Warren Buffett in 2002, loves collateralization:

We try to be alert to any sort of megacatastrophe risk, and that posture may make us unduly apprehensive about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal. ... Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen).
Buffett in 2008: collateralization is a deal-breaker:
Only a small percentage of our contracts call for any posting of collateral when the market moves against us. Even under the chaotic conditions existing in last year’s fourth quarter, we had to post less than 1% of our securities portfolio. ... This is the only derivatives business [credit default swaps] we write that has any counterparty risk; the party that buys the contract from us must be good for the quarterly premiums it will owe us over the five years. We are unlikely to expand this business to any extent because most buyers of this protection now insist that the seller post collateral, and we will not enter into such an arrangement.
In other words, "collateralization for thee, but not for me." I'm fine with Buffett applying a double-standard to collateralization of derivatives; he is, after all, Warren Buffett.

Paul Volcker is obviously right that it's shameful that the Treasury Department is so badly understaffed right now (the "Treasury Officials" page is hilarious):

"There is an area that I think is, I don't know, shameful is the word," Paul Volcker said this morning at a Joint Economic Committee hearing. "The Secretary of the Treasury is sitting there without a deputy, without any undersecretaries, without any, as far as I know, assistant secretaries responsible in substantive areas at a time of very severe crisis. He shouldn't be sitting there alone."
Felix Salmon agrees (the same Salmon who called the lack of detail in Geithner's banking rescue "inexplicable" a couple weeks ago). Salmon considers this a huge blunder by the Obama administration, as well as an indication that the Obama administration is being managed inefficiently. This isn't the Obama administration's fault. The reason Geithner is sitting there alone is that the top 33 positions in the Treasury Department are Senate-confirmable, and not only does that slow down the hiring process by introducing political factors into the search, but the Senate confirmation process also takes a long time. The following Treasury positions are Senate-confirmable: Deputy Secretary of the Treasury Undersecretary for Domestic Finance Assistant Secretary for Financial Institutions Assistant Secretary for Financial Markets Assistant Secretary for Economic Policy Undersecretary for International Affairs Assistant Secretary for International Financial Markets and Investment Policy Assistant Secretary for International Economics and Development General Counsel Assistant Secretary for Legislative Affairs All of these officials have to survive a Senate confirmation hearing in a brutal political environment, especially for anyone who has ever worked on Wall Street (at any point during his/her life). Even if the Obama administration announced nominees for all of these positions tomorrow, it would still take weeks to get them all confirmed—and that's assuming they all do get confirmed, which isn't a foregone conclusion in the current environment. People seem to be surprised that the Treasury is understaffed. Do people think entire federal executive departments are magically staffed in the first week or something? The Treasury won't be fully staffed until June at the earliest, and it's one of the smallest executive departments. Washington is slow. Always has been, always will be.

So reports Bloomberg:

President Barack Obama’s first budget request would provide as much as $750 billion in new aid to the financial industry, as well as overhaul the U.S. health-care system and launch a program to cut carbon-dioxide emissions. ... The official, speaking on condition of anonymity, said the White House hasn’t decided whether the $750 billion in additional aid to the financial industry will be needed. He said it will be put in the budget as “placeholder.” The official said the aid would appear in the budget as about $250 billion because the rules require policymakers to record the plan’s net cost to taxpayers. The government anticipates it would eventually recoup some, though not all, of the money expended to help financial companies.
The idea that the extra $750 billion is just a "placeholder" is eerily reminiscent of Hank Paulson's infamous "bazooka" strategy:
The Treasury Department has asked Congress to approve an unlimited, temporary line of credit to Fannie and Freddie. Paulson said he was seeking an open-ended amount in the hope that the credit lines would never need to be tapped. "If you've got a squirt gun in your pocket, you may have to take it out. If you've got a bazooka and people know you've got it ... you're not likely to take it out," Paulson said. "By having something that's unspecified, it will increase confidence and by increasing confidence it will greatly reduce the likelihood it will ever be used."
How'd that work out?

Wednesday, February 25, 2009

Stress Test and House Prices

Paul Krugman is unhappy with the house price assumptions in the "adverse scenario" of the Treasury and FDIC's stress test:

And color me baffled at what they consider an adverse case for housing prices. They consider a fall of housing prices, as measured by the Case-Shiller 10-city index, of 27 percent from 4th-quarter 2008 levels to be as bad as it could get. But the CS-10 were around 30 percent overvalued relative to rents or overall consumer prices in 2008 Q4 — so their worst case is for housing prices to fall to historical norms, with no overshooting. What a letdown.
Leaving aside that price-to-rent isn't the best metric (price-to-income is better), Krugman is wrong that the adverse scenario only assumes a return to historical norms for house prices, as Calculated Risk's graph of the baseline vs. adverse scenario shows:
The baseline scenario assumes a return to historical norms (the price-to-rent ratio usually fluctuates around 1.0). The adverse scenario assumes that house prices overshoot on the downside. It's important to remember that for the stress test to be successful, its worst-case scenario only has to be worse, or on par with, what investors believe is the worst-case scenario. The Treasury is essentially trying to induce a private-sector recapitalization of the major banks. The point of the stress test is to convince investors that the banks will survive even without their capital, and even under worst-case scenario assumptions. If investors are convinced of this, then the banks will probably be able to raise private capital. And once the banks raise private capital, they'll be able to withstand a real worst-case scenario (the kind Krugman envisions)—crucially, without more taxpayer money.

Tuesday, February 24, 2009

Elizabeth Duke Defends the CRA

Fed Governor Elizabeth Duke gave a speech on the Community Reinvestment Act (CRA) today, and had some harsh words for the crazy right-wingers who claim that the CRA caused the subprime crisis:

