On Financial Events – A Notebook

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Policy oriented articles:

Murray Z. Frank (January 27, 2009) An ETF Detoxification.pdf  An economic approach to help solve the banking problem is described in general terms.

Murray Z. Frank and Dorothy Wong (September 21, 2008) Blank Check  When the original Treasury proposal for TARP came out we wrote this one opposing the proposal.


Obama Seen as Anti-Business by 77% of U.S. Investors.


Are the other 23% actually awake?


“Obama’s 71 percent unfavorable rating among U.S. investors is almost matched by two members of his economic team. Both Treasury Secretary Timothy F. Geithner and Lawrence Summers, president of the National Economic Council. U.S. respondents give Geithner a 63 percent unfavorable rating and Summers 67 percent. … One financial figure to find favor among U.S. respondents is Federal Reserve Board Chairman Ben S. Bernanke, who garners a 68 percent approval rating,”


So naturally today we learn, More Democrats Come Out Against Bernanke.


January 22, 2010


Fixing the Problem?


At the heart of the financial crisis was real estate.  Tons of folks bet big on the prices rising forever.  They did this with lots of encouragement and pressure from Washington and politicians of both parties.  Think Fannie, and Freddie and low interest rates from the Fed.  Then Paulsen and Bernanke turned the big problem into a major crisis with the TARP proposal and all that went with it.


So how are we going to fix this problem?  How are we going to make sure that we do not have a repeat?  By making sure that the banks that take consumer deposits cannot make prop trades?


Reinstating something akin to Glass-Stegall might be a good idea, or it might be a bad idea.  The details matter, and we do not yet have the details.  But it has virtually nothing to do with the crisis we have been living through. 


This is how stage magicians operate, you redirect the audience’s attention away from what is really going on.  Unfortunately this manufactured assault on the financial sector will have damaging real economic consequences.


Washington is actively and intentionally increasing the risk in the system. Risk has real consequences that are bad for economic performance.


Demagogues need villains to point at.  Apparently the bankers are being designated to play that role.


January 22, 2010


What they Say and What it Means


Washington Speak: “too big to fail”


Translation into English: We in Washington are not willing to keep our hands off your firm.  So, we are going to punish you, to make sure that you are not going to be allowed, to tempt us into misbehaving.


Washington Speak: “it’s a fight I am ready to have”


Translation into English: Please, please, please forget about Massachusetts and Health Care deals for Nebraska and for the unions.  The bankers are to blame (for pretty much everything bad).  

“But AIG wasn’t a bank. Neither Lehman Brothers nor Bear Stearns took consumer deposits. And the hundreds of billions in losses at Fannie Mae and Freddie Mac — as well as the destruction of Wachovia, Washington Mutual and Countrywide had nothing to do with prop trading.”

“That was caused by banks lending money to millions of Americans to buy houses they couldn’t afford. You won’t hear much of that coming from Washington. After all, “It’s Actually Your Fault, America” is not a good slogan for a re-election campaign.” obama-is-killing-america-by-killing-wall-street

January 21, 2010



The War Against Wall Street Returns


commercial banks would be prohibited from owning, investing in or advising hedge funds or private equity firms.” "Never again will the American taxpayer be held hostage by a bank that is too big to fail," Mr. Obama said Thursday.  Kill the Banks


“If these folks want a fight, it’s a fight I’m ready to have,” Obama said. Going to War?


Maybe they could try passing laws forbidding government bailouts instead? But of course, then the market might make decisions instead of Washington. That would never do.


Remember, the Great Depression, while very bad for Americans in general, was very good for the Democratic Party. Obama is apparently going to return to full demonization mode in an effort to redirect anger. 


January 21, 2010


What Comes Next?


Last night a Republican won the senate seat from Massachusetts.  This would normally be hard to fathom.  However, it is actually not so hard in this case.

1.  While unemployment has been rising, Washington has pursued erratic policies that have made unemployment worse.

2. They have been building up the national debt almost as fast as they can, thereby creating a longer term problem for the country.

3. The Health Care bills have scared the middle class – especially the young and the elderly.  The deal making has been unusually crass even by Washington standards.

4. Obama, both in rhetoric and in policy, has provided the most purely partisan governance in many decades. Just look at the voting divide.    


This is not how one convinces independents to go along.


It will be interesting to see whether Obama wants to become more like Clinton by turning to the center, or more like Carter and push ahead as if nothing has happened.  Whose votes matter more to Obama, Norway’s or Ohio’s?  We shall soon find out.


January 20, 2010


Beating the Bankers


This morning a bunch of the top bank CEOs have been testifying.

(http://online.wsj.com/article/SB10001424052748704362004575000752756113586.html?mod=WSJ_hps_LEFTWhatsNews). On CNBC I saw the first part in which Angelides the chair was being very aggressive in going after Lloyd Blankfein the CEO of Goldman Sachs. It was rather interesting to see that Angelides did not listen, and seemingly he could not wrap his mind around the idea of what a market maker does. Trying hard to demonize Blankfein rather than actually trying to get information, is no way to figure out what really happened and why.


Blankfein was substantively impressive in dealing the questions that he was asked.  Not all of what we need to know was asked unfortunately. If Angelides is typical of what is to come, we will not learn much from this process since he does not understand key elements, and is not even asking about them.  All he want is for Blankfein to admit that he and his firm are the Devil. Blankfein is not going to say that.


On the other hand, there may be much more that we need to know about the interactions between Goldman Sachs and the US government. A very interesting article (goldman_sachs-aig_its_likely_worse_than_you_think) argues that Goldman took trading advantage of information that Geitner decided to keep private about planned government policy. If this claim is true, it sounds at best borderline illegal. It shows why the determination of Geitner and Bernanke to keep so much policy information secret was seriously misguided.


January 13, 2010


Obama Unemployment Rate in Context


Average monthly US unemployment rates while President.


Obama, B.         9.11%

Bush, G.            5.27%

Clinton, B.         5.20%

Bush, H.            6.30%

Reagan, R.         7.54%

Carter, J.          6.54%

Nixon/Ford        5.84%


There are “long and variable lags”. So it is always debatable how much of this to attribute to a President’s own policies. To mitigate this concern, consider the final month for each of the Presidents. It is the least subject to this problem.


Final monthly US unemployment rates.


Obama, B.         10.2% (Oct 2009)

Bush, G.            7.2%

Clinton, B.         3.9%

Bush, H.            7.4%

Reagan, R.         5.3%

Carter, J.          7.2%

Nixon/Ford        3.4%


Data is:  Civilian Unemployment Rate, Percent, Monthly, Seasonally Adjusted.  Link: http://research.stlouisfed.org/fred2


Another kind of context is provided by Off The Chart. He provided a link to the predicted impact of the Stimulus from the President’s economic team: http://m.factcheck.org/Images/image/2009/Articles/6_16_2009_Making_Sense_Stimulus_Spending/Romer-Bernstein_Chart.jpg. Without the stimulus plan we were supposed to be at about 9% unemployment currently. Since we undertook the stimulus plan we were supposed to now be below 8%.


It is always possible that it will get better (or worse) reasonably soon. Without a theory, history provides almost no help in predicting. The only other time (post WW2) the US had double digit unemployment was from September 1982 until June 1983, while Reagan was President. The peak was at 10.8 in November and December 1982. 


The 1982-3 period is widely understood to have been, at least partly a result of the Volker fight against inflation. When people look back at the current period, how will they explain such dreadful performance?  How much of it will be attributed to the erratic and unpredictable policy making over the past year and a half?



November 16, 2009


There is No Silver Lining


Unemployment rate as of October 2009: 10.2%. Worst in a quarter of a century.


November 6, 2009


Greatest Hits in Financial Policy Making (2008-09 edition)


From time to time it is useful to take stock.  It has been just over a year since the original TARP proposal (September 2008).  Here are two awards, for the best and the worst policy passed over the period.


Worst Financial Policy Award (2008-09): The TARP.


This might have been a hard call, given how much truly terrible policy has been passed in the US during the year.  However, despite many serious competitors, there seems little doubt as to the true winner.  It is closely followed by the governments oscillating policy over whether to save or not save various major financial institutions (Lehmann, Merrill, etc.) “You we save, you we demand protection money from.”  What serious justification exists for the sharply varying ways in which Lehmann, AIG, BofA, Merrill, Morgan Stanley, Wells Fargo and JP Morgan were treated?  Little beyond the mood of the moment seems to have been at work. 


