Category: Commentary

The Importance of Battlefield Nuclear Weapons

I’ve been writing a lot about the game of chicken recently, most often in connection with the GM and Chrysler bailouts. On the Chrysler front, the game is in its last hours. Even after a consortium of large banks agreed to the proposed debt-for-equity swap, some smaller hedge funds are holding out for more money, and even the extra $250 million that Treasury agreed to kick in seems unlikely to keep Chrysler out of bankruptcy.

The problem is that bankruptcy is the only weapon Chrysler and Treasury have in this fight, and it’s a strategic nuclear weapon. Bankruptcy is the only threat that can get the bondholders to agree to a swap; but because a bankruptcy carries some risk of destroying Chrysler (because control will lie in the hands of a bankruptcy judge – not Chrysler, Treasury, the UAW, or Fiat), and taking hundreds of thousands of jobs with it, everyone knows that Treasury would prefer not to use it. The bondholders are betting that they can use Treasury’s fear of a bankruptcy to extract better terms at the last minute. (And it’s even possible that the large banks agreed to the swap knowing they could count on the smaller, less politically exposed hedge funds to veto it.) But Treasury may still press the button, because it needs to make a statement in advance of the bigger GM confrontation scheduled for a month from now.

But there’s a much bigger, slower game going on at the same time, and the administration’s basic problem is the same: all it has is strategic nuclear weapons that it absolutely does not want to use. The New York Times had an article today about how “a growing number of banks are resisting the Obama administration’s proposals for fixing the financial system.”  It didn’t have a lot of new information, but it summarized the outlines of the game.

Continue reading “The Importance of Battlefield Nuclear Weapons” →

Pierre Bourdieu, Tim Geithner, and Cultural Capital

France in the 1960s and 1970s was the source of a tremendous amount of new philosophical, literary, and critical thinking – Foucault, Derrida, Lévi-Strauss, Baudrillard, Barthes, etc. But in my opinion, the most important member of that intellectual generation was the sociologist Pierre Bourdieu. In Distinction, Bourdieu’s best-known work, he described how economic class is reinforced by cultural capital: economic elites create cultural distinctions, and pass on to their children the ability to make those distinctions, in order to use cultural sophistication as a means of perpetuating class dominance. This may sound abstract, but think about the example that is the subject of Bourdieu’s The Love of Art: museums. Upper-class parents take their children to fine art museums and teach them how to talk about Rembrandt, Monet, and Picasso; later in college, job interviews, and cocktail parties, the ability to talk about Rembrandt, Monet, and Picasso is one of the markers that people use, consciously or unconsciously, to identify people as being from their own tribe. (Note that democratizing museums – making them open to anyone – doesn’t undermine cultural capital, because the key is not looking at paintings, but learning how to talk about them.)

We used the term “cultural capital” in our Atlantic article as a way of describing the influence of Wall Street over Washington. By this, we meant that one of the primary means by which Wall Street got its way in Washington was by creating and propagating the understanding – among sophisticated, educated, cultured people, as opposed to “populists” or the “rabble” that showed up at anti-globalization protests – that what was good for Wall Street was good for the country as a whole. We didn’t mean to say that old-fashioned campaign contributions and lobbying did not play an important role. (We did, however, say that we thought out-and-out corruption of the Jack Abramoff variety was probably a minor factor – not because we have any insider knowledge one way or the other, but simply because such criminal behavior was simply unnecessary given the other levers available.) But I don’t think that implicit quid pro quo bargaining is a sufficient explanation, because I believe it entirely possible that there are honest politicians and civil servants who really, truly believe that they are acting in the public interest when they come to the aid of the largest banks.

Tim Geithner may very well be such a man.

Continue reading “Pierre Bourdieu, Tim Geithner, and Cultural Capital” →

Larry Summers’ New Model

Larry Summers spoke on Friday afternoon at the InterAmerican Development Bank in Washington DC.  As he was addressing a group with  much experience living through and dealing professionally as economists with major crises, he spoke the “language of economics” (as he called it) and largely cut to the analytical chase.

Summers made five points that reveal a great deal about his personal thinking – and the structure of thought that lies behind most of what the Administration is doing vis-a-vis the crisis.  Some of this we knew or guessed at before, but it was still the clearest articulation I have seen. Continue reading “Larry Summers’ New Model” →

The Next Big Hearing? (Bill Moyers Tonight)

Bill Moyers asked me to join his conversation this week with Michael Perino – a law professor and expert on securities law – who is working on a detailed history of the 1932-33 “Pecora Hearings,” which uncovered wrongdoing on Wall Street and laid the foundation for major legislation that reformed banking and the stock market.

