned works, MUA is unable to put on its exhibitions, and is doomed.

When MUA finally closes its doors, Tyler Green uses that fact as supporting evidence for his contention that any museum which deaccessions works to pay operating expenses will inevitably die. Since MUA no longer exists, and history is written by the victors, Green and the AAMD sail smugly on, and the art world loses a unique and important institution.

I’m not sure what the moral of this story is, except that it’s not necessarily the case that any deaccessioning is a sign of failure. Maybe, conceivably, it could be a sign of success. Until, that is, an innovative instution runs into a group of hidebound and rules-based culture czars.

Posted in art | 1 Comment

Smith Barney Math

Posted on January 11, 2009 by Felix

I’m trying to work out the mathematics of the proposed joint venture between Citigroup and Morgan Stanley, and what it does for Citi’s balance sheet, using stories from the FT and Bloomberg.

According to the FT, Citigroup has 15,500 brokers; according to Bloomberg, the companies have 22,000 brokers between them. Let’s be charitable to Citigroup and assume that Citi’s brokers are worth just as much, on a per-broker basis, as Morgan Stanley’s. And let’s further assume that the FT is right and Morgan Stanley is going to pay Citi $2.5 billion for a 51% stake in the joint venture. How could that correspond to the $10 billion gain Bloomberg says that Citi would book?

If the joint venture simply merged on an all-brokers-are-equal basis, then Morgan Stanley would own 6,500/22,000 or 29.5% of the joint venture. So if it ends up with 51%, or 11,220 brokers, that means it’s essentially buying 4,720 brokers from Citigroup for $2.5 billion. Which values each broker at about $530,000.

At that valuation, the entire joint venture would be worth $530,000 times 22,000, or $11.65 billion. Citi will have received $2.5 billion in cash, and would own 49% of the joint venture, worth another $5.7 billion, for a total of $8.2 billion.

If that’s the case, how on earth can Citi gain $10 billion "from writing up the value of Citigroup’s Smith Barney brokerage unit to the new price set by the deal"? Smith Barney might not be worth a lot on Citi’s balance sheet right now, but it’s surely worth more than $0.

And this puzzles me, too:

The gain of $5 billion to $6 billion after taxes would flow into Citigroup’s capital…

After taxes? What taxes? I thought that Citi had managed to lose so much money of late that it has enormous tax losses which essentially mean it’s not going to pay any taxes for the foreseeable future. But now Bloomberg’s implying that 40% to 50% of the $10 billion gain on Smith Barney will have to be paid in taxes — which seems like a ludicriously high tax rate at the best of times.

Is there something I’m missing here? Are Smith Barney brokers actually worth more than Morgan Stanley brokers? Are some of the numbers wrong? Or is this just a case of journalists getting different numbers from different sources, and not stopping to ask whether they play nice with each other?

Update: A reader points out that the Bloomberg article does talk about "a $20 billion joint venture", and only "as much as" $10 billion in Citigroup gains. So maybe we can work backwards from the $20 billion number? That would value the joint venture at about $900,000 per broker, on average.

But let’s say that the Citi brokers are worth only $800,000 each, while the Morgan Stanley brokers are worth $1.2 million apiece.

In that case, the joint venture before any cash payment would be worth $800,000 times 15,500 on the Citi side, or $12.4 billion, and $1.2 million times 6,500 on the Morgan Stanley side, or $7.8 billion. Total: just over $20 billion, with Morgan Stanley having a 39% stake. In order to raise its stake to 51%, Morgan Stanley would need to buy another 12%, and 12% of $20 billion is $2.5 billion.

That would explain the $2.5 billion. After receiving the cash, Citigroup would also have 49% of a $20 billion joint venture, worth $9.8 billion. So altogether it would have $12.3 billion, and depending on the current book value of Smith Barney, a large chunk of that might find its way into write-ups.

Posted in banking | 2 Comments

Ben Stein Watch: January 11, 2009

Posted on January 11, 2009 by Felix

Ben Stein sat in on some cabinet meetings in 1974, and learned that high-ranking political officials aren’t always super-smart. This, he seems to think, was not a good thing. He then says that since even very smart people have been humbled by the current crisis, it’s foolish to place too much faith in any politicians, even ones as smart as those currently coming in to office.

