Extra Credit, Sunday Edition

Posted on November 16, 2008 by Felix

Top Goldman Sachs Executives Will Not Receive Bonuses for 2008: A 99% pay cut for Lloyd Blankfein, but none of his $68.5 million 2007 bonus is being clawed back.

A New Bailout Low: Buy a $10 million bank, get a $3.4 billion bailout free!

Foreign Aid Goes Military! Easterly on Collier. Important.

A Pig in a Poke: How Morgan Stanley misled retail investors in Singapore, who thought they were taking Australia and Singapore credit risk but who were actually taking Kaupthing and AIG credit risk — and who have now lost pretty much all their money.

Confirmation Hearings: "I always find it amusing to hear poobahs from hedge funds or private equity nattering on about their oh-so important ‘industries.’ They always seem to omit the critical modifier ‘cottage’ in front of the word ‘industry.’ Christ, Citigroup fires more people in a week than work in hedge funds and private equity combined."

Joe the Subscription Website Operator

Posted in remainders | Comments Off on Extra Credit, Sunday Edition

GM: The Bailout vs Bankruptcy Meme

Posted on November 16, 2008 by Felix

There’s a bailout vs bankruptcy meme going around with regard to GM — a choice which makes me want to tick "none of the above". I’ve seen it in dozens of places of late, but since it comes with the imprimatur of Paul Krugman, let’s look at the argument of Jonathan Cohn:

GM can’t build cars without parts, and it can’t get parts without credit. Chapter 11 companies typically get that sort of credit from something called Debtor-in-Possession (DIP) loans. But the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate.

That’s why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation… [cue visions of millions of newly-unemployed workers and hundreds of billions of dollars in losses]…

Those are among the reasons most analysts and economists, however reluctantly, have concluded that a better solution would be another government bailout.

At heart, this argument is simple. There’s no available DIP financing for an orderly Chapter 11 bankruptcy, and Chapter 7 liquidation would be disastrous, therefore we need a bailout which avoids any kind of bankruptcy at all.

But I don’t see why a government bailout must, ipso facto, avoid any kind of bankruptcy. GM alone has $35 billion in long-term debt, most of which is trading at about 20 cents on the dollar. That might only be a drop in the bucket compared to its total liabilities of $193 billion, but it’s a good place to start: if bondholders took an 80% writedown while the government pitched in $12 billion of preferred equity in the post-restructuring entity, that’s a $40 billion improvement to GM’s balance sheet right there. And of course bankruptcy would give GM the opportunity to renegotiate onerous contracts with its dealers, as well as other real and contingent liabilities.

This is what I’ve been referring to as a "bail-in", and it makes quite a lot of sense on its face. Let the government provide the necessary financing, but ensure that bondholders share some of the pain as well, especially since doing so would simply ratify the mark-to-market losses they’ve already taken.

Such a plan would involve working out the details of a bankruptcy in advance: there are large dangers involved when a company the size of GM enters bankruptcy without any clear conception of how it might exit. So there would need to be serious negotiations between all of GM’s stakeholders and the government — negotiations which, I’ll concede, would be all but impossible during this uncomfortable interregnum between the election and the inauguration. Even if GM can somehow muddle through until January, it can hardly expect such negotiations to be concluded in a matter of weeks. So there’s a timing problem here, given that the present administration has demonstrated zero inclination to help out Detroit.

But I still think that it would be useful to stop thinking of a bailout as an alternative to bankruptcy, and start thinking more imaginatively about the different mechanisms, including both government funds and bankruptcy, which could help put Detroit on a more sustainable footing.

Update: Ryan Avent seems to be thinking along similar lines, in a blog entry entitled "Chapter Something Else":

If Congress can pass a special, tailor-made rescue bill for the automakers, then certainly it can also pass a special, tailor-made bankruptcy bill for them.

I guess my only question is what’s wrong with Chapter 11. Why create a whole new class of automaker bankruptcies, if a pre-packaged Chapter 11 would work fine?

Posted in bailouts, bankruptcy | Comments Off on GM: The Bailout vs Bankruptcy Meme

Broken link datapoint of the day

Posted on November 16, 2008 by Felix

Four years ago, Apartment Therapy ran a Sleeper Sofa competition. (Evidently, four years ago the switch from “sofabeds” to “sleeper sofas” had already happened.)

Apartment Therapy put together a shortlist with 15 sofas on it. I found it quite quickly, when I started looking for a sofabed myself. And how many of the links to those 15 sofas are now broken? All of them. People, I’m all in favor of keeping websites fresh. But don’t break all your old links when you do so.

Posted in Not economics | 2 Comments

Auction Results and Hammer Prices, Redux

Posted on November 15, 2008 by Felix

It turns out I’m not the only person who cares about the weird way in which auction house estimates are compared to hammer prices (ex commission) during an auction, but are compared to the total price paid (including commission) after an auction. But while I think that reporting hammer prices is idiotic, Lee Rosenbaum takes the other side of the argument: she complains that looking at the total price paid "makes the sale results look better than they actually are, because they’ve been inflated by the commission".

For me, the total price paid is the total price paid, and is the only really concrete number in the whole hullaballoo. A high estimate is a completely pointless and useless number; a low estimate is only useful in that it signals to potential buyers the point at which (in hammer-price terms) they’re guaranteed to walk away with the painting if they win the auction. Below that point there’s always a risk that the work won’t have reached its reserve, and will end up being bought in.

Rosenbaum says that "the correct comparisons", in judging the success or failure of an auction, involve comparing hammer prices to pre-sale estimates. I don’t think it’s nearly as simple as that. I think that the correct comparisons should always involve the total price paid, since that’s the sum of money actually being spent on the art in question. As Rosenbaum says:

Because commission-inflated results are the guideposts for determining record prices, it is theoretically possible to set a new auction record this winter for an artist who fetched the same hammer price last spring.