My role was to talk about potential parallels betweeen the situation in the early 1930s and today, and together we argued out whether the Pecora Hearings could or should be considered a model for today.

Bill has a great sense of timing.  On Wednesday night the Senate passed, by a vote of 92-4, a measure that would create an independent commission to investigate the causes of our current economic crisis; we taped our discussion on Thursday morning.  In the usual format of Bill’s show, a segment of this kind would be 20+ minutes, but I believe that tonight our conversation will occupy the full hour (airs at 9pm in most markets; available on the web from about 10pm). Continue reading “The Next Big Hearing? (Bill Moyers Tonight)” →

Irreversible Errors

The Administration’s top thinkers on banking regard themselves as avoiding “irreversible errors” – meaning precipitate moves on banking.  They argue that “wait and see” may work out and, if it doesn’t, they can always take more dramatic action later (e.g., of the Hoenig variety).

Writing in the NYT.com’s Economix today, Peter Boone and I argue that this line of reasoning makes sense, but needs to be taken to its logical conclusion.  Specifically, we should recognize that delay in banking crises almost always and pretty much everywhere leads to lower growth and higher fiscal costs – the price of eventual bailouts increases and the amount of fiscal stimulus required goes up.  The jobs lost, the longer recovery, and the higher national debt are all costs that must be weighed in the balance.  And that balance, in our view, indicates moving faster and in a more comprehensive manner in the direction suggested by Thomas Hoenig – a senior Federal Reserve official who has a great deal of experience dealing with insolvent banks. Continue reading “Irreversible Errors” →

The Missed Opportunity

For a snapshot of what’s wrong with our banking policy, look at the front page of the business section of today’s New York Times. On the left side: “U.S. in Standoff with Banks over Chrysler.” On the right side: “Banks Show Clout on Legislation to Help Consumers.”

On the left side, a consortium of banks holding Chrysler debt is refusing to agree to the current restructuring plan, which involves bondholders holding $6.9 billion in secured debt getting about 15 cents on the dollar – roughly where the bonds are currently trading, according to the Times.* The banks are playing the ongoing game of chicken with the government, betting that the government will cave and give them a better deal rather than take a risk on a bankruptcy.

On the right side, the banks are using their lobbying clout to block the administration’s proposals to help consumers and households, including the mortgage cram-down provision (which would allow bankruptcy courts to modify mortgages on first homes) and added consumer protections for credit card customers. They currently have all 41 Republican votes in the Senate tied up, which means nothing can pass.

The banks leading the charge over Chrysler: JPMorgan Chase and Citigroup. The banks opposed to cram-downs: Bank of America, JPMorgan Chase and Wells Fargo. The banks blocking credit card protections: American Express, Bank of America, Capital One Financial, Citigroup, Discover Financial Services, and JPMorgan Chase. All or almost all are bailout beneficiaries. But don’t blame them: they’re just doing what they can to maximize their profits at the expense of the taxpayer, which is perfectly legal (and even ethical, depending on your conception of shareholder rights). Instead, you should be wondering why they are in a position to be maximizing profits at the taxpayer’s expense.

Continue reading “The Missed Opportunity” →

The Missing Witness

Yesterday’s JEC Hearing on Too Big To Fail did not include any financial industry representatives.  This surprised me – surely they want to go public with their views on the future structure of the financial system?  Obviously, they have great behind-the-doors access on Capitol Hill, but surely it is not in their interest to have right, left, and center piling on with regard to breaking up Big Finance?  Yesterday, Thomas Hoenig, Joseph Stiglitz, and I were in complete agreement on this point, and my idea of using antitrust measures against major banks seemed to gain traction during and after the hearing.

Apparently, the committee invited a number of leading people from the industry (i.e., individuals who generally articulate the case for big banks) and they were all too busy to attend (Update: this statement is incorrect; the potential witnesses who were unable to attend are academics).  This is a curious coincidence, because someone else – in an unrelated initiative – has been trying to set up a discussion involving me and people from the Financial Services Roundtable and/or the American Bankers Association, to be held at the National Press Club, but their calendars are completely full (i.e., there is literally no day that works for them, ever). Continue reading “The Missing Witness” →

Two Hearings On Banks Today

This morning, by coincidence, there are parallel hearings on Capitol Hill dealing with the nature of our banking system and attempts to stabilize it.  In the Cannon House Office Building, starting at 9:30am, the Joint Economic Committee will hear from Thomas Hoenig, Joseph Stiglitz, and me, on whether Big Finance is too big to save (see yesterday’s preview for details).

