The very best presentation by Jim Cramer, Monday. A tour-de-force as to why financial engineering has destroyed the retail investor.
http://video.cnbc.com/gallery/?video=3000091443
Showing posts with label jp morgan. Show all posts
Showing posts with label jp morgan. Show all posts
Wednesday, May 23, 2012
Saturday, December 4, 2010
Jamie Dimon: Becoming Too Big to Save -- Creating Fiscal Disaster
The Baseline Scenario
Posted: 03 Dec 2010 05:47 AM PST
By Simon Johnson
In Sunday’s New York Times magazine, Roger Lowenstein profiles Jamie Dimon, head of JP Morgan Chase. The piece, titled “Jamie Dimon: America’s Least-Hated Banker,” is generally sympathetic, but in every significant detail it confirms that Mr. Dimon is now – without question – our most dangerous banker.
Mr. Dimon is not dangerous because he is in any narrow sense incompetent. On the contrary, Mr. Dimon is very good at getting what he wants. And now he wants to run a bigger, more interconnected, and more global bank that – if it were to fail – would cause great chaos around the world. Lowenstein writes,
“Dimon has always been unusually blunt, and he told me that not only are big banks like JP Morgan (it has $2 trillion in assets) not too big, but that they should be allowed to grow bigger.”
The problem with very big banks is not that they are “too big to fail,” in the sense that it is physically impossible for them to fail. It is that they are so large and therefore so connected with each other — and with all aspects of how the modern economy operates — that the failure of even one such bank would cause great damage throughout the world.
Lehman Brothers had a balance sheet of around $600 billion when it failed. Its collapse helped trigger the worst financial crisis and deepest recession since the 1930s. Imagine what would happen if JP Morgan Chase – even at today’s scale – were allowed to go bankrupt.
Dimon is brilliantly disingenuous on this key point.
“No one should be too big to fail,” he tells me. And J. P. Morgan? “Right,” he says. “Morgan should have to file for bankruptcy.”
But Dimon himself argued, in a November 2009 op ed in the Washington Post, that regular bankruptcy is not a feasible option for megabanks. Instead he eloquently advocated the creation of a special resolution mechanism for big banks – an update and expansion of the powers that the FDIC has long used to handle the orderly failure of small and medium-sized banks with insured retail deposits.
“Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank’s shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets. Those who benefited from mismanaging risks or taking on inappropriate risk should feel the pain. We can learn here from how the Federal Deposit Insurance Corp. closes banks. As with the FDIC process, as long as shareholders and creditors are losing their value, the industry should pay its fair share.”
Unfortunately, the resolution authority that ended up being created by the 2010 Dodd-Frank financial reform legislation does not cover JP Morgan Chase because Dimon’s bank operates so extensively outside the US (30% non-US in its current business, on its way to 50%, according to Lowenstein). There is nothing in the current resolution mechanism or the broader powers of the Financial Stability Oversight Council that enables the relevant authorities to implement the orderly winding down of a cross-border bank, like JP Morgan is today or Lehman was in 2008.
And there is no prospect of any kind of inter-governmental agreement to put in place a process for imposing orderly and foreseeable losses on the creditors to cross-border bank. In fact, the Basel Committee of bank regulators, which has jurisdiction in this matter – and which Dimon praises in the NYT interview –has definitely decided not to take up the issue.
JP Morgan Chase is already Too Big To Fail. If it were to threaten failure, the government would face a terrible choice: provide some form of unsavory bailout, i.e., fully protecting creditors; or risk the outbreak of a Second Great Depression. While the executive branch pondered these alternatives, there would be global financial panic.
But that is not the worst of our worries. Jamie Dimon is apparently dead set on ensuring JP Morgan Chase becomes even larger, in part by expanding its operations in emerging markets in India, China, and elsewhere.
As Ireland and other European countries have recently discovered to their horror, Too Big To Fail banks that want to expand globally can grow so large that they become Too Big To Save. “Too Big To Save” means that the government wants to save the bank – e.g., by providing a blanket guarantee, as the Irish did in October 2008 – but that creates such a large liability for the state that it pushes the entire country into insolvency.
JP Morgan Chase is well on its way to becoming Too Big To Save. Through expanding overseas, it effectively bypasses the weak controls we still have in place on bank size (no bank is supposed to have more than 10 percent of total retail deposits). Experience in Europe is that this strategy can enable individual banks to build balance sheets that are larger than the GDP of the country in which they are based – in the UK, for example, the Royal Bank of Scotland had a balance approaching 1.5 times the size of the British economy. And then it failed.
If JP Morgan Chase were to reach the equivalent size in the US, it would be a $20 trillion bank. Perhaps that would take a while, but JP Morgan Chase soon at $4 trillion or $8 trillion is easy to imagine.
Dimon argues that banks becoming bigger is the natural outcome of market processes. He is completely wrong – as Thomas Hoenig, president of the Kansas City Fed explained in a NYT op ed this week:
“These firms [big banks] reached their present size through the subsidies they received because they were too big to fail. Therefore, diminishing their size and scope, thereby reducing or removing this subsidy and the competitive advantage it provides, would restore competitive balance to our economic system.” (See also this news coverage on Hoenig’s views.)
Or listen to Gene Fama – the father of the modern “efficient markets” view of finance. He told CNBC that Too Big To Fail banks are “perverting activities and incentives”, giving big financial firms,
“a license to increase risk; where the taxpayers will bear the downside and firms will bear the upside.”
Or read the recent letter to the Financial Times by Anat Admati and other top names in academic finance (here’s the version of their text on the Stanford website). They could be speaking directly of Dimon and his views in the NYT piece when they say:
“Many bankers oppose increased equity requirements, possibly because of a vested interest in the current systems of subsidies and compensation. But the policy goal must be a healthier banking system, rather than high returns for banks’ shareholders and managers, with taxpayers picking up losses and economies suffering the fall-out.” (See also Professor Admati’s follow up letter to the FT this week, further blasting the views of top bankers and their acolytes; see this link for a version not behind the FT wall: latest letter.)
Jamie Dimon’s job is to make money for his shareholders and even he has struggled – the bank’s stock price is only roughly where it was when Dimon took control in 2004. He really believes that the answer to his stock price doldrums is to make JP Morgan Chase bigger and more complex. In effect, he wants to load up on risk – hoping that this will pay off for him, his employees, and (presumably) his shareholders, and really not caring much about who bears the downside risk.
Lowenstein mentions at various points that Dimon was a protégé of Sandy Weill, but he neglects to remind us that Weill in his heyday espoused many of the same ideas that Dimon stresses in the interview. Weill believed there were great synergies between commercial and investment banking (and insurance). Weill was convinced that bigger was undoubtedly better both for shareholders and for society. He was wrong on all counts, as explained by Katrina Brooker in the NYT earlier this year,
“The dream, the mirage has always been the global supermarket, but the reality is that it was a shopping mall,” says Chris Whalen, editor of The Institutional Risk Analyst, of Citi’s evolution over the last decade. “You can talk about synergies all day long. It never happened.”
Sandy Weill, of course, built the modern Citigroup, which effectively collapsed – in spectacular fashion – in 2008-09, and which had to be rescued by the government at least twice. What was Citigroup’s balance sheet at the time? It was just over $2 trillion, roughly the size of JP Morgan Chase today. And Citigroup was (and is) extremely global – doing business in more than 100 countries.
Jamie Dimon is intent on building a bank that will surpass all the size and complexity records set by Sandy Weill’s Citigroup.
Whether or not JP Morgan Chase will fail on Jamie Dimon’s watch remains to be seen. He is, without doubt, a relatively careful risk manager in an industry where hubris tends to run amok.
But sooner or later Jamie Dimon will hand over the reins to someone who is decidedly less careful, someone who goes with the groupthink, and perhaps even someone like Chuck Prince, head of Citigroup, who inherited Sandy Weill’s mantle and said – in July 2007,
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
The music had already stopped when he said that.
If the Dimon’s bigger, more global, and greatly interconnected JP Morgan Chase is still dancing next time the music stops, the choice will not be bailout vs. great recession. The real choice will be no choice at all: fiscal disaster through attempted bailout (Ireland), or fiscal disaster through economic collapse (Iceland).
Posted: 03 Dec 2010 05:47 AM PST
By Simon Johnson
In Sunday’s New York Times magazine, Roger Lowenstein profiles Jamie Dimon, head of JP Morgan Chase. The piece, titled “Jamie Dimon: America’s Least-Hated Banker,” is generally sympathetic, but in every significant detail it confirms that Mr. Dimon is now – without question – our most dangerous banker.
Mr. Dimon is not dangerous because he is in any narrow sense incompetent. On the contrary, Mr. Dimon is very good at getting what he wants. And now he wants to run a bigger, more interconnected, and more global bank that – if it were to fail – would cause great chaos around the world. Lowenstein writes,
“Dimon has always been unusually blunt, and he told me that not only are big banks like JP Morgan (it has $2 trillion in assets) not too big, but that they should be allowed to grow bigger.”
The problem with very big banks is not that they are “too big to fail,” in the sense that it is physically impossible for them to fail. It is that they are so large and therefore so connected with each other — and with all aspects of how the modern economy operates — that the failure of even one such bank would cause great damage throughout the world.
