Category: Guest Post

A Whiff of Repo 105

The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here).  Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.

To the uninitiated, the term ‘Repo 105’ evokes the name of a basic finance course or perhaps an expensive perfume.  However, the broader implication of Lehman’s corrupt accounting strategy is neither simple nor does it pass the smell test.

While hiding $50 billion off balance sheet is nothing to sneeze at, ‘Repo 105’ may be an unfortunate distraction. We should focus our attention on a far more mainstream and dangerous use of repurchase agreements backed by securitized bonds to grow balance sheets. This practice, enabled by a 2005 legal change, directly destabilized the financial sector and led to the ultimate credit crisis of 2008. In other words, the approximately $7-10 trillion repo financing market created what Gary Gorton and Andrew Metrick call the “run on repo” or what Gerald Epstein describes as a “run on the banking system by the banking system.”

A repurchase agreement or “repo” is a two-part arrangement. The seller (cash borrower) agrees to sell securities at a slight discount to a buyer (cash lender). Under that same agreement, that original seller agrees to buy them back at a future date at a higher price. The securities are known as “collateral.” The discount is known as the margin or a “haircut.” The ratio between the increase in price and the original price is known as the rate.

With ‘Repo 105,’ Lehman, according to volume III of the examiner’s report, acting as a seller (cash borrower), treated $50 billion in repo transactions as sales instead of financing transactions. Lehman did not reveal to investors that it was doing so. In contrast, standard practice was to record these transactions on balance sheet by increasing both cash (assets on the left side) and collateralized financing (liabilities on the right side). Thus a properly recorded repo transaction results in both a larger balance sheet and also higher leverage ratios.

Not wanting to issue more equity to boost leverage ratios, Lehman instead chose a cosmetic solution. With ‘Repo 105,” near the end of a reporting period, Lehman treated the transactions as sales and used the cash proceeds to pay down other liabilities. This made the firm appear to have a smaller balance sheet and less leverage than it truly had. The transactions were called ‘Repo 105’ and ‘Repo 108’ in reference to the size of the haircut. In other words, for ‘Repo 105’ transactions, Lehman would provide collateral purportedly worth 105% of the amount of cash it received.

As we blame the bad apples at Lehman, we fail to see how recent legal changes brought about bigger problems in the repo markets and how instead of reversing these missteps, the law may instead amplify it. Indeed, as discussed below, language in the Dodd draft released Monday, March 15th suggests we have not learned some basic lessons.

Continue reading “A Whiff of Repo 105”

Are Health Insurers Worth Bashing?

This guest post was contributed by Andrzej Kuhl, a colleague of mine from a former life. Andrzej is a management consultant based in Montclair, New Jersey.  His company, Kuhl Solutions, helps improve the efficiency and effectiveness of operations in financial sector companies.

I am getting thoroughly frustrated with a facet of the health care debate – the singular focus on health insurers, with total disregard of other contributors to health care costs.  Yes, I am in total agreement with the concept of providing health insurance to folks who currently cannot afford it, or who do not have access at any cost (because of pre-existing conditions).  I also believe that the rate of increase of health spending needs to be significantly reduced.  But, I do not believe that we can achieve any meaningful health spending reduction just by bashing or financially squeezing the health insurance companies.

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Uncontrolled Lending to Consumers Spawned the Financial Crisis

This guest post was contributed by Norman I. Silber, a Professor of Law at Hofstra Law School, and Jeff Sovern , a Professor of Law at St. John’s University. They were principal drafters of a statement signed by more than eighty-five professors who teach in fields related to banking and consumer law, supporting H. 3126, which would create an independent Consumer Financial Protection Agency.  Some of the research on which this essay is based is drawn from an article by Professor Sovern.

Did under-regulated lending to consumers play a big part in destabilizing the financial system? Many knowledgeable people say yes, but Professor Todd Zywicki disagrees. (“Complex Loans Didn’t Cause the Financial Crisis,” Wall Street Journal, February 19, 2010).  He claims that the present troubles resulted from the “rational behavior of borrowers and lenders responding to misaligned incentives, not fraud or borrower stupidity.”

Professor Zywicki’s argument enjoys, at least, the modest virtue of technical accuracy, because many objectionable misleading sales practices and agreements that lenders used were, and continue to be, unfortunately, quite legal.  Lending practices may have been regularly misleading and confusing and reckless-but fraudulent?  Well, no, usually not unlawful by the remarkably low standards of the day.   But that in itself is an argument for saying consumer protection laws failed.