This just goes to prove how silly hammer prices are as a guide to how much a painting is being sold for. If I pay $1 million for a painting, it doesn’t matter to me overmuch how much of that money goes to the auction house and how much to the seller. In fact, I don’t know what the final breakdown is, since the auction houses won’t reveal how much, if any, commission has been charged to any given seller.

The total sale price can and should be used in lots of useful comparisons — such as how much the same picture sold for at previous auctions, or how much last year’s auction raised in total compared to this year’s. The comparison to pre-sale estimates is always a bit silly anyway, since estimates are much more about salesmanship than they are about some kind of objective market value.

Maybe the simplest solution to this whole problem would be for auction houses to stop claiming that the estimates refer to the hammer price and not the total sale price. They could continue to implement a rule that the reserve hammer price can never be as high as the low estimate, but otherwise tell anybody who asks that the estimate is simply a rough guide to how much they think the painting is worth, and that the only real way of telling for sure is to go to the auction and see what it sells for.

After all, Rosenbaum’s entire article is based on the single assumption that the pre-sale estimates are the auction houses’ "published predictions of the range in which an object’s hammer price is expected to fall". If the auction houses stop making that claim, then there’s really nothing for Rosenbaum to complain about.

(Via Maneker)

Posted in art, auctions | 1 Comment

From Frying Pan to Fire, Stockbroker Edition

Posted on November 14, 2008 by Felix

The WSJ today reprises the New York Post’s story from earlier this month about a culture clash between Merrill Lynch and Bank of America. For all the clashing, though, we’re told that 90% of the brokers who BofA wanted to keep — the ones offered signing bonuses — have stayed.

Still, some have left, either because they weren’t running a lot of money or because they were offered more elsewhere. And some of those might be wondering whether they made the right decision:

Last night I get a call from my Merrill Lynch broker (and a FedEx package this morning) telling me that after much "research and reflection" he is moving his practice to Smith Barney (a division of Citigroup.) I am left with only one question for him: Are you kidding?

This is a big problem for brokers, even if they survive the latest round of Citigroup job losses. In good times, brokers generally lose few of their clients when they move from one shop to another: after all, their clients’ relationship is with the broker personally rather than with the firm.

But these are not good times, and Merrill brokers moving to the beleaguered Citigroup might have a very hard time trying to persuade their clients to come with them. Given that brokers work on an eat-what-you-kill basis, they might be living off their signing bonuses for some time: their annual income might be about to fall dramatically.

Posted in banking | Comments Off on From Frying Pan to Fire, Stockbroker Edition

When Stabilization Isn’t Stimulus

Posted on November 14, 2008 by Felix

Quote of the day comes from Neel Kashkari:

Treasury Assistant Secretary Neel Kashkari, who is heading up the government’s implementation of the rescue plan, defended the department’s actions, saying that no one should expect the plan to solve all of the nation’s economic problems. "It’s not a stimulus, it’s not an economic growth plan," Mr. Kashkari told lawmakers. "It’s an economic stabilization plan."

You understand the difference, right? An economic stimulus plan is what happens when the economy is looking shaky and the government spends lots of money in an attempt to stop things getting worse. An economic stabilization plan, on the other hand, is what happens when the economy is looking shaky and the government spends lots of money in an attempt to stop things getting worse — and minimize the number of job losses at Goldman Sachs at the same time.

Incidentally, when it comes to revisionism, the Democrats are just as bad as Paulson and Bernanke:

Lawmakers were especially critical of Treasury Secretary Henry Paulson’s announcement earlier this week that the $700 billion rescue plan likely wouldn’t be used to purchase troubled assets from financial institutions. When conceived during negotiations between Treasury and lawmakers, the plan originally was to have the federal government buy up the assets in order to unfreeze credit markets.

"I think it’s fairly obvious that Congress would have never passed the [rescue plan] had it known how Treasury would marshal the resources it was given," Rep. Dennis Kucinich (D., Ohio) chairman of the subcommittee, said during his opening remarks.

No, Dennis, that’s not obvious at all. As I recall, the main criticism of the TARP was precisely that buying up toxic assets was a silly use of $700 billion, and that it would be much better to just inject that money directly into the banks in the form of preferred equity — which is exactly what Treasury ended up doing. If you’re willing to vote for a vague plan to shore up the financial sector by buying mortgage bonds, you’ll definitely be willing to vote for a much more concrete plan to shore up the financial sector directly.

Posted in bailouts, fiscal and monetary policy | Comments Off on When Stabilization Isn’t Stimulus

Citi’s Achilles Heel: Foreign Depositors

Posted on November 14, 2008 by Felix

Dick Parsons, lead outside director of Citigroup, is sounding just a tiny bit defensive these days:

We are confident that the direction our management team has set is the right direction — and the winning direction — for these extraordinary times. Citi is well positioned for growth because of its unique global universal bank model, and because it has the right talent, the right management, and the right approach.

If you ask me, Citi’s "unique global universal bank model" is in fact its greatest weakness. As of June 30, Citigroup had a whopping $820 billion in total deposits — but its estimated insured deposits were only $126 billion, and fully $554 billion — yes, well over half a trillion dollars — was held abroad.

The FDIC, of course, doesn’t insure foreign deposits. The governments of the countries in question might provide some level of deposit insurance, but most of this money comes from corporate clients and upper-middle-class Citigold customers who are looking to put their money in a big safe global bank rather than some local shop which could close down tomorrow.

Citi, of course, is big and global, but it’s not looking nearly as safe these days as it used to be. And so it stands to reason that a large number of Citi’s foreign depositors might be moving their money elsewhere. If that happens, it’s hard to see how Citi can survive without a massive cash infusion of hundreds of billions of dollars. All banks are vulnerable to bank runs, but Citi is one of the few which is vulnerable to even a large minority of its foreign customers deciding to take their money out.

