More good stuff in Friday's show than I've ever read:
http://www.madmoneyrecap.com/madmoney_nightlyrecap_062509_1.htm
Tuesday, June 30, 2009
Baseline Scenario
The Baseline Scenario
No Way Out: Treasury And The Price Of TARP Warrants
Debating the Public Plan
The Paradox of Strategic Defaults
No Way Out: Treasury And The Price Of TARP Warrants
Posted: 29 Jun 2009 03:58 AM PDT
Buried in the late wire news on Friday – and therefore barely registering in the newspapers over the weekend – Treasury announced the rules for pricing its option to buy shares in banks that participated in TARP.
The Treasury Department said the banks will make the first offer for the warrants. Treasury will then decide to sell at that price or make a counteroffer. If the government and a bank cannot agree on a fair price for the warrants, the two sides will have the right to use private appraisers.
This is a mistake.
The only sensible way to dispose of these options is for Treasury to set a floor price, and then hold an auction that permits anyone to buy any part – e.g., people could submit sealed bids and the highest price wins.
In Treasury’s scheme, there is significant risk of implicit gift exchange with banks - good jobs/political support/other favors down the road – or even explicit corruption. For sure, there will be accusations that someone at Treasury was too close to this or that bidder. Why would Treasury’s leadership want to be involved in price setting in this fashion?
Treasury apparently sees corruption as an issue about personalities (i.e., WE aren’t ever corrupt) rather than about institutional structure. For example, if you create an arrangement that easily permits corruption, such as through nontransparent decision making or negotiation around warrant pricing, you set up incentives to be corrupt. Either existing people change their behavior, or new people will seek appointment in order to participate in corruption.
This is also a point, by the way, that Treasury has been making for years through its representatives at the International Monetary Fund – including during the Clinton Administration, when the same people were running U.S. economic policy as now. It’s a good point and never easy for countries-with-potential-corruption to hear. It applies as much to the United States as to anywhere else.
Treasury will argue the disposal of warrants is a one-off event, but this is not a plausible line: it is part of a much longer series of nontransparent decisions over finance. The attitude that “we can be nontransparent because we will never be corrupt” creates reputational risk for both Treasury and participating banks. If extraordinary support for the financial sector lasts several years, we will likely have at least one time-consuming and damaging investigation into all the details of these settlements.
In any crisis, technical mistakes are made due to high pressure, lack of information, and political considerations; this is unavoidable. But this proposed pricing for TARP warrants looks like a pure unforced error, and should be quietly overriden by the White House – hopefully, senior congressional leaders will quickly make this point behind the scenes.
There is obviously unappealing midterm election risk in this pricing scheme and making a correction now – before major banks have participated – would be relatively straightforward.
(Primer on option pricing, applied to warrants; background on how we got here)
By Simon Johnson
Debating the Public Plan
Posted: 28 Jun 2009 08:01 PM PDT
Greg Mankiw weighs in directly (as opposed to beating around the bush) on the public plan. Here’s the summary:
Recall a basic lesson of economics: A market participant with a dominant position can influence prices in a way that a small, competitive player cannot. . . .
If the government has a dominant role in buying the services of doctors and other health care providers, it can force prices down. Once the government is virtually the only game in town, health care providers will have little choice but to take whatever they can get. . . .
To be sure, squeezing suppliers would have unpleasant side effects. Over time, society would end up with fewer doctors and other health care workers. The reduced quantity of services would somehow need to be rationed among competing demands. Such rationing is unlikely to work well. . . .
A competitive system of private insurers, lightly regulated to ensure that the market works well, would offer Americans the best health care at the best prices.
Whenever someone uses the phrase “basic lesson of economics” when discussing the U.S. health care system, you should be suspicious. As Paul Krugman says, “the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough.”
I earlier tried to make this point in more detail: “lightly regulated” private health insurance is a fantasy, because the whole point of a for-profit insurer is to charge premiums that expect the expected payout under the policy; as a result, no sick person would be able to afford insurance. You don’t need adverse selection or moral hazard to explain this: if I know someone has an expensive form of cancer, I’m going to charge him $100,000 for health insurance, and he won’t be able to pay. The free market for health care is one in which sick people die, and smart people who ignore that point are being less than honest. (Or maybe they are hiding behind the phrase “lightly regulated” – if they consider the prohibition of medical underwriting “light regulation.”)
And if dominant market participants are the problem, then we already have that problem. Check out page 6 of this report (hat tip Krugman). In the median state in the U.S., the top two insurers have a combined market share of 69%.
Finally, it’s clear that the current system isn’t working – we have both 50 million uninsured people (plus many millions more who are not sufficiently insured against a major medical problem), and we have rising health care costs that will destroy the federal budget over the next several decades. So when Mankiw says we need “a competitive system of private insurers, lightly regulated to ensure that the market works well,” what is he saying? That we need less regulation than we have now? Or is he just talking about abstract principles?
By James Kwak
The Paradox of Strategic Defaults
Posted: 28 Jun 2009 07:00 PM PDT
Real Time Economics and Calculated Risk both discuss new research by Paola Sapienza, Luigi Zingales, and Luigi Guiso on homeowners defaulting on mortgages even though they have the money to pay them. According to their research, 17% of households would default when their negative equity reaches 50% of the house’s value. The argument is that public policy has not sufficiently addressed this problem, focusing instead on homeowners who cannot afford their mortgages.
Let’s make this a little more concrete. Let’s say you bought a house with zero money down for $300,000 in early 2006. A few years later, the house is now worth $200,000, so your negative equity is 50% of the market value. Yet only 17% of people in your situation would walk away from the house. The other 83% would continue to pay the mortgage, essentially throwing money away. Apparently people value the transaction costs of moving and the damage to their credit ratings at $100,000 (I think my numbers are approximately on the right scale – if anything they are probably low) – even after the fact that you can live in a house for free for several months before being evicted.
Or people are not as rational as economists would assume.
By James Kwak
No Way Out: Treasury And The Price Of TARP Warrants
Debating the Public Plan
The Paradox of Strategic Defaults
No Way Out: Treasury And The Price Of TARP Warrants
Posted: 29 Jun 2009 03:58 AM PDT
Buried in the late wire news on Friday – and therefore barely registering in the newspapers over the weekend – Treasury announced the rules for pricing its option to buy shares in banks that participated in TARP.
The Treasury Department said the banks will make the first offer for the warrants. Treasury will then decide to sell at that price or make a counteroffer. If the government and a bank cannot agree on a fair price for the warrants, the two sides will have the right to use private appraisers.
This is a mistake.
The only sensible way to dispose of these options is for Treasury to set a floor price, and then hold an auction that permits anyone to buy any part – e.g., people could submit sealed bids and the highest price wins.
In Treasury’s scheme, there is significant risk of implicit gift exchange with banks - good jobs/political support/other favors down the road – or even explicit corruption. For sure, there will be accusations that someone at Treasury was too close to this or that bidder. Why would Treasury’s leadership want to be involved in price setting in this fashion?
Treasury apparently sees corruption as an issue about personalities (i.e., WE aren’t ever corrupt) rather than about institutional structure. For example, if you create an arrangement that easily permits corruption, such as through nontransparent decision making or negotiation around warrant pricing, you set up incentives to be corrupt. Either existing people change their behavior, or new people will seek appointment in order to participate in corruption.
This is also a point, by the way, that Treasury has been making for years through its representatives at the International Monetary Fund – including during the Clinton Administration, when the same people were running U.S. economic policy as now. It’s a good point and never easy for countries-with-potential-corruption to hear. It applies as much to the United States as to anywhere else.
Treasury will argue the disposal of warrants is a one-off event, but this is not a plausible line: it is part of a much longer series of nontransparent decisions over finance. The attitude that “we can be nontransparent because we will never be corrupt” creates reputational risk for both Treasury and participating banks. If extraordinary support for the financial sector lasts several years, we will likely have at least one time-consuming and damaging investigation into all the details of these settlements.
In any crisis, technical mistakes are made due to high pressure, lack of information, and political considerations; this is unavoidable. But this proposed pricing for TARP warrants looks like a pure unforced error, and should be quietly overriden by the White House – hopefully, senior congressional leaders will quickly make this point behind the scenes.
There is obviously unappealing midterm election risk in this pricing scheme and making a correction now – before major banks have participated – would be relatively straightforward.
(Primer on option pricing, applied to warrants; background on how we got here)
By Simon Johnson
Debating the Public Plan
Posted: 28 Jun 2009 08:01 PM PDT
Greg Mankiw weighs in directly (as opposed to beating around the bush) on the public plan. Here’s the summary:
Recall a basic lesson of economics: A market participant with a dominant position can influence prices in a way that a small, competitive player cannot. . . .
If the government has a dominant role in buying the services of doctors and other health care providers, it can force prices down. Once the government is virtually the only game in town, health care providers will have little choice but to take whatever they can get. . . .
To be sure, squeezing suppliers would have unpleasant side effects. Over time, society would end up with fewer doctors and other health care workers. The reduced quantity of services would somehow need to be rationed among competing demands. Such rationing is unlikely to work well. . . .
A competitive system of private insurers, lightly regulated to ensure that the market works well, would offer Americans the best health care at the best prices.
Whenever someone uses the phrase “basic lesson of economics” when discussing the U.S. health care system, you should be suspicious. As Paul Krugman says, “the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough.”
I earlier tried to make this point in more detail: “lightly regulated” private health insurance is a fantasy, because the whole point of a for-profit insurer is to charge premiums that expect the expected payout under the policy; as a result, no sick person would be able to afford insurance. You don’t need adverse selection or moral hazard to explain this: if I know someone has an expensive form of cancer, I’m going to charge him $100,000 for health insurance, and he won’t be able to pay. The free market for health care is one in which sick people die, and smart people who ignore that point are being less than honest. (Or maybe they are hiding behind the phrase “lightly regulated” – if they consider the prohibition of medical underwriting “light regulation.”)
And if dominant market participants are the problem, then we already have that problem. Check out page 6 of this report (hat tip Krugman). In the median state in the U.S., the top two insurers have a combined market share of 69%.
Finally, it’s clear that the current system isn’t working – we have both 50 million uninsured people (plus many millions more who are not sufficiently insured against a major medical problem), and we have rising health care costs that will destroy the federal budget over the next several decades. So when Mankiw says we need “a competitive system of private insurers, lightly regulated to ensure that the market works well,” what is he saying? That we need less regulation than we have now? Or is he just talking about abstract principles?
