Two Lingering Questions for Krugman
Nobody has earned the the right to say "I told you so" as honestly as Paul Krugman. Like many others, I have not hidden my gratitude. Yet I wonder about two of his claims against Geithner's plan that seem to me both crucial and not sufficiently answered, at least not in Krugman's writings and public appearances I have seen. If we are going to put major banks into receivership--in effect, nationalize them--the answer to both had better be "no." (I have some working hypotheses, but l am prepared to be enlightened.)
1. The first has to do with the meaning of insolvency, or its flip, the recoverable value of mortgage-backed securities on banks' balance sheets. Krugman (supported by terrific bloggers on this site) insists that Geithner is not acknowledging the size of the housing bubble, that is, the very low actual values of these assets, as compared with the values they were booked at. But these values, much like the price of oil, depend almost entirely on the pace of recovery. What, if anything, can be said about that?
The value of housing will almost certainly not get back to what it was at the height of the bubble--probably not even close. Still, obviously, mortgage-backed securities are worth something very different in an economy that is contracting as opposed to one that is growing at just 2% a year. In that economy, many fewer households are defaulting on their mortgages, fewer loans are "under-water," and so forth.
Krugman attributes to Geithner a Wall Streetish view that "the bad assets on banks' books are really worth much, much more than anyone is currently willing to pay for them." But might they be worth only "much" more? The issue at hand is how fast do we get to reasonable levels of growth and does the nationalizing of major banks hinder or accelerate recovery.
Krugman, looking at the U.S. in the 1930s, or Japan in the 1990s, has concluded that we will not get back to more normal levels of growth for some time. But what exactly does that mean? If our growth is flat for a decade, as in Japan, then these assets are very, very bad indeed, and tax-payers are suckers for leveraging private equity purchases of them. But if the economy starts turning around in, say, 18 months (partly, but not only, as a result of this temporary leveraging), then the assets are merely bad, and Geithner's plan must be seen as the best under the circumstances.
So the first question is this: Given how much faster financial capital and entrepreneurial information move today than they did in the 1930s, or even in Japan in the 1990s, can we not assume that the pace, not only of decline, but recovery, too, will be much faster than any historical precedent? The president implied that he thought so in his "Sixty Minutes" interview last week, when he spoke of how "wired" the world has become.
2. Krugman suggests that Geithner (Summers, etc.) is a creature of Wall Street. But this begs the question of whether personal loyalty to bankers, or grudging professional respect for them, motivates him and, in any case, should concern us.
Krugman is right (and Geithner agrees) that managers of banks, investment banks, hedge-funds, etc., cashed in on government largesse and incompetence in the past. But in spite of their demonstrable greed, and even herd behavior, is replacing hundreds, perhaps thousands, of senior bank executives with public servants a little like disbanding and de-Ba'athifying Sadaam's army, a morally satisfying but systemically catastrophic thing?
So the second question is this: Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery? Is there not real know-how here, not just know-about (that is, insider stuff, like ways of betting against "AIG's book")?
This is not a completely rhetorical question. I have not spent nearly as much time with the managers of banks and funds as I have with managers of technology companies. I really cannot say whether senior bank executives at Citigroup or Bank of America should be compared with executives at Google or IBM; whether they are really creative and talented people or just glorified salespeople with stunning commissions thanks to the sheer size of deals they have been rolling. And I can see the point of forcing the resignation of some banking CEOs, for the same reason GM's Rick Wagoner had to go.
Still, is running a bank like running, well, Phillip Morris, a job with its own challenges, to be sure, but nothing that smart, experienced managers can't pick up after a few months, and with trivial impact on the economy as a whole? Krugman wants bankers to be "boring" again? But in this same "wired" world, can they ever be boring again? Geithner seems to want to keep the management of banks more or less intact, even as he contemplates regulations that may make them more boring. Is this moderation not more prudent?
Your second question is most compelling, I think. Well, the first one is very important but I have no way of answering it, so I'll tackle your second:
2) Is this like de-baathifying the Iraqi army? I say no. A reality of Saddam era Iraq was that you were a member of the Baath party or an enemy of the Baath party, especially if you wanted to serve in the military to defend your country. By de-baathifying the Iraqi army we probably got rid of a lot of people who were patriots or public servants by inclination and members of the Baath by necessity.
You make no such compromise to take a job on Wall Street. While you might believe that under a different government members of the Iraqi army would act differently, there's no reason to believe that Wall Streeters will act differently while we're administering an economic rescue.
March 31, 2009 8:58 AM | Reply | Permalink
1) I reject your premise that with quick recovery, that this plan "must be seen as the best under the circumstances". No- it is still a needless handout to the stockholders and bond holders of these banks. They are the ones who made the risky bets, and they should be suffering the losses. Forcing taxpayers to suffer more losses under this 97/3-split plan does nothing to alleviate the underlying problem, which is that bad loans were made. At this point, nothing can really alleviate that problem.