The most recent misperception promulgated by many who either do not know much about the law or don't like it, is that the CRA caused the subprime mortgage meltdown.
That makes two conservative Fed Governors (Duke and Randall Kroszner, both of whom were appointed by Bush) who have recently offered vigorous defenses of the CRA, and have flatly rejected the argument that the CRA had anything to do with the subprime crisis. And their analyses were based on two comprehensive Fed studies of the CRA, which definitely disproved the CRA-subprime argument [1], [2]. (In fact, the Fed studies showed that the CRA often improved lending standards.) Conservative idiots like Phil Gramm, Peter Wallison, and Steve Sailer, however, are still pushing the argument that the CRA caused the subprime crisis, which their wingnut followers will no doubt continue to eat up. It's sad, really, because when we eventually get around to reforming financial regulations, the Republicans will argue—citing the likes of Gramm and Wallison—that we need to repeal the CRA, not reform financial regulations. Update: The Boston Fed has now posted their new book about the CRA online, which can be found here. The book is titled, Revisiting the CRA: Perspectives on the Future of the Community Reinvestment Act. Amazingly, the book includes the following passage in an article by NYU Stern professor Lawrence White, who is a longtime CRA critic and an extremely conservative economist:
There have recently been broader critiques of the CRA: that it encouraged banks to make subprime mortgage loans (which were then securitized) and thus the CRA bears major responsibility for the housing bubble of 1999–2006, and then for the mortgage-related securities crisis that began in 2007. I believe that these broader critiques are badly aimed. It appears that the bulk of the subprime lending of the earlier years of this decade was made by nonbank lenders—that is, by “mortgage banks” that either securitized the mortgages themselves or that quickly sold the mortgages to securitizers. These nonbank lenders were not covered by CRA requirements. Further, the major financial difficulties that were related to investments in these mortgage securities were experienced mostly by investment banks (such as Bear Stearns, Lehman Brothers, Morgan Stanley, and Merrill Lynch) and by a large insurance conglomerate (AIG)—none of which was covered by the CRA. Where banks did experience difficulties that were related to subprime mortgages, such as CitiBank, WaMu, Wachovia (having absorbed Golden West in 2006), IndyMac, and Countrywide, it appears that they were heavily involved in subprime lending because of its perceived profitability (and their underappreciation of the risks) and not because of CRA pressures. The CRA has multiple flaws, but responsibility for the subprime mortgage lending and securities debacle does not appear to be one of them.
White, who I've generally had very little respect for as an economist (he was a professor of mine at Stern way back when), actually does the right thing here by acknowledging that the data do not support the argument that the CRA contributed to the subprime crisis. Good for him.

This is kind of humiliating for Citi. Credit defaults swaps on Citi's subordinated debt are now trading on a points-upfront basis—that is, in addition to fixed quarterly premiums of 500bps, protection sellers are demanding substantial upfront payments to insure Citi's sub debt. Upfront payments are only required for CDS on the riskiest references (i.e., companies with credit ratings below investment grade). A move to trading a company's CDS on a points-upfront basis is sort of like being downgraded to junk status by the CDS market. According to Reuters, CDS on Citi's sub debt is trading at 9.5 percent upfront (i.e., $950,000 upfront and $500,000 quarterly to insure $10 million of Citi's debt for 5 years). For the sake of comparison, the week before Lehman filed for bankruptcy, CDS on Lehman's senior debt was trading at around 11-12 percent upfront. Obviously there's a difference between senior and subordinated CDS, but still, this is a little embarrassing for Citi.

Am I crazy, or did the most articulate and useful questions for Bernanke in the Senate Banking Committee hearing really come from Bob Corker? Questions in committee hearings are usually irrelevant and often barely coherent, but Corker's questions about the details of the Fed's "stress tests" of the major banks were actually quite good, and made him look reasonably well-informed. It was probably an aberration, but if Corker keeps this up, he might eventually be known as something other than the Senator with the Hottest Daughter.

Given how atrocious the reporting on credit default swaps has been during the financial crisis, it's refreshing to see this paragraph in a Bloomberg article by Shannon Harrington and John Rega about CDS clearinghouse developments:

Bets made through credit-defaults swaps helped push American International Group Inc., once the world’s biggest insurer, to the brink of bankruptcy before the U.S. government bailed it out with a $150 billion rescue package. New York-based AIG’s troubled trades were largely linked to hard-to-value mortgage debt securities, rather than the actively traded contracts that are likely to be backed by clearinghouses.
This is true, and very important. With two simple sentences, Harrington and Rega informed their readers that a clearinghouse isn't a silver bullet, and that it won't even touch the corner of the CDS market that brought down AIG. Harrington and Rega's readers are now significantly better informed than readers of the New York Times and Washington Post.

Richard Florida's big article in The Atlantic about the recession's impact on economic geography is decent enough, though not terribly original. If you're already familiar with Florida's work, you won't find anything new. One frustrating aspect of the article is that Florida constantly conflates the changes he wants to happen with the changes that will happen. A particularly glaring example comes near the end of the article. First, Florida states what he thinks should happen—namely, policies aimed at increasing the number of renters and decreasing the number of homeowners:

The foreclosure crisis creates a real opportunity here. Instead of resisting foreclosures, the government should seek to facilitate them in ways that can minimize pain and disruption. Banks that take back homes, for instance, could be required to offer to rent each home to the previous homeowner, at market rates—which are typically lower than mortgage payments—for some number of years. (At the end of that period, the former homeowner could be given the option to repurchase the home at the prevailing market price.) A bigger, healthier rental market, with more choices, would make renting a more attractive option for many people; it would also make the economy as a whole more flexible and responsive.
A few paragraphs later, though, Florida states:
What will this geography look like? ... Its great mega-regions will rise farther upward and extend farther outward. It will feature a lower rate of homeownership, and a more mobile population of renters.
He obviously missed the step that explains why the policy changes he wants to happen actually will happen. He acknowledges that government policy has long stacked the deck in favor of homeownership, mainly through the mortgage-interest deduction and Fannie/Freddie. But he never suggests that these longstanding policies will be changed in any way—he doesn't say that the mortgage-interest deduction will likely be repealed, or that Fannie and Freddie will likely be dismantled. Nor does he suggest that the government will adopt a version of his rent-to-own proposal. Instead, he simply assumes that because these changes should occur, they will occur. And when it comes to housing policy, that's a very dubious assumption.

I'm not even sure what this means:

Like Mr. Sanford, Republican Gov. Haley Barbour of Mississippi said Sunday that he would also reject some of the stimulus funds. "There is some [money] we will not take in Mississippi," he said on CNN's "State of the Union." "You don't get more jobs by putting an extra tax on creating jobs."
Stupidity, thy name is Haley Barbour.

Tom Friedman wants the government to focus on "real innovators," and to that end, he has a suggestion:

As we invest taxpayer money, let’s do it with an eye to starting a new generation of biotech, info-tech, nanotech and clean-tech companies, with real innovators, real 21st-century jobs and potentially real profits for taxpayers.
Notice a theme? Honestly, I think that in Friedman's mind, technology is synonymous with innovation. If your industry ends in "tech," you're an innovator. If not, you're dead weight, and will probably be crushed by the Super-Awesome Globalization Machine anyway. For someone who loves free markets, innovation, and entrepreneurs, and who hates excessive regulation, Friedman sure spends a lot of time advocating for a strong U.S. industrial policy.

Maureen Dowd apparently thinks Obama's election ended racism in America:

Obama is oozing empathy compared with his attorney general, who last week called us “a nation of cowards” about race. Eric Holder, who showed precious little bravery in standing up to Clinton on a pardon for the scoundrel Marc Rich, is wrong. We have just inaugurated a black president who installed a black attorney general. We need leaders to help us through our crises, not provide us with crude evaluations of our character. And we don’t need sermons from liberal virtuecrats, anymore than from conservative virtuecrats. In the middle of all the Heimlich maneuvers required now — for the economy, Iran, Pakistan, Afghanistan, health care, the environment and education — we don’t need a Jackson/Sharpton-style lecture on race. Barack Obama’s election was supposed to get us past that.
Sure, because voting for a black presidential candidate is exactly the same as having a frank conversation about race. No difference whatsoever. Exept for the 47% of the population that didn't vote for Obama. And the fact that pulling a lever in no way involves talking about race. Other than that, though, it's totally the same. Dowd also seems to be unaware that there are more than 2 races: in her world, there are white people and there are black people. And that's it. Seriously, is it even possible for Maureen Dowd to be more shallow?