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Why AIG was in the CDS Business

Posted on November 14, 2008 by Felix

Gari has a question about AIG, in the comments:

Why did a well-capitalised insurance company with plenty of long-dated liabilities decide that it was a better use of shareholders’ and policyholders’ cash to write protection against debt instruments rather than owning them? I think part of the reason was the anomaly in the pricing of CDS compared to bond yields that the CPDO tried to exploit. I don’t know whether I’m just raging against accounting arbitrage here, but doesn’t any examination of systemic risk and CDS need to focus on this question?

You don’t need to know about CPDOs or about the spread between CDS and bond yields in order to answer this question. It’s much, much simpler than that. The fact is that AIG didn’t use "shareholders’ and policyholders’ cash to write protection against debt instruments". If it wanted to buy bonds, then it would have needed to come up with some cash to do so. But writing protection, by contrast, was a way of receiving money, not spending it.

When AIG wrote protection on CDOs and the like, it got insurance premiums in return, and considered those premiums to essentially be free money, since (according to AIG’s own models, and those of the ratings agencies) the chances of those CDOs defaulting were essentially zero.

Now, of course, it’s clear that those insurance contracts constitute an enormous contingent liability for AIG — one so big that without government help the company would have gone bust. But at the time, no one at AIG was worried about that, so busy were they raking in the dollars insuring CDOs which they were positive would never suffer any losses.

AIG’s biggest mistake was in failing to realize that this business couldn’t scale in the way that most insurance does scale. Most insurance does scale: if you insure a house against fire, for instance, it’s easy to lose much more money than was paid in insurance premiums. But if you insure houses across the country against fire, you’d need a nationwide conflagration in order to lose lots of money.

The CDO market doesn’t work like that, however. The reason AIG’s models said the CDOs couldn’t suffer any losses was that house prices don’t fall in all areas of the country simultaneously. Since AIG was only insuring the last-loss CDO tranches, investors with lower-rated tranches took the risk that prices in Florida, or Arizona, or California might fall. AIG would only lose money if prices fell in all those states at once — which is, of course, exactly what happened.

But AIG never stopped to think that the event which would precipitate a payout on one CDO was exactly the same event which would precipitate a payout on all the other CDOs as well. AIG could easily afford any given CDS contract. What it couldn’t afford was lots of CDS contracts — because with CDS, unlike with most insurance, there was no safety in numbers, only more danger.

The investors in CPDOs, at least, put their money up front, and looked to make their relatively modest profits slowly, over time. They lost their money, but at least they had their money before they lost it. At AIG, the financial products group booked its profits immediately, without spending any money at all. When their losses arrived, the firm had to scramble to find the cash, since it had never allocated much in the way of capital to the group.

Insurers are always happy to take your money. But spending money on insurance is always fraught. You’ve spent your money up front, and now you hope that if the thing you’re insuring against comes to pass, the insurance company will do the right thing and pay out. Your big fear is that they won’t, either because they think they’ve found a reason to reject the claim, or because they’ve gone bust.

That’s why insurers need to be very highly regulated. If they weren’t, anybody could set themselves up as an insurer, take in lots of premiums, and then simply disappear. But that’s also why AIG was writing protection on bonds rather than buying bonds outright. Under the insurance model, you can rake in your premiums and provision very little capital against them, so long as you wow your regulator with enough whiz-bang models saying that you’ll never need to pay out on those policies. If you buy a bond, by contrast, the seller wants cash up front. And where’s the fun in that?

Posted in derivatives, insurance | Comments Off on Why AIG was in the CDS Business

The Right Kind of Bailout

Posted on November 14, 2008 by Felix

Today’s NYT has an article about the enormous obstacles facing any Detroit bailout bill between now and October, with Senator Richard Shelby of Alabama saying that "the financial situation facing the Big Three is not a national problem but their problem," and

John Boehner, the Republican leader, saying that a bailout would not be "sound fiscal policy".

The NYT also, however, has a pointed column from Floyd Norris, who notes the double standard being applied here: while the government is disinclined to give Detroit any help at all, it’s much more well-disposed towards companies like AIG and Fannie Mae which are coming back for second helpings of bailout money, after having made clearly insufficient changes the first time around.

What’s really needed here — and what we obviously aren’t going to get before January — is a clearly-explained and internally-consistent government fiscal policy which sets medium-term strategic objectives and then puts both TARP and any forthcoming stimulus plan to work in achieving those goals. Hank Paulson hasn’t come close, and neither he nor George Bush seems inclined to work with Barack Obama’s transition team and put in place policies which could be acceptable to both the present administration and the coming one.

Instead, we get bailouts for Wall Street which have undoubtedly increased the job security of thousands of bankers on seven-figure salaries, while creating only the most nebulous positive effects for Main Street. I’m getting a bit fed up with Paulson’s "trust me, things would be so much worse for you if we hadn’t done this": frankly, I don’t trust him at all any more.

The much-vaunted accountability provisions in the TARP legislation seem to have been forgotten about entirely, even as the government fights to keep details of the Fed’s liquidity provisions secret. So I have limited sympathy for those who suddenly find themselves overly concerned about the costs and benefits of a Detroit bailout, as compared to, say, an entirely hypothetical multi-billion-dollar "retraining and job placement" program the likes of which the US has never successfully implemented since the WPA and which in any case would have precious little immediate effect on the devastated Rust Belt.

To be clear, I am not averse to bankruptcy protection for troubled automakers — but I do think that if GM is to declare bankruptcy, it should do so with the support of the government and a clear plan to come out of bankruptcy with at the very least its warranty obligations intact and its parts suppliers still operating. GM deserves government support; GM’s bondholders do not. And the government might well find that its support is best put to use within the context of bankruptcy, rather than with an eye to preventing bankruptcy.

