Category: Commentary

The Department Of Justice Is On Line Two

I don’t generally overreact to news (from the NYT this morning, on the AIG-Goldman connection that runs through Edward Liddy’s stock ownership), but this has gone far enough. 

Have we completely lost of sense of what is and is not a conflict of interest?  Have we really built a system in which greed fully overshadows responsibility?  Is it not time for a complete rethink of what constitutes acceptable executive behavior?

One of our country’s leading corporate attorneys made a telling point to me on Wednesday night, “the only way to control executive behavior is to criminalize it,” i.e., civil penalties do not change behavior – the prospect of jail time has to be on the table.  His broader point was that antitrust action can make a difference in today’s world, but only if this includes potential criminal charges. Continue reading “The Department Of Justice Is On Line Two” →

New Day, New Bank, Same Story

JPMorgan Chase reported its quarterly earnings today. The headline was $2.1 billion in net income, beating analysts’ estimates. Behind the headlines, it was similar to the story that Goldman told earlier this week: a huge jump in fixed-income trading, status quo everywhere else, and continuing writedowns. For example, if you look at the breakdown of revenue by type of activity (not line of business) on page 4 of the supplement, you’ll see that revenue was flat or down in every category except one: principal transactions, where it jumped from a loss of $7.9 billion to a gain of $2.0 billion. That $9.9 billion improvement more than explains the entire increase in pretax profit from negative $1.3 billion to positive $3.1 billion.

As with Goldman, it was clearly a good quarter for JPMorgan; making money beats losing money any day. But the question to ask is whether it is sustainable, either for JPMorgan or for the banking industry as a whole. To answer that question, here are some pictures.

Continue reading “New Day, New Bank, Same Story” →

Forecasting The Official Forecasts, Spring 2009 Edition

Our forecast of official growth forecasts back in the fall turned out to be fairly accurate.  My update of this assessment – for the new IMF numbers due out next week – is now online at NYT.com.

Many officials seem to have bought into some version of the “it’s a V!” take on the global recession.  To me, this looks like wishful thinking.  Whether or not you support the “V” view fully, officials should surely be spending more time preparing for worse scenarios. 

Just in case – why not prepare properly for the cross-border resolution issues that would arise from the failure of a major global bank?  Why did the G20 decline to take on this issue properly?  Even the IMF’s baseline, I expect, will suggest potentially serious problems ahead.

Bring In The Antitrust Division (On Banking)

In early February I suggested there was a showdown underway between the US Treasury and the country’s largest banks.  Treasury (with the Fed and other regulators) is responsible for the safety and soundness of the financial system, the banks are mostly looking out for their own executives, and the tension between these goals is – by now – quite evident.

As we’ve been arguing since the beginning of the year, saving the banking system – at reasonable cost to the taxpayer – implies standing up to the bankers.  You can do this in various ways, through recapitalization if you are willing to commit more taxpayer money or pre-packaged bankruptcy if you want to try it with less, but any sensible way forward involves Treasury being tough on the biggest banks.

The Administration seems to prefer “forbearance”, meaning you just ignore the problem, hope the economy recovers anyway, and wait for time or global economic events to wash away banking insolvency concerns.  But this strategy is increasingly being undermined by the banks themselves – their actions threaten financial system stability, will likely force even greater costs on the taxpayer, and demonstrate fundamentally anticompetitive practices that inflict massive financial damage on ordinary citizens. Continue reading “Bring In The Antitrust Division (On Banking)” →

Is Goldman Really That Good?

Goldman Sachs released its quarterly earnings yesterday, and the headline was  net income of $1.8 billion, doubling analysts’ estimates. I would say this is definitely good news for Goldman; whether it’s good news for the banking sector as a whole is more uncertain.

First, as Bruce Wayne, one of our readers, pointed out, the quarter-over-quarter comparisons left out December. Because Goldman just changed its fiscal year end, its previous quarter ended in November and its latest quarter ended in March. December was reported separately and – surprise, surprise – Goldman took a net loss of $0.8 billion. So if they had mashed December into Q1, they would have had a four-month “quarter” with $1.0 billion in profits.

Second, the positive results probably reflect a better mix of businesses than other banks enjoy. Although Goldman has made big one-sided bets, its trading operation traditionally hedged many of its positions and made a lot of its money on volume. Its positive Q1 results were largely due to strong performance in fixed income, currencies, and commodities (FICC) trading, which reflects the fact that Q1 was a busy quarter – in part because of the massive unwind at AIG – and, as Goldman’s CFO politely said, “Many of our traditional competitors have retreated from the marketplace.” With fewer players in town, the oligopoly profits go up – another reason why the big banks are even more powerful than they were before the crisis.