Saturday, February 21, 2009

How Quickly Things Change

With its endowment down an estimated 30%, Harvard is evidently "short on cash":

The school relies on its endowment to generate a third of the money for its operations, and the endowment is on the verge of posting its biggest loss in 40 years. With much of its money tied up for the long term, it is scrambling to meet some obligations. Harvard has frozen salaries for faculty and nonunion staff members, and offered early retirement to 1,600 employees. The divinity school has warned it may not be able to cover tuition for all its students with need, the school of arts and sciences is cutting its billion-dollar budget roughly 10 percent, and the university president said this week than the unprecedented drop in the endowment was causing it to delay its planned expansion, starting with a $1 billion science center, into the Allston neighborhood of Boston.
Similarly, Yale's endowment is down about 25%. Bradeis University is in such dire straits that it's actually liquidating a prized art collection valued at $350 million. A mere 14 months ago, Fay Vincent was musing in the Wall Street Journal that university endowments' spectacular performance might soon lead to the end of tuition, or very close to it, at elite universities:
[T]hese powerful investment returns will change tuition pricing and financial aid -- and not just at Harvard. A scholar who follows these matters closely recently told me that he anticipates that the elite private colleges and universities will, in the not-too-distant future, stop charging tuition to any student whose annual family income is below the top 5% of all American families -- currently around $200,000.
Vincent's op-ed was titled, "Harvard for Free." Last week, Harvard announced a 3.5% increase in tuition. How quickly things change.

I'm continually amazed by how quickly commentators have forgotten that the primary purpose of TARP was to prevent the complete collapse of the U.S. (and global) financial system, and not just to increase bank lending to consumers and businesses. We were in the middle of an epic financial panic, complete with a classic run on key parts of the shadow banking system, and a devastating margin spiral that had engulfed the entire financial system. Needless to say, a collapse of the financial system would also have meant a collapse of bank lending to consumers and businesses. But the idea that banks' failure to increase lending is somehow proof that TARP failed (or is failing) is simply divorced from reality. This New York Times op-ed by Harvard's John Coates and David Scharfstein, which criticizes TARP for directing aid to bank holding companies rather than the bank subsidiaries, exemplifies this kind of revisionist history. Coates and Scharfstein claim that TARP didn't have its "desired effect," which they blithely assume was "higher levels of bank lending." Now, by the time TARP was actually enacted, it had more than one purpose. But there's no denying that the overriding purpose was to prevent the collapse of the financial system. Ben Bernanke, in a speech delivered shortly after TARP was passed, summarized its purpose (emphasis mine):

The intensification of the financial crisis in recent weeks made clear that a more powerful and comprehensive approach involving the fiscal authorities was needed to solve these problems. On that basis, the Secretary of the Treasury, with the support of the Federal Reserve, went to the Congress to ask for a substantial program aimed at stabilizing our financial markets. As you know, last week the Congress passed and the President signed the Emergency Economic Stabilization Act. This legislation provides important new tools for addressing the distress in financial markets and thus mitigating the risks to the economy. The act adds broad, flexible authorities to buy troubled assets, to provide guarantees, and to directly strengthen the balance sheets of individual institutions. ... The TARP's purchases of illiquid assets from banks and other financial institutions will create liquidity and promote price discovery in the markets for these assets. This in turn will reduce investor uncertainty about the current value and prospects of financial institutions, enabling banks and other institutions to raise capital and increasing the willingness of counterparties to engage. More generally, increased liquidity and transparency in pricing will help to restore confidence in our financial markets and promote more normal functioning. With time, strengthening our financial institutions and markets will allow credit to begin flowing again, supporting economic growth.
I understand that all the cool kids are bashing Hank Paulson and TARP, but geez, this was only 5 months ago, and it was the kind of period that people tend to remember. There are plenty of actual criticisms of TARP to be made; no need to make criticisms up.

Megan McArdle notes that the "mania for rules" in the public sector is different than in the private sector: in the private sector, "companies that become too encrusted eventually succumb to competition from nimbler firms," whereas in the public sector "[t]he feedback to discipline . . . is much slower and clumsier." That's generally true, but two points deserve mention: 1. The source of the mania for regulation is often the private sector itself. This is especially true in finance. Banks and other financial institutions have an almost insatiable need for "legal certainty." If a statute or regulation contains ambiguous terms, banks demand additional regulations that clarify the ambiguities and further define the terms. If a regulation's application to particular circumstances is uncertain, banks demand more regulations to clarify the application issues. No regulatory term left undefined, no contingency left unaddressed. Anyone who has ever had the misfortune of reading (or, worse, writing) public comments on proposed SEC rules, for example, understands how absurd the financial sector's demands can get. Unfortunately, clarity (or "legal certainty") usually requires more regulations than most outside observers would deem necessary. It's true that additional regulations aimed at providing further clarity sometimes end up adding to the legal uncertainty, leading to yet more clarifying regulations, and so on—I won't get into that. My point is simply that the mania for regulations isn't always a function of public sector inefficiency; often it's a function of private sector demand. 2. It's not necessarily appropriate to compare the public and private sectors' respective proclivity for rules. The Constitution places restrictions on the public sector that don't apply to the private sector, and these constitutional restrictions necessitate additional rules. For example, the process of terminating a federal government employee has to satisfy standards of due process, which requires an elaborate regulatory scheme that's absent from private sector employment law. Again, this isn't a function of public sector inefficiency; it's a function of, well....the U.S. Constitution.

Friday, February 20, 2009

Yes, Fire John Yoo

I agree with Brad DeLong: John Yoo should be fired. I am not a constitutional lawyer. I think most non-lawyers would be surprised to find that a vast majority of U.S. constitutional law is mind-numbingly boring. But a good friend from law school who is a bona fide constitutional law expert has repeatedly assured me that Yoo's so-called "Torture Memo" is undeniably false, and that Yoo is effectively guilty of professional misconduct. Had the Torture Memo been submitted to a court, Yoo's failure to even address Youngstown Sheet & Tube Co. v. Sawyer (1952) would have violated Rule 3.3(a)(2) of the Model Rules of Professional Conduct, which prohibits lawyers from "knowingly . . . fail[ing] to disclose to the tribunal legal authority in the controlling jurisdiction known to the lawyer to be directly adverse to the position of the client and not disclosed by opposing counsel." On grounds of professional misconduct alone, Yoo could—and should—be fired from Berkeley Law. DeLong's reasoning is solid, but the arguments about academic freedom are extraneous. Repeat after me: OLC memos are not academic scholarship. "Academic freedom" is not the same thing as "immunity for academics." Yoo is guilty of professional misconduct, and is probably criminally liable as well. Giving arguments about "academic freedom" the time of day is far too generous, in my opinion.

