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 derivatives. Show all posts
Showing posts with label derivatives. Show all posts
Wednesday, May 23, 2012
Monday, June 27, 2011
Derivatives Cloud the Greece Analysis
So the one question I would ask CNBC, etc.: "Why do credit default swaps even exist now????"
http://www.nytimes.com/2011/06/23/business/global/23swaps.html?scp=1&sq=derivatives%20cloud&st=cse
http://www.nytimes.com/2011/06/23/business/global/23swaps.html?scp=1&sq=derivatives%20cloud&st=cse
Monday, February 14, 2011
Wall Street's Dead End
This article caught my fancy. Why? See the first bolded paragraph.
Wall Street’s Dead End
By FELIX SALMON
Published: February 13, 2011
THE stock market has been big news in recent days. Last week’s report that Deutsche Börse, a giant German exchange, intends to buy the New York Stock Exchange, creating a company worth some $24 billion, arrived shortly after the Dow broke the 12,000-point barrier for the first time since before the financial crisis.
These developments drew headlines because they seemed to exemplify significant trends in the American economy. But look at America’s stock exchanges more closely, and there’s less to them than meets the eye. In truth, the stock market is becoming increasingly irrelevant — a trend that threatens the core principles of American capitalism.
These days a healthy stock market doesn’t mean a healthy economy, as a glance at the high unemployment rate or the low labor-market participation rate will show. The Tea Party is right about one thing: What’s good for Wall Street isn’t necessarily good for Main Street. And the Germans aren’t buying the New York Stock Exchange for its commoditized, highly competitive and ultra-low-margin stock business, but rather for its lucrative derivatives operations.
The stock market is still huge, of course: the companies listed on American exchanges are valued at more than $17 trillion, and they’re not going to disappear in the foreseeable future.
But the glory days of publicly traded companies dominating the American business landscape may be over. The number of companies listed on the major domestic exchanges peaked in 1997 at more than 7,000, and it has been falling ever since. It’s now down to about 4,000 companies, and given its steep downward trend will surely continue to shrink.
Nor are the remaining stocks an obvious proxy for the health of the American economy. Innovative American companies like Apple and Google may be worth hundreds of billions of dollars, but most of them don’t pay dividends or employ many Americans, and their shares are essentially speculative investments for people making a bet on how we’re going to live in the future.
Put another way, as the number of initial public offerings steadily declines, the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money.
What the market is not doing so well is its core public function: allocating capital efficiently. Apple, for instance, is hugely profitable and sits on an enormous pile of cash; it is thus very unlikely to use its highly rated stock to pay for any acquisitions. It hasn’t used the stock market to raise money since 1981, and there’s a good bet it never will again.
Meanwhile, the companies in which people most want to invest, technology stars like Facebook and Twitter, are managing to avoid the public markets entirely by raising hundreds of millions or even billions of dollars privately. You and I can’t buy into these companies; only very select institutions and well-connected individuals can. And companies prefer it that way.
A private company’s stock isn’t affected by the unpredictable waves of the stock market as a whole. Its chief executive can concentrate on running the company rather than answering endless questions from investors, analysts and the press.
There’s much less pressure to meet quarterly earnings targets. When the stock does trade, the deals can be negotiated quietly, in private markets, rather than fall victim to short-term speculation from the high-frequency traders who populate public markets. And companies love how private markets allow them to avoid much of the regulatory burden of being public.
That burden comes largely from the Securities and Exchange Commission, which was created in the wake of the 1929 stock-market crash to protect small investors. But if the move to private markets continues, small investors aren’t going to need much protection any more: they’ll be able to invest in only a relative handful of companies anyway.
Only the biggest and oldest companies are happy being listed on public markets today. As a result, the stock market as a whole increasingly fails to reflect the vibrancy and heterogeneity of the broader economy. To invest in younger, smaller companies, you increasingly need to be a member of the ultra-rich elite.
At risk, then, is the shareholder democracy that America forged, slowly, over the past 50 years. Civilians, rather than plutocrats, controlled corporate America, and that relationship improved standards of living and usually kept the worst of corporate abuses in check. With America Inc. owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the postwar period.
Today, however, stock markets, once the bedrock of American capitalism, are slowly becoming a noisy sideshow that churns out increasingly meager returns. The show still gets lots of attention, but the real business of the global economy is inexorably leaving the stock market — and the vast majority of us — behind.
Felix Salmon is the finance blogger at Reuters.
Wall Street’s Dead End
By FELIX SALMON
Published: February 13, 2011
THE stock market has been big news in recent days. Last week’s report that Deutsche Börse, a giant German exchange, intends to buy the New York Stock Exchange, creating a company worth some $24 billion, arrived shortly after the Dow broke the 12,000-point barrier for the first time since before the financial crisis.
These developments drew headlines because they seemed to exemplify significant trends in the American economy. But look at America’s stock exchanges more closely, and there’s less to them than meets the eye. In truth, the stock market is becoming increasingly irrelevant — a trend that threatens the core principles of American capitalism.
These days a healthy stock market doesn’t mean a healthy economy, as a glance at the high unemployment rate or the low labor-market participation rate will show. The Tea Party is right about one thing: What’s good for Wall Street isn’t necessarily good for Main Street. And the Germans aren’t buying the New York Stock Exchange for its commoditized, highly competitive and ultra-low-margin stock business, but rather for its lucrative derivatives operations.
The stock market is still huge, of course: the companies listed on American exchanges are valued at more than $17 trillion, and they’re not going to disappear in the foreseeable future.
But the glory days of publicly traded companies dominating the American business landscape may be over. The number of companies listed on the major domestic exchanges peaked in 1997 at more than 7,000, and it has been falling ever since. It’s now down to about 4,000 companies, and given its steep downward trend will surely continue to shrink.
Nor are the remaining stocks an obvious proxy for the health of the American economy. Innovative American companies like Apple and Google may be worth hundreds of billions of dollars, but most of them don’t pay dividends or employ many Americans, and their shares are essentially speculative investments for people making a bet on how we’re going to live in the future.
Put another way, as the number of initial public offerings steadily declines, the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money.
What the market is not doing so well is its core public function: allocating capital efficiently. Apple, for instance, is hugely profitable and sits on an enormous pile of cash; it is thus very unlikely to use its highly rated stock to pay for any acquisitions. It hasn’t used the stock market to raise money since 1981, and there’s a good bet it never will again.
Meanwhile, the companies in which people most want to invest, technology stars like Facebook and Twitter, are managing to avoid the public markets entirely by raising hundreds of millions or even billions of dollars privately. You and I can’t buy into these companies; only very select institutions and well-connected individuals can. And companies prefer it that way.
A private company’s stock isn’t affected by the unpredictable waves of the stock market as a whole. Its chief executive can concentrate on running the company rather than answering endless questions from investors, analysts and the press.
There’s much less pressure to meet quarterly earnings targets. When the stock does trade, the deals can be negotiated quietly, in private markets, rather than fall victim to short-term speculation from the high-frequency traders who populate public markets. And companies love how private markets allow them to avoid much of the regulatory burden of being public.
That burden comes largely from the Securities and Exchange Commission, which was created in the wake of the 1929 stock-market crash to protect small investors. But if the move to private markets continues, small investors aren’t going to need much protection any more: they’ll be able to invest in only a relative handful of companies anyway.
Only the biggest and oldest companies are happy being listed on public markets today. As a result, the stock market as a whole increasingly fails to reflect the vibrancy and heterogeneity of the broader economy. To invest in younger, smaller companies, you increasingly need to be a member of the ultra-rich elite.
At risk, then, is the shareholder democracy that America forged, slowly, over the past 50 years. Civilians, rather than plutocrats, controlled corporate America, and that relationship improved standards of living and usually kept the worst of corporate abuses in check. With America Inc. owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the postwar period.
Today, however, stock markets, once the bedrock of American capitalism, are slowly becoming a noisy sideshow that churns out increasingly meager returns. The show still gets lots of attention, but the real business of the global economy is inexorably leaving the stock market — and the vast majority of us — behind.
Felix Salmon is the finance blogger at Reuters.
Saturday, June 12, 2010
Wonkish But Important
The Baseline Scenario
--------------------------------------------------------------------------------
Why Section 716 is the Indispensable Reform
Posted: 10 Jun 2010 06:30 PM PDT
By Jane D’Arista
This guest post is contributed by Jane D’Arista, a research associate at the Political Economy Research Institute at the University of Massachusetts, Amherst, and co-coordinator of its Economists’ Committee for Stable, Accountable, Fair, and Efficient Financial Reform (SAFER). She has taught in graduate economics programs at several universities and served on committee staffs of the U.S. House of Representatives.
Dominated by the world’s largest banks, the over-the-counter (OTC) derivatives market has been expanding since the break-down of the Bretton Woods Agreement in the early 1970s privatized the international monetary system by shifting the payments process from central banks to commercial banks. The proliferation of foreign exchange forwards and swaps that followed set in motion an ever-expanding menu of exotic instruments that reached a nominal value of over $600 trillion by the middle of the current decade. Central banks and financial regulators ignored the implications of the growth of this market and ignored warnings from the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) from 2002 forward that OTC derivatives were at the center of what had become a global casino in which the largest international institutions were the biggest speculators.