Stein, the son of two extremely smart parents, has built an entire career out of being (perceived to be) smart, so it’s maybe not surprising that he considers the present crisis to have come about despite the best efforts of very smart people, rather than because of them. But leverage is an inherently and obviously dangerous thing, and invariably it was extremely smart people who managed to persuade themselves, counterintuitively, that it was something to be embraced and maximized.

A stupid fund manager would never buy a CDO, because there’s no remotely obvious way of working out how much it’s worth or what the default risks are. But smart fund managers, working with Monte Carlo simulations and copula models, were happy to rush in. There are a thousand other examples, but suffice to say that AIG Financial Products was predicated on the idea that it could monetize exceptional intelligence.

So when Stein tells us this week that smart people can make big mistakes, the only reasonable reaction is a "well, duh". Which doesn’t mean, of course, that Stein himself is excused from being incredibly stupid:

While some foresighted people had inklings of danger, the exact total magnitude of the liabilities associated with low-grade credit instruments was not known, as far as I am aware, to anyone…

Right now, I think it’s obvious that the next step for policy is the issuance of guarantees for banks that make loans.

Far from not being known by anyone, the total liabilities associated with "low-grade credit instruments" (by which I think Stein means subprime mortgages) were extremely well-known: all you needed to do to get the number was add up total subprime issuance — an exercise which many people engaged in, including Stein himself.

And I’m getting really annoyed with Stein inserting this Big Idea of his about loan guarantees into every column he writes, without ever bothering to explain what on earth he’s talking about. If he has a bright idea, he should tell us all what it is, rather than just waving vaguely in its direction on a regular basis. "For some reason," says Stein, "Mr. Bernanke and Mr. Paulson don’t see it" — maybe that’s because it doesn’t exist, except for in Stein’s fevered imagination.

Stein concludes with an imprecation to "put not your trust in princes", which would be reasonable enough if it weren’t for the fact that he’s spent the past year railing against princes (Hank Paulson, Ben Bernanke, Jan Hatzius, etc etc) whom, he reckons, have let him down.

Of course, there’s one person Stein doesn’t blame — the person who wrote this.

I’m writing this on Aug. 13, 2007… the stock market is cheap on a price-earnings basis, profits are fabulous… and in the long run, both here and abroad, stocks are a lovely place to be.

Posted in ben stein watch | 1 Comment

Extra Credit, Friday Edition

Posted on January 9, 2009 by Felix

Accountability for the

Troubled Asset Relief Program: The second Warren report (pdf).

Nationwide Inquiry on Bids for Municipal Bonds: It’s always been a very sleazy backwater of finance, and it’s good to see it getting its comeuppance. A very good overview of the scandal from the NYT.

Post Model Manifesto: "If everyone has the same truth, the system fails as it teeters toward an extreme. A uni-model system is less stable than multi modeled one."

Merkin’s Art Adviser Bought Expensive Rothkos, Lost Millions: The disgraced Ezra Merkin owns two 9’x15′ late Rothkos. But maybe not for long.

The "Show Me" Presidency: Ezra Klein on Obama’s response to Krugman’s column and blog entry.

So If You Lose Less Than A Billion, What Does That Make You? Once a star trader, always a star trader.

Posted in remainders | 1 Comment

Rubin Deserts a Sinking Citi

Posted on January 9, 2009 by Felix

Robert Rubin built the basis of his reputation, and his fortune, at Goldman Sachs. He then went to work on the two in sequence: the former at Treasury, and the latter at Citigroup. It all worked out quite well for him, except for the way in which the $115 million (plus now-worthless options) he made at Citi managed to substantially detract from the reputation he so carefully built up in Washington.

Now, he’s leaving Citi as the bank ponders selling off two of its crown jewels — the bread-and-butter predictable income stream from the Smith Barney brokerage operation, and the hugely profitable and successful Banamex, which has a presence in Mexico which borders on the monopolistic.

