Monday, March 23, 2009
AIG and "Payment in Full"
Some press stories note that the Fed is paying holders of AIG credit default swaps full face value. I am not really sure what that means. My understanding of the CDSs is that when issued, they were structured to have a zero value, with the premium being paid just sufficient to cover the insurance liability. If the likelihood of default on the underlying security went up, then there would be a premium paid for that contract. So to say that the Fed (I take this to be the Maiden Lane funds that were set up) is paying full face value is kind of nonsensical. I suspect what is happening is that the Fed is buying a portfolio of underlying securities and the related CDS/insurance for full face value of the underlying security. That makes sense, for a holder of both the security and the CDS would essentially have a guarantee of full payment (so long as the seller of the insurance was going to pay). If this is the case, there is nothing that I see wrong in paying 100% of face value of the underlying security and in fact that makes sense. The transaction eliminates a liability from AIG’s balance sheet and eliminates a need for them to post collateral – and these are the reasons the Fed bailed out AIG in the first place.
AIG and the House of Thugs
The US House of Representatives actually caved in to the rising clamor of populist rhetoric and passed some kind of bill that would ostensibly tax AIG bonuses at 90%.
I only hope that the world sees this as the grandstanding which it is, not as a true willingness to use the United States Tax Code not just as a tool of social policy but as a device to enforce the Members’/Thugs’ code of ethical behavior.
The AIG bonuses do upset anyone, me included, at first hearing. But calmer people think about it a bit and reflect on why they perhaps make sense. There is also a long history -- well, several months -- of Fed and/or Treasury employees dealing with this issue. Our President and his Treasury Secretary would be well advised to stop fueling the populist fires.
Let’s see if the Senate can put the damper on this craziness. If not, Obama’s chickens will have come home to roost.
I only hope that the world sees this as the grandstanding which it is, not as a true willingness to use the United States Tax Code not just as a tool of social policy but as a device to enforce the Members’/Thugs’ code of ethical behavior.
The AIG bonuses do upset anyone, me included, at first hearing. But calmer people think about it a bit and reflect on why they perhaps make sense. There is also a long history -- well, several months -- of Fed and/or Treasury employees dealing with this issue. Our President and his Treasury Secretary would be well advised to stop fueling the populist fires.
Let’s see if the Senate can put the damper on this craziness. If not, Obama’s chickens will have come home to roost.
Wednesday, March 11, 2009
The Meaning of Leadership
President Obama signed an omnibus spending bill today that included 9,000 earmarks worth over $8 billion (yes, that is real money). Several news sources have noted that he signed the bill outside the range of cameras, but he did come out to make comments on the bill and earmarks. Here is part of what he said:
Ah yes, the old Prisoner's Dilemma. Hey, if everyone is feeding at the trough, I am an idiot for starving my constituents.
What a leader would do is eliminate the incentives for everyone to behave like a pig instead of complaining about how legislators act in their own self interest.
President Obama added: "Now, let me be clear: Done right, earmarks give legislators the opportunity to direct federal money to worthy projects that benefit people in their district, and that's why I have opposed their outright elimination. I also find it ironic that some of those who railed the loudest against this bill because of earmarks actually inserted earmarks of their own -- and will tout them in their own states and districts.
Ah yes, the old Prisoner's Dilemma. Hey, if everyone is feeding at the trough, I am an idiot for starving my constituents.
What a leader would do is eliminate the incentives for everyone to behave like a pig instead of complaining about how legislators act in their own self interest.
On Hiring Foreign MBAs
The WSJ today printed an editorial from my colleagues and fellow deans Matt Slaughter and Paul Danos, and me.
The topic is the Employ American Workers Act, which restricts hiring practices of US companies that accepted stimulus and/or TARP funds. Like I said in my NYT post -- see here -- once you accept Federal money, you better be prepared to have them tell you what to do.
In this case, the government's restrictions are especially pernicious. Besides the economic illogic of it, pitting US citizens and foreign citizens against one another is not the way to go. A colleague sent me an email with the words from the Statue of Liberty, and they say it better than anything else:
Some people want to close that golden door -- and they accuse the bankers of being selfish!
The topic is the Employ American Workers Act, which restricts hiring practices of US companies that accepted stimulus and/or TARP funds. Like I said in my NYT post -- see here -- once you accept Federal money, you better be prepared to have them tell you what to do.
In this case, the government's restrictions are especially pernicious. Besides the economic illogic of it, pitting US citizens and foreign citizens against one another is not the way to go. A colleague sent me an email with the words from the Statue of Liberty, and they say it better than anything else:
"Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tost to me,
I lift my lamp beside the golden door!"
Some people want to close that golden door -- and they accuse the bankers of being selfish!
