Remuneration Datapoint of the Day

Posted on September 27, 2008 by Felix

From Gretchen Morgenson’s article on AIG Financial Products, the 377-person unit which brought down a 116,000-employee behemoth:

Over all, A.I.G. Financial Products paid its employees $3.56 billion during the last seven years.

Posted in derivatives, insurance, pay | 1 Comment

McCain’s Economics

Posted on September 26, 2008 by Felix

Don’t ask me who won the debate in terms of persuading formerly undecided voters to fix an allegiance. The number of undecided voters who understand the difference between financial and fiscal is minuscule, and the number of those who think that the difference actually matters is probably zero. But from a technocratic standpoint, the fact that McCain twice referred to the financial crisis as a "fiscal crisis" is telling. It means (a) that he doesn’t really understand it, and (b) that insofar as he does, he thinks that government is at least as much part of the problem as it is part of the solution.

But McCain really lost me here:

Yes, I went back to Washington, and I met with my Republicans in the House of Representatives. And they weren’t part of the negotiations, and I understand that. And it was the House Republicans that decided that they would be part of the solution to this problem.

In what conceivable way, shape or form have the House Republicans decided that they would be part of the solution to this problem? By sitting on an idiotic idea until the last possible moment, not sharing it with anyone, and then declaring it the only plan they would support?

McCain, here, is allying himself with precisely these House Republicans, and that worries me. Remember, he doesn’t like government takeovers: "I want to make sure we’re not handing the health care system over to the federal government," he said. No one asked what he felt about handing a substantial portion of the national banking system’s assets over the Federal government, but I can’t imagine that he’s getting on particularly well with Hank Paulson these days.

And he said that the US is the world’s largest exporter; it isn’t. More substantively, a spending freeze is not the first best thing to implement in a recession.

When it comes to the economy, then, I’d say that Obama lived up to reasonably high expectations, while McCain sounded, to anybody with a real grasp of the situation, as though he had very little idea what he was talking about. On the other hand, I have yet to meet a single person with a real grasp of the financial crisis who is an undecided voter. So it is quite conceivable that this will do McCain no electoral harm at all.

Posted in economics, Politics | Comments Off on McCain’s Economics

Extra Credit, Friday Edition

Posted on September 26, 2008 by Felix

Why the GOP Plan Won’t Work: A very lucid explanation.

JP Morgan Chase raises $10bn after Washington Mutual buyout: With an oversubscribed plain-vanilla equity offering. Simple, quiet, fast, effective.

Fallen Tycoon to Auction Prized Works: Dick Fuld and his wife are selling $20 million of drawings by the likes of Gorky and de Kooning.

Did Liberals Cause the Sub-Prime Crisis? It’s worth disinterring this column from April, in the light of all the fingers which have been pointing of late at the Community Reinvestment Act as somehow the cause of the present financial mess. It isn’t, of course.

DeLong Smackdown Watch (Special Self-Smackdown Edition): Greenspanism and Its Discontents: Brad DeLong finally recants his Greenspanism.

Do Charles Tyrwhitt shirts destroy shareholder value? "Charles Tyrwhitt New York City store #1 is located at Madison Avenue & 46th Street, on the ground floor of the ex-Bear Stearns corporate headquarters. Charles Tyrwhitt New York City store #2 is located at 7th Avenue & 50th Street, on the ground floor of the ex-Lehman Brothers corporate headquarters."

And finally:

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

Does the TED Spread Really Matter?

Posted on September 26, 2008 by Felix

I’m hardly the only person paying close attention to the TED spread right now. Here’s a few blog entries about it from today alone: 1 2 3 4 5 6 7 8 9 — there was even a joking fight between Paul Krugman and Brad DeLong about who was responsible for making it "the consensus indicator of the depth of the current financial crunch".

But here’s the thing: TED is the spread between three-month Libor and three-month Treasuries. Three-month Treasuries are a classic flight-to-quality buy: the place you go to when you want to just hide out in a cave and not get eaten by a marauding bear. Three-month Libor, on the other hand, is the rate at which banks will lend out their precious capital to another bank for a full 90 days: an eternity, in this market.

More to the point, if you’re a bank, you really neither want nor need three-month interbank funding right now. Global central banks, led by the Federal Reserve, have flooded the system with so much overnight liquidity that you can get as much cash as you need, at a much lower interest rate, directly from your central bank, overnight. The choice between that and locking in a high interest rate for three months is a no-brainer.

Remember too that Libor is an indicative rate: it’s the rate at which banks would lend to each other, if they were lending. If they stop lending, they still need to report some interest rate to the Libor committee. But it might well bear very little relation to banks’ cost of funds in the real world, where the interbank markets are becoming increasingly dried-up and unhelpful.

Henry Blodget has a bank-analyst friend who thinks that the TED spread is crucially important:

The TED Spread, he explained, is 300+ basis points, and unless that changes, the whole system will shut down in a matter of days (the TED Spread measures the difference between 3-Month Treasuries and 3-Month LIBOR and represents how much many banks have to pay to borrow short-term money from each other. Banks either have to borrow or sell assets, the analyst said, and banks aren’t going to borrow much at a 300bp TED when that’s often bigger than their entire net interest margin.)