By James Kwak
The Paradox of Strategic Defaults
Posted: 28 Jun 2009 07:00 PM PDT
Real Time Economics and Calculated Risk both discuss new research by Paola Sapienza, Luigi Zingales, and Luigi Guiso on homeowners defaulting on mortgages even though they have the money to pay them. According to their research, 17% of households would default when their negative equity reaches 50% of the house’s value. The argument is that public policy has not sufficiently addressed this problem, focusing instead on homeowners who cannot afford their mortgages.
Let’s make this a little more concrete. Let’s say you bought a house with zero money down for $300,000 in early 2006. A few years later, the house is now worth $200,000, so your negative equity is 50% of the market value. Yet only 17% of people in your situation would walk away from the house. The other 83% would continue to pay the mortgage, essentially throwing money away. Apparently people value the transaction costs of moving and the damage to their credit ratings at $100,000 (I think my numbers are approximately on the right scale – if anything they are probably low) – even after the fact that you can live in a house for free for several months before being evicted.
Or people are not as rational as economists would assume.
By James Kwak
Sunday, June 28, 2009
David Segal -- The Haggler -- Travel Insurance (The Scam)
This is good, if shocking, but what isn't nowadays in the financial/insurance/credit card field:
http://www.nytimes.com/2009/06/28/your-money/28haggler.html?_r=1&8dpc
http://www.nytimes.com/2009/06/28/your-money/28haggler.html?_r=1&8dpc
Baseline Scenario
A very good one, right in line with my thinking on this blog, from day one.
The Baseline Scenario
The Danger of Discretion
Posted: 26 Jun 2009 10:09 PM PDT
Justin Fox says that financial regulation should be simpler and should give less discretion to regulators.
The argument goes like this: the biggest flaw in current financial regulation is not that there is too little of it or too much, but that it relies on regulators knowing best. We regulate because financial systems are fragile, prone to booms and busts that can have harmful effects on the real economy. But regulators aren’t immune to the boom-bust cycle. They have an understandable habit of easing up when times are good and cracking down when they’re not.
As I’ve said before, the Obama Administration’s plan is likely to give us more sophisticated regulation, but if it doesn’t give us more powerful regulators with more incentive to stand up to the industry, all the sophistication in the world won’t matter. Regulators didn’t use the tools they had – the Fed could have policed risky mortgages (and raised interest rates), the bank regulators could have insisted on higher capital requirements, etc. – because they lacked the motivation to use them in the face of overwhelming opposition from the banking industry and, probably, the power to resist Congress and the administration, whichever party controlled them.
As Ezra Klein puts it: “When evaluating a particular financial regulation proposal, ask yourself this question: Would these regulations have worked if Alan Greenspan hadn’t wanted to implement them?” That’s a good question, although it’s a bit unfair: if you posit a regulator who doesn’t believe in regulation, then virtually any regulatory scheme is bound to fail. This is why Fox and Klein argue for ironclad rules that don’t leave room for discretion. In addition, though, I think we also need to think about how to make sure we get regulators who are not cheerleaders for or captives of the financial services industry.
By James Kwak
The Baseline Scenario
The Danger of Discretion
Posted: 26 Jun 2009 10:09 PM PDT
Justin Fox says that financial regulation should be simpler and should give less discretion to regulators.
The argument goes like this: the biggest flaw in current financial regulation is not that there is too little of it or too much, but that it relies on regulators knowing best. We regulate because financial systems are fragile, prone to booms and busts that can have harmful effects on the real economy. But regulators aren’t immune to the boom-bust cycle. They have an understandable habit of easing up when times are good and cracking down when they’re not.
As I’ve said before, the Obama Administration’s plan is likely to give us more sophisticated regulation, but if it doesn’t give us more powerful regulators with more incentive to stand up to the industry, all the sophistication in the world won’t matter. Regulators didn’t use the tools they had – the Fed could have policed risky mortgages (and raised interest rates), the bank regulators could have insisted on higher capital requirements, etc. – because they lacked the motivation to use them in the face of overwhelming opposition from the banking industry and, probably, the power to resist Congress and the administration, whichever party controlled them.
As Ezra Klein puts it: “When evaluating a particular financial regulation proposal, ask yourself this question: Would these regulations have worked if Alan Greenspan hadn’t wanted to implement them?” That’s a good question, although it’s a bit unfair: if you posit a regulator who doesn’t believe in regulation, then virtually any regulatory scheme is bound to fail. This is why Fox and Klein argue for ironclad rules that don’t leave room for discretion. In addition, though, I think we also need to think about how to make sure we get regulators who are not cheerleaders for or captives of the financial services industry.
By James Kwak
Saturday, June 27, 2009
Baseline Scenario -- Hedge Funds and Doctors' Pay
The Baseline Scenario
Questions about Doctors
Posted: 26 Jun 2009 01:30 PM PDT
Greg Mankiw posts data showing that doctors in the U.S. make much more than doctors elsewhere. From a 1999 paper by Uwe Reinhardt, among others:
As a dollar amount, U.S. per capita spending for physician services was the highest in the OECD in 1999: $988, compared with an OECD median of $342. . . .
In 1996, the most recent year for which data are available for multiple countries, the average U.S. physician income was $199,000. The comparable OECD median physician income was $70,324.* The ratio of the average income of U.S. physicians to average employee compensation for the United States as a whole was about 5.5. Germany’s was the next highest, at only 3.4; Canada, 3.2; Australia, 2.2; Switzerland, 2.1; France, 1.9; Sweden, 1.5; and the United Kingdom, 1.4.
Mankiw posts three discussion questions. I’m just going to take a stab at the second one:
On the issue of doctor training: Suppose that in country A physicians get free training through a taxpayer-financed educational system, while in country B physicians finance their own education and then, once trained, are paid higher fees. (a) If country A classifies these training expenses as education rather than healthcare spending, which country would report higher healthcare costs? (b) Is that difference in healthcare costs real or an artifact of labeling? (c) In which country would doctors, once trained, have more incentive to work long hours? (d) In which country would there be more doctors? (e) Which country’s system, in your judgment, is more efficient and equitable?
(a)-(b) I get Mankiw’s rhetorical point. And I guess it makes sense to count educational costs as part of the production costs of healthcare. But $199,000 – $70,000 = $120,000. So the higher med-school costs people pay in the U.S. get made up in two years out of a career of 30-40 years.
(c) The short answer is that physicians would have more incentive in country B (the U.S.), because the marginal return on labor is higher. But do we want doctors working longer hours? Medicine is not like, say, baking bread – the more hours you put in, the more good stuff you end up with. We are already the country with the highest hourly wages, and one of our major problems is not lack of doctoring capacity, at least not in aggregate; on the contrary, we have the problem of overutilization of many types of services (the expensive ones). Put another way, because we have higher wages for expensive procedures, we have doctors working longer hours doing those procedures by prescribing more of those procedures than are medically appropriate. Because we overcompensate for some services and undercompensate for others (relative to each other), we have too few of some kinds of doctors (family practice, for example) – but that is a product of the way we pay for healthcare, not the way we produce doctors.
(d) You should get more doctors in whichever country gives you the higher aggregate returns to being a doctor. Right now that’s the U.S. But the key point here is not the financing of medical school; it’s the constraint on the number of doctors enforced by the American Medical Association. That’s why, as Mankiw points out, we actually have fewer doctors per capita than the average OECD country.
(e) I’ll leave that as an exercise for you.
* Yes, it says “average” for the U.S. and “median” for the OECD. I can’t tell from the original paper if that is accurate or not. The rest of the paragraph says it is dealing with averages. In any case, I think it’s fair to assume that the median U.S. doctor made well over $70,324 in 1996.
Hedge Funds Make A Political Mistake
Posted: 26 Jun 2009 03:08 AM PDT
The political flavor of the month is to push back against even the Obama adminstration’s mildly reformist inclinations on finance (e.g., Peter Weinberg in today’s FT is a nice example). And, of course, once you hire a lobbyist, he or she tells you that “winning” means stirring up Congress in favor of the status quo. Measured in these terms, the hedge fund industry has had a string of notable recent victories effectively preventing tighter regulation.
Advocates have a point, of course, when they argue that big banks rather than hedge funds were primarily responsible for crisis. But this misses where we are in the long-cycle of regulation/deregulation. Look at this picture (source: WSJ; more on Ariell Reshef’s webpage).
If we’re at the top of the long deregulation wave and likely headed for tighter control of the financial sector – if not this year, then soon – where do you want to be in the political equation?
You can resist change, but this is just asking for trouble. You know that individual (lightly regulated) funds – whether or not these are officially “hedge funds” is irrelevant - will have high profile trouble. The latest alleged tunneling details in the case of Danny Pang are a precursor to broader social fascination with this phenomenon – you know that a dozen screenwriters are already at work. Sooner or later, there will be a more focused backlash against specific practices revealed or implied in this kind of case.
At the same time, the broader Treasury attempt to respond with only milder controls over big banks will likely also run into trouble (see my latest Economix column), so more social pressure will appear from that direction also. Big banks repeatedly get into serious scrapes, but their political clout consistently allows them to deflect attention onto others. The idea that big banks and hedge funds have some natural congruence of political interests in this space is simply wrong.
In fact, if hedge funds dig in too deeply with “the crisis was not our fault” position, that is just asking for trouble – and to be scapegoated – down the road. It would be much smarter to get out ahead of the political dynamic, and to propose ways to measure, control, and regulate risk.
Voluntarily keeping hedge funds “small enough to fail,” without endangering the system, would also make sense – particularly if accompanied by a complementary political strategy that emphasizes that it is big banks that have done almost all the damage.
By Simon Johnson
Questions about Doctors
Posted: 26 Jun 2009 01:30 PM PDT
Greg Mankiw posts data showing that doctors in the U.S. make much more than doctors elsewhere. From a 1999 paper by Uwe Reinhardt, among others:
As a dollar amount, U.S. per capita spending for physician services was the highest in the OECD in 1999: $988, compared with an OECD median of $342. . . .
In 1996, the most recent year for which data are available for multiple countries, the average U.S. physician income was $199,000. The comparable OECD median physician income was $70,324.* The ratio of the average income of U.S. physicians to average employee compensation for the United States as a whole was about 5.5. Germany’s was the next highest, at only 3.4; Canada, 3.2; Australia, 2.2; Switzerland, 2.1; France, 1.9; Sweden, 1.5; and the United Kingdom, 1.4.
Mankiw posts three discussion questions. I’m just going to take a stab at the second one:
On the issue of doctor training: Suppose that in country A physicians get free training through a taxpayer-financed educational system, while in country B physicians finance their own education and then, once trained, are paid higher fees. (a) If country A classifies these training expenses as education rather than healthcare spending, which country would report higher healthcare costs? (b) Is that difference in healthcare costs real or an artifact of labeling? (c) In which country would doctors, once trained, have more incentive to work long hours? (d) In which country would there be more doctors? (e) Which country’s system, in your judgment, is more efficient and equitable?