2) Of course "bankers" know something about managing risk. But in a "boring" financial world, we will need to be much more prudent about how we do that. These failed executives operated in a 20% profit margin world, and we need banks to operate in a 1% profit margin world. Completely different skill sets.
And I also lack your faith that Geithner's "contemplating" regulation will lead to any substantial changes to our regulatory systems. We need to change our entire capital reward structure to move money out of the financial system. We need to stop the risky practices that Geithner is now rewarding, break up the banks that Geithner is now protecting, and eliminate the Wall-Street-centric way of thinking that Geithner is now engaged in.
Geithner has to change or get out of the way.
March 31, 2009 9:37 AM | Reply | Permalink
"mortgage-backed securities are worth something very different in an economy that is contracting as opposed to one that is growing at just 2% a year."
An economy that grows at 2% a year, isn't magically in and of itself an economy that supports broad based homeownership.
Even if the US economy "returns to growth" in 18 months, we'll still have to Wait (and probably wait and wait) for that growth to trickle down to would-be homeowners. Based on our recent trajectory, here, including the current job loss following close on the Bush era "jobless recovery," I'm a huge skeptic.
I also don't think it's entirely inaccurate to describe the more pro-active stimulative ideas of the current Administration as some cross between continuing to float the financial sector and the rather better off classes and pensioners who derive some benefit therefrom, and some typically weak attempts to foster a future generation through (what else?) "education."
I don't see either of these things, nor the temporary employment provided by the stimulus plan, as having much of an impact on the housing market. Sure, we could always come up with some plan to put people in houses, but I don't see it also being enormously profitable. We could even go with the Thomas Friedman plan of importing "more productive" workers to fill them, and I still don't see it being enormously profitable.
Thus, the apparently requisite tax payer subsidy, one way or another.
But I do agree that economists opposed to the Geithner plan could do a better job at substantively making their case. Not that anyone who thinks the economy or the future value of mortgage backed assets is all about "perceptions" actually wants them to do so.
Because, I guess, that would be a real downer.
March 31, 2009 10:11 AM | Reply | Permalink
Solid questions. The other night I asked a banker friend with much government experience a question similar to your second: Do the bankers whom the Geithner bailout keeps in place actually know something that we need in place? Who would the government put in their place if we had something like nationalization? My friend has populist impulses. He is not a stooge for oligopolists. He thinks it would be very hard to recruit knowledgeable people to run the banks if you rule out those who are tainted.
March 31, 2009 10:18 AM | Reply | Permalink
While all the basic facts are not available because Obama has not required transparency from the banks, there is IMO enough information out on the internets to conclude that Avishai's questions have been answered (he's late to the conversation) and Krugman's conclusion is correct.
Krugman judges that leaders have only a finite number of chances to put their policies into effect; thus, every mistaken tactic results in one less opportunity. And Krugman judges that whether or not Geithner's plan actually results in "legacy assets" coming off insolvent banks' balance sheets, that "success" will make little difference with respect to the goal of getting an economic recovery going.*
Since "success" is problematic and "failure" will enrage the polity and make any other solution Obama later offers politically difficult if not impossible to effect, Krugman concludes that the plan is bad by definition.
* See, John Hussman for a straightforward explanation (of many out there) of why repairing consumers' balance sheets and not banks' balance sheets is the only effective method of generating a U-recovery rather than an L-decade.
March 31, 2009 10:26 AM | Reply | Permalink
Thanks Ellen. Now that's an argument I can actually follow, and that appeals to more than gut instincts and generalized class suspicions.
March 31, 2009 10:48 AM | Reply | Permalink
Without disputing Hussman's piece (good link, BTW) I still think Krugman in entirely blind to the realities of the political debate in Washington.
In other words, the Geithner plan may not be the most desirable from an economic perspective, but it might be the most effective given our dysfunctional political environment, in which the chief concern seems to be adding to goverment debt, even when faced with the very real possibility of an extended deflationary period.
March 31, 2009 11:07 AM | Reply | Permalink
That might be true. One thing that might help is for Krugman to stop taking so much relish in his new role as a standard-issue snarky pundit, and start acting like a professional economist again. I am having a hard time taking the meat of his criticisms as seriously as I perhaps should because I can't get over the feeling that he is playing to the crowd.
March 31, 2009 11:24 AM | Reply | Permalink
Ellen, I am late to many conversations but, in this case, it is truly because I have listened patiently, and in vain, for compelling answers. I have seen Hussman-like claims; I am not sure they are not themselves based on a number of arguable speculations.
Hussman: "The difficulty is that without clear restrictions on the use of that capital, banks have the freedom to continue business as usual, including using the public capital to finance bonus payments and other expenditures. Absent explicit restrictions, there is also no assurance that the public funds will be lent out."
Is this really beyond the authority of the Treasury to control, what with the web exposing every abuse? And what about the hit stock-holders of banks have already taken? Geithner's plan will not make them whole.