Tuesday, March 10, 2009
Mark to Market: Gains to come
The mark-to-market, fair value debate is a rich one, with the two sides both having support. In principle, of course, mark to market is great -- market prices impound all relevant information, so they should be used in financial statements and in regulation as well. The issue today is not even how informative prices are (I could argue they are not) but how informative mark to model results are. Without knowing all the parameters that were used to fairly value assets, in the absence of relevant market prices, I think I might prefer just full disclosure of holdings and let me do the valuations (of course, we don't have full disclosure either, so we are really choosing from imperfect choices).
But nonetheless, my belief is that for banks, most securities and derivatives have been marked down to levels that are, at worst, not too much above any sense of true value. Thus, there is a tremendous upside for mark-ups once asset prices begin to rise (and they will). If we repeal mark to market now, banks will be able to take some write-ups, which will of course get reported as profits, just as the writedowns were taken as losses. If we don't repeal mark to market, I expect the gains will come a bit later, as valuation models won't change immediately. The total gains to be reported will be the same, but the timing may well be different. If one believes in some market psychology, I suppose that there could be a differential effect. I am not one to bet on such things, but I could see an argument for keeping mark to model for now and letting the writeups occur with a big bang all at once -- hopefully sometime soon. Since in principle I think mark to market is what we want, we might as well stick to our principles and hold out for what could be some massive writeups.
But nonetheless, my belief is that for banks, most securities and derivatives have been marked down to levels that are, at worst, not too much above any sense of true value. Thus, there is a tremendous upside for mark-ups once asset prices begin to rise (and they will). If we repeal mark to market now, banks will be able to take some write-ups, which will of course get reported as profits, just as the writedowns were taken as losses. If we don't repeal mark to market, I expect the gains will come a bit later, as valuation models won't change immediately. The total gains to be reported will be the same, but the timing may well be different. If one believes in some market psychology, I suppose that there could be a differential effect. I am not one to bet on such things, but I could see an argument for keeping mark to model for now and letting the writeups occur with a big bang all at once -- hopefully sometime soon. Since in principle I think mark to market is what we want, we might as well stick to our principles and hold out for what could be some massive writeups.
Thursday, March 05, 2009
Layoffs, Across the Board Wage Cuts, and Elections
We had our local school budget vote in Hanover on March 3 -- one of the great things about NH that is taken for granted is that we still have significant local control over school issues that matter (like the budget).
On the ballot was a special item: a single ballot measure that asked for an appropriation of around $80,000 to keep one elementary school teacher position. This was over and above the vote on the overall budget. If this single item did not pass, a teacher would lose his/her job and class sizes, especially for the third grade, would increase slightly.
I voted for it, and I usually vote for resources for our schools. I don't have any children in the elementary or middle schools any longer, and just one senior in high school. I do have an interest as a Tuck professor in making sure that our schools are excellent, for faculty recruiting purposes. So that is my disclosure.
One would think, in these times, and with all the outcry for people to take salary cuts to allow others to keep their jobs, that something like this would win by a landslide. At a cost of $17 on average per household (increased property taxes) one could let a teacher keep their job, and at the same time improve the quality of education at the elementary school. Think about it -- this is not a "redundant" position we are eliminating, like many layoffs where the work just no longer needs to be done or even can be done. This is a teacher's position, which if eliminated means more students for the other teachers to deal with.
It barely passed. By 20 votes on a total vote cast of around 1,000.
Now maybe it is my viewpoint, but I see this as interesting commentary on those calls for working people to take salary cuts to maintain the jobs of others. And I don't take it as positive, even though the item passed. What is striking is that so few people were willing to cough up a few more dollars to keep a teacher!
In another post to come, I will lay out why I think the push for wage cuts to preserve jobs is generally ill-advised.
On the ballot was a special item: a single ballot measure that asked for an appropriation of around $80,000 to keep one elementary school teacher position. This was over and above the vote on the overall budget. If this single item did not pass, a teacher would lose his/her job and class sizes, especially for the third grade, would increase slightly.
I voted for it, and I usually vote for resources for our schools. I don't have any children in the elementary or middle schools any longer, and just one senior in high school. I do have an interest as a Tuck professor in making sure that our schools are excellent, for faculty recruiting purposes. So that is my disclosure.
One would think, in these times, and with all the outcry for people to take salary cuts to allow others to keep their jobs, that something like this would win by a landslide. At a cost of $17 on average per household (increased property taxes) one could let a teacher keep their job, and at the same time improve the quality of education at the elementary school. Think about it -- this is not a "redundant" position we are eliminating, like many layoffs where the work just no longer needs to be done or even can be done. This is a teacher's position, which if eliminated means more students for the other teachers to deal with.
It barely passed. By 20 votes on a total vote cast of around 1,000.
Now maybe it is my viewpoint, but I see this as interesting commentary on those calls for working people to take salary cuts to maintain the jobs of others. And I don't take it as positive, even though the item passed. What is striking is that so few people were willing to cough up a few more dollars to keep a teacher!
In another post to come, I will lay out why I think the push for wage cuts to preserve jobs is generally ill-advised.