(a)-(b) I get Mankiw’s rhetorical point. And I guess it makes sense to count educational costs as part of the production costs of healthcare. But $199,000 – $70,000 = $120,000. So the higher med-school costs people pay in the U.S. get made up in two years out of a career of 30-40 years.
(c) The short answer is that physicians would have more incentive in country B (the U.S.), because the marginal return on labor is higher. But do we want doctors working longer hours? Medicine is not like, say, baking bread – the more hours you put in, the more good stuff you end up with. We are already the country with the highest hourly wages, and one of our major problems is not lack of doctoring capacity, at least not in aggregate; on the contrary, we have the problem of overutilization of many types of services (the expensive ones). Put another way, because we have higher wages for expensive procedures, we have doctors working longer hours doing those procedures by prescribing more of those procedures than are medically appropriate. Because we overcompensate for some services and undercompensate for others (relative to each other), we have too few of some kinds of doctors (family practice, for example) – but that is a product of the way we pay for healthcare, not the way we produce doctors.
(d) You should get more doctors in whichever country gives you the higher aggregate returns to being a doctor. Right now that’s the U.S. But the key point here is not the financing of medical school; it’s the constraint on the number of doctors enforced by the American Medical Association. That’s why, as Mankiw points out, we actually have fewer doctors per capita than the average OECD country.
(e) I’ll leave that as an exercise for you.
* Yes, it says “average” for the U.S. and “median” for the OECD. I can’t tell from the original paper if that is accurate or not. The rest of the paragraph says it is dealing with averages. In any case, I think it’s fair to assume that the median U.S. doctor made well over $70,324 in 1996.
Hedge Funds Make A Political Mistake
Posted: 26 Jun 2009 03:08 AM PDT
The political flavor of the month is to push back against even the Obama adminstration’s mildly reformist inclinations on finance (e.g., Peter Weinberg in today’s FT is a nice example). And, of course, once you hire a lobbyist, he or she tells you that “winning” means stirring up Congress in favor of the status quo. Measured in these terms, the hedge fund industry has had a string of notable recent victories effectively preventing tighter regulation.
Advocates have a point, of course, when they argue that big banks rather than hedge funds were primarily responsible for crisis. But this misses where we are in the long-cycle of regulation/deregulation. Look at this picture (source: WSJ; more on Ariell Reshef’s webpage).
If we’re at the top of the long deregulation wave and likely headed for tighter control of the financial sector – if not this year, then soon – where do you want to be in the political equation?
You can resist change, but this is just asking for trouble. You know that individual (lightly regulated) funds – whether or not these are officially “hedge funds” is irrelevant - will have high profile trouble. The latest alleged tunneling details in the case of Danny Pang are a precursor to broader social fascination with this phenomenon – you know that a dozen screenwriters are already at work. Sooner or later, there will be a more focused backlash against specific practices revealed or implied in this kind of case.
At the same time, the broader Treasury attempt to respond with only milder controls over big banks will likely also run into trouble (see my latest Economix column), so more social pressure will appear from that direction also. Big banks repeatedly get into serious scrapes, but their political clout consistently allows them to deflect attention onto others. The idea that big banks and hedge funds have some natural congruence of political interests in this space is simply wrong.
In fact, if hedge funds dig in too deeply with “the crisis was not our fault” position, that is just asking for trouble – and to be scapegoated – down the road. It would be much smarter to get out ahead of the political dynamic, and to propose ways to measure, control, and regulate risk.
Voluntarily keeping hedge funds “small enough to fail,” without endangering the system, would also make sense – particularly if accompanied by a complementary political strategy that emphasizes that it is big banks that have done almost all the damage.
By Simon Johnson
Nocera -- Some Meat, Not Enough
SEC goes after small fries because of the metrics; misses Madoff:
http://www.nytimes.com/2009/06/27/business/27nocera.html?_r=1&8dpc
http://www.nytimes.com/2009/06/27/business/27nocera.html?_r=1&8dpc
Friday, June 26, 2009
Thursday, June 25, 2009
David Faber -- Good Guy -- Writes Good New Book Apparently
Was interviewed on Charlie Rose last week. Missed it. But his new book was lauded by Charlie. Too lazy to get title right now. Will fix later.
Wednesday, June 24, 2009
Baseline Scenario
The Baseline Scenario
It Takes A Citi
Goldman’s Best Year Ever?
Modeling Everything, Public Plan Edition
It Takes A Citi
Posted: 24 Jun 2009 05:52 PM PDT
Washington-based policy tinkerers seem increasingly drawn to the idea that greater reliance on market information can forestall future problems – e.g., providing input into an early warning system that can be acted upon by a “macroprudential system regulator”. And while leading critics of the administration’s proposed approach to rating agencies make some good points, they also seem to think that the market tells us when big trouble is brewing.
The history of Citigroup’s credit default swap (CDS) spread is not so encouraging.
It’s true that in some instances during the past two years, CDS spreads have indicated pressure points, e.g., within types of lenders or across countries. And if you can tell me how Citi survives going forward with a CDS spread around 450 basis points, I would be grateful.
The people who price CDS obviously have every interest in assessing risk in a hard headed and accurate manner. But Greenspan’s Lament applies to CDS traders just as much as to incentives within mismanaged banks – where in the Citi CDS spread chart do you see the build up of risk through the end of 2006? If anything, the market for default probability was saying that Citi – and by implication the financial system with all its growing subprime vulnerabilities – was becoming less risky.
You can hope that, in the future, the market will not be so generally exuberant, but 400 years of modern financial history begs to differ.
The WSJ gets this right: regulatory capture is not only pervasive, it is by design. But what’s the implication?
All regulators must ultimately fail and, when that happens, markets may well also misprice risk. The question is: When this Twin Failure occurs next time, how much will be on the line?
You cannot design a financial system that is immune to crash – this would be like declaring earthquakes illegal. But in the aftermath of unexpectedly high damage from a serious earthquake, it makes sense to completely overhaul your building code and retrofit vulnerable buildings. In fact, if you largely ignored what the earthquake revealed in terms of structural weakness, wouldn’t that be negligence?
By Simon Johnson
Goldman’s Best Year Ever?
Posted: 23 Jun 2009 07:41 PM PDT
A reader pointed me to this story in The Guardian citing Goldman insiders saying this could be the investment bank’s most profitable year ever.
Staff in London were briefed last week on the banking and securities company’s prospects and told they could look forward to bumper bonuses if, as predicted, it completed its most profitable year ever. Figures next month detailing the firm’s second-quarter earnings are expected to show a further jump in profits.
A couple months back I said that it would be unlikely for the banks to repeat their spectacular first-quarter results in the second quarter, because it depended on fixed-income revenues being even higher than during the peak of the boom. It looks like I was wrong.
Like most things, there are two ways to interpret this. For the optimists, if some of the big banks are making big profits, that gets us back to a normally functioning financial sector sooner and reduces the chance that they will face a panic in the short term. As many people have pointed out, including us, this is basically the Obama Administration’s strategy.
For the pessimists, the phoenix-rising-from-the-ashes profitability of the big banks is a direct result of massive government aid in the form of cheap money, liquidity programs, and let’s not forget the bailout of AIG; it’s also the result of reduced competition resulting from the consolidation of Bear Stearns into JPMorgan, the failure of Lehman, and the weakened state of Citigroup and Bank of America/Merrill. So the government bought a partially healthy banking sector (the big question is what Citi and B of A will report) with public funds, the few winners (Goldman, JPMorgan) are more powerful than ever, and the government is hoping to get an anemic regulatory reform package through Congress in exchange.
By James Kwak
Modeling Everything, Public Plan Edition
Posted: 23 Jun 2009 06:58 PM PDT
Ezra Klein and Paul Krugman are both highlighting Nate Silver’s analysis of campaign contributions and the public health plan option. The quick summary? Campaign contributions matter – in this case, by about nine senators. Mainly I’m impressed and encouraged that people can use publicly-available data to quickly whip together plausible models answering questions that otherwise we would all just pontificate about.
Coincidentally, I was getting my car inspected this morning and picked up an October 2008 copy of New York Magazine in the waiting room, which had an article about . . . Nate Silver. The article includes a picture of the presidential electoral map as Silver predicted on October 8, in which he called every state correctly except Missouri (which, remember, took a few weeks to figure out whom it had voted for). Most of the article is about how the empirical approach to baseball turns out to be useful in other areas, like politics and public policy.
Update: Mark Thoma points out this counterargument by Brendan Nyhan (who long ago wrote a blog with the brother of one of the best developers at my company). Nyhan says “studies have typically found minimal effects of campaign contributions on roll call votes in Congress,” and cites a Journal of Economic Perspectives paper as backup.
OK, Nyhan may be right. But he may not be.
I looked at that paper. First, it cites a stack of papers that support Silver’s view (that campaign contributions do influence policy). (Of course, it’s common to cite the papers you are trying to refute.) Then it describes a logical argument against Silver’s view (”Tullock’s Puzzle”), which makes no sense to me, at least as summarized there. The argument is that campaign contributions are pitifully small given the amounts of money at stake, and so firms cannot possibly see contributions as an investment in policy. For example:
Dairy producers, who since 1996 have had to have subsidies renewed annually, gave $1.3 million in 2000 and received price supports worth almost $1 billion in the Farm Security and Rural Investment Act of 2002.
I dont’ see the puzzle; if I can get $1 billion in subsidies by paying $1.3 million, why would I pay any more? It seems to me that the explanation here has to do with special-interest politics; no other constituency is sufficiently mobilized to fight against dairy producers, so they get their subsidy. Here’s the conceptual argument: “The figures above imply astronomically high rates of return on investments. In a normal market, with such high rates of return, existing donors should want to increase their contributions.” But this assumes that the “investment return” on campaign contributions is a smooth, monotonic (always increasing) function, which seems fundamentally at odds with the way Congress works. But as I said, maybe Tullock did a better job explaining his puzzle.
Finally, they do a regression of “roll call” votes in Congress against campaign contributions and find little influence. But this analysis has serious limitations in the present context.
First, the dependent variable is the aggregate rating of each legislator by the U.S. Chamber of Commerce. (They got similar results using other organizations.) That is, it’s an average of a large number of votes made in the course of a session on a large number of issues. So the finding is that corporate contributions only pull a legislator a couple of points toward the Chamber of Commerce’s positions overall; but that doesn’t mean that on a given issue, he might switch his vote because of one or two large campaign contributors from the affected industry.