Lehman Brothers had a balance sheet of around $600 billion when it failed. Its collapse helped trigger the worst financial crisis and deepest recession since the 1930s. Imagine what would happen if JP Morgan Chase – even at today’s scale – were allowed to go bankrupt.
Dimon is brilliantly disingenuous on this key point.
“No one should be too big to fail,” he tells me. And J. P. Morgan? “Right,” he says. “Morgan should have to file for bankruptcy.”
But Dimon himself argued, in a November 2009 op ed in the Washington Post, that regular bankruptcy is not a feasible option for megabanks. Instead he eloquently advocated the creation of a special resolution mechanism for big banks – an update and expansion of the powers that the FDIC has long used to handle the orderly failure of small and medium-sized banks with insured retail deposits.
“Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank’s shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets. Those who benefited from mismanaging risks or taking on inappropriate risk should feel the pain. We can learn here from how the Federal Deposit Insurance Corp. closes banks. As with the FDIC process, as long as shareholders and creditors are losing their value, the industry should pay its fair share.”
Unfortunately, the resolution authority that ended up being created by the 2010 Dodd-Frank financial reform legislation does not cover JP Morgan Chase because Dimon’s bank operates so extensively outside the US (30% non-US in its current business, on its way to 50%, according to Lowenstein). There is nothing in the current resolution mechanism or the broader powers of the Financial Stability Oversight Council that enables the relevant authorities to implement the orderly winding down of a cross-border bank, like JP Morgan is today or Lehman was in 2008.
And there is no prospect of any kind of inter-governmental agreement to put in place a process for imposing orderly and foreseeable losses on the creditors to cross-border bank. In fact, the Basel Committee of bank regulators, which has jurisdiction in this matter – and which Dimon praises in the NYT interview –has definitely decided not to take up the issue.
JP Morgan Chase is already Too Big To Fail. If it were to threaten failure, the government would face a terrible choice: provide some form of unsavory bailout, i.e., fully protecting creditors; or risk the outbreak of a Second Great Depression. While the executive branch pondered these alternatives, there would be global financial panic.
But that is not the worst of our worries. Jamie Dimon is apparently dead set on ensuring JP Morgan Chase becomes even larger, in part by expanding its operations in emerging markets in India, China, and elsewhere.
As Ireland and other European countries have recently discovered to their horror, Too Big To Fail banks that want to expand globally can grow so large that they become Too Big To Save. “Too Big To Save” means that the government wants to save the bank – e.g., by providing a blanket guarantee, as the Irish did in October 2008 – but that creates such a large liability for the state that it pushes the entire country into insolvency.
JP Morgan Chase is well on its way to becoming Too Big To Save. Through expanding overseas, it effectively bypasses the weak controls we still have in place on bank size (no bank is supposed to have more than 10 percent of total retail deposits). Experience in Europe is that this strategy can enable individual banks to build balance sheets that are larger than the GDP of the country in which they are based – in the UK, for example, the Royal Bank of Scotland had a balance approaching 1.5 times the size of the British economy. And then it failed.
If JP Morgan Chase were to reach the equivalent size in the US, it would be a $20 trillion bank. Perhaps that would take a while, but JP Morgan Chase soon at $4 trillion or $8 trillion is easy to imagine.
Dimon argues that banks becoming bigger is the natural outcome of market processes. He is completely wrong – as Thomas Hoenig, president of the Kansas City Fed explained in a NYT op ed this week:
“These firms [big banks] reached their present size through the subsidies they received because they were too big to fail. Therefore, diminishing their size and scope, thereby reducing or removing this subsidy and the competitive advantage it provides, would restore competitive balance to our economic system.” (See also this news coverage on Hoenig’s views.)
Or listen to Gene Fama – the father of the modern “efficient markets” view of finance. He told CNBC that Too Big To Fail banks are “perverting activities and incentives”, giving big financial firms,
“a license to increase risk; where the taxpayers will bear the downside and firms will bear the upside.”
Or read the recent letter to the Financial Times by Anat Admati and other top names in academic finance (here’s the version of their text on the Stanford website). They could be speaking directly of Dimon and his views in the NYT piece when they say:
“Many bankers oppose increased equity requirements, possibly because of a vested interest in the current systems of subsidies and compensation. But the policy goal must be a healthier banking system, rather than high returns for banks’ shareholders and managers, with taxpayers picking up losses and economies suffering the fall-out.” (See also Professor Admati’s follow up letter to the FT this week, further blasting the views of top bankers and their acolytes; see this link for a version not behind the FT wall: latest letter.)
Jamie Dimon’s job is to make money for his shareholders and even he has struggled – the bank’s stock price is only roughly where it was when Dimon took control in 2004. He really believes that the answer to his stock price doldrums is to make JP Morgan Chase bigger and more complex. In effect, he wants to load up on risk – hoping that this will pay off for him, his employees, and (presumably) his shareholders, and really not caring much about who bears the downside risk.
Lowenstein mentions at various points that Dimon was a protégé of Sandy Weill, but he neglects to remind us that Weill in his heyday espoused many of the same ideas that Dimon stresses in the interview. Weill believed there were great synergies between commercial and investment banking (and insurance). Weill was convinced that bigger was undoubtedly better both for shareholders and for society. He was wrong on all counts, as explained by Katrina Brooker in the NYT earlier this year,
“The dream, the mirage has always been the global supermarket, but the reality is that it was a shopping mall,” says Chris Whalen, editor of The Institutional Risk Analyst, of Citi’s evolution over the last decade. “You can talk about synergies all day long. It never happened.”
Sandy Weill, of course, built the modern Citigroup, which effectively collapsed – in spectacular fashion – in 2008-09, and which had to be rescued by the government at least twice. What was Citigroup’s balance sheet at the time? It was just over $2 trillion, roughly the size of JP Morgan Chase today. And Citigroup was (and is) extremely global – doing business in more than 100 countries.
Jamie Dimon is intent on building a bank that will surpass all the size and complexity records set by Sandy Weill’s Citigroup.
Whether or not JP Morgan Chase will fail on Jamie Dimon’s watch remains to be seen. He is, without doubt, a relatively careful risk manager in an industry where hubris tends to run amok.
But sooner or later Jamie Dimon will hand over the reins to someone who is decidedly less careful, someone who goes with the groupthink, and perhaps even someone like Chuck Prince, head of Citigroup, who inherited Sandy Weill’s mantle and said – in July 2007,
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
The music had already stopped when he said that.
If the Dimon’s bigger, more global, and greatly interconnected JP Morgan Chase is still dancing next time the music stops, the choice will not be bailout vs. great recession. The real choice will be no choice at all: fiscal disaster through attempted bailout (Ireland), or fiscal disaster through economic collapse (Iceland).
Wednesday, April 14, 2010
Magnetar -- Remember This Name
(c) 2010 F. Bruce Abel
This posting by James Kwak (skip over the Simon Johnson piece for the moment), is a must, must read.
The Baseline Scenario
--------------------------------------------------------------------------------
Greek Bailout, Lehman Deceit, And Tim Geithner
Posted: 13 Apr 2010 04:53 AM PDT
By Simon Johnson
We live in an age of unprecedented bailouts. The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.
The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures. Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?
But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).
The sharp decline in market confidence last week – marked by the jump in Greek yields – scared the main European banks, and also showed there could be a real run on Greek banks; other Europeans are trying to stop it all from getting out of hand. But there is no new program that would bring order to Greece’s troubled public finances.
It’s money for nothing – with no change in the incentive and belief system that brought Greece to this point, very much like the way big banks were saved in the US last year.
If anything, incentives are worse after these bailouts – Greece and other weaker European countries on the one hand, and big US banks on the other hand, know now for sure that in their respective contexts they are too big to fail.
This is “moral hazard” – put simply, it is clear a country/big bank can get a package of support if needed, and this gives less incentive to be careful. Fiscal management for countries will not improve; and risk management for banks will remain prone to weakening when asset prices rise.
If a country hits a problem, the incentive is to wait and see if things get better – perhaps the world economy will improve and Greece can grow out of its difficulties. If such delay means that the problems actually worsen, Greece can just ask Germany for a bigger bailout.
Similarly, if a too-big-to-fail bank hits trouble, the incentive is to hide problems, hoping that financial conditions will improve. Essentially the management finds ways to “prop up” the bank; on modern Wall Street this is done with undisclosed accounting manipulation (in some other countries, it is done with cash). If this means the ultimate collapse is that much more damaging, it’s not the bank executives’ problem any way – their downside is limited, if it exists at all.
The Greeks will now:
Lobby for a large multi-year program from the IMF. They’ll want a path for fiscal policy that is easy in the first year and then gets tougher.
When they reach the tough stage, can’t deliver on the budget, and are about to default, the Greek government will call for another rapid agreement under pressure – with future promises of reform. The eurozone will again accept because it feels the spillovers otherwise would be too negative.
The Greek hope is that the global economy recovers enough to get out, but more realistically, they will start revealing a set of negative “surprises” that mean they miss targets. If the surprises add to the feeling of crisis and further potential bad consequences, that just helps to get a bailout.