Gore on the Warming Debate (Oops, I'm sorry, there is no debate)
Al Gore had a great little exchange with Bjorn Lomborg, as reported in the Wall Street Journal:
Right, climate change is not a matter of theory. Then what exactly is it? Empirical evidence without any theory to tell us how to interpret the data?
I don't know what the political system of the Maldives is, but if the NH legislature were to pass a bill saying that we needed to build a coastal defense against sea rise, I would not give it a minute of thought (but it would be amusing).
And, even if there is a significant human element to climate change, does it automatically follow that resources should be devoted to climate change rather than to other problems?
You should be wary when people move to close off debate. How many "certain" things in economics and finance have been challenged successfully after having been broadly accepted? Several for sure (the CAPM being perhaps the number one example).
But he was challenged by Mr. Lomborg, the Danish skeptical environmentalist who thinks the world would be better off spending more money on health and education issues than curbing carbon emissions.
“I don’t mean to corner you, or maybe I do mean to corner you, but would you be willing to have a debate with me on that point?” asked the polo-shirt wearing Dane.
“I want to be polite to you,” Mr. Gore responded. But, no. “The scientific community has gone through this chapter and verse. We have long since passed the time when we should pretend this is a ‘on the one hand, on the other hand’ issue,” he said. “It’s not a matter of theory or conjecture, for goodness sake,” he added.
As an example, he pointed to a new addition to the budget for the island nation of the Maldives: “Funds to buy a new nation.”
Right, climate change is not a matter of theory. Then what exactly is it? Empirical evidence without any theory to tell us how to interpret the data?
I don't know what the political system of the Maldives is, but if the NH legislature were to pass a bill saying that we needed to build a coastal defense against sea rise, I would not give it a minute of thought (but it would be amusing).
And, even if there is a significant human element to climate change, does it automatically follow that resources should be devoted to climate change rather than to other problems?
You should be wary when people move to close off debate. How many "certain" things in economics and finance have been challenged successfully after having been broadly accepted? Several for sure (the CAPM being perhaps the number one example).
Tuesday, March 03, 2009
Lloyd Blankfein's Views
For those who have not seen it, Lloyd Blankfein, CEO of Goldman Sachs, gives a nice overview of lessons learned in the Financial Times. See here.
I cannot agree more on his point that the financial services industry has destroyed a lot of trust. I am not sure what they have destroyed more of -- trust or wealth.
The thing that bothers me most is the destruction of trust in markets generally. There will be a wholesale shift to the public sector. It won't surprise me to see some Eastern European countries shifting seriously back to a communistic mentality, thinking that they were actually better off back then. I for one think that is very wrong.
One source of optimism is that sales of Atlas Shrugged have been soaring. The Economist had the original story, but here is a link from another paper.
I cannot agree more on his point that the financial services industry has destroyed a lot of trust. I am not sure what they have destroyed more of -- trust or wealth.
The thing that bothers me most is the destruction of trust in markets generally. There will be a wholesale shift to the public sector. It won't surprise me to see some Eastern European countries shifting seriously back to a communistic mentality, thinking that they were actually better off back then. I for one think that is very wrong.
One source of optimism is that sales of Atlas Shrugged have been soaring. The Economist had the original story, but here is a link from another paper.
Saturday, February 28, 2009
AIG, Maiden Lane, and Buying CDOs
I have another question concerning AIG and CDOs that maybe someone can help with. The Fed set up Maiden Lane II and III as special purpose vehicles to assist in the bailout of AIG. These funds buy the underlying CDOs that AIG wrote insurance on. Once the funds own the underlying CDOs, they can extinguish the CDS written on them (thus saving AIG from collateral calls and further writedowns). So here is the question: If one of the big problems with TARP was how to buy mortgage backed securities from the banks, how is the Fed managing to buy tens of billions of mortgage backed securities to bail out AIG? It would seem a particularly difficult transaction since the holder may own the CDO as well as the CDS, ie,, the insurance. So does the Fed just have to pay 100% on the dollar? Well, that would explain how they can get the deals done.
AIG, Foreign Banks, and the Role of Regulation
There is an underlying story in the AIG fiasco that does not get adequate attention. See, for instance, Joe Nocera's generally excellent piece in the NYT today, or for a piece from last September that makes my point really well, see this article in International Financial Law Review.
AIG was engaged in a big way in regulatory and ratings arbitrage. Many commentators fault the regulatory system for failing to monitor and control AIG, even though there were regulators sitting in AIG's US headquarters continuously. Perhaps part of the problem was that the Financial Products Group was based in London. It is probably a lot harder to regulate things offshore.
And why was the FPG in London? Well, I cannot find figures on it, but there is certainly a lot of qualitative evidence that European banks (French, German) were very big buyers of AIG's credit default swaps (read: insurance). Why? Because Basel II, the international banking regulatory accord, specified the amount of capital required to be held against different classes of assets. If you could get a AAA rating on assets (insurance, I think, was actually the key), then the amount of capital you needed was much lower (doesn't this sound like the issue with the US investment banks and leverage -- indeed it is). So how can we get a AAA rating on some of our subprime assets? In steps AIG, with their credit default swaps.