Continue reading “Uncontrolled Lending to Consumers Spawned the Financial Crisis”

How Supposed Free-Market Theorists Destroyed Free-Market Theory

This guest post was contributed by Dan Geldon, a fellow at the Roosevelt Institute.  He is a former counsel at the Congressional Oversight Panel and a graduate of Harvard Law School.

Over the past year, there has been much discussion about how the financial crisis exposed weaknesses in free-market theory.  What has attracted less discussion is the extent to which the high priests of free-market theory themselves destroyed meaningful contracts and other bedrocks of functioning markets and, in the process, created the conditions for the theory’s weaknesses to emerge.

The story begins before Wall Street’s capture of Washington in the 1980s and 1990s and the deregulatory push that began around the same time.  In many ways, it started in 1944.

Continue reading “How Supposed Free-Market Theorists Destroyed Free-Market Theory”

New Deal for U.S. Climate Policy?

This guest post was submitted by James K. Boyce, an economist at the University of Massachusetts, Amherst. He has been a proponent of a “cap-and-dividend” policy to curb global warming while protecting the incomes of American families.

Last Friday, Senators Maria Cantwell (D-WA) and Susan Collins (R-ME) unveiled the CLEAR (Carbon Limits and Energy for America’s Renewal) Act, which could break the impasse in the debate over U.S. policy on climate change (McClatchy coverage is here.)

CLEAR has won a favorable reception from a broad swath of the political spectrum, ranging from ExxonMobil to Friends of the Earth. The scroll of supportive statements on Cantwell’s website includes praise from the AARP, the American Enterprise Institute, former U.S. Labor Secretary Robert Reich, Alaska’s Republican Senator Lisa Murkowski, and

Continue reading “New Deal for U.S. Climate Policy?”

How To Kill OTC Derivatives Reform in Two Sentences

The post below, which looks like it could be extremely important, is by Mike Konczal, author of the popular (for those in the know) Rortybomb blog, a previous guest blogger on this site, and now a fellow at the Roosevelt Institute — James

Have lobbyists snuck another major loophole into the OTC Derivatives bill? This week the final touches are being put on Barney Frank’s financial regulation bill – H.R. 4173 – “Wall Street Reform and Consumer Protection Act of 2009.” One of the centerpieces of this reform is Title III: Over-the-Counter Derivatives Markets Act. And one of the goals of this reform would be to get as many derivatives as possible to trade on exchanges.

An initial hurdle for Barney Frank was what to do with an “end-user exemption.” This would exempt certain types of derivative buyers who use derivatives, say corporations hedging interest rate risk without speculating, from the extra scrutiny and regulation that comes with the exchange/clearing system. One of the narratives of financial reform so far has been that this initial end-user exemption was too large a loophole at first, and instead of just handling 10-20% of the market, it would let a large majority of the market sneak through, but ultimately Barney Frank was convinced by consumer groups and people pushing for stronger financial regulation and fixed this issue. See Noah Scheiber here in “Could Wall Street Actually Lose in Congress?” for this story, and it shows up as well in a recent profile of Barney Frank in Newsweek.

Continue reading “How To Kill OTC Derivatives Reform in Two Sentences”

Auto Race to the Bottom

This guest post was contributed by Raj Date, head of the Cambridge Winter Center for Financial Institutions Policy and a former McKinsey consultant, bank senior executive, and Wall Street managing director. For further information on the auto dealer exemption, see the recent study by the Cambridge Winter Center.

Over the past several months, Congress has debated ways to strengthen and rationalize consumer protection in financial services.  Central to that debate is the proposed creation of a new agency focused exclusively on this issue, the Consumer Financial Protection Agency (the “CFPA”).

Even among proponents, however, there are varying conceptions of the scope and function of the CFPA.  For example, the CFPA as envisioned by the House Financial Services Committee would exclude auto dealers from the CFPA’s coverage.  The Administration’s original proposal would have included them.  Starting this week, the Senate Banking Committee will have to wrestle with the same question.

They shouldn’t have to wrestle long:  Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA appears profoundly ill conceived.  Exempting auto dealers would simultaneously be bad for consumers, bad for industry stability, and bad for what remaining sense of free-market integrity we still have.

