The horizon is not so far as we can see, but as far as we can imagine

Month: April 2009 Page 1 of 5

The Chrysler Bankruptcy May Not Be As Smooth As Hoped

Chrysler went into bankruptcy because creditors wouldn’t agree to be wiped out.  They may believe that they will do better in front of a bankruptcy court, or some of them may have credit default swaps (CDSs) and have wanted Chrysler to go under so they would be paid off at full dollar (which points out another problem with CDSs, that they make bondholders more willing to force companies into bankruptcy.)

The government’s plan is to have a quick 30 to 60 day bankruptcy, shed the debts, and come out of it with the United Auto Workers owning 55%, the US government 8%, the Canadian and Ontario sharing 2% and Fiat receiving 10% with the possibility of more.

But bankruptcy court is not a sure thing.  The bankruptcy judge will have discretion and there are laws to be followed.  It is by no means a sure thing that this plan will survive contact with the court.  The debt holders will go to the judge and argue that they deserve to own much more Chrysler or that it should be broken up and that their claims take precedence.

I don’t know if they’ll succeed.  Certainly the government will put all their weight behind the current plan.

The next question, then, is GM, where the same calculation is playing out: a lot of debt holders think that they can do better in bankruptcy than through the government plan.  How the bankruptcy judge starts ruling in the first days of Chrysler’s bankruptcy will have a lot to do with whether GM debt-holders crumble.  If the judge seems ready to ram through the government plan, then GM probably won’t go bankrupt.  If he isn’t, it probably will.  Assuming of course that enough debt-holders don’t have CDSs covering their GM debt.  If they do, well, it’s in their interest to crash the company no matter what.

Garrison Keillor: Don’t Prosecute Torture and Make the Trains Run On Time

Well, pretty close, anyway:

Rather than square off in a bloody battle over war crimes, let’s return decent train service to the Midwest and test out the German maglev (magnetic levitation) system — the 360 mph trains — and connect Chicago and St. Paul-Minneapolis, Cleveland, Detroit, Omaha, Kansas City.

Sometimes I do fear that satire, while not dead, might be mortally wounded.  As for Keillor, never understood why everyone loves him, since most of what he writes is pap.

US To Take Majority GM Stake, United Auto Workers Get 38%

I’d say it’s the right thing to do, though what will really matter is what the government does once it’s in control.  This is what should have been done to the banks, in effect.  Just take them over, put your own board in charge and go to it.  As for giving the UAW a big stake, that’s only fair, as their pensions, health care salaries and very jobs are at stake, and indeed, the workforce will be cut by another third.

For banks, the equivalent would be to give depositors and bondholders a share, turning them into what amount to mutual companies (where the customers own the company.)  Not the worst idea in the world, but it won’t happen.

[Source: Corrente]

Addendum: Apparently the UAW will get 55% of Chrysler.  Clever man, Obama.  If he’d just made the UAW eat all these concessions for nothing, he would have reaped a lot of hatred.  My hat’s off to him on this one.

Why Pakistan’s Decline Is Almost Inevitable

Image by takebackpackistan

Image by takebackpackistan

Benazir Bhutto’s niece, Fatima Bhutto, lays out the reasons for decline as  succinctly as anyone I’ve read:

The Taliban and their ilk, on the other hand, are able to seat themselves in towns and villages across Pakistan without much difficulty largely because they do not come empty-handed. In a country that has a literacy rate of around 30 percent, the Islamists set up madrassas and educate local children for free. In districts where government hospitals are not fit for animals, they set up medical camps—in fact, they’ve been doing medical relief work since the 2005 earthquake hit Northern Pakistan. Where there is no electricity, because the local government officials have placed their friends and relatives in charge of local electrical plants, the Islamists bring generators. In short, they fill a vacuum that the state, through political negligence and gross graft, has created.

To combat the Taliban’s incursions further into poverty-stricken parts of the country, Pakistan’s government only has to do its job less leisurely. That’s the frightening truth.

Napoleon once said that the moral is to the physical as ten is to one.  My simple rule of thumb for determining who will win civil and guerilla wars is “who is the government?”  Now if I were to ask 100 people who the government of northwest Pakistan is, 99 would probably say “the government of Pakistan.”