So the banking regulatory system, set up to a great extent by the Europeans, created a demand for the insurance that AIG was more than willing to sell.
What is to blame? The regulation that created the demand, or the lack of regulation that allowed AIG to persist? Not clear to me. Some of both, no doubt -- and some serious lack of oversight at AIG themselves.
Perhaps it does come back to what more and more people tell me: you need the overall leverage restrictions on the banking system. If you start parsing risk and saying these kinds of assets need x% capital, and another kind of asset only y%, you are asking for regulatory and ratings arbitrage. And just like with illegal drugs, once the demand is created, it is very hard to restrict supply.
I wonder how much European banks really are benefitting from the US taxpayer's bailout of AIG. Why is Treasury and the Fed so willing to do this? Are they extracting something from the European banks? How long will it take before we hear about the sorry state of European banks (of course some of that has come out already, but I suspect not nearly all of it).
AIG was engaged in a big way in regulatory and ratings arbitrage. Many commentators fault the regulatory system for failing to monitor and control AIG, even though there were regulators sitting in AIG's US headquarters continuously. Perhaps part of the problem was that the Financial Products Group was based in London. It is probably a lot harder to regulate things offshore.
And why was the FPG in London? Well, I cannot find figures on it, but there is certainly a lot of qualitative evidence that European banks (French, German) were very big buyers of AIG's credit default swaps (read: insurance). Why? Because Basel II, the international banking regulatory accord, specified the amount of capital required to be held against different classes of assets. If you could get a AAA rating on assets (insurance, I think, was actually the key), then the amount of capital you needed was much lower (doesn't this sound like the issue with the US investment banks and leverage -- indeed it is). So how can we get a AAA rating on some of our subprime assets? In steps AIG, with their credit default swaps.
So the banking regulatory system, set up to a great extent by the Europeans, created a demand for the insurance that AIG was more than willing to sell.
What is to blame? The regulation that created the demand, or the lack of regulation that allowed AIG to persist? Not clear to me. Some of both, no doubt -- and some serious lack of oversight at AIG themselves.
Perhaps it does come back to what more and more people tell me: you need the overall leverage restrictions on the banking system. If you start parsing risk and saying these kinds of assets need x% capital, and another kind of asset only y%, you are asking for regulatory and ratings arbitrage. And just like with illegal drugs, once the demand is created, it is very hard to restrict supply.
I wonder how much European banks really are benefitting from the US taxpayer's bailout of AIG. Why is Treasury and the Fed so willing to do this? Are they extracting something from the European banks? How long will it take before we hear about the sorry state of European banks (of course some of that has come out already, but I suspect not nearly all of it).
Friday, February 27, 2009
Back from Behind Enemy Lines: Redistribution Logic
See my post immediately below about my venture onto the New York Times' blog, Room for Debate.
I am really surprised, and somewhat dismayed, at the vitriol heaped on my comments, and on me personally. Wow. Several lessons to be learned there, mostly concerning the nature of the NYT readership and the curious trust that liberals give the Federal government on some issues (the wisdom of the stimulus bill) but not on others.
But one set of comments in particular stood out and showed me the redistributionist, entitlement mentality that is now quite prevalent. Look at these quotes:
Let's leave aside the fact that in 2006, the top 1% of the taxpayers in this country paid 40% of the personal income taxes while earning 20% of the income.
The more important issue here is the tone in the above quote: The other 99% MUST share in only 80%...the remaining 99% of us...have ONLY A CHANCE TO EARN FAR LESS THAN 1% APIECE...
No, sorry, that is not the way this country or any market economy works. Actually, everyone has the chance to get into that top 1%. It might take some effort. You are not going to get there from complaining. It might take several generations -- of parents sacrificing for their children, who then move up, and give the next generation an even better chance. I come across loads of people like that who are in the top earning categories.
It may have been forgotten by many, but the beauty of this country is indeed that everyone has opportunity to become great, and to get respect and wealth.
I am really surprised, and somewhat dismayed, at the vitriol heaped on my comments, and on me personally. Wow. Several lessons to be learned there, mostly concerning the nature of the NYT readership and the curious trust that liberals give the Federal government on some issues (the wisdom of the stimulus bill) but not on others.
But one set of comments in particular stood out and showed me the redistributionist, entitlement mentality that is now quite prevalent. Look at these quotes:
The result is that 1% of America’s wealthiest families take home 20% of the nations earnings.
Think about that. Does that seem fair to you?
The other 99% of Americans must share in only 80% of our country’s earnings. While 1% of the wealthiest Americans enjoy 20% of our nation’s earnings, the
remaining 99% of us, on average, have only a chance to earn far less than 1% apiece of the money our nation produces every year.