Hussman:
"As a result, the only point in the public having anything to do with these securitized mortgages is if all of the tranches of a given issue can be purchased simultaneously, so that the underlying payment obligations of the homeowners can be restructured. That is, if the entire issue could be purchased at 50% of the original face amount, the underlying mortgages could be written down by the same proportion. Those mortgages would then be far more likely to be repaid, and as a result, the restructured debt could be sold back into the financial markets without the need for taxpayers to hold it to maturity."
Fair enough. The assets should clearly not be disassembled. But why 50%? Where did that number come from? What if the write-down were just 25%? Yes, the assets are worth more when the government is providing an incentive to buy. The question is, how much more can debtors bear, which has to do with the larger picture of recovery. This assumption that home prices are so highly over-priced seems another way of saying we are stuck in the trough a long time. Perhaps. But I can make an argument that we are not. And what about the number people (including myself) meanwhile refinancing as a result of a drop in rates?
Hussman:
"But this is part of the contract – when one lends money to a financial institution, one also assumes the risk and responsibility of bearing the losses. Congress always has the ability to mitigate the losses of some parties, such as pension funds, if it is agreed that this is in the public interest. But to defend all bondholders of financial institutions at public expense is to commit the future economic output of innocent citizens to cover the losses of mismanaged financial institutions."
The "innocent civilians" may be losing their pensions in this fairness. Why is this more tolerable than tax-payers temporarily leveraging the value of assets while the economy recovers (or at least that is the bet).
Hussman:
"The objective of receivership provisions would be to allow the failing institution to be partitioned into an operating entity (including whatever questionable loans are on the books), while cutting away the obligations to the stockholders and bondholders of that institution. Upon the sale, liquidation, or re-privatization of the institution, the bondholders would receive the portion of the proceeds that are not required as regulatory capital."
Sounds so simple. But what happens to the management of these institutions while all this partitioning, cutting, liquidation, etc., is going on? Who is doing this once the whole institution fails and the owners completely wiped out? Washington Mutual was one bank, which was taken over by another. What bank will just take over Citi and Bank of America?
I could go on. I do not mean to impugn Hussman, or you, but only to suggest that speculation is necessarily part of this conversation. What I resent, I suppose, is notions that values are "actual" and there is one intelligent, if not scientifically entailed, result.
I do appreciate your suspicion that the Obama administration may be using the impending insolvency of the FDIC tactically, to put the Congress's back to the wall. Interesting.
March 31, 2009 11:46 AM | Reply | Permalink
Without picking nits I should say that I consider our present situation analogous to that of the Great Depression -- a demand-side impaired economy.
We didn't get out of the Great Depression until consumer balance sheets were repaired by full employment during WWII and the forced savings resulting from rationing.
Those savings (repaired balance sheets) produced the post-1948 economic takeoff. What's different today?
March 31, 2009 12:01 PM | Reply | Permalink
Ellen and RobertoW,
What is different about a wired world--much different from the 1930s--is not only the velocity with which mortgage backed securities can find fisherman-pretending-to-be-investment-bankers in Iceland. It is the velocity with which financial capital from Qatar meets business plans in Silicon Valley. As I wrote, we are not living with surface mail, short-wave, and letters of credit. I do not doubt that things will get very bad, fast. Even 15% unemployment. But why should we believe that it will take ten years to get people into new industries? I am currently writing a piece about the electric car. It seems very much like what transformative industries like cell phones were in the 1980s.
March 31, 2009 1:03 PM | Reply | Permalink
Sir,
I think you are suffering from a some myopia as to what happened to the money. The money is gone, it is not hiding.
The money never existed. Anything of value over the last 10 years has been priced based on the availability of debt that was created without any basis in actual or future production.
If you give 30 people in town loans that don't have any chance of being repaid then, until they have to be repaid, they can bid up the price of almost everything in town. These new values are fictitious but seem real while the loans haven't come due. Once the borrowers default the value of the things they used to bid for must fall back to the level they used exist at. That's why Atrios calls these loans and the assets they purchased at inflated prices "Shitpiles."tm
Now that the loans are gone, fu-evah as they say, so are the values. We are left with use, delay, and obsolescence (see Krugman). That's because, apart from these three, people can't spend money anymore until they repair their balance sheets so that they can retire at some standard greater than poverty. Actually, it's worse than that because Europe, another potential source of demand is experiencing a whole different though related problem of even greater size, so there will be no help there either.
Velocity is an interesting artifact of this basic premise.
The real question is where will demand come from? I have it in my head that the third world is the only place possible, but that is another discussion.
March 31, 2009 1:50 PM | Reply | Permalink
Recommended, not for the article's analysis but for the comments.
My pet peeve: The Geithner v. Krugman frame. While it does help, it also limits. There are more than two options available, and some of them are not merely a mix of the two too often presented as "either or".
Geithner rewards management and stock and bond holders, as others have noted. This is wrong. Haircuts please. Maybe G. should require banks to buy into their own rescues, if they are to be rescued.
Or maybe new banks should be funded from private cash (there are trillions out there) and people can just move their accounts to the new banks. Of course this might drive yields up on T-bills, thus costing the parasitic government more in debt service...