A chaotic descent by General Motors into forced bankruptcy with no pre-packaged way out and no hint of government support, however, is most emphatically not in this nation’s interest. I’m all in favor of creative destruction, but not for some of the biggest and most symbolically-important companies in the country, in the middle of the worst recession in living memory.

Yesterday, I got an email from Ken, a loyal reader, asking about the AIG bailout:

What have they been spending the $100+ billion they have received from the govt on? Paying off swaps? What damage has this prevented? Why doesn’t AIG have to report what it’s doing with all those funds? And when will they start auctioning off their allegedly profitable and valuable insurance subsidiaries to pay off that bailout?

These are good questions. Most of the money has been spent to put up collateral against CDS contracts written by AIG Financial Products; a large chunk of the rest was used to cover completely unnecessary losses associated with AIG’s securities-lending program. AIG was meant to start auctioning off their insurance subsidiaries immediately, but now its new CEO has persuaded the government to give it a few more years.

But the biggest question of the lot is the one which is hardest to answer: what damage has the AIG bailout prevented? I don’t know, and I haven’t seen anybody at Treasury or elsewhere give a good answer to that question. The idea, I think, was that if AIG hadn’t been bailed out, it would have defaulted on its credit default swaps, which generally insured CDOs held by big US banks. In turn, the big US banks would have had to take enormous write-downs on their CDO portfolios — yes, even bigger than the ones they’ve taken already. And that could have raised serious concerns about the US banking system, causing financial meltdown.

But it would be really nice if someone could quantify exactly how much of this kind of exposure the US banking system had to AIG. After all, US banks are reasonably adept at juggling counterparty risk, and Goldman Sachs, for one — which seems to have had more CDS outstanding with AIG than anybody else — has consistently claimed that its exposure to AIG was well hedged.

The other reason to bail out AIG was to shore up the CDS market more generally: if AIG were to default on its CDS obligations, that might start a chain reaction of other CDS defaults. Again, I haven’t seen anybody make this case very explicitly. AIG wrote very particular CDS, which weren’t and aren’t traded: it wasn’t really part of the CDS market, so much as a bespoke provider of tailored CDS, situated at one remove from the market as a whole. The huge edifice of traded CDS on single names and indices might well have emerged largely unscathed from an AIG collapse, since it never had much connection with AIG in the first place. Again, I don’t know, but I am a bit upset at the fact that nobody has really spelled anything out for the taxpayers who have now twice bailed out AIG with very little to show for it.

Compared to the effects of the AIG bailout, then, the effects of a GM bailout would be much more tangible, and would include not only saved jobs in one of the most depressed areas of the United States, but — if it was done right — the first steps towards a coherent energy and security policy. I just hope that by the time Barack Obama comes into power, it won’t be too late; there seems to be no chance that the present administration is willing to go down that road.

Posted in bailouts, fiscal and monetary policy | Comments Off on The Right Kind of Bailout

Is Your Money Safe at Citibank?

Posted on November 13, 2008 by Felix

The massive Wall Street rally this afternoon, and a statement in support of Citigroup’s chairman, didn’t help Citi, which closed down slightly on the day at $9.45 a share. Clearly the market is very worried about Citi’s future, and the fact that it’s trading in single digits — which means that a modest $1 decline in the share price means headlines about a 10% plunge — doesn’t help.

But this is important: don’t panic. Citi really is too big to fail, and its depositors are safe. Sprizouse is wrong when he says this:

The FDIC cannot protect all of CitiBank’s depositors if the massive behemoth of bank goes under.

In fact, the FDIC can easily protect all of Citi’s insured depositors. According to the FDIC, the combined total domestic deposits of Citigroup’s insured subsidiaries was $266 billion as of June 30. Of that $219 billion was in the largest subsidiary, Citibank NA, and of that, just 40.58% was actually insured — or about $89 billion.

Now that number will have gone up when the FDIC raised its insurance limit to $250,000 from $100,000, but even now I doubt that the total amount of money the FDIC is insuring at Citibank is much more than $100 billion. A lot of money? Yes. But not a huge amount by TARP standards, and easily within the abilities of the US government to cover.

Now, if you have uninsured deposits at Citibank — and the vast majority of Citibank’s $773 billion in deposits are uninsured, mostly because they’re held outside the US — then you might do well to wonder how safe those deposits really are. If even a large minority of those depositors ends up deciding to move their money elsewhere, then Citi, I’m pretty sure, is toast.

But for most individuals with checking accounts, CDs, and the like at Citibank, there’s nothing to worry about, even if Citi fails. And the same is true for anybody with a brokerage account at Smith Barney. Your money is safe, you can sleep easily tonight.

Posted in banking | 1 Comment

Blogonomics: The End of Micropublishing?

Posted on November 13, 2008 by Felix

I don’t fully understand Nick Denton’s decision to fold Valleywag into Gawker. Gawker’s readers don’t care about Silicon Valley gossip, and Valleywag’s readers don’t care who was spotted having lunch at Michael’s yesterday. What’s more, Gawker’s clearly having difficulty selling out its inventory already — hence the end of pay-per-pageview. So readers won’t benefit, and although Gawker.com will get a traffic boost from this, it’s not going to be easy to monetize that.

But I do think this is pretty much the end of the micropublishing business model, at least for the time being.

Denton’s original idea was to sell narrowly-targeted blogs at high-end advertisers; that never worked, for him, and for a few years now he’s cared much more about the quantity of his readers than he has about their quality. More recently, Denton has been repurposing blog entries across his network, with some but not all Valleywag posts appearing on Gawker, Gawker posts appearing on Defamer, that kind of thing. That’s good for traffic, and for getting readers of one site to read the others — and Henry Blodget, for one, has been following a very similar strategy with his network of sites.

