Category: Financial Crisis Page 11 of 13

Because sometimes, I told you so is necessary, in the hope that next time people might listen. This is what I wrote September 20th, 2008:

This is a stickup. Paulson is trying to stampede the Congressional herd into giving him powers and money that he knows they would never give if they had time to think it through carefully. It worked with the Patriot Act. It worked with the AUMF. He’s betting it’ll work again. Create a crisis (or lie one into existence) then demand dictatorial powers and unlimited spending authority to deal with it.

Congress needs to not succumb to fear or to explicit or implicit blackmail. If the crisis was as severe as Paulson makes it out to be, virtually the end of market capitalism, he wouldn’t be quibbling over whether or not CEOs get to keep their golden parachutes.

In effect, that quibble is like you walking into your local bank and saying “I need you to loan me a million bucks. Here are the conditions I must insist are met before I let you lend me the money. First…”

Say what?

He’s given his tell, that he’s a liar, a thief and a scam artist.

Time for Congress to call his bluff, and to see that the financial crisis is dealt with on their terms, with strict oversight by people they can trust, not by a scam artist and liar like Paulson.

Of course, Congress didn’t call his bluff and Congress did fall for it. But let’s remember our history. The House voted against. Nancy Pelosi indicated that she would not pass TARP unless Republicans voted for it in the same proportion as Democrats. They weren’t going to do that, so TARP was dead.

Then Barack Obama stepped in and started twisting arms. TARP is Obama’s baby. If you like it, or don’t like it, remember, without Barack Obama it would have died.

This is the fundamental problem right now with Democrats. They passed a lousy stimulus, they made TARP Democratic policy by passing it with majority Democratic votes and they are on their way to passing a lousy healthcare bill which won’t even kick in till 2013.

Bad policy leads to bad outcomes. Bad outcomes get blamed on the incumbents (as they should). TARP, the Stimulus, healthcare and the economy become less and less the Republican’s problem every month that passed. Even if they screwed it up, Democrats control the House, Congress and the Presidency. It’s up to them to fix George Bush’s mess, and if they don’t they will be judged as failures, and that judgment will be accurate and deserved.

And the outcomes are going to be bad. The stimulus bill was both badly put together (too many tax cuts, not properly targeted) and too small. The healthcare bill should be single payor, because single payor is proven to work and the witch’s brew that Congress has put together isn’t proven to work and they can’t afford to fail. And TARP was, and is, a piece of crap, but the differences between Bush/Paulson financial policy and Obama/Geithner are so thin as to be largely cosmetic.

Policy has consequences. The “compromise” position between “doing it right” and “doing it wrong” may work sometimes, but it doesn’t work when a nation is in crisis and has spent 30 years digging itself into a hole.

By the time Obama comes up for reelection, Americans won’t have better healthcare and they will have less jobs than before the recession and the stimulus.

That’s what he’ll be judged on, and all because he signed on for Paulson/Bush financial policies, and compromised his key domestic and economic policies to the point where they wouldn’t work.

The consequences of (yet again) failing to stand up to the banks

By Ian Welsh

On May 14, 2009

23 Comments

sunset-by-vj-fliks The Senate just stopped limits on credit card rates. Sometimes it takes a socialist to say the obvious:

“When banks are charging 30 percent interest rates, they are not making credit available,” said Mr. Sanders, who noted credit unions are limited to 15 percent. “They are engaged in loan-sharking.”

The banks have been given, loaned and guaranteed trillions. They are given access to money at very close to zero percent. They then lend it out at much much higher rates. As Sanders notes, 1/3 of credit card holders are being charged more than 20%, some as high as 40%.

That’s usury. More to the point, it means that for all intents and purposes they aren’t making credit available.

Does anyone wonder why consumer spending dropped again? Would you borrow at 20% to 40% to buy anything other than food or pay for housing, when jobs are still being lost at over half a million a month? No one with any sense would.

Months ago I noted that the simplest way to get banks lending again would be to either have the Fed lend directly to consumers, or have the FDIC take over a major bank like Citigroup or Bank of America and use that bank to lend at decent rates.

Instead of doing that, the Bush and then Obama administrations decided to give money, guarantees, loans and nearly free money to banks which were impaired and which needed to gouge their customers as hard as they could to make a profit. The result is that treasury secretary Timothy Geithner keeps saying the financial sector is fine, while more Americans lose jobs, consumer spending drops, banks won’t allow homeowners to get out from under bad mortgages even when it would save the bank money, and a new round of foreclosures is on its way.

On top of that, the mark to market rule was changed to allow banks to keep assets on their books at mark to model (ie. mark to fantasy) values.

All of this money will have to be paid back eventually. The strategy is simple enough.

1) Give the banks money.

2) Let them not acknowledge as much of their losses as possible.

3) Allow them to gouge taxpayers for as much as possible, to dig themselves out of the hole over a number of years.