The large, international institutions that created the OTC market for foreign exchange forwards and swaps were commercial banks. Following established banking practice, they conducted their derivatives business like portfolio lenders rather than broker/dealers, buying and selling forwards and swaps outside of established markets. But OTC derivatives contracts can’t be classified as assets or liabilities until they are settled and can’t be held on banks’ balance sheets the way loans and deposits are held. Instead, they were booked off balance sheet as contingent liabilities. The market structure that emerged in what came to be the largest market in the global economy was one in which non-tradable contracts were bought by and sold to customers without real time information on volume or pricing or the aggregate positions of the dealers themselves. Moreover, the fact that the contracts were illiquid required constant hedging by dealers that expanded their positions and inflated the size of the market relative to all other national and international financial markets. Meanwhile, the commercial bank dealers’ derivatives business was operating with all the implicit guarantees and subsidies that governments put in place to protect this core financial sector. In 2008, those guarantees became explicit and were exercised.
Are there reasons to protect derivatives dealers?
Because the largest U.S. commercial banks were dominant players in the OTC derivatives markets, Federal Reserve lending, FDIC guarantees and taxpayer bailouts during the 2008 crisis gave explicit protection to both bank and non-bank swap dealers and major swap participants. Those protections are not grounded in the traditions and practices of U.S. financial law and regulation. They are no more appropriate than would be an extension of federal protection to financial entities (including bank affiliates) that market and trade corporate stocks and bonds. Recognizing how far the government’s response in 2008 deviated from the existing rational framework for government intervention, Section 716 of the Senate bill makes clear that such protections are not to be given statutory approval; that allowing banks to continue to deal and trade in derivatives would be to accept this egregious violation of prudential standards in legislation intended to reform and strengthen a fragile financial system.
The movement of the largest banks into the business of marketing and trading OTC derivatives occurred during a period when the process of deregulation was sweeping away traditional regulatory barriers and was not challenged. That fact should not, however, lead to the assumption that this is a “normal” banking activity. There is no economic or systemic reason why derivatives should be sold by banks. As the entry of large investment banks into the business in the 1980s suggests, it is not tied to the traditional deposit-taking and lending activities of banks or to the payments system. It is, in fact, so esoteric an activity that, currently, only five institutions account for 90 percent of the market. The remaining 8,000 or so U.S. banks do not sell derivatives or trade them for their own account.
Equally questionable is the assertion that dealing in derivatives is part of banks’ role as intermediaries; that they are helping to meet the hedging needs of their customers. As CFTC Chairman Gary Gensler recently pointed out, BIS data show that sales and trades with commercial end-users account for only eight to nine percent of the OTC market. Over 90 percent of contracts involve transactions between dealers or with other financial institutions. Meanwhile, the events of 2008 have made a mockery of the frequently voiced assertion that derivatives were invaluable in shifting risk to those most able to bear it – unless, of course, the assumption was that those most able to bear it were taxpayers.
Risk and fiduciary responsibility
Housing the business of marketing and trading derivatives in banks intensifies systemic risk and undermines fiduciary responsibility. Buying and selling OTC derivatives contracts is a zero sum game. Unlike portfolio lending that links the fortunes of borrowers and lenders, one party to a derivatives transaction wins while the counterparty loses. Given the nature of the game, dealers must constantly hedge their positions but, unable to do so by trading their side of the contract, their exposures grow higher and higher and include a number of contracts with long maturities. Systemic risk is embedded in this type of market structure – the more so since the buildup in these positions over the decade preceding the crisis depended on short-term borrowing and rising leverage. Touted as a way to defuse risk, the expansion of banks’ derivatives business actually intensified it
The buildup in derivatives positions among the large dealers also created a new and dramatically intense form of systemic risk: interconnectedness. The share of total transactions accounted for by contracts between a relatively small group of dealers resulted in an increasingly symbiotic web of interdependence among the largest institutions in the global market. The size of individual dealers’ positions contributed to systemic risk but interconnectedness was at the epicenter of the problem.
What section 716 does to alleviate the problem
The most important element in section 716 is the structure it provides – one that makes a clear separation between the business of banking and that of marketing and trading derivatives. This structure makes it possible to protect the core financial functions of banks without extending those protections to cover highly risky derivatives transactions.
By requiring that dealing and trading derivatives move to separately capitalized affiliates that do not have access to Fed lending facilities or FDIC guarantees, section 716 will also contribute to shrinking the size of individual institutions’ positions and the market itself. The huge capital reserves of the five institutions that dominate the U.S. market will no longer be available to support their outsized positions. The capital of derivatives affiliates – even if within the same holding company – will necessarily be much smaller and will limit their aggregate positions. This will create opportunities for non-bank firms to enter the market with capital positions equivalent to those of the affiliates of major institutions.
By shifting the activity to affiliates, section 716 eliminates the burgeoning counterparty risk the largest banks incur through marketing and trading OTC derivatives. Encouraging an expansion in the number of dealers will help reduce the risk to the system as a whole. The intent in both the House and Senate bills to require clearing and trading on exchanges using a central counterparty structure is another critical element for alleviating interconnectedness but only if the pressure to create loopholes is resisted.
Are there other provisions that mitigate these risks if banks are allowed to continue selling and trading derivatives?
There are other provisions in the House and Senate bills that address some aspects of bank exposure to risks involving derivatives but none of them remove the government guarantee backing their marketing and trading by banks. For example, the Volcker Rule in section 619 of the Senate bill deals with the equally important problem of proprietary trading by proposing to bar trading in any financial instrument, including derivatives, for a bank’s own account. The Merkley-Levin amendment strengthens this provision by making the reform a statutory ban rather than leaving it to the discretion of regulators. In addition, it would crack down on trades that conflict with customers’ interests.
But Merkley-Levin is not a substitute for section 716. It would still allow banks to deal and trade on behalf of their clients. Their derivatives business would still be backed and subsidized by Federal Reserve lending and FDIC guarantees and, in the event of another crisis, might require taxpayer bailouts to protect the banking functions of these huge enterprises.
Other sections of the Senate bill – sections 608–611 – address the systemic risk posed by interconnectedness. Section 610 limits a bank’s credit exposure (including derivatives) to another bank or financial institution as a percentage of its capital. This provision will tend to shrink the OTC derivatives market since, as noted, over 90 percent of aggregate transactions involves trades between dealers or with other financial institutions. Another section (608) complements section 716 by limiting a bank’s credit exposure (including derivatives) to affiliates. But, again, banks would still be able to conduct their derivatives business within the bank and the government backing for the bank that constitutes a guarantee and subsidy for selling and trading derivatives would remain.
Both the House and Senate bills authorize regulators to impose aggregate position limits on traded contracts and swaps. These provisions complement both sections 610 and 716 in the Senate bill by allowing regulators to address excesses and imbalances in the derivatives positions of individual institutions and the aggregate market as well. They are a very important tool for strengthening the regulation of derivatives markets but – once more – they do not remove the anticompetitive government support uniquely enjoyed by the derivatives operations of the five largest U.S. financial institutions.
In summary, there are no substitutes for section 716 – no provisions that will accomplish what it does in terms of removing the subsidy enjoyed by (literally) a handful of institutions and ending the ongoing threat to the taxpayer that the guarantee of their derivatives business poses. Ignoring that threat would undermine all the other contributions to reform that the House and Senate bills provide.
--------------------------------------------------------------------------------
Why Section 716 is the Indispensable Reform
Posted: 10 Jun 2010 06:30 PM PDT
By Jane D’Arista
This guest post is contributed by Jane D’Arista, a research associate at the Political Economy Research Institute at the University of Massachusetts, Amherst, and co-coordinator of its Economists’ Committee for Stable, Accountable, Fair, and Efficient Financial Reform (SAFER). She has taught in graduate economics programs at several universities and served on committee staffs of the U.S. House of Representatives.
Dominated by the world’s largest banks, the over-the-counter (OTC) derivatives market has been expanding since the break-down of the Bretton Woods Agreement in the early 1970s privatized the international monetary system by shifting the payments process from central banks to commercial banks. The proliferation of foreign exchange forwards and swaps that followed set in motion an ever-expanding menu of exotic instruments that reached a nominal value of over $600 trillion by the middle of the current decade. Central banks and financial regulators ignored the implications of the growth of this market and ignored warnings from the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) from 2002 forward that OTC derivatives were at the center of what had become a global casino in which the largest international institutions were the biggest speculators.
The large, international institutions that created the OTC market for foreign exchange forwards and swaps were commercial banks. Following established banking practice, they conducted their derivatives business like portfolio lenders rather than broker/dealers, buying and selling forwards and swaps outside of established markets. But OTC derivatives contracts can’t be classified as assets or liabilities until they are settled and can’t be held on banks’ balance sheets the way loans and deposits are held. Instead, they were booked off balance sheet as contingent liabilities. The market structure that emerged in what came to be the largest market in the global economy was one in which non-tradable contracts were bought by and sold to customers without real time information on volume or pricing or the aggregate positions of the dealers themselves. Moreover, the fact that the contracts were illiquid required constant hedging by dealers that expanded their positions and inflated the size of the market relative to all other national and international financial markets. Meanwhile, the commercial bank dealers’ derivatives business was operating with all the implicit guarantees and subsidies that governments put in place to protect this core financial sector. In 2008, those guarantees became explicit and were exercised.
Are there reasons to protect derivatives dealers?
Because the largest U.S. commercial banks were dominant players in the OTC derivatives markets, Federal Reserve lending, FDIC guarantees and taxpayer bailouts during the 2008 crisis gave explicit protection to both bank and non-bank swap dealers and major swap participants. Those protections are not grounded in the traditions and practices of U.S. financial law and regulation. They are no more appropriate than would be an extension of federal protection to financial entities (including bank affiliates) that market and trade corporate stocks and bonds. Recognizing how far the government’s response in 2008 deviated from the existing rational framework for government intervention, Section 716 of the Senate bill makes clear that such protections are not to be given statutory approval; that allowing banks to continue to deal and trade in derivatives would be to accept this egregious violation of prudential standards in legislation intended to reform and strengthen a fragile financial system.