I can't remember the last time Paul Krugman was optimistic about the economy (and his pessimism was, obviously, entirely warranted). So I was caught off-guard by this little ray of optimism in his column this morning:

So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.
I actually checked the byline again to make sure I was reading the right column.

Beating a credit rating agency ($) in rating tranches of synthetic CDOs isn't something to write home about, but it's better than nothing:

In this paper, we demonstrate how CDS-implied ratings for corporate reference names, together with an analytic CDO ratings model, can be used to derive CDS-implied tranche ratings for corporate synthetic CDOs (CSOs). It is an experiment in which we change one key variable, the ratings of the portfolio of reference entities, while holding other data and model assumptions constant and measure how tranche ratings perform. We find that CDS-implied tranche ratings lead changes in Moody's ratings, more accurately rank order default losses by rating, and exhibit higher loss prediction accuracy ratios for the riskiest tranches.

Saturday, February 14, 2009

Ex-Bankers

I want to take issue with something Simon Johnson of MIT said on Bill Moyers' show tonight, because I think it was very insulting. From the transcript:

BILL MOYERS: Geithner has hired as his chief-of-staff, the lobbyist from Goldman Sachs. The new deputy secretary of state was, until last year, a CEO of Citigroup. Another CFO from Citigroup is now assistant to the president, and deputy national security advisor for International Economic Affairs. And one of his deputies also came from Citigroup. One new member of the president's Economic Recovery Advisory Board comes from UBS, which is being investigated for helping rich clients evade taxes. ... SIMON JOHNSON: Absolutely. I don't think you have enough time on your show to go through the full list of people and all the positions they've taken. I'm sure these are good people. Don't get me wrong. These are find upstanding citizens who have a certain perspective, and a certain kind of interest, and they see the world a certain way. And it's exactly a web of interest, I think, is what you said. And that's exactly the right way to think about it. That web of interest is not my interest, or your interest, or the interest of the taxpayer. It's the interest, first and foremost, of the financial industry in this country.
Johnson's blanket assumption that Treasury officials who come from the financial industry don't have the taxpayers' interests at heart is incredibly insulting. These people are public servants, and yet Johnson doesn't hesitate in assuming that they're not acting the public interest. Why does working in the financial sector mean that everything you do subsequently is in the service of the financial sector? The implication is that working on Wall Street makes you incapable of acting in the public interest. Now, there are definitely plenty of people on Wall Street who are incapable of separating Wall Street's interests from the public's interests. But the idea that any Treasury official who came straight from the financial sector is essentially a Wall Street lackey is absurd. It's a childish argument that Johnson makes. His claim that he thinks "[t]hese are fine upstanding people" rings hollow, since after getting that disclaimer out of the way he proceeds to accuse them of failing to have the public's interests at heart. Believe it or not, favoring a banking solution that's as harsh as possible on Wall Street doesn't show how "tough" or "bold" you are. The world's not that simple. You can have contempt for Wall Street without believing that the most effective banking plan is the one that inflicts the most pain on Wall Street.

I like how Michael Moore has already concluded that the financial crisis is "the biggest swindle in American history" and "the greatest crime story ever told," even though he's obviously still in the research stage. That sounds like a recipe for a fact-based, impartial analysis best-selling documentary.

Brad DeLong flags a series of horrendous articles by Cato Institute "scholar" Daniel Mitchell, but the best one is the article exhorting advanced economies to emulate Iceland:

March 21, 2007: Iceland Comes in From the Cold With Flat Tax Revolution: Listen up, Gordon Brown and George Osborne. Iceland has joined a growing list of nations that have sharply cut their corporate tax rates and adopted flat-rate individual income taxes, with hugely positive consequences on economic performance.... The reduction in the top tax rates was introduced to cut penalties on productive activities.... All these reforms have helped Iceland climb from 26th to ninth in the "Economic Freedom of the World" rankings since 1990.... Tax reform and economic liberalisation have helped Iceland prosper. Let's hope that other industrial nations – and especially Brown and Osborne – will learn from Iceland's success...
As the Sports Guy would say, a 10 on the Unintentional Comedy scale.

I want to second Reihan Salam's recommendation of The Venturesome Economy, by Amar Bhidé. It's a tremendous book; I probably learned more from Bhidé's book than any book I've read in several years (save possibly for Power and Plenty). Bhidé examines in detail how innovation actually occurs in modern economies, and demonstrates how little successful innovation has to do with high-level scientific research. Bhidé eviscerates the arguments of people like Thomas Friedman who claim that America has to start churning out people with math and science degrees in order to maintain our "competitiveness" with countries like China and India. The book is essentially an extension of Paul Krugman's famous Foreign Affairs essay, "Competitiveness: A Dangerous Obsession." That was a classic Krugman essay, on par with "The Myth of Asia's Miracle" and "The Great Capitol Hill Baby-Sitting Co-Op." (The "competitiveness" essay was, in case you're too young to remember, one of several in which Krugman absolutely shredded Robert Reich.)

Tyler at Zero Hedge has an excellent post about index basis trades—arbitraging the differences in pricing between CDS indices and their single-name constituents—and how the IG11 index basis (or "skew") has exploded negative ever since Lehman. As Tyler notes, three IG11 constituents are trading on a points upfront basis, and considering that the IG11 is trading 46bps wide to the deal spread, that makes it pretty expensive to put on an index basis trade. (We'll ignore the irony of three constituents in an "investment grade" index being so distressed that they're trading on a points upfront basis.) It's also worth noting that the investment grade CDS index curves in both Europe and the US are severely inverted, and have been for a few months. Here are the spreads for the iTraxx Europe index:

And here are the spreads for the CDX IG11:
It's not surprising for CDS index curves to be inverted during times of market stress, but it's much more common for high yield indexes, and investment grade CDS index curves have never been this inverted for anything close to this long before. When the curves for the CDX IG and iTraxx Europe indexes are both severely inverted for several months, you know we're really screwed. (P.S. When the next index roll comes around in March, will we even be able to fill all 125 spots in the CDX IG index? Wouldn't everyone be happier if we just shrink the constituent pool instead of forcing garbage companies that are still technically "investment grade" like MBIA and the New York Times Co. into the CDX IG index? Just think about it.)

