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Tuesday, October 7, 2008

AS nails it

AS live blogs

10.26 pm. Israel and Iran: I'm relieved that this question is raised. It's the hardest question the next president will have to face. I honestly feel very conflicted about this. I want to know how these candidates will react. McCain's invocation of a "league of democracies" as the answer is a little bizarre. Obama's answer was very political and very persuasive. I just don't believe we can stop Iran, although Obama's answer on gasoline imports was specific and smart. He won the exchange, but he didn't convince me. I wish he had.


I LIKED OBAMA BETTER DURING THE PRIMARIES, WHEN HE WAS TALKING ABOUT ENDING GOP-DRIVEN MINDSETS

I concur with AS's assessment of the importance and of the unsatisfying nature of the replies.

What ought to have been said? Well, for one, we ought to jettison the GOP mindset that the best way to exercise US power is to run around shouting at people and "telling them" what to do and "scolding them". Confronting everyone and pledging to work outside what few, international legal frameworks exist that constrain the unlawful exercise of military force in the world ..., etc., is rank arrogance, the hubris that goes before the fall.

So, I was saddened that Obama is repeating the GOP mantra, "We must not allow Iran to get nuclear weapons". This is not what you say when you are trying to run a public pressure campaign, that diffuses the rhetoric of your opponents (the Iranian hardliners). You don't issue threats, so much, you try to persuade, to provide counterfactuals that make it hard for your opponent to get traction.


Accordingly, Obama might have emphasized that we need to act before Iran does something that is not in their interest, something that will destabilize the region by setting off a further regional race for the most terrible weapons in the world. We need to convince the Iranians - reaching out directly to the Iranian people, at least - that some weaponry is not in their interest, that they can trust the U.S., Russia, and China with the proposal to have safe, nuclear energy, and engage as many nations as possible to join in common cause to talk to the Iranians and let them know they do not need these weapons to be a great nation.

There are counter-examples, like S Africa and Lybia, who have given up their nuclear programs.

Instead, we have these belittling remarks and posturing on Israel, that can only infuriate the Iranians ... as it would us, if someone spoke to America the way we do to others, right?

What's more, it's alarming (to me) that American leadership has put its public face so firmly against "Russia". It seems possible to make a case about Georgia, without getting so fired-up that we are talking in terms that rival those reserved for the Soviet Union. Good grief.

Risk Aversion Approaches Category 5

Gripped by fear: the near-term 'price of risk' soars to highest levels on record for US stocks.

Despite a great deal of "price creation", the signs from Asia tonight suggest that risk aversion may be set to reach to the highest pitches, perhaps on record, before this rout is over.

We have yet to see whether 'the system' can absorb a crushing body-blow like that and rebound, as it should.

It seems likely it will be tested, however.

Fasten your seat belts.

Oh, by the way, whatever was said at the debate tonight? None of it will matter, depending on how the next weeks go, I shouldn't think.

It's impossible to know whether 'deleveraging' (good) is causing the continuation of debt market / credit market "weirdness" or whether there are more shoes to drop from our wonderful banking "system", in short order. Accordingly, it is possible that Great History is being written and we, the unkowning, will see it only through the rear-view mirror. The next President may have his Administration defined by economic issues ...

It's all in your head

COGNITIVE ERRORS

AS calls attention to Megan McArdle's piece on the foundation of ... quasi-rational economics, to borrow a phrase, as it relates judgment errors that contributed to the current 'financial panic'. I like reading Megan.

Can the astute reader spot why MM's piece might be the subject of ... cognitive error itself?

Without knowing the full dimensions of all of what is going on, I would hesitate to guess about the causes, let alone the errors (unless it was a really, really wide guess), apart from those things that are obvious contributors.

For instance, I have yet to see solid statistics on the evolution of the subprime and alt-a market. Some datasets suggest that there was a great deal of fraud going on and I'd like to be able to account for that, as much as buyers being too optimistic about home prices.