The end result of this is going to be Japanification—at best. Not a “lost decade” as many folks have said, but a semi-permanent wavering between slight job gains and job losses, where a good economy never, ever, comes back. And because the US, unlike Japan, is not a net exporter, it’s questionable how long Japanification can work in the US, in any case.

The banks took trillions of dollars of losses. The refusal to make them take their losses; the refusal to wind up any of the big banks; the refusal to recognize that what is important isn’t the banking system but what the banking system does, and thus the unwillingness to cut past the big banks and lend directly means that those trillions of dollars of losses are going to have to be paid back by consumers and taxpayers. You will pay. You will pay not just in high interest rates, but in lower wages, and for many of you, a lack of jobs. The economy will not, before the next recession after this downturn, return to the same level of employment the US had before this crisis.

All of this because neither party, and neither President, had what it took to stand up to the banks.

(What a good policy would have looked like.)

Central Bank Inflation Targeting Wasn’t Quite the Problem

By Ian Welsh

On May 6, 2009

4 Comments

Martin Wolf, one of the best economics commenters, notes that the widespread idea that central banks, over the past 30 years, had found the holy grail of policy in inflation targeting, was clearly wrong. That’s good as far as it goes, and he’s right. But it’s worth taking farther—the problems with inflation targeting included the definition of inflation, the inflation target and the uncontrolled flow of money

Inflation as measured during this period did not take into account asset bubbles. Wolf almost notices this, when he notes that the Fed didn’t see it as its job to stop asset bubbles. But he doesn’t go quite far enough: asset price increases are a type of inflation. If it costs more to buy a dollar of future income, a house, or a share in a company, that’s inflation. To manage inflation properly, as a central bank, requires first to know what inflation is, and that means adding asset inflation into an inflation index. This would be the opposite of the current “core inflation” index, which is non-asset inflation minus food and energy prices, ostensibly to remove volatility (which is not the way to remove volatility, the way to remove volatility is to use a moving average.) Of course, in the real world, increases in fuel prices and energy prices are, well, inflation. Add in credit price increases as well, and you’d have a measure which actually measures inflation. Target that, and you’d be targeting something real.

The second issue is simpler, the inflation target was too low. It seems like inflation being low is nothing but good, but in fact the lower it is, the more sectors of the economy are actually in deflation at any given time. If inflation is 5% and consumer goods, say, are 4% less than that, they aren’t in deflation. If inflation is at 3% and consumer goods are at 4% less, they’re at -1% and are deflating. As the last little while (and the Great Depression) have taught us, deflation is not a good thing, and yet for a long time large parts of the economy have been in and out of deflation fairly constantly. In addition, a higher rate of inflation discounts past economic activity, which isn’t an entirely bad thing, as it means people have to be agressive with their money. In a world where fraud and financial speculation wasn’t the best way to make returns, that is a good thing. (In our world, perhaps not, admittedly.)

Finally, open financial flows turn bank policies into something of a joke. As Wolf himself notes, foreign central bank independence from the Fed was largely chimerical: other central banks had to lower interest rates along with the Fed, and if they didn’t, then hot money would pour in from the US, or for that matter, from Japan, which was running its interest at zero or near zero for much of the past 20 years.

As a result, the effective interest rate was whatever the lowest interest rate of a large credible central bank with relatively stable currency was. (If you’re borrowing from a country with an unstable currency, and the currency appreciates suddenly, your apparent low interest rate can turn into a trap which costs you greatly.)

This meant that even if central banks wanted money to be expensive, for those people and corprorations able to borrow from foreign sources, it wasn’t, and the asset bubbles, inflation and so on which came from that came even if the bank was trying to be conservative. Real independent monetary policy is greatly damaged by free money flows between countries, which is even before you get to its damaging effect on real free trade and comparative advantage.

And old management maxim is that you get what you measure. Central banks weren’t measuring all inflation, and so they weren’t managing asset inflation, which is one main reason we got asset bubbles. Add to that that even where they were targetting inflation, they were targetting it at too low a level and that international money flows made it difficult to run an independent bank policy even in countries which might have wanted to, and you had a very flawed central banking system in virtually every country in the world.

So it’s not clear to me that inflation targetting is necessarily a bad policy. It seems more likely that it might have been a good policy, implemented in a very bad way. It disciplined the small actors in the economy, small businesses and ordinary workers—restricting their wages and their goods inflation, while allowing rampant inflation in securities and real-estate and (in the 90s) stocks.

The people who weren’t disciplined, then, drove a truck through the hole created and caused a disaster. The lesson isn’t “we shouldn’t target inflation”, the lesson is “we need to target all inflation” not just inflation which effects some people.