An amended version of Batshit McCrazy's Rep. Collin Peterson's derivatives bill was voted out of the House Agriculture Committee today [update: post-markup information available here; main revisions in the Manager's amendment and the Boswell amendment]. I'm still waiting for the markup report, but Reuters is saying that the CFTC's authority to ban trading in CDS was scaled back during markup, and now applies only when the SEC institutes a short-selling ban, and then only to "naked" CDS written on reference entities that appear on the SEC's do-not-short list. The committee also revised the section on the clearing of OTC transactions. According to Reuters, the revised bill apparently requires all OTC transactions to be cleared by a CFTC-regulated clearinghouse unless the CFTC grants an exemption; the alternative of reporting OTC transactions to the CFTC was stripped out of the bill. However, Barney Frank has effectively killed Peterson's bill. This morning's CongressDaily AM ($) reported that Frank "said he would seek a referral of the bill to his panel and called Peterson's measure to regulate the derivatives market a mistake." Not surprisingly given his close relationship with the House leadership, the bill was referred to Frank's House Financial Services Committee, where it will die a slow, justified death. It's worth noting that Peterson was one of only eleven House Democrats who voted against the first draft of the stimulus bill, so this isn't a "liberal vs. conservative" dispute, it's a "stupid vs. smart" dispute. The CongressDaily report also draws my attention to another crazy provision in the bill, which I didn't notice the first time around: apparently the bill would "deny the Fed -- which has oversight of banks -- the authority to establish regulations or rules with regard to clearing OTC transactions." (See Section 13(d)(3)). That would of course hurt ICE Trust, the proposed dealer-backed clearinghouse for CDS, which would be organized as a bank supervised by the New York Fed. Can you say, "jurisdictional turf war"? Luckily, this is a turf war Barney Frank will win. Like I said yesterday, there's no way Collin fucking Peterson is going to write the new financial sector regulations.

Wednesday, February 11, 2009

Here We Go Again: Peterson's New CDS Bill

Rep. Collin Peterson, Chairman of the House Agriculture Committe, has introduced the final version of the Derivatives Markets Transparency and Accountability Act of 2009 (H.R. 977). The draft bill included an absurb attempt to ban so-called "naked" credit default swaps (though the bill was so incompetently drafted that it wouldn't actually have banned naked CDS). The final version dialed down the crazy a bit, and now simply permits the CFTC, with the President's approval, to suspend trading in CDS if "the public interest and the protection of investors so require." Even in the (highly) unlikely event that this bill ever becomes law, the only way the CFTC and the President would ever suspend trading in CDS is if there's another panic and the short-selling ban is reinstituted. The bill would also require all OTC transactions to either:

  1. Be settled and cleared through a CFTC-regulated derivative clearing organization (DCO) or, depending on the contract, through an SEC-regulated clearing agency; or
  2. Be reported to the CFTC or other approved agency.
Here's the catch: if you choose to report the OTC transaction to the CFTC instead of using a clearinghouse, the CFTC is required to impose "a net capital requirement that is comparable to the net capital requirement that would be associated with such a transaction were it cleared." So if this bill were to become law, all OTC transactions would be subject to CFTC-established net capital requirements. Of course, it's highly unlikely that Peterson's bill will ever become law—Collin freaking Peterson isn't going to write the new financial regulations—so this is all just academic.

From 1995 to 2007, the average subordination level for AAA-rated CMBS tranches fell from 34.1% to 12.3%. (Data from Wachovia Capital.) I just thought you should know that, since the government has decided to get in the CMBS game. I hope you like risk...

Will Wilkinson mocks Paul Krugman for not including political factors in his economic thinking:

Perhaps more than any economist of his caliber, Krugman understands that policy is largely determined by the outcome of the public opinion shoutfest. Yet this recognition seems to have no effect on Krugman’s ideas. Rather than bring inside his models disagreement over economic theory and the lack of political incentive to faithfully apply them, which would lead him to radically revise his prescriptions, Krugman leaves his textbook theory untouched and simply tries to win the shoutfest. Krugman’s often unbearable stridency seems to reflect an attempt to overcome the problems of democratic disagreement and incentive compatibility through sheer force of will–as if the deep reality of politics is no match for the rhetorical gifts and gold-plated reputation of Paul Freaking Krugman.
It's strange that Wilkinson espoused this theory just days after Krugman laid out the economic case for including the "Buy American" provision in the stimulus bill, and then rejected the provision for reasons of political economy. Here's how Krugman summarized his views the next day:
First of all: my piece was NOT an endorsement of protectionism — it was an explanation that there is an economic case for it, but also that there is a strong political economy case (which I consider dominant) against acting on that economic case. It was, in short, an attempt to be intellectually honest.
If Wilkinson's theory was right, then Krugman would have tried to "win the shoutfest" on the "Buy American" provision. But he didn't. Instead, Krugman essentially acknowledged that he couldn't win the shoutfest—that is, neither he nor anyone else would be able to stop the cycle of protectionist retaliations. Recognizing this, he concluded that the "political economy case" against the "Buy American" provision was dominant. It would be hard to come up with a better example of Krugman incorporating politics into his economic thinking. Krugman's treatment of the "Buy American" provision definitely disproves Wilkinson's theory about Krugman sticking to the pure economics and trying to "win the shoutfest." Which makes it all the more amusing that Wilkinson espoused his theory a mere 4 days after Krugman disproved it.

Tim Geithner is taking a lot of criticism for his lack of specificity yesterday, but some of the criticism, like this from the WSJ, is just absurb:

Some investors said the program, called the Public-Private Investment Fund, likely will be too small to spur purchases of battered mortgages and other assets. Others complained that the plan is so vague that they are likely to stay on the sidelines for now.
Of course they are. No one was expecting investors to sign onto a plan that doesn't even exist yet. Until the details of the public-private bad bank are released, potential investors have no choice but to "stay on the sidelines." Investors couldn't get off the sidelines and start using the public-private bad bank even if they wanted to.

John Taylor undoubtedly made some great contributions to monetary economics—foremost among them being the famous Taylor Rule. But an astute observer of financial markets he is most certainly not. His diagnosis of the financial crisis is comical at best. It really is unhinged from reality. Taylor really jumps the shark when he claims that the government's handling of the bailout, rather than Lehman's collapse, caused the financial crisis:

The realization by the public that the government's intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks.
This is literally nonsensical. If Lehman's collapse actually hadn't harmed the financial system, then uncertainty about which financial institutions the government was planning to shower with money wouldn't have caused investors and counterparties to flee because, after all, the financial institutions were fine, and why would investors and counterparties flee financial institutions that were perfectly healthy? Think about it. Why would a plan to give money to banks—even a poorly thought-out plan—cause counterparties to flee banks and other financial institutions? If the financial system really didn't need bailing out, as Taylor seems to believe, then the government money was just icing on the cake. This is yet another example of why you shouldn't rely on academic economists to explain the financial crisis.

