Baseline Scenario -- Especially on the New Home Buyers' Tax Credit Through the Spring

(c) 2009 F. Bruce Abel

Kwak is good today in Baselind Scenario, on many fronts, as usual.


The Baseline Scenario
How Big?
Paging Jamie Dimon
Homebuyer Tax Credit Update
More Too Big to Fail
How Big?
Posted: 28 Oct 2009 06:48 AM PDT
You hear a lot these days that banks need to be big to serve their clients. Charles Calomiris said this morning that we can’t run the global economy with “mom-and-pop banks.” Sure, I’m willing to concede that. But how that’s a silly debating tactic. More seriously, how big do they need to be?
Yves Smith, no friend of the mega-banks, says, “The elephant in the room is derivatives. The big players have massive OTC derivatives exposures. You need a really big balance sheet to provide OTC derivatives cost effectively.”
How big?
Here’s a starting point. In 1998, Goldman Sachs had $217 billion of assets. (Lehman had $154 billion.) In today’s dollars (using the GDP price index), that would be about $270 billion. I think that they were probably doing a perfectly good job of serving their clients at the time. Adjusting for inflation, I don’t think their clients are substantially bigger or more global now than they were then. So the question is (multiple choice):
(a) Has the financial world changed so much that Goldman now needs more than $270 billion to serve clients effectively (and if so, is that change we want)?
(b) Is $270 billion enough?
I don’t claim to know the answer to this one, but if it’s (a), I’d like to see some evidence.
By James Kwak

Paging Jamie Dimon
Posted: 28 Oct 2009 06:29 AM PDT
Surprise, surprise — GMAC needs more money. As you may recall, GMAC was the one institution that got a C- on the stress tests this spring that were impossible to fail. I imagine the analysts at the Fed really wanted to give it an F, but they couldn’t. In any case, it seems that GMAC is too big to fail, because of its importance to the auto industry. Yves Smith says, “The reason for more dough to GMAC is so GM and Chrysler can continue to finance auto purchases, not as a result of greater than expected losses on its existing portfolio. So this is cash for clunkers under another brand name.”
Again, not surprisingly, the government is treating the 50% ownership threshold as some sort of magic line. From the Times article:
“With all three helpings of federal aid, it is possible that the government could wind up owning at least half of the company. But GMAC and Treasury officials are discussing ways to structure the investment in a way that could limit the government’s ownership interests. One possible option would be to also ask some of its private preferred stockholders to convert their investments into common stock.”
So I have two ideas. The first is that if we put more money in GMAC, we should divide it in two and let the mortgage lending part fail. If we insist on keeping the whole thing afloat, that means we are subsidizing both the auto lending part (which is supposedly critical to the economy) and the mortgage lending part (which isn’t).
The second is that this would be a great time for JPMorgan Chase to get some good PR by stepping in and offering to replace GMAC as the funding source for GM and Chrysler dealers, so the government can abandon GMAC. Or even buying GMAC outright, including assuming all its debt and committing to subsidize the auto business, for $1 or so. Yes, that would make JPMorgan bigger, which I’m not thrilled about. But from Jamie Dimon’s perspective, it would show the potential benefits of having big banks that are willing to act in the national interest now and then, and it would be a little like Goldman declining to haggle over the price of buying back its warrants from Treasury.
Now the idea of relying on big banks to serve the national interest obviously sounds like bad policy to me. But if Jamie Dimon wants to take this problem off the taxpayer’s hand, I think he would be welcome to it.
By James Kwak

Homebuyer Tax Credit Update
Posted: 28 Oct 2009 06:12 AM PDT
Calculated Risk says there is a deal (bullet points are from his post):
Income eligibility for first-time home buyers stays at $75,000 for individuals, and $150,000 for couples.
For move-up buyers, income eligibility is $125,000 for individuals and $250,000 for couples.
There is a minimum 5 year residency requirement – in their current home – for move-up home buyers.
The tax credit is the lesser of $7,290 or 10% of the purchase price.
The credit runs from Dec. 1, 2009 to April 30, 2010, with an additional 60 day period to close escrow. (So end of April to sign contract, end of June to close escrow)
Expect bill to be signed by Friday, packaged with the unemployment benefit extension.
So my wife and I fit under the $250,000 couples limit. We’ve lived in our house for eight years. So now the government is willing to give me $7,000 to buy a new house? That would be a sale that wouldn’t have happened otherwise — but what good would it do the economy?
As I tried to explain previously, an $8,000 credit for first-time homebuyers will raise prices by less than $8,000 (leaving aside the effect of leverage for simplicity), because demand at any price point only goes up for first-time homebuyers, not all homebuyers. That means that the buyer gets a fair chunk of the subsidy. But vastly expanding eligibility like this (about 67% of households own houses, and probably about half of them have been in the same house for five years) increases the amount by which prices will go up, which lowers the buyer’s share of the subsidy and increases the seller’s share.
By James Kwak

More Too Big to Fail
Posted: 28 Oct 2009 05:47 AM PDT
Simon and Charles Calomiris were quoted on NPR this morning on the topic of the day — too big to fail.
I thought one of Calomiris’s examples was interesting. He cited Mexico, where banking was dominated by six families that wouldn’t lend to potential competitors. After the Mexican financial crisis and the entry of foreign banks, now it is easier for companies to raise money. It seems to me that story could be used by either side.
By James Kwak