The FDIC Is Levying Money From Banks To Spend: Not For “Confidence”

By Ian Welsh

On May 3, 2009

Brian Angliss notes that the FDIC is levying a huge 20 cent per 100 dollars on deposit at the bank fee. He notes that the largest banks, having received lots of TARP money, will be able to pay that off using their taxpayer money, while smaller banks will get hammered and may either go under or be forced to cut back on jobs, branches and so on.

But Brian seems to take the FDIC’s announcement that they are doing this to improve confidence at face value. I think, rather, the FDIC has made this sudden cash grab for a different reason: it needs the money for Geithners plan to buy up toxic assets.

Remember that the FDIC is providing most of the cash of the first part of the plan, up to 850 billion dollars worth of it. That’s a lot of money. Of course, the levy won’t raise that much, but it can and will be leveraged to buy up the toxic assets. So what is taken away from the banks will be given back, in the form of removing toxic assets at overvalued prices.

The question though, is which banks will benefit. By and large, so far, the largest banks have received the majority of help from the Feds. If assets are not proportionally bought from all the banks (and they won’t be) this could well lead to exactly what Brian fears—money being taken from small banks disproportionately, which will damage them and cause many to fail.

The Chrysler Bankruptcy May Not Be As Smooth As Hoped

By Ian Welsh

On April 30, 2009

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.

Evaluating Geithner’s Stress Test

By Ian Welsh

On April 27, 2009

1 Comment

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

4.1 Trillion of Losses?

By Ian Welsh

On April 21, 2009

2 Comments

The IMF put losses at 4.1 trillion today. As a friend noted, that needs a couple of big caveats:

Losses to this point. Not losses that are yet to occur.
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.

Bank Profits And the The Choice America Has Made

By Ian Welsh

On April 13, 2009

11 Comments

Peter Morici points out something which should be obvious:

Monday afternoon, Goldman Sachs reported much larger than expected first quarter profits, and this comes on the heels of Wells Fargo’s strong earnings reported last week.

No one should be surprised.

The Federal Reserve has provided the banks with lots of cheap funds through its various emergency lending facilities and quantitative easing.

The Federal Reserve has permitted the banks and financial houses to park vast sums of unmarketable paper on its books—securities made nearly worthless by the misjudgment and avarice of bankers. In return, the Fed has provided these scions of finance with fresh funds, cheaply, that they may lend at healthy rates on credit cards, auto loans and even mortgages.

While the Fed cuts the banks slack, the bankers are busy turning the screws on their debtors by raising credit card rates and fees, and harassing distressed borrowers with all the zeal of the Roman army sacking Palestine.

Yes, well, there you go. Morici goes on to point out that low interest rates screw over old people who have certificates of deposit, and that the banks now want to “repay” the loans because when you’re being given money for nothing, and allowed to keep bad assets on your books at whatever price you feel is ok (since mark to market is gone), well, everything is wonderful in banker land.

(Well, unless you’re so far gone, like Citi, or Bank of America, that even in fantasy land you can’t make it work.)

As Stirling Newberry has pointed out, the economy has become clearly divided into two different economies. One for the people who have access to money cheap and whose job is to take care of foreigners, and the other one, where credit is dear and you’re losing your job.

Guess which economy you live in?

This isn’t just going to be about employment, though that is going to suck for the forseeable future, and will, in effect, never recover. It is also going to be about real income. Forget the headline CPI, the costs you pay are going to go up faster than your wages (which are probably going to deflate), and your assets are going to deflate. Riptide inflation, which catches you on both the up and downsides.

Real standards of living for median Americans are going to drop. It’s just that simple.

In 4 to 8 years, the Republicans will probably get back in again. They will do stupd things again. By the end of their orgy of looting and warring (which will be even worse than Obama’s) the country is going to be extremely damaged. Right now things could be fixed. They probably won’t be, because Barack Obama has no intention of fixing main street, but they could be. By the time the US gets its next real chance, well, this hole is going to be mighty mighty deep.

The US has made the choice of continuing to put its primary efforts into pursuing a chimerical paper economy which promises easy alchemical gold, rather than fixing the real economy.

But there’s no such thing as free money, not on aggregate over the long run.

And the long run is here, and by “aggregate” I mean “you aren’t an executive with the power to pay yourself millions in bonuses for destroying the US’s economy. But you will have less money because of them.”

(Note: quote from an email from Morici, article does not appear to be online)

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

Category: Financial Crisis Page 11 of 13

Memory Lane on the Paulson/Goldman Stickup: What I wrote Sept 20, 2008 and why it matters today

The consequences of (yet again) failing to stand up to the banks

Central Bank Inflation Targeting Wasn’t Quite the Problem

The FDIC Is Levying Money From Banks To Spend: Not For “Confidence”

The Chrysler Bankruptcy May Not Be As Smooth As Hoped

Evaluating Geithner’s Stress Test

4.1 Trillion of Losses?

Bank Profits And the The Choice America Has Made