Tuesday, February 10, 2009

Update on CDS Clearinghouse

ICE Trust—which will presumably be the dominant CDS clearinghouse, since it has the backing of the major dealer banks— is struggling with the issue of how to price less liquid bespoke CDS contracts. From Bloomberg:

Intercontinental Exchange Inc.’s planned clearinghouse for the $28 trillion credit-default swap market is stalled over pricing on less frequently traded contracts, Chief Executive Officer Jeff Sprecher said. U.S. regulators and industry representatives are working with Intercontinental to create a system to determine prices for credit-default swaps that differ from the standard five-year contract, Sprecher said today on a conference call with analysts.
It's not entirely clear from the article whether the issue is the pricing of bespoke contracts, or the pricing of less liquid contracts more generally. Bespoke CDS contracts are definitely illiquid, but not all illiquid contracts are bespoke. I would be very surprised if ICE Trust agrees to clear a significant amount of bespoke contracts; I'm under the assumption that ICE Trust is only going to clear standardized contracts. Not all standardized contracts are highly liquid, however—for example, off-the-run single name CDS are usually less liquid. I imagine the dispute is primarily over the pricing of less liquid standardized contracts. Back to Bloomberg:
“There’s an interactive discussion” going on about how to price contracts that don’t trade often, Sprecher said. “That’s why the clearinghouse has not been approved. We’re working with the market on this.” Chief Financial Officer Scott Hill said regulatory approval may come “in the very near term.” ... Pricing contracts that don’t trade often could be accomplished through an auction at the end of the trading day, Sprecher said. Intercontinental’s credit-default swap clearinghouse would have the ability to mark prices during the trading day in case contracts move sharply higher or lower, said Hill, the finance chief. “There’s clearly the ability to do intraday margin calls if spreads blow out,” Hill said in an interview. “We are developing the capacity to understand intraday risks.” The process has been complicated, he said. ... Intercontinental also needs federal approval for the credit- default swap clearinghouse in order to close its purchase of Clearing Corp., Sprecher said. ... Atlanta-based Intercontinental is awaiting regulatory approval from the Federal Reserve and the U.S. Securities and Exchange Commission. “We’re at the tail end of that” regulatory process, he said. “A lot of decisions have been made, especially in January.”
My guess is that they get the clearinghouse up and running just before the June 20th roll.

One of the things to watch for tomorrow when Geithner unveils the new bank bailout is whether the range of asset-backed securities (ABS) eligible for some form of government help is broadened. The Fed already announced a significant expansion of the Term Asset Backed Securities Lending Facility (TALF), with eligible collateral now including triple-A rated ABS backed by student loans, auto loans, credit card loans, and SBA-guaranteed 7(a) and 504 small business loans. There are rumors that the TALF will be expanded again tomorrow to include CMBS and non-agency RMBS, which, depending on the terms, could dramatically increase the use of the TALF. It could also, by the way, dramatically increase the risk the Fed is taking on. The public-private bad bank will also presumably accept various forms of ABS, and potentially even CDOs. The point of a bad bank is, after all, to remove the "toxic assets" from the banks' balance sheets, and CDOs are nothing if not toxic. Somehow I doubt that synthetic CDOs will be eligible, but I guess it's possible. The point is, the new plan may very well end up being a bailout for structured finance.

Monday, February 9, 2009

Via Matt Yglesias, here's "centrist" Sen. Claire McCaskill's lame defense of her demands to cut the stimulus bill:

She Tweets “Just saw Krugman’s comments on reduction in recov act. Question for him. Would no stimulus act be better than one thats 800 B instead of 900.” And follows up “Compromise had to happen or we would NOT have 60 votes. Period.”
We wouldn't have had 60 votes because YOU wouldn't have voted for it! If you hadn't demanded cuts, then no "compromise" would have been necessary. You can't defend the cuts as a political necessity if they were only a political necessity because of you. One of the problems with Senators using twitter is that everyone can see exactly how politically unsavvy they really are. Thank god for staffers.

Am I crazy, or did newly-elected RNC chair Michael Steele actually argue on ABC this morning that government jobs aren't really jobs? I'm paraphrasing, but Steele basically argued that the stimulus bill won't create any jobs because the government would only be hiring people for a couple years, and jobs with a "fixed period" of time don't count as real jobs. I kid you not. Steele's employment contract with the RNC undoubtedly lasts for a fixed period of time, which raises the question: does Steele consider himself employed?

Outrage over exhorbitant executive pay at companies receiving TARP funds is entirely justified. But realistically, the government will never be able to restrict executive pay, and anyone who thinks otherwise is delusional. There are entire companies, not to mention entire legal departments, dedicated to structuring compensation packages that circumvent U.S. laws. No matter what restrictions on executive pay the government puts in place, an endless stream of lawyers and accountants will quickly find new ways to circumvent the restrictions. Government officials are simply overmatched—they have neither the time nor the resources to compete with sophisticated compensation firms. I wish that wasn't true, but it is. Gretchen Morgenson uses her column this week to offer numerous suggestions for how to "make Washington’s plan to rein in executive pay airtight." Morgenson, who lacks the intellectual capacity to understand credit default swaps (one of the simplest financial instruments), versus compensation firms. This is the kind of match-up I'm talking about.

It's always amusing when journalists discover that male traders—get this!—like to take on risk. Yes, and in other news, a new study says that bears tend to shit in the woods. Nick Krstoff (who I actually think is one of the best columnists around) takes his turn on this subject in his latest column:

[A recent] study also suggested that elevated testosterone levels could lead to greater assumption of risk; high testosterone levels “may shift risk preferences and even affect a trader’s ability to engage in rational choice.” In other words: when male traders crash ... boy, they crash. ... One of the shortcomings of any system of men sitting in front of screens making financial bets was reported last year in the journal Evolution and Human Behavior, in case you missed your copy. That study found that men are particularly likely to make high-risk bets when under financial pressure and surrounded by other males of similar status. As for women, their risk-taking was unaffected by this kind of peer pressure.
Female traders take on less risk? All 7 of them?

Saturday, February 7, 2009

Battleship and Rating Agencies

Last summer, the SEC proposed new rules for credit rating agencies, and last week it published the final rules. The new rules are aimed at, among other things, conflicts of interests in the rating process. Specifically, the new rules prohibit rating agencies from issuing or maintaining a credit rating where the rating agency (or a person associated with the rating agency):

"made recommendations to the obligor or the issuer, underwriter, or sponsor of the security about the corporate or legal structure, assets, liabilities, or activities of the obligor or issuer of the security."
What constitutes a "recommendation"? Here's what the SEC, helpful as always, had to say:
[T]he Commission does not view an explanation by an NRSRO of the assumptions and rationales it uses to arrive at ratings decisions and how they apply to a given rating transaction as a recommendation.
Clear as mud. Thanks, guys. Essentially, the new rules will turn the rating process into an elaborate game of Battleship. The sponsor of a structured security, which needs a top rating so it can be sold to real-money investors like pension funds, won't be permitted to ask the rating agency what changes it can make to the structure of a security to obtain the desired credit rating. Instead, the sponsor will have to guess what changes would lead the rating agency to issue the desired credit rating, and the rating agency can only tell the sponsor if its guess is right or wrong. Presumably, every time the sponsor proposes a new change, the rating agency will say either "hit" or "miss." And when the sponsor finally makes enough changes to warrant a triple-A (or whatever the desired rating is), the rating agency will presumably yell, "you've sunk my battleship!" Or at least that's what I hope will happen. The new rules were primarily designed to prevent the issuers (or sponsors) from unduly influencing the rating agencies, not the other way around. But prohibiting the rating agencies from making "recommendations" to issuers actually diminishes the rating agencies' influence in the rating process. In other words, the SEC, in all its wisdom, has decided to diminish the influence of the party it believes is being unduly influenced! Go figure.

