Be Careful What You Tweet

In Guatemala, at least. Various commenters on this blog have, at one time or another, recommended pulling your money out of those “too big to fail” banks that are getting so much government support. In Guatemala, Jean Anleu Fernandez was arrested and jailed for sending this out on Twitter:

First concrete action should be remove cash from Banrural and bankrupt the bank of the corrupt.

I guess he also said the bank was corrupt. Well, people have said that around here, too.

More broadly, the government is in crisis, with frequent popular protests, over allegations that Rodrigo Rosenberg was assassinated on the orders of the president because he uncovered evidence of murder and corruption by the government. 

Continue reading “Be Careful What You Tweet” →

More Bank Balance Sheets for Beginners

If you read this blog and listen to Planet Money, you may have had enough of this topic, but Calculated Risk pitched in with two posts on liquidity and solvency crises, complete with graphical balance sheet illustrations. He does a better job than I have of conceptually illustrating the workings of the various bank bailout plans that have been offered. 

This is his assessment of the current strategy:

The Geithner approach is to keep injecting capital into the banks to cover the losses. This is known as the “Zombie” bank approach. . . .

Although the bank is balance sheet insolvent, the bank will never be business insolvent [unable to pay its debts as they come due] because the government will continue to provide money to cover losses.

If only a small percentage of financial assets are held by zombie banks, then this approach will probably work. These banks will be crippled, but the other banks can meet the financing needs of the economy.

I should note that CR does not say the entire banking system is insolvent, or that any banks in particular are insolvent.

The posts are from late April but I missed them, probably because they were on my birthday.

By James Kwak

Guest Post: Interpreting The Indian Election

This guest post was contributed by Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics.  He notes two surprises in the outcome of India’s recently concluded election and suggests that India offers an alternative model of development for much of the world.

The results from the Indian elections point to a victory for the incumbent Congress party and its allies.  Congress was led de jure by the economist-turned-politician Dr. Manmohan Singh and de facto by the Italian-born Sonia Gandhi, who is part of the Nehru family, which has been a force in Indian politics since the late 1800s and provided three Prime Ministers.

Two casualties of the election have been the Communists who resisted economic policy reform and opposed the nuclear agreement between India and the United States, and the Hindu nationalist party, the BJP.

Going forward, these results augur well for Indian economic policy reform. The Congress will be numerically strong enough not to have to rely on partners for political support and will be able to push through new policy initiatives.

Another likely consequence is that the Nehru family will probably provide India, not immediately but within the next couple of years, with its fourth Prime Minister—Rahul Gandhi, son of Rajiv Gandhi, grandson of Indira Gandhi, and great grandson of India’s first Prime Minister Jawaharlal Nehru. 

These results are surprising for two reasons.  Indian elections have traditionally been characterized by the phenomenon of anti-incumbency: ruling politicians get routinely thrown out of power.  This government is the first in over 40 years that has been re-elected after a full term in office. Continue reading “Guest Post: Interpreting The Indian Election” →

Microsoft: Just Another Company

Earlier this week, Microsoft issued long-term debt for the first time in its history, selling $3.75 billion of  5-, 10-, and 30-year bonds. From a corporate finance perspective, I guess this makes sense, since it got to lock in historically low borrowing rates. Treasuries are low, and Microsoft paid only about one percentage point more than the U.S. government, which makes sense since it does have over $20 billion in cash, no other long-term debt, and – let’s not forget – a virtual monopoly on computer operating systems and basic desktop software. (In some ways, Microsoft looks like a safer place to lend mone than the U.S. Treasury, except for the ability of the latter to print its own money.) But it’s still a little sad.

Continue reading “Microsoft: Just Another Company” →

Peer Steinbrück’s Peers (Weekend Comment Competition)

Everyone has their favorite politician.  Mine is Peer Steinbrück, Germany’s Minister of Finance.  In terms of having inappropriate – but revealing – things to say at just the wrong moment, Mr. Steinbrück is world class.