Let's leave aside the fact that in 2006, the top 1% of the taxpayers in this country paid 40% of the personal income taxes while earning 20% of the income.
The more important issue here is the tone in the above quote: The other 99% MUST share in only 80%...the remaining 99% of us...have ONLY A CHANCE TO EARN FAR LESS THAN 1% APIECE...
No, sorry, that is not the way this country or any market economy works. Actually, everyone has the chance to get into that top 1%. It might take some effort. You are not going to get there from complaining. It might take several generations -- of parents sacrificing for their children, who then move up, and give the next generation an even better chance. I come across loads of people like that who are in the top earning categories.
It may have been forgotten by many, but the beauty of this country is indeed that everyone has opportunity to become great, and to get respect and wealth.
Thursday, February 26, 2009
Republican Governors Rejecting Fed Money?
I did a guest post on a New York Times blog tonight; they asked me to comment on why some governors might reject Federal stimulus money. Seems to me that they don't want to get caught in the Federal bear hug, but I doubt that they will actually go through with their threat to turn down the money.
At any rate, I seem to have riled up a few NYT readers.
Check it out here: http://roomfordebate.blogs.nytimes.com/2009/02/26/when-to-take-a-federal-hand-out/
At any rate, I seem to have riled up a few NYT readers.
Check it out here: http://roomfordebate.blogs.nytimes.com/2009/02/26/when-to-take-a-federal-hand-out/
Thursday, February 19, 2009
The Obama Mortgage Plan
I understand the desire to help those homeowners who have problems with their mortgages.
But I also believe there is a need to get mortgage-related assets off the books of the banks and into the hands of less risk-averse investors. This must be the biggest potentially mutually beneficial exchange since...well, the Resolution Trust Corporation.
The new mortgage plan has a mixed set of consequences, some unintended. I fear that it throws a lot more uncertainty into the valuation process. It will also take some of the more clearly profitable mortgages out of the pools -- which could be a plus. On the first point, uncertainty, it would seem to make the valuation of mortgages and mortgage backed securities even more difficult. Who is now going to be in default? How do we assess likely default rates if the feds are encouraging the lowering of interest payments? How does all this work within the confines of contract law in the context of mortgage backed securities? Senior tranches may prefer foreclosure and liquidation to stretching things out and accepting lower payments - if they can even be forced to accept lower payments. But more to my point, who is going to bid a reasonable price to buy senior MBS from banks with this kind of uncertainty? Have we made the valuation problem easier or more difficult?
On the second point, taking out the most profitable mortgages, the plan makes it easier for mortgagees to refinance at lower rates. Great for them, and this gets full payment of principal into the hands of the trusts holding the mortgages, which will in turn pay off the senior tranches according to priority. That is good, for as those tranches are repaid, the securities are retired and the holders can book what is likely to be a profit. What is left, however, is truly the most toxic -- mortgages that cannot qualify even for these generous (moral hazard-inducing!) restructuring terms. What this implies for the valuation of the remaining lower tranches is probably not pretty.
But I also believe there is a need to get mortgage-related assets off the books of the banks and into the hands of less risk-averse investors. This must be the biggest potentially mutually beneficial exchange since...well, the Resolution Trust Corporation.
The new mortgage plan has a mixed set of consequences, some unintended. I fear that it throws a lot more uncertainty into the valuation process. It will also take some of the more clearly profitable mortgages out of the pools -- which could be a plus. On the first point, uncertainty, it would seem to make the valuation of mortgages and mortgage backed securities even more difficult. Who is now going to be in default? How do we assess likely default rates if the feds are encouraging the lowering of interest payments? How does all this work within the confines of contract law in the context of mortgage backed securities? Senior tranches may prefer foreclosure and liquidation to stretching things out and accepting lower payments - if they can even be forced to accept lower payments. But more to my point, who is going to bid a reasonable price to buy senior MBS from banks with this kind of uncertainty? Have we made the valuation problem easier or more difficult?
On the second point, taking out the most profitable mortgages, the plan makes it easier for mortgagees to refinance at lower rates. Great for them, and this gets full payment of principal into the hands of the trusts holding the mortgages, which will in turn pay off the senior tranches according to priority. That is good, for as those tranches are repaid, the securities are retired and the holders can book what is likely to be a profit. What is left, however, is truly the most toxic -- mortgages that cannot qualify even for these generous (moral hazard-inducing!) restructuring terms. What this implies for the valuation of the remaining lower tranches is probably not pretty.
The 2004 Leverage Regulation
I did have the chance to ask a retired risk officer from a major bank his views on the 2004 leverage regulation change.
To brazenly and hopefully honestly summarize, he definitely lays a fair amount of blame on that change. Not everything, of course, and there are some caveats. Somehow he was even able to pick the firms that he thought would have shown the biggest response to it, and his predictions pretty well matched up with the Wikipedia graph noted in earlier posts and comments.