This latest decision is yet another step in the more-is-more direction — one of the key drivers of HuffPo’s success. And it’s a sign that blogs are much more likely to work as mass media than they are as niche publishers. I think the key line from Denton’s bearish blog entry on Tuesday is this one:

Marketers and their agencies can track engagement and clicks in great detail online; but it’s still only television advertising that can demonstrate a correlation between spending and a boost to a marketer’s sales.

Why is that? Simple: television is a mass medium, which can reliably reach tens of millions of people. The dream of internet publishers was that media buyers would flock to a more niche medium, where they could target people much more accurately. But the problem is that media buyers, and ad sales people, get paid a lot of money: it’s just not worth their while to collaborate on a campaign which only reaches a relative handful of readers. To be successful in publishing, you need economies of scale, and that means big websites with a mass audience rather than niche blogs which need to be sold separately by expensive sales teams.

To be sure, there are exceptions: I think the Brownstoner business model, for instance, is absolute genius, although it remains to be seen how it will perform during a real-estate bust. But there’s a reason why Google has made so much more money than anybody else by selling targeted ads: Google is the only company with the scale to be able to deliver narrowly-targeted ads to millions of readers every day.

The consequence is that sites like Gawker are going to become increasingly all-things-to-all-people: as Brad Stone puts it, it’s becoming "a more nationally oriented gossip site". Clearly, those of us who like less-frequently-updated blogs with more of an individual voice aren’t numerous enough to provide the audience that media buyers demand. That doesn’t bother me too much: there are more than enough blogs out there without an advertising-driven business model to keep me happy, and I’m happy for other people to read Gawker and HuffPo.

But if you think you can make real money from your small-time blog startup’s advertising revenues, think again. It’s never been easy, and now it’s going to be harder than ever.

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Bush’s Peculiar Wall Street Speech

Posted on November 13, 2008 by Felix

Bush’s speech on Wall Street today is a most peculiar thing — a mixture of free-market platitudes, cryptic code, and outright weirdness. For instance, what does this mean?

One vital principle of reform is that our nations must make our financial markets more transparent. For example, we should consider improving accounting rules for securities, so that investors around the world can understand the true value of the assets they purchase.

"Accounting rules for securities" — that sounds like mark-to-market, right? But even the people who want to abolish mark-to-market accounting don’t go so far as to say that doing so will improve transparency or make "the true value of assets" more obvious. This statement is the kind of thing which would be made by someone urging a move to mark-to-market accounting, not a move away from it. Does Bush think there isn’t enough mark-to-market accounting?

Bush then continues:

We should move forward with other significant reforms to make the IMF and World Bank more transparent, accountable, and effective. For example, the IMF should agree to work more closely with member countries to ensure that exchange rate policies are market-oriented and fair.

Is this a reference to China? Is Bush really trying to outsource to the International Monetary Fund responsibility for getting China to play nice with its exchange rate?

After that, Bush gets downright disingenuous:

We must recognize that government intervention is not a cure-all. For example, some blame the crisis on insufficient regulation of the American mortgage market. But many European countries had much more extensive regulations and still experienced problems almost identical to our own.

Yes, George — because they bought American mortgages! But he’s not done with this theme:

History has shown that the greater threat to economic prosperity is not too little government involvement in the market – but too much. We saw this in the case of Fannie Mae and Freddie Mac. Because these firms were chartered by Congress, many believed they were backed by the full faith and credit of the United States government. Investors put huge amounts of money in Fannie and Freddie, which they used to build up irresponsibly large portfolios of mortgage-backed securities. When the housing market declined, these securities plummeted in value. And it took a taxpayer-funded rescue to keep Fannie and Freddie from collapsing in a way that would have devastated the global financial system. There is a clear lesson: Our aim should not be more government – it should be smarter government.

Oh, come on. The problem with Frannie wasn’t "government involvement in the market" — it was government deliberately exempting Fannie and Freddie from the capital-adequacy rules which applied to everybody else, and thereby encouraging them to maximize the amount of leverage they took on — all in the name of "encouraging homeownership". What we needed was precisely more government: a Frannie regulator with teeth, and a government which refused to let nominally-private corporations lever up to obviously-dangerous levels. The implicit government guarantee wouldn’t have been a problem if it wasn’t for the amount of leverage involved.

But even if you concede Bush’s point about Frannie, it’s still weird how contentious and cryptic he’s being elsewhere in the speech. What’s the signal he’s trying to send, and who is he trying to send it to? Does he really think that the G20 summit is going to be full of people lauding the merits of the economic system in Cuba? I’m rather puzzled by the whole thing.

Posted in Politics | Comments Off on Bush’s Peculiar Wall Street Speech

Hedge Fund Datapoint of the Day

Posted on November 13, 2008 by Felix

From John Paulson’s testimony to Congress (link fixed, sorry):

Eighty percent of our assets under management come from foreign investors.

Was this always the case? Or is it a relatively new thing, dating only to Paulson’s recent celebrity status?

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The US Firebreak

Posted on November 13, 2008 by Felix

One thing I remember vividly from the economic crises of 1998 was the way that stock-market losses would chase each other around the globe, in a never-ending cycle. A fall in the US would precipitate a fall in Asia, which would cause a fall in Europe, which resulted in another fall in the US, and so on: it seemed that it was impossible to escape.

This time, however, it doesn’t seem to work like that: Asia might react to the US (the Nikkei fell more than 5% today), but it doesn’t normally feed through to Europe (flat today) or the US (which is opening a little higher, despite some gruesome unemployment-claims numbers).

Jim Surowiecki recently bemoaned the corrosive effects of "contagion, where selling in one market triggers selling in the next" — but I’d be very interested to see some empirical data on that front. It seems to me that the US open is acting as a reasonably efficient firebreak, and rarely reacts in a knee-jerk manner to market moves elsewhere in the world.