Robert Waldmann responds to my comments on CDS (which were a continuation of an exchange in the comments section). I must admit, though, I'm a bit puzzled by some of his responses. This, for instance:

In particular I think the pricing of debt implied by the CDS market was totally wrong.
Based on what? All the evidence suggests that the CDS market provides the most accurate prices, so this criticism doesn't really hold water. I'm also not entirely sure what Waldmann means by this:
If markets were efficient, then it would be very useful to look up a market price. If they are not efficient but not totally massively utterly wrong except as often as a stopped clock is right, then price discovery is socially useful. I don't think that market price discovery is socially useful.
He seems to be arguing that the price discovery provided by the CDS market isn't socially useful because CDS prices are completely and hopelessly wrong. But as I noted above, it's simply not true that CDS prices are hopelessly wrong. Back to Waldmann:
Also I'm not sure that any socially useful purpose is served by knowing exactly what bonds are worth. I'd say a socially useful interaction of bonds and financial markets is that people can buy a balanced portfolio of bonds -- a bond index fund when they are young and sell it when they retire.
Look, I understand that in the current environment, people want to avoid saying things like, "financial markets are useful because they efficiently allocate capital." But at the same time, saying that accurate bond prices are socially useful doesn't exactly make you an Efficient Markets apostle. And believe me, I'm no Efficient Markets apostle. How would Waldmann know whether his "balanced portfolio of bonds" is actually "balanced" without accurate bond prices? Accurate bond prices help lenders decide which businesses to lend money to. It's as simple as that. I'm not arguing that bond prices are accurate, just that accurate bond prices are socially useful. And while correcting small mispricings may not seem terribly useful to Waldmann, I assure you that the banks and other large investors that have billions of dollars of bonds would strongly disagree. A "small mispricing" in the bond market is probably larger than a lot of people's annual income. As for Waldmann's concerns about volatility, I'd point him to the study in the Journal of Fixed Income that I highlighted last week.

Friday, February 6, 2009

Bipartisanship!

Newspapers have been quick to note the bipartisan makeup of Obama's new Economic Recovery Advisory Board, emphasizing that the Board includes even well-known Republican economist Martin Feldstein. What other board does Feldstein sit on? AIG. But does he sit on any of AIG's board committees? Yep, the Finance Committee. Just sayin'.

I'm still stranded in London, unfortunately, but my three extra days here have taught me two important lessons: 1. Even in miserable weather, British people are still extremely polite. 2. British TV is terrible. I'm sorry, but it's true.

The WSJ has a long piece on Boaz Weinstein's tenure at Deutsche Bank. Weinstein was DB's "star trader" for a few years—right up until he managed to lose $1.8 billion. So how did Weinstein lose $1.8 billion? The same way every "star trader" loses a boatload of money: they make a lot of money exploiting arbitrage opportunities in good times, and then lose it all when their market goes berserk in a crisis. Repeat as necessary. Specifically, Weinstein lost most of the money on basis trades when Lehman collapsed and the corporate bond market froze:

By early 2008, Mr. Weinstein was at the top of his game. He, along with a colleague in London, was overseeing global credit trading for all of Deutsche Bank. His own trading group, Saba, had grown greatly, to roughly $30 billion of positions and $10 billion in capital. And his control also extended to the bank's trading for customers. Wall Street traders were optimistic in early 2008 that the mortgage crisis was contained, though there were some strains in short-term lending markets, causing corporate-bond prices to decline. On several businesses, such as Ford Motor Co., Lyondell Chemical Co. and General Electric Capital Corp., Mr. Weinstein bought corporate bonds or loans as well as credit-default swaps. The swaps would pay off if the debt defaulted. And the cost of this protection was less than the income produced by the bonds. Mr. Weinstein believed the debt was cheap relative to the cost of protecting it with swaps. Corporate bond prices soon rallied, leading to a tidy profit for Mr. Weinstein's group, after the Fed's brokering of a deal for reeling Bear Stearns Cos. stabilized the credit markets. Emboldened, Mr. Weinstein added to his positions in succeeding months. His group entered September in the black for the year, expecting to tack on more gains. But the simmering financial crisis finally boiled over. The government said early in September that it would take over mortgage giants Freddie Mac and Fannie Mae. And Lehman Brothers Holdings Inc. was teetering. Traders worried about losses they might incur if Lehman failed. ... The next day it became clear Lehman would fail, and a struggling Merrill Lynch & Co. agreed to sell itself to Bank of America Corp. Within days, the government bailed out another big player in credit derivatives, American International Group Inc. Brooding in his office overlooking Wall Street, Mr. Weinstein remained outwardly calm as markets went haywire, traders say. The value of his group's holdings of corporate bonds and loans began to slide as other investors, needing to raise money, sold such securities. At the same time, trading in credit-default swaps was curtailed because market players were concerned about entering trades with banks that potentially could collapse. This left Mr. Weinstein's group increasingly unprotected against losses in corporate bonds and loans, because it used swaps to hedge those positions. Mr. Weinstein wasn't alone. Similar positions held by banks and hedge funds across Wall Street fell apart amid the seismic dislocations after the Lehman collapse. As prices of corporate bonds and loans slumped to new lows and stocks plunged too, Mr. Weinstein wanted to buy more swaps to protect his positions, traders say. He told traders that in such a trading environment, "the primary objective is to get as flat as possible to the market" -- not betting on either a rise or a fall -- according to a person familiar with the conversation. But in contentious conference calls, risk managers at Deutsche Bank told Mr. Weinstein to scale back positions or sell them entirely, traders say. Mr. Weinstein's stock-trading desk was instructed to sell nearly every holding, effectively shutting it down.
I don't think the dislocation in the CDS market after the Lehman collapse was as simple as the WSJ article suggests. It wasn't just that "players were concerned about entering trades with banks that potentially could collapse." That was definitely part of the problem, especially for Merrill. But as I noted earlier, a big problem was that protection buyers all wanted to lock in their profits when spreads exploded wider (or, alternatively, net protection sellers wanted to cap their losses). And since the dealer banks generally try to run matched books—note that Weinstein's biggest concern in the crisis was getting "as flat as possible to the market"—all the end-users demanding to unwind their CDS trades essentially forced dealers to unwind off-the-run contracts at off-market prices, which is expensive for the dealers and generally requires a sizable upfront payment. It probably didn't help that traders at the dealer banks, being traders, couldn't stop shooting at each other. As the WSJ article notes, however, the losses on Weinstein's basis trades came predominantly from the corporate bond leg, not the CDS leg. That's what happens when the entire corporate bond market suddenly shuts down, I guess.