The Greek authorities will add a ground game against the European Central Bank, saying things like: “the ECB is too tight, so we need more funds”. We’ll see how that divides the eurozone.
In their space, big US banks will continue to load up on risk as the cycle turns – while hiding that fact. Serious problems will never be revealed in good time – and the authorities will again have good reason (from their perspective) to agree to the hiding of issues until they get out of control, just as the Federal Reserve did for Lehman Brothers. Moral hazard not only ruins incentives, it also massively distorts the available and disclosed information.
As for Mr. Geithner, head of the New York Fed in 2008 and Secretary of the Treasury in 2009: Those who cannot remember the bailout are condemned to repeat it.
The Cover-Up
Posted: 12 Apr 2010 06:59 PM PDT
By James Kwak
Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.
The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.
I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.
This past weekend’s episode of This American Life includes a long story on a particular trade put on Magnetar (ProPublica story here), http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going a hedge fund that I first read about in Yves Smith’s ECONned. The main point of the story is to show how one group of people not only anticipated the collapse, and not only bet on it, but in doing so prolonged the bubble and made the ultimate collapse even worse. But it also raises some key issues about Wall Street and its behavior over the past decade.
This will require a brief description of what exactly Magnetar was doing. (If you know already, you can skip the next two paragraphs.) It’s now a cliche that a CDO is a set of securities that “slices and dices” a different set of securities. But it’s slightly more complicated than that. First there is a pile of mortgage-backed securities (or other bond-like securities) that are collected by an investment bank. The CDO itself is a new legal entity (a company) that buys these MBS from the bank; that’s the asset side of its balance sheet. Its liability side, like that of any company, includes debt and equity. There’s a small amount of equity bought by one investor and a lot of debt, issued in tranches that get paid off in a specific order, bought by other investors. The investment bank not only sells MBS to the CDO, but it also places the CDO’s bonds with other investors. Whoever buys the equity is like the “shareholder” of this company. There is also a CDO manager, whose job is to run the CDO — deciding which MBS it buys in the first place, and then (theoretically) selling MBS that go bad and replacing them by buying new ones. The CDO itself is like an investment fund, and the CDO manager is like the fund manager.
According to the story, in 2006, when the subprime-backed CDO market was starting to slow down, Magnetar started buying the equity layer — the riskiest part — of new CDOs. Since they were buying the equity, they were the CDOs’ sponsor, and they pressured the CDO managers to put especially risky MBS into the CDOs — making them more likely to fail. Then Magnetar bought credit default swaps on the debt issued by the CDOs. If the CDOs collapsed, as many did, their equity would become worthless, but their credit default swaps on the debt would repay them many, many times over.
The key is that Magnetar was exploiting the flaws in Wall Street’s process for manufacturing CDOs. Because the banks made up-front fees for creating CDOs, the actual human beings making the decisions did not particularly care if the CDOs collapsed — they just wanted Magnetar’s money to make the CDOs possible. (No one to buy the highly risky equity, no CDO.) Because the ratings agencies’ models did not particularly discriminate between the contents that went into the CDOs (see pages 169-71 of The Big Short, for example), Magnetar and the banks could stuff them with the most toxic inputs possible to make them more likely to fail.
Now, one question you should be asking yourself is, how is this even arithmetically possible? How is it possible that a CDO can have so little equity that you can buy credit default swaps on the debt at a low enough price to make a killing when the thing collapses? You would think that: (a) in order to sell the bonds at all, there would have to be more equity to protect the debt; and (b) the credit default swaps would have been expensive enough to eat up the profits on the deal. Remember, this is 2006, when several hedge funds were shorting CDOs and many investment banks were looking for protection for their CDO portfolios.
The answer is that nothing was being priced efficiently. The CDO debt was being priced according to the rating agencies’ models, which weren’t even looking at sufficiently detailed data. And the credit default swaps were underpriced because they allowed banks to create new synthetic CDOs, which were another source of profits. So here’s the first lesson: the idea that markets result in efficient prices was, in this case, hogwash.
By taking advantage of these inefficiencies, Magnetar made the Wall Street banks look like chumps. This American Life talks about one deal where Magnetar put up $10 million in equity and then shorted $1 billion of AAA-rated bonds issued by the CDO. It turned out that in this deal, JPMorgan Chase, the investment bank, actually held onto those AAA-rated bonds and eventually took a loss of $880 million. This was in exchange for about $20 million in up-front fees it earned.
But who’s the chump? Sure, JPMorgan Chase the bank lost $880 million. But of that $20 million in fees, about $10 million was paid out in compensation (investment banks pay out about half of their net revenues as compensation), much of it to the bankers who did the deal. JPMorgan’s bankers did just fine, despite having placed a ticking time bomb on their own bank’s balance sheet. Here’s the second lesson: the idea that bankers’ pay is based on their performance is also hogwash. (The idea that their pay is based on their net contribution to society is even more absurd.)
So who’s to blame? The first instinct is to get mad at Magnetar. But this overlooks a Wall Street maxim cited by TAL: you can’t blame the predator for eating the prey. Magnetar was out to make money for its limited partners; if it had bet wrong and lost money, no one would have bailed it out. Although I probably wouldn’t have behaved the same way under the circumstances, I have no problem with Magnetar.
I do have a problem with the Wall Street bankers in this story, however. Because losing $880 million of your own company’s money to make a quick buck for yourself is either incompetent or just wrong. And allowing Magnetar to create CDOs that are as toxic as possible — and then actively selling their debt to investors (that’s where the banks differ from Magnetar, in my opinion) — is either incompetent or just wrong. But even so, I don’t think the frontline bankers are ultimately at fault. Maybe they were simply incompetent. Or maybe, they were knowingly exploiting the system to maximize their earnings — only in this case the system they were exploiting was their own banks’ screwed-up compensation policies, risk management “systems,” and ethical guidelines.
In which case the real blame belongs to those who created that system and made it possible. And that would be the bank executives who failed at managing compensation, risk, or ethics, endangering or killing their companies in the process. And that would be the regulators and politicians who allowed these no-money down no-doc negative-amortization loans to be made in the first place; who allowed investment banks to sell whatever they wanted to investors, with no requirements or duties whatsoever; who allowed banks to outsource their capital requirements to rating agencies, giving them an incentive to hold mis-rated securities; who declined to regulate the credit default swaps that Magnetar used to amass its short positions; who allowed banks like Citigroup and JPMorgan Chase to get into this game with federally insured money; and who failed at monitoring the safety and soundness of the banks playing the game.
The lessons of Magnetar are the basic lessons of the financial crisis. Unregulated financial markets do not necessarily provide efficient prices or the optimal allocation of capital. The winners are not necessarily those who provide the most benefit to their clients or to society, but those who figure out how to exploit the rules of the game to their advantage. The crisis happened because the banks wanted unregulated financial markets and went out and got them — only it turned out they were not as smart as they thought they were and blew themselves up. It was not an innocent accident.
This posting by James Kwak (skip over the Simon Johnson piece for the moment), is a must, must read.
The Baseline Scenario
--------------------------------------------------------------------------------
Greek Bailout, Lehman Deceit, And Tim Geithner
Posted: 13 Apr 2010 04:53 AM PDT
By Simon Johnson
We live in an age of unprecedented bailouts. The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.
The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures. Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?
But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).
The sharp decline in market confidence last week – marked by the jump in Greek yields – scared the main European banks, and also showed there could be a real run on Greek banks; other Europeans are trying to stop it all from getting out of hand. But there is no new program that would bring order to Greece’s troubled public finances.
It’s money for nothing – with no change in the incentive and belief system that brought Greece to this point, very much like the way big banks were saved in the US last year.
If anything, incentives are worse after these bailouts – Greece and other weaker European countries on the one hand, and big US banks on the other hand, know now for sure that in their respective contexts they are too big to fail.
This is “moral hazard” – put simply, it is clear a country/big bank can get a package of support if needed, and this gives less incentive to be careful. Fiscal management for countries will not improve; and risk management for banks will remain prone to weakening when asset prices rise.
If a country hits a problem, the incentive is to wait and see if things get better – perhaps the world economy will improve and Greece can grow out of its difficulties. If such delay means that the problems actually worsen, Greece can just ask Germany for a bigger bailout.
Similarly, if a too-big-to-fail bank hits trouble, the incentive is to hide problems, hoping that financial conditions will improve. Essentially the management finds ways to “prop up” the bank; on modern Wall Street this is done with undisclosed accounting manipulation (in some other countries, it is done with cash). If this means the ultimate collapse is that much more damaging, it’s not the bank executives’ problem any way – their downside is limited, if it exists at all.
The Greeks will now:
Lobby for a large multi-year program from the IMF. They’ll want a path for fiscal policy that is easy in the first year and then gets tougher.
When they reach the tough stage, can’t deliver on the budget, and are about to default, the Greek government will call for another rapid agreement under pressure – with future promises of reform. The eurozone will again accept because it feels the spillovers otherwise would be too negative.
The Greek hope is that the global economy recovers enough to get out, but more realistically, they will start revealing a set of negative “surprises” that mean they miss targets. If the surprises add to the feeling of crisis and further potential bad consequences, that just helps to get a bailout.
The Greek authorities will add a ground game against the European Central Bank, saying things like: “the ECB is too tight, so we need more funds”. We’ll see how that divides the eurozone.