The movement of the largest banks into the business of marketing and trading OTC derivatives occurred during a period when the process of deregulation was sweeping away traditional regulatory barriers and was not challenged. That fact should not, however, lead to the assumption that this is a “normal” banking activity. There is no economic or systemic reason why derivatives should be sold by banks. As the entry of large investment banks into the business in the 1980s suggests, it is not tied to the traditional deposit-taking and lending activities of banks or to the payments system. It is, in fact, so esoteric an activity that, currently, only five institutions account for 90 percent of the market. The remaining 8,000 or so U.S. banks do not sell derivatives or trade them for their own account.
Equally questionable is the assertion that dealing in derivatives is part of banks’ role as intermediaries; that they are helping to meet the hedging needs of their customers. As CFTC Chairman Gary Gensler recently pointed out, BIS data show that sales and trades with commercial end-users account for only eight to nine percent of the OTC market. Over 90 percent of contracts involve transactions between dealers or with other financial institutions. Meanwhile, the events of 2008 have made a mockery of the frequently voiced assertion that derivatives were invaluable in shifting risk to those most able to bear it – unless, of course, the assumption was that those most able to bear it were taxpayers.
Risk and fiduciary responsibility
Housing the business of marketing and trading derivatives in banks intensifies systemic risk and undermines fiduciary responsibility. Buying and selling OTC derivatives contracts is a zero sum game. Unlike portfolio lending that links the fortunes of borrowers and lenders, one party to a derivatives transaction wins while the counterparty loses. Given the nature of the game, dealers must constantly hedge their positions but, unable to do so by trading their side of the contract, their exposures grow higher and higher and include a number of contracts with long maturities. Systemic risk is embedded in this type of market structure – the more so since the buildup in these positions over the decade preceding the crisis depended on short-term borrowing and rising leverage. Touted as a way to defuse risk, the expansion of banks’ derivatives business actually intensified it
The buildup in derivatives positions among the large dealers also created a new and dramatically intense form of systemic risk: interconnectedness. The share of total transactions accounted for by contracts between a relatively small group of dealers resulted in an increasingly symbiotic web of interdependence among the largest institutions in the global market. The size of individual dealers’ positions contributed to systemic risk but interconnectedness was at the epicenter of the problem.
What section 716 does to alleviate the problem
The most important element in section 716 is the structure it provides – one that makes a clear separation between the business of banking and that of marketing and trading derivatives. This structure makes it possible to protect the core financial functions of banks without extending those protections to cover highly risky derivatives transactions.
By requiring that dealing and trading derivatives move to separately capitalized affiliates that do not have access to Fed lending facilities or FDIC guarantees, section 716 will also contribute to shrinking the size of individual institutions’ positions and the market itself. The huge capital reserves of the five institutions that dominate the U.S. market will no longer be available to support their outsized positions. The capital of derivatives affiliates – even if within the same holding company – will necessarily be much smaller and will limit their aggregate positions. This will create opportunities for non-bank firms to enter the market with capital positions equivalent to those of the affiliates of major institutions.
By shifting the activity to affiliates, section 716 eliminates the burgeoning counterparty risk the largest banks incur through marketing and trading OTC derivatives. Encouraging an expansion in the number of dealers will help reduce the risk to the system as a whole. The intent in both the House and Senate bills to require clearing and trading on exchanges using a central counterparty structure is another critical element for alleviating interconnectedness but only if the pressure to create loopholes is resisted.
Are there other provisions that mitigate these risks if banks are allowed to continue selling and trading derivatives?
There are other provisions in the House and Senate bills that address some aspects of bank exposure to risks involving derivatives but none of them remove the government guarantee backing their marketing and trading by banks. For example, the Volcker Rule in section 619 of the Senate bill deals with the equally important problem of proprietary trading by proposing to bar trading in any financial instrument, including derivatives, for a bank’s own account. The Merkley-Levin amendment strengthens this provision by making the reform a statutory ban rather than leaving it to the discretion of regulators. In addition, it would crack down on trades that conflict with customers’ interests.
But Merkley-Levin is not a substitute for section 716. It would still allow banks to deal and trade on behalf of their clients. Their derivatives business would still be backed and subsidized by Federal Reserve lending and FDIC guarantees and, in the event of another crisis, might require taxpayer bailouts to protect the banking functions of these huge enterprises.
Other sections of the Senate bill – sections 608–611 – address the systemic risk posed by interconnectedness. Section 610 limits a bank’s credit exposure (including derivatives) to another bank or financial institution as a percentage of its capital. This provision will tend to shrink the OTC derivatives market since, as noted, over 90 percent of aggregate transactions involves trades between dealers or with other financial institutions. Another section (608) complements section 716 by limiting a bank’s credit exposure (including derivatives) to affiliates. But, again, banks would still be able to conduct their derivatives business within the bank and the government backing for the bank that constitutes a guarantee and subsidy for selling and trading derivatives would remain.
Both the House and Senate bills authorize regulators to impose aggregate position limits on traded contracts and swaps. These provisions complement both sections 610 and 716 in the Senate bill by allowing regulators to address excesses and imbalances in the derivatives positions of individual institutions and the aggregate market as well. They are a very important tool for strengthening the regulation of derivatives markets but – once more – they do not remove the anticompetitive government support uniquely enjoyed by the derivatives operations of the five largest U.S. financial institutions.
In summary, there are no substitutes for section 716 – no provisions that will accomplish what it does in terms of removing the subsidy enjoyed by (literally) a handful of institutions and ending the ongoing threat to the taxpayer that the guarantee of their derivatives business poses. Ignoring that threat would undermine all the other contributions to reform that the House and Senate bills provide.
Sunday, May 30, 2010
Oh Oh My First Casualty: Flynn’s Oil Company, Exeter New Hampshire, News Releases - NHDOJ
Flynn’s Oil Company, Exeter New Hampshire, News Releases - NHDOJ: "Flynn’s Oil Company sells home heating oil to consumers. The State’s Petition for Injunctive Relief alleges that Flynn’s has entered into prebuy contracts for the purchase and delivery of home heating oil, but has failed to comply with RSA 339:79. RSA 339:79 requires an oil company which sells oil and requires prepayment by the consumer to include in its contact &rlquo;a clear explanation of the means by which the dealer will meet the obligations of the contract for the entire contract period, including supplier agreements, futures contracts, bonding, or a line of credit.”"
Sunday, May 2, 2010
Notes From the (Berkshire Hathaway) Front
(c) 2010 F. Bruce Abel
The following is a nice theoretical explanation. What is ignored is that it took people's money to bail out the insurers of these types of transactions. So the effects are far from theoretical. (I think.)
So...Warren talks tough on derivatives and "explains" the Abacus deal, defending Goldman Sachs. Click on enclosure link and enjoy. Does he explain who ultimately was caught holding the bag? I don't think so.
Buffett gave a detailed explanation of the nature of the much discussed ABACUS transaction, for which Goldman has been sued by the SEC.
An excerpt on the Abacus deal, which I will now consider.
The customer was a large bank, ABN Amro, now part of RBS. They guaranteed the credit of ACA, which insured the bonds covered by said instrument, and consequently suffered a large loss. Berkshire itself often engages in similar transactions, and collects a fee for guaranteeing similar credit. Berkshire evaluates bonds and prices them, exactly as ACA did.
In this case, ABN Amro was paid $1.6 million to bear the risk on $900 million worth of bonds, which turned out to be worthless.
Buffett believes many municipal bonds insurers expanded into new business such as structured credits when the margins on their traditional muni bonds business narrowed. But they were much less familiar with the new complicated securities, with unsurprising dreadful results.
Buffett has little sympathy for the bank making dumb credit decisions. ACA has
And then this video of Blankfein explaining that Goldman was just a market maker in the deal -- like the NY Stock Exchange.
http://www.huffingtonpost.com/2010/05/01/goldman-sachs-lloyd-blank_n_559606.html
Wednesday, April 28, 2010
Goldman Sachs -- "Sociopaths"
(c) 2010 F. Bruce Abel
The best comment yet on the Goldman hearings earlier this week, from "KT NY":
(Who else ever started a piece with the word "telling?" Very effective.)
April 28th, 2010 10:51 am
Telling to me was the fact that, although they most certainly had been warned by their attorneys to treat the hearing seriously and the Senators respectfully, the Goldman Sachs crew exuded contempt and smugness from every pore. "Our net worth is higher than yours," they seemed to be saying, "So you're stupid and we win."
What to do about these lunkheads? Clearly, it will not help to explain to them that not all smart people choose to devote their lives to making money: some design the Hadron Collider, identify the gene that causes breast cancer, write symphonies, and even become U.S. Senators. It will not help to explain, because to these guys, competition and its rewards -- status and cash -- are all that matter in life. Period. They're built that way, psychologically, and we're not going to change their minds.
What we can do, however, is recognize that while Wall Street culture -- the Goldman Sachs syndrome -- does in fact add value to our society, by allowing money to move through the system to those who need money to run businesses, that culture must be contained. That's because, as we saw in the Senate hearings yesterday, those who excel at the art of the deal are basically sociopaths, with few moral values and no ethical brakes. Their contributions to society might be analogized to nuclear energy: we build reactors, and the reactors make electricity. Yet those reactors have to be carefully monitored and controlled. If we let them blow up, we all die.
Because of its erroneous, free market ideology -- not to mention the money that it collects from Wall Street -- the Republican Party is incapable of recognizing that letting Wall Street operate without restraints is like building a nuclear reactor in Times Square and yelling "Let 'er rip!" In its own way, the GOP is as blind, and clueless, as the Goldman Sachs traders. That is why regulation is not merely needed, but will occur only if the public starts calling Senators -- like tomorrow -- to make its will known.
