Month: March 2009 Page 3 of 4

On March 24, 2009

Credit default swaps (CDSs) are still a big issue. Estimates of how much of the market is at risk vary, but the lowest I’ve seen is about $15 trillion. If that goes bad, we’re probably talking another $3 or $4 trillion of damage.

While I agree that CDSs are an issue, I also think that taking bad assets off firm’s hands makes defaults on CDSs more unlikely, and thus reduces exposure to them.

Of course, this really depends on whether the fundamental problem lies with the economy or the financial market—or both. If the economy keeps going south, then bailout after bailout will be needed, defaults will happen anyway, and CDSs will be called. If the combination of fixing the financial sector plus the stimulus bill and military spending is enough to stop the economy’s downward spiral, on the other hand, then Geithner’s plan may well do the trick (once a couple more trillion are spent). We’ll see.

(Aside: Interest rate and currency swaps are about a 7 times larger market than CDSs. The real risk is a currency meltdown by a major economy.)

Market Rallies On News of Trillion Dollar Giveaway

Image by TW Collins

Is anyone really surprised the DOW is up almost 500 points, after Geithner promised to give private investors almost $1 trillion to gamble with?

The details of the giveaway are fascinating. I sure wish that I could get financing like this to play the market:

Under one part of the plan focused on bad loans, the Treasury will provide up to 80 percent of initial capital alongside investment by private funds. The FDIC would then offer debt financing for up to six times the pooled amount.

Now, unless I’m messing up my math, that’s 24/1 leverage. If older details hold, and the 80% is a non-recourse loan, meaning that it’s secured only by the value of securities bought, then it’s even sweeter.

PIMCO has announced it’s interested in participating, which means that the plan has succeeded in one sense—it has the buy-in of some very smart money. That doesn’t mean that it’s necessarily good for taxpayers, or that it will be good in the long term for the economy, necessarily, but at least it isn’t being laughed out of Dodge. On the other hand, would you refuse 24/1 to one financing? Or even matching funds, as contained in part two of the plan?

I sure wouldn’t. And PIMCO have been scavengers before. They bet heavily in Fannie and Freddie bonds after it was clear Fannie and Freddie were insolvent, which was a bet that the government wouldn’t shear bondholders when it bailed out Freddie and Fannie. Smart bet, but not a good return for taxpayers, who would have been better served by letting Freddie and Fannie’s debtholders lose money.

I am becoming increasingly convinced that my original call was the right one: that the various bailouts would lead to Japanification. For 20 years now, since its own bubble burst, Japan has had an economy which slips in and out of recessions like clockwork and which never ever really got good again. In Japan’s case, the lousy economy was in large part because they left a lot of debt debt on the books of private corporations. In America’s case, the debt may be transfered to taxpayers, but the end result is likely to be the same, only compounded by attempts to create secondary bubbles so that the toxic waste regains enough value to claim a win.

Given that Geithner’s trillion dollar giveaway has been greated ecstatically by the financial sector, I expect we’ll see more money used in this fashion. This plan appears to be good for about $2 trillion of lousy debt ($1 trillion from the matching 1/1 program, $1 trillion from the high leveraged portion). Total current toxic waste on the banks books is probably about $4 trillion, which will still have to be dealt with.

That money will have to be paid off, eventually. Doing so will cost the US and the world a great deal of future growth, and individuals a great deal of future income and employment. As things stand right now, I don’t think employment levels as measured by employment/population ratios will recover in the forseeable future—post recession “full” employment will just be lower than pre-recession “full” employment. There are still some ways this could be made to work for everyone, and I’ll discuss those at a later date.

Employee Free Choice Threatened by New Lobbying Campaign

A new big business lobbying campaign against the Employee Free Choice Act (EFCA HR1409/S.560) threatens to eviscerate the bill. Starbucks, Whole Foods and CostCo are lobbying together to weaken the pro-labor Cardcheck Bill.

The proposed provisions would tighten some organizing rules in favor of workers and keep the secret ballot, but at the expense of eliminating mandatory arbitration. Mark Ambinder reports that the new provision would also require 70% or workers to sign cards to form a union (cardcheck) vs 50% yes vote by secret ballot.

historical union membership

I don’t see any appeal for organized labor in this “compromise”. First, mandatory arbitration is a big deal because in many cases firms simply drag out negotiations forever, making sure there is no contract—even when unions are recognized. And 70% is a high hurdle. As compromises go, this one will do nothing but compromise unions’ ability to organize more workers and negotiate contracts.

Even if you don’t care about workers’ right to unionize, the fact is that where unions are strong, Democrats win. Republicans know this, which is why they’ve done everything they can to weaken unions. Unions also raise wages generally in the population. As Nathan Newman notes, even non-union workers benefit from unions, because employers increase wages to be competitive, so they aren’t too easy to unionize.

This is a battle worth fighting.

The AIG Bonus Clawback Bill Won’t Work But Here’s What Will

Last week the House passed a bill designed to claw back bonuses over $250K from recipients of TARP money.