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How Well Prepared Are Americans for Retirement?

The following guest post was contributed by Andrew Biggs. He has studied the issue of retirement savings for a couple of orders of magnitude longer than I, so I wanted to give him the opportunity to outline his perspective on the topic. He regularly blogs on his own blog and, along with about four dozen other people, over here.

After our exchange regarding Tuesday’s blog on The Retirement Problem in the Washington Post (which started over at AEI’s Enterprise blog and continued here),  James generously offered to let me guest-post my thoughts on Americans’ level of preparation for retirement. Overall I’m not so pessimistic, although there are surely problems that must be addressed. But most of the detailed research out there points to problems, but not a crisis.

Both James’s analysis and my own response were built on relatively simple projections using stylized workers who pay into Social Security and participate in 401(k) plans. These illustrations are useful for fleshing out basic issues – plus, in this case, finding how the SSA’s online benefit calculator may have skewed some of the results.

But the best research on retirement preparedness is more involved than this. Most analysis of current retirees uses survey data, such as from the Health and Retirement Study (HRS), the Survey of Income and Program Participation (SIPP), the Fed’s Survey of Consumer Finances (SCF) and the Current Population Survey (CPS). Each survey has strengths and weaknesses.

In addition, broader models of the population are built using this survey data. These models allow for simulations of how policy changes affect current retirees, as well as projecting the population into the future. Such comprehensive models include the Social Security Administration/Urban Institute MINT (Modeling Income in the Near Term) model, the Congressional Budget Office’s CBOLT (CBO Long Term) and the Policy Simulation Group’s PSG suite of models, used by the Government Accountability Office and the Department of Labor for Social Security and private pension projections. While these models, like any others, rely on assumptions regarding a large number of factors, they are also the most closely scrutinized to ensure these assumptions are consistent with current trends.

Continue reading “How Well Prepared Are Americans for Retirement?”

Peter Fox-Penner Replies

On October 24, we published a guest post, “Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors,” by Peter Fox-Penner.  Below is his response to some of your more than 200 comments.

As a stuck-in-the-last-century guy, I’m remiss in not replying to the many comments to my guest post. As an I-O (industrial organization) economist, I learned a lot more than I contributed reading the many colloquies.  Here are just a few general observations stimulated by the discussion:

To start off, there seems to be agreement on the difficulty of measuring risk, either because there is no transparency and/or the instruments are so darn complex.  Incidentally, the best short piece I’ve ever read on the emerging science of systemic risk measurement is Andrew Lo’s Senate testimony; perhaps all of you have other good pieces.  The one thing I learned from Andrew’s piece is that we are a long way from knowing how to do it. Continue reading “Peter Fox-Penner Replies”

Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors

This guest post was submitted by Peter Fox-Penner, a leading expert on regulation at The Brattle Group.  The views expressed here are those of the author alone.

Improving the regulation of the financial sector is a prime topic of conversation amongst financial economists, and appropriately so.  Most agree that massive failures of financial regulation were one, if not perhaps the largest, cause of the 2008 meltdown.     

When the conversation turns to the specifics of what needs to be regulated, how regulation should work, and what agencies should be involved, the range of views is tremendous.  There is agreement that some kind of prudent regulation is needed, as is investor and consumer protection, but that’s about it.  Fueled by billions of dollars of lobbying and purchased research, everyone has their own idea.  One super-regulator?  Council of regulators?  Control bankers compensation schemes?  Exchange-trade them?  The cacophony is deafening. 

As an industrial organization economist, I think this discussion would benefit greatly from a consensus on the role and goals of financial regulation.  Paul Joskow, a dean in the IO economics community, recently noted that:

Continue reading “Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors”

What Is Consumer Freedom?

This guest post was contributed by Lawrence B. Glickman, who teaches history at the University of South Carolina. He put the fight for the Consumer Financial Protection Agency in historical perspective in his previous post on this blog.

A recent ad taken out by the “The Center for Consumer Freedom” marks the latest assault by business lobbyists and conservatives on the idea of consumer protection.  This organization’s motto — Promoting Personal Freedom and Protecting Consumer Choice — defines consumer freedom as “the right of adults and parents to choose how they live their lives, what they eat and drink, how they manage their finances, and how they enjoy themselves.”

Continue reading “What Is Consumer Freedom?”