Maybe G. should be test-driven on assets from already failed banks, if it's to be tried at all. The FDIC lends people X% to pay itself X%, and allows people to buy the assets more or less like G. proposes, part loan part private equity. No bankers or stock or bond holders at the bank benefit from this, unless of course they bid on the assets for sale using private money.
The potential for gaming G. has been noted but not refuted. Rent-seeking must be prevented.
...
March 31, 2009 2:54 PM | Reply | Permalink
Sorry, my above comment should have been directed at the OP, not at Greenberg's comment.
March 31, 2009 2:56 PM | Reply | Permalink
maybe the electric car isn't the best analogy to draw from to make your point about the swiftness of the modern economy. i can't think of a better example of how supposedly pure capitalistic corporate entities have managed to side-line a perfectly good technology for so long for such specious reasons. i think your analogy points to just how dysfunctional our modern and supposedly "wired" global economy often is, especially when powerful corporatists are able to game the system to their advantage.
if memory serves me right, the electric car was actually invented before the internal combustion car. yet we still don't have them on our streets, and we probably won't have the en masse in yours or my lifetimes.
March 31, 2009 2:01 PM | Reply | Permalink
It seems to me that the wired global economy has mostly served as a means of rapidly moving capital around the globe in order to generate mostly paper profits, based on some new, emerging market narrative storyline. Once the bubble is blown "the smart money" takes off, leaving the local population to pick up the pieces. ie., many little dot-com bubbles with an amazon.com left here and there.
I'm not impressed.
March 31, 2009 3:27 PM | Reply | Permalink
Hussman says:
I'd like to see evidence that forcing AON would enable cramdowns on the underlying mortgages.If I were a holder of these mortgages, i.e., the guy getting paid the flow-through payments from whatever tranch(es) of whatever CDO(s) I hold, I would be very interested in running a variety of minimax algorithm: if I give up $X in principle on set Y of mortgages, set Z will default and I will get a total of $T after foreclosure proceedings. (Obviously T is an estimate and changes with real-estate market changes. There is also a time component, and a dollar today is worth more than a dollar tomorrow, except in a deflationary environment where a dollar tomorrow is actually worth more.) Try this for lots of different X-sub-i values and pick the one that maximises T.
We have pretty good evidence that, for at least some (really "most") sub-prime and alt-A mortgages, maximum T is achieved with nonzero X: giving up some principal amount results in keeping more money. If I own sets of mortgages outright, this is all pretty straightforward. (I do in fact own one, and have looked at both interest rate reductions and principal reductions. We're currently working on the interest rate reduction.)
But here's where it gets tricky. If I own a CDO, I don't actually own an entire mortgage. I own a slice of many mortgages. Not only does this create competing interests—whoever owns the "top" slices maximises their $T with different numbers than those who own the bottom tranches—but it also creates a legal question: who, if anyone, has authority to reduce the principal (ie, "cramdown")?
Simply requiring AON (all or none) on the "toxic assets" does not, to me, seem sufficient to allow for cramdowns. It may also not be necessary.
March 31, 2009 5:35 PM | Reply | Permalink
"I own a slice of many mortgages."
Your slice contains many [whole] mortgages, or what you own is a compilation of parts of many mortgages?
They don't slice individual mortgages, do they?
March 31, 2009 7:47 PM | Reply | Permalink
As an example, consider a "complete package". We start with 100 (or 1000 or some other convenient number) of mortgages (or other payment streams ... credit card payment for instance, but then the details differ greatly since there's no principal / asset behind the stream). These have both interest payments (coupons, if you will) and principal (re)payments. As a CDO packager/seller, we bundle them up and then slice the bundle. The most likely payments, of interest and principal both, go into the "top" tranche. The middle-quality ones go into the middle tranche and the least-likely ones—the ones that may never arrive, if the mortgagees stop paying and the houses are foreclosed-upon—go in the bottom tranche. These three tranches become three separate CDOs. (The top one gets that AAA rating from the rating agency.)
If I (instead of "we" :-) ) buy one of these tranches, I own a slice of each mortgage. I do not actually own any whole mortgage.
March 31, 2009 11:11 PM | Reply | Permalink
Still not clear. Do the interest and principal from a given mortgage get split off from each other for each mortgage, and become different CDOs? That would be one kind of slice or dice. You'd have a principal repayment slice and an interest payment slice. But that seems quite awkward at best.
Or do the interest and principal stay together? That would be no slice, the individual mortgage financing remains intact. But it can be bundled with other similar risk mortgages, and that would be slicing the risk.
A tranche is usually a risk category, a different kind of slice or dice. That is allocating risky mortgage types to a low tranche and safer ones to a high tranche. But that doesn't necessarily slice up the individual mortgage components into sub-atomic parts.
I don't see how you can slice a given mortgage into parts other than as a partnership, we agree to take X% and 100-X% of the cash flows each (on a two way split) just like any partnership venture according to shares. Is that what these CDO and CMOs are, giant partnership agreements?