It still surprises me that the binding constraint on risk was a government regulation. I would have thought that the folks whose livelihood depended on survival of the firms, as well as counterparties, would have induced a more conservative stance than the loose regulations allowed. Lesson learned.
To brazenly and hopefully honestly summarize, he definitely lays a fair amount of blame on that change. Not everything, of course, and there are some caveats. Somehow he was even able to pick the firms that he thought would have shown the biggest response to it, and his predictions pretty well matched up with the Wikipedia graph noted in earlier posts and comments.
It still surprises me that the binding constraint on risk was a government regulation. I would have thought that the folks whose livelihood depended on survival of the firms, as well as counterparties, would have induced a more conservative stance than the loose regulations allowed. Lesson learned.
Tuesday, February 17, 2009
Heated Arguments over Crowding Out
Will the fiscal stimulus work -- will the increase in government spending cause GDP to increase and unemployment to decrease?
One of the key issues is what economists call "crowding out". I hate to give just a simple explanation of it, because as you will see, economists have been attacking one another over simplistic (and some not too simplistic) explanations. But anyway, crowding out refers to the possibility that an increase in government spending will cause spending by other agents (especially businesses) to spend less. If that were to occur, then there might be no overall increase in aggregate demand, and no stimulus.
See here for a piece by John Cochrane at Chicago titled "Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?" Gene Fama gives his own thoughts in a new blog feature on the DFA website. See here and here for some rather testy responses by DeLong and Krugman.
It is enlightening to read the comments on either the DeLong or Krugman sites to get a sense for who is reading those blogs.
At any rate, when I was in graduate school at UCLA in the early 80s, crowding out was a huge question. You can address it pretty well by the old IS/LM model. I am not a macroeconomist, but my casual observation from the later 80s and 90s is that the crowding out argument did pretty well, and the standard Keynesian "government spending will increase GDP" result was relegated to the "tired models" shelf, to be brought down in honor only in extreme times. Well, it certainly has come back with a vengeance.
With governments worldwide heading to the capital markets in a real big way, I don't see how we won't get some crowding out. Yes, there is another equilibrium with higher world income and higher consumption, government spending, and higher private investment too -- that is the rosy view with little crowding out and big multiplier. There is a less rosy view, with just slightly higher world income, much higher government spending, and less consumption and investment.
One of the key issues is what economists call "crowding out". I hate to give just a simple explanation of it, because as you will see, economists have been attacking one another over simplistic (and some not too simplistic) explanations. But anyway, crowding out refers to the possibility that an increase in government spending will cause spending by other agents (especially businesses) to spend less. If that were to occur, then there might be no overall increase in aggregate demand, and no stimulus.
See here for a piece by John Cochrane at Chicago titled "Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?" Gene Fama gives his own thoughts in a new blog feature on the DFA website. See here and here for some rather testy responses by DeLong and Krugman.
It is enlightening to read the comments on either the DeLong or Krugman sites to get a sense for who is reading those blogs.
At any rate, when I was in graduate school at UCLA in the early 80s, crowding out was a huge question. You can address it pretty well by the old IS/LM model. I am not a macroeconomist, but my casual observation from the later 80s and 90s is that the crowding out argument did pretty well, and the standard Keynesian "government spending will increase GDP" result was relegated to the "tired models" shelf, to be brought down in honor only in extreme times. Well, it certainly has come back with a vengeance.
With governments worldwide heading to the capital markets in a real big way, I don't see how we won't get some crowding out. Yes, there is another equilibrium with higher world income and higher consumption, government spending, and higher private investment too -- that is the rosy view with little crowding out and big multiplier. There is a less rosy view, with just slightly higher world income, much higher government spending, and less consumption and investment.
Sunday, February 15, 2009
Information from the NYT
Concerning my post below, The 2004 Banking Leverage Rule Change, there was an interesting comment from an anonymous poster.
I had noted a NYT article titled,"Agency's '04 Rule Let Banks Pile Up New Debt" and pointed out, first, that a quick check of Bear Stearns leverage ratios did not support the story, and second, that it would have been nice for the NYT to do a bit more work and provide the data to support or reject their hypothesis.
"Anonymous" found a very nice post on Wikipedia that gives a graph of five banks' (gross) leverage from 2003 to 2007. I will leave readers to look at the graph and make their own conclusion (my response to the comment might help). I think the graph supports my first point above, which is that the 2004 change in leverage regulation is no smoking gun.
"Anonymous" concludes with, annoyingly I have to say, "I think that I'm gonna get my info from the NYT going forward..."
Well, no. Look how easy it was for you to find that quite nice chart on Wikipedia, with (clickable!) references. Or for me to find the original data in the Bear annual report.
I think the right conclusion is: Wikipedia 1, NYT 0.