I think what the analyst is missing here is that so long as banks can borrow from the central bank overnight, the TED spread is largely unrelated to their real-world cost of capital. Which doesn’t make me an optimist, by any means. But I do think that the TED spread can remain elevated for some time without the world coming to an end.

Posted in banking, bonds and loans | Comments Off on Does the TED Spread Really Matter?

Does Bankruptcy Save Jobs?

Posted on September 26, 2008 by Felix

Remember all those pictures of dejected Lehman bankers walking out of their offices with cardboard boxes full of personal possessions? Well, it seems they might have acted rather prematurely. In fact, there seems to be a good chance that there will be fewer job losses at Lehman than there were at Bear Stearns, which didn’t declare bankruptcy. Likewise, JP Morgan will likely keep on many more of WaMu’s employees after buying the bank out of bankruptcy than it would have done if it had had to shoulder a large chunk of WaMu’s debts.

Barclays, which bought the US operations of Lehman Brothers, has given every indication that it wants most of its new employees to stay on. Meanwhile, Nomura, which just bought Lehman’s European operations for $2 after spending $225 million on the Asian franchise, is, my sources tell me, telling key Lehman employees (the highest-paid ones) in both Europe and Asia that they will be paid at least as much money in 2008 and 2009 as they earned in 2007.

In other words, it looks very much as though when bondholders lose money, there’s magically more money available to pay employees. Maybe employees at Wachovia should be rooting for a bankruptcy filing, rather than a sale. They might lose on their stock holdings, but those have been mostly wiped out anyway. And they’d have a higher probability of keeping their jobs.

Posted in banking, bankruptcy | Comments Off on Does Bankruptcy Save Jobs?

The $2 Trillion in Uninsured Bank Deposits

Posted on September 26, 2008 by Felix

Many thanks to Don Fishback, who alerted me to the fact that (with a lot of work) one can actually find reasonably up-to-date statistics on total uninsured deposits at the FDIC’s website. He did just that back in July, using numbers as of March 31; I’ve re-run the report using numbers as of July 31. The lines you’re looking at are line 4 and line 36: total domestic deposits held by individuals, partnerships and corporations, and estimated insured deposits.

The former comes to $6.6 trillion; the latter is $4.5 trillion. The difference, $2.1 trillion, is the total amount of uninsured deposits in the system. (It’s not exact, but it’s very close.)

Now $2.1 trillion is a lot of money: it’s three times the size of the proposed bailout, for starters. But exactly where that $2.1 trillion is, in terms of depository institutions and in terms of geography, I really don’t have much information. I am surprised at the magnitude of the number — and it would make sense if a lot of those excess deposits were being transferred into money-market mutual funds, which the government is now insuring.

I’m unclear about whether Treasury’s insurance scheme covers bank money-market accounts; I assume that it doesn’t. If Treasury wants to avoid a mass exodus of bank deposits, they might want to revisit that policy.

Posted in Portfolio | 2 Comments

The Parallel Universe of Leadership Events

Posted on September 26, 2008 by Felix

(Cross-posted from Market Movers)

The World Business Forum is a two-day event; I only made the second afternoon. But even that was enough to almost make my head explode. I knew in theory that there’s an almost insatiable appetite for motivational speakers and leadership tips from boldface names. But seeing the event in real life, at Radio City Music Hall, only served to bring home to me the reality of this whole parallel universe.

Before each session, the lights would dim and the audience — thousands of us — would be subjected to a full-frontal audiovisual assault of extremely noisy ads for various conference sponsors, including Fox Business News. And just in case the message wasn’t hammered home enough, Fox had placed promotional antimacassars on the backs of all the seats, advertising the fact that it broadcasts in HD. Which presumably is the kind of thing which gets conference attendees to watch it.

Then the speakers would come on: a parade of successful men in expensive suits walking purposefully around the stage while talking about vague concepts like Greatness or Leadership or Success. In a sense, I can see why that’s necessary: the audience was so broad that anything more specific would risk being irrelevant to many. But no one ever seemed to credit the audience with any extrapolation skills: the speakers made sure always to do all the necessary extrapolation in advance. Rather than being able to map X’s experience directly across to their own situation, attendees were instead only able to apply the simple principles which X had generated for them from his own experience.

Indeed, the whole thing felt very much like television: the same ultra-low signal-to-noise ratio, the same feel that everything was targeted to the lowest common denominator, the same need to intersperse the serious stuff (Mohammed Yunus and Tony Blair, yesterday afternoon) with a StrongManager who was great at peppering his slogans with jokes.

Most depressing of all, the event had television’s astonishing ability to take reasonably smart people and turn them into blabbering morons. Jeremy Siegel came on for a few minutes, to talk about the credit crunch; here’s a verbatim sentence.

We need to substitute illiquid mortgage-backed treasuries with high-quality US treasury bonds known as tier 1 capital to get the banks lending again: if we do that, we will get to a point where we can liquefy these deposits.