April 1, 2009 4:06 PM | Reply | Permalink
It's also important to remember that each CDO or CMO is (at least potentially) unique: there are standard templates for creating them, but the terms (conditions for triggers and remedies) vary.
April 2, 2009 3:16 AM | Reply | Permalink
In that link's example it seems the bond interest and principal stay together. But thanks for the link.
April 2, 2009 2:27 PM | Reply | Permalink
I probably should add: in the example I linked, the underlying MBSes are really just ordinary MBS bonds, and the mortgage servicer still holds the mortgages in question. They have not actually been "sliced"—it's the payment streams that were sliced; the mortgages are all intact—so in that sense all the mortgages are still pretty traceable.
The problem is, the mortgage servicer can't afford to rewrite any of the mortgages he holds as he has pledged away all the payments. Whatever legalese was on the papers he signed in handing over the payments may (read: will) include that he can't change the terms of the mortgage. Thus, technically, it's not the mortgage itself that has been sliced. Rather, it's the payment flows, and with them, the legal rights to change the terms, that have been sliced up.
April 2, 2009 3:33 AM | Reply | Permalink
Anyone who took such a contract is a fool or a criminal, and needs to take large losses.
April 2, 2009 11:03 PM | Reply | Permalink
Krugman has good points on both claims.
1. There is no good reason for believing that the US economy, which we now know was heavily propelled by the speculative bubble in real estate and financial junk, will "bounce back" soon. It is more likely to continue sinking, and most likely to hit a bottom reasonably soon but then limp along at low growth rates for quite a while, possibly a very long while.
2. There is of course a tremendous oversupply of underemployed bankers nowadays whose job and income prospects in the private sector are lower than they have been in years. There should no great difficulty, in principle, in selecting a small reliable subset to help run banks in receivership. The analogy to Saddam's army is ridiculous.
That said, Krugman, who is NOT part of the administration (why not? one could and perhaps should ask), has the luxury of making theoretically nice proposals that he has no responsibility to implement. America cannot nationalize all its troubled financial institutions. Switching from "too big to fail" to too big NOT to fail, raises many questions of where to draw the line, for example which bondholders and toxic junk counterparties would take how much of a "haircut" and how would the cutting be done?
Politically, Obama-Greithner are constrained. They need to be taking action, but not so much action that they will get directly blamed as things get worse for a while longer before getting better. So we have a messy worst of both worlds where the feds spend huge amounts of money but don't really turn things around.
In some ways the most disturbing feature of all this is the lack or at least very deficient level of accountability on the part of the people who created this mess, on Wall Street, on Main Street, in Congress, in the regulatory agencies. Here Krugman is as out to lunch as anyone. Constantly looking to the 1930s for "lessons" when the mess today has radically different origins and feasible solutions.
March 31, 2009 10:35 AM | Reply | Permalink
The ratio of housing prices to income was fairly constant for a hundred years (price ~ 3 times income).
That ratio more than doubled during the bubble. Since people can't support higher prices in the long term, prices HAVE to come back to that level and stay there. The US economy expands, on average, about 2% per year. So we need 2% per year just for normal growth.
The bonds that were sold in 2006/2007 were based on bubble prices and are the toxic assets (along with other, even crazier "financial products").
On top of that, there was also huge leverage, which meant when these asset prices fell, the loss was 20 or 30 times the investment.
In other words, the major banks are in a bottomless pit and there isn't enough money in the US to fill it. That is why Krugman thinks what he does.
Geithner wants to re-inflate asset prices, but that is like wanting to push dot.com prices back to their peak.
March 31, 2009 11:11 AM | Reply | Permalink
Question:
"Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery?"
Answer:
No, they don't have much special or esoteric or important knowledge in the long run. In the short run some of them, not all or even most by any means, should continue to have the power they had previously.
"I really cannot say whether senior bank executives at Citigroup or Bank of America should be compared with executives at Google or IBM; whether they are really creative and talented people or just glorified salespeople with stunning commissions thanks to the sheer size of deals they have been rolling."
Well, I don't think there's any doubt at all but that the vast majority of them are nothing but glorified salesmen with stunning and totally unjustifiable salaries, let alone commissions. The very idea that what these people do is so specialized and complicated that only they can do it is utter and complete hogwash. If we were talking about engineering or surgery it would be a different story, but the leadership of the financial sector turned banking and investment into a vast casino. The only problem is that the managers were the people with the worst gambling addictions and they managed to bankrupt the casino. We don't allow actual casino's to be run in the loose manner we treated the financial sector. If any casino operation in America were run as poorly as our major banks and investment houses the executives would all be headed to jail by now.
