Month: June 2009

Latvia: Should You Care?

In the current field of grand economic strategy, against crisis and for recovery, Latvia looms small. This is a country with just two million residents, best known recently for a huge current account deficit – the excess of imports over exports peaked out around 25 percent of GDP. Ordinarily, there is nothing here that should move the world economy.

Yet, there are some intriguing and somewhat disconcerting signs that point towards our common future – much like a close study of Iceland, back in October 2008, told us a great deal about what was to come.

Continue reading “Latvia: Should You Care?” →

Bernanke Didn’t Go Far Enough

Ben Bernanke gave a good speech yesterday, warning about the dangers associated with not putting the federal budget immediately on a path to credible fiscal consolidation. But he didn’t push his points hard enough – see my column, joint with Peter Boone, on the NYT’s Economix this morning.

U.S fiscal policies helped break the recent panic by showing that the government will support aggregate spending, irrespective of what the private sector fears. But once households and firms calm down, you need to demonstrate that the national debt is not on an explosive path.

Mr. Geithner’s speech in China this week, trying to make this claim, was not convincing. Mr. Bernanke, politely but firmly, pointed this out yesterday.

We should also worry about the Fed, of course, because there is no indication that they are ready, willing or able to curtail their quantitative easing if the real economy definitely turns more positive. David Wessel’s column in the WSJ today (page A2) has a sensible discussion.

By Simon Johnson

Legacy Loan Program Called Off

New York Times:

The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration’s bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets. . . .

Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.

I don’t think I’ve ever done this before, but . . . Simon and I, March 24:

The problem in the market today is that the prices demanded by the banks are much higher than the prices that private buyers (hedge funds, private equity firms, sovereign wealth funds) are willing to pay. The government has no way to bring down the banks’ minimum sale prices . . .

The subsidy may not be sweet enough to close the deal. According to one analysis, a specific mortgage-backed security was held on a bank’s books at 97 cents, while its market price was about 38 cents. Even if you limit the buyer’s potential loss to the capital he put in, it’s unlikely he will raise his bid from 38 cents to anything near 97 cents. . . .

Continue reading “Legacy Loan Program Called Off” →

Stimulus Watch: Your Input Solicited

The folks who run US Budget Watch are interested in your thoughts about how best to redesign their page that watches over the fiscal (and other) stimulus. Post your comments here.

I’ve already given them some ideas on how to organize and prioritize the data, as well as suggestions about background material that would help reach a broader readership. More thoughts on style or substance would be greatly appreciated. They’re on a deadline, so don’t delay.

By Simon Johnson

The View from the Top

One of our longtime readers recommended “The Death of Kings,” Nick Paumgarten’s “notes from a meltdown” in The New Yorker (subscription required, or $5 for this issue alone) a few weeks back. The article is mainly color rather than analysis; it’s a series of portraits of people on “Wall Street,” ranging from the merely rich to the astoundingly rich, and what they think of the crisis. Paumgarten paints a picture of people who know that we are all screwed but regard the phenomenon with a mix of intellectual superiority, self-righteousness, and resignation. The vignettes are certainly not representative; I’m sure most bankers and traders, though perhaps not working quite as hard as in 2005, are still scrambling to make the next killing. But they are still a window into a world most of us will never see.

There are two passages in the article I thought were particularly . . . “insightful” isn’t the quite word . . . maybe “poetic” is better. The first is a quotation from Colin Negrych, a successful money manager and the article’s Voice of Wisdom:

“What constituency is there for pessimism? People believe optimism is necessary, an American right. The presumption of optimism is the problem. That’s what creates the debt we have now.”

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What Would Gorbachev Say? On The US, China, And Saudi Arabia

President Obama is on his way to Saudi Arabia, and Secretary Geithner is done with his major initiative in China. In part, this is just the US normalizing its relations with the rest of the world and rebuilding some basic diplomatic niceness. But it’s also about reshaping – or not – the way the world’s economy works after the crisis.

From all appearances, President Obama will ask the Saudis to continue their efforts to stabilize the oil market, including by bringing new production on stream, and the Saudis will offer – to the best of the abilities – to play exactly this role within OPEC. Of course Secretary Geithner just asked the Chinese to continue their efforts to stabilize the market for long Treasuries, including by investing their current account surplus in US secruties, and the Chinese have agreed – with some pretend grumbling – to play this role.