There is an election coming up. It's time to let your Senators know that the Era of the Poopy Deal must come to an end.
Globular and Mailer
(first the link to the New York Times article and comments above; too lazy to reformat above the title):
http://community.nytimes.com/comments/www.nytimes.com/2010/04/28/opinion/28dowd.html?scp=3&sq=sociopaths&st=cse
And some good from the Globe & Mail, especially the comments after the article, in today's Business section:
http://www.theglobeandmail.com/globe-investor/markets/markets-blog/the-casino-analogy/article1549918/?cid=art-rail-marketsblog
The best comment yet on the Goldman hearings earlier this week, from "KT NY":
(Who else ever started a piece with the word "telling?" Very effective.)
April 28th, 2010 10:51 am
Telling to me was the fact that, although they most certainly had been warned by their attorneys to treat the hearing seriously and the Senators respectfully, the Goldman Sachs crew exuded contempt and smugness from every pore. "Our net worth is higher than yours," they seemed to be saying, "So you're stupid and we win."
What to do about these lunkheads? Clearly, it will not help to explain to them that not all smart people choose to devote their lives to making money: some design the Hadron Collider, identify the gene that causes breast cancer, write symphonies, and even become U.S. Senators. It will not help to explain, because to these guys, competition and its rewards -- status and cash -- are all that matter in life. Period. They're built that way, psychologically, and we're not going to change their minds.
What we can do, however, is recognize that while Wall Street culture -- the Goldman Sachs syndrome -- does in fact add value to our society, by allowing money to move through the system to those who need money to run businesses, that culture must be contained. That's because, as we saw in the Senate hearings yesterday, those who excel at the art of the deal are basically sociopaths, with few moral values and no ethical brakes. Their contributions to society might be analogized to nuclear energy: we build reactors, and the reactors make electricity. Yet those reactors have to be carefully monitored and controlled. If we let them blow up, we all die.
Because of its erroneous, free market ideology -- not to mention the money that it collects from Wall Street -- the Republican Party is incapable of recognizing that letting Wall Street operate without restraints is like building a nuclear reactor in Times Square and yelling "Let 'er rip!" In its own way, the GOP is as blind, and clueless, as the Goldman Sachs traders. That is why regulation is not merely needed, but will occur only if the public starts calling Senators -- like tomorrow -- to make its will known.
There is an election coming up. It's time to let your Senators know that the Era of the Poopy Deal must come to an end.
Globular and Mailer
(first the link to the New York Times article and comments above; too lazy to reformat above the title):
http://community.nytimes.com/comments/www.nytimes.com/2010/04/28/opinion/28dowd.html?scp=3&sq=sociopaths&st=cse
And some good from the Globe & Mail, especially the comments after the article, in today's Business section:
http://www.theglobeandmail.com/globe-investor/markets/markets-blog/the-casino-analogy/article1549918/?cid=art-rail-marketsblog
Monday, March 22, 2010
The Big Short
(c) 2010 F. Bruce Abel
Readers of this blog will recognize that when I use both names for a "Label," this person is special! They also know that I have more entries for Michael Lewis and "Liar's Poker" than almost anything else. And I started doing this years before the crash.
Herein is a brief review of his new book. If it is as good as "Liar's Poker" I will fill up another room with copies I will buy on the used-book market, as I did for many years, giving them to everyone I met.
http://www.npr.org/templates/player/mediaPlayer.html?action=1&t=1&islist=false&id=124690424&m=124734885
http://www.nytimes.com/2010/03/15/books/15book.html?scp=1&sq=michael%20lewis&st=cse
Readers of this blog will recognize that when I use both names for a "Label," this person is special! They also know that I have more entries for Michael Lewis and "Liar's Poker" than almost anything else. And I started doing this years before the crash.
Herein is a brief review of his new book. If it is as good as "Liar's Poker" I will fill up another room with copies I will buy on the used-book market, as I did for many years, giving them to everyone I met.
http://www.npr.org/templates/player/mediaPlayer.html?action=1&t=1&islist=false&id=124690424&m=124734885
http://www.nytimes.com/2010/03/15/books/15book.html?scp=1&sq=michael%20lewis&st=cse
Friday, March 12, 2010
Et Tu Brute?
(c) 2010 F. Bruce Abel
I'm Globing & Mailing this morning.
Italy, meet Greece. Or come to lunch with Goldman Sachs.
Ian Simpson
Milan — Reuters Published on Thursday, Mar. 11, 2010 10:56AM EST Last updated on Thursday, Mar. 11, 2010 11:28AM EST
Financial markets are gripped by the role derivatives have played in Greece's debt crisis, but Italy also has a derivatives time bomb, and hundreds of cities are in the €24-billion blast zone.
Many local governments eager to cut financing costs for years rushed to sign up for complex derivatives contracts, even when the terms were in English. But some cities, facing big losses when interest rates go up, are now trying to pull out of derivatives and suing the international and local banks that arranged the deals.
In a test case, a judge in Milan will decide in coming weeks whether to try 13 people and four banks – UBS, Deutsche Bank, Germany's Depfa and JPMorgan Chase & Co – on aggravated fraud charges. The case stems from a derivatives swap over a €1.68-billion 30-year bond, the biggest issued by an Italian city.
Milan, Italy's financial capital, is facing a €100-million loss on the deal, city officials say. Milan is also suing the banks for €239-million in overall liabilities.
In the southern region of Puglia, prosecutors are seeking to bar Merrill Lynch, a unit of Bank of America Corp, from government contracts for two years. The move stems from derivatives losses from €870-million in regional bonds.
JPMorgan, UBS and Deutsche have denied wrongdoing, and Depfa has declined comment. Merrill has not commented.
Almost 500 small and large Italian cities are facing mark-to-market losses of €2.5-billion on the contracts, according to the Bank of Italy. Analysts say that figure will balloon when interest rates go up.
Most of the contracts involved switching fixed rates on loans to variable ones with banks.
“With the economic crisis, the problem has been lessened a bit (with lower rates) ... But in fact with a rate rise it becomes an even worse problem,” said Fabio Amatucci, an expert on local government finances at Milan's Bocconi University.
The European Central Bank is expected to start hiking rates at the end of this year or early next year.
U.S. and European officials are looking into how U.S. investment bank Goldman Sachs Group Inc. may have helped Greece disguise the size of its budget deficit through the use of cross-currency derivatives in 2001.
The Italian deals differ somewhat from the Greek case since the instruments were usually for switching rates on loans, but Italy stands out because of the vast number of cities, regions and public entities – even a theatre association – that turned to them from 2001 to 2008.
The Bank of Italy put the notional value of derivatives contracts at €24.1-billion in June 2009. However, Il Sole 24 Ore business newspaper on Thursday cited Treasury data to put the overall figure at €35.5-billion – a third of local governments' debt – when wider criteria were used.
Although central bank figures show 467 local governments had derivatives contracts at the end of September, Mr. Amatucci believes the real number could be around 3,000 as more deals emerge.
The government banned new contracts in 2008 pending new rules. Economy Minister Giulio Tremonti has said there is “no effect” from derivatives held by local governments.
Local governments rushed into derivatives in part because they helped ease the rigidity of a 2001 law that bars taking on new debt except to finance investment.
But another big draw was the upfront payment many cities got in advance for signing revamped agreements, usually done without a bidding process, analysts said.
Renegotiated deals shoved back payment and costs in a “political manipulation” of signings, said Giampaolo Gialazzo with the Tiche consultancy in Treviso.
Revised deals also carried increasingly restrictive terms and higher costs for municipalities and other local governments.
“Greece did nothing more than get itself money right away and then pay it back slowly. Local administrations in Italy did the same thing,” said Massimiliano Palumbaro with CFI Advisors in Pescara.
Pescara, a southern Italian city, itself took out a total of €108-million in interest rate swaps and is suing UniCredit SpA and BNL, a unit of France's BNP Paribas, over them. UniCredit had no comment, while BNL had no immediate comment.
When rates are low, as they were when many contracts were agreed to, local authorities using a variable rate could find their costs shrinking. However, when rates rose, officials would find themselves owing more money.
Milan has argued, as have many other local administrations, that the contracts were murky, carried hidden costs and banks had failed to explain them.
However, a source close to the issue said Milan could not argue that it was ignorant about derivatives since the 2005 swap replaced a contract that had been renegotiated repeatedly.
The city also has wide securities markets experience given its joint control of listed utility A2A, the source said.
With banks putting in place a complex deal that had to be overseen for 30 years with hefty back-office costs, “the city could not expect that the banks were going to take that position for free,” said the source.
Despite the court cases, Milan is still interested in derivatives. The city council said on Wednesday it was studying a switch from a variable rate on the contract to a fixed one.
I'm Globing & Mailing this morning.
Italy, meet Greece. Or come to lunch with Goldman Sachs.
Ian Simpson
Milan — Reuters Published on Thursday, Mar. 11, 2010 10:56AM EST Last updated on Thursday, Mar. 11, 2010 11:28AM EST
Financial markets are gripped by the role derivatives have played in Greece's debt crisis, but Italy also has a derivatives time bomb, and hundreds of cities are in the €24-billion blast zone.
Many local governments eager to cut financing costs for years rushed to sign up for complex derivatives contracts, even when the terms were in English. But some cities, facing big losses when interest rates go up, are now trying to pull out of derivatives and suing the international and local banks that arranged the deals.
In a test case, a judge in Milan will decide in coming weeks whether to try 13 people and four banks – UBS, Deutsche Bank, Germany's Depfa and JPMorgan Chase & Co – on aggravated fraud charges. The case stems from a derivatives swap over a €1.68-billion 30-year bond, the biggest issued by an Italian city.