March 31, 2009 11:26 AM | Reply | Permalink
It has always struck me as nonsense to suggest that nationalizing or receivership--or whatever legal authority comes up-- means somehow replacing every important employee at these institutions with some green bureaucrat-moron, or that everyone will suddenly be paid like a DMV clerk. Bankruptcy doesn't mean that. There's no reason competent people can't be kept on as employees and paid salaries, even bonuses--and others replaced or hired for ad hoc duties. There's no reason to believe that everyone will leave without extortionate pay or because of restructuring. It's also the case that these institutions are constantly replacing and hiring employees of different compensation and expertise levels themselves; so the idea of a sacred continuity is also nonsense. The government, the fed, nonprofits, believe it or not, hire and employ highly qualified finance people all the time, for less than insane rewards: the idea that we need to keep everyone or replace everyone with idiots is an entirely false choice.
March 31, 2009 12:11 PM | Reply | Permalink
Exactly. For the interim, and for however long cleaning up this colossal mess takes, they'll be professionally paid civil servants. Like, say, US Senators.
If they prefer to "eat what they kill" as traders--because they're really that brilliant-- then they're free to go figure out how to do that elsewhere. Frankly, I think most of them will starve without the benefit of the institutionalized insider trading that goes on at investment banks--or, that's what independent traders seem to suggest about most of our name brand high rollers, anyway.
(At least their ritual scapegoat, Martha Stewart, created a real business).
When compensation schemes destroy an entire business sector, it becomes clear to any person with a modicum of common sense that that business sector does not support a whole gaggle of little Warren Buffets, even if that business sector is "finance" itself.
This is doubly clear when it retrospectively becomes apparent that that business sector had go to the government to twist all the extant laws in order to generate those pay outs, and it *still* needed to resort to committing massive fraud (and at this point, it's getting repetitive) in order to pull it off.
So, while I don't doubt that the clean up job is going to cost the public quite a bit irregardless of the details, and I wouldn't want to generate unnecessary panic and financial pain in the larger economy, I fail to see how supporting the insupportable should be more of the cost of that job than necessary.
This looks like the General Motors-ification of the financial services industry. Mercifully, these very people have long been tutoring us that what's good for GM is good for the country, and that we should make haste to put the screws to it and its employees.
At this point, we may well have less to lose by taking their old lessons in free market economy than we have in buying into their new lessons in state supported finance aristocracy.
Libertarianism isn't all bad.
March 31, 2009 3:18 PM | Reply | Permalink
Interesting questions. Thank you for contributing to reasoned debate.
March 31, 2009 11:31 AM | Reply | Permalink
The two recent public dust ups over AIG and GM/Chrysler management are powerful warnings that nationalization of any business, much less the multi-trillion dollar finance "industry" are fraught with peril
Government's interest and derivatively the public's interest are rightly more concerned about equity than efficiency - witness the "double standard" criticism leveled at the Wagoner firing
Every major corporate decision cannot be subjected to such debates with any expectation that the company involved can be run effectively or efficiently
Krugman completely ignores this issue
March 31, 2009 11:31 AM | Reply | Permalink
As pointed out downthread, we're not talking about nationalization. Nationalization is a scare word designed to distract from the real issues. Read downthread for more.
April 1, 2009 4:34 AM | Reply | Permalink
"Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery?"
I think they have the essential skills to manage corporations, and the requisite greed to make them want to do it. I also think the last 8-20 years have set them up for massive failure.
I think lack of oversight permitted them to take greed-induced risks that they never should have taken. I think with proper oversight, they can do the job right.
I also think that nationalizing the big banks would create a permanent class of rich, angry Republicans, while Obama's current approach to Bush's disaster may turn many of them into essentially political agnostics. I don't see many becoming Democrats, but I see them rejecting the party of fiscal irresponsibility. IMO Obama's approach may hasten the demise of the Republican party and the birth of the new, different opposition party that we need.
March 31, 2009 11:49 AM | Reply | Permalink
First off: these financial institutions are not banks covered by the FDIC, so we have no authority to nationalize them without new legislation. The Obama Admin is seeking such authority, but we don't have it yet.
Second: nationalization of insolvent institutions will cost more than taking over an FDIC regulated bank because FDIC can step in well before a bank is insolvent. They are under-capitalized, but not insolvent. Also, FDIC regulated institutions pay insurance (when Congress allows FDIC to collect it), while the BofAs never paid insurance.
So taking over these failed institutions is nothing like taking over an FDIC regulated bank. The long term goal is to correct this situation, but we can't just step in now and do it. It won't save us any money. Instead, we are slowly replacing their private lending functions with government programs (recommended by Dr. Doom, when he said government needs to be the lender of first and last resort).
March 31, 2009 11:55 AM | Reply | Permalink
Excellent posts.
I also agree that while the housing bubble has burst, we shouldn't get into a negative bubble where we believe that housing values will always drop forever. They don't rise forever, and they don't fall forever.
I think Krugman raises a lot of good issues, but hasn't done a good job of clearly explaining and arguing all the individual pieces very well. There's a lot of assumptions that aren't stated up front.
He's been a good critic, but not so good at concrete alternatives with price tags attached. He throws aroudn the absolute rosiest scenario to nationalization (The Swedish Model) sort of like Dick Cheney threw around scenarios about the Iraq War paying for itself.