I had noted a NYT article titled,"Agency's '04 Rule Let Banks Pile Up New Debt" and pointed out, first, that a quick check of Bear Stearns leverage ratios did not support the story, and second, that it would have been nice for the NYT to do a bit more work and provide the data to support or reject their hypothesis.
"Anonymous" found a very nice post on Wikipedia that gives a graph of five banks' (gross) leverage from 2003 to 2007. I will leave readers to look at the graph and make their own conclusion (my response to the comment might help). I think the graph supports my first point above, which is that the 2004 change in leverage regulation is no smoking gun.
"Anonymous" concludes with, annoyingly I have to say, "I think that I'm gonna get my info from the NYT going forward..."
Well, no. Look how easy it was for you to find that quite nice chart on Wikipedia, with (clickable!) references. Or for me to find the original data in the Bear annual report.
I think the right conclusion is: Wikipedia 1, NYT 0.
More Biased Climate Change Reporting
With a dearth of serious science showing that climate change is accelerating (indeed, even keeping pace with model predictions), it should not surprise us to see the media overstretching to attempt to maintain the momentum on public funding and policy intiatives.
Google News this morning had this article from the Washington Post: "Scientists: Pace of Climate Change Exceeds Estimates." The body of the article is essentially arguing that the pace of climate change might be stronger because carbon emissions have continued to increase and some additional positive feedbacks in the climate cycle have been identified. But unless we include the mere concentration of carbon dioxide in the atmosphere to constitute climate change, then the headline is certainly misleading.
Does anyone else want to suggest that the search for positive climate feedbacks is heavily favored over negative feedbacks? Bad science, when most effort is spent trying to confirm a theory rather than reject it.
The Climate Science site picked up on these headlines as well: "An Egregious Example Of Biased News Reporting."
Google News this morning had this article from the Washington Post: "Scientists: Pace of Climate Change Exceeds Estimates." The body of the article is essentially arguing that the pace of climate change might be stronger because carbon emissions have continued to increase and some additional positive feedbacks in the climate cycle have been identified. But unless we include the mere concentration of carbon dioxide in the atmosphere to constitute climate change, then the headline is certainly misleading.
Does anyone else want to suggest that the search for positive climate feedbacks is heavily favored over negative feedbacks? Bad science, when most effort is spent trying to confirm a theory rather than reject it.
The Climate Science site picked up on these headlines as well: "An Egregious Example Of Biased News Reporting."
Saturday, February 14, 2009
The End of Responsibility
All signs point to the end of individual responsibility. I just read an article by Rebecca Solnit for the Los Angeles Times on the Icelandic financial crisis.
Here is perhaps the most worrisome quote: "It's official. Capitalism is monstrous. Try talking about the benefits of free markets and you will be treated like someone promoting the benefits of rape."
Capitalism is monstrous? Just because the citizens of Iceland were given some very attractive prices at which to borrow, and they blindly took a bit too much advantage of those prices?
So much of the Western world is now looking for government actions to not only save us from this recession (has nobody lived through a recession before, by the way?) but to prevent us from ever making such mistakes again.
I will give the "monstrous" label to something, but it is not to capitalism, which is nothing but the flourishing of individual liberty. Monstrous is this $787 billion "stimulus" plan and the whole process by which the new politics of fear got it passed. If that process and the result is indicative of how government is going to save us from ourselves, I am afraid we have taken a turn onto the road to serfdom.
Here is perhaps the most worrisome quote: "It's official. Capitalism is monstrous. Try talking about the benefits of free markets and you will be treated like someone promoting the benefits of rape."
Capitalism is monstrous? Just because the citizens of Iceland were given some very attractive prices at which to borrow, and they blindly took a bit too much advantage of those prices?
So much of the Western world is now looking for government actions to not only save us from this recession (has nobody lived through a recession before, by the way?) but to prevent us from ever making such mistakes again.
I will give the "monstrous" label to something, but it is not to capitalism, which is nothing but the flourishing of individual liberty. Monstrous is this $787 billion "stimulus" plan and the whole process by which the new politics of fear got it passed. If that process and the result is indicative of how government is going to save us from ourselves, I am afraid we have taken a turn onto the road to serfdom.
Tuesday, February 10, 2009
Welcome to the Treasury Amateur Hour
So our new Treasury Secretary comes out after having plenty of time to work out some details, and what do we get?
More uncertainty. Just what the markets and the economy need.
There is a beast in the room, and nobody wants to move because they don't know which way the beast will run. The beast of course is the Federal Government, doing their best to avoid the laws of unintended consequences.
A few quotes from the Wall Street Journal's story are very illuminating:
"But critical details of the plan remained unanswered, despite the weeks of planning leading up to Tuesday's announcement."
"Mr. Geithner said the plan to stem foreclosures would be announced in coming weeks."
"He also provided few details of the asset-purchase plan, which is designed to be done in partnership with the private sector."
"The absence of detail speaks to the thorny issues that lie at the heart of the financial crisis: how to value the toxic assets causing banks to report losses and how to shuffle aid to homeowners and stem the rise of foreclosures."