No.  Government is what government does and Taliban is the government in most of that region.  The organization which supplies security, social services and law is the government, and it doesn’t matter who is recognized by foreign powers.  This is a mistake which the West makes over and over and over again, most recently in Somalia when the US greenlighted and aided in the destruction of Somalia incipient government, the Islamic Courts Union, plunging the country back into even worse anarchy than before, and pretending that the foreign chosen “interim government”, which had no popular support, was actually a government.

Now Napoleon didn’t say the moral is to the physical as infinity to one.  If you’re badly enough outgunned and outnumbered, well, being the government may not be enough, especially if you’ve only been the government for a brief time.

This is why a lot of analysts believe that Pakistan can never “fall”, because the Pakistani army is very powerful.

I am far less sanguine.  The army has shown very little willingness or ability to fight the Pakistani Taliban.  It is unclear to me that the Pakistani army is willing to fight the Taliban, at least all out and if ordered to do so that it would obey that order, either at the top level, or at the operational level.  Which is to say, just because the “President” orders it to do something, doesn’t mean it will, and even if the military took back over through another coup (quite likely) that officers and even line soldiers are willing to be used against the Taliban, when the Taliban is actually a more effective government than they one they ostensibly serve.

The legitimacy of a government comes from doing what a government does.  The Pakistani “government” is less of a government to most of the country than the Pakistani Taliban.  The danger is that it will continue to expand into places where the Islamabad government is not actually acting as a government, till it controls most of the countryside and some of the smaller cities.  From there it will likely reach an accommodation with the army.

Although they aren’t communists, this is classical Maoist style countryside to city guerilla strategy.  By the time the major cities fall, they will be all that is left, completely isolated from the rest of the country.

The Pakistani army is powerful, but it is only an army, not a government.

Government is as government does.  If the current Pakistani government wants to stay in charge, Fatima is right, it needs to do its job.  If it doesn’t, those who are willing to do the job will take over.


1. Fatima does have an axe to grind with the other faction of her family, but that doesn’t make her statements inaccurate.

2. Certainly Juan Cole is correct that the government is not likely to fall in the next 6 months to a year. In fact it might never fall, per se.  Despite the fact that Hezbollah is more powerful than the Lebanese central government, that government still exists.

Evaluating Geithner’s Stress Test

With the release of the stress test methodology(pdf), let’s take a look at what the stress test is, what it isn’t and how it’s done.

What the Stress Test Is, is a test of the whether the 19 bank holding companies with more than 100 billion in assets have enough income and reserves to survive till the end of 2010, with enough reserves left at that time to make it through 2010. Banks were required to report their expected income for the next two years, then that was compared to their reported expected losses for the duration.

The Stress Test Is Not a test of whether or not, if a given bank holding company were liquidated right now, it would be worth more than 0 dollars. As such, it is not, primarily about mark-to-market accounting. The question is now “are the banks solvent”, the question is “can they keep operating and if not how much money do they need to keep operating?” In household terms, think of it as “can they pay their bills”, not “what is their net worth?”

The assumption is thus that all loans will be held to maturity and not sold on the market. What matters, then, is the income on those loans and how likely those loans are to default. Income is thus loan income minus defaults, taking into account any ability to recover losses. (For example, if a homeowner defaults on a mortgage, how much will the bank receive when it seizes and sells the house?)

Something over 150 people worked on the test on the government side. They were divided into teams by asset and income areas, such as “Commercial Real Estate Loans”, “First and Second Lien Mortgages” and “Credit Cards and Other Consumer Loans”. Each of these teams evaluated the submissions off all the Banks for that area.

Using the Banks Own Models

An initial criticism of the Stress test was that it used the banks own financial models-the same models which didn’t predict this mess in the first place. That’s mostly, but not entirely correct. The banks run the numbers based on their models, but they have to give the assumptions underlying those models to the supervisory teams. If the teams don’t agree with the banks model, they can insist on changes. How much they have done so, we don’t know, but there is some indication in the methodology that the teams did their own analysis of likely losses. For example, when referring to mortgages, the methodology reports that:

Certain attributes, in particular FICO, LTV bands, vintage, product type, and geography, were found to be strongly predictive of default. These attributes were used to further evaluate submissions by the firms, and where necessary, loss estimates were adjusted to better reflect portfolio characteristics in a consistent way across firms.

There are also indications that the teams found some substantial differences in underwriting standards between firms, and have taken that into account as well. Nonetheless, given that this was done in a 2 month period, with a little over a 150 people reviewing 19 massive banks, the teams would not have been able to develop their own models and could only have tweaked the bank models.