If macro-policy were eligible there might have been another serious contender. The so-called “stimulus” might have been a strong contender.  However, even if it had been eligible, it would not have won.  The hundreds of billions in stimulus spending was merely wasteful payback to groups favored by those in power.  The main drawback was the opportunity cost of the funds.  Sadly the main thing that it seems to have stimulated is an increase in unemployment. Perhaps a 1% or a 2% increase in unemployment is due to the “stimulus” and the policy uncertainty regime it helped foster.  While serious damaging, it was not damaging on the scale of the devastation unleashed by TARP.  


Best Financial Policy Award (2008-09): The Banking Stress Tests.


This is genuinely a surprise winner. In the spring when it was happening, I must admit that I was skeptical that it would make much difference.  However, in retrospect this does seem to have genuinely helped calm things down.  We can argue over details.  We can argue over whether the market should have found it reassuring.  However, it really did seem to help. It helped facilitate the raising of about $53 billion in new equity by 18 banks. (Do not ask about GMAC.) It helped create confidence and it gave the banks time to breath, time to acknowledge loan losses, time to start (at least for some of them) earning money again.     


November 5, 2009



“Special Master” not “Pay Czar”


Apparently I have been mistaken in referring to Mr. Feinberg as the pay czar. He is actually our “Special Master”.  There, doesn’t that feel better?  We have a “Special Master”. The job title sounds like something Saturday Night Live might have come up with.


In any case, he has now decided to drastically cut the compensation for top executives at several of the main TARP recipient banks.


This is a double victory for JP Morgan and Goldman Sachs et al.  By having escaped from the TARP they can run their own businesses without any help from the “Special Master”.  At the same time the government is telling several of their competitors how to run their businesses. They may also be able to cherry pick from the employees of the TARP firms.  It will not just be the directly affected employees either. This may well do serious damage to the affected TARP firms.


I guess that many of the top executives at the TARP firms will head for the exits as quickly and as quietly as they can.  Of course our Special Master has thought of that:


“Requires Three Years of Service, and TARP Repaid, Before Payment: To ensure that taxpayers continue to receive the benefits of the executives' talents, the Special Master's ruling requires that any incentive awards be paid only if the employee provides at least three years of service to the company after the award is made.  And, under Treasury regulations, the awards must be paid in the form of restricted stock that may not be paid unless the company repays its TARP obligations.” The Special Master for TARP Executive Compensation Issues First Rulings


Suppose you were one of these executives. How do you think this would strike you?  Would you stick around on those terms?  Or would you be quietly job hunting at a non-TARP firm?


“Special Master” indeed.


October 22, 2009.


Dealing with the Pay Czar


Citigroup, as a big recipient of government money, is in a weak position to withstand pressure from Washington’s Pay Czar (Mr. Feinberg). As a result they have now sold Phibro to Occidental at a fire-sale price. 

“Mr. Feinberg, who is completing his pay reviews this month, urged Citigroup executives to unload Phibro, based in Westport, Conn., warning that he would issue a ruling likely to embarrass the banking giant if it honored Mr. Hall's contract, according to people familiar with the situation.

Citi had little leverage to resist the pressure.

“When Citigroup contacted Occidental, Mr. Chazen, the company's president and finance chief, said he immediately made clear that he wouldn't pay a premium for Phibro, given the government's well-publicized pressure on Citigroup to sell. Citigroup's representatives told him to make a bid anyway.” How Occidental Scored Citi Unit Cheaply

Given the current realities this may have been the best that Pandit could make of an awkward political situation. In the past we have criticized other countries for politicizing business decisions (think Indonesia, or Russia for instance). I guess, “that was then.”


Is it really a great idea to intentionally hobble the money making ability of a firm that owe us money?


October 12, 2009



More From the Master of Words


Stephanopolous Interview of Obama:

“STEPHANOPOULOS: That may be, but it's still a tax increase.

“OBAMA: No. That's not true, George. The -- for us to say that you've got to take a responsibility to get health insurance is absolutely not a tax increase. What it's saying is, is that we're not going to have other people carrying your burdens for you anymore than the fact that right now everybody in America, just about, has to get auto insurance. Nobody considers that a tax increase.

“People say to themselves, that is a fair way to make sure that if you hit my car, that I'm not covering all the costs.

“STEPHANOPOULOS: But it may be fair, it may be good public policy...

“OBAMA: No, but -- but, George, you -- you can't just make up that language and decide that that's called a tax increase. ...”

I guess that George does not have Presidential permission to use the T-word. But the President really ought to have a word with the folks on the Finance Committee who actually have a draft bill. In the draft bill itself, they call it an excise tax:


“The consequence for not maintaining insurance would be an excise tax.” …


“The excise tax would be assessed through the tax code and applied as an additional amount of Federal tax owed.” http://www.politico.com/news/stories/0909/27384.html


September 22, 2009.


Presidential Actions and Rhetoric


Actions: On the weekend Obama imposed a tariff on Chinese tires.  Did they think that if they made the announcement on the weekend, the media would not cover it, and so the Chinese would not notice?  It worked for the embarrassing Van Jones resignation, so why not for tariffs on Chinese tires?


Rhetoric Today: Obama Says Tariff Ruling on Chinese Tires Isn’t Protectionism


Humpty Dumpty from Alice in Wonderland would have approved:


 "When I use a word," Humpty Dumpty said in a rather a scornful tone, "it means just what I choose it to mean – neither more nor less."
"The question is," said Alice, "whether you can make words mean different things."
"The question is," said Humpty Dumpty, "which is to be master – that's all." http://en.wikipedia.org/wiki/Humpty_Dumpty


Obama is clearly the “master” of words.


This mastery of words by Obama is not new. Consider his rhetoric last week, on the topic of the moment, health care.


Rhetoric Last Week: The President’s description of what his opponents fear might eventually follow, if his plan is enacted, is that these are people who will use “scare tactics and fear-mongering”.  The concerns of these people who are “not telling the truth” are “not legitimate.”


Obama now:

“What are not legitimate concerns are those being put forward claiming a public option is somehow a Trojan horse for a single-payer system. I'll be honest. There are countries where a single-payer system may be working. But I believe – and I've even taken some flak from members of my own party for this belief – that it is important for us to build on our traditions here in the United States. So, when you hear the naysayers claim that I'm trying to bring about government-run health care, know this – they are not telling the truth.” Obama Text 


Obama then:

Obama Has Consistently Said That If We Were Starting From Scratch, He Would Support A Single Payer System, But Now We Need To Build On The System We Have”


If Obama Were Starting From Scratch, He Would Support A Single Payer System. Obama said, "Here's the bottom line. If I were designing a system from scratch I would probably set up a single-payer system...But we're not designing a system from scratch...And when we had a healthcare forum before I set up my healthcare plan here in Iowa there was a lot of resistance to a single-payer system. So what I believe is we should set up a series of choices....Over time it may be that we end up transitioning to such a system. http://www.barackobama.com/factcheck/2008/01/05/fact_check_obama_consistent_in.php


Sept 14, 2009.



Who is to Decide?


Health care battles have been central stage as the financial crisis has calmed a fair bit.  It is striking how virulent the language in the debate. Passions are high as befits a life and death issue.


The supporters of the various versions of the reform plans frequently argue from a fundamental misunderstanding. They assume the necessity of a central planner.  Here is a sophisticated version of the error:

“There are no easy answers. Unfortunately for Mr Obama, some of his academic chums have pondered seriously and publicly about the questions.  Ezekiel Emanuel, a doctor whose brother is Mr Obama’s chief of staff, wrote a paper for the Lancet, a medical journal, in which he proposed a system for determining who should be first in line for such things as liver transplants or vaccines during an epidemic. Among other factors, he suggested taking age into account, with adolescents and young adults getting priority, because they have fully developed personalities and many years of life ahead. This may be philosophically defensible, but it is political poison—Dr Emanuel even included a graph showing voters above and below the ideal age how much less their lives are worth. … Mr Obama’s supporters say that objections to his reforms are largely based on misunderstanding, fuelled by Republican scaremongering. They have a point.” The politics of death

Actually, no.  There is no need for someone to decide for all.  There is no need for central planning and a “philosophically defensible” system.  There is every reason to have such decisions made on a decentralized basis. 


Exactly the same mistake is made repeatedly by the President in his speeches when he talks about having a centralized determination of best medical practice.  Medicine treatment choice is not a math problem.  While some situations really do have pretty well defined best practice, a huge number of situations do not.  Differences of opinion are real – even among experts.  Ever heard of getting a second opinion? 


Even where there is a consensus or at least a majority, it is not always right.  If I as a doctor or a patient hold a minority opinion, why should I be obliged to follow the government’s dictates? If there are not externalities, what business is it of yours to make a decision that affects me over my objection?


On NPR there was an interesting example concerning the use of stents: Stents Audio.  Here is a rough transcription of that program: NPR-Stents? If you were the patient which doctor would you rather listen to?  If you were trying to save government cash which doctor would you rather listen to?


