Economics of Contempt

No need to beat around the bush here: Ron Suskind’s “Confidence Men” is a terrible book. It’s not even remotely accurate, and contains surprisingly little new, original information.

The fundamental problem is that Suskind is stunningly ignorant of basic macroeconomics, financial markets, the financial crisis, and financial regulations — basically, all the subjects you’d need to understand in order to write a competent book about the Obama administration’s economic team. It also contains so many patently absurd, completely unsourced assertions that it’s really not a question of whether Suskind makes up some of his material, but rather how much of his material is made up.

Curiously, the articles slamming Suskind’s book almost all cite a series of minor errors (e.g., saying Tim Geithner was the “chairman” of the NY Fed rather than the “president”) in order to demonstrate Suskind’s incompetence. The book is riddled with much more major errors — errors which provide the foundation for his cooked-up narrative. To give you a flavor of what I’m talking about, here are a few representative examples.

Suskind’s Ignorance of Basic Macroeconomics/Monetary Policy

On page 22, Suskind claims that the idea of making interest rate cuts the primary tool of monetary policy was “an innovation of previous Fed chairman Alan Greenspan.” Yep, no central banker had ever thought to make interest rate cuts their primary policy tool before Greenspan. It gets worse though. Suskind then claims that Fed interest rate cuts only stimulate the economy because they “prompt everyone, everywhere, to roll over debts of all kinds by replacing whatever is on their balance sheet with its equivalent.” That’s it. Interest rates are cut, everyone refinances all their loans, and that’s it. No new loans being made, no inflation, nothing. This is what he thinks monetary policy is (and he repeats this several more times in the book, so it’s clearly how he thinks monetary policy works). This is not some trivial detail, either — how can Suskind be expected to understand the decisions that were being made if he can’t even understand how the Fed works on the most basic level?

Suskind’s Ignorance of the Repo Market

On pages 72–73, Suskind’s complete ignorance of the repo market causes him to badly misinterpret something Tim Geithner said to him — an interpretation which he then uses to further his very unflattering portrait of Geithner.

First of all, Suskind simply asserts, without any sourcing at all, that in August 2007, Geithner had only a “passing familiarity” with the repo market. The idea that the president of the NY Fed had only a “passing familiarity” with repos is absurd on its face. One of the NY Fed’s primary functions is implementing monetary policy, and one of the main ways it does this is by entering into — you guessed it! — repos. Did someone tell Suskind that Geithner only had a “passing familiarity” with repos? Clearly not, or else he would have sourced it, even anonymously. No, it’s clear that Suskind simply made it up in order to further his fictitious unflattering portrait of Geithner.

Ironically, Suskind then proceeds to demonstrate his own ignorance of the repo market, in a discussion of Countrywide’s difficulties securing repo financing in August 2007. From the book (emphasis on the comically wrong parts added):

“That was really interesting,” Geithner later reflected, “because Countrywide had no idea what its exposure was, no understanding of what it had gotten into. And the fact that the market was unwilling to fund Treasuries if Countrywide was a counterparty was the best example of how fragile confidence was and how quickly it turned.”

Translation: the market would not even lend Countrywide cash to buy Treasury bonds, the safest investment in the firmament. CDOs, MBSs, or similar types of mortgage-based collateral that Countrywide was using to roll over its repo loans were suddenly seen as impossible to value or sell in August 2007, meaning that it was illiquid. The whole point of collateral is that it can be taken — the way the repo man repossesses your car after too many missed payments — and sold in liquid markets for cash. Collateral that is illiquid is no collateral at all. Countrywide’s intended use for the borrowed funds — to go out, like Sal Naro, and buy Treasuries and shore up its balance sheet or to use them as collateral for emergency bank loans — was irrelevant. Its collateral was no good.

Geithner, at the time and looking back, saw this strictly in terms of confidence.

No, no, a thousand times no! Suskind completely misinterpreted what Geithner was saying. Countrywide wasn’t trying to use CDOs and MBSs to fund its repo book — it was trying to use Treasuries as collateral on repos, and counterparties were still refusing to roll over Countrywide’s repos. That’s why Geithner said it was “really interesting” — because market participants had become so scared of counterparty risk that they wouldn’t even lend against Treasuries (which in theory shouldn’t happen). Suskind evidently doesn’t know that Countrywide originated the subprime mortgages that went into the MBSs and CBOs; it wasn’t the end investor in the CDOs. But Suskind uses his horrible misinterpretation to paint Geithner as naïve and in denial about the depth of the problems in subprime MBSs and CDOs. (“Silly Geithner, he thought it was just a confidence problem!”) There’s a mistake like this on practically every page of the book (his misinterpretation of a memo by UBS’s Robert Wolf is classic in its utter wrongness too), and it all contributes to a narrative that, at the end of the day, is simply false.

Suskind’s Ignorance of the Difference Between Creditors and Equity Holders

Finally, in the chapter on Geithner’s alleged refusal to resolve Citigroup (which very clearly never happened) Suskind writes:

Geithner, on this point, would not budge. Debt was sacrosanct. No creditor would suffer. Bair was equally intransigent. Secured creditors, such as equity holders, of course, wouldn’t be wiped out, but they had to face consequences for lending money to an institution whose recklessness had led to its demise. They must, she said, “face some discipline.”

Yes, you read that right: Suskind does not know the difference between secured creditors and equity holders. He apparently thinks that in a resolution of Citi, equity holders “wouldn’t be wiped out” (“of course,” he says). Again, this is not a trivial mistake — this is enormously important, because the entire debate over what to do with Citi revolved around the distinction between creditors and equity holders. The FDIC was (allegedly) advocating putting Citi’s commercial bank subsidiary into receivership, which would haircut creditors, whereas Geithner was advocating the stress tests, which in a worst-case scenario would lead to the government diluting equity holders, but not haircutting creditors.