Cash for Trash: Better Never than Late

The following guest post was written by Linus Wilson, a finance professor at the University of Louisiana at Lafayette, the media’s go-to guy on calculating the value of transactions between the government and the banks, and an occasional commenter on this blog. Linus also analyzes government-bank transactions at Seeking Alpha.

The U.S. government does few thing better than create debt.  After a year of talking about it, the government is going to have the chance to throw their good debt, Treasury bills notes and bonds, after bad, non-performing toxic loans and securities.  The Federal Deposit Insurance Corporation (FDIC) and the U.S. Treasury are going their separate ways on their cash for trash schemes at this point.  Accountants and investors should be wary of the big prices they see coming from the FDIC’s auctions, but taxpayers should be afraid of the U.S. Treasury’s efforts to re-inflate the securitization bubble.

Continue reading “Cash for Trash: Better Never than Late”

Consumer Protection Redux: The Lessons of History

For your Labor Day reading enjoyment, we bring you this guest post by Lawrence B. Glickman, who teaches history at the University of South Carolina and is the author of Buying Power: A History of Consumer Activism in America.

“We’re proposing a new and powerful agency charged with just one job: looking out for ordinary consumers,” said the president on June 17th.  The centerpiece of his proposed overhaul of the nation’s financial system, the Consumer Financial Protection Agency (CFPA), is designed to end what the president called “failure of…government to provide adequate oversight” by monitoring banking transactions, including mortgages, credit cards and checking and savings accounts. It did not take long for the predictable critics to denounce the agency with predictable rhetoric.  “It’s bad for the consumers,” said Steve Bartlett, president of the Financial Services Roundtable, a lobbying group for banks.  The institution will add “yet another regulatory layer” while advancing “the agenda of activist special interests,” according to the U.S. Chamber of Commerce.  The new agency represents “an unprecedented grant of power to mandate business practices” claims the American Bankers Association.

This is the language of conservative populism, a mainstay of the Republican party from Ronald Reagan to Newt Gingrich to Karl Rove. Conservative populism, wrote Jonathan Chait in the New Republic last year, “dismisses any inference that the rich and the non-rich might have opposing interests” and defines elites in cultural rather than economic terms as  “intellectuals and other snobs who fancy themselves better than average Americans.” Several decades of repetition have made this rhetoric familiar: federal efforts to help ordinary people–consumers–will inevitably hurt them; government is the problem rather than the solution; bureaucracy is “bumbling” (to use the words of a Crain’s New York Business poll about the proposed Agency); federal agencies designed to serve the public good actually serve narrow special interests.  It has been, in no small measure, through the ready deployment of this language that the Republicans have positioned themselves as simultaneously the party of big business and working Americans while denouncing Democrats as representing both intrusive government and elitism. This meme has been devastating for liberals since any expansion of government services can be dismissed with a quip–Bureaucrat!, Red Tape!, Nanny State!– rather than an argument. Recently, for example, Senator Lindsay Graham said that the American people would never tolerate the public choice option in health insurance because “you’ve got a bureaucrat standing in between the patient and the doctor.” For similar reasons, Senator Kit Bond dismissed the CFPA proposal as a “bad idea.”

Continue reading “Consumer Protection Redux: The Lessons of History”

Healthcare Rationing Is Good

This guest post was contributed by StatsGuy, a regular commenter on this blog.

In the current healthcare debate, Conservatives warn us that a single payer system will bring government rationing…  Progressives argue that we already have rationing, based on wealth.  Both sides are right, but both pretend that rationing is bad.  Yet as every economist knows, the allocation of scarce resources is the basis of economics itself.  The question is not whether we will have rationing – the question is how to structure a system of rationing that accomplishes our goals.

Two primary themes dominate this debate:

The Uninsured: In the past two decades, both the total number and the percentage of uninsured have increased in spite of some modest programs designed to expand coverage (like CHIP). (Original chart is here.)


The graph above, which extends through 2007, has surely worsened since 57% of US citizens are insured through their workplace (down from 63% in 2000) and unemployment increased from under 5% to 9.4% in the last couple years.

Continue reading “Healthcare Rationing Is Good”

Dean Baker’s Right To Rent

There’s another problem with trying to deal with the foreclosure problem – the most obvious solution, mortgage cramdowns, are very unpopular. They failed to pass last spring, and are probably even less likely to pass now. People don’t like thinking that they are rewarding those who made bad mortgage decisions. Very few people have ever come close to trading a credit default swap – every adult has had to make a choice about mortgages over the past 10 years, and rewarding, in the words of CNBC, “the losers” is a political no-go in the United States.