This isn’t Jeremy Siegel, Wharton professor; it’s Jeremy Siegel, the “wizard of Wharton”, and a man who is utterly unafraid to make a complete fool of himself so long as he gets paid lots of money for his appearance.

Of course, he didn’t make a complete fool of himself, because the audience wasn’t really paying attention to what he was saying. The idea isn’t to write down Siegel’s wizardly words and then puzzle over them later, deciding that they make no sense at all: the idea is to get the impression of having been exposed to Very Important People — people whose Importance presumably will rub off in some manner onto the members of the audience.

For me, the whole experience was like being an atheist in church. The president of Cadillac came on stage, and talked about how “as leaders, our job is to unleash our teams’ strength” — and no one so much as giggled at how ridiculous it all was. One of the organizers of the conference, sitting down to interview Tony Blair, actually asked him: “What are the main three or four characteristics of a successful leader?”

Blair played gamely along: I’m sure he was being paid an astonishing amount of money to do so. But in the pause before his answer, you could feel his frustration and brief twinge of self-loathing. There’s only one correct answer to that question, and it’s the one answer you’re never allowed to give.

Posted in Econoblog | 1 Comment

Worrying About Large-Deposit Bank Runs

Posted on September 26, 2008 by Felix

Dealbook gives us something new to worry about:

In Washington Mutual’s case, customers withdrew $16.7 billion in cash from the thrift in the last nine days, according to the Office of Thrift Supervision. The majority of those that withdrew cash were holders of retail deposits that were over the government’s $100,000 insurance cap.

It’s a potentially troubling tale: If depositors that have more that $100,000 began withdrawing their cash all around the country, the banking industry would have a serious problem.

Is this true? If everybody with more than $100,000 on deposit moved their money to one of the Big Three banks (Citi, Chase, BofA), would that cause "a serious problem" for the banking industry as a whole? If such people had $16.7 billion on deposit at WaMu alone, one can only imagine the sums they have on deposit in aggregate at smaller banks and thrifts across America. And if that kind of money moved en masse to the Big Three, there would surely be some huge dislocations in the banking industry.

The statistic doesn’t actually come fromthe OTS factsheet, but rather from the conference call, where an OTS official said that

a majority of the deposit outflows (a) came from the state of California, and (b) were deposits in excess of the insurance deposit limit.

I can certainly imagine that California has more deposits in excess of $100,000 than any other state. WaMu was very big in California, so maybe it was particularly at risk of large-deposit outflows. This is actually reassuring: we don’t need to worry about banks in general suffering large-deposit outflows, just those banks in the richest parts of the country where you’re likely to find large deposits in the first place.

Since the largest bank in California is Bank of America, and the largest banks in the Washington-Boston corridor are Chase and Citibank, there probably won’t be a big problem there. There could conceivably be a problem with Wells Fargo, but since it still has a market cap of well over $100 billion, I doubt it. What’s more, even depositors with more than $100,000 in WaMu are untouched: all deposits, of whatever size, have been taken over by JP Morgan Chase.

Incidentally, one line from the conference call jumped out at me: another OTS official saying that what happened at WaMu "was a liquidity crisis, not a problem bank crisis". The clear implication is that JP Morgan got itself quite an attractive deal and that WaMu was solvent even before its bondholders were wiped out to the tune of $30 billion or so. I can imagine that they’re extremely unhappy right now: expect lawsuits.

Posted in banking | Comments Off on Worrying About Large-Deposit Bank Runs

Flow Chart of the Day

Posted on September 26, 2008 by Felix

Zubin’s flow chart of the Palin Economy:

palineconom.gif

As Zubin says,

Not only will the bailout help us with the overall economy, but we’ll also improve health care, jobs, trade, the budget, AND the tax system.

And one other thing, too: it’s all thanks to John McCain.

Posted in bailouts, humor, Politics | Comments Off on Flow Chart of the Day

The Calm Before the Storm?

Posted on September 26, 2008 by Felix

It’s definitely not just stocks: the credit markets have failed to deteriorate today as everybody expected them to, on the day after the largest banking collapse in US history. Libor’s down a little, TED’s down a lot, and generally there’s no sign at all of any panic.

Justin Fox has a few theories for why this might be the case. The first one is the least likely: basically, that John McCain is right when he says that "there has been significant progress toward a bipartisan agreement" on the bailout. The facts, of course, is that he isn’t and there hasn’t.

The second theory is that liquidity injections by global central banks, after signally failing to work for the past 14 months, have suddenly started working. That seems improbable to me, too — if anything, central banks are now lending so much money so freely into the banking system that there’s little if any need for banks to lend money to each other. Extra liquidity, in such a scenario, can increase interbank rates as easily as it can decrease them.

The third theory is the least unlikely and the most hopeful:

Maybe we don’t need the bailout, at least not in the this-must-happen-tomorrow-or-we’ll-all-die sense of late last week. By acting to backstop money market mutual funds, and magically transforming the last two big investment banks standing–Goldman Sachs and Morgan Stanley–into banks, the government already addressed the two big panic button issues of last week. And now most all the remaining financial institutions that anybody might have serious worries about are within the banking system, where we have pretty well-established rules for dealing with insolvency and experienced civil servants who administer them. Not problem solved–nowhere near–but problem steered in a direction where it could conceivably be resolved without emergency legislation right now.

