Month: November 2009

Details

Now that the financial regulatory reform bills are progressing in both houses of Congress, it means that to really be on top of things, you not only have to read the bills, you have to read the amendments. One example is the Miller-Moore amendment (full text here), which passed the committee 34-32, only to run into criticism from Andrew Ross Sorkin and Yves Smith, among others, as well as defenses by Felix Salmon.

The amendment applies to cases where (a) a systemically important (TBTF) financial institution is taken over by the government and (b) the government has to take a loss on the transaction (that is, the assets cannot be liquidated for enough to cover the secured creditors and the insured depositors). In those cases, it says that the receiver can choose to treat up to 20% of a secured debt as unsecured. (A mortgage is an example of secured debt; if you can’t pay off your mortgage, the bank gets the house instead. For financial institutions, we are largely talking about repos — transactions where Bank A sells securities to Bank B and promises to buy them back later, which is effectively a secured loan from Bank B to Bank A — and collateral held provided by Bank A to Bank B when derivatives trades move against Bank A.)

Continue reading “Details” →

What’s Wrong with Our Health Care Debate

Uwe Reinhardt has a post on Economix that zeroes in on Senator Kay Bailey Hutchinson’s criticism of the new mammogram guidelines. Here’s the quote from Hutchinson:

“So this task force says all of a sudden we’re going to change the guidelines that we have had for all these years. And now the public option may not pay for those, and that means the insurance companies are going to follow. The key is that these are covered by insurance so women will not have to decide if they’re going to spend $250 to get a mammogram because they and their doctors believe it is right to do so.”

Basically, the critics of the mammogram guidelines* are bemoaning the fact that certain women may not be able to get mammograms paid for by insurance — without mentioning the fact that many women don’t have insurance to begin with.

Or, to paraphrase Reinhardt: If certain medical procedures are so important to people’s health — shouldn’t everyone get them regardless of income or insurability?

* On which, let me make clear, I have no opinion, nor any qualified basis on which to have an opinion.

By James Kwak

Coordinated Capital Controls: A Further Elaboration

This guest post is by Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics.  His recent proposal that countries consider coordinated capital controls has stimulated a great deal of discussion, and here he explains how discouraging capital flows relates to arguments about the attractiveness of a Tobin-type tax. 

Paul Krugman, in his Friday column for the New York Times, endorsed a tax on financial transactions, proposed recently by Adair Turner, Britain’s top financial regulator.  It is important to distinguish this Turner proposal from the original Tobin tax on international flows and these two taxes in turn from the kind of coordinated capital controls I proposed in this blog post two weeks ago.

Tobin’s original idea was to discourage speculation by taxing flows of international capital.  The Turner variant is to tax all financial transactions, domestic and international.  What they have in common is that both are seen as structural measures to be applied regardless of the state of the macroeconomic cycle.

In contrast, the capital controls that are now being proposed are more in the spirit of “macroprudential” measures, to be taken in response to surges in international capital flows (and not to steady and permanent flows) to emerging markets that have the potential of creating bubbles in asset prices, including exchange rates.  Such measures are therefore intended to be taken during the upswing of the cycle and not at all times. Continue reading “Coordinated Capital Controls: A Further Elaboration” →

Does Dubai Matter? Ask Ireland

Presumably the rulers of Dubai and Abu Dhabi are currently locked in negotiations regarding the exact terms that will be attached to a “bailout” for Dubai World.  We’ll never know the details but if, as seems likely, the final deal involves creditors taking some sort of hit (perhaps getting 75 cents in the dollar, at the end of the day), does that matter?

Dubai probably has around $100bn in total liabilities, if we include off-balance sheet transactions, so total credit losses of $30-50bn need to be assigned.  The direct effects so far seem small.  HSBC leads the pack, in terms of exposure,  but our baseline estimate is a 3 percent loss relative to its equity – not good, but manageable (and the stock already fell 5 percent on the news).  The impact among other financial institutions that lent to Dubai seems fairly spread out and mostly within continental Europe.

Korean construction companies and Ukrainian/Russian steelmakers are also affected by the likely fall off in construction activity, but the broader boom in emerging markets is unlikely to be disrupted.  The repricing of risk so far does not apply significantly to East Asia or Latin America.

However, there is a worrying impact on Ireland. Continue reading “Does Dubai Matter? Ask Ireland” →

How Big Is Too Big?

As legislation on restructuring the banking industry moves forward, attention on Capitol Hill is increasingly drawn to the issue of bank size. Should our biggest banks be made smaller?

Senator Bernard Sanders, an independent from Vermont, introduced the “Too Big To Fail Is Too Big to Exist” bill in early November; this helped focus attention. Since then, in the legislative trenches where the detailed crafting takes place, Representative Paul E. Kanjorski — the Pennsylvania Democrat who is chairman of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises — proposed an amendment to the Financial Stability Improvement Act (currently before the House Financial Services Committee) that

would empower federal regulators to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy.