In their space, big US banks will continue to load up on risk as the cycle turns – while hiding that fact. Serious problems will never be revealed in good time – and the authorities will again have good reason (from their perspective) to agree to the hiding of issues until they get out of control, just as the Federal Reserve did for Lehman Brothers. Moral hazard not only ruins incentives, it also massively distorts the available and disclosed information.
As for Mr. Geithner, head of the New York Fed in 2008 and Secretary of the Treasury in 2009: Those who cannot remember the bailout are condemned to repeat it.
The Cover-Up
Posted: 12 Apr 2010 06:59 PM PDT
By James Kwak
Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.
The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.
I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.
This past weekend’s episode of This American Life includes a long story on a particular trade put on Magnetar (ProPublica story here), http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going a hedge fund that I first read about in Yves Smith’s ECONned. The main point of the story is to show how one group of people not only anticipated the collapse, and not only bet on it, but in doing so prolonged the bubble and made the ultimate collapse even worse. But it also raises some key issues about Wall Street and its behavior over the past decade.
This will require a brief description of what exactly Magnetar was doing. (If you know already, you can skip the next two paragraphs.) It’s now a cliche that a CDO is a set of securities that “slices and dices” a different set of securities. But it’s slightly more complicated than that. First there is a pile of mortgage-backed securities (or other bond-like securities) that are collected by an investment bank. The CDO itself is a new legal entity (a company) that buys these MBS from the bank; that’s the asset side of its balance sheet. Its liability side, like that of any company, includes debt and equity. There’s a small amount of equity bought by one investor and a lot of debt, issued in tranches that get paid off in a specific order, bought by other investors. The investment bank not only sells MBS to the CDO, but it also places the CDO’s bonds with other investors. Whoever buys the equity is like the “shareholder” of this company. There is also a CDO manager, whose job is to run the CDO — deciding which MBS it buys in the first place, and then (theoretically) selling MBS that go bad and replacing them by buying new ones. The CDO itself is like an investment fund, and the CDO manager is like the fund manager.
According to the story, in 2006, when the subprime-backed CDO market was starting to slow down, Magnetar started buying the equity layer — the riskiest part — of new CDOs. Since they were buying the equity, they were the CDOs’ sponsor, and they pressured the CDO managers to put especially risky MBS into the CDOs — making them more likely to fail. Then Magnetar bought credit default swaps on the debt issued by the CDOs. If the CDOs collapsed, as many did, their equity would become worthless, but their credit default swaps on the debt would repay them many, many times over.
The key is that Magnetar was exploiting the flaws in Wall Street’s process for manufacturing CDOs. Because the banks made up-front fees for creating CDOs, the actual human beings making the decisions did not particularly care if the CDOs collapsed — they just wanted Magnetar’s money to make the CDOs possible. (No one to buy the highly risky equity, no CDO.) Because the ratings agencies’ models did not particularly discriminate between the contents that went into the CDOs (see pages 169-71 of The Big Short, for example), Magnetar and the banks could stuff them with the most toxic inputs possible to make them more likely to fail.
Now, one question you should be asking yourself is, how is this even arithmetically possible? How is it possible that a CDO can have so little equity that you can buy credit default swaps on the debt at a low enough price to make a killing when the thing collapses? You would think that: (a) in order to sell the bonds at all, there would have to be more equity to protect the debt; and (b) the credit default swaps would have been expensive enough to eat up the profits on the deal. Remember, this is 2006, when several hedge funds were shorting CDOs and many investment banks were looking for protection for their CDO portfolios.
The answer is that nothing was being priced efficiently. The CDO debt was being priced according to the rating agencies’ models, which weren’t even looking at sufficiently detailed data. And the credit default swaps were underpriced because they allowed banks to create new synthetic CDOs, which were another source of profits. So here’s the first lesson: the idea that markets result in efficient prices was, in this case, hogwash.
By taking advantage of these inefficiencies, Magnetar made the Wall Street banks look like chumps. This American Life talks about one deal where Magnetar put up $10 million in equity and then shorted $1 billion of AAA-rated bonds issued by the CDO. It turned out that in this deal, JPMorgan Chase, the investment bank, actually held onto those AAA-rated bonds and eventually took a loss of $880 million. This was in exchange for about $20 million in up-front fees it earned.
But who’s the chump? Sure, JPMorgan Chase the bank lost $880 million. But of that $20 million in fees, about $10 million was paid out in compensation (investment banks pay out about half of their net revenues as compensation), much of it to the bankers who did the deal. JPMorgan’s bankers did just fine, despite having placed a ticking time bomb on their own bank’s balance sheet. Here’s the second lesson: the idea that bankers’ pay is based on their performance is also hogwash. (The idea that their pay is based on their net contribution to society is even more absurd.)
So who’s to blame? The first instinct is to get mad at Magnetar. But this overlooks a Wall Street maxim cited by TAL: you can’t blame the predator for eating the prey. Magnetar was out to make money for its limited partners; if it had bet wrong and lost money, no one would have bailed it out. Although I probably wouldn’t have behaved the same way under the circumstances, I have no problem with Magnetar.
I do have a problem with the Wall Street bankers in this story, however. Because losing $880 million of your own company’s money to make a quick buck for yourself is either incompetent or just wrong. And allowing Magnetar to create CDOs that are as toxic as possible — and then actively selling their debt to investors (that’s where the banks differ from Magnetar, in my opinion) — is either incompetent or just wrong. But even so, I don’t think the frontline bankers are ultimately at fault. Maybe they were simply incompetent. Or maybe, they were knowingly exploiting the system to maximize their earnings — only in this case the system they were exploiting was their own banks’ screwed-up compensation policies, risk management “systems,” and ethical guidelines.
In which case the real blame belongs to those who created that system and made it possible. And that would be the bank executives who failed at managing compensation, risk, or ethics, endangering or killing their companies in the process. And that would be the regulators and politicians who allowed these no-money down no-doc negative-amortization loans to be made in the first place; who allowed investment banks to sell whatever they wanted to investors, with no requirements or duties whatsoever; who allowed banks to outsource their capital requirements to rating agencies, giving them an incentive to hold mis-rated securities; who declined to regulate the credit default swaps that Magnetar used to amass its short positions; who allowed banks like Citigroup and JPMorgan Chase to get into this game with federally insured money; and who failed at monitoring the safety and soundness of the banks playing the game.
The lessons of Magnetar are the basic lessons of the financial crisis. Unregulated financial markets do not necessarily provide efficient prices or the optimal allocation of capital. The winners are not necessarily those who provide the most benefit to their clients or to society, but those who figure out how to exploit the rules of the game to their advantage. The crisis happened because the banks wanted unregulated financial markets and went out and got them — only it turned out they were not as smart as they thought they were and blew themselves up. It was not an innocent accident.
Wednesday, July 29, 2009
Managing Huge Amounts of Government Money
Soliciting the Pension Guaranty Benefit Corporation.
Yes this looks bad, but how else to do it?
http://www.nytimes.com/2009/07/29/business/29pensions.html?partner=rss&emc=rss
Yes this looks bad, but how else to do it?
http://www.nytimes.com/2009/07/29/business/29pensions.html?partner=rss&emc=rss
Friday, May 29, 2009
New Yorker Must Read This Week Explaining the Financial Catastrophe
Outsmarted
High finance vs. human nature.
by John Lanchester June 1, 2009
Complex risk engineering ignored emotions like avarice and envy.
Keywords
Economic Crisis;
Banking;
“Fool’s Gold” (Free Press; $26);
Gillian Tett;
“A Failure of Capitalism” (Harvard; $23.95);
Richard A. Posner;
Economy
The world of banking, it’s becoming clear, operates according to different norms from those of the rest of the business world. Take the offsite corporate weekend. Normal behavior on these occasions consists of punishing the minibar and nursing consequent hangovers, hitting on long-fancied colleagues, and putting embarrassing items, ideally pornographic videos, on one another’s hotel bills. For form’s sake, a few new ideas are cooked up, and then gradually allowed to die a natural death when everyone is back at work and liver-function levels have stabilized.
In June, 1994, when a team from J. P. Morgan went on an off-site weekend to Boca Raton, they conformed to normative behavior in certain respects. Binge drinking occurred; a senior colleague’s nose was broken; somebody charged a trashed Jet Ski and many cheeseburgers to somebody else’s account. Where the J. P. Morgan team broke with tradition was in coming up with a real idea—an idea that changed the entire nature of modern banking, with consequences that are currently rocking the planet.
The new idea was based on an old one, that of the swap. Say you’re in the grocery business, and feel gloomy about your prospects. Your immediate neighbor is in the stationery business, and he feels gloomy about his prospects, less so about yours. You get to talking, and one of you hits on a brilliant idea: why not just swap revenues? You take his earnings for the year, and he takes yours. The actual business doesn’t change hands, making the swap, in banking terminology, “synthetic.” The first currency swap took place in 1981, and allowed I.B.M. to trade surplus Swiss francs and Deutsche marks for dollars held by the World Bank. The two institutions exchanged their obligations to bondholders and their bond earnings without actually exchanging the bonds. The deal, brokered by Salomon Brothers, was worth two hundred and ten million dollars over ten years and ushered in a whole new field of finance. As Gillian Tett tells it in her book “Fool’s Gold” (Free Press; $26), by the time of the Boca Raton off-site, swaps had become a roaringly successful feature of the banking world: the volume of such interest-rate and currency derivatives was worth twelve trillion dollars, more than the entire U.S. economy.