Milan, Italy's financial capital, is facing a €100-million loss on the deal, city officials say. Milan is also suing the banks for €239-million in overall liabilities.
In the southern region of Puglia, prosecutors are seeking to bar Merrill Lynch, a unit of Bank of America Corp, from government contracts for two years. The move stems from derivatives losses from €870-million in regional bonds.
JPMorgan, UBS and Deutsche have denied wrongdoing, and Depfa has declined comment. Merrill has not commented.
Almost 500 small and large Italian cities are facing mark-to-market losses of €2.5-billion on the contracts, according to the Bank of Italy. Analysts say that figure will balloon when interest rates go up.
Most of the contracts involved switching fixed rates on loans to variable ones with banks.
“With the economic crisis, the problem has been lessened a bit (with lower rates) ... But in fact with a rate rise it becomes an even worse problem,” said Fabio Amatucci, an expert on local government finances at Milan's Bocconi University.
The European Central Bank is expected to start hiking rates at the end of this year or early next year.
U.S. and European officials are looking into how U.S. investment bank Goldman Sachs Group Inc. may have helped Greece disguise the size of its budget deficit through the use of cross-currency derivatives in 2001.
The Italian deals differ somewhat from the Greek case since the instruments were usually for switching rates on loans, but Italy stands out because of the vast number of cities, regions and public entities – even a theatre association – that turned to them from 2001 to 2008.
The Bank of Italy put the notional value of derivatives contracts at €24.1-billion in June 2009. However, Il Sole 24 Ore business newspaper on Thursday cited Treasury data to put the overall figure at €35.5-billion – a third of local governments' debt – when wider criteria were used.
Although central bank figures show 467 local governments had derivatives contracts at the end of September, Mr. Amatucci believes the real number could be around 3,000 as more deals emerge.
The government banned new contracts in 2008 pending new rules. Economy Minister Giulio Tremonti has said there is “no effect” from derivatives held by local governments.
Local governments rushed into derivatives in part because they helped ease the rigidity of a 2001 law that bars taking on new debt except to finance investment.
But another big draw was the upfront payment many cities got in advance for signing revamped agreements, usually done without a bidding process, analysts said.
Renegotiated deals shoved back payment and costs in a “political manipulation” of signings, said Giampaolo Gialazzo with the Tiche consultancy in Treviso.
Revised deals also carried increasingly restrictive terms and higher costs for municipalities and other local governments.
“Greece did nothing more than get itself money right away and then pay it back slowly. Local administrations in Italy did the same thing,” said Massimiliano Palumbaro with CFI Advisors in Pescara.
Pescara, a southern Italian city, itself took out a total of €108-million in interest rate swaps and is suing UniCredit SpA and BNL, a unit of France's BNP Paribas, over them. UniCredit had no comment, while BNL had no immediate comment.
When rates are low, as they were when many contracts were agreed to, local authorities using a variable rate could find their costs shrinking. However, when rates rose, officials would find themselves owing more money.
Milan has argued, as have many other local administrations, that the contracts were murky, carried hidden costs and banks had failed to explain them.
However, a source close to the issue said Milan could not argue that it was ignorant about derivatives since the 2005 swap replaced a contract that had been renegotiated repeatedly.
The city also has wide securities markets experience given its joint control of listed utility A2A, the source said.
With banks putting in place a complex deal that had to be overseen for 30 years with hefty back-office costs, “the city could not expect that the banks were going to take that position for free,” said the source.
Despite the court cases, Milan is still interested in derivatives. The city council said on Wednesday it was studying a switch from a variable rate on the contract to a fixed one.
Sunday, February 14, 2010
GS -- Of Course
(c) 2010 F. Bruce Abel
And Goldman Sachs was there in the 1980s to show Japan how to get over end-of-fiscal-year issues that set the country back about 15 years.
And GS was in South Korea...
http://www.nytimes.com/2010/02/14/business/global/14debt.html?hp
And Goldman Sachs was there in the 1980s to show Japan how to get over end-of-fiscal-year issues that set the country back about 15 years.
And GS was in South Korea...
http://www.nytimes.com/2010/02/14/business/global/14debt.html?hp
Friday, January 22, 2010
Derivatives
(c) 2010 F. Bruce Abel
I've wondered how this works.
"Close in we do swaps (for fuel). Further out we do call options." Continental Airlines CEO on Squak Box just now.
I've wondered how this works.
"Close in we do swaps (for fuel). Further out we do call options." Continental Airlines CEO on Squak Box just now.
Friday, January 8, 2010
Italy and Philippines -- Two Catholic Countries
(c) 2010 F. Bruce Abel
This blog carries out one theme I began yesterday: how the Italians view Americans. Last year around this time I wrote this for the Glendale Literary Club, on the topic of Manila and how the Philippines viewed Americans. Both Italy and the Philippines are Catholic countries, of course. But, as an aside, apart for showing visitors I felt that Italians could take or leave the Church, at least in Rome and Florence.
OK, I’ll admit it. From the moment I stepped onto Philippine Airlines Flight 103 from Los Angeles, when I faced 200 sitting Filipinos, until the moment I stepped off Philippine Airlines Flight 112 in Los Angeles, I felt, well, “special.” Lynn, the drivers, and many service people, emitted this feeling toward all of us.
It has a name. A little reading in the bookstores of Manila leads me to conclude it is rooted in the proverbial utang na loob or sense of gratitude. A Filipino, as [Clarence M.] Recto, [appointed to become foreign minister,] pointed out to General Wachi Takhji, [chief of staff of the Japanese Fourteenth Army,] is easily won by kindness and a little act of kindness is repaid with loyalty.
“There” is a Catholic city of what some say is a failed state, but surely a city of “fits and starts.” It is anchored by a beautiful waterfront created by Daniel Burnham, American architect and city designer trying out his Chicago Lakeshore Drive plan. According to Eunie’s library friend Jose, Taft Avenue, named after the beloved William Howard Taft, the first American administrator of the Philippines, is the only remaining street in Metro Manila with an American name left on it.
Burnham’s Manila waterfront roads and boulevards were designed, of course, after we won the Spanish-American War of 1898, and after Spain ceded the Philippines to us.
American Period Following Admiral George Dewey's defeat of the Spanish fleet in Manila Bay, the U.S. occupied the Philippines. Spain ceded the islands to the United States under the terms of the Treaty of Paris (December 10, 1898) that ended the war.
Technically, the Spanish Period began when Portuguese explorer Ferdinand Magellan reached the Philippines and claimed the archipelago for Spain in 1521, but he stayed for only a few days.
When we regained control of the Philippines in 1945 we destroyed the so-called “Open City” of Manila after MacArthur landed on Leyte and declared “Mission Accomplished” to the world. But he then felt driven to muscle out the Japanese with cannons firing at zero degree elevation as the remaining Japanese were, after all, killing and raping the women in the wealthy section of town in a last-ditch impulse. This rendered Manila as the second most destroyed city of the war, after Warsaw.
So we made a pass at helping to restore Manila by throwing $45 million at them and then leaving.
Now “there” is where entire floors of high-rise buildings contain young English-speaking Filipinos in American-related call centers, and a city which is American as could be, passionately, slavishly, openly-so, with Madison-Avenue billboards and other signage and movies and music making the city indistinguishable from Broadway and 42nd Street or Madison Avenue itself.
Best of all “there” is not “here.” Example: the plump daily Manila Inquirer, unlike the skeletal Cincinnati Enquirer, is supported by pages and pages of automobile advertisements.
The country has banks with plenty of surplus capital, and other indicia of a growing economy lucky not to have been ready or allowed by statute to buy Wall Street toxic paper and derivatives. Conservative regulatory policies, including the prohibition of investments in structured products, shielded the insurance sector from exposure to distressed financial firms.
This blog carries out one theme I began yesterday: how the Italians view Americans. Last year around this time I wrote this for the Glendale Literary Club, on the topic of Manila and how the Philippines viewed Americans. Both Italy and the Philippines are Catholic countries, of course. But, as an aside, apart for showing visitors I felt that Italians could take or leave the Church, at least in Rome and Florence.
OK, I’ll admit it. From the moment I stepped onto Philippine Airlines Flight 103 from Los Angeles, when I faced 200 sitting Filipinos, until the moment I stepped off Philippine Airlines Flight 112 in Los Angeles, I felt, well, “special.” Lynn, the drivers, and many service people, emitted this feeling toward all of us.
It has a name. A little reading in the bookstores of Manila leads me to conclude it is rooted in the proverbial utang na loob or sense of gratitude. A Filipino, as [Clarence M.] Recto, [appointed to become foreign minister,] pointed out to General Wachi Takhji, [chief of staff of the Japanese Fourteenth Army,] is easily won by kindness and a little act of kindness is repaid with loyalty.
“There” is a Catholic city of what some say is a failed state, but surely a city of “fits and starts.” It is anchored by a beautiful waterfront created by Daniel Burnham, American architect and city designer trying out his Chicago Lakeshore Drive plan. According to Eunie’s library friend Jose, Taft Avenue, named after the beloved William Howard Taft, the first American administrator of the Philippines, is the only remaining street in Metro Manila with an American name left on it.
Burnham’s Manila waterfront roads and boulevards were designed, of course, after we won the Spanish-American War of 1898, and after Spain ceded the Philippines to us.
American Period Following Admiral George Dewey's defeat of the Spanish fleet in Manila Bay, the U.S. occupied the Philippines. Spain ceded the islands to the United States under the terms of the Treaty of Paris (December 10, 1898) that ended the war.
Technically, the Spanish Period began when Portuguese explorer Ferdinand Magellan reached the Philippines and claimed the archipelago for Spain in 1521, but he stayed for only a few days.