Second, it ignores the complexities of the legislative process. On many key issues, there is no roll call. For example, whether the public plan even comes to a meaningful vote will depend on Harry Reid – who may not even want the public plan – and whether he thinks he has the votes. The power of some members of Congress goes well beyond their individual votes.
Third, the data are from 1978-1994. I’m not a student of American politics, but casually reading The New York Times indicates a few changes in politics since 1994: there is more money; there is more money that is not controlled by political parties (weakening bonds to party, which historically explained a lot of votes); and there is more money that gets spent directly on advertising and is not contributed to political campaigns. This last factor could cut either way, but I think it’s fair to assume that if a company gave you $50,000, they are probably also donating to soft-money groups that take the same positions.
So here we have: on the one hand, a quick-and-dirty model on this specific question by a guy without a Ph.D. in anything (I think), which correctly picks the positions of 87 out of 99 senators (but it’s possible that the model would have done just as well without campaign contributions); on the other hand, a guy with a Ph.D. in political science and a research fellowship in health policy at a very good university, citing a paper by three MIT professors that’s more or less on the same general topic, arguing that campaign contributions don’t affect policy.
By James Kwak
It Takes A Citi
Goldman’s Best Year Ever?
Modeling Everything, Public Plan Edition
It Takes A Citi
Posted: 24 Jun 2009 05:52 PM PDT
Washington-based policy tinkerers seem increasingly drawn to the idea that greater reliance on market information can forestall future problems – e.g., providing input into an early warning system that can be acted upon by a “macroprudential system regulator”. And while leading critics of the administration’s proposed approach to rating agencies make some good points, they also seem to think that the market tells us when big trouble is brewing.
The history of Citigroup’s credit default swap (CDS) spread is not so encouraging.
It’s true that in some instances during the past two years, CDS spreads have indicated pressure points, e.g., within types of lenders or across countries. And if you can tell me how Citi survives going forward with a CDS spread around 450 basis points, I would be grateful.
The people who price CDS obviously have every interest in assessing risk in a hard headed and accurate manner. But Greenspan’s Lament applies to CDS traders just as much as to incentives within mismanaged banks – where in the Citi CDS spread chart do you see the build up of risk through the end of 2006? If anything, the market for default probability was saying that Citi – and by implication the financial system with all its growing subprime vulnerabilities – was becoming less risky.
You can hope that, in the future, the market will not be so generally exuberant, but 400 years of modern financial history begs to differ.
The WSJ gets this right: regulatory capture is not only pervasive, it is by design. But what’s the implication?
All regulators must ultimately fail and, when that happens, markets may well also misprice risk. The question is: When this Twin Failure occurs next time, how much will be on the line?
You cannot design a financial system that is immune to crash – this would be like declaring earthquakes illegal. But in the aftermath of unexpectedly high damage from a serious earthquake, it makes sense to completely overhaul your building code and retrofit vulnerable buildings. In fact, if you largely ignored what the earthquake revealed in terms of structural weakness, wouldn’t that be negligence?
By Simon Johnson
Goldman’s Best Year Ever?
Posted: 23 Jun 2009 07:41 PM PDT
A reader pointed me to this story in The Guardian citing Goldman insiders saying this could be the investment bank’s most profitable year ever.
Staff in London were briefed last week on the banking and securities company’s prospects and told they could look forward to bumper bonuses if, as predicted, it completed its most profitable year ever. Figures next month detailing the firm’s second-quarter earnings are expected to show a further jump in profits.
A couple months back I said that it would be unlikely for the banks to repeat their spectacular first-quarter results in the second quarter, because it depended on fixed-income revenues being even higher than during the peak of the boom. It looks like I was wrong.
Like most things, there are two ways to interpret this. For the optimists, if some of the big banks are making big profits, that gets us back to a normally functioning financial sector sooner and reduces the chance that they will face a panic in the short term. As many people have pointed out, including us, this is basically the Obama Administration’s strategy.
For the pessimists, the phoenix-rising-from-the-ashes profitability of the big banks is a direct result of massive government aid in the form of cheap money, liquidity programs, and let’s not forget the bailout of AIG; it’s also the result of reduced competition resulting from the consolidation of Bear Stearns into JPMorgan, the failure of Lehman, and the weakened state of Citigroup and Bank of America/Merrill. So the government bought a partially healthy banking sector (the big question is what Citi and B of A will report) with public funds, the few winners (Goldman, JPMorgan) are more powerful than ever, and the government is hoping to get an anemic regulatory reform package through Congress in exchange.
By James Kwak
Modeling Everything, Public Plan Edition
Posted: 23 Jun 2009 06:58 PM PDT
Ezra Klein and Paul Krugman are both highlighting Nate Silver’s analysis of campaign contributions and the public health plan option. The quick summary? Campaign contributions matter – in this case, by about nine senators. Mainly I’m impressed and encouraged that people can use publicly-available data to quickly whip together plausible models answering questions that otherwise we would all just pontificate about.
Coincidentally, I was getting my car inspected this morning and picked up an October 2008 copy of New York Magazine in the waiting room, which had an article about . . . Nate Silver. The article includes a picture of the presidential electoral map as Silver predicted on October 8, in which he called every state correctly except Missouri (which, remember, took a few weeks to figure out whom it had voted for). Most of the article is about how the empirical approach to baseball turns out to be useful in other areas, like politics and public policy.
Update: Mark Thoma points out this counterargument by Brendan Nyhan (who long ago wrote a blog with the brother of one of the best developers at my company). Nyhan says “studies have typically found minimal effects of campaign contributions on roll call votes in Congress,” and cites a Journal of Economic Perspectives paper as backup.
OK, Nyhan may be right. But he may not be.
I looked at that paper. First, it cites a stack of papers that support Silver’s view (that campaign contributions do influence policy). (Of course, it’s common to cite the papers you are trying to refute.) Then it describes a logical argument against Silver’s view (”Tullock’s Puzzle”), which makes no sense to me, at least as summarized there. The argument is that campaign contributions are pitifully small given the amounts of money at stake, and so firms cannot possibly see contributions as an investment in policy. For example:
Dairy producers, who since 1996 have had to have subsidies renewed annually, gave $1.3 million in 2000 and received price supports worth almost $1 billion in the Farm Security and Rural Investment Act of 2002.
I dont’ see the puzzle; if I can get $1 billion in subsidies by paying $1.3 million, why would I pay any more? It seems to me that the explanation here has to do with special-interest politics; no other constituency is sufficiently mobilized to fight against dairy producers, so they get their subsidy. Here’s the conceptual argument: “The figures above imply astronomically high rates of return on investments. In a normal market, with such high rates of return, existing donors should want to increase their contributions.” But this assumes that the “investment return” on campaign contributions is a smooth, monotonic (always increasing) function, which seems fundamentally at odds with the way Congress works. But as I said, maybe Tullock did a better job explaining his puzzle.
Finally, they do a regression of “roll call” votes in Congress against campaign contributions and find little influence. But this analysis has serious limitations in the present context.
First, the dependent variable is the aggregate rating of each legislator by the U.S. Chamber of Commerce. (They got similar results using other organizations.) That is, it’s an average of a large number of votes made in the course of a session on a large number of issues. So the finding is that corporate contributions only pull a legislator a couple of points toward the Chamber of Commerce’s positions overall; but that doesn’t mean that on a given issue, he might switch his vote because of one or two large campaign contributors from the affected industry.
Second, it ignores the complexities of the legislative process. On many key issues, there is no roll call. For example, whether the public plan even comes to a meaningful vote will depend on Harry Reid – who may not even want the public plan – and whether he thinks he has the votes. The power of some members of Congress goes well beyond their individual votes.
Third, the data are from 1978-1994. I’m not a student of American politics, but casually reading The New York Times indicates a few changes in politics since 1994: there is more money; there is more money that is not controlled by political parties (weakening bonds to party, which historically explained a lot of votes); and there is more money that gets spent directly on advertising and is not contributed to political campaigns. This last factor could cut either way, but I think it’s fair to assume that if a company gave you $50,000, they are probably also donating to soft-money groups that take the same positions.
So here we have: on the one hand, a quick-and-dirty model on this specific question by a guy without a Ph.D. in anything (I think), which correctly picks the positions of 87 out of 99 senators (but it’s possible that the model would have done just as well without campaign contributions); on the other hand, a guy with a Ph.D. in political science and a research fellowship in health policy at a very good university, citing a paper by three MIT professors that’s more or less on the same general topic, arguing that campaign contributions don’t affect policy.
By James Kwak
Cautionary
Still Wary of Those Financial Weapons of Mass Destruction [View article] Derivatives at the heart of the crisis, catastrophic losses are inevitable, financial system is headed for oblivion.It is this powder keg that has everyone trembling with fear and foreboding, because the inevitable losses will be catastrophic, with losses which may exceed the entire world's GDP, thus obliterating the balance sheets of every major Wall Street commercial bank, including the Fed itself, while virtually every major bank and financial institution in nations throughout the world join them on the receiving end of a destructive juggernaut of loss, insolvency, failure and bankruptcy. In the aftermath, most will be nationalized. The entire world financial system is headed for oblivion, and there is nothing on earth that can stop it. All they can do currently is try to delay and hide the destruction so that they can continue to milk their Ponzi system dry, ripping off the sheople in one final orgy of fraud and profligacy before the government and financial system are merged into an all-powerful super-entity that will rule all non-insider institutions with an iron fist. Frankly, from what i have seen lately, we are already there. The final step to nationalization of our financial system will be little more than a formality. The stage is set, there is no way to avoid the global losses on 500 trillion dollars, the losses are already there, they just have not be realized yet. Throwing 12 trillion dollars at a 200 trillion hole is like filling a bathtub with a squirtgun.These market rallies up and down are simply window dressing to as Warren Buffett says "Mass Destruction". The upside is that we get to start over again. lets hope we get it right next time.
The Investment Neighborhood
(c) 2009 F. Bruce Abel
OK, here's my analogy and this is totally original. I have seen it nowhere else. We each create and enter into our Investment Neighborhood. Once we do this we have to fight to control it, get out of it, give in to it, whatever.
My Neighborhood was created the beginning of the month and consisted of:
300 X
500 ADCT
100 SLV
500 BAC
100 EJ
I felt good about building up and buying into this Neighborhood. But it deteriorated fairly quickly. I lightened up by selling EJ. Today I sold 100 X.
You could say that my Neighborhood was a mix between China Town, (ADCT, EJ), Jimmy Rogers Town, (SLV), James Cramer town, (X, BAC), and Go With The Hedgies Pile-in Town, (X,BAC).