But competition was making those swap deals less profitable. The quest was for a new, and therefore newly lucrative, product to sell. What got the J. P. Morgan team rolling was this thought: instead of swapping bonds or currency or interest rates, why not swap the risk of default? In effect, it could sell the risk that a borrower won’t be able to pay back his debt. Since banking is based on making loans to customers, the risk of default by those customers is a crucial part of the business. A product that made it possible to reduce that risk—by selling it to somebody else—had the potential to create a gigantic new market.
The broad outline of the financial crash is becoming well known. The value of Gillian Tett’s book is in the level of detail with which she tells the story, concentrating on the specific sequence of inventions and innovations that made it possible. Tett, a Financial Times reporter who covered the credit markets, was one of the few people to have seen the implosion coming. A critical factor was that she has a Ph.D. in social anthropology—a “hippie” background, as one banker told her, intending no compliment. It helped her focus on what she calls “social silences” in the world of banking. It’s not always what people say that contains the most important information; often, it’s what they take for granted. To Tett, it was obvious that the banking sector was running irresponsibly large risks in the overexpansion of credit and the overingenuity of its financial engineering. So she was perfectly placed to follow the story as it happened, and to pull together the story of how we got here.
There are a number of different ways of peeling this particular onion; Tett does so through the J. P. Morgan team that helped create the new credit derivatives. These lie at the heart of the current crisis, and Tett’s account of their invention and dispersal makes “Fool’s Gold” a gripping and indispensable book.
The Boca Raton meeting first bore fruit when Exxon needed to open a line of credit to cover potential damages of five billion dollars resulting from the 1989 Exxon Valdez oil spill. J. P. Morgan was reluctant to turn down Exxon, which was an old client, but the deal would tie up a lot of reserve cash to provide for the risk of the loans going bad. The so-called Basel rules, named for the town in Switzerland where they were formulated, required that the banks hold eight per cent of their capital in reserve against the risk of outstanding loans. That limited the amount of lending bankers could do, the amount of risk they could take on, and therefore the amount of profit they could make. But, if the risk of the loans could be sold, it logically followed that the loans were now risk-free; and, if that were the case, what would have been the reserve cash could now be freely loaned out. No need to suck up useful capital.
In late 1994, Blythe Masters, a member of the J. P. Morgan swaps team, pitched the idea of selling the credit risk to the European Bank of Reconstruction and Development. So, if Exxon defaulted, the E.B.R.D. would be on the hook for it—and, in return for taking on the risk, would receive a fee from J. P. Morgan. Exxon would get its credit line, and J. P. Morgan would get to honor its client relationship but also to keep its credit lines intact for sexier activities. The deal was so new that it didn’t even have a name: eventually, the one settled on was “credit-default swap.”
So far, so good for J. P. Morgan. But the deal had been laborious and time-consuming, and the bank wouldn’t be able to make real money out of credit-default swaps until the process became streamlined and industrialized. The invention that allowed all this to happen was securitization. Traditionally, banking involves a case-by-case assessment of the risk of every loan, and it’s hard to industrialize that process. What securitization did was bundle together a package of these loans, and then rely on safety in numbers and the law of averages: even if some loans did default, the others wouldn’t, and would keep the stream of revenue going, thereby diffusing and minimizing the risk of default. So there would be two sources of revenue: one from the sale of the loans, and another from the steady flow of repayments. Then someone had the idea of dividing up the securities into different levels of risk—a technique called tranching—and selling them off accordingly, so that riskier tranches of debt would pay a higher rate of interest than safer ones. Bill Demchak, a “structured finance” star at J. P. Morgan, took the lead in creating bundles of credit-default swaps—insurance against default—and selling them to investors. The investors would get the streams of revenue, according to the risk-and-reward level they chose; the bank would get insurance against its loans, and fees for setting up the deal.
There was one final component to the J. P. Morgan team’s invention. The team set up a kind of offshore shell company, called a Special Purpose Vehicle, to fulfill the role supplied by the European Bank for Reconstruction and Development in the first credit-default swap. The shell company would assume $9.7 billion of J. P. Morgan’s risk (in this case, outstanding loans that the bank had made to some three hundred companies) and sell off that risk to investors, in the form of securities paying differing rates of interest. According to J. P. Morgan’s calculations, the underlying loans were so safe that it needed to collect only seven hundred million dollars in order to cover the $9.7-billion debt. In 1997, the credit agency Moodys agreed, and a whole new era in banking dawned. J. P. Morgan had found a way to shift risk off its books while simultaneously generating income from that risk, and freeing up capital to lend elsewhere. It was magic. The only thing wrong with it was the name, BISTRO, for Broad Index Secured Trust Offering, which made the new rocket-science financial instrument sound like a place you went to for steak frites. The market came to prefer a different term: “synthetic collateralized debt obligations.”
Inevitably, J. P. Morgan’s innovation was taken up by more aggressive and less cautious banks. Mortgage-based versions of collateralized debt obligations were especially profitable. These C.D.O.s involved the techniques that the J. P. Morgan team had developed, but their underlying assets were pools of mortgages—many of them based on the most lucrative mortgages, the now notorious subprime loans, which paid higher than usual rates of interest. (These new instruments could be pretty exotic: some consisted of C.D.O.s of C.D.O.s, pools of pools of debt.) J. P. Morgan was wary of them, as it happens, because it didn’t see how the risks were being engineered down to a safe level. But institutions like Citigroup, U.B.S., and Merrill Lynch plunged in.
The new financial instruments, as clever as they were, had an unfortunate side effect: they broke banking. At its heart, banking is a simple business. Customers deposit money at a bank, in return for interest; the bank lends that money to other people, at a higher rate of interest. This isn’t glamorous or interesting, but banking is not supposed to resemble skydiving or hip-hop; what recommends it is that it’s a good way of making steady money (and of creating credit in the economy), as long as the bank is careful about whom it lends money to. The quality of the loans is critical, because those loans are the bank’s earning assets.
This isn’t some incidental issue; it’s the very core of what banking is. But the model of packaging plus securitization spurned the principle that a bank had to individually assess and monitor every loan. The mathematics of valuation models—horrendously complex equations to assess probabilities and correlations, cooked up in mad-scientist style by the firms’ “quants”—took on the burden of assessing statistical risk. The idea that a banker looks a borrower in the eye and takes a view on whether he can trust him came to seem laughably nineteenth-century. As for the risks? Well, as Lawrence Summers said when he was Deputy Secretary of the Treasury, “The parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies.”
Alas, Richard A. Posner, a judge on the U.S. Court of Appeals for the Seventh Circuit, observes with pointed restraint, “That turned out not to be true.” The result has been, in the title phrase of Posner’s new book, “A Failure of Capitalism” (Harvard; $23.95). He argues that we are now in a bona-fide depression, which he defines as “a steep reduction in output that causes or threatens to cause deflation and creates widespread public anxiety and, among the political and economic elites, a sense of crisis that evokes extremely costly efforts at remediation.” His book is an attempt to write “a concise, constructive, jargon- and acronym-free, non-technical, unsensational, light-on-anecdote, analytical examination of the major facets of the biggest U.S. economic disaster in my lifetime and that of most people living today.”
Accounts of the banking-and-credit crisis tend to focus their explanations, which usually also means their blame, on one or more of the following four factors: greed, stupidity, government, and the banks. The process resembles a children’s game in which you spin an arrow and it lands on a word. Tett spins twice, and lands on greed and the banks; Posner suggests that he doesn’t know what the word “greed” means, and his spin lands firmly on government. “We are learning from it that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails,” he writes. “The movement to deregulate the financial industry went too far by exaggerating the resilience—the self-healing powers—of laissez-faire capitalism.”
This isn’t an original conclusion, but the way Posner arrives at it is new and bracing. His first claim to fame was as one of the founders of a school of thought that takes economic ideas and techniques and applies them to the law, as well as to life more generally. He has published nearly twenty books in just the past decade, a superhuman rate of productivity, bearing in mind that Posner is also a practicing judge, a senior lecturer at the University of Chicago, and an energetic blogger (in association with the Nobel Prize-winning economist Gary Becker). He has the rare kind of mind that is a pure pleasure to watch in action, regardless of the subject and the argument being made.
“A Failure of Capitalism” argues that the risks taken by the banks were rational, for two main reasons. First, it’s only with the benefit of hindsight that we can know that a bubble in prices was taking place. Bankers had to assign a probability to the prospect that there was a bubble, and, second, to the prospect that, if there was a bubble and it burst, house prices would fall by twenty per cent or more—this being the decline that precipitated the general crisis of bank insolvency. Now, suppose that the risk of both things happening was one per cent. Whether an event with that likelihood is worth worrying about depends on what its consequences will be. From the larger point of view, the consequences included systemic meltdown; but Posner invites us to focus our attention on what they looked like for individual bankers. They had strong incentives for taking the maximum amount of risks in their lending, since risks are correlated with rewards, and the bankers were so well paid that they didn’t really have to worry about being laid off. “The greater the gains are from taking risks that enable very high short-term profits, and the better cushioned the executive is by his severance package against the cost of losing his job, the more risks he rationally will take,” Posner notes. Besides, if a bank avoids these risks, and its competitors don’t and therefore make more money during the boom, the cautious bank risks going out of business anyway, because its clients will walk away.