This week he blasted the US bank stress tests as worthless.  Back in October 2008 he famously denied there was any problem in the European banking system, shortly before the G7/IMF weekend that culminated in European bank rescues.  And in early 2008 he and his subordinates castigated the IMF for suggesting that Germany and the eurozone could experience even a mild slowdown – have you seen the latest data?

This comment competition is straightforward.  Find the politician (or other leading public figure in any country) with the most untimely quote of the past 18 months.  We’re looking for hubris and denial, preferably 24 hours before an abrupt policy U-turn – so please indicate the precise context that makes the quote appealing.  If your choice is Peer Steinbruck, pick his most perfect moment.

By Simon Johnson

The Green Shoots Debate

Earlier today, Simon suggested that “we are out of the panic phase of the crisis.” Bond Girl said in response, “There appears to be some confusion between exiting the panic phase of the crisis and actually recovering.” That is something that I certainly agree with, and I suspect Simon does as well (although he may not agree with her entire comment.) 

There has been a lot of discussion of “green shoots” scattered around the Internet recently. Most of it, I think is premature. A lot of economic indicators seem to show that things are getting worse at a slower rate than before. One major source of optimism was last week’s jobs report, which showed a net loss of “only” 539,000 jobs. Here’s an excerpt from the New York Times coverage:

Yet the deterioration was milder than expected, prompting encouraging talk.

“The most intense spate of weakness is probably behind us,” said Michael T. Darda, chief economist at the research and trading firm MKM Partners. “Less bad is always a prelude to good. It’s going to take some time for this economy to get back on its feet, but we might be closer to the recession ending.”

Investors bought into that message, sending stock prices soaring.

To put this in perspective, I turn to the always-accurate Menzie Chinn (follow the link for a good picture):

Revisions are downward (but getting smaller over time), the growth rate becomes less negative, but hours continue to decline rapidly.

Continue reading “The Green Shoots Debate” →

Self-Defeating Marketing

Today I got a “Welcome Guide” from Bank of America because I was until recently a Countrywide customer. Countrywide, like many institutions that are in trouble, was offering some very high CD rates last year before being acquired by Bank of America, so I put money there – below the FDIC limit, of course – just like I put money at IndyMac and Wachovia shortly before they failed. (For people who like to chase high rates, I recommend Bank Deals.)

Anyway, this nicely designed welcome guide had a page titled “Clarity,” with this text:

We’re working to take the guesswork out of home lending with ideas such as our Clarity Commitment. This simple one-page loan summary clearly highlights key terms of each new loan. We’ve made it easy to read and easy to understand. So when you’re ready to buy or refinance, you can be confident that you’re choosing a loan that’s right for you.

Unfortunately, there’s a footnote that say, in very fine print:

This summary is provided as a convenience, does not serve as a substitute for a borrower’s actual loan documents and is not a commitment to lend. Borrowers should become fully informed by reviewing all of the loan and disclosure documentation provided. Not available on all products and programs.

I understand the value of high-level disclosures and the need for detailed contracts. But as a marketing message, this one seems to shoot itself in the foot.

By James Kwak

Is The Crisis Over Yet? The CBO Weighs In

Confidence is returning to most credit markets, consumer spending is likely to rebound for some items (autos and housing repair are leading contenders), and firms in the US are starting to sound more optimistic.  On NYT.com’s Economix yesterday, Peter Boone and I suggested that we are out of the panic phase of the crisis – in large part because the US fiscal stimulus has reassured people worldwide, but also because President Obama has had a broader calming effect.

Today, the Congressional Budget Office is pointing out that it would be premature to congratulate ourselves too much (disclosure: I’ve joined the CBO’s Panel of Economic Advisers, but none of the information here comes from them).  As you likely know, the administration is proposing to lend $100bn to the IMF, as part of that organization’s increase in resources following the G20 summit.  Peter Orszag, head of OMB, argued that there was zero probability of this money being lost, so $100bn should be “scored” for budget purposes as $0bn – which is how this kind of transaction has been handled in the past.  As the IMF likes to say, it is “the lender of last resort, but the first to be repaid.”