If that’s true, the reason is quite obvious. Asia is clearly susceptible to drops in US markets, and tends to follow the US down. But in 1998, we were going through what everybody called at the time "the Asian crisis" — which meant that all eyes were on Asian markets, and that if they fell, everybody else was likely to sell off as a result. Whatever else the present crisis might be, it’s not Asian, and market moves in Japan or China have negligible systemic implications for the US. And as a result, US and European traders simply don’t care nearly as much as they did ten years ago what’s going on across the Pacific.

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Citi Valuation Question

Posted on November 13, 2008 by Felix

A quick follow-up to the Citi post: Citigroup’s market capitalization, of $53 billion, is $73 billion below its book value, of $126 billion. Has any company ever traded more than $50 billion below book and survived?

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Citi’s Desperate Straits

Posted on November 13, 2008 by Felix

America, we have a problem. Citigroup is the largest bank in America, with a balance sheet of over $2 trillion — and it’s also the most dysfunctional. Since Vikram Pandit took over, Citi has lost not only $20 billion but also more than 70% of its market capitalization, making it now worth significantly less than, say, Genentech. Cue major board-level squabbles:

The board of Citigroup Inc. is growing increasingly dissatisfied with the financial giant’s performance, and some directors are considering replacing Sir Win Bischoff as chairman…

The possible replacement of Sir Win comes as the New York company’s board is adopting an increasingly assertive stance toward overseeing Chief Executive Officer Vikram Pandit and his tightknit team of executives. Those executives took power last December after Citigroup’s previous CEO, Charles Prince, stepped down amid mounting losses. Some directors have grown concerned that Sir Win, who is based in London, hasn’t been exercising adequate oversight…

Over the summer, several directors complained to Mr. Pandit that he hadn’t adequately kept them in the loop about his plans. In recent months, the board has been holding meetings twice a month and trying to be more assertive about supervising management decisions. That change has irked some Citigroup executives, who said the board’s involvement in the negotiations to buy Wachovia Corp. slowed the process and gave Wells Fargo & Co. time to re-emerge with a superior offer.

So the board’s unhappy with management, management’s unhappy with the board, and, to top it all off, the chairman now looks like he’s going to be ousted in a high-level coup. This would be farcical if it wasn’t so tragic.

Back in June, I was already worried about Citi being too big to rescue — and that was before the TARP even existed, let alone was divvied up among dozens of different institutions. Citi closed on Wednesday at $9.64 a share — a level which prices in a very high probability that the stock will go all the way to zero.

Citi might well turn out to be Hank Paulson’s largest and biggest headache. There’s no one he can sell it to — it’s far too big already. Which means that Paulson’s only real option, if things deteriorate much further from here, is nationalization. Bits of it could be sold, at a price — the retail bank to Santander, perhaps; other bits to JP Morgan or Goldman Sachs — but the losses to the taxpayer would be enormous, and the disruption associated with breaking Citi up and then trying to integrate the pieces in the middle of a major financial crisis would likely be devastating to the economy.

The one option being mulled right now — replacing Win Bischoff with Dick Parsons — is clearly taken straight from the deckchairs-on-the-Titanic playbook. Parsons, remember, is the man about whom Joe Nocera said that "all his professional life, he’s wanted to be seen as someone who never seems to break a sweat". In any case, Bischoff isn’t the problem. The problem is that Vikram Pandit gave himself altogether too much time to get smaller, and then decided his best chance at salvation was to get bigger — by buying Wachovia. Now, it’s too late: the die has been cast. Will Citi buy Chevy Chase Bank? It really doesn’t make any difference either way.

In rough seas, it helps to be big and heavy — up to the point at which it helps to be smaller and lighter. Citi is the biggest and heaviest ship in a storm of unprecedented magnitude, she’s creaking badly, and there’s nothing the captain can do about it: you can’t fix a vessel like that in the middle of a hurricane. All you can do is hold on tight, and pray.

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Extra Credit, Wednesday Edition

Posted on November 12, 2008 by Felix

Family Foresight Hall of Shame: Sheldon Adelson: "He put an empire of over $30 billion at the mercy of a single 12-month earnings covenant in a single credit agreement, with almost no margin of safety. His foundation, and those who would benefit from it, have sufferred as a result."

How to get bang from the stimulus buck

ft.com/editors: A blog where you can give them feedback on their redesign. Interestingly, there’s no link to it from anywhere on the site.

Against team players

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Stocks: Recession Bites

Posted on November 12, 2008 by Felix

For some reason, I started paying more attention than usual to the stock market today. The closing prices are sobering: Sears Holdings and Goldman Sachs, down 10% to new lows. Google below $300. Citigroup below $10. Morgan Stanley down 15%. Portfolio cover star American Apparel down 35%. Sure, they’ll all probably be up tomorrow. But this is what a bear market looks like: lower lows, lower highs.

What’s an investor to do in such a market? Holding on for dear life seems like a recipe for wealth destruction, while selling at the lows seems even more stupid. And buying, of course, is only for the brave.

I think a lot of people might be reconsidering why they’re investors in the first place. Was the extra money they hoped to make in capital gains really worth the kind of pain they’re going through now? The financial services industry has spent billions of dollars bombarding us with the message that we should invest our money rather than just keep it in a CD at the bank, but those who refused to listen can be forgiven for feeling rather smug right now, with the S&P 500 down more than 45% from its October 2007 high.

Stock markets are a great way for a society to determine where best to allocate its capital. But once in a while we get a reminder that they’re best suited for long-term capital you don’t really need. Because when the recession really bites and you lose your job and you’re forced to fall back on your nest egg, that’s a particularly gruesome time to be forced to liquidate your portfolio.

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Apple Loyalty Datapoint of the Day

Posted on November 12, 2008 by Felix

As John Gapper notes, the new Taylor Swift album is only $3.99 at Amazon, for an unencrypted, iPod-friendly MP3. At iTunes, by contrast, it’s $11.99 for an encrypted AAC. Yet it’s still the top-selling album on iTunes. Is there anything which would prompt consumers to desert iTunes for a better and cheaper alternative?