This demonstrates quite clearly that Suskind lacked the knowledge or ability to understand the central dispute in his own book — the dispute that made headlines all over the country. How can Suskind be expected to understand what happened in this dispute if he couldn’t even understand what the dispute was about in the first place?

The answer, obviously, is that Suskind’s account of the dispute is not credible. (Bolstering that conclusion is the fact that the meeting in which Obama allegedly ordered the resolution of Citi has been reported on several times before, and every other journalist reported that Obama decided against resolving Citi.)

Anyone who is even remotely familiar with the financial crisis, or financial markets in general, would be able to catch 90% of Suskind’s mistakes/fabrications, so I don’t know how anyone who knows this material could possibly consider Suskind’s book credible. His account of the financial reform debate was, if possible, even more riddled with fundamental misunderstandings and mistakes, which renders his telling largely false. I was as close to the financial reform debate as anyone, and Suskind’s account is simply not what happened.

In any event, don’t waste your money.

I want to smack down this particular bit of misinformation before the regulators release their proposed Volcker Rule, so that they don’t get hammered for absolutely no reason.

Last week, the WSJ ran a story claiming that a draft version of the regulators’ proposed Volcker Rule would substantially weaken the original law, because the draft rule defines “hedging” on a “portfolio basis.” The problem with this story is that it’s 100% wrong. From the article (emphasis mine):

At issue is how regulators and banks define “hedging,” or trades designed to offset risk taken by a bank, usually on behalf of customers.

The law originally defined hedging narrowly as trades tied to specific bets.

Actually, no. The law did NOT originally define hedging narrowly as trades tied to specific bets. Here’s how the law defined “risk-mitigating hedging activities,” which are exempt from the prop trading ban (emphasis mine):

“(C) Risk-mitigating hedging activities in connection with and related to individual or aggregated positions, contracts, or other holdings of a banking entity that are designed to reduce the specific risks to the banking entity in connection with and related to such positions, contracts, or other holdings.” (Dodd-Frank § 619(d)(1)(C))

As you can see, it was the original law that defined hedging on a portfolio basis. This means that the regulators had no choice but to define hedging on a portfolio basis — the regulators are simply interpreting and fleshing out the original law, and the original law said that banks can permissibly hedge on a portfolio basis.

The law said that the hedges have to be “designed to reduce specific risks,” but risks can be — and, in fact, almost always are — faced on a portfolio basis. Interest-rate risk, for example, is typically measured and hedged on a portfolio basis — banks don’t hedge the interest rate risk on each Agency MBS they hold in inventory individually, because that would be horribly inefficient; instead, they measure the interest-rate risk of their entire Agency MBS portfolio, and hedge that. (And in reality, this “specific risks” limitation is meaningless anyway, because if a transaction wasn’t designed to reduce a specific risk, then it wouldn’t be a “hedge” in the first place, now would it?)

So, clearly, the original law explicitly stated that banks are allowed to hedge on a portoflio basis. The fact that the regulators’ draft rule allows banks to hedge on a portfolio basis does not weaken, dilute, or otherwise change the scope of the Volcker Rule one bit.

Since everyone is telling their 9/11 stories today, I guess I'll share mine. Having experienced the terrorist attacks on 9/11 up close, this day always bring back terrible memories.

My wife and I were both working in the Financial District, and my wife's office was very, very close to the Twin Towers. I had walked over to my wife's office to drop something off that she had forgotten at home, and I was standing in her office waiting for her to finish a call when we heard the first plane hit the North Tower. Most people on her floor went outside to see what was going on / get a better look, because none of us had any idea what had happened. We were standing outside when the second plane hit the South Tower, although I didn't actually see the impact; it was, however, the loudest noise I've heard in my life. I thought there had been a massive explosion in the North Tower at first. Even at that point, we weren't really sure it was an attack, because we still didn't know for sure what had happened to the North Tower. People had been speculating that a plane had hit the North Tower, but no one we talked to had actually seen the plane go into the tower. All you could see was a giant hole in the side of the building with smoke pouring out.

After the second plane hit, people naturally started to panic. My wife always kept a near-lifetime-supply of bottled water in her office, so we went back inside to get them to hand out to people who were coming down the street from the WTC. Handing out bottled water seemed like a very good idea at the time; we hadn't yet realized how dangerous it was to be so close to the WTC. Partly that's because, despite what everyone says in hindsight, a lot of people still weren't sure that we were under attack even after the second plane hit, and so were just standing around staring at the towers rather than fleeing. I wasn't 100% convinced myself, because some people were still claiming that the explosion in the North Tower had been a massive pipe explosion. Anyway, after we handed out the bottled waters and made a few calls on our cell phones to check on friends who worked in the WTC, police officers started telling everyone to clear the entire area immediately. So we started moving down Liberty Street (toward the bridge).

We had only been walking away for about 60 seconds when the South Tower collapsed. I had my back turned initially, but I remember turning around when the rumbling started and seeing the massive cloud of dust and debris rushing toward us. Everyone turned and ran, and I was shocked at how quickly the cloud of dust/debris was on top of us. We barely made it half a block before the cloud effectively engulfed us. (It was very hot.) Once the dust/debris started to clear, it was just pure chaos. There's no other way to describe it. We moved as fast as we could toward the bridge, but everyone seemed to be running in different directions. (No one really knew where we were supposed to run to; "away from here" was the only real consensus.) Eventually we made it to the bridge, where, like everyone else, we remained for basically the rest of the day.

It was, obviously, the most harrowing experience of my life.