When we regained control of the Philippines in 1945 we destroyed the so-called “Open City” of Manila after MacArthur landed on Leyte and declared “Mission Accomplished” to the world. But he then felt driven to muscle out the Japanese with cannons firing at zero degree elevation as the remaining Japanese were, after all, killing and raping the women in the wealthy section of town in a last-ditch impulse. This rendered Manila as the second most destroyed city of the war, after Warsaw.
So we made a pass at helping to restore Manila by throwing $45 million at them and then leaving.
Now “there” is where entire floors of high-rise buildings contain young English-speaking Filipinos in American-related call centers, and a city which is American as could be, passionately, slavishly, openly-so, with Madison-Avenue billboards and other signage and movies and music making the city indistinguishable from Broadway and 42nd Street or Madison Avenue itself.
Best of all “there” is not “here.” Example: the plump daily Manila Inquirer, unlike the skeletal Cincinnati Enquirer, is supported by pages and pages of automobile advertisements.
The country has banks with plenty of surplus capital, and other indicia of a growing economy lucky not to have been ready or allowed by statute to buy Wall Street toxic paper and derivatives. Conservative regulatory policies, including the prohibition of investments in structured products, shielded the insurance sector from exposure to distressed financial firms.
And from another blog, dealing with Philippine culture:
Book Title
Culture Shock! - Philippines
Authors
Alfredo Roces and Grace Roces
Language
English
Copyright
1992
Publisher
Graphic Arts Center Publishing
ISBN
1558680896
My Rating
3 stars (out of 5)
This book was recommended to me as required reading before my first trip to the Philippines in 1999. At that time there was much in the book which sailed right over my head. After being married to a Filipina for more than two years now, I recently reread the book and I picked up on many things which had eluded me before.The authors take us on a tour of Filipino culture and there are separate chapters devoted to values, traditional customs, living in the Philippines, and doing business in the Philippines. There is also a chapter dealing with Filipino history but it is much too brief to do the subject justice. There is also a chapter called "Profile of a Filipino" in which the various roles that Filipinos play in society are discussed. Overall, the book covers a lot of ground without getting bogged down into too many details in any one area.The reason the authors give for writing the book are explained in the introduction:"The Western visitor finds he is talking the same language, but not communicating at all. With a sinking feeling he realizes he is not in America, or England, or Canada, but in an entirely different world."The explanation of Filipino culture to the Westerner is the goal of this book. Of course, one annoying assumption that the authors make is that all Westerners are alike. Americans, Canadians, Brits, Australians, etc. are conveniently lumped into one category called "Westerner" and they are assumed to all have similar characteristics. But then again, Tagalogs, Cebuanos, Ilocanos, etc. are conveniently lumped into one category called "Filipino" and they also are assumed to all have similar characteristics.Be that as it may, how well the book succeeds in its goal of explaining Filipino culture to the Westerner, can only be judged by how accurate its descriptions of Filipino culture are. And in that regard this reviewer is not in any way qualified to judge. Having spent a total of four weeks in the Philippines in my whole life, I can only give you my impressions with few facts to back them up.With that caveat in mind, I found that there are many areas where the book is spot on in its description of Filipino behavior. Yes, Filipinos will not open a gift they receive from you in front of you. They take it in the back room to open and appraise it later. Yes, Filipinos operate on Filipino time and are frequently late. Yes, I have seen young folk greet their parents and grandparents by taking the hand of their elder and placing it on their forehead (i.e., mano po). Yes, a Filipino will turn his/her palm down and bend the fingers to signal that you should come to them. And on and on. When it comes to descriptions of Filipino body language the book agrees perfectly with my own observations.But later on, beginning with chapter 3, the book moves on to the much more murky area of Filipino values. The first of these values is HIYA (SHAME). Of course, Tagalog words are used throughout the book (the Cebuano equivalent of HIYA is ULAW). The authors define HIYA as "a universal social sanction, creating a deep emotional realization of having failed to live up to the standards of society". Of course, HIYA is to be avoided at all costs by Filipinos. The greatest insult is to say that someone is WALANG HIYA (WITHOUT SHAME).The question I kept asking myself upon reading this passage is the following: Is it the sin itself (i.e., conscience) that causes the HIYA or is it the community's recognition that one has sinned (i.e., censure) that causes the HIYA? The book is not clear on this issue. For example, the book says that the practice of Filipino men having mistresses (QUERIDAS) is socially acceptable. One would ordinarily assume that such a man would have HIYA over the fact that he has a mistress. But if society accepts this then perhaps he feels no HIYA after all? The book also says that the fact that a man has a mistress is not talked about in public. Why should this be the case if it is socially acceptable? Apparent paradoxes abound on the subject of HIYA.The second value is something the book calls AMOR PROPIO (a Spanish phrase meaning "love of self" or "self-respect"). In the Western context perhaps the word "ego" would be the best translation. When a Filipino suffers HIYA his/her AMOR PROPIO is damaged, so this value is just a restatement of the first value. The way to think of this might be as follows. For a Filipino, HIYA must be avoided so that AMOR PROPIO can be sustained. If you've watched any Filipino news then you already know that there are frequent demonstrations in the Philippines. Filipinos will readily protest against any institution which they feel threatens their rights. This is AMOR PROPIO in action.The third value is PAKIKISAMA (GETTING ALONG WITH OTHERS). Since it is important that no one in the group should suffer HIYA, Filipino culture stresses getting along with others. A Filipino must always be careful in his words and deeds not to offend members of his community. Of course, this is the exact opposite of American culture in which problems must be confronted face on in order to be resolved.The fourth value is UTANG NA LOOB (DEBT OF GRATITUDE). In Filipino society one must always be conscious of the debt one owes others. Of course, this debt is not necessarily a financial debt. If one receives a favor from a member of the group then one is expected to repay the debt upon request. It is UTANG NA LOOB which binds the members of the group to one another. And to the Filipino way of thinking, the greatest UTANG NA LOOB that one has is to one's parents for bringing you into the world (specifically to one's mother). That is why the number one role that a Filipino can play is to be a good son/daughter to his/her mother. Filipinos value this role over others such as being a good husband/wife. One's obligations to one's parents are paramount. That is why both Filipinos and Filipinas will continue to live with their parents well into their 20's and 30's or until they get married.One question I have about UTANG NA LOOB is this. Does a Filipino consider UTANG NA LOOB to be a burden which will eventually be lifted? Or does a Filipino accept UTANG NA LOOB as a permanent state of affairs? Does a Filipino seek to pay off the UTANG NA LOOB and cancel his/her debt? Or does a Filipino accept the UTANG NA LOOB which he/she owes another as normal? The book is not clear on these issues.To confuse things even more, on page 47 the book states "the values previously mentioned very often apply only within each kinship grouping rather than in universal fashion. An outsider is viewed as fair game, and a different set of values is applied to deal with such persons or groups." Oh great!, all that stuff we just talked about (HIYA, AMOR PROPIO, PAKIKISAMA, UTANG NA LOOB) doesn't apply to us foreigners (at least initially). They can screw us over and not feel bad about it because we don't belong to their kinship structure. Apparently these rules apply only within the kinship group (i.e., extended family). The book defines the kinship group as the immediate family and close relatives on both the father's side and the mother's side. How far out it extends is never explained. Presumably, we foreigners by marrying into the Filipino family, are included into the kinship group and we now fall under the sway of UTANG NA LOOB.Perhaps nothing is more confusing to the Westerner than the relative meaning of the words YES and NO. As page 225 explains, the word YES can mean any of the following:1.) Yes, of course2.) I don't know3.) Maybe4.) If you say so5.) No, but I won't openly disagree with youWhat to make of this? The best way I have of explaining it is the following. We Westerners inhabit a universe of atoms and quantum physics and planets and supernovae and Boolean logic. But that is not the universe that Filipinos inhabit. Filipinos inhabit a social universe. Westerners value precision in their language, but that is only because we have 25 centuries of scientific thinking behind us going all the way back to Aristotle and his syllogisms. To Filipinos PAKIKISAMA is of paramount importance in language. No one's feelings should be hurt, and that is why a Filipino is more than willing to tell you what he thinks you want to hear. This is what my wife calls "riding on". She works in an office and sometimes her boss holds a meeting and says something she doesn't understand at all. But she will never ask him to explain himself. When I ask her why not she replies, "He just talk and talk. And I ride on". (And I am so glad that she didn't take that job as a technician at the nuclear power plant!)One of the disappointments that I had when reading the book was its treatment of the supernatural. On page 216 it lists certain creatures such as the ASWANG (WITCH), MANANANGGAL (FEMALE VAMPIRE), NUNO SA PUNSO (DWARF), etc. If one didn't know better one might assume that such a listing has no more significance than the inclusion of such words as "werewolf", "vampire", etc. in an English dictionary. The mere fact that we Westerners have such words does not mean that we believe in the existence of such creatures. But that is not true for most Filipinos. Even many educated Filipinos have a strong belief in the actual physical existence of such creatures. It is a very brave or a very foolish Filipino who will approach a balete tree (especially at night), where a variety of supernatural creatures are believed to have their abode. Upon learning this fact, I was astonished because I had always viewed the Philippines as a predominantly Roman Catholic country. But the pre-Christian beliefs are still there in a submerged form. The book does not deal with this issue at all.The book tends to jump around a lot. It has lots of details on Filipino fiestas, baptism etiquette, wedding etiquette, renting a house, dealing with the house help, doing business in the Philippines, etc., etc. Most of these topics are of limited interest to Fil-Am couples. There is no direct discussion of what to expect when you marry a Filipina. There is no discussion of the culture shock that your Filipina wife will feel when she comes to America or to Canada or to wherever. But overall it does give some useful information and I would recommend it to anyone contemplating their first trip to the Philippines. On the deeper philosophical issues I think it leaves more questions unanswered than it answers. Therefore I give it a rating of three stars (out of five).
geovisit();
Saturday, August 15, 2009
Baseline Scenario -- A Good Read Today, If Wonkish
The Baseline Scenario
Waiting For The Federal Reserve’s Next Apology
Posted: 14 Aug 2009 05:18 AM PDT
In November 2002, Ben Bernanke apologized – for the Fed’s role in causing the Great Depression of the 1930s. “I would like to say to Milton [Friedman] and Anna [Schwartz]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again” (conclusion of this speech).