The supporters of the current proposals so far have not even tried to consider the substance of this fundamental issue.  


September 4, 2009.



US Government Debt


During the Bush years, many complained about the irresponsible fiscal policy that allowed US debt to reach about 2/3 of GDP. 


This year the government is planning to have it jump to almost as high as it was at the end of WWII. It is forecast to continue at record levels for the rest of the president’s current term. This is despite having some rather optimistic economic assumptions built in.


Presumably if health care gets passed in something like the suggested form, these numbers will prove to be significant underestimates of government debt.


One possibility is that the government will permanently maintain higher debt. That way a much greater fraction of future government revenue would be used to pay interest on debt. 


Another possibility is that a more responsible approach to government might emerge that would reduce the debt back to Clinton levels or to Bush levels. How could they do that?  The government seems unlikely to default on the debt.  They also seem very unwilling to reduce spending.  Indeed they want to further increase it.  So the real question is whether the way out would be inflation increases, or taxation increases, or both.



Gross Debt in Billions

as % of GDP























































2009 (est.)



2010 (est.)



2011 (est.)



2012 (est.)



2013 (est.)



2014 (est.)




The above data is from hist.pdf although the handy tabulation is from wiki.



September 1, 2009.



Transparency and the FED


“The Fed has refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under the emergency programs, saying disclosure might set off a run by depositors and unsettle shareholders.” Secrecy?


The Federal Reserve is arguing in court that it should not be obliged to disclose which financial institutions got emergency help.  Apparently shareholders and depositors might become ‘unsettled’ if they new what was really happening at the institutions in which they are investing.


What ever happened to ideas like “sunlight is the best disinfectant”?  If investors are to be shielded from the truth, then what are they going to assume about what they cannot see?  This does not seem like a good recipe for a well run market.


The Fed is arguing that disclosure might induce investors and depositors to leave.  Well, yes.  Good.  That is the point.  Resources should be removed from institutions that are not using resources properly.  How else will we get efficient use of society’s resources?


August 27, 2009


Value of the Marginal Product?


Washington is sure that nobody should get paid “too much.” But who is to decide how much is too much?  Clearly we need a pay czar in Washington to decide.  Oh. Actually we have one already: U.S. pay czar says he can "claw back" exec compensation.



An interesting element in this has been the pay trouble at Citigroup.  There is a division of Citi called Phibro that makes big commodity bets.  Often they win big, but not always (of course).  Contractually they are owed far more than Washington wants anyone paid.


“Citigroup Inc., under pressure from the Obama administration to reduce executive compensation, may try to persuade energy trader Andrew Hall to accept stock instead of cash in 2010 after paying him about $100 million last year, people familiar with the matter said.  … Citigroup, which lost $27.7 billion in 2008, booked $667 million in profits from commodities trading that same year, primarily from Phibro. … Pandit cut his pay to $1 this year after getting a total of $10.8 million in 2008.” Phibro Pay


In short for 2008 Pandit oversaw a loss of about $27.7 billion, while Hall oversaw a profit of around $667 million. Pandit got paid $10.8 million for 2008, and Hall got $100 million for the year.  As best we can tell, in 2009 so far Citi is still losing money, while Phibro is still making money.  But the year is not over. For 2009 Pandit is to get $1, while Hall’s pay for 2009 is subject to controversy because he apparently has the nerve to ask for what Citi contractually agreed to pay.


Clearly, calculating the true value of marginal product is not easy.  But, as an owner which paycheck would you rather sign?  Who seems more overpaid Pandit or Hall?


Hint: Warren Buffett reportedly tried to buy the Phibro unit from Citi, but his offer was turned down. citigroup-considers-changes-at-phibro



August 17, 2009



Reassigning the Fed?


There has be discussion lately about making the Fed a kind of grand boss in charge of “systemically important” banks. At the same time congress is trying to increasingly bring political authority over the Fed. Taylor offers a rather important set of concerns about the idea of changing the role of the Fed: Fed does not need more powers.


August 10, 2009



No Micromanging by Washington?

“The role of the government in setting pay is reaching a pivotal moment. Seven banks and industrial companies that received significant bailouts must submit proposals for their compensation packages by Aug. 13.: Citigroup Inc., Bank of America Corp., American International Group Inc., General Motors Co., Chrysler Corp., Chrysler Financial and GMAC Financial Services Inc.

“Treasury Department official Kenneth Feinberg, who has authority to oversee pay for the 100 highest-paid employees at those companies, has been meeting regularly with the seven firms to help them fix a level and structure of compensation that the government deems proper, say industry and U.S. officials.” US Pay Czar

“A top Citigroup Inc. trader is pressing the financial giant to honor a 2009 pay package that could total $100 million, setting the stage for a potential showdown between Citi and the government's new pay czar. …

 “Mr. Hall's pay package puts Citigroup in a tight spot. Ripping up the contract could trigger Mr. Hall's departure and a potentially messy legal fight. But making any large payouts, even if they're based on previously agreed contracts, could subject Citigroup to political and investor fallout. …

Phibro, with a small core group of traders, has generated hundreds of millions of dollars in profit for Citigroup over the years.” Citi in $100 Million Pay Clash

Of course, the US government does not want to tell the banks how to run their businesses.  At least not more than they want to tell GM what products to produce, and where to locate their corporate headquarters.

July 27, 2009


Economic Growth Rates Past and Future


According to http://www.measuringworth.com/ the average USA real GDP growth rate from 1948 to 2008 was 2.53%.


According to http://www.politico.com/ the administration is forecasting USA economic growth as follows:


“Obama’s current forecasts envision 3.2 percent growth next year, 4 percent growth in 2011, 4.6 percent growth in 2012 and 4.2 percent growth in 2013.”


That would sure be nice. 

July 14, 2009



More Demands on B of A


One of the strange aspects of the Washington response to the crisis has been the ongoing pressure on Bank of America.  The bank seems to have been pushed around a great deal – from the Merrill deal, through replacements of directors, to thinly veiled attempts to remove the CEO.  Apparently it is still continuing: Bank of America Said to Balk at Paying Backstop Fee.


The story this time is not complex.  BofA and the government were negotiating a deal in which Washington would provide a financial backstop in case the Merrill losses spiraled too far out of control.  Apparently there was a tentative agreement on the broad outlines of a deal, but not on the details.  The tentative agreement required that the specific assets to be included had to be listed and agreed upon.  Sorting out such details was a time consuming process, in which agreement on the details was not automatic. 


Treasury was rather preoccupied, and the deal was never actually agreed and signed.  Eventually BofA decided that going ahead was not worth it.  Everyone apparently agrees that no final contract was signed, and no money changed hands.


“Regulators contend Bank of America owes at least part of a $4 billion fee it agreed to pay in January -- even without a completed legal document -- because the company benefited from implied U.S. backing on about $118 billion of Merrill Lynch assets…” Demands.


So the government feels entitled to $4 billion in exchange for having negotiated and come close to reaching an agreement, that they were to busy to actually finish working out.


This is a bit like a student who put time into working on a paper for a course, who took up a lot of the faculty time discussing the paper, and wants to get an A   despite the fact that he never quite got around to actually writing the paper and turning in. 

July 13, 2009




In December 2008 unemployment was at 7.2% (Source: http://www.bls.gov/ (Series Id:LNS14000000), Unemployment rate, 16 years and over).  As of the latest data our unemployment rate is now at 9.5%.  This is the worst that it has been since the early 1980s.  In June 1982 unemployment hit 9.6% and a year later it was at 10.1%.  By the end of 1983 it had fallen back to 8.3%.

Apart from the early 1980s, this is now the worst it has been since 1948 when the modern BLS data starts coverage.

Economic policy has lags that are hard to quantify precisely. All administrations like to blame the previous administration for problems, and claim credit for all goodness.  This is normal.  At what point does this become “the Obama unemployment rate”?

July 2, 2009

More “Stimulus” Coming?

“Christina Romer, who heads Obama's Council of Economic Advisers, said the White House wished Thursday's data were better, … Asked if the administration is considering a second stimulus package to jolt the economy back to life, Ms. Romer said, "We'll do whatever it takes."” Romer

July 2, 2009

Picking Winners

The Obama Energy Department has apparently decided that: UniStar Nuclear Energy, NRG Energy Inc., Scana Corp and Southern Co. deserve to get Nuclear Loan Guarantees. 

But Exelon is unworthy.  So Exelon is cancelling its plans to build new nuclear power plants. Exelon Cancel.