People taking out what now look like crazily risky mortgage loans were being rational, too, because they were acting on the widespread assumption that house prices would continue rising. If house prices fell, well, tough luck, they’d walk away from the loan and go bankrupt—but they probably had lousy credit ratings anyway. “Thus the downside of the home buyer’s speculative investment is truncated, making his ‘reckless’ behavior not only rational but also consistent with his being well informed about the risks,” Posner writes. The conclusion: “Risky behavior of the sort I have been describing was individually rational during the bubble. But it was collectively irrational.” As for the idea that the bankers were dumb to get so carried away: “I am skeptical that readily avoidable mistakes, failures of rationality, or the intellectual deficiencies of financial managers whose IQs exceed my own were major factors in the economic collapse. Had the mistakes that brought down the banking industry been readily avoidable, they would have been avoided.”
This is a familiar place for these arguments to end up: economists often find that apparently erratic behavior is, at heart, rational. It helps that the definition of rationality can be stretched to include emotion, which “is not necessarily or even typically irrational,” Posner argues. Reckless greed, incompetent assessments of probability, blindness to the inevitability of downturns, failure to hedge risks so big that they threaten a firm’s very existence: all are rational.
It seems a pity that a man as unflinching as Posner didn’t put his ideas under more pressure from the specifics of what the bankers did. He is willing to criticize those who have criticized bankers—“the distinguished economist Paul Krugman,” for instance, “who should know better”—but no banker is named and blamed. One can regret that Posner didn’t get the chance to read Tett’s book, which offers the opportunity to assess in detail the kind of risks that the bankers were taking.
Blythe Masters, who was in charge of the Exxon Valdez deal, and of selling the very first BISTRO notes, and thus one of the creators of the entire credit-default-swap industry, was among those baffled by the C.D.O. boom. “How are the other banks doing it?” she asked. “How are they making so much money?” The answer, Tett says, is that “she was so steeped in the ways of J. P. Morgan that it never occurred to her that the other banks might simply ignore all the risk controls J. P. Morgan had adhered to. That they might do so was simply outside her cognitive map.”
In particular, those banks had accumulated huge amounts of super-senior debt. In the first BISTRO, remember, only seven hundred million dollars was reserved to cover $9.7 billion of risk. The remainder of the debt was regarded as marvellously safe. Bankers call that kind of debt “super-senior,” i.e., better than AAA grade, safer than U.S. Treasury bills, so secure that it didn’t need to be insured. So what to do with it? Some banks simply let the super-senior debt accumulate on their balance sheets. The amount of this debt “was a closely guarded secret, even within the banks themselves,” Tett writes, and the collapse in their value helped bring down the big banks. It would be interesting to read Posner’s analysis of these specific actions, which to the layman seem, as they seemed to so many of the J. P. Morgan team, insanely reckless.
A common mistake of very smart people is to assume that other people’s minds work in the same way that theirs do. This is a particular problem in economics. Its mathematically based models and assumptions of rational conduct can appear, to non-economists, like toys, entertaining but, by definition, of limited utility. Even Posner, who spent years extending the purview of economic thought, thinks that “the depression is a wake-up call to the economics profession.” It’s no surprise to find the Yale economist Robert J. Shiller as one of the first respondents to that call. Shiller—not content with having predicted the bursting of the dot-com bubble in his book “Irrational Exuberance”; co-creating the standard measure for tracking house prices, the Case-Shiller index; going on the record with worries about the housing bubble as early as 2003; and writing one of the first books on the crash, “The Subprime Solution,” in 2008—has now, with George A. Akerlof, the 2001 Nobel winner in economics, co-written a book on the influence of emotions on economics. “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism” (Princeton; $24.95) takes its title from John Maynard Keynes, who, in a famous passage of his 1936 treatise “The General Theory of Employment, Interest and Money,” mused about how businessmen manage to make decisions, given the level of uncertainty about the future. “Our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing,” he wrote. We can’t know the future, and therefore our inclination to act, to do things, “can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction.” Akerlof and Shiller extrapolate from this an idea of animal spirits encompassing “noneconomic motives and irrational behaviors,” a slightly broader idea than Keynes’s usage, but one that allows them to study a range of negative impulses as well as the basic urge to optimism about which Keynes was talking.
“Animal Spirits” is addressed to a general reader, but it’s hard not to feel that the book’s real audience is among economists. The general reader needs no persuading about the influence of non-rational, non-economic forces on economic thinking. Within the economic profession, however, the subject of strict rationality is the occasion of a permanent pitched battle. (Posner: “The very existence of warring schools within a field is a clue that the field is weak, however brilliant its practitioners.”) “Animal Spirits,” like “A Failure of Capitalism,” is a campaigning maneuver in this ongoing struggle.
Akerlof and Shiller have a set of specific proposals for how the animal spirits might be incorporated into their science. They set out a framework of factors—Confidence (and the lack thereof), Fairness, Corruption and Bad Faith, Money Illusion (the failure to understand the impact of inflation), and Stories—and then apply their ideas to a series of specific questions. Some of this is very timely, such as a chapter on “The Current Financial Crisis” and one asking “Why Are Financial Prices and Corporate Investments So Volatile?” But it’s clear that the great white whale of modern economics, a thing that would appease the descendants of both Milton Friedman and John Maynard Keynes, is a quantifiable, evidence-based theory of how bubbles are formed, and, hence, how to forestall them. Bubbles are irrefutably clear in hindsight; but an economist who found a way of proving their presence with foresight would be doing humanity a profound favor.
We aren’t there yet, though Akerlof and Shiller’s book does give the profession some suggestions for the search. There is barely a page of “Animal Spirits” without a fascinating fact or insight, and by no means all from a reflexively liberal viewpoint. One of their culprits for the crisis is Andrew Cuomo, who, as Secretary of Housing and Urban Development, sharply increased the mandated lending to underserved communities by Fannie Mae and Freddie Mac, and in the process lowered credit standards, thus making it “easy for mortgage lenders to justify loosening their own lending standards.” Despite the various ideological and methodological differences with Richard Posner, Akerlof and Shiller’s fundamental view of how capitalism should work is similar: “What allows capitalism to function is the regulations,” they write. This should be an enduring lesson of the crisis—an understanding that the rules governing the operating of markets were not handed down on stone tablets but are made by men, and are in constant need of revision, supervision, and active, imaginative enforcement. All these books coincide on this point: human beings make markets. A general recognition of that fact, led by the economic profession and taken to heart by politicians, would be a step so important as to be almost worth what it has cost to be reminded of it. ♦
And the following link is worth following up on for its excellent comments afterward, and comments on comments, especially the weakness of Tett's reasoning and experience in places:
http://www.amazon.co.uk/Fools-Gold-Unrestrained-Corrupted-Catastrophe/dp/1408701642
High finance vs. human nature.
by John Lanchester June 1, 2009
Complex risk engineering ignored emotions like avarice and envy.
Keywords
Economic Crisis;
Banking;
“Fool’s Gold” (Free Press; $26);
Gillian Tett;
“A Failure of Capitalism” (Harvard; $23.95);
Richard A. Posner;
Economy
The world of banking, it’s becoming clear, operates according to different norms from those of the rest of the business world. Take the offsite corporate weekend. Normal behavior on these occasions consists of punishing the minibar and nursing consequent hangovers, hitting on long-fancied colleagues, and putting embarrassing items, ideally pornographic videos, on one another’s hotel bills. For form’s sake, a few new ideas are cooked up, and then gradually allowed to die a natural death when everyone is back at work and liver-function levels have stabilized.
In June, 1994, when a team from J. P. Morgan went on an off-site weekend to Boca Raton, they conformed to normative behavior in certain respects. Binge drinking occurred; a senior colleague’s nose was broken; somebody charged a trashed Jet Ski and many cheeseburgers to somebody else’s account. Where the J. P. Morgan team broke with tradition was in coming up with a real idea—an idea that changed the entire nature of modern banking, with consequences that are currently rocking the planet.
The new idea was based on an old one, that of the swap. Say you’re in the grocery business, and feel gloomy about your prospects. Your immediate neighbor is in the stationery business, and he feels gloomy about his prospects, less so about yours. You get to talking, and one of you hits on a brilliant idea: why not just swap revenues? You take his earnings for the year, and he takes yours. The actual business doesn’t change hands, making the swap, in banking terminology, “synthetic.” The first currency swap took place in 1981, and allowed I.B.M. to trade surplus Swiss francs and Deutsche marks for dollars held by the World Bank. The two institutions exchanged their obligations to bondholders and their bond earnings without actually exchanging the bonds. The deal, brokered by Salomon Brothers, was worth two hundred and ten million dollars over ten years and ushered in a whole new field of finance. As Gillian Tett tells it in her book “Fool’s Gold” (Free Press; $26), by the time of the Boca Raton off-site, swaps had become a roaringly successful feature of the banking world: the volume of such interest-rate and currency derivatives was worth twelve trillion dollars, more than the entire U.S. economy.