I devoutly wish this were true; I put it at p=0.5, or thereabouts. But even if it is true, it would only represent a slight change in the thing that the bailout is designed to avert. Rather than immediate and certain financial chaos in the event the bailout doesn’t happen, we’d just have contingent and could-happen-at-any-time financial chaos. Which is an improvement, but not much of one.

Posted in bailouts | Comments Off on The Calm Before the Storm?

Stocks: Unruffled

Posted on September 26, 2008 by Felix

This is what napalm in the morning smells like, this is the sound of a primal scream: Dow down 38 points, or 0.35%; S&P 500 down 13 points, or 1.1%; Bank of America up $1.16 a share, or 3.4%. If this is what markets look like when all the news is really, really bad, then I guess they’re much more resilient than I ever gave them credit for.

Obviously, the real carnage is going on in credit markets, not in stocks. But still, the stock market is normally a pretty good indicator of sentiment. And its behavior this morning does give me some glimmer of hope.

Update: Just noticed that Libor actually fell today, even if only by half a basis point. It’s still insanely high, but at least it’s not getting worse.

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Bailout Talks Lose Sight of Cost Question

Posted on September 26, 2008 by Felix

Andy Kessler reckons that if the government buys up bad loans at 35 cents on the dollar and eventually receives 50 cents for them, it could make well over $1 trillion on this bailout. I’m not sure how that works: a 43% return on $700 billion is a profit of only $300 billion.

In any case, it seems clear that even under Kessler’s optimistic scenarios, if the government buys bonds at about 60-65 cents on the dollar — which is very much within the realm of possibility, listening to how Ben Bernanke described the bailout — then the taxpayer is liable to be on the hook for a very large sum indeed.

All of which only goes to reinforce the central irony of the bailout negotiations. While the politicians argue about things like executive pay and insurance funds, there’s only one thing which really matters: the price the government pays for bad assets.

Paulson and Bernanke are leaving that key number deliberately vague, while the House Republicans’ plan seems to envisage ultimately paying a full 100 cents on the dollar, through a new insurance fund, with some unknown part of that payment coming from the banking industry itself. Either way, the cost of the plan is very much up in the air. But for reasons I don’t pretend to understand, the real sticking point of the negotiations is the "how", and not the "how much". Weird.

Posted in bailouts, Politics | Comments Off on Bailout Talks Lose Sight of Cost Question

How to Get the House Republicans On Board

Posted on September 26, 2008 by Felix

Is this elegant, or simply disingenuous?

There are disagreements over aspects of the rescue plan, but there is no disagreement that something substantial must be done. The legislative process is sometimes not very pretty, but we are going to get a package passed. We will rise to the occasion. Republicans and Democrats will come together and pass a substantial rescue plan.

There aren’t disagreements over "aspects" of the rescue plan, there’s a very basic, fundamental disagreement over whether there should be a government-funded rescue plan at all.

But as Justin Fox says, the House Republicans’ plan isn’t obviously better from a fiscal standpoint: it just shunts uknowably large losses onto a state-owned insurance fund, rather than recognizing at the outset that a lot of money is going to have to be spent.

I think the trick now is for Paulson to put a very large price tag on the House Republican’s plan, making it clear that it’s not a clever get-out-of-jail-free card. I honestly believe that a lot of House Republicans think their plan is cheaper than Paulson’s bailout. If they’re shown that in fact it’s more expensive, they might be more amenable to constructive dialogue.

Posted in bailouts, Politics | Comments Off on How to Get the House Republicans On Board

CDS Datapoint of the Day

Posted on September 26, 2008 by Felix

From Paul Davies:

One broker quoted McDonald’s CDS at about 26.5 basis points, compared with 30bp for the US, on Friday morning.

Yes, the cost of protecting US Treasury bonds against default has now reached 30bp — higher than McDonald’s. Is there some way on a blog I can do that thing that Jon Stewart does where he madly pretends to rub his eyes with his fists?

Posted in derivatives | Comments Off on CDS Datapoint of the Day

What Was Paulson Begging For?

Posted on September 26, 2008 by Felix

It’s the defining moment of Thursday’s breakdown in negotiations:

In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to “blow it up” by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.

“I didn’t know you were Catholic,” Ms. Pelosi said, a wry reference to Mr. Paulson’s kneeling, according to someone who observed the exchange. She went on: “It’s not me blowing this up, it’s the Republicans.”

Mr. Paulson sighed. “I know. I know.”

But if it was the Republicans’ fault, why was Paulson pleading with Pelosi?

The answer is that the Democrats have a majority in the House, and that with the bipartisan support in the Senate, and the full backing of the White House, the bailout bill could, in theory, be pushed through even without the support of the House Republicans.

Pelosi, however, made it clear all along that she wouldn’t do that: without bipartisan support, no deal. Politically, her decision makes all the sense in the world: she doesn’t want to let the Republicans have their cake (a nice $700 billion bailout bill) and eat it (the luxury of criticizing Washington pork and being able to say that you voted against it). From an economic perspective, however, Pelosi’s decision could be very harmful. And so Paulson was making a last-ditch, desperate effort to ask her to change her mind — since he clearly felt he was closer to her than he was to the House Republicans. Maybe it’s a Rich Coastal Elite thing.