OK, here's my analogy and this is totally original. I have seen it nowhere else. We each create and enter into our Investment Neighborhood. Once we do this we have to fight to control it, get out of it, give in to it, whatever.
My Neighborhood was created the beginning of the month and consisted of:
300 X
500 ADCT
100 SLV
500 BAC
100 EJ
I felt good about building up and buying into this Neighborhood. But it deteriorated fairly quickly. I lightened up by selling EJ. Today I sold 100 X.
You could say that my Neighborhood was a mix between China Town, (ADCT, EJ), Jimmy Rogers Town, (SLV), James Cramer town, (X, BAC), and Go With The Hedgies Pile-in Town, (X,BAC).
Friedman -- So Good it's Criminal
It's like watching Ken Griffey/Stan Musial bat. So effortless. So correct.
http://www.nytimes.com/2009/06/24/opinion/24friedman.html?_r=1
http://www.nytimes.com/2009/06/24/opinion/24friedman.html?_r=1
Baseline Scenario
Two views of the global financial crisis:
The Baseline Scenario
What Next For The Global Crisis?
Posted: 22 Jun 2009 08:14 PM PDT
Slides for speech to World Bank conference (Lessons from East Asia and the Global Financial Crisis), Tuesday in Seoul (1pm local time), are attached. This post summarizes my main points.
There are two views of the global financial crisis and – more importantly – of what comes next. The first is shared by almost all officials and underpins government thinking in the United States, the remainder of the G7, Western Europe, and beyond. The second is quite unofficial – no government official has yet been found anywhere near this position. Yet versions of this unofficial view have a great deal of support and may even be gaining traction over time as events unfold.
The official view is that a rare and unfortunate accident occurred in the fall of 2008. The heart of the world’s financial system, in and around the United States, suddenly became unstable. Presumably this instability had a cause – and most official statements begin with “the crisis had many causes” – but this is less important than the need for immediate and overwhelming macroeconomic policy action.
The official strategy, for example as stated clearly by Larry Summers is to support the banking system with all the financial means at the disposal of the official sector. This includes large amounts of cash, courtesy of Federal Reserve credits; repeated attempts to remove “bad assets” in some form or other, and – the apparent masterstroke – regulatory forbearance, as signaled through the recent stress tests.
But most important, it includes a massive fiscal stimulus implying, when all is said and done, that debt/GDP in the United States will roughly double (from 41% of GDP initially, up towards 80% of GDP).
Not surprisingly, funneling unlimited and essentially unconditional resources into the financial sector has buoyed confidence in both that sector and at least temporarily helped shore up confidence in financial markets more broadly.
And now, in striking contrast to the dramatic action they call for on the macroeconomic/bailout front, the official consensus claims relatively small adjustments to our regulatory system will be enough to close the case – and presumably prevent further recurrence of problems on this scale. If the exact causes and presumed redress are lost in mind-numbingly long list of adjustments, so much the better.
This is, after all, a crisis of experts – they deregulated, they ran risk management at major financial firms, they opined at board meetings – and now they have fixed it.
Maybe.
The second view, of course, is rather more skeptical regarding whether we are really out of crisis in any meaningful sense. In this view, the underlying cause of the crisis is much simpler – the economic supersizing of finance in the United States and elsewhere, as manifest particularly in the rise of big banks to positions of extraordinary political and cultural power.
If the size, nature, and clout of finance is the problem, then the official view is nothing close to a solution. At best, pumping resources into the financial sector delays the day of reckoning and likely increases its costs. More likely, the Mother of All Bailouts is storing up serious problems for the near-term future.
We’ll double our national debt (as a percent of GDP), and for what? To further entrench a rent-seeking set of firms that the government determined are “too big to fail,” but will not now take any steps to break up or otherwise limit their size.
We need to disengage from a financial sector that has become unsustainably large (see slides before and after #19; the cross-country data should be handled with care).
We can do this in various ways; there is no need to be dogmatic about any potential approach – if it works politically, do it. But the various current proposals for dealing with this issue – both from the administration and the leading committees of Congress – would make essentially zero progress.
As moving in this direction does not seem imminent, the probable consequences or – if you prefer – collateral damage looks horrible. You can see it as higher taxes in the future, lower growth, a bigger drag on our innovative capacity, fewer startups, and less genuinely productive entrepreneurship. Plenty of people will be hurt, and they are starting to figure this out – and to think harder about what needs to be done and by whom.
“Small enough to fail” may well prevail eventually – at least sensible ideas have won through in past US episodes – but it will take a while. The official consensus always seems immutable, right up until the moment it changes completely and forever.
By Simon Johnson
The Baseline Scenario
What Next For The Global Crisis?
Posted: 22 Jun 2009 08:14 PM PDT
Slides for speech to World Bank conference (Lessons from East Asia and the Global Financial Crisis), Tuesday in Seoul (1pm local time), are attached. This post summarizes my main points.
There are two views of the global financial crisis and – more importantly – of what comes next. The first is shared by almost all officials and underpins government thinking in the United States, the remainder of the G7, Western Europe, and beyond. The second is quite unofficial – no government official has yet been found anywhere near this position. Yet versions of this unofficial view have a great deal of support and may even be gaining traction over time as events unfold.
The official view is that a rare and unfortunate accident occurred in the fall of 2008. The heart of the world’s financial system, in and around the United States, suddenly became unstable. Presumably this instability had a cause – and most official statements begin with “the crisis had many causes” – but this is less important than the need for immediate and overwhelming macroeconomic policy action.
The official strategy, for example as stated clearly by Larry Summers is to support the banking system with all the financial means at the disposal of the official sector. This includes large amounts of cash, courtesy of Federal Reserve credits; repeated attempts to remove “bad assets” in some form or other, and – the apparent masterstroke – regulatory forbearance, as signaled through the recent stress tests.
But most important, it includes a massive fiscal stimulus implying, when all is said and done, that debt/GDP in the United States will roughly double (from 41% of GDP initially, up towards 80% of GDP).
Not surprisingly, funneling unlimited and essentially unconditional resources into the financial sector has buoyed confidence in both that sector and at least temporarily helped shore up confidence in financial markets more broadly.
And now, in striking contrast to the dramatic action they call for on the macroeconomic/bailout front, the official consensus claims relatively small adjustments to our regulatory system will be enough to close the case – and presumably prevent further recurrence of problems on this scale. If the exact causes and presumed redress are lost in mind-numbingly long list of adjustments, so much the better.
This is, after all, a crisis of experts – they deregulated, they ran risk management at major financial firms, they opined at board meetings – and now they have fixed it.
Maybe.
The second view, of course, is rather more skeptical regarding whether we are really out of crisis in any meaningful sense. In this view, the underlying cause of the crisis is much simpler – the economic supersizing of finance in the United States and elsewhere, as manifest particularly in the rise of big banks to positions of extraordinary political and cultural power.
If the size, nature, and clout of finance is the problem, then the official view is nothing close to a solution. At best, pumping resources into the financial sector delays the day of reckoning and likely increases its costs. More likely, the Mother of All Bailouts is storing up serious problems for the near-term future.
We’ll double our national debt (as a percent of GDP), and for what? To further entrench a rent-seeking set of firms that the government determined are “too big to fail,” but will not now take any steps to break up or otherwise limit their size.
We need to disengage from a financial sector that has become unsustainably large (see slides before and after #19; the cross-country data should be handled with care).
We can do this in various ways; there is no need to be dogmatic about any potential approach – if it works politically, do it. But the various current proposals for dealing with this issue – both from the administration and the leading committees of Congress – would make essentially zero progress.
As moving in this direction does not seem imminent, the probable consequences or – if you prefer – collateral damage looks horrible. You can see it as higher taxes in the future, lower growth, a bigger drag on our innovative capacity, fewer startups, and less genuinely productive entrepreneurship. Plenty of people will be hurt, and they are starting to figure this out – and to think harder about what needs to be done and by whom.
“Small enough to fail” may well prevail eventually – at least sensible ideas have won through in past US episodes – but it will take a while. The official consensus always seems immutable, right up until the moment it changes completely and forever.
By Simon Johnson
Cramer Last Night
Being up in Canada I am not watching the market the way I do normally. So Mad Money becomes more important.
http://www.madmoneyrecap.com/madmoney_nightlyrecap_062309_6.htm
Jim Cramer is a friend. In the way many may say this: we emailed back and forth a few times many years ago, and I got semi-invited to write for theStreet.com on public utility matters.
Last night's key was that he sneaks in the thought that that he's been saying one must wait until the severe decline is over before jumping back in. Whaa? Where?
http://www.madmoneyrecap.com/madmoney_nightlyrecap_062309_6.htm
Jim Cramer is a friend. In the way many may say this: we emailed back and forth a few times many years ago, and I got semi-invited to write for theStreet.com on public utility matters.
Last night's key was that he sneaks in the thought that that he's been saying one must wait until the severe decline is over before jumping back in. Whaa? Where?
Tuesday, June 23, 2009
A Man in Full -- James Cramer
(c) 2009 F. Bruce Abel
Readers of this blog know that I am an advocate of Jim Cramer and what he does for the individual investor. Up here in Canada I have taken the time to glean from one of his chapters ten rules he came up with coming out of his mistakes.
Think about that -- from his mistakes. What other Wall Streeter would do this.
Ten Lessons From Cramer’s Bad Calls, from "Mad Money, Watch TV, Get Rich"
1. Resisting the Business Cycle is Futile.
2. There’s a Market for Everything; Pay Attention to it.
3. It’s Not Enough to do the Homework; Do the Right Homework.
4. Latin America is Always a Trade.
5. Don’t be Afraid to Say It’s Too Hard: Some Things Like Restaurant Same-Store Sales Are Just Too Difficult to Game.
6. Not All Companies That Produce Commodities Are as Interchangeable as Their Products.
7. Past Performance is Not an Indicator of Future Success.
8. Never Invest Based on Borrowed Convictions.
9. When You’re Playing a Big Rally, Make Sure Your Stocks Actually Fill the Bill.
10. Don’t Try to Smash Iconic Truths; Try to Make Money.
Readers of this blog know that I am an advocate of Jim Cramer and what he does for the individual investor. Up here in Canada I have taken the time to glean from one of his chapters ten rules he came up with coming out of his mistakes.
Think about that -- from his mistakes. What other Wall Streeter would do this.