Neither of the mooted buyers makes much sense to me. Smith Barney to Morgan Stanley? Didn’t Stanley learn its lesson with the Dean Witter acquisition? And Banamex to JP Morgan? I know there’s an unspoken rule in financial journalism that JP Morgan always has to be top of any list of potential acquirers, but never, to my knowledge, has Jamie Dimon expressed the tiniest bit of interest in taking his Chase retail brand abroad.

Indeed, there’s no obvious buyer for Banamex at all. Santander already owns one of Mexico’s big three banks, so it can’t buy another. HSBC might be interested, but in general most banks are highly capital constrained right now and don’t have the money to buy Banamex. More likely, in my view, would be a spin-off, with Manuel Medina-Mora taking Banamex public in what would certainly be the biggest Latin American IPO of the year.

The idea of selling these assets does imply to me that Citi is facing up to reality: realizing that it can’t save itself through acquisition, as it briefly attempted to do when Wachovia went belly-up, it’s shrinking down to a more manageable size.

I wonder how much time has been spent pondering the really radical option: pulling a Bank of New York and selling off the retail-banking operation. Citibank in the US is a large but dreary bank which has never been run particularly well at the retail level — that’s one reason why Citi’s executives wanted to hand responsibility for it to the Wachovia executives in Charlotte. Now that’s an asset which you could really get a bidding war going for.

Posted in banking | 1 Comment

Why Mortgage Payments Should be Lower than Rents

Posted on January 9, 2009 by Felix

It’s clearly Ryan Avent morning here at Market Movers, since I also find myself with a minor case of siwoti upon reading this:

We have folks trying to sell homes of necessity (and increasingly this will be due to job loss, rather than foolish borrowing) and finding that even prices corresponding to mortgage payments below prevailing rents are failing to draw interesting. This is not a desirable place to be, and it’s worth government attention.

It is not the job of government to prop up house prices to the point at which mortgages cost more than prevailing rents. In fact, right now, it is entirely rational that a new mortgage should cost less than prevailing rents. Here’s a few reasons why:

  1. Mortgage rates are extremely low — which means that when you come to sell the house, they’ll probably be higher. Since resale value is an enormous part of the price you’re willing to pay for the house, this is a very important consideration.
  2. Cash is king, right now — everybody wants liquidity. To get a mortgage, you need to make a downpayment, in cash. The opportunity cost of that downpayment has never been higher.
  3. House prices rose for over a decade; they’ve been falling for a couple of years. It’s entirely reasonable to expect them to continue to fall, whatever happens to rents, for many years yet.
  4. A house, right now, is a liability, not an asset. It ties you down to one place, which makes it harder to get a good job if you become unemployed. It needs constant maintenance, it comes with obligations to pay property taxes and insurance, and, if you do end up renting it out, there’s all the inevitable hassles with the renters. Without much if any expectation of house-price appreciation, why go there?

If government attention is to be paid to housing, I would love to see it concentrated on the affordable-housing front (which might conceivably include lower interest rates) rather than on the higher-house-prices front (which really do no good to anybody in the long term). Yes, falling house prices are very bad for credit markets, and we might need to intervene for that reason. But worrying about mortgages being lower than rents is silly.

Update: Avent adds that if someone can rent out an apartment for more than the cost of the mortgage, "money is lying on the ground, waiting to be picked up". Not true.

Yes, you need to look at the cost of the mortgage, but you also need to consider the total annualized rent, including the periods the apartment is empty and looking for a renter, and including the risk of rent default, not to mention the cost of eviction should that become necessary. You also need to consider the opportunity cost of both your home equity and your own time. And then, of course, you need to discount for the risk that home prices will fall.

Yes, it’s possible to make money being a landlord. But it’s not an easy occupation, nor is it risk-free. Some people are suited to it; most aren’t. And generally it’s something best done by professionals.

Posted in housing | 1 Comment

Can We Really Guide the Economy?