After considerable back and forth, the scoring issue was refered to the CBO.  The CBO has reportedly decided there is a 5 percent probability of default by the IMF.  This is an extraordinarily important statement.  Most informed people just assume that the risk of IMF default is zero, because that would essentially constitute a complete breakdown of the global economy and payments system.  But nothing is zero probability, particularly in a world of massive financial panics, incipient protectionism, and improvised global governance. Continue reading “Is The Crisis Over Yet? The CBO Weighs In” →

The Skirmish over Credit Cards

The Senate may be voting this week on a bill to tighten regulation of credit card issuers – or not, since you can never tell with the Senate. Despite an agreement between the ranking members of the Senate Banking Committee, there is a series of amendments from both sides to go through; Real Time Economics has a summary of the issues that were open as of earlier this week.

I wrote a post on The Hearing earlier describing the debate as one between two economic perspectives: classical economics (credit card issuers should be able to offer any terms they want; if people accept them, that by definition means it increases their utility) and behavioral economics (people suffer from cognitive fallacies, like thinking that they will never pay any of those fees threatened in the credit card agreement, so regulations should help people make better decisions and protect them from bad decisions).

Looking back over that post, it was far too balanced. There is a plausible theoretical argument that tighter restrictions have the effect of limiting the supply of credit to marginal customers, but that’s not what’s going on here. First of all, there isn’t much demand for credit these days. Second, it’s really about whether credit card issuers will be able to use increased interest rates and fees to partially offset their increased default rates. And of course, this isn’t going to be decided by economics, but by power. The more relevant question is the one that Simon was asked on MSNBC: “Do the banks own the Senate?”

Continue reading “The Skirmish over Credit Cards” →

New Forms of Internet Communication

Arnold Kling has developed a new form of communication across the Internet: he wrote a blog post entitled “Paging Simon Johnson and James Kwak,” pointing to a 2000 paper by a Federal Reserve economist on the usage of securitization and off-balance sheet entities to effectively lower banks’ capital requirements for the same level of asset exposure. According to Kling, “the article clearly shows that the Fed was aware of regulatory capital arbitrage (RCA)and it paints a largely sympathetic picture of the phenomenon.”

I haven’t sprung for the $31.50 to download the full article yet, but it is going on my reading list.

Kling also said he is “researching the history of capital regulation,” which is something I would also look forward to reading.

Update: One of my friends pointed out that my university has online access to lots of journals, including the one this paper was published in, so I now have a copy. 

By James Kwak

Can The US Save The World? (House Testimony)

Yesterday I testified to the House Subcommittee on International Monetary Policy and Trade (part of the House Financial Services Committee).  The hearing’s title was “Implications of the G-20 Leaders Summit for Low Income Countries and the Global Economy,” and the main topic was whether Congress should support an extra $100bn for the IMF that the Obama Administration agreed at the G20 summit in early April (witness list, webcast, and written testimony).

The committee was mostly in favor of the US continuing to play a leading role in supporting the IMF, but pressed the witnesses to explain whether the IMF could lose this money (highly unlikely), how this would protect American jobs (definitely, but hard to quantify precisely), and if the broader package of IMF reform should also be supported (e.g., the proposed gold sales are being reassessed, to see they could generate more resources for aid to developing countries).

Politico is reporting that US funding for the IMF is likely to be attached to the war supplemental spending bill.  The subcommittee’s chairman, Gregory Meeks, seemed positive – as did all the Democrats who spoke, along with Gary Miller, the Ranking Member/Senior Republican.  But, based on remarks made by at least two Republican members of the subcommittee, there is likely to be a big public fight at some point.  My guess is that the Democratic side will press hard for President Obama to more publicly explain why supporting the IMF (and the G20) is very much in the US interest.