Ten Lessons From Cramer’s Bad Calls, from "Mad Money, Watch TV, Get Rich"
1. Resisting the Business Cycle is Futile.
2. There’s a Market for Everything; Pay Attention to it.
3. It’s Not Enough to do the Homework; Do the Right Homework.
4. Latin America is Always a Trade.
5. Don’t be Afraid to Say It’s Too Hard: Some Things Like Restaurant Same-Store Sales Are Just Too Difficult to Game.
6. Not All Companies That Produce Commodities Are as Interchangeable as Their Products.
7. Past Performance is Not an Indicator of Future Success.
8. Never Invest Based on Borrowed Convictions.
9. When You’re Playing a Big Rally, Make Sure Your Stocks Actually Fill the Bill.
10. Don’t Try to Smash Iconic Truths; Try to Make Money.
Monday, June 22, 2009
Mozilo Profile in This Week's New Yorker
Mozio, as difficult a man to analyze as his name is to spell.
The following may not work if you don't have a subscription to the New Yorker:
http://archives.newyorker.com/?i=2009-06-29&email-analytics=newsletter090629p046#folio=054
The following may not work if you don't have a subscription to the New Yorker:
http://archives.newyorker.com/?i=2009-06-29&email-analytics=newsletter090629p046#folio=054
Diversification Will Kill You -- Jimmy Rogers
Jimmy Rogers, June 21, 2009:
Diversification Will Kill You
Diversification is something that stock brokers came up with to protect themselves, so they wouldn't get sued. Henry Ford never diversified, Bill Gates didn't diversify. The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket.You can go broke diversifying. Ask anyone who's diversified in the last three years. They've lost money.
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Jim Rogers, Singapore. Born in 1942. "Buy low and sell high" is the most important investment rule!
Sunday, June 21, 2009
Baseline Scenario -- The McAllen, Texas Problem in Health Care
This was discussed in a recent New Yorker article on health care comparisons within two different towns in Texas.
The Baseline Scenario
The McAllen Problem
Posted: 21 Jun 2009 05:00 AM PDT
What is the lesson of McAllen, Texas, the focus of Atul Gawande’s celebrated article (discussed here and here)? This is my attempt at an answer:
Currently, our health care system has high-cost and low-cost areas; the high-cost areas have no better outcomes than the low-cost areas. So theoretically we can solve our health care cost problem by making the high-cost areas behave like the low-cost areas.
However, the market incentives go in the other direction; the economically rational thing for providers (doctors, hospitals, etc.) to do is to run up procedures and thereby costs. It would be better if providers focused more on patient outcomes or organized themselves into accountable care organizations, as Gawande prefers; but there is no economic reason for them to do so. People are not magically going to become more altruistic overnight. Even shame has only a temporary effect on behavior. Here’s Gail Wilensky from a Health Affairs roundtable:
It’s only by being able to offer compelling evidence that it’s the physician that is the outlier relative to his or her peers, that the patients really aren’t different, and in fact they are not having better outcomes, that you are able to pull back physician behavior — although there seems to be a high recidivism rate.
(Emphasis added.)
In some ways McAllen isn’t the aberration; according to the old Chicago economics department, everywhere should be like McAllen.
Remember all the people who said that you can’t blame mortgage brokers and investment bankers for being greedy, because that’s how a capitalist economy works? Well, you could make the same defense for the McAllen doctors. We long ago stopped expecting lawyers and accountants to behave contrary to their economic interests; now we simply expect them to conform to the law and to certain professional codes of conduct, and otherwise make as much money as possible. Why should we expect anything different from doctors?
In a capitalist economy, the thing that is supposed to keep prices in check is the buyers. If someone offers me a product that costs more than it is worth to me, then I won’t buy it. But we can’t count on patients to play this role in health care, because there is no way to make patients internalize all of the costs of their care; they simply don’t have the money. Furthermore, most people don’t understand the health production function (the relationship between treatments and outcomes), so they don’t have the ability to select treatments that provide benefits that are worth their costs. (And, in many cases, it’s not obvious even to professionals that a treatment isn’t worth the cost; it’s only obvious when you look at the data in aggregate.)
What about payers (health insurers?) A “market” solution would be to change the reimbursement rates for different procedures – increase payment for things that doctors should do more of and reduce payment for things that doctors should do less of. Theoretically, payers should be doing this already. However, in the current situation, a private payer who tried to reduce the rates for popular, expensive procedures would find itself unable to attract providers. The only payer with any real negotiating power is Medicare. The private payers have little ability to control costs. Or, if they have the ability, they aren’t exercising it.
In short, prices will only go up. As a result, the cost of health insurance goes up, and the market finally kicks in in the crudest possible form: people who can’t afford it become uninsured. At some point, if we have enough uninsured people, the health care industry will hit a point where it cannot increase revenues anymore, because it has fewer and fewer paying customers.
The proposed public health insurance plan would have the power to negotiate lower rates with providers. That’s why some providers don’t like it. That’s also why private payers don’t like it; they would be at a cost disadvantage to the public plan. (They can live with Medicare because Medicare leaves them the entire under-65 market.) Maybe that’s unfair. But the current situation isn’t working.
By James Kwak
The Baseline Scenario
The McAllen Problem
Posted: 21 Jun 2009 05:00 AM PDT
What is the lesson of McAllen, Texas, the focus of Atul Gawande’s celebrated article (discussed here and here)? This is my attempt at an answer:
Currently, our health care system has high-cost and low-cost areas; the high-cost areas have no better outcomes than the low-cost areas. So theoretically we can solve our health care cost problem by making the high-cost areas behave like the low-cost areas.
However, the market incentives go in the other direction; the economically rational thing for providers (doctors, hospitals, etc.) to do is to run up procedures and thereby costs. It would be better if providers focused more on patient outcomes or organized themselves into accountable care organizations, as Gawande prefers; but there is no economic reason for them to do so. People are not magically going to become more altruistic overnight. Even shame has only a temporary effect on behavior. Here’s Gail Wilensky from a Health Affairs roundtable:
It’s only by being able to offer compelling evidence that it’s the physician that is the outlier relative to his or her peers, that the patients really aren’t different, and in fact they are not having better outcomes, that you are able to pull back physician behavior — although there seems to be a high recidivism rate.
(Emphasis added.)
In some ways McAllen isn’t the aberration; according to the old Chicago economics department, everywhere should be like McAllen.
Remember all the people who said that you can’t blame mortgage brokers and investment bankers for being greedy, because that’s how a capitalist economy works? Well, you could make the same defense for the McAllen doctors. We long ago stopped expecting lawyers and accountants to behave contrary to their economic interests; now we simply expect them to conform to the law and to certain professional codes of conduct, and otherwise make as much money as possible. Why should we expect anything different from doctors?
In a capitalist economy, the thing that is supposed to keep prices in check is the buyers. If someone offers me a product that costs more than it is worth to me, then I won’t buy it. But we can’t count on patients to play this role in health care, because there is no way to make patients internalize all of the costs of their care; they simply don’t have the money. Furthermore, most people don’t understand the health production function (the relationship between treatments and outcomes), so they don’t have the ability to select treatments that provide benefits that are worth their costs. (And, in many cases, it’s not obvious even to professionals that a treatment isn’t worth the cost; it’s only obvious when you look at the data in aggregate.)
What about payers (health insurers?) A “market” solution would be to change the reimbursement rates for different procedures – increase payment for things that doctors should do more of and reduce payment for things that doctors should do less of. Theoretically, payers should be doing this already. However, in the current situation, a private payer who tried to reduce the rates for popular, expensive procedures would find itself unable to attract providers. The only payer with any real negotiating power is Medicare. The private payers have little ability to control costs. Or, if they have the ability, they aren’t exercising it.
In short, prices will only go up. As a result, the cost of health insurance goes up, and the market finally kicks in in the crudest possible form: people who can’t afford it become uninsured. At some point, if we have enough uninsured people, the health care industry will hit a point where it cannot increase revenues anymore, because it has fewer and fewer paying customers.
The proposed public health insurance plan would have the power to negotiate lower rates with providers. That’s why some providers don’t like it. That’s also why private payers don’t like it; they would be at a cost disadvantage to the public plan. (They can live with Medicare because Medicare leaves them the entire under-65 market.) Maybe that’s unfair. But the current situation isn’t working.
By James Kwak
Why I Was Too Busy
(c) 2009 F. Bruce Abel
Every year up here on this absolutely quiet island in Canada my mind settles down after a wonderful evening with my family and a good night's sleep and a beautiful calm day arising on the Georgian Bay, I am settled enough to call up my favorite past blogs I have posted -- I have done blogging now for almost three years. Some, just a few, are just "edits" which means that they are not "published," and they contain diary-like remembrances that the reader would not find of interest.
Most -- 499 out of 500, say -- are not of this variety because I believe the reader will get something deeper out of it as I did.
One that I have published, over and over again, is "Why I Was Too Busy to Write This Paper."
You see we belong to a Glendale Literary Club, Glendale, Ohio, which has 16 or so couples who live in Glendale, which meets once a month on a Sunday night at the home of a member, or at the Glendale Lyceum library. After wine, coffee and pastries, the hosts give an original paper, usually about twenty minutes long.
Beth Smith, who lives with John, her husband, in the Hubbards' old house, wrote this paper in February, 2004, when I was Secretary of the club. I wanted to cancel the meeting because a big impending snow storm was coming.
Being secretary, I easily got the paper and scanned it. (With permission.)
The paper, not the snow storm, staggered me with its jewel-like clarity and force.
I have scanned this paper into my blog "numerous of times," as one of my clients says.
(With permission.)
I then have created a "label" entitled "Why I Was Too Busy" so the reader can enjoy this paper for himself.
Every year up here on this absolutely quiet island in Canada my mind settles down after a wonderful evening with my family and a good night's sleep and a beautiful calm day arising on the Georgian Bay, I am settled enough to call up my favorite past blogs I have posted -- I have done blogging now for almost three years. Some, just a few, are just "edits" which means that they are not "published," and they contain diary-like remembrances that the reader would not find of interest.
Most -- 499 out of 500, say -- are not of this variety because I believe the reader will get something deeper out of it as I did.
One that I have published, over and over again, is "Why I Was Too Busy to Write This Paper."
You see we belong to a Glendale Literary Club, Glendale, Ohio, which has 16 or so couples who live in Glendale, which meets once a month on a Sunday night at the home of a member, or at the Glendale Lyceum library. After wine, coffee and pastries, the hosts give an original paper, usually about twenty minutes long.
Beth Smith, who lives with John, her husband, in the Hubbards' old house, wrote this paper in February, 2004, when I was Secretary of the club. I wanted to cancel the meeting because a big impending snow storm was coming.
Being secretary, I easily got the paper and scanned it. (With permission.)
The paper, not the snow storm, staggered me with its jewel-like clarity and force.
I have scanned this paper into my blog "numerous of times," as one of my clients says.
(With permission.)