Posted on January 9, 2009 by Felix

Ryan Avent says that he thinks the "plausible range of economic outcomes is, at the moment, quite wide indeed", and wonders whether "the size of this conceivable range is actually reflective of potential outcomes, rather than simple ignorance":

If it seems like things could go really well or really poorly, is it because outcomes are very dependent on our actions or because we have no idea what’s going on? And I suppose that if you want to understand the different approaches to policy advocated by liberals relative to libertarians, that question, and its answer, is key.

The easy answer is that this is not "simple ignorance". Studies have shown repeatedly and convincingly that the range of possible outcomes is nearly always greater than you think, not smaller. Economically speaking, actual results regularly come out quite far away from even pretty near-term forecasts, which is one reason why asking economists (or journalists, for that matter) to predict when we’re going to come out of recession is an exercise in futility.

On the other hand, that doesn’t necessarily mean that outcomes are very dependent on our actions. What action, for instance, did we take to send the price of oil plunging by $100 a barrel in the space of a few short months? That’s the kind of thing which can only happen in a highly complex and therefore wholly unpredictable system.

So I don’t think of liberals’ policy approach as being deterministic — if we do this, then the economy will do that. Instead, I think of it as working the other way around: if the economy does this, then we should do that. Right now, the economy is tanking, and so we should apply a large dose of stimulus. We can’t predict with any accuracy what the results will be, but there’s a very high chance that they will be better than if we did nothing, which is the default libertarian position.

Posted in economics, fiscal and monetary policy | 2 Comments

Warren vs Treasury, Cont.

Posted on January 9, 2009 by Felix

I’m not quite sure what to make of the fact that Elizabeth Warren is shamelessly leaking her latest TARP oversight report all over the media — to the NYT, to the WSJ, even, on-camera, to Good Morning America. Doesn’t she work for the public, and have a perfectly good official website on which to release her findings?

On balance, though, I think this is a good thing. The public doesn’t get its news from cop.senate.gov, it gets it from news organizations, which (sadly) are much more likely to report something if they’re leaked a draft than if they simply download it from an official website. And the fact that Warren is getting out there, plugging her report as hard as she can, stands in admirable and stark contrast to the way in which Treasury released its official reply to her first report late on New Year’s Eve, when no one was around to notice.

Even better, however, would be if Treasury started being receptive enough to Warren’s criticisms that she didn’t feel the need to shout like this. The important thing, ultimately, is to spend the TARP money as effectively as possible — and if David Cho is to be believed, the incoming administration is not far from Warren on the questions of how to do that. Oversight does not mean opposition — and if Treasury can start working constructively with Warren, we might all be spared this kind of public invective in future.

Posted in bailouts, Politics | 1 Comment

Yet Another Gruesome Employment Report

Posted on January 9, 2009 by Felix

For most of the past decade, I’ve happily ignored the payroll report on the first Friday of every month. The market often got very excited about it, but the headline payrolls number was generally unreliable and full of more noise than signal.

The unemployment number, however, wasn’t. And the 7.2% unemployment rate — which rises to a whopping 13.5% if you use the broader figure which includes the underemployed as well — is very, very scary. We knew we would almost certainly see these numbers at some point in 2009, but the fact that we got there by the end of 2008 really underlines just how bad this recession is becoming.

The fact that unemployment is rising fast has no silver linings. Does it mean that companies are reacting fast and decisively to the recession, laying off workers in good time to avoid closing their doors entirely? There’s not much evidence of that. Instead, it means higher unemployment payments, lower consumer sentiment and spending, and the continuation of a vicious spiral which is reaching Charybdis-like proportions.

If you’re desperate for good news, you can cling to the 5-cents-an-hour increase in wages, but don’t expect earnings to rise in 2009 by anything like the 3.7% they went up in 2008. Or maybe you can take solace in the fact that the headline payrolls figure (if you ignore the unemployment figure) was at least in line with expectations. But for me, that just means that economists and forecasters have finally woken up to grim reality.

Maybe the only real upside to this report is that it should light a fire under Congress to pass a stimulus package sooner rather than later — including the release of the second tranche of TARP funds. Let’s start getting money out the door now: that’s more important than haggling over what goes where.