What is another choice? How about “Right To Rent”? Here’s Simon Johnson back in November of 2008 calling what would happen over the next 10 months and then suggesting a version of Right To Rent:

Washington is beginning to turn its attention to housing, and there is progress on plans to make it easier to modify delinquent mortgages where there is a win-win solution for the borrower and the lender.

At best, though, this is only a partial solution. Many homeowners will be unable to afford any mortgage that lenders will accept. Complicated relationships between servicers and secondary-market investors will make it difficult, impossible or illegal to restructure many mortgages…

In addition to limiting the number of foreclosures, it will be critical to manage the flow of foreclosed properties onto the market. Otherwise, the mounting wave of foreclosed condos and single-family homes threatens to push housing prices far below long-term sustainable levels, inflicting unneeded pain on homeowners and the economy…. Here are some ways to facilitate an orderly unwinding of real estate…

The borrower turns over the deed to the servicer and rents the property back from the mortgage investor for some period of time. At the end of the period, the renter can get a new mortgage from the investor at prevailing market rates if the borrower qualifies; if not, the property goes on the market.

I want to take that idea and flesh it out further. I think the best approach is the version suggested by Dean Baker’s, who also originated the idea, described here:

There is an easier route. In recognition of the extraordinary situation created by the housing bubble and its collapse, Congress could approve a temporary change to the rules governing the foreclosure process. This change would give homeowners facing foreclosure the right to stay in their homes, paying the market rent for a substantial period of time (eg seven to 10 years).

This change would have two effects. First, it would immediately give housing security to the millions of families facing foreclosure. If they like the house, the neighbourhood, the schools for their kids, they would have the option to remain there for a substantial period of time.

Also by keeping homes occupied, this rule change can help prevent the blight of foreclosures that has depressed property values in many areas. Vacant homes are often not maintained and can become havens for drug use and crime.

Dean Baker has had this proposal out there for a while, since at least 2007. Felix Salmon had it as one of his Fixing The World Ideas in The Atlantic Monthly. Some conservative economists, including Andrew Samwick have signed on, and there’s a version of a bill floating out there.

So what are the advantages? The foreclosure is avoided, keeping pressure off the community and not displacing a family. The rent is set by an appraiser to the neighborhood renting value, and reassessed whenever either the lender or borrower requests it at their cost. This prevents it from becoming a de facto form of rent control, while the externality effect of people losing the value of being able to sell their home because of foreclosures down the block has gone away, not to mention the more general social cost of abandoned housing.

Now is this a gift to those who made terrible decisions? No. As opposed to a normal foreclosure in most states, it is purposely designed so that any equity built up in the loan isn’t transferred over to the consumer. Normally if the bank sells your house for more than the loan outstanding plus fees in a foreclosure, you get the remainder. Not so with Right to Rent, the bank gets all that upside and the other party gets their equity wiped out.

Some versions of similar plans are designed so the bank is required to sell back to the renter first at a later date; I see no reason for this, as the bank will almost certainly offer it first to the people at the property if they can afford it. If they sell it to someone else however, the person still gets to rent their home. Personally I’d like to see the timeframe for the home rental to be on the order of 3-5 years, though that is debatable. Ideally it would also have accelerated eviction rules, so that people who couldn’t even afford the rent aren’t still living in said property.

This requires no taxpayer funding, and can be done in our very efficient bankruptcy courts. How great of a deal is that?

What are the downsides? It is an intrusion onto the property rights of the lender. The lender can still sell, but will sell with a tenant attached to the property. For the time being, the social costs being accumulated by neighborhoods as properties sit vacant is devastating, enough so that we need to take action. Lendors will become landlords, though there are a lot number of civic groups, third parties, businesses, etc. who can contract that labor out if it can’t be done in-house.

What are your critiques? Thoughts? Personally, in terms of our current political dialogue, I wonder if the type of social conservative who is willing to lock up large segments of the population to prevent a “broken window” from forming would be willing to ask a lender to take a small haircut to save the entire house from rotting in foreclosure, windows included. Nothing increases the “disorder” of a neighborhood than having foreclosed houses rotting away on them…