I then have created a "label" entitled "Why I Was Too Busy" so the reader can enjoy this paper for himself.
Morgenson -- A Reflection
(c) 2009 F. Bruce Abel
How do you regulate "too big to fail?"
How do you regulate a man's hand as it signs a "bespoke" contract committing billions to another?
Or that same hand cliking "ok" on a similar transaction, electronically?
Simon Johnson and many others say "Don't pay the man a commission for going to the casino and winning, for God's sake, without taking the commission away when he loses." Why pay him a commission or salary at all? Don't go to the casino!
But the former is not enough because questionable gate-keepers are telling us what "winning" is.
For example how many years did AIG have deferred "concepts" listed as assets on the balance sheet supposedly supporting its bets? (Post-retirement health benefits tax credits usable only if the company still existed. Timing differences on deferred accounting for accelerated depreciation.")
How do you regulate "too big to fail?"
How do you regulate a man's hand as it signs a "bespoke" contract committing billions to another?
Or that same hand cliking "ok" on a similar transaction, electronically?
Simon Johnson and many others say "Don't pay the man a commission for going to the casino and winning, for God's sake, without taking the commission away when he loses." Why pay him a commission or salary at all? Don't go to the casino!
But the former is not enough because questionable gate-keepers are telling us what "winning" is.
For example how many years did AIG have deferred "concepts" listed as assets on the balance sheet supposedly supporting its bets? (Post-retirement health benefits tax credits usable only if the company still existed. Timing differences on deferred accounting for accelerated depreciation.")
Roger Cohen -- An Unbelievable Daring and Unique Report From the Iranian Street Front
Read this. You won't believe what's happening to this brave, wonderful New York Times editor and correspondent,
http://www.nytimes.com/2009/06/21/opinion/21tehran.html
http://www.nytimes.com/2009/06/21/opinion/21tehran.html
Plain Vanilla Friedman on Iran
Plain vanilla, but necessary to read to get a historical context:
http://www.nytimes.com/2009/06/21/opinion/21friedman.html
http://www.nytimes.com/2009/06/21/opinion/21friedman.html
Saturday, June 20, 2009
Baseline Scenario
The Baseline Scenario
Shadow Banking for Beginners
Posted: 20 Jun 2009 05:00 AM PDT
Last Friday, Mark Thoma wrote a guest post for The Hearing arguing that the “shadow banking system” was a significant contributor to the financial crisis and needed to be regulated. This prompted a series of posts either attacking or defending his position; for a rundown, see today’s Hearing post.
For now, I just want to highlight the analysis by Mike at Rortybomb (hat tip Mark Thoma). (Those who have read Gary Gorton’s new paper can probably skip this post.) Mike points out that people mean at least three different things by “shadow banking system:”
1) Subprime lenders, who were not subject to the same regulatory burden as depository institutions.
2) A market that trades “informationally insensitive” debt as the result of the repo market and securitized debt as collateral. Where depositors are corporations and money market funds and where lenders are financial firms.
3) Traditional firms who took big bets in the investment markets while their regulators were not present or asleep at the wheel.
For Mike, #2 is the the one that matters. Here’s his explanation:
A bank is, in abstract, an institution that borrowers short and lends long.
Your local bank borrows short deposits and lends long investments. If it needs liquidity it can always go to the central bank’s discount window. The central bank’s discount window is the market maker of last resort for this banking system. [Regulated banks can always borrow money from the Fed at a pre-set interest rate, so they always have access to cash.] This prevents bank runs. In exchange it is regulated by the government.
Your local shadow bank took in money in the repo market as deposits, and used senior tranches of debt as the collateral. Now what happens when it needs liquidity? There is no market maker of last resort who the system as a whole could turn to. Repeat that again. It exists in the shadows, there is nowhere to turn to for emergency liquidity. There is no regulation/liquidity tradeoff here. This is what is meant by being unregulated – not that there weren’t any government agents in sight.
I’ll take that last paragraph a little slower. A repo, or repurchase agreement, is a transaction where one party (the “shadow bank”) sells some securities to another party (the “depositor”) in exchange for cash and simultaneously agrees to buy those securities back at a predetermined (higher) price at some date in the (near) future (like tomorrow). In effect, the depositor is lending cash to the shadow bank, and holding the securities as collateral; the difference in the two prices is the interest. It wants the collateral because nothing else is guaranteeing its loan to the shadow bank (as opposed to ordinary FDIC-insured deposits). The collateral is generally worth at least as much as the amount of the loan, to minimize the risk to the depositor; but the remaining risk is that the shadow bank won’t make good on the repo and the collateral will fall in value.
Why would this happen? The depositors do it because they get higher interest rates than they can get in an ordinary deposit account at a commercial bank. Why would the shadow bank offer higher interest rates? It wants to attract the cash so it can lend it out at a yet higher interest rate (”lend” here could mean buying up subprime mortgages to package into securities that are then used as the collateral for more repurchase agreements to start the cycle again); it doesn’t want to become a commercial bank because commercial banks were traditionally more highly regulated. For example, the major commercial banks were significantly less leveraged than the investment banks during the boom.
The problem that Mike highlights is that there was no liquidity backstop for the shadow banking system. So when the “depositors” got nervous about investment banks like Bear Stearns, they refused to roll over their repo agreements (that is, when the shadow bank closed a repo by buying back the securities, the depositor refused to lend new cash via a new repo), or they imposed a larger “haircut” – they lent less cash for the same amount of collateral. The result is a bank run – only this time the run is on the shadow bank. (Gorton focuses on a slightly different problem, which is that when the same collateral doesn’t bring in as much cash, you have to shrink your balance sheet by dumping assets.)
Mike’s analysis draws heavily on Gorton’s paper, which is helpfully summarized by Ezra Klein. The basic conclusion of both Mike and Gorton is that banking systems need to be reliable, the shadow banking system is a banking system, and hence the shadow banking system must be regulated to some degree. Robert Lucas, quoted in Mike’s post, puts it well:
The regulatory problem that needs to be solved is roughly this: The public needs a conveniently provided medium of exchange that is free of default risk or “bank runs.” The best way to achieve this would be to have a competitive banking system with government-insured deposits.
But this can only work if the assets held by these banks are tightly regulated. If such an equilibrium could be reached, it would still be possible for an institution outside this regulated system to offer deposits that are only slightly more risky but that also pay a higher return than deposits at the regulated banks. Some consumers and firms will find this attractive and switch their deposits. But if everyone does, the regulations will no longer protect anyone. The regulatory structure designed in the 1930s seemed to solve this problem for 60 years, but something else will be needed for the next 60.
By James Kwak
Shadow Banking for Beginners
Posted: 20 Jun 2009 05:00 AM PDT
Last Friday, Mark Thoma wrote a guest post for The Hearing arguing that the “shadow banking system” was a significant contributor to the financial crisis and needed to be regulated. This prompted a series of posts either attacking or defending his position; for a rundown, see today’s Hearing post.
For now, I just want to highlight the analysis by Mike at Rortybomb (hat tip Mark Thoma). (Those who have read Gary Gorton’s new paper can probably skip this post.) Mike points out that people mean at least three different things by “shadow banking system:”
1) Subprime lenders, who were not subject to the same regulatory burden as depository institutions.
2) A market that trades “informationally insensitive” debt as the result of the repo market and securitized debt as collateral. Where depositors are corporations and money market funds and where lenders are financial firms.
3) Traditional firms who took big bets in the investment markets while their regulators were not present or asleep at the wheel.
For Mike, #2 is the the one that matters. Here’s his explanation:
A bank is, in abstract, an institution that borrowers short and lends long.
Your local bank borrows short deposits and lends long investments. If it needs liquidity it can always go to the central bank’s discount window. The central bank’s discount window is the market maker of last resort for this banking system. [Regulated banks can always borrow money from the Fed at a pre-set interest rate, so they always have access to cash.] This prevents bank runs. In exchange it is regulated by the government.
Your local shadow bank took in money in the repo market as deposits, and used senior tranches of debt as the collateral. Now what happens when it needs liquidity? There is no market maker of last resort who the system as a whole could turn to. Repeat that again. It exists in the shadows, there is nowhere to turn to for emergency liquidity. There is no regulation/liquidity tradeoff here. This is what is meant by being unregulated – not that there weren’t any government agents in sight.
I’ll take that last paragraph a little slower. A repo, or repurchase agreement, is a transaction where one party (the “shadow bank”) sells some securities to another party (the “depositor”) in exchange for cash and simultaneously agrees to buy those securities back at a predetermined (higher) price at some date in the (near) future (like tomorrow). In effect, the depositor is lending cash to the shadow bank, and holding the securities as collateral; the difference in the two prices is the interest. It wants the collateral because nothing else is guaranteeing its loan to the shadow bank (as opposed to ordinary FDIC-insured deposits). The collateral is generally worth at least as much as the amount of the loan, to minimize the risk to the depositor; but the remaining risk is that the shadow bank won’t make good on the repo and the collateral will fall in value.
Why would this happen? The depositors do it because they get higher interest rates than they can get in an ordinary deposit account at a commercial bank. Why would the shadow bank offer higher interest rates? It wants to attract the cash so it can lend it out at a yet higher interest rate (”lend” here could mean buying up subprime mortgages to package into securities that are then used as the collateral for more repurchase agreements to start the cycle again); it doesn’t want to become a commercial bank because commercial banks were traditionally more highly regulated. For example, the major commercial banks were significantly less leveraged than the investment banks during the boom.
The problem that Mike highlights is that there was no liquidity backstop for the shadow banking system. So when the “depositors” got nervous about investment banks like Bear Stearns, they refused to roll over their repo agreements (that is, when the shadow bank closed a repo by buying back the securities, the depositor refused to lend new cash via a new repo), or they imposed a larger “haircut” – they lent less cash for the same amount of collateral. The result is a bank run – only this time the run is on the shadow bank. (Gorton focuses on a slightly different problem, which is that when the same collateral doesn’t bring in as much cash, you have to shrink your balance sheet by dumping assets.)
Mike’s analysis draws heavily on Gorton’s paper, which is helpfully summarized by Ezra Klein. The basic conclusion of both Mike and Gorton is that banking systems need to be reliable, the shadow banking system is a banking system, and hence the shadow banking system must be regulated to some degree. Robert Lucas, quoted in Mike’s post, puts it well:
The regulatory problem that needs to be solved is roughly this: The public needs a conveniently provided medium of exchange that is free of default risk or “bank runs.” The best way to achieve this would be to have a competitive banking system with government-insured deposits.