At 10am over on the Senate side (Dirksen Senate Office Building), Secretary Geithner will appear before the TARP Congressional Oversight Panel.  We preview that event this morning on The Hearing, with a discussion of the context, the latest numbers, and our forecast of the ideas that will be expressed; it’s a viewer’s guide – but one that you can talk to by sending in comments (and, most important, your questions for the Secretary). Continue reading “Two Hearings On Banks Today” →

70% Off Sale!

There has been a fair amount of hand-wringing along Sand Hill Road in Menlo Park over the lack of “exits” – IPOs and acquisitions – for venture-backed technology companies. Given the way the stock market has behaved recently, it’s pretty near impossible for a young technology company to go public. And the large technology companies that do most of the acquiring have been unusually quiet, presumably because they are watching their cash and avoiding risks given the global economic downturn.

However, there’s one major reason why large technology companies should be buying:

orcl-java

Blue is the share price of Oracle; red is the price of Sun (the spike in March is Sun’s merger negotiations with IBM). At some point, prices fall to the point where people start buying again. While the recession has hurt almost every company, it disproportionately hurts companies that do not have fat profit margins, hordes of repeat customers, and deep cash reserves that they can rely on in hard times. The result is huge changes in the relative values of companies, creating some once-in-a-generation bargains.

I don’t think the Oracle-Sun acquisition is a sign of a bottom or anything dramatic like that. But it shows that at least some companies are doing what they should be doing.

By James Kwak

Your Hearing: New Blog at WashingtonPost.com

Some readers have emphasized how the current economic and financial situation leaves them feeling powerless.  Others complain that it’s hard for outsiders even to understand the process through which ideas are debated and become policies – how Capitol Hill really works is a fascinating mystery at many levels.

This morning we’re extending our efforts to address these issues with the launch of The Hearing, a new blog at the Washington Post.  James and I are the moderators and we’ll focus the discussion around Congressional hearings – including the broader debates in which these are situated.

The Post has great impact in Washington and it’s our hope that The Hearing will allow you to express ideas in ways and at a time that can have real effects on policies.  For this reason, we’ll preview public events and provide ways for you to suggest questions that need to be heard.  At the very least, we can all learn more about what is happening and exactly why.

We’re open to suggestion regarding the exact format, guest contributors, and generally how to make The Hearing more effective.  We will, of course, keep BaselineScenario as our primary outlet for opinions and analysis – The Hearing is intended to be complementary, by bringing your voices into the specifics of idea flow through Congress.  We’ll tell you here when you should consider going to look there.

My first post deals with tomorrow’s JEC hearing on “Is Big Finance Too Big To Save”?  I preview what Joe Stiglitz and Thomas Hoenig are likely to say (based on their racing form), and I anticipate where the discussion will go – or at least where I will try to push it, as I’m on the panel also. 

If you have points or questions you want raised, please post them here or on the Post’s site.  There’s no guarantee your issues will be taken up, of course, but my guess is that this new forum will help sensible requests – of the kind often seen here – gain broader traction.

By Simon Johnson

More Accounting Games

The New York Times is reporting that the administration is thinking of stretching its TARP funds further by converting its preferred shareholdings to common stock.

The change to common stock would not require the government to contribute any additional cash, but it could increase the capital of big banks by more than $100 billion.

I hope this is one of those trial balloons they float and later think better of. Most importantly, it makes no sense. That is, there’s nothing fundamentally wrong with converting preferred for common, but it doesn’t create anything of value out of thin air. I wrote a long article about preferred and common stock a while back, but here are some of the highlights.

  • If you don’t give a bank any more money, it doesn’t have any more money. By converting preferred into common, you haven’t changed the chances of the bank going bankrupt, because its assets haven’t changed, and its liabilities haven’t changed. If it had enough money to cover its liabilities, but it couldn’t buy back its preferred shares from Treasury, it’s not like the government would have forced it into bankruptcy anyway.
  • If you accept the idea that converting preferred into common creates new capital, then you are implying that those preferred shares weren’t capital in the first place. From a capital perspective, then, the initial TARP “recapitalizations” did nothing, and nothing happens until the conversion. You can’t say that JPMorgan got $25 billion of capital last fall and it’s going to get another $25 billion now just by virtue of the conversion.
  • Tangible common equity and Tier 1 capital are just two ways of measuring the health of a bank. Taking money that wasn’t TCE and calling it TCE doesn’t serve any economic purpose. There is a minor benefit to the bank because now it doesn’t have to pay dividends on the preferred. But otherwise you’ve just shuffled together the claims of the last two groups of claimants – the preferred and the common shareholders. You’ve made things look better from the perspective of the common shareholders as a group, because they no longer have preferred shareholders standing in front of them, but the total amount available to all shareholders hasn’t changed.