But there is no free lunch. Nationalization will cost money and have other downsides and risks, and it is not honest to hide these in a public policy debate.
Although I'm not sure how the markets or pundits would react, I would love to see an economic summit, where leading economists could come to the Treasury or White House and debate and discuss their ideas and concerns face to face. Enough sniping from the sidelines. Enough personal grudges. Come armed with strong arguments, numbers and evidence and hash it out.
I've also been asking TPM to give us a big grid of proposals and their pros, cons and estimated price tags.
March 31, 2009 11:55 AM | Reply | Permalink
Silly questions, both. The second one is sillier, though. What the top brass at any company is good at is self-promotion, organizational politics and, in some cases, manipulating balance sheets. None of the CEOs at any company are the company's most talented employees when it comes to creating or improving his or her company's products.
Not that the question is even relevant, which is probably why Krugman hasn't addressed it. But I will: The FDIC can ask whichever managers it wants to to stay on. Obviously.
But even that is irrelevant. The point of nationalization is 1) to refuse to bail out shareholders and bondholders at taxpayer expense, partly as a matter of fairness, partly to avoid moral hazard and 2) to break up these companies into entities that are not to big to fail. The point is not especially to punish CEOs.
March 31, 2009 12:09 PM | Reply | Permalink
But even that is irrelevant. The point of nationalization is 1) to refuse to bail out shareholders and bondholders at taxpayer expense, partly as a matter of fairness, partly to avoid moral hazard and 2) to break up these companies into entities that are not to big to fail.
But isn't this the problem with nationalization: Full nationalization of the larger banking institutions would set off a chain-reaction of swap contracts being triggered for any securitized debt instruments or bonds issued by the nationalized banks.
These contracts are mostly held by other banks and large financial institutions, and many of those institutions could then find themselves under-capitalized as a result (as debt instruments and bonds they hold suddenly decline in value and lose their triple A ratings), forcing the FDIC to step in and ultimately pay out just as much or more in public money in deposit insurance since, under the Bush II's newly revised bankruptcy laws, CDS obligations can't be dismissed when their issuers go into receivership.
Those trillions of dollars of crazy, uncollateralized swaps obligations we're always hearing about would have to be paid off before any other obligations, basically sucking the banks dry.
With the banks under-capitalized and all the domino effects from there causing further erosion of their operating capital, the FDIC's reserves would quickly be spent and then we'd have to pump just as much public money into the banks through the FDIC just to keep all those deposits secure. The only way we could meet those needs would be to print more and more money out of thin air, causing rapid inflation.
Basically, nationalization of the banks on any kind of large scale would be disastrous for these reasons, wouldn't it?
March 31, 2009 1:01 PM | Reply | Permalink
1) Who says those swaps have to be paid at all? They certainly don't have to be paid at 100 cents to the dollar.
2) Who says they can't be unwound?
March 31, 2009 1:11 PM | Reply | Permalink
Well, my (admittedly imperfect) understanding is that the contracts are written in such a way that a step like nationalization would trigger the swap contracts. And as Josh discussed a while back the counterparties to swap contracts (CDSs) get to jump in line ahead of everyone else in the event of bankruptcy thanks to new regulations that the "International Swaps and Derivatives Association" lobbied heavily to put into Bush II's bankruptcy law reforms. (So if a bank goes bust, in other words, depositors get paid only after any CDS counterparties the bank might owe do, if there's still anything left. Now, I don't think non-investment banks are allowed to issue swaps, but I think they are allowed to have financial products subsidiaries that do.)
Nationalization may not equal receivership (I honestly don't know what the law is there), but let's say, we nationalized a bank like Citigroup. Obviously, lots of other institutions hold bonds issued by Citigroup, and have probably taken out swap contracts to minimize their risks in holding those bonds (on top of those, of course, there are the third-party swaps, synthetic CDOs and so on, but let's not even get into all that yet). So if the bonds suddenly become worthless, not only do those institutions find themselves now with a lot of worthless assets on their books (potentially pushing them into the undercapitalized column), the issuers of the swap contracts (and if I'm not mistaken, financial institutions holding certain exotic derivatives like synthetic CDOs that reference those swap contracts) now find themselves contractually obligated to pay out large sums to big blocks of counterparties.
And thanks to the new bankruptcy rules, even if they go bust, they have to pay out those obligations before any other obligations they may have. If they don't end up going completely insolvent by the time all these obligations are met, they likely end up at least being under-capitalized.
The problem, I think, with the current financial system is that the whole machine is so precisely calibrated to maximize risk while at the same time spreading risk around, there's no way to recalibrate much of anything without causing systemic failure.
March 31, 2009 1:58 PM | Reply | Permalink
Thanks for the link! Interesting.
The U.S. government would have to be prepared to declare some of these null and void. But I think there is a little bit of confusion here. If an insurance company cancels your fire insurance policy, your house doesn't disappear. You just don't have any insurance. And if you were betting on someone else's house burning down and the insurance company canceled that policy, I'm not seeing how you are particularly damaged by that, especially if you got a refund.