Who is Exelon? “Exelon has one of the industry’s largest portfolios of electricity generation capacity, with a nationwide reach and strong positions in the Midwest and Mid-Atlantic. Exelon operates the largest and most efficient nuclear fleet in the United States and the third largest commercial nuclear fleet in the world.http://www.exeloncorp.com/aboutus/

Why UniStar and not Exelon?  Part of the answer is known:

“Foreign partners that might be able to contribute loans or equity were also considered a plus.” For instance, UniStar hopes to get the French government to kick in $10 billion; NRG wants the Japanese government to underwrite one-third of its costs. Nuclear Loan Guarantees.

Remember Chrysler?

July 1, 2009


“In the weeks just before President Obama took office, his economic advisers made a mistake. They got a little carried away with hope. To make the case for a big stimulus package, they released their economic forecast for the next few years. Without the stimulus, they saw the unemployment rate — then 7.2 percent — rising above 8 percent in 2009 and peaking at 9 percent next year. With the stimulus, the advisers said, unemployment would probably peak at 8 percent late this year. We now know that this forecast was terribly optimistic. The jobless rate has already reached 9.4 percent.” A Forecast With Hope Built In

Since the above quote is from the New York Times, you will not be surprised that the author thinks that the “stimulus” package was not big enough. 

Another possibility is that their base case forecasts were actually correct.  Maybe without “stimulus” unemployment would now be at about 8 percent. In that case the extra 1.4 percent unemployment would be due to the new policy regime.

How could this happen?  By seriously adding to policy uncertainty, government policy can and at times does make things worse.  The impact of policy uncertainty is not built in to their Keynesian models.  But it really does matter in reality.

Do I believe that this channel is big enough to account for the extra 1.4 percent?  My best guess is that the magnitude is too big.  In January and February I wrote that the so-called stimulus package itself would create specific winners and losers.  But it would have little or no aggregate impact. The broader policy environment is potentially more damaging.  Policy uncertainty is very important but hard to credibly quantify.


Clearly the Obama folks believe in “multipliers.”  Over time I hope that they come to understand budget constraints, opportunity costs, and policy uncertainty.  


July 1, 2009


Original Mindset


The regulatory and legal mistakes that underlie the origins of the financial crisis did not arise in a vacuum, nor did they arise by accident. In fact the same pressures appear to be continuing even today after all that has happened:


Barney Frank “and New York Representative Anthony Weiner have sent a letter to the heads of Fannie and Freddie exhorting them to lower lending standards for condo buyers.” Barney Frank


When the history of the crisis is written, this will be well worth recalling. It helps give some insight into the mindset of Congress and the policy roots of the crisis.


June 25, 2009


TARP Repayments


Recently a number of the Tarp recipients have been allowed to repay some of the money.  News reports have been spotty, but with a lag the government is reporting things here:  TARP Report. In most cases the banks have been permitted to return the capital, but the government is still holding the warrants.  


Why are the warrants worth more to the government at this stage, than they are worth to the banks?  There does not seem to be an official explanation. Why does the government feel the need to still hold the warrants but permits the repayment of the capital? 


Normally we think of a warrant as having a financial value.  Here I guess that there is also an implied threat value.  If the bank management does not do what it is told, the government can exercise the warrants.  That would dilute equity, and create a big enough stake to likely take effective control and oust management.  The banks understand this, and will presumably act accordingly. 


The key question over the next year or two is whether the banks will go back to ordinary bank business, or become full fledged GSEs.  Either path seems plausible at this point.


June 25, 2009


Keynes or Schumpeter?


In the last month or so, things have settled down a bit.  Unemployment continues to gradually and painfully drift up towards double digits.  The stock market has recouped part of the excessive panic selling.  The USA economy typically recovers from recession after a year or two.  The standard source of dates is: http://www.nber.org/cycles/ They date the current recession as having started in December 2007.  So normally recovery ought to have been beginning by now.  There is at least some evidence of this.  But it is not clear cut.


The administration continues to put more of the private sector under more and more government control and/or outright ownership.  Presumably this will continue until the polls turn against Obama.  As a result they are trying to make as many changes as fast as they can.  To do this Obama has been subcontracting a fair bit of actual policy choice to Reid and to Pelosi.


In economics there is a long-standing policy disagreement between those who favor Schumpeter and “creative destruction”, versus those who favor Keynesian government “stimulus” policies.  Two particularly high profile Keynesian experiments were the USA during the 1930s under Roosevelt, and Japan during the 1990s.  Perhaps the closest parallel to what Obama is trying to do is found in the Atlantic provinces of Canada since WWII.  Each episode has unique elements and no parallel is ever perfect.  These were each catastrophically bad in many ways and for many people which makes me nervous.


There has never been as clear cut a test of Schumpeter.  Perhaps South Korea after the Asian crisis in the later 1990s has some elements of it.  China over the past 20 years, while not a perfect test, has clear Schumpeterian elements.  At least the Chinese have been very willing to permit firms to exit.



In any case the current US administration is choosing a highly interventionist and primarily Keynesian path.  Rather than permitting exit, favored firms are being propped up as long as they are big enough and cooperative enough.  Rules keep changing in rather unpredictable ways as the government tries to figure out what they really want to do. 


I hope that this does not lead to a lost decade for us.


June 22, 2009



The Bankers Need to Be Told


Apparently there are more things that the bankers need to be told to do.  At the start (Treasury-CEO-TalkingPoints.pdf) they were told to take government cash and turnover preferred shares whether they wanted to or not.  (Some needed the cash, others were bullied.)


Then they were told to cancel executive aircraft orders, and marketing jaunts whether these were profitable expenditures or not.


Then they were told to limit employee compensation whether that would cost them valuable employees or not.


Then they were told to go ahead with unattractive mergers whether they wanted to or not.


Today they are being told by the FDIC to alter their boards of directors whether they want to or not.


Today the FDIC has also warned that soon the banks will be told to sell “toxic assets” whether they want to or not.


“Bair’s remarks may help ease concern that banks won’t participate in the government-financed programs because they are hesitant to record a loss on loans that they haven’t marked down. The FDIC is planning a pilot program to buy as much as $1 billion of so-called legacy loans next month.” (Bair Says Some Banks ‘Need to Be Told’ to Sell Toxic Assets)


How nice it must be.  You have an asset that I want. So I offer you a very low price.  You refuse.   Normally this means I have to offer you more, or forget about it.  But not apparently, if you are the FDIC.  You simply tell them that they have to.


May 15, 2009  



The Assault on Bank of America Continues


When the history of this period is written (Treasury-CEO-TalkingPoints.pdf, Paulson as "Godfather"), one of the strangest aspects will be the ongoing assault by Washington on Bank of America and its management.  For some reason it really seems as if this bank is being targeted. 


It seems to stem from the decision last December, of Paulson and (perhaps) Bernanke, to insist that BofA go through with the Merrill deal without informing the shareholders, that they were undertaking huge undisclosed losses.  The CEO Lewis caved under the pressure.  For that the shareholders were none too happy. 


Today we read that the FDIC also wants to decide who should be on the board of directors of BofA (Revamp BofA Board).  It seems that the FDIC now wants to takeover tasks normally left to private citizens and to the Fed (Regulators Clash).


I guess that turf fights between various regulators are to be expected in an environment in which government control is replacing private control of more and more of the economy.


May 15, 2009


Blame Bush


Over the last few years, many sophisticated liberal commentators used to complain that Bush was overspending and running up the debt unnecessarily.  They were probably right. 


Now that Bush is gone, government debt policy has in fact changed: “The government will have to borrow nearly 50 cents for every dollar it spends this year, exploding the record federal deficit past $1.8 trillion under new White House estimates.  Budget office figures released Monday would add $89 billion to the 2009 red ink _ increasing it to more than four times last year's all-time high…” (Largest Debt)


The sophisticated view on this is, of course, that we should blame Bush.  After all the current administration, while increasing the red ink more than four fold did manage to indentify: “roughly $17 billion in savings for FY 2010 that the Administration has proposed by eliminating or scaling back over 100 programs that don’t work or whose costs are excessive.” (Party Line)


Who says that they have no sense of humor?


May 11, 2009


Chicago Rules Have Come to Washington.


The payoff to the UAW, at the expense of the investors and the taxpayers, for the work that the unions have done on behalf of Obama, is nearly complete. See: oppenheimer-withdraws-from-dissident-chrysler-group


The administration is learning that bullying works.  Get ready to see much more of this over the rest of the life of this administration.


May 8, 2009


More On White House Pressure


new-allegations-of-white-house-threats-over-chysler-2009-5 Does Obama really aspire to become Peron? 


May 5, 2009


White House Pressure


“A leading bankruptcy attorney representing hedge funds and money managers told ABC News Saturday that Steve Rattner, the leader of the Obama administration's Auto Industry Task Force, threatened one of the firms, an investment bank, that if it continued to oppose the administration's Chrysler bankruptcy plan, the White House would use the White House press corps to destroy its reputation.” (White House Threats). 