I wouldn't presume to generalize about what people knew or were thinking about 50 years of home price rises.

FICO SCORE MADNESS

On the other hand, it's fairly clear that lenders were just plain over-confident in something as flimsy as a FICO score, which was 'invented' to provide a low-cost *guess* about someone's financial capacity and willingness. Too many people bet their companies on that. I'd rate that as just stupid, not as a cognitive judgment error.


What's worse, so many are still treating this ridiculous measure as if it meant something (e.g. Suze Orman) or was a usable figure. FICO is a "black box". It is impossible to tell how any one of your actions will affect your FICO score, except at the extremes... Trying to "manage" your FICO score is like trying to catch a fish with your hands!

As for writing CDS on mortgage-backed securities... Well, no one has pockets deep enough for that, to sell a hedge of the business-cycle / credit-cycle. I'm not sure yet, whether this falls into the realm of cognitive error, because the whole story isn't out in the public yet. For instance, it's not clear how well hedged these CDS are or can be. For now, it looks more like an agency problem: the people under-writing the risks and collecting at payday were not the ones who were responsible for saying ... "enough, the cup is full".

Remarkable Day: AIG


THINK OF THE MESSAGE IT SENDS TO THE CHILDREN

You probably didn't watch or hear all of the hearings on the astounding AIG failure-cum-rescue.

Neither did I, but let me share the crowning morsel from the parts that I heard.

AIG management contracted a guy who was supposed to look at the stuff going on in the Financial Products area, the one that wrote some $400+ billion in off balance sheet products, reportedly (at notional value, I assume).

The head of the group thumbed his nose at him, so the guy resigned, because he could not do his job, the job that AIG had hired him to do.

Despite this conspicuous happening, complete with written, clarion warnings to all the right people inside and outside the firm about it, management apparently ... did nothing further, apart from refer the matter to legal.

Oh, everyone got their bonus, including the CEO (only about $5 million, though).

So, you had a bad day ...

Reading Mankiw these days is like exercising your obliques, it's so opaquely not his, a reader's digest.

Anyway, on the very same day that (a) BOA settles an $8.4 billion fraud lawsuit and (b) there is testimony on the Hill that an SEC relaxation in 2004 of capital requirements helped to inspire sugar-plum leverage levels on Wall Street, Mankiw draws attention to some guy who thinks it was all because of ... monetary policy, which made greedy and risky mavens out of the helpless-by-competition managements and all-around do-gooders:

So the first cause of the crisis lies with the Fed, not with deregulation. If too much money was lent and borrowed, it was because Chinese savings made capital cheap and the Fed was not aggressive enough in hiking interest rates to counteract that.


Just savor that morsel for a moment. To "solve" the so-called Greenspan conundrum, the Fed should have hiked short-term rates (inducing the USA's key lenders to lend short-term, while raising the Treasury's borrowing costs?), to counteract Chinese willingness to lend at attractive rates, whilst basing their monetary action and Fed credibility on a theory about competitive, destabilizing overleveraging and shabby credit underwriting that had yet to occur ...

Mankiw should stick to the GOP line of proposing unpaid-for tax "cuts" to solve every problem, no matter how big, don't you think?

Start Opening Up Your Checkbook for the FDIC

DID YOU THINK THAT RISE TO $250,000, TO COVER YOUR SENATOR'S DEPOSITS, WAS FREE?

WASHINGTON -

The FDIC is considering a plan to increase the fees paid by U.S. banks and thrifts to replenish the deposit insurance fund.


You know, the banks pass these fees on to all depositors, in the form of lower rates and higher fees ...

An Everything Bagel

A REAL STEW

Slowly going through the actual Emergency-Pork-to-Save-The-Economy-and-Insure-Wealthy-Depositors-Bill, one comes away with the impression that, despite the headlines, the Bill has a little of almost everything in it.