When it comes to the value of its own investments, Goldman seems to have done less well. Its net revenues for principal investments, mainly “Other corporate and real estate gains and losses,” were negative $1.4 billion in Q1 and negative $0.8 billion in December. While Goldman was able to more than offset this with trading gains, I wonder what the implication is for commercial banks that are not dominant players in trading.

(The FT also raised an eyebrow at the fact that per-employee compensation in Q1 was much higher than in the year-earlier period. That actually doesn’t worry me, because I’m guessing those compensation expenses are bonus accruals – the better the quarter you have, the more money you have to set aside for year-end bonuses.)

By James Kwak

The Bank Run Next Time (Frankenstein’s Monster)

Think about the current and potential future pressure on our largest banks like this.  The underlying problems are deep, but the “run” comes from the credit default swap market, and presumably from experienced professional investors – many of whom used to work in the largest banks. 

The big banks helped set up these markets.  They trained many of the people who are now engaged in speculative attacks on these banks.  And the excessive bonuses of yesterday form the capital base for many hedge funds that now lead the attack.

In my Economix column at NYT.com this morning, I explore the ironies and emphasize the dangers.  The system may have a tendency to self-destruct, but don’t think that the costs to the rest of us will be anything less than huge.

Calling All Shareholders

If you cast your mind back to when executive compensation and bonus limits first reached the mainstream debate, you may recall people saying these would be ineffective and the issue is a red herring.

These points do not now seem compelling.  People who work at the big banks are quite irked by what they see as unjustified limits on their bonuses.  Some of the “talent” is jumping ship.  Big bank leadership is lobbying hard to remove the restrictions or, failing that, for the right to pay back government TARP funds in order to escape the bonus cap – leading firms, such as Goldman Sachs, seem poised to raise new capital to that end.

This is a remarkable moment.  Excessive risk taking in large firms was based on inappropriate bonus structures (take risk and get compensated now; face the consequences of that risk down the road), facilitated by a deep failure to understand/control risk inside these organizations and probably made possible by the implicit put option from being too big or too complex to fail (i.e., Wall Street insiders own the upside; taxpayer owns the downside).  We have all focused of late on the costs for taxpayers, which of course are horrible, and going forward – with the implicit option now explicit – who can believe this will lead to anything other than further massive bailouts?

But think about this arrangement from the perspective of shareholders.  Are we looking at the greatest tunneling scheme in the history of organized finance? Continue reading “Calling All Shareholders” →

$3.5 Million or $5 Million?

In the midst of a severe economic crisis that is, among other things, depressing federal tax revenues and adding to the national debt, the debate over the estate tax has flared up again. The basic question is whether the exemption will be raised from $1 million – where it was in 2002-03 and where it is scheduled to return after the Bush tax cuts expire – to $3.5 million (Obama) or $5 million (Lincoln-Kyl) per person; there is also disagreement over whether the marginal rate should be 35% or 45%. (Note that even with Obama’s proposed 45% tax rate, the average effective tax rate on estate would be 19%, because of the $3.5 million exemption.)

There is plenty of debate over this already, so I will confine myself to three points.

Continue reading “$3.5 Million or $5 Million?” →

Why Bail Out Life Insurers?

That’s the question I woke up with this morning. Sad, isn’t it.

The Wall Street Journal reported this week that Treasury will soon announce that it will use TARP funds to invest in life insurers, or at least those who snuck under the federal regulatory umbrella by buying a bank of some sort. The argument for the bailout is a version of the “No more Lehmans” theory: the failure of a large financial institution could have ripple effects on other financial markets and institutions that could cause systemic damage. For a bank, the ripple effect is primarily caused by two things: (a) defaulting on liabilities hurts bank creditors, and (b) defaulting on trades (primarily derivatives) hurts bank counterparties, if they aren’t sufficiently collateralized (think AIG).

My thought this morning was that life insurance policies are long-term liabilities that are already guaranteed by state guarantee funds, so we don’t have to worry about (a), and hopefully most life insurers were not doing (b) – large, one-sided bets on credit risk like AIG. So why not just let them fail and let the states take over their subsidiaries? But then I checked the facts, and it turns out that the limits on state guarantee fund payouts are pretty low. So the scenario is this: you hear bad things about your life insurer, you decide to redeem your policy (usually at a significant loss to yourself), turning it into a short-term liability, and then the insurer has to start dumping assets into a lousy market, pushing the prices of everything further down and hurting everyone holding those assets. Would this really cause a systemic crisis worse than we’ve already got? I don’t know, but no one in Washington wants to take that risk.

Continue reading “Why Bail Out Life Insurers?” →

The Economy and Popular Democracy

One of the central themes of the current economic crisis has been the cozy relationship between “Wall Street” and Washington that resulted from both ideological convergence and old-fashioned campaign contributions. Another theme, as Simon discussed yesterday, has been the absence of a simple left-right axis for opinions to coalesce around. If you think that fixing the banking sector requires a government conservatorship and forcible balance sheet cleanup – rather than periodically dribbling large amounts of cash into institutions and management teams that have already failed by any free-market measure – it’s not clear who your advocates in government are.