But this can only work if the assets held by these banks are tightly regulated. If such an equilibrium could be reached, it would still be possible for an institution outside this regulated system to offer deposits that are only slightly more risky but that also pay a higher return than deposits at the regulated banks. Some consumers and firms will find this attractive and switch their deposits. But if everyone does, the regulations will no longer protect anyone. The regulatory structure designed in the 1930s seemed to solve this problem for 60 years, but something else will be needed for the next 60.
By James Kwak
Baseline Scenario
The Baseline Scenario
TARP for Rating Agencies
Posted: 19 Jun 2009 06:15 AM PDT
I would have thought that the credit rating agencies would be at least one group that everyone could agree to throw under the bus. We know that the powerful chieftains of Wall Street are trying to pin the credit crisis on rating agencies – see page 3 of JPMorgan’s blame-shifting attempt, for example. Yet the new Financial Regulatory Reform plan has almost nothing on the subject. Apparently the rating agencies, too, are Too Big to Fail.
Reuters catalogs the provisions relating to the rating agencies. Here’s the summary:
The plan urges Moody’s Corp’s Moody’s Investors Service, McGraw-Hill Cos Inc’ Standard & Poor’s and Fimalac SA’s Fitch Ratings and others to bolster the integrity of their ratings, especially in structured finance.
It also calls for reduced conflicts of interest and for regulators worldwide to tighten oversight.
But the blueprint does nothing to address what critics call the industry’s key shortcoming: That the biggest agencies are paid by issuers whose securities they rate, creating an incentive to win more business by assigning high ratings. . . .
“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.
Also see the Huffington Post, which has this understated but damning criticism: “Today, the agencies welcome the government proposals, saying that they favored improved ratings quality and transparency.”
Perhaps this is one area where Congress can improve on the administration’s plan.
Update: Krugman:
The plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
By James Kwak
TARP for Regulators!
Posted: 19 Jun 2009 04:00 AM PDT
We’ve had TARP for banks, TARP for auto companies, and now, with the Obama Administration’s plan for financial regulatory reform, we have TARP for regulators. After AIG, Citigroup, Bank of America, and General Motors, the administration has decided that all the existing regulators are Too Big to Fail – except for the Office of Thrift Supervision, which must play the role of poor Lehman Brothers in this saga. (Actually, they are more like Merrill Lynch, since they are getting merged into the new National Bank Supervisor, so most of them will probably keep their jobs.)
There is actually a serious issue here, and one with no obvious solution. One question that has gotten a lot of ink, both before and after the unveiling of the plan yesterday, has been the identity of the systemic risk regulator: new agency? council of agencies? the Fed? What this really shows is that it’s easier for the media, the administration, and Congress to focus on the how the agency acronyms will be reshuffled, which is a bit like covering a sporting event, than on the underlying issues, like how to make those agencies more effective.
(Warning: I’m about to argue three sides of an issue.)
(1) So, for example, it’s a little ridiculous that the Federal Reserve is being given the role of systemic risk regulator, since the Fed (under Greenspan, but with no dissent from Bernanke) completely missed the housing bubble, the risks of a massive derivatives market, and the systemic implications of toxic mortgages that it was actually supposed to be regulating – and, in fact, contributed to the financial crisis by keeping interest rates low for the first half of this decade, and then helped aggravate it by letting Lehman fail. Yes, I know, most economists didn’t predict the crisis, either, but no one is nominating them for systemic risk regulator.
(2) But what’s the alternative? You could posit a new regulatory agency focused on systemic risk; let’s call it Bill. But you have no right to simply assert that Bill will do any better than the Fed. In fact, since Bill will start out with no building, no computers, and no staff, you could argue that the Fed, after being given an appropriate pep talk, would do better than Bill. It’s likely that many of the people working for Bill would be people who used to work for the Fed. Planet Money had a story a while back (I think it’s in this episode) about how when the Federal Home Loan Bank Board was abolished in the wake of the savings and loan crisis, its employees just kept on working and eventually the sign on the building was changed to Office of Thrift Supervision.
So given those alternatives, it’s easy for someone as smart as Larry Summers to argue that the Fed is a better choice than a new agency, or a committee, as he did on All Things Considered today. Basically he is positing an ideal Fed – one with the technical skills it has today (according to Summers) but not the huge blind spots it had in the past. I can posit an ideal Bill, but it won’t be any better than his ideal Fed.
(3) The real issue behind this reshuffling of agencies and responsibilities is how you can get better regulators – people with the skills, motivation, and stomach to stand up to both banks and politicians who are screaming at them to get out of the way of progress and prosperity. And here I don’t think the administration’s plan gives us anything.
What could it have done? Here’s one idea: it could have spun the regulatory agencies off into semi-independent bodies, so their heads aren’t replaceable at will by political figures (as is currently true of the Fed); established a long prohibition (5 years?) on making any money from the financial sector after leaving the agency; and then doubled the salaries of every single regulator. (I know there are some transition issues you would have to deal with, like getting rid of a lot of the people who were asleep at the wheel.)
That would be a step toward increasing the status of regulators and reducing the threat of regulatory capture. I’m sure there are problems with these proposals, but at least they address the real problem.
Update: Krugman:
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen. . . .
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
Ezra Klein:
The question with this package is not if it’s well-suited to a world where regulators want to regulate. It’s if it’s well-suited to a world in which they don’t. A world in which growth is quick and greed looks good. A world in which Wall Street seems to be helping Main Street buy, if not houses, then a surprising number of wind turbines. One of the lessons of the past few years is that regulation has to be impartial and disinterested because regulators, and even Fed chairman, get swept up in the cultural manias behind asset bubbles as surely as traders do.
By James Kwak
TARP for Rating Agencies
Posted: 19 Jun 2009 06:15 AM PDT
I would have thought that the credit rating agencies would be at least one group that everyone could agree to throw under the bus. We know that the powerful chieftains of Wall Street are trying to pin the credit crisis on rating agencies – see page 3 of JPMorgan’s blame-shifting attempt, for example. Yet the new Financial Regulatory Reform plan has almost nothing on the subject. Apparently the rating agencies, too, are Too Big to Fail.
Reuters catalogs the provisions relating to the rating agencies. Here’s the summary:
The plan urges Moody’s Corp’s Moody’s Investors Service, McGraw-Hill Cos Inc’ Standard & Poor’s and Fimalac SA’s Fitch Ratings and others to bolster the integrity of their ratings, especially in structured finance.
It also calls for reduced conflicts of interest and for regulators worldwide to tighten oversight.
But the blueprint does nothing to address what critics call the industry’s key shortcoming: That the biggest agencies are paid by issuers whose securities they rate, creating an incentive to win more business by assigning high ratings. . . .
“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.
Also see the Huffington Post, which has this understated but damning criticism: “Today, the agencies welcome the government proposals, saying that they favored improved ratings quality and transparency.”
Perhaps this is one area where Congress can improve on the administration’s plan.
Update: Krugman:
The plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
By James Kwak
TARP for Regulators!
Posted: 19 Jun 2009 04:00 AM PDT
We’ve had TARP for banks, TARP for auto companies, and now, with the Obama Administration’s plan for financial regulatory reform, we have TARP for regulators. After AIG, Citigroup, Bank of America, and General Motors, the administration has decided that all the existing regulators are Too Big to Fail – except for the Office of Thrift Supervision, which must play the role of poor Lehman Brothers in this saga. (Actually, they are more like Merrill Lynch, since they are getting merged into the new National Bank Supervisor, so most of them will probably keep their jobs.)
There is actually a serious issue here, and one with no obvious solution. One question that has gotten a lot of ink, both before and after the unveiling of the plan yesterday, has been the identity of the systemic risk regulator: new agency? council of agencies? the Fed? What this really shows is that it’s easier for the media, the administration, and Congress to focus on the how the agency acronyms will be reshuffled, which is a bit like covering a sporting event, than on the underlying issues, like how to make those agencies more effective.
(Warning: I’m about to argue three sides of an issue.)
(1) So, for example, it’s a little ridiculous that the Federal Reserve is being given the role of systemic risk regulator, since the Fed (under Greenspan, but with no dissent from Bernanke) completely missed the housing bubble, the risks of a massive derivatives market, and the systemic implications of toxic mortgages that it was actually supposed to be regulating – and, in fact, contributed to the financial crisis by keeping interest rates low for the first half of this decade, and then helped aggravate it by letting Lehman fail. Yes, I know, most economists didn’t predict the crisis, either, but no one is nominating them for systemic risk regulator.
(2) But what’s the alternative? You could posit a new regulatory agency focused on systemic risk; let’s call it Bill. But you have no right to simply assert that Bill will do any better than the Fed. In fact, since Bill will start out with no building, no computers, and no staff, you could argue that the Fed, after being given an appropriate pep talk, would do better than Bill. It’s likely that many of the people working for Bill would be people who used to work for the Fed. Planet Money had a story a while back (I think it’s in this episode) about how when the Federal Home Loan Bank Board was abolished in the wake of the savings and loan crisis, its employees just kept on working and eventually the sign on the building was changed to Office of Thrift Supervision.
So given those alternatives, it’s easy for someone as smart as Larry Summers to argue that the Fed is a better choice than a new agency, or a committee, as he did on All Things Considered today. Basically he is positing an ideal Fed – one with the technical skills it has today (according to Summers) but not the huge blind spots it had in the past. I can posit an ideal Bill, but it won’t be any better than his ideal Fed.
(3) The real issue behind this reshuffling of agencies and responsibilities is how you can get better regulators – people with the skills, motivation, and stomach to stand up to both banks and politicians who are screaming at them to get out of the way of progress and prosperity. And here I don’t think the administration’s plan gives us anything.
What could it have done? Here’s one idea: it could have spun the regulatory agencies off into semi-independent bodies, so their heads aren’t replaceable at will by political figures (as is currently true of the Fed); established a long prohibition (5 years?) on making any money from the financial sector after leaving the agency; and then doubled the salaries of every single regulator. (I know there are some transition issues you would have to deal with, like getting rid of a lot of the people who were asleep at the wheel.)
That would be a step toward increasing the status of regulators and reducing the threat of regulatory capture. I’m sure there are problems with these proposals, but at least they address the real problem.
Update: Krugman:
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen. . . .
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
Ezra Klein:
The question with this package is not if it’s well-suited to a world where regulators want to regulate. It’s if it’s well-suited to a world in which they don’t. A world in which growth is quick and greed looks good. A world in which Wall Street seems to be helping Main Street buy, if not houses, then a surprising number of wind turbines. One of the lessons of the past few years is that regulation has to be impartial and disinterested because regulators, and even Fed chairman, get swept up in the cultural manias behind asset bubbles as surely as traders do.
By James Kwak
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