So, the White House may, or may not, have threatened some investment firms to forgo their contractual rights in the Chrysler bankruptcy negotiations.  Some of the firms deny the pressure, as does the White House.  Others claim that the pressure was real. 


Some firms agreed to give up their rights (particularly TARP banks), others refused.


Then the President went on television to condemn those who did not give up their contractual rights.


Pressure?  Threats?  How could you ever think such a thing?


By the way, the firm that was “allegedly” threatened was Perella Weinberg Partners. 


 Perella Weinberg said in a statement that the firm decided to back the government-proposed settlement Thursday afternoon, after Mr. Obama criticized the lenders in harsh terms.” (Backing Down)




People learn from experience. 

1.    What lesson will the White House have learned from this episode? Direct threats work much faster than passing laws.


2.    What lessons will the private sector learn from this episode? According to (chrysler-an-anti-union-backlash-in-financings), the lesson is: do not finance unionized firms.


Not pretty.


May 4, 2009




The Fed is running very expansionary monetary policy.  The administration has passed very large expansions of government spending, and government debt.  The budgetary arithmetic is not pretty.  This combination has plenty of people worried about inflation and perhaps, 1970s style economic trouble.


Melzer tells us that the 1970s was not due to ignorance: Inflation.


Bernanke dreams of being remembered as the one who avoided a repeat of the 1930s.  If Melzer is correct, then Bernanke may be remembered as the one who repeated the mistakes of the failed Fed policies of the 1960s.


May 4, 2009


Political Risk for Corporate Debt Contracts


In bankruptcy there is an ordering of rights.  Roughly speaking it goes: equity has lowest priority, then unsecured creditors, then we have secured creditors, and above them are the providers of debt after the filing of the bankruptcy (“debtor-in-possession”).  A US government description of the normal impact of bankruptcy on employees is here: Employer Bankruptcy.  My understanding (I am no lawyer) is that under US law employee claims in excess of $4650 are considered as unsecured claims.


Going back decades there has been a debate over the best choice of priority ordering for bankruptcy.  From time to time the law gets changed.  In recent years the changes seemed to enhance the strictness of the ordering.


In the last few days the US government has decided that, at least for the US auto industry, then do not like the ordering prescribed by law.  They prefer to give higher priority to employees than the law prescribes. We saw this in the GM proposal (GM Offers U.S. a Majority Stake) and now in the Chrysler bankruptcy.


What then to do?  If you do not like the law, and you have control of the Presidency, the House, and the Senate, the obvious thing to do is to change the law.  Nothing wrong with that – it is why we have elections.


But, of course, that might take time.  You might need to make arguments, and get votes. You might need to actually think through the full implications, for other situations, of what you currently feel like doing. This is why we have governance procedures with committee hearings, votes, etc.


Why bother?


Obama returned yesterday to full demonization mode.  Secured creditors who do not want to give up their legal rights were declared to be the bad guys: Chrysler Lenders Tried Obama’s Patience.


It is obviously no accident that the TARP banks decided to give up their contractual rights, while the non-TARP institutions were less enthusiastic: statement-from-non-tarp-lenders-of-chrysler. The big banks are becoming government sponsored enterprises, much like Fannie and Freddie in the old days.


We are left in an odd situation. If I am considering buying secured corporate debt, do I offer a price that assumes I am secured?  Or do I price it assuming that I will be treated as unsecured?  These prices may be rather different.  Do I assume that this new priority ordering only applies to the auto industry?  Or, does it apply more broadly?   Does it depend on what political donations have been made in the past?  Or, do I just give up and avoid buying such debt altogether?


Assessing this kind of political risk was always important in considering the debt of companies in underdeveloped countries.  That is part of the reason that most underdeveloped countries do not have well developed public debt markets.  Now this kind of political risk matters in the US too.  Change is coming to America.


I hope they can find a way to get this back under control before serious damage is done to our public debt markets, and the firms that make use of them.


May 1, 2009



Long and Variable Lags?


In the old days it used to be said that the time from the implementing macro policy, and its having an actual effect, involved “long and variable lags”.  Lots of Keynesians and Monetarists, who disagreed about almost everything, seemed to agree on that.  But now everything is new.  We are supposed to believe that old lessons no longer matter.


To date almost none of the Stimulus bill expenditures have yet been spent. Furthermore it was literally just a few hours ago that the House approved the budget (House Approves) with by far the largest deficit in US history.  So, over the next few years we will have vast increases in government spending – fiscal stimulus.  It is coming. 


Remarkably, the economy is already improving according to the Fed: Fed Sees Signs Recession Easing.


Gosh that fiscal policy stuff sure is powerful!  This medicine works even before you take it.


April 29, 2009



How Clueless can they Really Be?


Just when you think that things are settling down, Washington finds a new way to make things worse.  The latest trial balloon is reported here: Converting.  The new idea is to create “safety” by increasing the government’s ownership of the top banks.


Recall that by the TARP, the government demanded that the top banks take cash and turn over preferred shares and warrants to the Treasury department.  The idea was that by giving the banks government money, they would have more capital to lend out.  Some banks needed the money.  Other banks were bullied into taking it.  Either way, the deed was done.  Now some of the stronger banks are trying to escape from TARP.


Apparently, in the opinion of the Treasury, some banks are still in need of more money (whether they want it or not).  Let’s suppose for argument sake that this is really true.  The obvious thing to do is not hard to see.  If someone is desperately short of cash, and can make good use of the money, then give them some cash and get an IOU in return.  This is not rocket science.


However, TARP is deeply unpopular and the Treasury is not sure that Congress would approve more funding.


So instead, they are considering converting the preferred equity that they got originally, into ordinary equity.  What genius!  Someone needs more cash, so of course, we will not give them more cash.  Instead we will no longer call their debt a debt.  Now perhaps we will call it an obligation.  There don’t you feel better now?


This does nothing to increase the funds in the hands of the banks.  It may have some effect on the banks ability to satisfy the regulatory requirements that the government itself imposes on the banks.  But, who is it that imposes these requirements that the government is trying to work around?  Oh I remember, that would be the government.


If this trial balloon is actually carried out then the government would dilute the existing common equity, and turn the US government into the largest shareholder in several of the top 19 banks.  Not surprisingly the stock market value of the financials tanked in response to the trial balloon.


Perhaps Washington really wants to nationalize the banks, and this is as close as they feel they can get politically for the time being. 


But perhaps they are really just clueless.  This interpretation is at least consistent with the wild fluctuations in policy coming out of the Treasury department over the past year.  These fluctuations are clearly part of the problem at this point.  Nobody can be sure what Treasury might do on their next whim.  This creates policy risk.


When the history of this period is written, it already seems clear that the Bernanke and the Fed are going to look a great deal better than will the Treasury (Paulson and Geithner).  The Fed seems to have done some useful things.  Probably some other things will turn out to have been wrong.  But at least they seem well intentioned and they seem to have some idea what they are trying to accomplish.  Sadly, the same cannot be said for Treasury.


April 21, 2009 



Ahead of the Stress Tests


The US government is currently evaluating 19 big banks in a process that they call “stress testing”.  They are planning to decide how much help various banks need.  The following article (Ahead of Stress Test) is well worth reading.


“Some of the banks in recent weeks have put on demonstrations of strength -- such as Goldman Sachs announcing this week that it would raise $5 billion to pay back federal bailout money -- to make the case that they should be left alone. They are concerned the administration will use the assessments to force them to sell assets at big losses and to accept larger government ownership stakes, hamstringing their ability to recover.

“Some senior federal officials counter that company posturing is hiding real problems. They are concerned that some banks are resisting needed help and that others, while strong enough to survive without federal aid, are putting pressure on weaker rivals to the detriment of the broader economy.”

weaker rivals” Hmm … Whatever happened to the insistence that the government was not going to prop up zombie banks?


Apparently at least some of the bankers have a less benign view of government aid, than do the government officials. Goldman Sachs, Bank of America, Wells Fargo, etc. are trying to preempt the government. They want to avoid the damage that might be caused by government help stemming from the stress test results.  


Given the exodus of talent from the main banks to smaller rivals that we are seeing (Stars Begin to Scatter), I guess that this is not too surprising. The banks worry about losing the best employees who generate money.  The government worries about broad unemployment rates, and implicitly regards individual bankers as more or less interchangeable.   