Bernanke’s point, of course, is that the Fed tightened monetary policy inappropriately – and allowed banks to fail – in 1929-33. And much has been made of his strong focus, over the past year, on avoiding a repeat of those or closely related mistakes (including here).
But today we need a different kind of apology, or at least a statement of responsibility, from Ben Bernanke and the Fed.
From the Federal Open Market Committee meeting transcript of August 2003, we know that Bernanke said, “Despite the good news, I think it’s premature to conclude that we should not consider further rate cuts, if not at this meeting then at some time in the near future depending on how the data play out” (p.63).
He was concerned not just to keep interest rates low for a prolonged period but also to signal this to financial markets, “To the extent that we can sharpen our message that economic growth no longer implies an immediate and automatic policy tightening, we should make every effort to do so” (p.65; see also his role in the broader discussion around p.93).
This was, of course, at a time that the speculative fever and outright malpractice in the housing market was really taking off. The build-up of financial market risk was starting to head towards system-threatening dimensions. And many consumers were being set up for a trampling of epic proportions. It is striking there is barely a mention of these issues in the FOMC transcripts.
And that’s the issue. We can argue for a long time about whether the Fed should have tightened earlier. Defenders of the Fed will say the data were ambiguous – and will point to the serious discussion of these issues in the FOMC transcript.
We can also dispute whether or not the Fed should have said anything in public about the impending housing-financial-consumer-taxpayer doom, or tried to tighten regulation. “It’s not our job” or “we don’t have the powers,” or “the politicians wouldn’t have supported us” is what senior Fed people now whisper around Washington.
But this and other FOMC transcripts make it clear that the senior Fed decision makers were not even thinking about the first order financial sector issues. They weren’t aware of what the big investment banks were really doing – show me the intelligence reports before the FOMC or the analytical discussion that indicated any degree of worry. No doubt someone somewhere in the Federal Reserve system was thinking critically about finance – feel free to send me any relevant details - but from the point of view of evaluating the institution, it only counts if the top decision-making body at least has the issues on the table.
We have transcripts so far through the end of 2003. Others should be forthcoming soon; there is supposed to be only a 5 year lag in their publication. But, given their likely content, it would not be a surprise if the appearance of these transcripts slows down.
At this moment of potential regulatory reform, who within the Fed really wants us to know that their leadership in the Greenspan era completely framed the problem wrong, didn’t understand what was happening, and repeatedly, brazenly, and callously ignored the damage being done to consumers?
I fully understand that financial market considerations are not the established focus of central bank interest rate deliberations. But the scope and nature of such deliberations has changed a great deal since the founding of the Fed almost 100 years ago. As the economy changes, central banks have to adapt their conceptual frameworks and our broader regulatory frameworks need to change also. We’ve done this many times before, and we need to do it again.
Huge problems were missed by people using anachronistic conceptual frameworks. Those frameworks should change. This was the assessment of Ben Bernanke, building on Friedman and Schwartz, for 1929-33, and this should be our assessment today.
Our top monetary policy makers completely missed the true nature of the Great Bubble and its consequences, until it was far too late. They should apologize for that and we can start work on redesigning the institution, its decision-making, and how financial markets operate, to make sure it won’t happen again. And it would also be nice if the Fed could avoid adding insult to injury – and stop opposing the administration’s consumer protection proposals.
Hopefully, this time the Fed’s apology won’t take 70 years.
By Simon Johnson
Health Care’s Senior Moment
Posted: 13 Aug 2009 06:30 PM PDT
Seniors have recently emerged as an important battleground in the health reform war. Katharine Seelye of the New York Times has a post on the “new generation gap” separating the elderly from the not-so-elderly, and multiple polls have shown that seniors are more resistant to reform, at least when it is phrased broadly. In addition, the nonsense about “death panels” has worried at least some seniors, enough for the AARP to pitch in to try to shoot it down.*
This should seem ironic, given that people over 65 are the one group that has already most benefited from health care reform – only their reform happened in the 1960s, when Medicare was created. But hey, it’s a democracy, and people don’t have to wish for others the benefits they themselves enjoy.
What are the underlying reasons why seniors are more likely to oppose “reform?” The first – leaving aside the self-contradicting notion that health care reform will mean a government takeover of Medicare – is probably fear that Medicare will be negatively affected. Now, there is a grain of a partial truth to this fear. Several of the proposals on the table include paying for health care reform (meaning, paying for the subsidies that poor people will need if we’re going to mandate universal coverage) in part by reducing growth in Medicare spending. One proposal is the Independent Medicare Advisory Committee, which would look for ways to increase efficiency in Medicare, which could include lower reimbursements for procedures that were deemed to be not providing benefits commensurate with their costs.
To its credit, here’s what the AARP** has to say about health care reform and Medicare:
What do the proposals say? It’s true they all seek to save billions from Medicare costs—not by cutting benefits, but by setting up new ways to pay doctors more fairly and to reward providers for quality of care instead of (as now) paying them a fee for each separate service; reducing waste and fraud; and reducing preventable hospital readmissions.
All the proposals would cut the amount of subsidies now paid to Medicare Advantage private health plans, which cost an average of 14 percent more per person than traditional Medicare does. Without subsidies, the private plans could become more efficient, or they could raise premiums, reduce benefits or withdraw from Medicare.
The proposals also add benefits to Medicare—such as covering more preventive services and narrowing the Part D “doughnut hole.”
More fundamentally, though, the need to reduce growth in Medicare spending stems from the simple fact that otherwise Medicare will blow through the entire Federal budget within the next few decades. Not reducing the Medicare growth rate is not an option. If I were a senior, or expected to be one in the next couple decades, I would very much want health care reform now, because the alternative will be much more draconian cuts to Medicare benefits in the future as the national debt explodes.
And reducing costs is precisely the other thing that seniors care about. According to Seelye, concern about health care costs rises with age. Now this makes sense; even with Medicare, seniors’ out-of-pocket medical expenses are considerably higher than those of younger people, for the simple reason that on average they consume more medical care. But there’s no good way to reduce seniors’ out-of-pocket spending without at the same time reducing Medicare spending because, broadly speaking, those two types of spending are buying the same thing – health care. You can’t have a system where Medicare spends more and more yet seniors spend less and less out of pocket (short of simply reducing seniors’ relative contribution to their health care costs, which would only make the fiscal problem worse).
It’s simply contradictory to oppose reductions in the growth rate of Medicare spending while favoring reductions in your out-of-pocket spending. Of course, there’s nothing that prevents people from holding two logically inconsistent thoughts in their heads at the same time. Uwe Reinhardt had a brilliant column a couple of weeks ago on the stew of inconsistencies that many Americans take for granted when it comes to health care.
Luckily, they elect representatives who can think clearly about these complex issues. Oh, wait, sorry about that.*
* On the other hand, what the hell does Chuck Grassley – one of the six people who think they are writing the health care bill – think he’s doing, saying “We should not have a government plan that will pull the plug on grandma?” As Brad DeLong might say, why oh why does he have a seat at the table?
** As far as I can tell from their website, the AARP is neither for nor against health care reform in general; they say they are working to make sure that health care reform is good for their constituency.
By James Kwak
Waiting For The Federal Reserve’s Next Apology
Posted: 14 Aug 2009 05:18 AM PDT
In November 2002, Ben Bernanke apologized – for the Fed’s role in causing the Great Depression of the 1930s. “I would like to say to Milton [Friedman] and Anna [Schwartz]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again” (conclusion of this speech).
Bernanke’s point, of course, is that the Fed tightened monetary policy inappropriately – and allowed banks to fail – in 1929-33. And much has been made of his strong focus, over the past year, on avoiding a repeat of those or closely related mistakes (including here).
But today we need a different kind of apology, or at least a statement of responsibility, from Ben Bernanke and the Fed.
From the Federal Open Market Committee meeting transcript of August 2003, we know that Bernanke said, “Despite the good news, I think it’s premature to conclude that we should not consider further rate cuts, if not at this meeting then at some time in the near future depending on how the data play out” (p.63).
He was concerned not just to keep interest rates low for a prolonged period but also to signal this to financial markets, “To the extent that we can sharpen our message that economic growth no longer implies an immediate and automatic policy tightening, we should make every effort to do so” (p.65; see also his role in the broader discussion around p.93).
This was, of course, at a time that the speculative fever and outright malpractice in the housing market was really taking off. The build-up of financial market risk was starting to head towards system-threatening dimensions. And many consumers were being set up for a trampling of epic proportions. It is striking there is barely a mention of these issues in the FOMC transcripts.
And that’s the issue. We can argue for a long time about whether the Fed should have tightened earlier. Defenders of the Fed will say the data were ambiguous – and will point to the serious discussion of these issues in the FOMC transcript.
We can also dispute whether or not the Fed should have said anything in public about the impending housing-financial-consumer-taxpayer doom, or tried to tighten regulation. “It’s not our job” or “we don’t have the powers,” or “the politicians wouldn’t have supported us” is what senior Fed people now whisper around Washington.