Posted in Politics | Comments Off on What Was Paulson Begging For?

When it Rains, it Pours

Posted on September 26, 2008 by Felix

This is really, really bad.

In a nutshell: the bailout package, which everybody thought was a done deal, has been undone by some combination of Republican recalcitrance and the heat of the presidential campaign. At the same time, WaMu’s gone under, with not only its stockholders but also its bondholders being largely wiped out.

Remember how Lehman’s default precipitated the this whole crisis in the first place: Lehman’s debt was a substantial part of some money-market funds, which then "broke the buck", and all manner of chaos ensued. Now, $30 billion of WaMu debt is going very close to zero, and there could be similar effects. Not to mention the fact that this credit event risks roiling the CDS market at a time when counterparty-risk fears are at an all-time high. Then, add in the fact that House Republicans have come out of nowhere to declare that they want their bailout to come for free — and suddenly the $700 billion that the market was counting on is thrown into jeopardy.

No one is a winner here. Yes, JP Morgan looks as though it’s got itself a good deal for WaMu — basically buying the bank for $1.9 billion unencumbered by any corporate debt or preferred stock. JP Morgan also now owns the bank which was largely responsible for reinventing retail banking over the past decade, and WaMu’s abilities on that front will be very valuable at for the Chase brand. But unless House Republicans start getting constructive on bailout negotiations today, no financial institution is going to look very healthy. (And top management at Goldman Sachs will look like geniuses for raising $15 billion just before everything fell apart.)

The vague sketch of the House Republican proposal in the NYT shows something miles removed from the bailout as it has been understood until now. Bush, Paulson, Bernanke, Obama, House Democrats, and the Senate all seem to be on board with Plan A; only House Republicans are supporting Plan B. And where McCain stands on all this is anybody’s guess. If House Republicans thought they were doing him a favor by waiting for him to turn up before blowing up the negotations, they miscalculated badly.

The results of all this? Well, for one thing, dollar Libor seems to be well over 4% and the TED spread is over 300bp.

Yves Smith sums up:

Hope you like the smell of napalm in the morning. Otherwise, this will not be your sort of day.

Brace yourself.

Posted in bailouts, banking, bonds and loans, economics, Politics | Comments Off on When it Rains, it Pours

Extra Credit, Thursday Edition

Posted on September 25, 2008 by Felix

J.P. Morgan to Buy Bulk

Of WaMu Operations: "The deal isn’t expected to result in any hit to the bank-insurance fund, which would be a huge relief given that some analysts worried that a failure of the thrift could cost more than $20 billion."

Surface Transit: "The fact that Manhattan’s very limited and very valuable public roadways are given over, free of charge, to so much private vehicle traffic and zero rapid transit is ridiculous."

The Bailout, A Play: "A Rational Man: Is this socialism? Henry Paulson: No, this is necessary."

And finally, you’ve gotta love Bernie Sanders:

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

The Pressure to Hedge in the Credit Markets

Posted on September 25, 2008 by Felix

Lex has a theory about the way in which the CDS market can drive a vicious cycle in credit:

The pressure to hedge has led the most liquid contracts to overshoot, in effect pricing in absurd default risks and recovery rates. These same prices are then used as supposedly objective indicators to value the securities the CDS contracts were designed to hedge – hence the spiral of over-hedging and overstated marked-to-market losses.

It sounds vaguely plausible — but is it really happening? If you want to reduce your credit exposure, it’s certainly easier to buy protection in the CDS market than it is to try to sell illiquid cash securities. But with counterparty risk spiking upwards, CDS protection is less of a hedge now than it’s ever been. And when banks say that they’ve been deleveraging, I never get the impression that they’ve been doing that by keeping all their existing assets on their books and then just buying billions of dollars of CDS.

So color me skeptical, here. Which insitutions, specifically, have reacted to "the pressure to hedge" buy buying large amounts of credit default swaps? Once we get an idea of who they are, we’ll probably better understand whether that dynamic can drive down bond prices.

Posted in derivatives | Comments Off on The Pressure to Hedge in the Credit Markets

When Single-A Corporates Default

Posted on September 25, 2008 by Felix

S&P is defending the single-A rating that Lehman had when it went bust.

"In our view, Lehman LEHNG.PK had a strong franchise across its core investment banking, trading, and investment management business," analyst Scott Sprinzen said in a statement…

"We believe the downfall of Lehman reflected escalating fears that led to a loss of confidence — ultimately becoming a real threat to Lehman’s viability in a way that fundamental credit analysis could not have anticipated with greater levels of certainty," he said.

I think this is exactly the wrong message for S&P to be sending, for two reasons.

Firstly, when people look to a ratings agency to guide them on the subject of default risk, they don’t think to themselves "well, the ratings agency will only give me the default risk that fundamental credit analysis can anticipate with certainty; I need to calculate the other types of default risk on my own". No — the role of a ratings agency is to come up with a rating which encompasses all possibly relevant default risks.