April 15, 2009





“President Obama has proposed the most significant shift toward collectivism and away from capitalism in the history of our republic. I believe his budget aspires to not merely promote economic recovery but to lay the groundwork for sweeping expansions of government authority in areas like health care, energy and even daily commerce. If handled poorly, I'm concerned this budget could turn our government into the world's largest health care provider, mortgage bank or car dealership, among other things.” Senator Coburn


At least for the moment, the government’s control remains very incomplete – even in finance.  While Obama and his team are happy to bully the bankers (Pitchforks), at least some bankers are still willing to push back: Banks Balk at Obama Demand to Cut Chrysler Debt.


April 3, 2009



Washington Increases Control


Politicians are increasingly replacing the business judgments of the private sector people, with their own political judgments.  This is true for an increasing number of topics, ranging from purchasing of executive aircraft, to compensation policies, to marketing efforts, to employee motivational trips that are deemed unseemly, to how best to run an accounting system (End of Mark to Market Accounting?). 


Today Obama fired the CEO of GM.  The stock market tanked (down more than 4% so far today).  This is not out of any belief that Wagoner had been doing a good job – GM really is a mess.  Rather it is a realization that we may be heading for a very different type of an economy. As they say, “Change has come.”


To understand what is taking place consider the financial sector.


“Lewis isn't the only CEO in trouble. Vikram Pandit took over from Prince at Citigroup, but Pandit's experience as a hedge fund manager and investment banker are not likely skills that appeal to government officials charged with curbing risk-taking at banks.” (see Wagoner Out)


“Treasury Secretary Timothy Geithner meanwhile signaled some banks are still ailing and will need further aid from the government.” (Governement Aid)




Bank of America is off more than 16% so far today.  All the financials are falling at the prospect of further aid from Geithner.


As for the autos:

“During this time, my team will be working closely with GM to produce a better business plan.


“They must ask themselves: have they consolidated enough unprofitable brands? Have they cleaned up their balance sheets or are they still saddled with so much debt that they can't make future investments? And above all, have they created a credible model for how to not only survive, but succeed in this competitive global market?


“Let me be clear: the United States government has no interest or intention of running GM.


“… starting today, the United States government will stand behind your warrantee.” Obama Text


For the moment, the financial sector, and the auto sector.  Next presumably anyone who does business with, or for, the government.  Then perhaps, the health care, insurance, and energy sectors.  After that, how far will they go?  What will be the political response, if their policies succeed in turning our recession into a depression? 


This is a crowd that is very good a certain kind of rhetoric.  They do not debate ideas.  They demonize.  This is a crowd that both condones and fosters class warfare sentiment.  This is not a crowd that will respond to adversity or opposition, with thoughtful modesty or introspection.


March 30, 2009.



Bank Asset Plan


Yesterday the Treasury department released more information about the plan to save the banks from those nasty “legacy assets” – toxic assets sounds so last week by now.  The market liked what it saw and jumped by about 6.5%.


Why?  First, and foremost the plan reduces uncertainty about government plans.  The odds of nationalization of the banks are markedly reduced.  Second, Obama gave an interview on 60 Minutes in which he turned down the class warfare rhetoric a bit.  Third, the plan may actually help some banks.


Is the plan good policy?  Unfortunately here the answer is much more complicated than just looking at the stock market response.  There are both plusses and minuses.  The biggest minus is the likely cost to the government.  The plan (Public Private Investment Program (PPIP)) calls for the FDIC to guarantee the debt with up to a 6 to 1 leverage.


The banks get to unload any assets that they want to get rid of, and keep any that they do not wish to get rid of.  So presumably the bankers will try to guess what the assets will fetch in the PPIP auctions (inclusive of the value of the FDIC guarantees), and compare it to what they believe the assets are “truly” worth. 


1) The potential for a lemons problem is clear enough here.  Banks will want to sell the assets that will gain most from the FDIC guarantee, all else equal.


2) Consider a bank that has not yet written down the assets enough on its books.  If it uses the PPIP then it will now be forced to acknowledge what has happened to the value of the assets.  Presumably banks that have been aggressive in really marking to market will be more willing to sell into this process, than will banks that have not.  I would guess that the weaker banks will have been less aggressive in marking things down properly – but this is just a guess.


If a bank puts assets that have been marked down into the process, they may realize substantial gains due to the FDIC guarantee available to the bidders.  This can be real money.  It will be the biggest for assets that benefit most from the guarantees, i.e. very risky assets.


What happens if many of the pools turn out badly?  What happens when a nontrival number of the pools of assets default?  The FDIC will have to come up with money.  Will it come from the FED’s printing presses, general taxes, or from a new levy on the healthy banks?  If it is a new levy, then in essence the healthy institutions will be forced to subsidize the rest.


What happens if many of the pools turn out well?  Then the new investors will earn strong returns that have been highly levered, using the government guarantees.  At that point will Barney Frank and Nancy Pelosi hold hearings and pass legislation to take the gains that “have been earned at the taxpayers’s expense”?


The government intends to designate about five Fund Managers for the pools of assets.  The details are a bit unclear, but apparently these managers will bid at auction on the pools.  The winner will get the right to manage the pool and resell it in some manner to their clients.  It is not too hard to guess who the will be the managers (think Goldman Sachs, Pimco, Blackrock, etc.) 


This may sound conservative and sensible.  It is not. It is a cause for concern.  These guys did not get to where they are by being generous. 


Are we really going to have a repeated series of auctions with only five bidders?  This sounds like a recipe for “taking turns” by the Managers.  I win this auction paying a fairly low price, you win the next paying a low price, then it is her turn, then … This is a potential recipe for collusive auctions and under-pricing of the assets.  What happens will depend on how egregious they are.


To some degree the collusion in the auctions is not all bad.  It may partially mitigate the impact of the government leverage and guarantees induced overpaying. 


What is my bottom line on this?  It is a mixed bag.  Which effects will dominate is, as yet unclear to me.  It will likely help some of the banks.  The five firms that will serve as Fund Mangers, are likely to make out very well.  The taxpayer is likely to be left with significant costs. 


March 24, 2009


A Better Class of Demons


Obama and his team continue whipping up the class warfare sentiment in the population.  After trying out various potential enemies, the Democratic party leaders have settled on the employees of AIG.  This is a good choice.  The firm clearly screwed up big time.  So we can all feel good about being mad at them. It also helps us avoid being “distracted” by what the government is actually doing. 

The House of Congress just passed a law intended to confiscate the retention bonuses paid to many of the AIG employees (Bonuses Law). The tax rate is 90%. It applies to the bonuses of employees earning more than $250,000 at companies that have received at least $5 billion from TARP. The tax is going to apply to bonuses paid on or after Jan. 1, 2009. In other words if you got a bonus a month ago, and you thought you knew the tax rate …

AIG is the demon of choice, but the law is written much more expansively.  Apparently Congress has decided that bankers ought not to be paid more than $250,000 per year.  Exactly where that number came from is mysterious.

If the Senate also passes this law there will be considerable damage to all sorts of businesses and governments in New York.  There will also be a big move to increase base pay and phase out incentive-based compensation at the banks.


I wonder if you can give employees, stocks or options in your firm and call it base pay?  For instance, suppose I pay you 10 shares each week in addition to paying you some cash.  Am I forced to call that a bonus if the payment is regular?  How frequently can I readjust your “base pay” without it being called a bonus?  We may find out.


The pressure on the banks to find a way out of TARP has been getting stronger. With government retroactively changing the rules, and demonizing people on a whim, banks that can, will get as far away as possible.  Employees of banks that cannot escape TARP, will try to find jobs at banks or institutions that can escape. 


I wonder if this 90% rate is going to take on a life of its own.  Prior to this law the top marginal federal personal income tax rate was 35%.


It has not always been that way. If you look at Historical Tax Rates, you will see that from 1954 to 1963 an individual earning more than $200,000 faced a tax rate of 91%. Earlier, the top rate was 94%.  


Will Obama continue to enflame the class warfare, or will he decide to start trying to lower the temperature?  A great deal hangs in the balance.


March 20, 2009


Demons Needed


Bush is now gone, and things are getting sharply worse since the election. (i.e. unemployment, the stock market, corporate investment, etc.) Obama needs a new demon to ensure that people do not get “distracted”. 


Apparently his advisors have decided to go after the very tiny number of journalists who have not been sympathetic.  Nixon would have approved.


