What happened to the global economy and what we can do about it
Author: James Kwak
Simon and Charles Calomiris were quoted on NPR this morning on the topic of the day — too big to fail.
I thought one of Calomiris’s examples was interesting. He cited Mexico, where banking was dominated by six families that wouldn’t lend to potential competitors. After the Mexican financial crisis and the entry of foreign banks, now it is easier for companies to raise money. It seems to me that story could be used by either side.
By James Kwak
Our Washington Post online column today is another cry in the wilderness against the homebuyer tax credit.
There are many arguments against the tax credit. One argument we make is that the tax credit is a benefit for sellers of houses more than for buyers of houses. This is simplest to see if you imagine a permanent credit available for all buyers: “Imagine the credit were expanded to all home buyers and made permanent. This would simply boost housing prices at the low end of the market by close to $8,000, since all buyers would be willing to pay $8,000 more. (Prices would rise by a little less than $8,000 because at higher prices, more people would be willing to sell.)”
It turns out Nemo had made a similar argument already.
Continue reading “Tax Credits, Screwdrivers, and Supply and Demand Curves”
One of the Free Exchange bloggers (some people know who is who by name, but I don’t — if anyone wants to enlighten me, I’m listening) admits choosing his bank because it was big, and staying there because it is big. He also links to James Surowiecki, who asks in the “notes” to his latest column,
“[W]hy, given the broader backlash against the big banks and the less-than-inspiring performance they’ve turned in over the last couple of years, are people still sticking with them? What makes this even more curious is that the big banks, which have historically offered their customers worse deals than smaller banks, have not changed their ways: they pay less for deposits, charge more for loans, make billions from overdraft fees, and have jacked up credit-card rates.”
Last week, Charles Calomiris wrote an op-ed in the Wall Street Journal arguing that big banks are better for various reasons. Simon wrote last week saying that Calomiris underestimated the political dimension, and that his proposed solution — a cross-border resolution mechanism for large institutions — is the policy equivalent of assuming a can opener.
I wanted to look at Calomiris’s specific claims. I think I’ve already dealt with the myth that banks “need to be large to operate on a global scale—and they need to do so because their clients are large and operate globally.” Calomiris also argues that there are economies of scope (it’s better to be big because you can play in multiple businesses). Here’s his evidence:
“True, some empirical studies in the field of finance have failed to find big gains from mergers. But those studies measured gains to banks only, and measured only the performance improvements of recently consolidated institutions against other institutions, many of which had improved their performance due to previous consolidation.
“Yet even unconsolidated banks have improved their performance under the pressure of increased competition following the removal of branching restrictions, which permitted the consolidation wave in banking. And when an entire industry is involved in a protracted consolidation wave, the best indicator of the gains from consolidation is the performance of the industry as a whole. One study of bank productivity growth during the heart of the merger wave (1991-1997), by Kevin Stiroh, an economist at the New York Federal Reserve, found that it rose more than 0.4% per year.”
Nate Silver thinks that financial regulation will be the big political issue of the first half of next year. And for better or for worse, he thinks the central political issue — the “public option,” if you will — will be TBTF and breaking up banks.
I have been skeptical of this. I have been following the conventional wisdom that public anger has receded into confusion, health care has taken over the stage, and no one can get interested in financial regulation — it’s just too boring. Also, I thought the fact that financial regulation doesn’t break down along party lines hurts its popular appeal. In particular, it leaves liberal Democrats very confused (conservative Republicans have an easier time — oppose anything Obama wants). But I suppose I could see breaking up banks — now that it’s come back from several months in the wilderness — becoming a rallying issue. And health insurance is intrinsically boring, too. In any case, Nate Silver knows politics a lot better than I do.
(Also, according to Silver, we are “Volckerists” and the other side are the “Summersists.” We could do worse.)
By James Kwak
Yves Smith has a long excerpt from testimony by Robert Johnson before the House Financial Services Committee on regulation of OTC derivatives. (Johnson’s testimony is not up at the committee site.) Johnson brings together the issues of too big to fail and derivatives regulation: “Absent a drastic simplification of derivative exposures and a transparent and comprehensive improvement in the monitoring of those positions when imbedded in large firms, complex derivatives render these behemoth institutions Too Difficult to Resolve (TDTR).”
In short, he argues that even if you give regulators the ability to “resolve” a Tier 1 financial institution in the event of a crisis, regulators will be afraid to pull the trigger as long as there is still this complicated web of non-standardized derivatives linking it to the rest of the financial system. In addition, this creates a bizarre incentive: if you think that you can escape being shut down by having an intimidatingly complex derivatives portfolio, then you will go out and create such a portfolio.
Kevin Hall of McClatchy has an article about Moody’s that goes beyond the usual — giving AAA ratings to products “structured by cows” and taking money from the cows (actually, the “cows” comment was from S&P). He documents how Moody’s forced out executives who questioned the lax rating policies, replaced them with executives from the structured finance division, and filled its compliance division with people from that same division.
In this week’s column at The Hearing, we discuss this as an example of a common tension within businesses — between the revenue-generating side of the business and the people responsible for product quality. The problem is that in the short term, you can maximize revenues by cutting corners on quality, but in the long term, cutting those corners can come back to hurt you. Or it can hurt your customers. Or the whole economy, as it turns out. Unfortunately, however, there is no particular reason to believe that companies will resolve this tension in a way that is good for them in the long term, let alone the economy.
By James Kwak
Mike Konczal has a post featuring the Grayson/Clay/Miller amendment to the current Consumer Financial Protection Agency proposal. The basic idea is that the agency would be required to do a periodic, statistical analysis to identify those financial products that were most implicated in causing bankruptcies and foreclosures in each state. The CFPA would then have to announce what these products are and who sold them, and could then take corrective action to restrict those products.
