Month: February 2009

Bad Banks on This American Life This Weekend

For public radio fans, Simon is on this weekend’s episode of This American Life, “Bad Bank,” with Adam Davidson and Alex Blumberg of Planet Money, explaining what happened to our banking system. Regular readers of this blog will already know most of what they cover, and some of it comes from episodes of Planet Money you may already have heard (including the “ransom note” conversation). But if your friends and relatives are not quite as up to speed as you are, feel free to recommend this episode. (It’s the third TAL episode to focus entirely on the economic crisis; the others are listed on our Beginners page.)

TAL plays at different times on public radio affiliates this weekend. Starting Sunday night or Monday, the free online stream will be available from the TAL page. And if you subscribe to their podcast, you’ll get the episode Sunday night or Monday.

In my opinion, TAL is the best show available in any medium anywhere, so I recommend listening to them even when they’re not talking about the economy.

Citigroup Arithmetic Explained

Since I’ve been writing about preferred and common stock so much this week, I thought I would just try to explain the arithmetic of the Citigroup deal announced today. (By the way, it isn’t a done deal: all it says is that Citi is offering a preferred-for-common conversion to its outside investors, and the government will match them dollar-for-dollar, although the WSJ says that several investors have agreed to participate.)

Continue reading “Citigroup Arithmetic Explained” →

The Smell Of Coffee

The late Rudi Dornbsuch of MIT had a way of cutting to the chase, preferably in public and with a minister of finance present.  He knew a huge amount about financial crisis, and could distill a lifetime of study and involvement in collapses succinctly: “it always takes longer than you think; but when it happens, it always happens faster than you can imagine.”

The latest credit default swap data for European banks bring Rudi’s perspective to mind – for the United States.  We’ve debated this week what to do about U.S. banks, arguing about which unappealing options are less bad.  In my view, the choice is not “nationalize vs. don’t nationalize,” but rather “keep our current partial nationalization/bottomless pit subsidy system vs. start down the road to reprivatization.”

But, honestly, this entire debate may be overtaken by events.  Continue reading “The Smell Of Coffee” →

No, Wait! You Got It Backwards!

AKA, Convertible Preferred Stock for Beginners.

There is nothing inherently wrong with convertible preferred stock. In Silicon Valley, for example, venture capitalists almost always invest by buying convertible preferred. The idea is that in the case of a bad outcome, the VCs are protected, because their shares have priority over the common shares held by the founders and employees. Say the VCs put in $10 million for 1 million shares, and the founders and employees also have 1 million shares, so the company immediately after the investment is worth $20 million. If the company liquidates for $15 million, the preferred shares have a “preference,” which means they get their $10 million back (often with a mandatory cumuluative dividend as well) first, and the common shareholders take the loss. However, in a good outcome, the VCs can exchange their preferred shares one-for-one for common. So if the company gets sold for $100 million, the VCs convert, and they now own 50% of the common stock, so they get $50 million.

When I heard that the government was going to give future capital as convertible preferred stock, and perhaps change some of the previous capital injections to convertible preferred, I thought this was a good thing. It would give the taxpayer more upside potential, and it would also give the government the option to take over the banks simply by converting its preferred stock to common whenever it wanted.

But the key in the Silicon Valley example is that the VCs have the option to convert or not. The Treasury Department’s new Capital Assistance Program has this precisely backwards.

Continue reading “No, Wait! You Got It Backwards!” →

Listening To The Secretary

Secretary Geithner spoke with NPR’s Adam Davidson today and the result, on the Planet Money podcast, is a helpful guide to official thinking.

The Secretary’s best line, at around the 18 minute mark is, “If you underestimate the problem; if you do too little, too late; if you don’t move aggressively enough; if you are not open and honest in trying to assess the true cost of this; then you will face a deeper long (sic) lasting crisis.”  Continue reading “Listening To The Secretary” →

But What About the Slump?

Simon’s reaction to Obama’s speech last night is up at The New Republic.

I think Simon and I agree that the speech was strong on long-term issues, but did not shed much-needed light on how we can emerge from our short-term challenges. One way to position this is to say that if we really are facing a potential “lost decade,” then talking about the long term is a bit premature. Imagine ten years of zero real GDP growth as opposed to 2.5% real GDP growth (with population continue to grow at 1-1.5% or something like that). That would take decades to make up (if it is even possible) and could outweigh any well-meaning efforts to bolster our long-term government finances.

On the other hand, I’m a bit more positive than Simon, because I wasn’t expecting the details of the banking rescue plan in a major speech to the whole country, for both practical reasons (I don’t think they are ready yet) and political ones (Obama wants to keep some measure of distance from whatever Geithner does). If I have time later today I’ll say something about the long-term issues.