“Barack Obama’s press secretary has called out by name another member of the media for criticizing the president’s economic policies,” Obamas-Press-Secretary-Takes-on-CNBC-Host-Again


“Top Democrats believe they have struck political gold by depicting Rush Limbaugh as the new face of the Republican Party, a full-scale effort first hatched by some of the most familiar names in politics and now being guided in part from inside the White House.” White House and Rush Limbaugh


March 4, 2009


On Obama’s Watch - Dow Jones Industrial Average


November 4, 2008: 9625.28 (election day)

March 2, 2009: 6763.29 (A drop of 29.7%)


“Rule one: Never allow a crisis to go to waste,” Mr. Emanuel said in an interview on Sunday. “They are opportunities to do big things.” Emanuel Quote


President Obama said Tuesday that he is not intently focused on the “day-to-day gyrations of the stock market,” comparing the downward roller-coaster on Wall Street to the fickle nature of political polls. “You know, it bobs up and down day to day,” Mr. Obama said. “And if you spend all your time worrying about that, then you’re probably going to get the long-term strategy wrong.” obama-says-he-isnt-focused-on-stock-market-gyrations


“Gibbs went on to say that the president’s plan was to fix the economy. It wasn’t always the case anymore, he said, that “if it was good for Wall Street it was good for Main Street.” Obamas-Press-Secretary-Takes-on-CNBC-Host-Again


March 4, 2009


If You Want to Believe …


Christina Romer provides The Macro Justification for the huge ‘Stimulus’ bill. 


In essence, she says that she believes in big multiplier effects from what she calls ‘very conventional’ models.  They are assuming that monetary policy will remain loose, and that the tax cuts for the middle class will be treated as permanent. 


She writes: “In these models, a tax cut has a multiplier of roughly 1.0 after about a year and a half, and spending has a multiplier of about 1.6. As I have suggested, it is very hard to claim that those are excessively large.”


It must be nice to be as optimistic as she is. 


March 3, 2009.

The Obama War on Investors

Those of us who thought that the market’s fear of Obama was overdone, have been proved wrong.  Unfortunately for me, I am one of those who got it wrong.  Washington is taking control of the economy to an extent that it has not in decades.  Perhaps more troubling, those in power do not see American investors as a legitimate part of America.  They think of investors as “fat cats” who deserve what they get, rather than hard working people who spent a life time accumulating assets for retirement. Those in power consider it patriotic to take investor’s money to be spent as Washington prefers. 

Under the rubric of a “stress test”, the government is in the process of deciding what fraction of the each bank it will own, and on what terms (Dissatisfaction over Citi deal weighs on banks).  This is the result of the process initiated by Paulson and Bernanke in the fall of 2008.

Investors are fleeing as best they can from Washington’s path.  Various sectors and firms get hammered from day to day depending on where the investors fear Washington will look next.  Now the main banks, soon perhaps the health care sector, or the energy sector…  Nobody really knows who is next.  But Washington’s massive appetite is now clear.

As a result we are witnessing the destruction of the financial sector on an epic scale.  The Dow has not been this low since May 1997 – more than a decade ago. 

February 27, 2009

Enough Bank Capital

According to the very old joke, you should be nervous when you hear: “We are from the government and we are here to help you.” This came to mind when I read an article in the New York Times (Bank Capital article) about how much bank capital is enough.

Traditionally banks have been told by government regulators to make sure that they have enough “Tier 1 capital”. The banks have done what they were told. By that measure the main banks – even including Citigroup – apparently have enough capital. Recently however, the markets have focused on a much narrower notion called “tangible common equity”. The NY Times tells us that: 

“Whereas Tier 1 capital gives regulators comfort because it captures a bank’s ability to weather a financial storm, stock investors, who suffer the first losses, are worried about their own exposure. Tangible common equity, or T.C.E., they argue, is the best measure for them. Until last fall, there was little difference between the two measures. But when the government made big investments of preferred stock to shore up banks, common shareholders became more vulnerable.”

In the fall, it did not seem that destroying shareholder value was the actual intent of the policy. Over the months that has changed. Consider the now routine Presidential rhetoric with thinly veiled demonizing of managers and investors, as well as actual government actions (In Merrill Deal, U.S. Played Hardball). A much wider range of interpretations of government intent now seems plausible.

February 25, 2009

Over the Cliff We Go?

In the fall of 2008 the interbank debt markets were in trouble as bankers mistrusted each other. It had started in the summer of 2007, but it had not improved. This apparently scared the living daylights out of Paulson and Bernanke. They responded by introducing a series of fluctuating policy announcements and initiatives to “save” the markets. In order to get these initiatives passed, they needed the cooperation of the politicians. To get their cooperation Paulson and Bernanke painted doomsday scenarios. This succeeded in scaring the politicians, and so they got approval for their massive financial market interventions. Unfortunately they made things much, much worse in the financial markets. Almost immediately following the TARP proposal in late September 2008, the panic moved from the interbank lending market to other financial markets, including most importantly, the equity markets.  

In the fall there was hope that after the election, a new set of leaders would help settle things down. Well, we now have our new leaders and they are starting to pass their policies. Today the President signed the “Stimulus bill”. Instead of making things better, their policies and announcements are making things worse. Geitner’s “plan-to-have-a-plan whenever he gets around to it,” cost the stock market roughly 4.5% of its value on a single day. Obama’s frequent talking down of the economic prospects, is having the effect of building up negative sentiment on the economy. Nancy Pelosi, Barney Frank, and Chris Dodd’s open hostility to business has stimulated a great deal of fear. Government has become increasingly active, and increasingly unpredictable. In this environment people and firms pull back. Many real investments get cancelled.

One of the most important effects is on retired and near retired people. The destruction of retirement plan wealth is devastating for vast numbers of people who worked hard, invested responsibly, and are now in their mid or late 60s. The level of wealth destruction induced by Paulson, Bernanke, Bush, Geitner, Obama, Summers, Dodd, Frank, Reid etc. is of historic proportion. As of the 3rd quarter of 2007 the personal sector held securities worth 19,143.7 billion. By the 3rd quarter of 2008 this had dropped to 15,457.2 billion a drop of 19% in a year (Flow of Funds Data). Holdings of equity dropped much more. Various asset classes have dropped at different rates, so for individual households the results may be merely bad, or they may be outright devastating.

If Washington really intends to create a multi-year Depression, they are well on their way. Unfortunately the rest of us have no choice but to go along for the ride. Buckle up. The ride is already getting bumpy.

February 17, 2009

Banker Pay

On the way to passing the Stimulus Bill, Senator Dodd seems to have indavertently done something very strange (Dodd's Changes). While talking tough, he appears to have helped the bankers escape from the government. The tough talk:

Dodd dismissed complaints that the provisions would spur talented managers to leave companies subject to the restrictions. “Some very high earners will have to adjust compensation expectations and maintain a different sense of proportion than in the past,” Dodd said in a statement Feb. 14. “The current job market should deter employees from leaving, and if they do, there are many qualified replacements.”

From reading this quote and the press coverage, you might think that this is going to seriously hurt the banks and the bankers who might have an inappropriate sense of proportion by his standards. This does seem to have been the intent. However, in the guise of further punishing the bankers, he has more-or-less got rid of the Obama administration’s limitations on banks in two respects.

1.    Dodd’s changes allow the banks to payoff the TARP funds in less than three years without raising new equity. Thus it becomes a bit easier for the banks to get out of TARP.

2.    The President had an actual dollar cap on compensation at $500,000 to top bank employees. Under Dodd’s changes, the cap is gone. Instead there is a limit on the annual bonus. A bank that actually followed Dodd’s intent would likely lose its top performers. However, he has created a pretty obvious way out. Instead of annual bonuses, there will be big annual changes to what we now call simply salary. Instead of giving a high flier $2 million in a lump at year end, we will now role it in to next year’s salary. Perhaps we will even gross it up a touch to compensate for the delay. The base salary for the high fliers, will now fluctate much more on a year to year basis in response to performance.

It is not surprising that the Administration is rushing to get this part rewritten. They are not trying to save the banks from Senator Dodd. They are trying to prevent the banks from using his changes to reduce the impact of government control.

Given how quickly the Stimulus bill was written and passed, there are almost certainly a variety of other “surprises” lurking in its pages. It will be interesting to see which special interests really got their money’s worth from their recent lobbying efforts.  

February 16, 2009

Government Borrowing Problems

A key issue for understanding the impact of the Stimulus bill is the effect of the government borrowing. At the moment we are in a panic, and investors are looking for whatever seems safe. Many investors have turned to buying US government debt. This has been very fortunate for us so far.

Other countries have been less fortunate. Italy Debt tells us that “Italy's large public debt (an estimated 105% of GDP in 2008 and rising) is deterring the government from introducing a major fiscal stimulus package …” In Germany they have had trouble both in January and yesterday (German Bond Failure) in issuing bonds.

If the US government keep expanding debt quickly, at some point the US government could suddenly look much less safe too. If investors start to flee from US government debt, the policy reaction could become truly catastrophic. For now we are told that: China to Stick with US bonds. How long will it last?