And secondly, the defensive stance from S&P strikes me as very similar to the people who say things like "InTrade said X only had a 10% chance of winning, but then X won. That proves prediction markets are crap."

A rating gives an idea of the probability of default. If that probability is zero, then the asset in question will have a triple-A rating. If that probability is nonzero, then sometimes entities with that rating will default. Lehman Brothers was a case of a single-A credit defaulting. This happens, sometimes. That’s what it means to be single-A and not risk-free.

Now we know that the ratings agencies were far off the mark when they were rating structured products. So far, however, they seem to have been doing OK when it comes to plain-vanilla corporate defaults. If the percentage of single-A companies defaulting were much larger than it should be, S&P would have something to be worried about. But I’m pretty sure it isn’t. So really there’s no need for this kind of defensiveness.

(HT: Alea)

Posted in credit ratings | Comments Off on When Single-A Corporates Default

The Parallel Universe of Leadership Events

Posted on September 25, 2008 by Felix

The World Business Forum is a two-day event; I only made the second afternoon. But even that was enough to almost make my head explode. I knew in theory that there’s an almost insatiable appetite for motivational speakers and leadership tips from boldface names. But seeing the event in real life, at Radio City Music Hall, only served to bring home to me the reality of this whole parallel universe.

Before each session, the lights would dim and the audience — thousands of us — would be subjected to a full-frontal audiovisual assault of extremely noisy ads for various conference sponsors, including Fox Business News. And just in case the message wasn’t hammered home enough, Fox had placed promotional antimacassars on the backs of all the seats, advertising the fact that it broadcasts in HD. Which presumably is the kind of thing which gets conference attendees to watch it.

Then the speakers would come on: a parade of successful men in expensive suits walking purposefully around the stage while talking about vague concepts like Greatness or Leadership or Success. In a sense, I can see why that’s necessary: the audience was so broad that anything more specific would risk being irrelevant to many. But no one ever seemed to credit the audience with any extrapolation skills: the speakers made sure always to do all the necessary extrapolation in advance. Rather than being able to map X’s experience directly across to their own situation, attendees were instead only able to apply the simple principles which X had generated for them from his own experience.

Indeed, the whole thing felt very much like television: the same ultra-low signal-to-noise ratio, the same feel that everything was targeted to the lowest common denominator, the same need to intersperse the serious stuff (Mohammed Yunus and Tony Blair, yesterday afternoon) with a StrongManager™ who was great at peppering his slogans with jokes.

Most depressing of all, the event had television’s astonishing ability to take reasonably smart people and turn them into blabbering morons. Jeremy Siegel came on for a few minutes, to talk about the credit crunch; here’s a verbatim sentence.

We need to substitute illiquid mortgage-backed treasuries with high-quality US treasury bonds known as tier 1 capital to get the banks lending again: if we do that, we will get to a point where we can liquefy these deposits.

This isn’t Jeremy Siegel, Wharton professor; it’s Jeremy Siegel, the "wizard of Wharton", and a man who is utterly unafraid to make a complete fool of himself so long as he gets paid lots of money for his appearance.

Of course, he didn’t make a complete fool of himself, because the audience wasn’t really paying attention to what he was saying. The idea isn’t to write down Siegel’s wizardly words and then puzzle over them later, deciding that they make no sense at all: the idea is to get the impression of having been exposed to Very Important People — people whose Importance presumably will rub off in some manner onto the members of the audience.

For me, the whole experience was like being an atheist in church. The president of Cadillac came on stage, and talked about how "as leaders, our job is to unleash our teams’ strength" — and no one so much as giggled at how ridiculous it all was. One of the organizers of the conference, sitting down to interview Tony Blair, actually asked him: "What are the main three or four characteristics of a successful leader?"

Blair played gamely along: I’m sure he was being paid an astonishing amount of money to do so. But in the pause before his answer, you could feel his frustration and brief twinge of self-loathing. There’s only one correct answer to that question, and it’s the one answer you’re never allowed to give.

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Don’t Worry About the FDIC

Posted on September 25, 2008 by Felix

Chris Whalen is quoted in a Bloomberg story today about the FDIC. But he’s no fan of the story, or any other story which implies that there’s any chance at all the FDIC could run out of money. He emails:

In the chaos of the last few days, a lot of erroneous press

reports are coming out about the FDIC and the deposit insurance fund. It is

important for people to understand that the deposit insurance fund, like all

federal trust funds, is simply an accounting entry with the US Treasury.

There is no separate fund.

He has a broader point, too, about whether the FDIC fund should even be written about at all:

The FDIC does not and will not run out of money. Like all federal

trust funds, the FDIC’s insurance "trust fund" does not exist. The reserves

shown in the fund simply evidence the amount of money contributed by the

banking industry into the fund. Like all federal trust funds, the cash

raised by FDIC insurance premiums goes into the Treasury’s general fund.

When the agency needs cash, then the Treasury makes the money available.