Economic Scenarios

The losses taken into account were based on two economic scenarios, a scenario based on median economists forecasts at the time the Stress Test was first planned, and a more adverse scenario. The first scenario has already been superseded by events, as the economy is performing worse than mainstream economists expected. The more adverse scenario has not yet been exceeded, but, for example, it models 8.9% unemployment in 2009, and current unemployment is running at 8.5. It is highly unlikely, in my opinion, that unemployment will not rise more than .4% in the rest of 2009 unless it’s for technical reasons like people despairing so much of finding a job that they just stop looking entirely.

What this means is that even if one accepts the models might be accurate after the examiners fiddled with them, losses will probably be higher than expected.

Banks that don’t pass will be required to raise enough capital to make it through the time period. They can try and do that on private markets, or the government may step in and provide capital. In addition, they can ask the government to convert its preferred shares into common stock, which will reduce the company’s expenses.

Concluding Remarks

The stress test is flawed, but not worthless. The economic forecast used was overly optimistic, and given that mainstream economic forecasts have been consistently off throughout the crisis, this should have been expected. The staffing may be sufficient to do superficial analysis, but this is by no means a real audit, in which hundreds of examiners swarm over each bank to discover whether or not the top end numbers they are supplying are accurate or if their accounting and underwriting has been weaker than declared or if there has been outright fraud.

While examining underwriting standards is useful, examining actual random cases in a professional audit to see whether or not underwriting standards had actually been followed would have been far more useful and predictive of future losses. To some extent, looking at comparative loss rates between banks can substitute for this, but only partially, as it is backwards looking rather than forward looking.

Bank default and valuation models are highly suspect, as well. As a rule the models used during the collateralization process did not sufficiently account for default clustering (i.e. for the fact that in a recession or depression a lot of people default in a short time period) or for the fact that there were housing or securitization bubbles. Those models have to be corrected for each particular class of securitized loan, since each one had its own model. Crude approximations were no doubt put in place by the teams and perhaps by the banks, but there’s still plenty of reason to question the models being used.

Given these flaws the stress test is only indicative, not final. Certainly any bank which fails them definitely needs money, but it may need more money than indicated by the test. Likewise banks that pass will likely not be viewed as out of the jungle, unless they pass with flying colors.

Likewise, the methodological paper was quite vague. The stress test will not be trusted without more specifics, and when results are released we will need firm numbers, not just the final numbers “needs X amount of money” or “passed” but the assumptions on default rates broken down by year, location of loan, type of loan and so on so that independent analysts can come to their own conclusions. Failure to do so will mean that the banks and Treasury are saying “trust us”, and unfortunately, at this point, no one does. Given the known flaws of the stress test, independent verification will be required

What Every Liberal Needs To Learn From A Conservative Parent

constitution-censoredSara Robinson, discussing the different parenting styles of liberal and conservatives notes that Conservative parenting can wind up teaching that:

they do have boundaries — but only to the extent that they’re personally willing to fight and able to defend them.

Let me put this another way, one you may be familiar with.

“you have only the rights you are willing to fight for”.

This is the lesson that liberals who didn’t have a parent with a conservative parenting style often don’t understand.  There are no such things, as a practical matter*, as innate rights.  They do not exist in the real world. You have only the rights that other people earned for you, usually by fighting, suffering and dying.  And as a group, you keep only the rights you are willing to fight, suffer and perhaps even die for.

Any “right” you are not willing to fight for is not a right, it is a privilege given to you by the powers that be, which can be revoked by them at any time it is convenient to them with no consequence to them.

* Yes, in theory there are innate rights. In practice, there aren’t.

17 Year Olds To Be Allowed Plan B: Why Not 12 Year Olds

Nope, I’m not kidding.  Frankly the younger they are, the more they should have access, since the younger they are the more likely it is that they shouldn’t have kids.  Women don’t have a lot of time to get Plan B, having to run to parents make its very unlikely you’ll get it in time, making either teenage pregnancy or an abortion far more likely.


4.1 Trillion of Losses?

american-dollar-toilet-paper1The IMF put losses at 4.1 trillion today. As a friend noted, that needs a couple of big caveats:

  1. Losses to this point.  Not losses that are yet to occur.
  2. Losses that people are willing to admit to.

But losses should slow down now that firms no longer have to mark assets to market. Mark to fantasy is very forgiving.  As we’ve seen in the last bit, with bank after bank declaring profits, mark to fantasy can turn almost any firm around.

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