Spring Break

My school is on break this week, so I’m taking some time off from now through Wednesday or Thursday. I probably won’t write anything very involved, but I will try to point out a few things I’ve been reading.

On that note, I finally read Amartya Sen’s essay “Capitalism in Crisis” from The New York Review of Books. The article meanders through a variety of topics, but two of the broad themes are: the economic systems we call “capitalist” involve much more intertwining of free markets and nonmarket goods and services (education, health care, pensions, etc.) than most people realize; and we need less to invent a new form of capitalism than to understand better the one we already have.

Nationalization and Capitalism

This is my last post on nationalization for at least a week, and hopefully a lot longer than that. I’m tired of writing about it. But I was listening to Raghuram  Rajan on Planet Money, and things became a little more clear to me.

Rajan was saying that he had some concerns about nationalization and didn’t think it was necessary to fix the banking system. His concerns were sensible, I have counter-arguments for them, and I don’t want to get into a detailed debate here. More importantly, he agreed with the nationalizers that the system is broken, hasn’t been fixed, and needs to be fixed – he just thinks you could do it a different way.

Continue reading “Nationalization and Capitalism” →

Bernie Madoff Day

As Bernie Madoff goes to his reward today, we should be asking how this could have happened. Not only Madoff and Allen Stanford, but also dozens of “mini-Madoffs” have been unearthed since the market collapse in September and October, which seems to have reminded the SEC that it has an law enforcement function. Not surprisingly, regulators are ramping up their enforcement divisions, and Congressmen are planning legislation to increase enforcement budgets.

A little late to close the barn door.

While Christopher Cox, SEC chairman from 2005 until this January, makes an obvious target, there is a deeper phenomenon at work than just the Bush administration’s hands-off attitude toward corporate fraud (an attitude largely shared by the Clinton administration). That is the general tendency of people – investors and officials alike – to underestimate the risk of fraud during a boom and overestimate the risk of fraud during a bust.

Continue reading “Bernie Madoff Day” →

The Real Halls of Power

Move over, Bill Moyers.* Simon is going to be on Stephen Colbert tonight.

If you have predictions about what Colbert is going to want to talk about, or ideas for witty comebacks, please post them. I believe Simon is traveling but will check in around 6 pm Eastern.

* Just kidding. Bill Moyers is one of our finest public servants.

Looting Goes Mainstream (Media)

A week ago, Simon wrote his “Confusion, Tunneling, and Looting” post, which argued that the confusion created by crises helps the powerful and well-positioned siphon assets out of institutions and out of the government. The revelations that much of the AIG bailout money has gone straight to its large bank counterparties in the form of collateral could fall under this heading.

The looting theme has gone mainstream, with David Leonhardt in The New York Times. I think Leonhardt’s article is good, but it describes looting (taking advantage of implicit government guarantees to take excessive risks) as a cause of the mess we are now in – and as something we’ll need to worry about in preventing crises in the future. But, as Simon argued, it’s also something to worry about right now. As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been. So whatever perverse incentives helped bring on the crisis are even stronger today.

But Are They Buying It?

As Simon wrote this morning, the administration strategy is to wait and see if the economy turns around, lifting banks out of the mess they created. How can you tell if this is working? One way is to look at bank bonds.

If the administration is right and the banks are healthy (and to the extent they aren’t healthy, their capital will be topped up with convertible preferred shares), then bank bonds are safe. Even subordinated bonds (the ones that get paid off after senior bonds and insured deposits) are protected by the bank’s capital – both common and preferred shares. So if the administration is correct that the banking system is adequately capitalized, and will be even more adequately capitalized after the stress tests and capital infusions, then banks will be able to pay off all of their bonds.

Even if the administration is wrong and the banks are not adequately capitalized, bondholders are only in danger if the administration decides not to protect them. This could happen in one of two ways. First, the administration could request, as a condition of a future bailout, that bondholders exchange some of their debt for equity. There is no law that says that bondholders have to exchange their bonds for equity just because the government asks, so the threat would be that the government would not bail out the bank otherwise (forcing it into bankruptcy or conservatorship).* Second, the administration could take over the banks; in that case, the regulator might decide not to pay back all of the bondholders – but it certainly could decide to pay them back. It’s just a question of whether losses are borne by the bondholders or the taxpayer (assuing the equity holders have been wiped out).

So what does the bond market think?

Continue reading “But Are They Buying It?” →

That Worked (?)

At last, our long wait to learn the Administration’s policy on banking is over.  The policy is: wait. 

This message comes from Bernanke, Geithner, and other officials over the past few days.  And, in this season of attempted policy message convergence within the G7 (it happens or tries to happen twice a year, ahead of the IMF/World Bank ministerial meetings), it is what we are starting to hear on all sides (e.g., from Trichet, head of the European Central Bank): we’ve done a lot, our economies might recover, and we don’t want to overdo it.  So we’ll wait.

Looking just at the US economy or just at the Eurozone, this might make sense.  But recognizing at what is heading our way from Eastern Europe and other rapidly slowing parts of the global economy, “the risks are weighted to the downside” (an official euphemism that you will hear frequently in the coming weeks).  And the market is not so easily convinced that all is now well or even significantly better. Continue reading “That Worked (?)” →

Financial Crisis Macroeconomics for Beginners

(For a complete list of Beginners posts, see Financial Crisis for Beginners.)