The FDIC under Bush, reportedly, will use "authority" to directly capitalize banks, without having to provide any proof or oversight reporting on how exactly it determines "systemic risk". No one put a price-tag on that, that I can tell.

HUD will expand the FHA even beyond its recently distorted state, under the assumptions that FHA know how to assess and charge for credit risk better than did the private markets (the FHA charges insurance, typically in the form of an upfront fee, that is supposed to protect the taxpayers from loss...gulp).

OVERSIGHT?

Congress missed the opportunity to set up a Financial Industry Board (the FIB), rather than delegate everything to the Treasury Secretary.

At least they could have used such a mechanism to have made sure that the people selected to run the thing had to pass the muster of a vote.

Monday, October 6, 2008

No one goes to jail

It's really amazing. You can get a 'disorderly persons' charge easier than you have to take personal responsibility for willingly participating in ... a fraud:

In a legal settlement with 11 states, Countrywide Financial Corp., the home mortgage lender bought by Bank of America Corp., will provide $8.4 billion in distressed borrower relief, including interest rate and loan principal reductions, to settle consumer fraud complaints. The measure is expected to affect about 400,000 homeowners, according to Attorneys General Lisa Madigan of Illinois and Edmund G. ``Jerry'' Brown of California.

Paulson Helps Bush Get Greeted as "Liberator" for Second Time ...

Global markets gave a liberators welcome to the Bush-Paulson plan, ceded to them by Congress. At one point today, the Dow average was off over 800 points ...

"DOW 10,000"

It's deja vu all over again.

Anyway, next week we will all be talking about stimulus and about how long The Plan will take to "work", even though it had to be passed by market's open last Monday to "restore confidence" with a "big bazooka", according to some eager to get their welfare package (including the media? why doesn't Colbert ever spoof the financial media, I wonder...).

For those only living in our banana Republic, rather than leading it, can't say we didn't warn appropriately or loudly enough ...

The $500 Million Dollar Man

Fuld was great, wasn't he? Free market capitalism is the best route to prosperity. (Ask Larry Kudlow). Fuld is *one* poster-boy for it. We're all better, somehow, because someone so obviously in a denial of sorts (if not an outright fraud) is drastically overpaid...

Paulson's Go-To Guy ...

... has no markets experience. He's an investment banker. Good grief. Next thing you know, he'll be hiring accountants to get us out of the mess.

Sunday, October 5, 2008

Note: In Memorium

Yesterday morning, we said goodbye to the last of our pets, our baby-girl. She was almost 18, but truly had never grown up. She had dropped to just four pounds, at the end.

All of them gone in the space of six months.

With the empty places they used to habit, our space feels more "house" than "home".

"Emergency Pork": We're a banana Republic alright ...

Got the policy wrong and, just as the March "tax rebate" stimulus was a big mistake and will have to be re-done, we'll pay another round of off-budget "emergency" pork:

Both presidential candidates, who have campaigned against lobbyists and earmarks, walked onto the Senate floor and voted yes on a financial-rescue bill festooned with lawmakers' pet projects and $150 billion of tax breaks.

-Bank Lobbyists Regained Clout After Vote in House, Wall Street Journal

Thursday, October 2, 2008

Senators Pass Deposit Insurance For ... Themselves

I wonder ... will the House follow?

While they were accepting, without any testimony, the spin about why a sudden increase in FDIC insurance was smart, did Senators bother to wonder how it looks that they are some of the main beneficiaries of their bailout for millionaires?

The Wealth of the Senate, Now Tax-payer Protected?

Palin Gets ... A BIG Pass

So, Obama gets endless questions about his associations, etc., etc., to the point that Stephanopoulos got ... too enthusiastic.

Sarah Palin?

Doesn't have to answer questions about troopergate, specifically the refusal of her staff to cooperate in an investigation. These are fundamental questions about her folksy view of Government and her relationship to the electorate (at least as much as her take on her own popularity in Alaska).