The main points from my written testimony are below.  While Treasury represents the US vis-a-vis the IMF and traditionally has considerable scope for action, the views of Congress on IMF details are very important as both guidance and constraints.  In our advice on the wide range of IMF-related issues below, both I and the other witnesses laid out broadly similar views with varying emphasis – there was actually much more disagreement among committee members than at the witness table. Continue reading “Can The US Save The World? (House Testimony)” →

Law, Economics, and Regulation

One of the curious things about coming to law school was discovering the very high regard that “economics” is held in, at least in some areas like torts and contracts, where “law and economics” has become the primary theoretical construct. In essence, this school of thought holds either that the law has developed in such a way as to promote efficient economic outcomes, or that it should promote efficient economic outcomes. There is now an empirical branch of law and economics, but historically the law and economics approach was largely theoretical. For example, in United States v. Carroll Towing Co., 159 F.2d 169 (2d Cir. 1947), Judge Learned Hand wrote that the whether behavior is negligent should be determined by multiplying the probably of an accident by the cost of the accident and comparing that to the cost of taking precautions. Twenty-five years later, Richard Posner argued that this rule would lead to the optimal level of accident prevention, because it doesn’t make economic sense to pay more for accident prevention than the corresponding reduction in the expected costs of accidents; at that point, the firm would be better off just paying damages to accident victims. (There, now you don’t need to take first-year torts – just apply that principle everywhere.)

The Hand-Posner principle has filtered into the world of public policy and regulation as the argument that the benefits of regulation must exceed their costs. This argument is ascribed to Cass Sunstein, who “cruised through Tuesday’s Senate confirmation hearing” to be the “regulatory czar” in the new administration, which sounds much more powerful than “Administrator of the Office of Information and Regulatory Affairs” in the Office of Management and Budget. Sunstein is a widely respected law professor who specializes in just about everything (constitutional law, administrative law, regulation, and now behavioral economics – he co-authored Nudge – with a brief foray into the death penalty on the side).In principle, he would be able to review new regulations being defined throughout the executive branch. So the cost-benefit model of regulation – already favored by the previous administration – may become more firmly entrenched in the federal government.

Continue reading “Law, Economics, and Regulation” →

Vote For (Or Against) The IMF

The Washington Post is widely read on Capitol Hill and the reception among key people to The Hearing blog (run by us and the Post) has been generally very positive.   Members of Congress and their staff want to get you more involved in their discussions around economic policy, and we’re experimenting with ways that will help your opinions – whatever they are – get across at a time and in a manner that increases their impact.

To that end, we’re developing on-line polls in which you can register your views on questions that are currently being debated – either in general terms or as specific legislation – on the Hill (of course, longer comments are also welcome; it’s a blog, after all).  Today’s question is about whether the United States should provide an additional $100bn to the IMF, as was agreed at and immediately after the recent G20 summit; this is for a hearing held by a subcommittee of House Financial Services, which starts at 10am. Continue reading “Vote For (Or Against) The IMF” →

Antitrust For Banks? Ask Carl Shapiro

The Department of Justice seems to thinking, at least in principle, about potential antitrust action in and around banking.  Assistant Attorney General Christine Varney spoke about this yesterday, but her exact wording is open to interpretation, “”I have to ask if too big to fail is a failure of antitrust enforcement.”  (The press release was uninformative on this point)

More encouraging was the background briefing given to the New York Times, as seen in this paragraph,

“Ms. Varney is expected to say that the Obama administration will be guided by the view that it was a major mistake during the outset of the Great Depression to relax antitrust enforcement, only to try to catch up and become more vigorous later. She will say the mistake enabled many large companies to engage in pricing, wage and collusive practices that harmed consumers and took years to reverse.”

The thinking among antitrust experts has been that there is not much market power, conventionally defined, in financial services.  But this thinking may change, for at least three reasons. Continue reading “Antitrust For Banks? Ask Carl Shapiro” →

Insurance and Health Insurance

I’ve been meaning to write a post on health insurance ever since hearing Karen Tumulty on Fresh Air. (She was discussing her Time article on underinsurance.) I happen to think that a free market for insurance works pretty well in most circumstances (and I did co-found an insurance software company); for example, if you can afford the house, you can generally afford the insurance for the house. But it doesn’t work very well for health care, because many people are simply uninsurable under free market principles (expected health care costs exceed their income, let alone their ability to pay), and hence would be left to die. We think we have a private, for-profit insurance  system today, but we can only avoid its disturbing implications by hedging it in with public backstops and regulations.

Since the Senate Finance Committee is taking up health care reform this week, I finally wrote that post today for The Hearing.

By James Kwak