Tomorrow, however, you can stand up and be counted. A New Way Forward is organizing demonstrations all around the country, most at 2 PM Eastern Time. The basic message is simple: “If it’s too big to fail, it’s too big to exist. Dismantle the power of the financial elite and make policies that keep a new crop from springing up. We want our economy and politics restored for the public.”

And don’t forget your pitchfork. (Just kidding.)

Does The US Still Face An Emerging Market-Type Crisis?

The US has developed some features more typically seen in an emerging market, including disproportionate power and system-threatening activities in the finance sector.  In fall 2007, the US (and the world) experienced the kind of precipitous fall in credit, output, and employment that was, in modern times, seen only in “emerging market crises”.  Our first Baseline Scenario was controversial and largely dismissed when it first appeared on September 29, 2008, but many of its arguments and policy recommendations have now been absorbed into official thinking (at least in the US).

Is the US out of the emerging market-type woods?  Can we now rule out the possibility of a great depression?  Such a severe economic outcome is not currently our baseline view (e.g., as discussed in this NBR interview), but it is still a downside scenario that needs to be taken seriously – and, at least in our interpretation – this is also the view of Bernanke’s Fed (see our piece on Sunday and the profile in yesterday’s Washington Post.)

Why is a depression scenario still on the table? Continue reading “Does The US Still Face An Emerging Market-Type Crisis?” →

What Next For Banks?

The case for keeping banks in something close to their current structure begins to take shape.  It’s not about traditional claims that big banks are more efficient, or Lloyd Blankfein’s argument that this is the only way to encourage risk-taking, or even the House Financial Services Committee view that immediate resumption of credit flows is essential for preserving jobs. 

Rather, the argument is: those opposed to banks and bankers are angry populists who, if unchecked, would do great damage.  Bankers should therefore agree to some mild reforms and more socially acceptable behavior in the short-run; in return, the centrists who control economic policymaking will protect them against the building backlash.  This is a version of Jamie Dimon’s line: “if you let them vilify us too much, the economic recovery will be greatly delayed.”

There are three problems with this argument: it is wrong, it won’t work, and it doesn’t move the reform process at all in the right direction. Continue reading “What Next For Banks?” →

Is It a V?

Yesterday, at the Peterson Institute for International Economics, Mike Mussa and I discussed – and debated – the likely shape of the US and global economic recovery.  Mike has great experience and an outstanding track record as an economic forecaster.  His view is that the entire post-war experience of the US indicates there will be a sharp rebound.  Victor Zarnowitz apparently stressed to Mike, a long time ago, “deep recessions are almost always followed by steep recoveries.”

I completely accept the idea that a slow or L-shaped recovery for the US and at the global level would be something outside the realm of experience over the past 50 years.  I would also suggest that the financial crisis in fall 2008, the speed of decline in the US, and the synchronicity of the slowndown around the world over the past 6 months has also surprised everyone (including most officials) who think that we are always destined to re-run some version of the post-1945 data. Continue reading “Is It a V?” →

Inflation Prospects In An Emerging Market, Like The U.S.

There are two ways to think about inflation in today’s economy.  The first, suggested by conventional macroeconomic frameworks for the US, is that, with rising unemployment and actual output sinking further below “potential” output, inflation will stay low – and we could actually experience the dangers of falling wages and prices (think what happens to mortgage defaults in that scenario).  This is the view, for example, expressed by Fed Vice Chair Don Kohn last week, and the Obama Administration seems to be on exactly the same page – talking already about a further very large fiscal stimulus.

Some people in this camp do see a danger of inflation, down the road, as the economy recovers – and resumes its potential level (or growth rate).  As a result, many of them stress that the Fed will need to start “withdrawing” its support for credit and raising interest rates as soon as the economy turns the corner.  One informed insider’s reaction to our piece on Ben Bernanke in the Washington Post on Sunday was that we were too easy on Bernanke for failing to tighten monetary conditions as the economy began to recover after the last big easing earlier this decade (specifically, our correspondent argues that Bernanke provided the intellectual underpinnings for what Greenspan wanted to do.)

In today’s post-G20 summit situation, some of my former IMF colleagues are worried that further monetary easing around the world will create inflationary pressure in middle-income emerging markets, where inflation is often harder to control than in richer “industrial countries.”  But if you think the broader political and economic dynamics of the United States have become more like those of emerging markets, e.g., the concentrated power of the financial elite and their ability to access corporate welfare, doesn’t that also have potential implications for inflation?

Continue reading “Inflation Prospects In An Emerging Market, Like The U.S.” →