Posted in economics, employment | 1 Comment

Will FHLB Atlanta’s Failure Spark a Major Regulatory Overhaul?

Posted on January 8, 2009 by Felix

Over a year ago, Chuck Schumer said (and I agreed) that the Federal Home Loan Bank of Atlanta was an all-but-unregulated nightmare of enormous proportions. Now, HousingWire’s Paul Jackson tweets a rumor that FHLB Atlanta is going to be taken over by its regulator — the same ineffectual Federal Housing Finance Board which has been so useless and complacent until now.

This has all the makings of a major fiasco — one which, if Barack Obama plays it right, could finally push Congress to conduct the soup-to-nuts regulatory overhaul which is long overdue. If, by this time next year, the FHFB, and the OTS and the OCC and the FHFA and the FDIC and the NCUA, not to mention the CFTC and the SEC and the state insurance commissioners and Uncle Tom Cobbley and all, are things of the past, then maybe some good will have come of this. But all that turf is jealously guarded, so I’m not holding my breath. Obama wants to change Washington, but Washington, by its nature, hates to be changed.

Update: It turns out that the FHFB, like OFHEO, was transmogrified into the FHFA. Are you reassured now?

Update 2: Paul Jackson now tweets that the rumor was false. In specifics, maybe, but FHLB Atlanta is surely overdue for being taken over.

Posted in banking, regulation | 1 Comment

Extra Credit, Thursday Edition

Posted on January 8, 2009 by Felix

Citi, Senators Reach Mortgage Deal: It’s sad but necessary that the banks need to sign on to any plan which allows mortgages to get included in bankruptcy proceedings. It’s promising that Citi has done so.

The 12 Most Important Cars of 2009: Zero from GM, one from Chrysler. And that one’s dubious.

Financial Modelers’ Manifesto

Geithner’s Track Record Cuts Two Ways: According to the WSJ, Geithner "clashed" with Paulson over Frannie.

Why Don’t Newspapers Do a Better Job of Advertising? The NYT, for one, should blow its own trumpet more effectively.

Bullshit Promises: When your bank lays out certain terms and then decrees, in the small print, that it can change those terms unilaterally. A useful coinage.

Economic Headlines Stretch Limits of Imagination: A great screengrab.

Posted in remainders | 1 Comment

Buying Equities for their Option Value

Posted on January 8, 2009 by Felix

Commenter dWj makes a good point about stocks: they are naturally going to be more richly valued than bonds, because of their option value. "Stockholders are long volatility," he writes, "at least relative to bondholders" — and he’s quite right, even if shellshocked stockholders right now are wishing they’d never seen the volatility of 2008.

The important thing to remember is that if you have a fixed-income asset, broadly defined — it might be credit, or Treasuries, or even cash — your downside is nearly always much bigger than your upside. No matter how safe you think you are, you can always be wiped out in some freak financial tsunami. Stocks can go to zero too, of course, but they have unlimited upside, and a small probability of a huge gain is something worth paying good money for.

John Cassidy, then, for all his protestations of optimism, doesn’t actually need to be an optimist for his move into equities to make sense:

Recently, I moved some of my savings from cash into stocks… In venturing into the stock market, I am taking out a long-term call option on the possibility that the doomsayers, my normal self included, are mistaken.

Indeed, the probability the doomsayers are mistaken can be quite low, and equities might still be attractive.

Nassim Taleb likes to talk about the difference between volatility and risk: equities are volatile, bonds are risky. The bursting of an equity bubble, as we saw in 2000, is reasonably benign; a debt bubble, as we saw in 2008, can be devastating when it bursts.

Donald Trump’s real-estate projects have a habit of going belly-up, but he has equity, not debt: when they do so, it’s his lenders who lose billions of dollars. Meanwhile, if he has a success, then he gets all the upside. It’s a nice job if you can get it (or persuade banks to fund it) — even if your projects lose money in aggregate, you can still end up making a fortune.