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Great Moments in Journalism, Amex Edition

Posted on November 12, 2008 by Felix

The AP reports on today’s fall in Amex shares:

American Express Co. shares plunged Wednesday after a report that the credit card issuer is seeking $3.5 billion in funds under the government’s plan to directly invest in financial firms…

The increased funding opportunities through government programs, including the potential $3.5 billion investment, could be a huge boost to American Express as one of its primary sources of funding has nearly disappeared amid the ongoing credit crisis…

The $3.5 billion from the government could help alleviate some of the company’s funding problem and help bolster reserves to protect against future losses.

Well, glad that’s cleared up, then. In reality, the move has nothing to do with TARP: all of the financials are falling, with Goldman down 13%, Morgan Stanley down 12%, Citigroup down 11%, Bank of America down 9%, etc. That’s what happens, these days, when the Dow’s down 400 points: the financials — the most leveraged stocks in the market — always underperform. And why is the Dow down 400 points? Because the market is volatile, and that’s the way it’s been behaving for a while. Really, there’s nothing more to it than that.

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Reasons to Bail Out GM

Posted on November 12, 2008 by Felix

Why bail out GM? I can think of quite a few reasons:

  1. As Andrew Leonard notes, it’s what Barack Obama was elected to do. "If evangelical supporters of George Bush had the right to expect conservative judge appointments and restrictions on stem cell research, then working class Midwesterners are equally justified in expecting delivery on Democratic economic promises. That’s how a democracy works." If Obama didn’t intend to bail out Detroit, he was being very slippery during his election campaign.
  2. It’s an efficient way of directing fiscal stimulus towards the rust-belt states which need it most. Up until now, Treasury’s been careful to separate the idea of bailouts as distinct from fiscal stimulus: we’re "investing" rather than "spending" the money going into the banks and AIG. But that’s a silly distinction. As Steve Waldman says, most government spending, outside of entitlement transfers, is investment.
  3. It might be cheaper than the alternative of letting GM fail and throwing its employees, and its suppliers’ employees, and its dealerships’ employees, and so on and so forth, onto the unemployment rolls at a time when it’s harder to find a new job than it has been in a very long time.
  4. It’s a great way of being able to implement the long-term strategic goals of the Obama administration when it comes to things like energy independence. Leonard, again:

A Manhattan Project-scale plan to move the U.S. into an energy-sustainable future should start with a complete restructuring of the automotive industry. It’s time to think big.

These aren’t the kind of reasons that Treasury put forward for bailing out the banks and AIG. In that case, we were worried about the collapse of the global financial system: the bailout was necessary to prevent systemic meltdown. A lot of the arguments against a GM bailout seem to say that there aren’t similar systemic reasons to bail out GM: that’s true. But it’s worth realizing that there are other reasons.

The government also has a lot more latitude about exactly whom it bails out than most commentators seem to realize. There seems to be an assumption that any bailout will, by necessity, have to be a bailout of all GM’s bondholders, and will probably leave some non-zero value for shareholders as well. But that doesn’t have to be the case: there are numerous ways of structuring a "bail-in" whereby GM’s bonds are restructured and its bondholders share some of the pain.

On the other hand, there are other reasons not to bail out GM, as well. Ryan Avent says that since the long-term future of the rust belt does not lie with the automakers, a bailout would simply stand in the way of the rust belt’s reinvention. "Political energy in the Rust Belt is geared toward maintaining the status quo at the expense of other priorities," he notes, and a bailout is much more likely to reinforce those tendencies than it is to shake them up.

That said, given the state of the economy, there is a strong case to be made, I think, for the government giving GM a helping hand in winding down slowly, maybe emerging as a smaller, leaner, sustainable carmaker, rather than simply collapsing overnight. So I disagree with Avent here:

$50bn spent propping up the Big Three is $50bn that can’t be spent on direct investments in the people and cities of the Rust Belt. That kind of money could fund early retirement for older workers and unemployment benefits and retraining for younger workers, with enough left over for infrastructure improvements, research incentives and educational grants for the region as a whole.

Ford, General Motors and Chrysler are American institutions. They have helped define the character, the shape and the economy of the nation for a century. They’re also just companies – corporate entities designed to provide goods and services at a profit. For too long, these firms have failed at that goal, and they’ve dragged down an entire region with them. We can spend that $50bn simply perpetuating, for a while longer, the names and structures of these companies. Or we can spend that $50bn helping the people and the cities of the Midwest. I don’t think we can do both.

I can envisage a bail-out which goes largely to fund the UAW’s healthcare trusts — directly helping the people of the Midwest — with a bit of extra cash to help bondholders put together a debt-for-equity swap and corporate restructuring. In other words, we can do both, especially considering the very low cost of US government funds.

So count me in on a strategically-oriented bail-in package which benefits the Midwest rather than GM’s bondholders and shareholders. And if you want to call it a bailout, that’s fine by me.

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Paulson Looks for a Private Sector Helping Hand

Posted on November 12, 2008 by Felix

Hank Paulson wants the private sector to give him a helping hand with his bailouts:

We are carefully evaluating programs which would further leverage the impact of a TARP investment by attracting private capital, potentially through matching investments.

I think this is a good idea, especially in a world where even Las Vegas Sands can attract new equity capital, and where Barclays shareholders are in revolt because they feel they’re being prevented from putting in new money. Clearly, there’s money out there to be invested, and Treasury should take advantage of that fact.

If the private sector does end up being asked to match Treasury cash injections, that would also make explicit any government subsidy. Goldman’s Treasury money was a lot cheaper than the cash it got from Warren Buffett; it’ll be interesting to see whether private-sector funds continue to get a higher return than public funds under this matching program.