Now I’m a class warfare guy on the side of regular folks (as opposed to the rich, who are winning the current war and won the last one), but this bill is counterproductive and won’t work. It is too easy to work around and it is targeting the wrong people.

The clawback only affects bonuses, leaving a loophole where TARP recipients can just recategorize bonuses as salaries.
If the clawback applied to all income, then employees would be moved to contract status or to companies which haven’t received TARP money (even if artificial companies have to be created for the purpose).
The threshold of $250K of household income is not that high, as Henry Blodgett points out. Don’t get me wrong, no family making that amount is poor, but they are still affluent. (I’ve never made anything close to it, so this isn’t a personal thing.) At the same time, they aren’t filthy rich, either, and they shouldn’t be taxed as if they were.

But concentrating on bonuses for employees at firms which have been bailed out misses the point. It’s not just those firms whose employees need to be taxed more heavily, it’s everyone.

The logic for increasing taxes is simple enough. For the last 20 years, American executives have been able to pay themselves such large bonuses that in 3 to 5 years they could amass enough money that hey would never need to work again. This executive compensation system created the incentive to do whatever was required in order to get those bonuses—leading to flagrant risk taking and outright fraud. It also led to a short-term focus on the business. When executives know that it doesn’t matter to their personal financial well-being if their firm exists in 5 years, they don’t worry about the long term consequences of their decisions. All that matters is booking “profit” now, so you can get money now, and become rich now.

Wall Street and the banks didn’t make any money in the last 10 years, for all that they booked record profits. The combined losses of the financial firms is larger than their entire reported profits. What they did was sell synthetic securities based on dubious assumptions about the future—that the housing bubble would continue forever, there would never be another recession, and defaults wouldn’t cluster; and book the entire calculated future profits of these securities as profit in the year they were created. Of course, those future profits were fictional, but the bonuses based on them were in real money.

In order to make sure this never happens again compensation needs to be restricted in every firm, not just in the US, but in the industrialized world. Executives and salespeople and auditors and loan officers (if banks decide to rehire any) need to know that ten years from now if a loan goes bad that they’re going to be on the carpet for it, that they might lose their job for it, and that they will still need a job in 10 years.

I recommend 7 measures to restrict compensation:

More Details On Geithner’s Plan

US Gold Coin

Bloomberg’s has more highlights of Obama’s plan for toxic assets that will be unveiled Monday by Treasury Secretary Geithner. Newer details include:

Geithner will ask Congress to give the Treasury and FDIC more powers: to guarantee more types of debt, limit payments to creditors, and break executive compensation contracts.
The Federal Reserves Term Asset Loan Facility program (TALF) will expand to riskier assets. Financing will be 1:1, and will apparently include private partners (in a way similar to the Treasury fund) who will make the investment decisions. Profits and losses will be shared between the government and the private sector.

I still don’t like the FDIC funding plan, because the public component is up to 97%, but the Fed TALF plan makes a lot more sense. Doing the funding 50% public, 50% private is much more fair, is not nearly as heavily leveraged (although leverage can be applied in other ways) and losses are shared much more equally, assuming these are not non-recourse loans (which they appear not to be, though that’s not certain.)

The additional powers Geithenr is asking for are acceptable, except for the ability to guarantee more types of debt. The FDIC is already guaranteeing many bank assets: the idea of them guaranteeing even riskier classes only serves to set up taxpayers to shoulder even more losses from the private sector’s.

Many of these concerns would be moot if the administration would just nationalize firms which are effectively insolvent. But, given that the administration won’t nationalize the banks, at least parts of this plan are not completely stupid.

The plan does however appear to perpetuate the trend of taking on private losses and putting taxpayers at risk for most of them.

News Flash for Fox News: Canada Doesn’t Need the US For Security

On March 22, 2009

Royal Canadian Regiment In Afghanistan

Canadian Lieutenant General Leslie Andrew Leslie recently noted that after Canada’s deployment in Afghanistan ends in 2011, Canada’s military may need a year to recover. The reason, as Ellen points out, is because Canada has been suffering 4 times the casualty rate of American troops in Afghanistan, because Canada’s in one of the most dangerous provinces.

Of course, Fox panelist Benson then mocked Canadians:

“I didn’t even know that they were in the war,” Benson said, adding he thought Canada was where someone went to avoid fighting.

No, Fox and the Republican party is where people go who avoid fighting. None of the panelists on the show appear to have ever served in the military.

Then Fox pundits made the suggestion that Canada leaches on the US for security:

“Would Canada be able to get away with this if they didn’t share a border with the most powerful country in the universe?”

Here’s a fact for Fox. There is only one country in the world which threatens Canada’s security in any meaningful way. Only one country in the world which might be able to successfully invade Canada: that’s the US.

Canada doesn’t need the US to save it from anyone but the US. Sort of like protection money: “Such a nice country you have there. Be a shame if anything any happened to it.”

Which is more or less what one panelist meant when he said:

“Isn’t this the perfect time to invade this ridiculous country?” Gutfeld asked panelist Doug Benson.

Brits Attempt to Snoop On Everything And Tell Anyone

On March 22, 2009