So it’s perfectly reasonable to move some savings — with the emphasis on the "some" — into equities right now, even if you believe, as I do, that they are ripe for another fall. I doubt that volatility is going to go away any time soon, and as dWj says, owning equities makes you long volatility.

On the other hand, most of us are overweight equities already, and have all the exposure we need to them and then some. Options are a form of leverage, remember, so if you’re buying equities for their option value, consider that a leveraged bet which should be based on a strong foundation of cash, TIPS, or other risk-free assets.

Posted in stocks | 1 Comment

The 4.375% Fixed-Rate Mortgage

Posted on January 8, 2009 by Felix

Remember all that speculation about the Fed trying to drive mortgage rates down to 4.5%? Well, they’re pretty close: here’s a screenshot from the Chase Home Mortgage website.

chaserates.jpg

According to Bloomberg, these rates "are for borrowers with excellent credit who put 20 percent down" — but even so, 4.375% is I think unprecedented in living memory. Is this rate available to people who have already paid off their home and just want to take out a cheap loan? That might well help to boost national spending.

Posted in housing | 1 Comment

Obama’s Big Speech

Posted on January 8, 2009 by Felix

I agree with pretty much everything in Barack Obama’s big speech today about his stimulus plan. And not (just) because I’m some kind of lefty: Alex Tabarrok feels much the same way, as does Evan Newmark. It’s necessarily vague, but it points in all the right directions. So I wonder why Obama felt compelled to quantify this:

That work begins with this plan – a plan I am confident will save or create at least three million jobs over the next few years.

It doesn’t really mean anything: "next few years" is vague enough to start with, but if you’re including jobs "saved" rather than created, then there’s no way of even counting, since there’s no way of knowing how many jobs would be lost had the plan not been implemented.

That said, I think the emphasis on jobs is an eminently sensible one, and I hope to have some numbers later backing up my assertion that the best bang for your buck, if you’re wanting to create jobs, is to spend money in the arts. There was nothing about the arts in Obama’s speech, but I still hold out hope. It’s hard to show that arts spending "works" in the kind of ROI sense that’s implied in Obama’s speech, since many of the returns on arts spending are non-financial. But that doesn’t make them any less important.

Posted in fiscal and monetary policy, Politics | 1 Comment

The Decline of Davos

Posted on January 8, 2009 by Felix

When I try to bring up a mental image of Davos Man these days, I envisage a bruised and beaten Danny Aiello at the end of Leon (aka The Professional), telling Natalie Portman that he’s the best place for her to keep her money: "Like a bank, you know,

except better than a bank,

because, you know,

banks always get knocked off."

John Gapper, today, says that the Satyam fraud "may take some of the gloss away from the India/Davos axis"; the fact is that the entire schmooztastic gabfest has lost most of its gloss over the past 12 months. Since Davos is dedicated primarily to extolling the wonders of globalization, I wonder what it will be like this year.

Much of the present economic nightmare can be blamed on globalization, I think: it was the global liquidity glut, and the concomitant demand for a bit of extra yield on fixed-income assets, which encouraged the lax subprime underwriting which etc etc. If the world hadn’t been perfectly happy to throw trillions of dollars a year into America bottomless appetite for capital, the bubble would never have happened, and neither would the subsequent bust.

What’s more, the financial crisis has actually helped the world’s not-rich, by bringing down food prices, commodity prices, and inflation, much more than any high-concept "creative capitalism" or the suchlike has ever done.

Of course, it’s easy to forget such concerns when you’re whizzing down a black run in Klosters or hitching a ride on a Google founder’s private jet. But Davos needs to preserve its relevance, otherwise it will wither away, an artifact of the bubble years. And it’s not obvious how it can do that.

Posted in Davos 2009 | 1 Comment

Singapore’s Outperforming Merrill Investment

Posted on January 8, 2009 by Felix

The FT says today that the government of Singapore’s $23-a-share investment in Merrill Lynch was worth just $12.10 per share at the end of 2008, a drop of 47%. A paper loss of more than $2 billion is tough for any investor to swallow, but for a stake in an investment bank bought at the end of 2007, this is actually an impressive outperformance.