In a major step forward, this passed the committee on Nov. 18. Continue reading “How Big Is Too Big?” →

Is It 1999 All Over Again?

The New York Times’ Bits blog has a post on Trefis, a Web 2.0 startup that apparently makes it easy for you to create your own valuation model for public companies. They give you starter models using public information, and you can then tweak the assumptions to come up with your own valuation. The pitch is that this puts the tools used by research analysts and professional investors in the hands of the retail investor. “Perhaps these new tools will put some added pressure on the sell-side professionals – many of whom are notorious for creating overly optimistic takes on the companies they follow.”

Or maybe they will make retail investors think they have an advantage that they really don’t. Advantages in stock valuation have to be based on superior information, which you can get by doing lots of market research (like some old-fashioned hedge funds do) or by having privileged access to company insiders. Superior information can include superior forecasting ability, so if you have some ability to predict the market size for routers better than anyone else, you can make money from it. But neither of these are things you get from models; they are things you plug into models. I’m sure the founders of Trefis don’t see it this way, but this feels to me like a great way to lure people into individual stock-picking, and thereby a boon to stock brokers everywhere.

Continue reading “Is It 1999 All Over Again?” →

More on Goldman and AIG

Thomas Adams, a lawyer and former bond insurer executive, wrote a guest post for naked capitalism on the question of why AIG was bailed out and the monoline bond insurers were not (wow, is it really almost two years since the monoline insurer crisis?). He estimates that the monolines together had roughly the same amount of exposure to CDOs that AIG did; in addition, since the monolines also insured trillions of dollars of municipal debt, there were potential spillover effects. (AIG, by contrast, insured tens of trillions of non-financial stuff — people’s lives, houses, cars, commercial liability, etc. — but that was in separately capitalized subsidiaries.)

The difference between the monolines and AIG, Adams posits, was Goldman Sachs.

Continue reading “More on Goldman and AIG” →

Data on the Debt

So far, my foray into the world of the national debt has consisted of this:

One of the curious things about the debt scare that is building in the media is that it is happening at a moment when long-term interest rates are very low. In other words, it’s based on a theory that the market is wrong in its collective assessment of the debt situation. I’ve heard this blamed on “non-economic actors” (that is, foreign governments that buy U.S. Treasuries not as a good investment, but for political reasons), or on a “carry trade” where investors are exploiting the steep yield curve (free short-term money, positive long-term interest rates), as Paul Krugman discusses here.

Menzie Chinn crunches some numbers. He takes a model that he and Jeff Frankel created several years ago to estimate the impact on interest rates of inflation, the future projected national debt, the output gap (economic output relative to potential), and foreign purchases of Treasuries. That last term is important, because the oft-heard fear is that foreign governments will suddenly stop buying our debt.

Continue reading “Data on the Debt” →

What’s on TV

Frontline has a program on tonight about the credit card industry, which may be a useful accompaniment to the regulatory reform debate. They include this juicy paragraph in their press release:

“They’re lower-income people-bad credits, bankrupts, young credits, no credits,” Mehta [former CEO of Providian] says. Providian also innovated by offering “free” credit cards that carried heavy hidden fees. “I used to use the word ‘penalty pricing’ or ‘stealth pricing,'” Mehta tells FRONTLINE. “When people make the buying decision, they don’t look at the penalty fees because they never believe they’ll be late. They never believe they’ll be over limit, right? … Our business took off. … We were making a billion dollars a year.”

Rings true to me.

By James Kwak

Morgan Stanley Speaks: Against Relying On Capital Requirements

Just when momentum was starting to build for increased capital requirements as the core element of an approach that will reign in reckless risk-taking, Morgan Stanley effectively demolishes the idea.

In “Banking – Large & Midcap Banks: Bid for Growth Caps Capital Ask,” (no public link available) Betsy Graseck, Ken Zorbo, Justin Kwon, and John Dunn of Morgan Stanley Research North America dissect the coming demands for more bank capital. 

“In short, we think the demand for growth and access to credit will trump desire for unprofitable capital levels…

For the large cap and midcap banks, we expect normalized median common tier-1 ratios to come in at 8.4% and 10.0% respectively.”

That’s less capital than Lehman had just before it failed – 11 percent.  (If you doubt this, read the transcript of the final Lehman conference call – link is in this NYT.com piece or try this direct link; see p.7, for example) Continue reading “Morgan Stanley Speaks: Against Relying On Capital Requirements” →

Blaming It on Obama

Last week I wrote a post about “government debt hysteria” that has gotten a lot of attention because of a link from Paul Krugman. (As Felix Salmon, said, “blogging is a lottery on the individual-blog-entry level.”) The main point of last week’s post was not that it’s wrong to be concerned about the national debt (I think everyone is concerned about it — the question is what to do about it and when), but that it’s irresponsible to title a column “Could America Go Broke?” and talk about hyperinflation without providing some evidence, or at least a logical argument that goes beyond tautology, that hyperinflation is something we should be worrying about it.