Other than that, Gov Palin's performance was like a nice flute recital, in which one overlooks the amateur character of it because she was able to achieve the caliber of a nice, Regnery-fed, College Republican.

And don't count Joe out. He may yet come up with an equivalent of that stupendous phrase he used on Giuliani, "A Noun, a verb, and 9/11"....

Wednesday, October 1, 2008

Dems Capitulate Without Forcing Look at Alternatives, GOP Rushes to Consolidate Gains

WALL STREET TO 'VOTE' NEXT

Nothing more to say, is there?

Was it Schumpeter who said that the fixes to the current crisis sow the seeds of the next one?

Tell me, if you've suckered the Federal Government's taxpayers and every depositor in the country into insuring giant-size depositors, what incentive do you have to manage the firm conservatively, sensibly? Since the government has guaranteed the downside, aren't you motivated to go look for the next best thing from Wall Street, without worry as to how that will be perceived ("don't worry, you are fully insured if it goes sour ... "). Or worse, "don't worry, if we don't participate in the Paulson plan."

As for large depositors, what incentive do they have to pressure for better disclosures, so that they can determine where to place their money, who is "safe" and who is too "risky"?

Yes, we can

FINDING YOUR INNER, SCREAMING LIBERAL

Krugman-sensei says:

I think that Congressional leaders know that it’s a bad bill, but feel compelled to defend it, because they’re (rightly) scared of the financial consequences of a second rejection. And to some extent economists like myself are in the same position; I think I called it the “hold your nose caucus.”

So am I for the bill? Yuk, phooey, I guess so. And I’m very angry at Paulson for putting us in this position.

Look, when are people going to stand up against 'politics-as-usual'?

If this season's "Yes, we can" doesn't translate to a new accountability and focus, then ...

As for there being no alternative to proceeding poorly, pun intended, one can disagree from a political-science perspective. Sometimes, things have to get worse, before they get better, before a new consensus emerges, one that is apart from the miserable, hop-along mentality that causes "nose holding", even on critical legislation. From that perspective, making a stand is key, if the topics are important enough ...

FEAR, THE MIND DESTROYER


Wall Street is expert at scaring people.

Myself, I remain unconvinced of many of the claims being issued. Here is one question, to sharpen the focus.

Who in the banking system are we "saving"? Do you know? I don't. I mean, when Greenspan "saved" Citibank in the early 1990s, we knew who we were 'saving', how, and why.

In fact, all we know outside closed doors is that this plan is definitely "who centric", not system-centric, per se. With this latest bill, we have taken the approach that all entities with "mortgage-related securities" are worth saving (one assumes that anyone can bid the Treasury for anything for which Treasury accepts a bid, even when they do it one-on-one with others - I mean, how are Treasury going to legally privileged a few lenders?).

With only two independent investment banks left, are we saving Goldman and Morgan Stanley? They both continue to signal that they have no worries. MS is even paying a handsome dividend!

JP Morgan-Chase? The work that they have left to do they look able to pay out of earnings (they also pay a fancy dividend)? BOA?

Who is left? WAMU and Wachovia are ... already gone.

Are we saving Citibank, again? It could be ... AIG?

AREN'T WE PAYING ANYWAY?

With reduced competition and bank funding from the Fed at super-cheap levels, profitability at Banks should be sky high, before write-downs.

Mark-to-market or not, there is going to be an "earn out" period for even healthy banks, that were under-reserved for the current mess. Nothing that the Bush-Paulson plan does either speeds that along or mitigates it, does it?

In short, there is every reason to believe that a real credit crunch will continue, long after the welfare plan for the "sytemtic risk" is in place.

Beyond Mark to Market

CONGRESS CAN DO AT LEAST ONE THING IMMEDIATELY

No where is the lack of coordination and information flow in today's financial crisis more evident than in the bruhaha over mark-to-market accounting rules, perhaps.