Obviously, a stake in Bear Stearns or Lehman would be worth much less. But look at Morgan Stanley, which fell from $53.11 to $16.04 during the course of 2008, a fall of 70%. Even Goldman Sachs fell from $215.05 to $84.39: a fall of 61%.

What’s more, it’s unclear where the $12.10 figure comes from: as the NYT notes, Merrill shares actually closed at $15.83 apiece on the last day of the year. Which would put Singapore’s Merrill loss at 31%, significantly outperforming the S&P 500.

So yes, Singapore lost money on its Merrill deal. But in the annals of bad banking investments, this one’s quite a small mistake, in comparison to say Texas Pacific’s recapitalization of Washington Mutual.

Posted in banking | 1 Comment

Why Aren’t Stocks Falling?

Posted on January 8, 2009 by Felix

As SAR notes, the "longer and deeper recession" meme is "becoming the popular view" — it’s increasingly difficult to find people who really think we’ll bounce back in the second half of this year, and economists generally are much more bearish now than they were a couple of months ago.

So why is the stock market up 20% since then?

My feeling, mainstream as it may be, is that stocks are drifting upwards in blissful ignorance of reality, much as they did for nearly all of 2007, even after the credit crisis first hit. The panic sellers and the people desperately needing liquidity have left, volumes have fallen (as they always do around the holidays, no news there), and volatility has decreased. And so both value and momentum players are feeling increasingly comfortable rotating back in to the market.

But if the recession gets to be as bad as people are increasingly expecting, fundamentals will eventually start asserting themselves — and if we’re unlucky, they’ll do so in a violent downward manner, much as they did last fall. Remember that the bond market is pricing in a serious wave of defaults — and I don’t think the stock market is. If and when those defaults arrive, with shareholders of the companies in question being largely wiped out, will the broader indices really remain unaffected? And more generally, a two-year-long recession does really nasty things for corporate profits, which rise much faster than GDP in boom years, but fall much faster than GDP in bust years.

The lesson of the past two years is that the stock market is a lagging, not a leading, indicator. I have no faith in this rally whatsoever; I hope that I’m wrong, but I just don’t see the current stock market reflecting an economy which is hugely reliant on retail spending and where holiday-season sales were the weakest in four decades. It’s always calmest before the storm, and I fear another gale might be brewing.

Posted in economics, stocks | 1 Comment

Google and Newspapers

Posted on January 8, 2009 by Felix

No, Google’s not going to buy the New York Times. But its CEO, Eric Schmidt, says it might come close:

I think the solution is tighter integration. In other words, we can do this without making an acquisition. The term I’ve been using is ‘merge without merging.’ The Web allows you to do that, where you can get the Web systems of both organizations fairly well integrated, and you don’t have to do it on exclusive basis.

The nytimes.com website is big and fast and very well designed already, so it’s probably not top of the list of candidates. But other, smaller, newspapers, which find it hard to afford the enormous continuing investments that great websites need, might well be very interested in outsourcing that kind of thing to Google, especially if Google will do it all for free, in return for being able to sell display ads on the site. If all goes according to plan, the newspaper would make more money, and the web would become a better and easier place to find news.

I think it’s worth a try, to see what happens. It’s certainly a better idea, from the perspective of Google’s bottom line, than Google News, which might no longer officially be in beta, but so far has yet to feature a single advertisement, and which therefore provides no revenue for Google at all.

I did do a double-take, however, when I saw this exchange with Fortune’s Adam Lashinsky:

AL: What about Google.org, Google’s for-profit philanthropic arm, which is investing in alternative-energy startups?

ES: We didn’t want to co-mingle philanthropy with business. We are in the advertising business.

Wasn’t Google.org set up with the express intention of co-mingling philanthropy with business? I think I understand what Schmidt is saying here, which is that he doesn’t want to co-mingle Google’s philanthropic activities with the advertising business in particular, because that’s the bailiwick of Google.com. I can half see that. But shouldn’t Google be playing to its strengths, instead of artificially constraining its philanthropic arm?

Posted in Media | Comments Off on Google and Newspapers