If you want to get caught up on the financial and economic crisis in a hurry (and get a quick refresher on first-year macroeconomics), Charles Jones has a drafted a new chapter on the crisis for his macroeconomics textbook. (If you’ve already read all of our Beginners posts, though, hopefully you won’t need to get caught up.) It’s 43 pages long (not very many words per page, though) and includes a relatively standard account of how the crisis came about (with a focus on the U.S. housing bubble), the impact on the real economy, and the thinking behind monetary policy, the fiscal stimulus, and the main proposals to fix the banking system. (Perhaps wisely, he doesn’t say which proposal – buying toxic assets, recapitalization, or reorganization – he recommends.) There is a discussion of what the crisis looks like in IS-LM terms – the main change from the standard version being the jump in the risk premium, which undermines the Fed’s ability to reduce effective interest rates. He also discusses the “zero bound” on nominal interest rates, in case you were wondering what that meant.

I think there should be a lot more on the crisis outside the U.S., for two reasons: first, it’s hitting harder in most other countries; and second, with so many countries being affected in so many different ways (Eastern Europe bubbles collapsing, China and Japan losing demand for exports, Russia hit by falling commodity prices, Iceland crashing under a hypertrophied banking sector), there would be lots to write about.

Jones even closes with a note of optimism:

Whatever happens in the coming years, it is worth remembering a key fact about the Great Depression, in evidence on the cover of the macroeconomics textbook . . . Even something as earth-shaking as the Great Depression essentially left the long-run GDP of the United States largely unaffected.

Update: I meant, but forgot, to add that Jones does not attempt to address the question of whether macroeconomics as a field needs to be revised in the light of the crisis. Mark Thoma has several posts on this question: a few are here, here, and here.

The World Bank And The Stress Test For U.S. Banks

Forecasters at international organizations often find themselves in a delicate position.  On the one hand, they have unparalleled access to hard data and intelligence about what is happening in every corner of the world economy.  On the other hand, their main shareholders – the US and larger European countries – do not want to hear predictions that are inconsistent with their own preferred baseline.

And, in the case of the US today, nothing could be more sensitive: it’s a relatively optimistic baseline, with a quick bounceback next year, that underpins the mild “stress scenario” being used for banks.  So if the World Bank or the IMF said that the world economy is going down and not coming back any time soon, that would raise major issues.

The World Bank clearly wants to speak truth to authority on this occasion, but can’t quite get the job done. Continue reading “The World Bank And The Stress Test For U.S. Banks” →

Nationalization for Beginners

“Nationalization” has been the word of the last month, with support not only from the usual suspects, but from Lindsey Graham, Alan Greenspan, and (to some degree, although they won’t say the word) Richard Shelby and John McCain. However, different people ascribe different meanings to this word; in particular, opponents like to define nationalization as the government taking over every bank permanently and turning banking into a government service.

As I see it, there are at least five different meanings of nationalization.

Continue reading “Nationalization for Beginners” →

President Obama’s Implied Future For Derivatives

If you’ve worked on economic policy formulation – or in any large bureaucracy – you know how to get your boss to make the decision you want.  The key is to frame the options in such a way that he or she feels that your preferred course of action is the only plausible direction.  Alternatives need to be undermined or discredited.

Smart bosses know this, of course, and they seek out sources of information or analysis that are not managed by their subordinates.  The problem is that, traditionally, most such sources are not sufficiently well informed, at a detailed level, to be really helpful in the decision-making process.  The format of most mainstream media – 800 words for the general reader, 4 minute stories, etc – does not allow engagement at the technical level; and, to be honest, technocrats are very good at manipulating the information flow to even the best journalist (who is usually a generalist).  And while there are always outside technical domain experts, research papers appear with a lag and op eds usually have a broad brush (again, a format constraint).

Seen in this context, President Obama – on the face of it – has the role of blogs exactly backwards.  But perhaps he is instead telling us something more profound. Continue reading “President Obama’s Implied Future For Derivatives” →

Everyone Has a Banking Plan Now

Another day, another banking plan, this one from two senior partners at McKinsey and Company, which may be the most influential company you may never have heard of.

The authors recognize the toxic-asset pricing problem: If the government buys them at market value, the banks become insolvent instantly; if the government pays book value, it is paying a massive subsidy. They also recognize the rough scale of the problem, predicting another $1 trillion in writedowns. And here’s the proposal:

[W]e propose that the government step in and establish a voluntary program to create a real market price and terms for the sale of bad assets. Rather than use modeling for valuation, the program would set discounts from either of the two basic approaches to accounting value [fair value and “hold-to-maturity,” which isn’t quite accurate, but that doesn’t matter], based on some recent past date (for instance, December 31, 2008). A reasonable level might be 10 percent off for securities already marked to fair value and 20 percent off for loans being held to maturity. Upon their sale to the government, existing shareholders would absorb the loss taken on the discount, and that loss of common stock value would be replaced by converting TARP preferred stock to nonvoting common (which would be vested with voting rights if sold to private parties).

Continue reading “Everyone Has a Banking Plan Now” →