Here’s something else that’s irresponsible. In that same column, Robert Samuelson says, “The Congressional Budget Office reckons the Obama administration’s planned budgets would increase the debt-to-GDP ratio from 41 percent in 2008 to 82 percent in 2019″ (emphasis added).

Continue reading “Blaming It on Obama” →

Government Debt Hysteria

I don’t spend a lot of time trying to police the economic news media — Dean Baker and Brad DeLong are much better on that — but I found myself reading a two-week-old Newsweek column by Robert Samuelson that enraged me enough to type this out. (I read it on old-fashioned paper, but here’s the WaPo version.) The title of the WaPo version is “Could America Go Broke?” and here’s the last paragraph:

“Deprived of international or domestic credit, defaulting countries in the past have suffered deep economic downturns, hyperinflation, or both. The odds may be against a wealthy society tempting that fate, but even the remote possibility underlines the precariousness and the novelty of the present situation. The arguments over whether we need more ‘stimulus’ (and debt) obscure the larger reality that past debt increasingly constricts governments’ economic maneuvering room.”

Deep economic downturns! Hyperinflation! “Precariousness and novelty of the present situation!” You’d think there was some actual reason to be afraid.

Continue reading “Government Debt Hysteria” →

The AIG-Maiden Lane III Controversy

As everyone knows by now, Neil Barofsky, special inspector general for TARP, has a new report out on the decision by the Federal Reserve Bank of New York last Fall to make various AIG counterparties (primarily some very big banks with names you know) whole on the the CDS protection they had bought from AIG to cover their risk on some CDOs. The potentially juicy bit has to do with the Maiden Lane III transaction (New York Fed summary here).

Continue reading “The AIG-Maiden Lane III Controversy” →

CRA Bashing, Nth Generation

The Community Reinvestment Act is a law originally passed in 1977 that directed federal regulatory agencies to ensure that the banks they supervised were not discriminating against particular communities in making credit available.The onset of the subprime mortgage crisis triggered a flood of sloppy, lazy attacks on the CRA claiming that since the crisis was created by excess lending to the poor, and the CRA was intended to increase lending to the poor, the CRA must have caused the crisis. These arguments suffered from a mistaken premise (subprime lending had a modest negative correlation with income, but many subprime loans were used by the middle class to buy expensive houses in the suburbs and exurbs of California and Nevada) and a failure to check their facts (“Only six percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes.” — Randall Kroszner, former Fed governor appointed by President George W. Bush, in a Federal Reserve study that also found that subprime loan performance was no worse in CRA-covered zip codes than in slightly more affluent zip codes not covered by the CRA.)

Yesterday at a Cato Institute conference, Edward Pinto, chief credit officer at Fannie from 1987 to 1989 and currently a real estate financial services industry consultant (according to recent Congressional testimony), rolled out the new line. The new argument is a curious mirror image of the old argument (which Pinto himself may not have made): now the subprime explosion did not cause the housing bubble, but was caused by the housing bubble and … wait for it … the CRA caused the housing bubble, along with the affordable housing goals of Fannie and Freddie.

Continue reading “CRA Bashing, Nth Generation” →

Written Testimony Submitted To The Congressional Oversight Panel

Testimony submitted to the Congressional Oversight Panel, hearing on “The overall impact of the Troubled Asset Relief Program (TARP) on the health of the financial system and the general U.S. economy,” Thursday, November 19, 2009. (pdf version)

Submitted by Simon Johnson, Ronald Kurtz Professor of Entrepreneurship, MIT Sloan School of Management; Senior Fellow, Peterson Institute for International Economics; and co-founder of http://BaselineScenario.com.

Summary

1)      In the immediate policy response to any major financial crisis – involving a generalized loss of confidence in major lending institutions – there are three main goals:

  1. To stabilize the core banking system,
  2. To prevent the overall level of spending from collapsing,
  3. To lay the groundwork for a sustainable recovery.

2)      IMF programs are routinely designed with these criteria in mind and are evaluated on the basis of: the depth of the recession and speed of the recovery, relative to the initial shock; the side-effects of the macroeconomic policy response, including inflation; and whether the underlying problems that created the vulnerability to panic, are addressed over a 12-24 month horizon.

3)      This same analytical framework can be applied to the United States since the inception of the Troubled Asset Relief Program (TARP).  While there were unique features to the US experience (as is the case in all countries), the broad pattern of financial and economic collapse, followed by a struggle to recover, is quite familiar.

Continue reading “Written Testimony Submitted To The Congressional Oversight Panel” →