Author: James Kwak

House Reform Bill Thread

As you already know if you read the news, the House version of the financial reform bill will probably come to a vote today, and it should have the votes to pass unless the Republicans/conservative Democrats manage to pass a poison pill amendment — like Walt Minnick’s amendment to kill off the CFPA and replace it with a council of regulators. (I’m not making this up.) The bank lobby moderate Democrats did manage to get federal preemption of state laws, which means that states can’t set higher standards than federal regulators and sounds like a bad thing (anyone remember the OTS?), but Mike Konczal says it might not be as bad as it sounds.

To be honest, I’m not sure what’s in this thing at the moment, and who knows how many little loopholes have managed to sneak in, especially when it comes to derivatives regulation. But if it has a meaningful CFPA (which I’m pretty sure it does), it’s a step forward. If it doesn’t break up big banks, it’s not enough.

By James Kwak

A Partisan Post, You Have Been Warned

Last night I read a post by Brad DeLong that made me so mad I had trouble falling asleep. (Not at DeLong, mind you.)  There’s really nothing unusual in there — hysteria about the deficit, people who voted for the Bush tax cuts and the unfunded Medicare prescription drug benefit but suddenly think the national debt is killing us, political pandering — but maybe it was the proverbial straw.

First, let me say that I largely agree with DeLong here:

“I am–in normal times–a deficit hawk. I think the right target for the deficit in normal times is zero, with the added provision that when there are foreseeable future increases in spending shares of GDP we should run a surplus to pay for those foreseeable increases in an actuarially-sound manner. I think this because I know that there will come abnormal times when spending increases are appropriate. And I think that the combination of (a) actuarially-sound provision for future increases in spending shares and (b) nominal balance for the operating budget in normal times will create the headroom for (c) deficit spending in emergencies when it is advisable while (d) maintaining a non-explosive path for the debt as a whole.”

Now, let me tell you what I am sick of:

Continue reading “A Partisan Post, You Have Been Warned” →

The Funniest 750 Words of the Financial Crisis

Hat tips to Uncle Billy and Felix Salmon:

“A FORMER INVESTMENT BANKER ANALYST FALLS BACK ON PLAN B.

“1. Explain why you want to attend law school.

“I want to attend law school because I want to make a difference in the world. My desire to attend law school has nothing to do with the fact that I was recently fired from my job as an analyst at an investment bank, where I worked in the mergers and acquisitions group. Since January, I’ve worked on approximately one merger, zero acquisitions, have played Spider Solitaire 434 times and updated my Facebook status, on average, five times a day. …”

It only gets better.

(Unfortunately, I suspect it’s about nine months too late — I imagine most analysts at Goldman and Morgan Stanley are quite happy there these days, thank you.)

By James Kwak

Revolution and Reform

Many of us bloggers are better at criticizing than at proposing anything — especially when the world makes it so easy to be a critic. The Epicurean Dealmaker, who has sent the occasional volley of criticism my way (I’m not linking to examples because my ego is too fragile), recently decided to deal with this head-on and wrote a “reformist manifesto,” complete with an epigraph from The Communist Manifesto, with a list of specific proposals.

Basically these include cleaning up the regulatory structure, expanding the scope of regulation (consumer protection, hedge funds), moving “virtually all” OTC derivatives onto exchanges or clearinghouses (I believe that “virtually all” means the currently-proposed exemption for “end-user” hedges would be drastically reduced), and increasing Fed transparency. There is also this one: “Ban political campaign contributions by the financial industry.” I think that would be great, although there is at least one constitutional problem and possibly two there.

There’s nothing on the list that I disagree with.

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Why Did Bank of America Pay Back the Money?

Everybody knows by now that Bank of America is buying back the $45 billion of preferred stock that the government currently owns. While the reason why they are doing this is obvious, I’m going to pretend it isn’t for a few paragraphs.

Buying back stock costs money — real cash money. Why would a company ever do such a thing? The textbook answer is that a company should do it if it doesn’t have investment opportunities that yield more than its cost of capital. The cash in its bank account, in some sense, belongs to its shareholders, who expect a certain return. If the bank can’t earn that return with the cash, it should return it to the shareholders. In this case, though, the interest rate on the preferred shares is only 5%, which is far lower than usual cost of equity. In fact, Bank of America just issued $19 billion of new stock in order to help buy back the government’s preferred stock. The cost of that new equity (in corporate finance terms) is certainly higher than 5%. In other words, Bank of America just threw money away.

Continue reading “Why Did Bank of America Pay Back the Money?” →

Buffett and Geithner

Andrew Ross Sorkin’s Too Big to Fail sure is a page-turner; even for events that I already knew about in general, it’s full of new details and juicy quotations.

For example, on page 508 it lays out the details of Warren Buffett’s October 2008 proposal for a “Public-Private Partnership Fund,” which would eventually become the PPIP announced by Tim Geithner in March 2009.  I knew that Buffett, Bill Gross, and Lloyd Blankfein had supported the idea, but I didn’t know the details. Buffett’s idea was slightly different from the eventual PPIP.

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Iron Cage for Nothing

When I gave away many of my old books a year ago, I kept my college copy of Max Weber’s The Protestant Ethic and the Spirit of Capitalism. Now Tyler Cowen cites a paper by Davide Cantoni demonstrating that Protestantism had nothing to do with economic development. (Cantoni also co-authored a paper with Simon and others on the impact of the French Revolution — via the Napoleonic conquests — on economic development.) He uses the “natural experiment” created by the division of the Holy Roman Empire (very roughly, modern-day Germany and Austria) into Protestant and Catholic states.

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Never a Good Sign

The board of GM asked Fritz Henderson to resign as CEO. I don’t have an opinion on Fritz Henderson. But here’s the worrying bit, from the New York Times article:

“’Fritz was just not enough of a change agent,’ [a person with direct knowledge of the board’s deliberations] said. ‘The board wants a world-class C.E.O. and now they have enough breathing room to find one.'”

Having tried and rejected the inside option (Henderson was a longtime GM executive chosen to replace Rick Wagoner, who was forced out earlier this year), the board is certain to go looking for a superstar CEO from outside the company and probably outside the industry. The phrase “world-class CEO” is always a dead giveaway for delusion.

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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.)

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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

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.

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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.

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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.

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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