It looks like adding up to a big mistake – just ask Mikhail Gorbachev. Continue reading “What Would Gorbachev Say? On The US, China, And Saudi Arabia” →

Help: Why Are SUVs More Profitable?

Many discussions of auto company economics include the assertion that SUVs and pickup trucks are more profitable than small cars, and so a shift from the former to the latter – as discussed by Felix Salmon, for example – will not be good for the auto companies, particularly GM and Chrysler (since they are in the news these days). I accept that as a historical statement, but I don’t understand why that is the case.

Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero; that’s clearly no help here. Profit margins should be higher in product segments with less competition, but basically every manufacturer makes a small, midsize, and large SUV, so I don’t think that’s the explanation.

Continue reading “Help: Why Are SUVs More Profitable?” →

Explicit and Implicit Guarantees

Note: I wrote this post on May 18 but somehow forgot to publish it; I just found it in my drafts. It’s a bit out of date, but I think the point still stands.

I’m not sure if it’s official, but it’s been widely rumored that large banks that want to repay their TARP money will have to be able to sell new debt without the FDIC guarantee they got back in October. As a result, banks are falling over themselves with new, non-guaranteed debt offerings. The idea, I guess, is that banks that can raise money without the guarantee are showing that they are sound enough to operate without government support.

But I think all we’ve done is replace an explicit guarantee with an implicit guarantee. In October, no one was sure whether the U.S. government would bail out bank creditors in a pinch; after all, Lehman creditors got back less than 10 cents on the dollar, and AIG creditors took a big haircut because the Fed’s credit line came in senior to them. So the explicit guarantee was necessary for banks to issue debt.

Since then, however, the government has shown in many ways that it isn’t going to let major banks fail or force a restructuring (indeed, it insists that it can’t force a restructuring). The message of the stress tests, ultimately, was that Treasury is standing by to provide whatever capital is needed. In that situation, what risk do bank creditors face? Virtually none, except maybe political risk (the risk that the government’s policy will change). So the banks get to raise money without the stigma of a guarantee, they don’t have to pay a premium to the FDIC, then they get to pay back their TARP money, and the government can say that the banking sector is healthy. Everyone’s happy.

And if things go badly, the taxpayer is still there to make good on all those non-guaranteed bonds – at least for the banks that are, still, too big to fail.

By James Kwak

Posner, Part 1: Two Conceptions of Blame

A few readers have asked us for our thoughts on Richard Posner’s recent writings on the economic crisis, beginning with his new book and continuing with his epic blogging for The Atlantic. (To read his account from the beginning you need to find the well-hidden Archives section in the right-hand sidebar of the blog.) The challenge is that every time I try to catch up Posner has written another couple of thousand words. So I’m going to have to do this in pieces.

Posner is a giant of legal scholarship and in the theoretical branch of law and economics, which (judging from my own education) is the dominant paradigm for several fields of law, including torts and contracts. To simplify his importance greatly, he helped shift the legal profession, including both the academy and the courts, from a focus on justice – law should redress the harm suffered by the victim – to a focus on incentives – law should create incentives that will produce the greatest good for society in the future. For example, in general, firms should only be held liable for injuries they negligently cause if the expected total damages they cause exceed the cost of preventing those injuries; if we require firms to conduct inspections whose cost exceeds the cost of the injuries that those inspections would prevent, then we are reducing aggregate utility.

As you might guess, Posner is also generally a pragmatic conservative, who thinks that free markets usually lead to better societal outcomes than government intervention, and that public policy should focus on making sure that independent rational actors have the right incentives to behave in ways that will benefit society as a whole. Not surprisingly, his account of the crisis focuses not on the actions of people in the financial industry but on the failings of people in government.

Continue reading “Posner, Part 1: Two Conceptions of Blame” →

China Pushes Hard

On his China visit, Secretary Geithner is immediately on the defensive. The language he is using on the Chinese policy of exchange rate undervaluation-through-intervention is the mildest available. And the commitment he is making, in terms of bringing down the US deficit – which we all favor – is an extraordinary thing to put numbers on in a foreign capital. Such commitments are of course unenforceable, but still the wording indicates – and is understood by China – great US weakness.

Not surprisingly, China seems likely to push for more. Their main idea is that some part of their US dollar holdings be transfered to a claim on the International Monetary Fund, which would shift it from being in dollars to being in Special Drawing Rights – and therefore a claim against (a) the IMF’s whole membership, and (b) presumably, the IMF’s gold reserves.

This is a bad idea. Continue reading “China Pushes Hard” →