Update: Now it’s later. The main thing I liked about the Obama speech is that it reflected what I believe to be the true long-term economic priorities of the country. The day after Obama was elected, I listed what I think are our top four long-term challenges (economic and non-economic): global warming, terrorism and nuclear proliferation, retirement savings (both the insufficiency of retirement savings, and the fact that retiree benefits threaten to break the federal government’s balance sheet), and health care.

Obama’s speech yesterday was mainly about four things: energy, health care, education, and fiscal sustainability. That maps pretty closely to what I think our priorities should be. He was willing to say that these are urgent, serious problems. And when it comes to the government deficit and the national debt, he has chosen to forgo the gimmicks used in the past: not only keeping the Iraq War out of the budget, but also pretending that the AMT will not be fixed every year in the future.

Admitting you have a problem, and recognizing its magnitude, is a necessary, though not sufficient, step on the way to solving it.

Tangible Common Equity for Beginners

For a complete list of Beginners articles, see Financial Crisis for Beginners.

You may have seen in the news that the government is thinking about exchanging its “preferred stock” in Citigroup for “common stock.” Here’s one of many articles. Which, if you are at all sensible and have any sense of proportion in your life, should be complete gobbledygook. The first part of this article will try to explain the gobbledygood; advanced readers can skim it. The second part will offer some of the usual commentary.

Continue reading “Tangible Common Equity for Beginners” →

Was It The Hedge Funds? (Diane Rehm Show at 11am)

Hedge funds have been nominated as a prime culprit in the current financial disaster.  European governments, in particular, seem keen to impose greater regulation on hedge funds, including more transparency and compliance requirements.  In fact, this is will be one of the main deliverables they seek at the G20 summit on April 2nd.

I’m not opposed to stronger regulation, and hedge funds have obviously disappointed investors – especially with their illiquidity under pressure.  But are hedge funds really responsible for the depth of the crisis?  They were present at the scene of the crime, in terms of buying and trading what we now call “toxic assets,” but surely their role was minor relative to supposedly “regulated” US and European banks. Continue reading “Was It The Hedge Funds? (Diane Rehm Show at 11am)” →

Defending A Peg: Lessons for the US Banking Authorities

You’ve seen it a thousand times.  A country’s exchange rate used to make sense, but now it is hopelessly overvalued.  And, consequently, your pegged exchange rate now looks like a one way bet.  Every Financial Times subscriber starts to think about how to either get out of your currency or, if they are feeling aggressive, how to more actively speculate that the exchange rate will soon depreciate.

And the beauty of this situation – from a speculator’s point of view – is that the relevant authorities will never move quickly or decisively to the inevitable end point.  Sooner or later, the currency will be devalued and, if the country’s citizens are lucky, sensible economic policies (and perhaps external financial support) will be put in place to support the new exchange rate.  But, for a surprisingly long time, the government will make statements along the lines of, “we will defend our exchange rate,” “we have plenty of reserves,” “we will never devalue,” or – my favorite – “the fundamentals are fine.”

This analogy sprang to mind when I read this morning’s joint statement by Treasury, the FDIC, OCC, OTS, and the Fed. Continue reading “Defending A Peg: Lessons for the US Banking Authorities” →

The Choice: Save Europe Now Or Later?

In major every crisis you have a choice.  You cannot choose between inaction and action, because ultimately you will be forced to act.  You do not really choose between bailout and no bailout, because very soon you find that all the reasonable options involve some sort of bailout for some people (and not for others).  And, try as you might, there is no way to choose to let your neighbors fail completely – because that failure has such awful consequences for their citizens and, in all likelihood, for your banks, that you finally come across with the money.

But you do have a choice on when to come to help your neighbors and your friends, and you can definitely choose the form of this assistance.  if you come in earlier and in a more systematic fashion, the cost for everyone is lower and the chances of a fast recovery are stronger.

The sensible decision might seems obvious from a distance or in retrospect, but it’s this exact choice that the richer and more stable countries in Western Europe are now struggling with. Continue reading “The Choice: Save Europe Now Or Later?” →

Bank Nationalization: A Viewer’s Guide

At the end of last week, Senators Dodd and Schumer signalled that financial elite solidarity has broken; “nationalization” is no longer taboo.  The consensus is dead (check with Barney Frank), crazy ideas abound, and long live what new policy approach?  Here’s five sets of issues to guide your viewing this week as we slip and slide sideways into our future. Continue reading “Bank Nationalization: A Viewer’s Guide” →