OK, these are not new issues.
The Government has two choices: One, come up with a credible and specific plan to buy toxic assets from financial institutions and support the ones that become insolvent as a result of having to take losses on the sales. Or two, step aside, and let natural market forces restore equilibrium.
Right now, the Government is effectively blocking mutually beneficial trades from taking place. Who wants to argue that financial institutions are the natural holders of these risky mortgage assets right now, instead of private investors? They never should have had such a concentration in the first place, so let's get on with the business of transferring that risk to those who are most willing and able to bear it.
UPDATE: I have to add this additional quote from Geithner's actual speech; it is just so perfect: "We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it."
Beautiful. How about you have the President ask some of those poor folks in Elkhart Indiana who "have no idea what to do or who to turn to."
More uncertainty. Just what the markets and the economy need.
There is a beast in the room, and nobody wants to move because they don't know which way the beast will run. The beast of course is the Federal Government, doing their best to avoid the laws of unintended consequences.
A few quotes from the Wall Street Journal's story are very illuminating:
"But critical details of the plan remained unanswered, despite the weeks of planning leading up to Tuesday's announcement."
"Mr. Geithner said the plan to stem foreclosures would be announced in coming weeks."
"He also provided few details of the asset-purchase plan, which is designed to be done in partnership with the private sector."
"The absence of detail speaks to the thorny issues that lie at the heart of the financial crisis: how to value the toxic assets causing banks to report losses and how to shuffle aid to homeowners and stem the rise of foreclosures."
OK, these are not new issues.
The Government has two choices: One, come up with a credible and specific plan to buy toxic assets from financial institutions and support the ones that become insolvent as a result of having to take losses on the sales. Or two, step aside, and let natural market forces restore equilibrium.
Right now, the Government is effectively blocking mutually beneficial trades from taking place. Who wants to argue that financial institutions are the natural holders of these risky mortgage assets right now, instead of private investors? They never should have had such a concentration in the first place, so let's get on with the business of transferring that risk to those who are most willing and able to bear it.
UPDATE: I have to add this additional quote from Geithner's actual speech; it is just so perfect: "We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it."
Beautiful. How about you have the President ask some of those poor folks in Elkhart Indiana who "have no idea what to do or who to turn to."
Monday, February 09, 2009
The 2004 Banking Leverage Rule Change
We can expect a lot of revisionist history in the next several months, as policymakers and pundits attempt to spin the historical record to fit their interests.
We had a speaker at Tuck today who mentioned the SEC's 2004 rule change, which eliminated some leverage restrictions on investment banks in favor of capital requirements by type of asset as well as more reliance on self-regulation and reporting to the SEC. A good reference for a similar story is here in the NYT.
I have been meaning to look into this "smoking gun" for some time as it did sound intriguing. Of course, the headline is usually something like the NYT's: "Agency's '04 Rule Let Banks Pile Up New Debt." The subheading is, naturally, that we need more regulation not less and that the Bush administration was at fault.
Now there might be some issues about regulation of the banks, and I myself am very surprised at how poorly market forces seemed to enforce reasonable behavior on the part of the banks. Like Alan Greenspan, I have I guess a nostalgic view of how self-regulation should work (well).
But as to the story on the 2004 deregulation -- it simply does not hold water. I pulled out the Bear Stearns 2003 and 2006 annual reports -- before and after the regulatory change, but before falling asset prices caused an endogenous increase in liquidity.
In 2003, Bear had an overall leverage ratio of 26.4, and a net adjusted leverage ratio of 12.4. In 2006, the respective numbers were 26.5 and 13.6.
Do you think the NYT reporter could have looked that up and told us as well?
We had a speaker at Tuck today who mentioned the SEC's 2004 rule change, which eliminated some leverage restrictions on investment banks in favor of capital requirements by type of asset as well as more reliance on self-regulation and reporting to the SEC. A good reference for a similar story is here in the NYT.
I have been meaning to look into this "smoking gun" for some time as it did sound intriguing. Of course, the headline is usually something like the NYT's: "Agency's '04 Rule Let Banks Pile Up New Debt." The subheading is, naturally, that we need more regulation not less and that the Bush administration was at fault.
Now there might be some issues about regulation of the banks, and I myself am very surprised at how poorly market forces seemed to enforce reasonable behavior on the part of the banks. Like Alan Greenspan, I have I guess a nostalgic view of how self-regulation should work (well).
But as to the story on the 2004 deregulation -- it simply does not hold water. I pulled out the Bear Stearns 2003 and 2006 annual reports -- before and after the regulatory change, but before falling asset prices caused an endogenous increase in liquidity.
In 2003, Bear had an overall leverage ratio of 26.4, and a net adjusted leverage ratio of 12.4. In 2006, the respective numbers were 26.5 and 13.6.
Do you think the NYT reporter could have looked that up and told us as well?
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