Is there another way to explain this even more simply?

Update: I made a mistake in interpretation last night. They aren’t floating a possible strategy here; this is already what is going to happen. I forgot that the Capital Assistance Program already announced by Treasury – the mechanism for giving more capital to banks that need it after the stress tests – specifies the use of convertible preferred shares. So imagine you are a bank with $5 billion in TARP capital already. You issue $5 billion of convertible preferred under the CAP, use the proceeds to redeem the initial TARP, and then – if and when you choose – convert the convertible preferred into common. So the mechanism to do it is there already. I guess they are floating the spin to see if anyone believes this would actually make healthier banks.

Update 2: In case it wasn’t clear from the above, I don’t have any problem with converting preferred for common. I am probably mildly in favor of it, even, for roughly the same reasons as Matt Yglesias: as a taxpayer, I’d rather have the upside and control that come with common shares.

By James Kwak

Our Fate Is in Their Hands?

Last month, Representative John Shimkus spoke out against regulating carbon dioxide emissions on the grounds that carbon dioxide is plant food. “So if we decrease the use of carbon dioxide, are we not taking away plant food from the atmosphere?” Shimkus is on the House Subcommittee on Energy and Environment, which means he has a vote on these issues.

In the wake of a financial and economic crisis of at least generational magnitude, our government will be rewriting the rules of the financial industry. And “our government” includes not just the pedigreed scholars in the executive branch (Larry Summers, Christina Romer, Austan Goolsbee, etc.), but Congressional representatives like John Shimkus – “like” in the sense that they were selected for their jobs, and for their committee seats, in exactly the same way that Shimkus ended up discussing the crucial role of fossil fuels in sustaining plant life on this planet. And when it comes to legislation, Summers, Romer, and Goolsbee have exactly zero votes between them; Shimkus has one.

Continue reading “Our Fate Is in Their Hands?” →

New Day, New Bank, Worse Story

It’s a beautiful day today, and after Goldman and JPMorgan, I don’t feel like diving deep into Citigroup’s earnings release. But judging from the Bloomberg article, it’s a similar story, just not as good.

1. All the good news was in fixed income trading: $4.7 billion in fixed income trading revenues; falling revenues in credit cards, consumer banking, and private client.

2. Assets continue to deteriorate: $5.6 billion in new writedowns in trading accounts; $3.1 billion in charge-offs and reserves for bad credit card debt.

3. Accounting fictions save the day (the new bit): $0.6 billion in losses that don’t have to be classified as other-than-temporary (and therefore affect the income statement) thanks to FASB; $2.5 billion in “profits” because of the fall in the value of Citigroup’s own debt. The theory behind the latter is that Citi could go into the market and buy back all of its distressed debt, which would be cheaper than paying it off at 100 cents on the dollar. Also: $0.4 billion in litigation expenses avoided (previously reserved) and tax benefits from an IRS audit.

Point 3 adds up to $3.5 billion, which dwarfs Citi’s $1.6 billion  profit. Why is everyone so optimistic about banks these days?

By James Kwak

Who Had This Good Idea First? (A Weekend Comment Competition)

In early February, James proposed that bankers’ bonuses be paid out in “toxic assets” – after all, the industry was arguing that these would definitely rebound (“it’s just a liquidity problem”) and that their “true” value was substantially above current market value.  The idea was well received by our readers but not so much by the banking or insurance industry.

Someone quickly pointed out that – back in December – Bloomberg reported Credit Suisse would actually use a version of the same idea.  And, in the whirlwind of the fall, I now vaguely remember this same point coming up even earlier in some bigger discussion.

So in the spirit of proper attribution (also because a reader asked and I’d like to know the answer), here is our first ever weekend “comment competition”.

Who really originated this (very good) idea, either in private discourse or – easier to document – in a public comment, blog post, corporate document, or the like?  We’d also welcome updates on where any form of this idea is being used in practice.

By Simon Johnson