But competition was making those swap deals less profitable. The quest was for a new, and therefore newly lucrative, product to sell. What got the J. P. Morgan team rolling was this thought: instead of swapping bonds or currency or interest rates, why not swap the risk of default? In effect, it could sell the risk that a borrower won’t be able to pay back his debt. Since banking is based on making loans to customers, the risk of default by those customers is a crucial part of the business. A product that made it possible to reduce that risk—by selling it to somebody else—had the potential to create a gigantic new market.
The broad outline of the financial crash is becoming well known. The value of Gillian Tett’s book is in the level of detail with which she tells the story, concentrating on the specific sequence of inventions and innovations that made it possible. Tett, a Financial Times reporter who covered the credit markets, was one of the few people to have seen the implosion coming. A critical factor was that she has a Ph.D. in social anthropology—a “hippie” background, as one banker told her, intending no compliment. It helped her focus on what she calls “social silences” in the world of banking. It’s not always what people say that contains the most important information; often, it’s what they take for granted. To Tett, it was obvious that the banking sector was running irresponsibly large risks in the overexpansion of credit and the overingenuity of its financial engineering. So she was perfectly placed to follow the story as it happened, and to pull together the story of how we got here.
There are a number of different ways of peeling this particular onion; Tett does so through the J. P. Morgan team that helped create the new credit derivatives. These lie at the heart of the current crisis, and Tett’s account of their invention and dispersal makes “Fool’s Gold” a gripping and indispensable book.
The Boca Raton meeting first bore fruit when Exxon needed to open a line of credit to cover potential damages of five billion dollars resulting from the 1989 Exxon Valdez oil spill. J. P. Morgan was reluctant to turn down Exxon, which was an old client, but the deal would tie up a lot of reserve cash to provide for the risk of the loans going bad. The so-called Basel rules, named for the town in Switzerland where they were formulated, required that the banks hold eight per cent of their capital in reserve against the risk of outstanding loans. That limited the amount of lending bankers could do, the amount of risk they could take on, and therefore the amount of profit they could make. But, if the risk of the loans could be sold, it logically followed that the loans were now risk-free; and, if that were the case, what would have been the reserve cash could now be freely loaned out. No need to suck up useful capital.
In late 1994, Blythe Masters, a member of the J. P. Morgan swaps team, pitched the idea of selling the credit risk to the European Bank of Reconstruction and Development. So, if Exxon defaulted, the E.B.R.D. would be on the hook for it—and, in return for taking on the risk, would receive a fee from J. P. Morgan. Exxon would get its credit line, and J. P. Morgan would get to honor its client relationship but also to keep its credit lines intact for sexier activities. The deal was so new that it didn’t even have a name: eventually, the one settled on was “credit-default swap.”
So far, so good for J. P. Morgan. But the deal had been laborious and time-consuming, and the bank wouldn’t be able to make real money out of credit-default swaps until the process became streamlined and industrialized. The invention that allowed all this to happen was securitization. Traditionally, banking involves a case-by-case assessment of the risk of every loan, and it’s hard to industrialize that process. What securitization did was bundle together a package of these loans, and then rely on safety in numbers and the law of averages: even if some loans did default, the others wouldn’t, and would keep the stream of revenue going, thereby diffusing and minimizing the risk of default. So there would be two sources of revenue: one from the sale of the loans, and another from the steady flow of repayments. Then someone had the idea of dividing up the securities into different levels of risk—a technique called tranching—and selling them off accordingly, so that riskier tranches of debt would pay a higher rate of interest than safer ones. Bill Demchak, a “structured finance” star at J. P. Morgan, took the lead in creating bundles of credit-default swaps—insurance against default—and selling them to investors. The investors would get the streams of revenue, according to the risk-and-reward level they chose; the bank would get insurance against its loans, and fees for setting up the deal.
There was one final component to the J. P. Morgan team’s invention. The team set up a kind of offshore shell company, called a Special Purpose Vehicle, to fulfill the role supplied by the European Bank for Reconstruction and Development in the first credit-default swap. The shell company would assume $9.7 billion of J. P. Morgan’s risk (in this case, outstanding loans that the bank had made to some three hundred companies) and sell off that risk to investors, in the form of securities paying differing rates of interest. According to J. P. Morgan’s calculations, the underlying loans were so safe that it needed to collect only seven hundred million dollars in order to cover the $9.7-billion debt. In 1997, the credit agency Moodys agreed, and a whole new era in banking dawned. J. P. Morgan had found a way to shift risk off its books while simultaneously generating income from that risk, and freeing up capital to lend elsewhere. It was magic. The only thing wrong with it was the name, BISTRO, for Broad Index Secured Trust Offering, which made the new rocket-science financial instrument sound like a place you went to for steak frites. The market came to prefer a different term: “synthetic collateralized debt obligations.”
Inevitably, J. P. Morgan’s innovation was taken up by more aggressive and less cautious banks. Mortgage-based versions of collateralized debt obligations were especially profitable. These C.D.O.s involved the techniques that the J. P. Morgan team had developed, but their underlying assets were pools of mortgages—many of them based on the most lucrative mortgages, the now notorious subprime loans, which paid higher than usual rates of interest. (These new instruments could be pretty exotic: some consisted of C.D.O.s of C.D.O.s, pools of pools of debt.) J. P. Morgan was wary of them, as it happens, because it didn’t see how the risks were being engineered down to a safe level. But institutions like Citigroup, U.B.S., and Merrill Lynch plunged in.
The new financial instruments, as clever as they were, had an unfortunate side effect: they broke banking. At its heart, banking is a simple business. Customers deposit money at a bank, in return for interest; the bank lends that money to other people, at a higher rate of interest. This isn’t glamorous or interesting, but banking is not supposed to resemble skydiving or hip-hop; what recommends it is that it’s a good way of making steady money (and of creating credit in the economy), as long as the bank is careful about whom it lends money to. The quality of the loans is critical, because those loans are the bank’s earning assets.
This isn’t some incidental issue; it’s the very core of what banking is. But the model of packaging plus securitization spurned the principle that a bank had to individually assess and monitor every loan. The mathematics of valuation models—horrendously complex equations to assess probabilities and correlations, cooked up in mad-scientist style by the firms’ “quants”—took on the burden of assessing statistical risk. The idea that a banker looks a borrower in the eye and takes a view on whether he can trust him came to seem laughably nineteenth-century. As for the risks? Well, as Lawrence Summers said when he was Deputy Secretary of the Treasury, “The parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies.”
Alas, Richard A. Posner, a judge on the U.S. Court of Appeals for the Seventh Circuit, observes with pointed restraint, “That turned out not to be true.” The result has been, in the title phrase of Posner’s new book, “A Failure of Capitalism” (Harvard; $23.95). He argues that we are now in a bona-fide depression, which he defines as “a steep reduction in output that causes or threatens to cause deflation and creates widespread public anxiety and, among the political and economic elites, a sense of crisis that evokes extremely costly efforts at remediation.” His book is an attempt to write “a concise, constructive, jargon- and acronym-free, non-technical, unsensational, light-on-anecdote, analytical examination of the major facets of the biggest U.S. economic disaster in my lifetime and that of most people living today.”
Accounts of the banking-and-credit crisis tend to focus their explanations, which usually also means their blame, on one or more of the following four factors: greed, stupidity, government, and the banks. The process resembles a children’s game in which you spin an arrow and it lands on a word. Tett spins twice, and lands on greed and the banks; Posner suggests that he doesn’t know what the word “greed” means, and his spin lands firmly on government. “We are learning from it that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails,” he writes. “The movement to deregulate the financial industry went too far by exaggerating the resilience—the self-healing powers—of laissez-faire capitalism.”
This isn’t an original conclusion, but the way Posner arrives at it is new and bracing. His first claim to fame was as one of the founders of a school of thought that takes economic ideas and techniques and applies them to the law, as well as to life more generally. He has published nearly twenty books in just the past decade, a superhuman rate of productivity, bearing in mind that Posner is also a practicing judge, a senior lecturer at the University of Chicago, and an energetic blogger (in association with the Nobel Prize-winning economist Gary Becker). He has the rare kind of mind that is a pure pleasure to watch in action, regardless of the subject and the argument being made.
“A Failure of Capitalism” argues that the risks taken by the banks were rational, for two main reasons. First, it’s only with the benefit of hindsight that we can know that a bubble in prices was taking place. Bankers had to assign a probability to the prospect that there was a bubble, and, second, to the prospect that, if there was a bubble and it burst, house prices would fall by twenty per cent or more—this being the decline that precipitated the general crisis of bank insolvency. Now, suppose that the risk of both things happening was one per cent. Whether an event with that likelihood is worth worrying about depends on what its consequences will be. From the larger point of view, the consequences included systemic meltdown; but Posner invites us to focus our attention on what they looked like for individual bankers. They had strong incentives for taking the maximum amount of risks in their lending, since risks are correlated with rewards, and the bankers were so well paid that they didn’t really have to worry about being laid off. “The greater the gains are from taking risks that enable very high short-term profits, and the better cushioned the executive is by his severance package against the cost of losing his job, the more risks he rationally will take,” Posner notes. Besides, if a bank avoids these risks, and its competitors don’t and therefore make more money during the boom, the cautious bank risks going out of business anyway, because its clients will walk away.