When the positive balance shown in the FDIC insurance fund is depleted, the

FDIC simply runs a negative balance with the Treasury, a loan that the

banking industry will repay over time…

Every time a member of the media writes about this they seem to get

it wrong. Indeed, I have come to the conclusion that it would be better if

members of the media did not write about this subject matter at all. The

government runs on CASH. The Treasury does not "invest" cash. It simply

manages receipts vs. payments and uses debt to make up the difference. The

editors and managers at Bloomberg, the AP and other news organizations need

to decide if they are part of the problem or part of the solution.

WHEN YOU WRITE NEWS STORIES ABOUT THE FDIC RUNNING OUT OF MONEY, YOU ARE SPREADING

PANIC AND FEAR AMONGST THE GENERAL POPULATION — INCLUDING YOUR OWN FRIENDS, COLLEAGUES AND FAMILIES. HOW IS THIS SERVING THE NEEDS OF THE COMMUNITY

THAT ALL RESPONSIBLE WRITERS ARE SUPPOSED TO SERVE WITH ACCURATE, FACTUAL

NEWS REPORTING? PLEASE STOP WRITING ABOUT THE FDIC.

The UK faced a similar issue during the Northern Rock meltdown. The long lines of people outside the bank trying to withdraw their money were newsworthy, to be sure — but the news coverage itself was probably more systemically dangerous than any initial mini bank run.

Coverage of the FDIC fund isn’t that dangerous. But this kind of thing, from Bloomberg, is not exactly reassuring:

It won’t take many more failures before the FDIC itself runs out of money. The agency had $45.2 billion in its coffers as of June 30, far short of the $200 billion Whalen says it will need to pay claims by the end of next year. The U.S. Treasury will almost certainly come to the rescue.

"Runs out of money"? "Almost certainly"? That kind of language is unhelpful, during a crisis.

On the other hand, if I may add a tiny bit of fuel to the fire (trusting my readers to be grown-ups here), there can be a big difference between money on deposit at your local bank, on the one hand, and having money on deposit at a bank which has been taken over by the FDIC, on the other. Waking up one morning to discover that you don’t have a bank account is not exactly fun, even if you do get a check for your entire deposit two days later from the FDIC. That’s why in the vast majority of cases accounts simply get transferred to another institution: the FDIC really does try its hardest to make things as painless as possible for depositors.

But what should you do if you’re still worried about going out on the town next weekend only to find your ATM card isn’t working any more? (FDIC takeovers always happen on a Friday.) How do you know which banks are safe and which aren’t? The simple answer is that you can’t know for sure. But if you move your money to a publicly-listed bank with a high nominal share price (over $15, say), that’s probably the safest place it can be.

Update: Jeff has the FDIC’s response to the Bloomberg story.

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Philanthropy vs Profit

Posted on September 25, 2008 by Felix

Muhammad Yunus gave a good speech to the World Business Forum yesterday, and he came down hard on anybody who would make facile comparisons between subprime lending and microfinance. The difference, he said, is the profit motive. In fact, he used a much simpler word to describe subprime lending:

It’s extreme greed. You misled people into getting involved. It’s irresponsible capitalism.

The most interesting part of the event was when Yunus talked to Michael Matthew Bishop, who’s co-written an entire book called "Philanthrocapitalism" based on the idea that the profit motive is a really good thing when it comes to philanthropy. He kept on trying to get Yunus to agree to this thesis, and Yunus steadfastly resisted.

Breaking even, said Yunus, was a great idea. If you want to supply water or credit or any other vital service to the poor, then by all means do so in a businesslike manner and set up a company which breaks even or even makes a small profit for customer-shareholders. But the minute that you start getting equity capital from abroad, everything changes.

Grameen makes a profit, but it goes back to the shareholders: the poor people. It’s not an opportunity for me, a rich person, to take away money from the poor. That’s what the moneylenders do…

There’s plenty of money right there in Bangladesh, we don’t need money from anywhere else. The day you take money from anyone else, you have currency risk. If you want a genuine microfinance program, it should be locally based, with local currency…

The moment profit idea comes to your mind, you have to focus on the people who can give you that money: the rich people. I’m not looking for that money which is looking for profit.

The poster child for philanthrocapitalism, or for-profit philanthropy, is Pierre Omidyar, with his idea that it’s not at all inconsistent for someone to do good and to make money at the same time; Google.org has the same idea. But Yunus was quite clear in his view that if Omidyar is making a profit by lending small amounts of money to poor people, he’s a "loan shark". After all, he doesn’t need the money, and they do.

And Yunus says he’s having no difficulty raising money which doesn’t want to see any return — money which can be used to set up a "social business", set up so that all the revenues stay in the country and none are ever dividended back to the original funders.

Foundation money, to begin with. Corporate social responsibility money too. I get a very good response when I talk to people. Intel has set up a social business in Bangladesh, and two French companies. They don’t make money, but they are self-sustaining. Then, the sky’s the limit, and you can interest millions of people.

It’s certainly possible that the likes of Bishop and Omidyar are right that the profit motive can help; I think that Bill Gates’s Creative Capitalism project is structured along similar lines. But for them to be right, there needs to be a shortage of investment in the developing world, and it needs to be the case that there isn’t enough grant money to make up that shortage, but that if you add a profit motive, there will be more than enough money to go around.