One of our readers emailed in a link to this Bloomberg story about the new “chief operating officer” of the enforcement division of the SEC: Adam Storch, “a 29-year-old from Goldman Sachs Group Inc.’s business intelligence unit” who “had worked since 2004 in a unit at that reviewed contracts and transactions for signs of fraud.”
I went back and forth about posting this because, as far as I can tell, it’s not that important a job; according to the WSJ, “Mr. Storch will oversee division operations that include budget, information technology and administrative services. He will also supervise the workflow associated with the collection and distribution of fair funds to harmed investors.” It’s back-office administration, not deciding whom the SEC is going to pursue. I don’t think this is in the same league as, say, Goldman’s chief lobbyist becoming the Treasury secretary’s chief of staff. (Note, however, that Zero Hedge says it is “arguably the most critical post at the SEC.”)
But still, even if it is a routine back-office job, why someone from Goldman who makes Neel Kashkari look like an elder statesman? As our reader pointed out, there are some relevant themes here. One is the revolving door. Another is cognitive capture: why does the SEC think it needs a Goldmanite to handle its budget, IT, and administrative services? There are other good companies out there, really, somewhere, or we have a much bigger problem on its hands.
Maybe he’s independently wealthy and immune to job offers from Wall Street. Maybe he’s a genius and aced his job interview. You’d think there must be something special about him that convinced the SEC to give him the job despite all the additional “Government Sachs” fodder it creates. I hope he does a wonderful job.
By James Kwak
Just kidding. I don’t have time to read it anyway (nor am I all that interested).
In case you’ve missed it, there has been an enormous controversy (by blogosphere standards) over a chapter in Superfreakonomics (to be released tomorrow, I think) on climate change, carbon reduction, and geo-engineering. Brad DeLong has the most coverage (I believe this was his first post; read backwards from there), including links to some people who are supportive of the book. The summary is that a number of people have accused Levitt and Dubner of saying silly things about climate change (bad), accepting an “expert’s” opinion without doing due diligence (more bad), and possibly distorting the opinion of another expert (very bad), with the assumed goal of being contrarian and controversial. Levitt and Dubner disagree. Paul Krugman has some interesting thoughts on the dynamics involved.
This did, however, make me think a little about the difference between blogs and books. [Note: After finishing this post — which is over 1,300 words — I realized it is not as interesting as I thought it would be. So feel free to go do something else fun.]
Continue reading “Hey, Where’s My Free Advance Copy of Superfreakonomics?”
Yves Smith returned from book-writing land to catch up on the Andrew Hall story, which is one that I pretty much decided to ignore from the beginning. Hall is the Citigroup trader who, according to his compensation agreement, was due a $100 million bonus. The bonus was so big because Hall and his team were due 30% of the profits from their trades, which is even more than typical hedge fund fees. (This tradition of particular trading groups negotiating a share of their profits dates back at least to Salomon in its heyday; AIG Financial Products also had this type of deal.)
But Smith focused on one element that got me thinking. Hall’s division, Phibro, was bought by Occidental Petroleum. “Oxy paid $250 million, the current value of Phibro’s trading positions. There was NO premium, zero, zip, nada, for the earning potential of the business. Zero. Oxy bought the business for its liquidation value.” Smith infers that no one was willing to pay more because the success of Phibro depended on its being part of Citigroup and benefiting from Citi’s low cost of funding; in other words, the massive profitability of Phibro was in part due to an accounting error — not charging it an appropriate cost of capital given the risk it was taking.
One of our readers not only suggested this post, but even sent me all the links; I’m just now getting around to writing it up. Thanks.
There has been a lot of talk about global imbalances, with most opinions varying from somewhat important (us) to very important (many global policymakers). Here’s Jean-Claude Trichet, for example, president of the European Central Bank, as reported by Reuters:
“The G20 has to address the issues of the domestic large imbalances between savings and investments, and of the set of unsustainable external imbalances.
“We know that these imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis. And this of course would be totally unacceptable.”
Continue reading “Cognitive Dissonance and Global Macroeconomics”
“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”
My jaw is still on my desk.
By James Kwak
Yves Smith has a very good post on how hard much of the mainstream media has fallen for the “everything is OK, go on with your lives” theme. She cites the Pew Research Center to show that media coverage of the financial crisis and recession has focused primarily on political battles – stimulus, bailouts, etc. – rather than on problems in the real economy. What’s more, economic coverage in general has fallen off since the stock market rebound earlier this year and the Obama administration’s “all clear” signal. She also discusses psychological research that shows that people can be easily influenced to believe things that are not true, simply because people around them seem to believe those things.
Smith traces this phenomenon to two main sources: the steady evolution of journalism into a traditional profit-oriented business than can no longer afford to invest heavily in investigative journalism; and the increased ability of political leaders, following the lead of private corporations, to control the message that is transmitted via the media. The Bush administration was allegedly the master of the latter, although the fact that they were so obvious about it sort of undermines that claim. (Although probably their attitude was that they didn’t care if the “New York liberal elite” saw how they were manipulating press coverage.) But the Obama administration is no slouch either.
According to Calvin Trillin (or, more accurately, the probably-at-least-semi-fictional interlocutor he meets at a bar in Midtown), the financial crisis was caused by smart people going to work on Wall Street. In the old days, the story goes, it was the lower third of the class that went to Wall Street, and “by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”
Then, however, as college debts and Wall Street pay grew in tandem, the smart kids started going to Wall Street to make the money, leading to derivatives and securitization, until finally: “When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was.”
The Baseline Scenario 