People taking out what now look like crazily risky mortgage loans were being rational, too, because they were acting on the widespread assumption that house prices would continue rising. If house prices fell, well, tough luck, they’d walk away from the loan and go bankrupt—but they probably had lousy credit ratings anyway. “Thus the downside of the home buyer’s speculative investment is truncated, making his ‘reckless’ behavior not only rational but also consistent with his being well informed about the risks,” Posner writes. The conclusion: “Risky behavior of the sort I have been describing was individually rational during the bubble. But it was collectively irrational.” As for the idea that the bankers were dumb to get so carried away: “I am skeptical that readily avoidable mistakes, failures of rationality, or the intellectual deficiencies of financial managers whose IQs exceed my own were major factors in the economic collapse. Had the mistakes that brought down the banking industry been readily avoidable, they would have been avoided.”
This is a familiar place for these arguments to end up: economists often find that apparently erratic behavior is, at heart, rational. It helps that the definition of rationality can be stretched to include emotion, which “is not necessarily or even typically irrational,” Posner argues. Reckless greed, incompetent assessments of probability, blindness to the inevitability of downturns, failure to hedge risks so big that they threaten a firm’s very existence: all are rational.
It seems a pity that a man as unflinching as Posner didn’t put his ideas under more pressure from the specifics of what the bankers did. He is willing to criticize those who have criticized bankers—“the distinguished economist Paul Krugman,” for instance, “who should know better”—but no banker is named and blamed. One can regret that Posner didn’t get the chance to read Tett’s book, which offers the opportunity to assess in detail the kind of risks that the bankers were taking.
Blythe Masters, who was in charge of the Exxon Valdez deal, and of selling the very first BISTRO notes, and thus one of the creators of the entire credit-default-swap industry, was among those baffled by the C.D.O. boom. “How are the other banks doing it?” she asked. “How are they making so much money?” The answer, Tett says, is that “she was so steeped in the ways of J. P. Morgan that it never occurred to her that the other banks might simply ignore all the risk controls J. P. Morgan had adhered to. That they might do so was simply outside her cognitive map.”
In particular, those banks had accumulated huge amounts of super-senior debt. In the first BISTRO, remember, only seven hundred million dollars was reserved to cover $9.7 billion of risk. The remainder of the debt was regarded as marvellously safe. Bankers call that kind of debt “super-senior,” i.e., better than AAA grade, safer than U.S. Treasury bills, so secure that it didn’t need to be insured. So what to do with it? Some banks simply let the super-senior debt accumulate on their balance sheets. The amount of this debt “was a closely guarded secret, even within the banks themselves,” Tett writes, and the collapse in their value helped bring down the big banks. It would be interesting to read Posner’s analysis of these specific actions, which to the layman seem, as they seemed to so many of the J. P. Morgan team, insanely reckless.
A common mistake of very smart people is to assume that other people’s minds work in the same way that theirs do. This is a particular problem in economics. Its mathematically based models and assumptions of rational conduct can appear, to non-economists, like toys, entertaining but, by definition, of limited utility. Even Posner, who spent years extending the purview of economic thought, thinks that “the depression is a wake-up call to the economics profession.” It’s no surprise to find the Yale economist Robert J. Shiller as one of the first respondents to that call. Shiller—not content with having predicted the bursting of the dot-com bubble in his book “Irrational Exuberance”; co-creating the standard measure for tracking house prices, the Case-Shiller index; going on the record with worries about the housing bubble as early as 2003; and writing one of the first books on the crash, “The Subprime Solution,” in 2008—has now, with George A. Akerlof, the 2001 Nobel winner in economics, co-written a book on the influence of emotions on economics. “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism” (Princeton; $24.95) takes its title from John Maynard Keynes, who, in a famous passage of his 1936 treatise “The General Theory of Employment, Interest and Money,” mused about how businessmen manage to make decisions, given the level of uncertainty about the future. “Our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing,” he wrote. We can’t know the future, and therefore our inclination to act, to do things, “can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction.” Akerlof and Shiller extrapolate from this an idea of animal spirits encompassing “noneconomic motives and irrational behaviors,” a slightly broader idea than Keynes’s usage, but one that allows them to study a range of negative impulses as well as the basic urge to optimism about which Keynes was talking.
“Animal Spirits” is addressed to a general reader, but it’s hard not to feel that the book’s real audience is among economists. The general reader needs no persuading about the influence of non-rational, non-economic forces on economic thinking. Within the economic profession, however, the subject of strict rationality is the occasion of a permanent pitched battle. (Posner: “The very existence of warring schools within a field is a clue that the field is weak, however brilliant its practitioners.”) “Animal Spirits,” like “A Failure of Capitalism,” is a campaigning maneuver in this ongoing struggle.
Akerlof and Shiller have a set of specific proposals for how the animal spirits might be incorporated into their science. They set out a framework of factors—Confidence (and the lack thereof), Fairness, Corruption and Bad Faith, Money Illusion (the failure to understand the impact of inflation), and Stories—and then apply their ideas to a series of specific questions. Some of this is very timely, such as a chapter on “The Current Financial Crisis” and one asking “Why Are Financial Prices and Corporate Investments So Volatile?” But it’s clear that the great white whale of modern economics, a thing that would appease the descendants of both Milton Friedman and John Maynard Keynes, is a quantifiable, evidence-based theory of how bubbles are formed, and, hence, how to forestall them. Bubbles are irrefutably clear in hindsight; but an economist who found a way of proving their presence with foresight would be doing humanity a profound favor.
We aren’t there yet, though Akerlof and Shiller’s book does give the profession some suggestions for the search. There is barely a page of “Animal Spirits” without a fascinating fact or insight, and by no means all from a reflexively liberal viewpoint. One of their culprits for the crisis is Andrew Cuomo, who, as Secretary of Housing and Urban Development, sharply increased the mandated lending to underserved communities by Fannie Mae and Freddie Mac, and in the process lowered credit standards, thus making it “easy for mortgage lenders to justify loosening their own lending standards.” Despite the various ideological and methodological differences with Richard Posner, Akerlof and Shiller’s fundamental view of how capitalism should work is similar: “What allows capitalism to function is the regulations,” they write. This should be an enduring lesson of the crisis—an understanding that the rules governing the operating of markets were not handed down on stone tablets but are made by men, and are in constant need of revision, supervision, and active, imaginative enforcement. All these books coincide on this point: human beings make markets. A general recognition of that fact, led by the economic profession and taken to heart by politicians, would be a step so important as to be almost worth what it has cost to be reminded of it. ♦
And the following link is worth following up on for its excellent comments afterward, and comments on comments, especially the weakness of Tett's reasoning and experience in places:
http://www.amazon.co.uk/Fools-Gold-Unrestrained-Corrupted-Catastrophe/dp/1408701642
Tuesday, April 28, 2009
An Interesting Side Issue With the Madoff Case
Seizure of assets and how America falls behind:
http://www.nytimes.com/2009/04/28/opinion/28intriago1.html
And a separate lawsuit charging J.P. Morgan with complicity:
http://www.nytimes.com/2009/04/25/business/economy/25madoff.html?fta=y
http://www.nytimes.com/2009/04/28/opinion/28intriago1.html
And a separate lawsuit charging J.P. Morgan with complicity:
http://www.nytimes.com/2009/04/25/business/economy/25madoff.html?fta=y
Saturday, April 25, 2009
The Word "Bank"
(c) 2009 F. Bruce Abel
It occurs to me that for the bailout to work we must wipe out a word from our vocabulary: "Bank," as in "Oh, you work for a bank, do you? I don't trust you, even though I work for a bank myself. In fact I don't even trust myself here at this bank, because I am addicted to trading credit default swaps."
We must now create another word, another category.
What is that word? I don't know. What about "Trank." This implies trust. But, now that I think about it, the phrase "Bank Trust Department" must be removed also.
It occurs to me that for the bailout to work we must wipe out a word from our vocabulary: "Bank," as in "Oh, you work for a bank, do you? I don't trust you, even though I work for a bank myself. In fact I don't even trust myself here at this bank, because I am addicted to trading credit default swaps."
We must now create another word, another category.
What is that word? I don't know. What about "Trank." This implies trust. But, now that I think about it, the phrase "Bank Trust Department" must be removed also.
Thursday, January 29, 2009
JP Morgan and its Pull-Out of the Madoff Fund
This article is a breakthrough. The actual interworkings of a major-firm role in feeding money to Madoff.
Study this article carefully. The "creation" of a triple leveraged instrument led to financial death and violation of JP Morgan's duty to its clients.
http://www.nytimes.com/2009/01/29/business/29madoff.html?hp
Link to "Walter Noel."
Study this article carefully. The "creation" of a triple leveraged instrument led to financial death and violation of JP Morgan's duty to its clients.
http://www.nytimes.com/2009/01/29/business/29madoff.html?hp
Link to "Walter Noel."
Subscribe to:
Posts (Atom)