Thursday, February 5, 2009

House Bill Limiting CDS Speculation

I was working on other things this week, so I didn't get a chance to comment on Rep. Collin Peterson's draft bill aimed at limiting speculation in credit default swaps (CDS). The bill is poorly drafted, to say the least. The operative language appears in Section 16, entitled "Limitation on Eligibility to Purchase A Credit Default Swap":

It shall be unlawful for any person to enter into a credit default swap unless the person would experience financial loss if an event that is the subject of the credit default swap occurs.
Where to start? First of all, contrary to media accounts, the bill does not require protection buyers to own the underlying bond. It simply provides that when the parties enter into a CDS, the protection buyer must be in a position to "experience financial loss" if a credit event occurs. Essentially, the protection buyer has to have exposure to the reference entity. Owning stock in the reference entity would almost certainly satisfy this requirement. In fact, owning an ETF that tracks the reference entity's stock would probably satisfy this requirement as currently written. (I'm sure lawyers could push this requirement even further too, and could conceivably define away its effect entirely. Not me personally, of course, but other, less public-spirited lawyers.) Second, the bill actually requires the protection seller to also be in a position to "experience financial loss" if a credit event occurs. This makes no sense whatsoever. It would be like requiring a fire insurance company to be a co-owner of all the houses it insures. Third, the requirement that the parties be in a position to experience financial loss upon the occurrence of a credit event only applies at the time the CDS is entered into—that is, on the "trade date." After the trade date, then, the parties would no longer have to have exposure to the reference entity. So presumably, both parties could just borrow a few shares of common stock in the reference entity, execute the CDS, and then return the stock to the lenders. That would appear to be legal under the current language, amazingly enough. It's not entirely clear what Rep. Peterson actually wanted to accomplish with this bill. I assume he wanted the bill to ban so-called "naked CDS," since that's more or less what the expert witnesses discussed in the hearings Peterson held on the proposed bill this week. Of course, the reality is that Peterson was just grandstanding—he gets his name in the headlines by proposing absurdly draconian legislation aimed at everyone's favorite villain, credit default swaps, knowing full well that his bill stands no chance of ever becoming law. He gets to look like a principled regulator standing up to Big Bad Wall Street, without, you know, actually having to stand up to Wall Street. Peterson has already backed off his original proposal now that his turn in the spotlight is over, claiming that his ban on CDS speculators would only apply when the SEC bans short-sales. "It would blink on and off based on what the SEC does," Peterson said yesterday. This is what Congressmen do with their time.

Last week, when the House was debating the stimulus bill, Marc Ambinder conducted an interview with Rep. Eric Cantor, the Republican Whip. Cantor's response (or lack thereof) to a simple question about government transfers is very telling:

[Ambinder:] Another plank in your proposal is to get rid of the tax on unemployment benefits. But in terms of a direct stimulus, increasing welfare benefits, increase food stamps, would be as much of a multiplier, if not more, than the Republican proposal? If the goal is to get a bill with as much stimulus as possible, how come Republicans aren't talking about increasing other government transfers? [Rep. Cantor:] Right now, the reality is you have growing unemployment in the country and what we've got to do is create an environment where you can sustain a certain level of activity. You're right. Unemployment benefit extension, lifting taxes on unemployment benefits is a safety net move. But there is some stimulative effect, although it's not great. It is recognition of reality.
Huh? Cantor's answer is totally incoherent. Virtually every economist agrees that extending unemployment insurance and increasing food stamps have the highest multipliers of all the available fiscal tools—that is, they provide the most bang for the buck. That much is not in dispute. So why does Cantor oppose more effective policies? It has something to do with sustaining "a certain level of activity," or possibly recognizing reality. It's not entirely clear. My guess is that it has a lot to do with Eric Cantor being a narrow-minded douchebag. But that's just me.

Dick Cheney is still the master of the false dilemma, as his recent interview with The Politico demonstrates:

“When we get people who are more concerned about reading the rights to an Al Qaeda terrorist than they are with protecting the United States against people who are absolutely committed to do anything they can to kill Americans, then I worry,” Cheney said.
Too bad legal rights and protection against terrorism aren't mutually exclusive.

A friend sends along what has to be the least attractive description of an investment firm's strategy ever:

We invest in what we believe to be the premier asset-backed securities in the world - U.S. residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. We enhance the return on our investment in these securities by using leverage. Similar to a bank, we seek to earn positive net interest income from the difference between the yield on our securities and the cost to finance them.
So let's recap: U.S. residential mortgage-backed securities? Check. Leverage? Check. Similar to banks? Check. What could posssibly go wrong? Maybe it's time to update the ol' website. Just a suggestion.

Monday, February 2, 2009

Random Thought

Is there any way Heathrow isn't the worst airport in the history of the world? I mean, O'Hare was in the running for a while there, but it seems to me that over the past 5 years, Heathrow has really pulled out all the stops. Its lead is pretty much insurmountable now.

Kudos to The New Republic for letting one giant in urban economics (Glaeser) review a book by another giant in urban economics (Ellickson). Not surprisingly, Glaeser is a fan of Ellickson's latest. With regard to the current foreclosure crisis, Glaeser advocates using a form of shared appreciation mortgages (SAM):

The best that can be done, I think, is to create an as-if situation that gets servicers to act like local banks. Ideally, a set of sensible rules could lead to renegotiating the mortgages of people who can pay for their homes and speedy evictions of people who bought more than they can afford. If the government sets a series of rules that give servicers safe harbor from lawsuits, then the whole process can be made more efficient. For example, the rules might specify a simple test that determines whether the current occupant can plausibly support the home. If thirty percent or less of the current owner's income can pay for reasonable mortgage payments, marked down to the level implied by current housing prices and interest rates, then the owner can afford the house. If the owner can afford the house under those terms, then the loan should be renegotiated, since that is pretty much all that the house could generate in the best of circumstances. If the owner cannot afford the house, even at today's lower prices and interest rates, then the owner should be quickly moved out. Such an arrangement would be fair all around. If lenders agreed to cut interest rates to current levels, and reduce principal in proportion to the level of housing price declines, then they should be rewarded with a share of the upside. Fully one-half of any future price appreciation, for example, could be shared between the lender and the owner. Ellickson would presumably warn us that this arrangement would reduce owners' incentives to care for their home. To address this problem, the lenders' share of appreciation could be based on the average price increase in the zip code, rather than the actual price of the home.
And being Ed Glaeser, he has some very sensible (and important) things to say about land use regulations:
Over the past forty years, as Ellickson presciently noted in 1975, land-use controls have steadily eroded landowners' rights to build on their property. As new construction in expensive areas declined, prices rose. The collision of robust demand and restricted supply caused prices to skyrocket in America's most attractive areas, such as coastal California and Manhattan. ... Rather than credit subsidies to increase borrowing, it would make more sense to re-think land-use controls. There are certainly legitimate reasons to regulate building, but it seems to me that many jurisdictions have gone too far, putting their own parochial interests first. Perhaps housing policy would do better to create real affordability by eliminating the barriers to building, rather than just inducing lower-income Americans to leverage themselves and bet more on housing.
I couldn't agree more.