Think of General Electric as a parallel. For many years it could borrow short term (commercial paper) at very low rates, and lend to others (credit cards, etc.) longer term at very high rates. The carrytrade profits were great. But when the mood changed, and investors decided that GE was not as safe as they had thought, GE was in trouble. Fortunately for GE, the US government stepped in to prevent a collapse (commercial paper program, and TLGP). If investors decide to flee US government securities, there is nobody positioned to bail us out. As Geitner found out on Tuesday, the mood can change for the worse rather quickly.

February 12, 2009

The Stimulus Bill

The agreed upon Stimulus bill is now available in summary form: The Stimulus Bill in Short. It is primarily about giving government favors to groups that the Democrats like. Given basic voting patterns in the last election, the list of “winners” is not too surprising.  

The basic economic claims – and there are many of them – seem to be offered mostly as decoration and as sales pitch:

·         For every dollar invested in broadband, the economy sees a ten-fold return on that investment

·         Every dollar in unemployment benefits creates at least $1.63 in economic activity

·         “Every dollar of food stamps creates at least $1.73 in economic activity”

Of course, nobody serious really believes such claims. If they did, we should obviously be investing the entire economy into each of these activities. Redo the process a few times and we would windup infinitely wealthy. Clearly the returns, which might even be positive, do not scale linearly. 

The sale pitch relies almost entirely on assertions describing the benefits, with no discussion of the costs. If the costs are zero and the benefits are positive then obviously all is well. But put this way it is obviously wrong. There are two major sources of costs:

·         When the government spends money on resources that have other uses, those other uses do not get to use the resources. This is often called “crowding out”. The sign of the effect is clear. But the empirical magnitude of this effect has long been a source of controversy among economists.

·         When the government spends money it has to get that money from somewhere. The plan is to borrow the money. Money that is borrowed by the government, is money that someone else did not get to borrow. This will raise the cost of capital in the economy. As a result fewer private sector investments will be undertaken. These cost are very hard to quantify. They hit all firms to a small degree, making empirical identification difficult. On the other hand, since they hit all potential investments, the aggregate magnitude can be very large. The fact that they are hard to indentify with our econometric methods, does not of course, imply that treating them as zero is correct.

I guess that if you like traditional Democratic tastes in spending, you will probably like this bill. If you do not like traditional Democratic tastes in spending, you will probably not like this bill. It is easy to see why the voting was just about as partisan as it can get.

February 12, 2009

Why the Stimulus Bill is Unlikely to Have Much Overall Effect

When the government spends money, it must pay for what it buys.  How will they get the extra money that is to be spent?  Government can get money by printing it, by levying taxes, or by borrowing.  Currently the idea is to borrow.

Obviously the people and institutions that lend money to the government must have money to lend.  What would they otherwise have done with that money? Whatever it was, it will no longer be getting the money that is now instead going to the government. They might otherwise have been intending to buy stuff to consume. They might otherwise have been intending to invest it in the private financial markets. They might otherwise have been intending to have put the money in the bank. Whichever it was, it will now be gone.

What fraction will likely come from each of these sources? It seems plausible that the reduced consumption effect will be trivial. We are largely talking about money that was intended for investment purposes. Thus the primary reductions will likely come from reduced private investments in corporate bonds and equities, as well as some reduction in bank deposits. The corporations and banks will have less private sector funds than they would otherwise have had. They will thus spend less.

Thus the Stimulus bill will inevitably involve more spending by government and a higher cost of capital for private firms overall. There will be winners and losers among the private firms. Most private firms will face a higher cost of capital but no increase in demand for their goods. Some lucky firms will have a higher cost of capital, but will gain from the government demand for their output.

Which effect is bigger? The cost imposed on all firms, or the gains for some firms? In theory either could be bigger. In order for the Stimulus bill to actually stimulate, it must be the case that the government expenditures will have more impact to increase economic activity, than the otherwise intended use of the funds would have had.

We want to stimulate those places where there are either unemployed resources (particularly labor) or where there are big externalities available. So the test comes down to whether the Stimulus bill is more focused on spending in these areas, than would the private sector firms that would otherwise have been getting the resources. The writers of the bill seem to care about giving resources to low income groups. Some of the changes will foster these folks becoming employed, others will tend to foster them remaining unemployed. The government does not seem terribly concerned about finding externalities. It is hard to get details. However here is a comparison of the House and Senate versions. House versus Senate.

There will be many specific winners. It sounds as if green energy firms, municipalities, and various low income groups are likely to come out ahead. Most businesses will be harmed a bit due to the increased cost of capital. Thus the overall impact is likely to be a bit of an increase in the size of the government relative to the private sector. But I would guess that to a first approximation there will be very little effect on the size of the aggregate US economy or on the pace of the business cycle. Whether you favor or oppose the bill should thus come down to whether you like their taste in which groups to give favors to.

February 11, 2009

Despite a great deal of nonsense, here is a good example of why I still think that DeLong is often worth reading:


February 11, 2009

Stimulus Debate - Rhetoric

The US government is in the process of passing a huge spending bill that is intended to help get us out of the current recession. A curious aspect of the debate has been the rhetoric on the part of many of the stimulus proponents. At the start of the debate, many of the advocates of greater government spending claimed that all economists were in favor of such a step (All Economists). A number of us signed a petition: Cato Petition to point out that the claimed unanimity does not exist.

Not everyone seems happy to have the illusion of unanimity broken. Delong writes about us:

And they are cowards.

They cannot even nerve themselves up to say what they really believe--that what we need is lowered tax rates and slashed government spending.”

Happily, just above his assessment of our moral character, he was kind enough to quote the text of the petition. The immediately preceding sentence, which is from our petition, reads:

Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth. 

First, Krugman, now DeLong, … what is happening to our left wing economists?

February 10, 2009

It is not the only factor at work, but the many fluctuations in US financial policy over the past year seems to have very seriously scared investors. As a group investors have been withdrawing as best they can. Just look at the massive mutual fund and hedge fund redemptions that have taken place in recent months.

How would you like to play a game in which from time to time, the referee announces that the rules have changed, or that your opponent gets to choose what move you will play this turn?

If they keep up the frequent unpredictable policy changes, and add in a bit of modern-day Smoot/Hawley (“buy American”), our Government might just succeed in creating another Depression.

February 5, 2009

The Madoff scandal has exposed interesting weaknesses in our financial regulation system. The things actually written by Harry Markopolos are fascinating and very thoughtful. The Wall Street Journal has put them online.  

This is was submitted in 2005: http://online.wsj.com/documents/Madoff_SECdocs_20081217.pdf

This is a written version of his testimony in February 2009: http://online.wsj.com/public/resources/documents/MarkopolosTestimony20090203.pdf

February 5, 2009

Above, you will find what amounts to a public notebook. In this notebook I am recording my impressions of the crisis as it develops.

As time passes it is turning into a more general notebook oriented towards finance related topics.


Some serious work about the ongoing financial crisis.

(If you have suggestions of papers to add, please let me know by e-mail.)

Swagel, P., March 2009, The Financial Crisis: An Inside View. He offers an account of the policy making discussions as the crisis developed.  He documents how and why the government decided over the past year or so, to increasingly replace private decision-making in financial markets.

Campello, Murillo, Graham, John R. and Harvey, Campbell R., January 2009, The Real Effects of Financial Constraints: Evidence from a Financial Crisis. They examine the impact of the crisis on corporate real actions. They find cuts in R&D, employment and capital expenditure.

Luigi Zingales is on a roll. He has written a bunch of things about the crisis that are well worth reading, whether you agree with him or not. Particularly noteworthy is "Paulson's Gift" (Pietro Veronesi and Luigi Zingales). They attempt to quantify some recent financial policy.

Ivashina, Victoria and Scharfstein, David S., December 2008, Bank Lending During the Financial Crisis of 2008. They tried to find the drop in bank lending in the data. They did find it. The difference relative to Chari et al. seems to be due to the nature of bank lines of credit. Drawing down an existing line is an increase in bank lending. Firms did that early in the crisis, and so we saw an “increase in bank lending”. But at that time the bank were reducing some existing lines limits, and refusing to extend lines to new borrowers. Hence the common perception of reduced bank lending.

Takeo Hoshi and Anil K Kashyap, December 2008. Will US Bank Recapitalization Succeed? Lessons from Japan. Japan in the 1990s provides a kind of test case for what not to do. They document many parallels. “it appears that U.S. is at risk for running into some of the same problems that hobbled the Japanese policies.”


V.V. Chari, Lawrence Christiano, and Patrick Kehoe, October 2008, Facts and Myths about the Financial Crisis of 2008. They tried to find the drop in bank lending in the then available data. They did not observe it.



Some Interesting Financial Blogs

Some Interesting Economics Blogs











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