But this and other FOMC transcripts make it clear that the senior Fed decision makers were not even thinking about the first order financial sector issues. They weren’t aware of what the big investment banks were really doing – show me the intelligence reports before the FOMC or the analytical discussion that indicated any degree of worry. No doubt someone somewhere in the Federal Reserve system was thinking critically about finance – feel free to send me any relevant details - but from the point of view of evaluating the institution, it only counts if the top decision-making body at least has the issues on the table.
We have transcripts so far through the end of 2003. Others should be forthcoming soon; there is supposed to be only a 5 year lag in their publication. But, given their likely content, it would not be a surprise if the appearance of these transcripts slows down.
At this moment of potential regulatory reform, who within the Fed really wants us to know that their leadership in the Greenspan era completely framed the problem wrong, didn’t understand what was happening, and repeatedly, brazenly, and callously ignored the damage being done to consumers?
I fully understand that financial market considerations are not the established focus of central bank interest rate deliberations. But the scope and nature of such deliberations has changed a great deal since the founding of the Fed almost 100 years ago. As the economy changes, central banks have to adapt their conceptual frameworks and our broader regulatory frameworks need to change also. We’ve done this many times before, and we need to do it again.
Huge problems were missed by people using anachronistic conceptual frameworks. Those frameworks should change. This was the assessment of Ben Bernanke, building on Friedman and Schwartz, for 1929-33, and this should be our assessment today.
Our top monetary policy makers completely missed the true nature of the Great Bubble and its consequences, until it was far too late. They should apologize for that and we can start work on redesigning the institution, its decision-making, and how financial markets operate, to make sure it won’t happen again. And it would also be nice if the Fed could avoid adding insult to injury – and stop opposing the administration’s consumer protection proposals.
Hopefully, this time the Fed’s apology won’t take 70 years.
By Simon Johnson
Health Care’s Senior Moment
Posted: 13 Aug 2009 06:30 PM PDT
Seniors have recently emerged as an important battleground in the health reform war. Katharine Seelye of the New York Times has a post on the “new generation gap” separating the elderly from the not-so-elderly, and multiple polls have shown that seniors are more resistant to reform, at least when it is phrased broadly. In addition, the nonsense about “death panels” has worried at least some seniors, enough for the AARP to pitch in to try to shoot it down.*
This should seem ironic, given that people over 65 are the one group that has already most benefited from health care reform – only their reform happened in the 1960s, when Medicare was created. But hey, it’s a democracy, and people don’t have to wish for others the benefits they themselves enjoy.
What are the underlying reasons why seniors are more likely to oppose “reform?” The first – leaving aside the self-contradicting notion that health care reform will mean a government takeover of Medicare – is probably fear that Medicare will be negatively affected. Now, there is a grain of a partial truth to this fear. Several of the proposals on the table include paying for health care reform (meaning, paying for the subsidies that poor people will need if we’re going to mandate universal coverage) in part by reducing growth in Medicare spending. One proposal is the Independent Medicare Advisory Committee, which would look for ways to increase efficiency in Medicare, which could include lower reimbursements for procedures that were deemed to be not providing benefits commensurate with their costs.
To its credit, here’s what the AARP** has to say about health care reform and Medicare:
What do the proposals say? It’s true they all seek to save billions from Medicare costs—not by cutting benefits, but by setting up new ways to pay doctors more fairly and to reward providers for quality of care instead of (as now) paying them a fee for each separate service; reducing waste and fraud; and reducing preventable hospital readmissions.
All the proposals would cut the amount of subsidies now paid to Medicare Advantage private health plans, which cost an average of 14 percent more per person than traditional Medicare does. Without subsidies, the private plans could become more efficient, or they could raise premiums, reduce benefits or withdraw from Medicare.
The proposals also add benefits to Medicare—such as covering more preventive services and narrowing the Part D “doughnut hole.”
More fundamentally, though, the need to reduce growth in Medicare spending stems from the simple fact that otherwise Medicare will blow through the entire Federal budget within the next few decades. Not reducing the Medicare growth rate is not an option. If I were a senior, or expected to be one in the next couple decades, I would very much want health care reform now, because the alternative will be much more draconian cuts to Medicare benefits in the future as the national debt explodes.
And reducing costs is precisely the other thing that seniors care about. According to Seelye, concern about health care costs rises with age. Now this makes sense; even with Medicare, seniors’ out-of-pocket medical expenses are considerably higher than those of younger people, for the simple reason that on average they consume more medical care. But there’s no good way to reduce seniors’ out-of-pocket spending without at the same time reducing Medicare spending because, broadly speaking, those two types of spending are buying the same thing – health care. You can’t have a system where Medicare spends more and more yet seniors spend less and less out of pocket (short of simply reducing seniors’ relative contribution to their health care costs, which would only make the fiscal problem worse).
It’s simply contradictory to oppose reductions in the growth rate of Medicare spending while favoring reductions in your out-of-pocket spending. Of course, there’s nothing that prevents people from holding two logically inconsistent thoughts in their heads at the same time. Uwe Reinhardt had a brilliant column a couple of weeks ago on the stew of inconsistencies that many Americans take for granted when it comes to health care.
Luckily, they elect representatives who can think clearly about these complex issues. Oh, wait, sorry about that.*
* On the other hand, what the hell does Chuck Grassley – one of the six people who think they are writing the health care bill – think he’s doing, saying “We should not have a government plan that will pull the plug on grandma?” As Brad DeLong might say, why oh why does he have a seat at the table?
** As far as I can tell from their website, the AARP is neither for nor against health care reform in general; they say they are working to make sure that health care reform is good for their constituency.
By James Kwak
Wednesday, June 24, 2009
Cautionary
Still Wary of Those Financial Weapons of Mass Destruction [View article] Derivatives at the heart of the crisis, catastrophic losses are inevitable, financial system is headed for oblivion.It is this powder keg that has everyone trembling with fear and foreboding, because the inevitable losses will be catastrophic, with losses which may exceed the entire world's GDP, thus obliterating the balance sheets of every major Wall Street commercial bank, including the Fed itself, while virtually every major bank and financial institution in nations throughout the world join them on the receiving end of a destructive juggernaut of loss, insolvency, failure and bankruptcy. In the aftermath, most will be nationalized. The entire world financial system is headed for oblivion, and there is nothing on earth that can stop it. All they can do currently is try to delay and hide the destruction so that they can continue to milk their Ponzi system dry, ripping off the sheople in one final orgy of fraud and profligacy before the government and financial system are merged into an all-powerful super-entity that will rule all non-insider institutions with an iron fist. Frankly, from what i have seen lately, we are already there. The final step to nationalization of our financial system will be little more than a formality. The stage is set, there is no way to avoid the global losses on 500 trillion dollars, the losses are already there, they just have not be realized yet. Throwing 12 trillion dollars at a 200 trillion hole is like filling a bathtub with a squirtgun.These market rallies up and down are simply window dressing to as Warren Buffett says "Mass Destruction". The upside is that we get to start over again. lets hope we get it right next time.
Friday, June 19, 2009
Krugman Joins Simon Johnson as the Guru of the Financial Regulating of Wall Street and Shadow Banks
As daughter Genny says: "Beer isn't just for breakfast anymore."
Krugman isn't just for Health Care anymore.
This article brilliantly discusses Obama's Regulating of the Financial Sector -- its apparant strengths and weaknesses.
This is a must:
http://www.nytimes.com/2009/06/19/opinion/19krugman.html
Krugman isn't just for Health Care anymore.
This article brilliantly discusses Obama's Regulating of the Financial Sector -- its apparant strengths and weaknesses.
This is a must:
http://www.nytimes.com/2009/06/19/opinion/19krugman.html
Saturday, June 13, 2009
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
Sunday, March 15, 2009
A Contract is a Contract -- AIG
Disgusting!
http://www.nytimes.com/2009/03/15/business/15AIG.html?_r=1&hp
And further disgusting: We don't know the names of those counterparties being bailed out along with AIG, who are not innocent and therefore could not have won a breach of contract suit:
http://www.nytimes.com/2009/03/15/opinion/15sun1.html
http://www.nytimes.com/2009/03/15/business/15AIG.html?_r=1&hp
And further disgusting: We don't know the names of those counterparties being bailed out along with AIG, who are not innocent and therefore could not have won a breach of contract suit:
http://www.nytimes.com/2009/03/15/opinion/15sun1.html
Sunday, March 8, 2009
Saturday, February 28, 2009
It's Buffett Annual Report Time -- What a Time!
With market at 10-year low, wow! And BRKA down 44%!
http://www.marketwatch.com/news/story/investors-await-buffett-letter-berkshire/story.aspx?guid=%7B53376EC0%2D9C85%2D4086%2DBB89%2D650B4B5B7790%7D&dist=morenews_ts
and more:
http://www.nytimes.com/2009/03/01/business/01buffett.html?_r=1&hp
and the full Letter to Shareholders:
http://www.berkshirehathaway.com/letters/2008ltr.pdf
and now the successor???
http://economictimes.indiatimes.com/News/International-Business/Will-Ajit-Jain-succeed-Warren-Buffet-in-Berkshire-Hathaway/articleshow/4209352.cms
http://www.marketwatch.com/news/story/investors-await-buffett-letter-berkshire/story.aspx?guid=%7B53376EC0%2D9C85%2D4086%2DBB89%2D650B4B5B7790%7D&dist=morenews_ts
and more:
http://www.nytimes.com/2009/03/01/business/01buffett.html?_r=1&hp
and the full Letter to Shareholders:
http://www.berkshirehathaway.com/letters/2008ltr.pdf
and now the successor???
http://economictimes.indiatimes.com/News/International-Business/Will-Ajit-Jain-succeed-Warren-Buffet-in-Berkshire-Hathaway/articleshow/4209352.cms
Subscribe to:
Posts (Atom)