First, no independent body, like a regulator, has come out to say exactly which instruments aren't trading. Until you describe a problem, you cannot adequately solve it, right? We're lead to believe that it is "sub-prime" assets that are targeted, but it could be prime as well (we know that default rates have been ticking up on those) as well as commercial real-estate loans. What's more, there are a series of other securities CDOs, et. al. We should know what these are, on a system wide basis. Estimates have been put together already, by rating agencies. They just need to come full well into the public domain, via the Congress (and its regulators).

MIDDLE GROUND


If something is trading only on a very limited basis (or not at all), then there is a legitimate tension about whether to include potentially huge liquidity discounts required to induce a trade (a.k.a. "firesale") as part of the fair value of an instrument.

In the event that illiquidity is threatening the safety and soundness of the system (and does appear to be, judging by the actions and comments of some players do have full transparency into asset quality), then the Fed is right to step in to spur on the development of a pricing mechanism.

A phased approach to getting that done is possible and smart.

The SEC, rather than suspend mark-to-market wholesale, should do it only for a time and make it clear that it will accept some independent mark-to-model value, while it moves on to a longer-term solution of getting a traded market primed and running. There are enough people running models to value mortgage pools, that it would be possible for the SEC or appointed industry self-regulatory group to appoint five or six model runners to provide model marks for any pool submitted for evaluation. Firms can then mark-to-model, not using their own, but an "industry" standard. To add nuance, if one standard is too "rigid" for managements to deal with, then the firms can disclose what their valuation assumptions are for broad asset classes, when using the industry-standard models and/or independent valuation "service(s)".

DEVELOPING A MARKET - THE FED / CONGRESS CAN ACT NOW

I cannot believe that the FED, the SEC, and others cannot act using a variety of tools already at their disposal to insist that a "market" for the sludge that is out there develop.

Perhaps there is a role for a reverse auction or a way to set-up a new price-discovery mechanism that is broader than the one that is current being used, which I assume is inter-dealer pricing. The FED is not the only organization that could facilitate setting up auctions (someone just needs to get the right people into a room) or even paper auctions.

The FED itself might select a number of "benchmark" pools and set-up a special program, trading those in its own account (perhaps even to the tune of $75 billion). This could be done in a number of ways, but a repo-like market suggests itself or one in which the Fed provides an indication daily of what the collateral requirements might be, based on valuation models keyed to as many market-given or implied inputs as possible.

In the event that is too hard, the Fed could try to run a program using a yield-to-worst approach, offering up liquidity for securities using the most adverse set of assumptions. These values put a floor under those that might be used for fair-value treatment in accounting exercises. They also add liquidity, because such an approach would add the 'certainty' of a almost limitless buyer at a known price...

PRIMING THE PUMP OF INSTITUTIONAL INVESTORS

Last, the Treasury/SEC ought to find out what needs to be done to prime the pump for institutional investors to get interested in buying up the illiquid securities, again, so that risk can be spread around.

There have to be alternative approaches, some that might requires a few months to cobble together, that involve more than just putting together as big a pool as possible of capital to buy distressed assets.

Some tool has to be available to help change the character of the assets themselves, either stand-alone or in combination.

It's entirely possible that a 21st century Central Bank needs to reinvent the notion of what it means to be lender of last resort. They *may* need to do more than provide capital. They may need to get involved in the derivatives markets in ways new to them (as may Congress).

We can only speculate what those way may be, however, because we do not have the full picture of where the lion's share of the sludge is concentrated and with whom.

In Crisis, Senate Bravely Votes Deposit Insurance for Millionaires

NO DEPOSIT LEFT BEHIND

In a Bill that no one has seen and that no one has commented on (including CBO?), the Senate reportedly will bravely vote to extend deposit insurance to millionaires (who else has $250,000 in cash, sitting around in deposit accounts?).

If that isn't picking up shells in the waves, what is?