There might be something else going on here, though, for the conspiracy-minded. Paulson’s already given out hundreds of billions of dollars of TARP money to his Wall Street buddies at bargain-basement rates. If he doesn’t want similar bargains to be extended to smelly people like General Motors, then one way of ensuring that would be to insist on private-sector matching funds.

If no one in the private sector has any interest in injecting capital into GM — which certainly seems to be the case right now — then oh dear, sorry, we can’t help you. Not our fault, you understand, our hands are tied. Which sounds very much like Paulson’s lame Lehman excuse, so it would hardly be unprecedented.

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How Banks Need to Mollify the Public Sector

Posted on November 12, 2008 by Felix

I just got off the phone with ProPublica’s Dick Tofel; we talked quite a bit about the Goldman Sachs story they put out yesterday, but unfortunately they don’t seem inclined to say anything on the record. One thing which is abundantly clear, however, is that right now banks, in the wake of receiving government cash injections, have to be very careful about anything they do which touches the public sector. Goldman isn’t used to being a bank, but it’s going to have to learn fast.

As Jeff Cane said yesterday, conflict with the likes of California’s treasurers "is not something you want when government anger is increasingly being directed at Wall Street". They have a lot of political clout, and they’re clearly unhappy at the kind of conversations which Goldman had with its buy-side clients.

My view is that this constitutes bullying tactics on the part of California: it’s trying to prevent Goldman from sharing its opinions with its buy-side clients, by kvetching loudly to the press and (presumably) punishing Goldman by no longer using them to underwrite its bond issues. Companies often do much the same thing, when analysts put "sell" ratings on their stocks and bonds, but companies don’t have the political wherewithal of states.

And it’s not just Goldman which now needs to be much more aware of the possible political repercussions of its actions. Come January, the Democrats will control both the White House and Congress, and they’re not likely to be very happy about things like this:

Banks are responding to the troubled economy by jacking up fees on their checking accounts to record amounts.

Last week, Citigroup Inc.’s Citibank started charging some customers a new $10 "overdraft protection transfer fee" to transfer money from a savings account or line of credit to cover a checking-account shortfall. Citibank had already raised foreign-exchange transaction fees on its debit cards and added minimum opening deposit requirements for its checking accounts…

With all these changes, the average costs of checking-account fees, including ATM surcharges, bounced-check fees and monthly service fees have hit record highs, according to a new study by research firm Bankrate Inc.

In other words, beleaguered Americans are bailing out the banks twice: once as taxpayers, and once as customers, forced to pay $10 fees for moving money from one account to another. They’re not going to be happy about this, and neither are their representatives. And the banks should be coming up with plans right now for how they’re going to mollify them. Otherwise, they could get bitten, hard.

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Treasury Enters its Lame Duck Phase

Posted on November 12, 2008 by Felix

A welcome sign of independent intelligent life at the NYT business section comes this morning, with Edmund Andrews’ piece on Frannie’s latest loan-mod plan. Both the WSJ and the FT played the story just as Treasury and FHFA wanted them to; the WSJ even sent out a "news alert" yesterday morning telling readers that a "mass loan modification plan" was on its way.

The WSJ headline is "U.S. Steps Up Help for Homeowners", while the FT opts for "New help for Fannie and Freddie borrowers". Here, by contrast, is Andrews, under the headline "White House Scales Back a Mortgage Relief Plan":

WASHINGTON — The Bush administration is backing away from proposals to have the government refinance a broad swath of homeowners who face foreclosure after taking out subprime mortgages and other high-risk loans over the last few years.

The clearest sign of retreat came on Tuesday, when administration officials announced a much more limited plan to help people who have become seriously delinquent on conventional loans guaranteed by Fannie Mae and Freddie Mac, the two government-controlled mortgage finance companies.

The plan announced on Tuesday could lead to lower monthly payments for several hundred thousand homeowners, according to officials. But it would have virtually no impact on the millions of people who took out expensive subprime loans and who are at the heart of the nation’s foreclosure crisis.

I think the Andrews slant is much closer to reality than the truth-but-not-the-whole-truth way in which the WSJ and FT decided to go. Clearly there was a huge fight with Sheila Bair, and equally clearly she lost — while, presumably, holding out hope for something much more substantial under the coming Obama administration.

There does indeed seem to have been a visible change in Treasury policy since the election. Until that point, it cared a little about optics. Now, it’s giving monster bailouts to the likes of AIG and American Express; it’s dragging its feet on homeowner relief; and in general Hank Paulson’s Wall Street buddies seem to be getting much better access than anybody in Detroit. And no one’s even trying very hard to defend these actions in public: they know they’ll be out of a job in January anyway, so they’re just doing what they want to do and what they feel is right, without caring much whether anybody else agrees with them.

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Extra Credit, Monday Edition

Posted on November 11, 2008 by Felix

World Bank to Lend $100 Billion to Poor Nations Over 3 Years: Including $35 billion to middle-income countries by the middle of next year. Finally, the World Bank can start making money from lending again!

Tosca

Monthly Shareholder Report,

October 2008: Down 20% on the month and 66% on the year, they whine about how there’s actually lots of "the factual upside in the core retained portfolio", whatever that’s supposed to mean.

The global slumpometer: What constitutes a "global recession"?

Et in Arcadia Ego: "Private educational institutions have been able to charge whatever the hell they want to for so long because Education has become the new Religion of the socially ambitious. There is almost no other way to classify the fervor, zealotry, and passion with which the parents and children of upwardly mobile classes pursue, discuss, and glorify the imprimatur of an Ivy League or equivalent degree, and the supposedly necessary interim steps thereto. Ask the typical upper middle class parents on the East or West Side of Manhattan whether they would prefer Junior to save his immortal soul or graduate from Princeton or Yale with a 4.0 grade point average, and they will look at you as if you had three heads. There simply is no question in their minds that eternal salvation takes a back seat to the right sheepskin on the wall."

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