So far, I don’t think that anybody has convincingly demonstrated that’s the case. It might be true, but for-profit philanthropies have very little in the way of a track record, and the track record they do have is not particularly good. Maybe that will change, in the future. But for the time being, I’d keep the idea of for-profit philanthropy in the "not proven" category.

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The Bailout Arrives

Posted on September 25, 2008 by Felix

McCain returning to Washington to work on the bailout? Unhelpful — and, in fact, he’s still in New York, at the Clinton Global Initiative, he hasn’t even gotten started on his legislative work yet.

But McCain announcing that he was going to return to

Washington to work on the bailout? Seems to have done the trick:

Lawmakers indicated Thursday that they were close to hashing out an agreement on a proposed $700 billion bailout of the financial system, hours before a high-stakes meeting at the White House to finalize the deal…

The Democrats had all but eliminated their differences, and both sides were hoping for a bipartisan consensus to emerge at midday, with the final imprimatur to come at the late afternoon meeting with President Bush, the Congressional leadership and the two presidential candidates…

Democrats were hoping to reach a final agreement on the framework of a bill ahead of that meeting, partly to deny any credit to Mr. McCain who took the bold step on Wednesday of suspending his campaign and announcing that he would return to Washington to help secure a deal. Democrats said they did not need his help.

In any case, once the meeting is over, McCain’s work would seem to be done, no?

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Chart of the Day: Sectoral Contribution to Debt

Posted on September 25, 2008 by Felix

Now that Robert Higgs and David Cay Johnston have both brought up personal and business lending as an indicator that credit isn’t frozen after all, I’m feeling a meme coming on. And this chart, from Martin Wolf in the FT, does a good job at showing the bigger picture.

debtmakeup.jpg

Wolf explains:

The aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007 (see charts). The balance sheets of the financial sector exploded, as did the sector’s notional profitability. But leverage, alas, works both ways.

To put it another way, in the chart, the red area at the bottom (mortgages, mainly) has been rising fast. The grey area at the top (financial-sector debt) has been rising even faster. The orange area in the middle (non-financial businesses) has been holding steady, and never really took part in the credit bubble. So if you look at the orange area in the middle, determine that it’s healthy, and conclude that the debt markets are fine, then you’re basically deliberately ignoring the entire problem.

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Are The Credit Markets Still Healthy?

Posted on September 25, 2008 by Felix

Robert Higgs has a long list of healthy-credit-market datapoints to support his contention that any talk of a frozen market is "hyperbole".

Commercial and industrial loans of all commercial banks, which are reported monthly, have grown rapidly. The most recent report, for August 2008, shows outstanding loans of $1,514 billion, an all-time high. This loan volume is 15.5 percent greater than it was a year earlier, and 30.8 percent greater than it was two years earlier. Frozen credit?

Consumer loans at all commercial banks, which are reported monthly, have also grown rapidly. The most recent report, for August 2008, shows outstanding loans of $845 billion, an all-time high. This loan volume is 9.2 percent greater than it was a year earlier, and 16.5 percent greater than it was two years earlier. Frozen credit?

Even real estate loans at all commercial banks, which are reported monthly, grew rapidly until very recently. The most recent report, for August 2008, shows outstanding loans of $3,642 billion, only slightly below the all-time high (in May 2008). This loan volume is 4.1 percent greater than it was a year earlier, and 15.5 percent greater than it was two years earlier. Frozen credit?

Lest one suspect that I have cherry-picked my examples, consider finally the amount of all bank credit at all commercial banks, which is reported weekly. For the most recent week reported, the one that ended on September 9, this credit amounted to $9,406 billion, which is only slightly less than the all-time peak of $9,485 reached in the week that ended on March 26, 2008. For the past six months, total commercial bank credit has remained on a high plateau, well above the levels reached in previous years, when everybody seemed to think that credit was ample.

I would make a few points in response to these intriguing numbers.

Firstly, they’re year-on-year numbers, which don’t give much of an impression of what’s happened over the past six months.

Secondly, remember that most of these loans were extended at very low interest rates. As a result, they don’t get paid down very fast. So even if you’re only lending a little, if it’s on top of a stock of existing loans which is basically staying steady, then your total loans outstanding will generally rise.

Thirdly, if banks are deleveraging, the direct bilateral loans to their relationship customers are the last things they’re going to want to cut. The first thing you do is try to sell off assets without damaging relationships. Most banks own a lot of debt securities, for instance: they’ll sell those before cutting back on their own lending, which is their most profitable business.

Finally, and most importantly, remember that bond issuance has crashed this year. The number to look at isn’t total lending, from banks: it’s total borrowing. And that’s gone down substantially: disintermediation preceded deleveraging.

What we’ve seen is that a lot of companies who would normally have issued bonds or other securities in the debt markets have chosen instead to tap their lines of credit and relationships with banks. So bank lending might well have gone up, even as the total supply of credit has gone down. That doesn’t mean credit markets aren’t in crisis: quite the opposite.

(Via Tabarrok, who adds interesting points of his own.)

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