A great many of these contracts are like that and would not therefore affect anyone's reserves. Possibly, one could simply pay back over time whatever people paid for the contracts, but I think we are, under the current policy, up to about 10 trillion dollars worth of taxpayer obligations and bail-out money so far. That's against a U.S. GDP of IIRC 14 trillion.
I'd rather tell the hedge funds to take a flying leap.
March 31, 2009 2:42 PM | Reply | Permalink
well, if the government just cancels the contracts, then investors might lose faith that the government can be trusted to honor and enforce contracts. without that certainty, you run into lots of other problems. plus, there'd be some considerable risk of exposure to lawsuit.
CDSs do expire eventually, but then, new contracts are still being written and traded even now and i don't know what the typical terms are.
i'm wading a out a little beyond my depth now, but i know that 5-year credit default swaps on US treasury bonds have been trading like hot cakes lately, so CDSs can at least have terms up to five years. they aren't really like insurance policies in that, if i decide i no longer want the protection, i can't just cancel the contract. i have to sell the contract on the market or else i'm still on the hook for the payments. that's part of what makes it possible to package them up into even crazier derivatives like synthetic CDOs, that have a fixed maturity date like bonds do.
and you don't even have to have a stake in whatever risk the swap is supposed to hedge you against. you might just want to buy a swap to speculate on the likelihood of some default event occurring (say you think AIG is gonna go down in the next 2 years--well, then buy CDSs against the latest AIG bond issue and put your money where your mouth is). that's why there are so many trillions of dollars tied up in these things. they represent a financial obligation manufactured out of thin air, with little or no requirement that the issuer actually have collateral to back them up in the event of default.
now, that's what i call "innovation"!
here's more detail about how CDSs work (or don't, as the case may be).
March 31, 2009 3:53 PM | Reply | Permalink
Thanks for the additional links.
I think the disaster is going to be on a scale exponentially greater than the Depression. At the moment, the big finance firms are looting what's left of the American economy and trying to stick taxpayers with the bill. They are, in essence, trying to convert their phony baloney money into U.S. government bonds. Kind of like AOL-Time Warner only bigger.
It simply has to be stopped.
March 31, 2009 5:37 PM | Reply | Permalink
"if the government just cancels the contracts, then investors might lose faith that the government can be trusted to honor and enforce contracts"
Investors SHOULD lose their illusions that they can gamble with our money. They SHOULD lose faith in contracts which violate public policy, or at least not have faith that the government will bail them out.
Isn't this trivial and obvious to everyone here??
The courts "cancel" contracts all the time. If the government is neither rash nor reckless, I don't see the problem.
March 31, 2009 7:51 PM | Reply | Permalink
"under the Bush II's newly revised bankruptcy laws, CDS obligations can't be dismissed when their issuers go into receivership."
Holy shit, is it that right?
Why can't the federal government assume something like "war powers" and just say, we'll were changing the rules. Just like they say, the Constitution ain't a suicide pact.
March 31, 2009 3:12 PM | Reply | Permalink
Think Harry Truman, steel mills. I agree that the government is going to have to do something like that, but it's going to provoke a Constitutional crisis.
March 31, 2009 3:39 PM | Reply | Permalink
The difference between bank honchos and those of other industries seems to be that the only business banks seem to be in is making money off of money. They don't make anything or provide any useful direct service like a doctor or lawyer. If you want to see just how easy it is to use other people's money to feather your own nest to an extravagant degree investigate how things went in Iceland. If fishermen can make the transition from catching fish to catching fools, anyone can do it. But, in the end, it's not real accomplishment, it's just a game that ends in disaster for everyone.
This Iceland example should clear up any confusion about what it takes to be a bank honcho:
http://www.vanityfair.com/politics/features/2009/04/iceland200904?printable=true¤tPage=all
March 31, 2009 12:20 PM | Reply | Permalink
"Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery? Is there not real know-how here, not just know-about (that is, insider stuff, like ways of betting against "AIG's book")?"
First stockbrocker I ever worked for (and I worked for quite a few) hired me for my education but then constantly reminded me that success in the field depended on "who you know, not what you know". He was 90+% right. There are areas where brains matter but the top earners are always connected to money.
March 31, 2009 12:21 PM | Reply | Permalink
Good discussion that further clarifies our options and the optimal path ahead.
One point I clearly agree with Krugman on, however, is the need for banking to once again be "boring." The notion that the banking/insurance industry is dependent upon a few elite executives tells me that it is a broken, unsustainable industry. That is no different than being subject to a 'benevolent king' rather than the 'rule of law.'
March 31, 2009 12:37 PM | Reply | Permalink
re: question 1)
Harper's ran an estimate of the total overvaluation of real estate last year which claimed that half of value at the peak of the bubble was vapor.
Add to that the deterioration of properties occurring as mortgagors and banks walk away from the bad deals--what evidence I've read suggests that it would be foolish to design any plan based on a short- or medium-term recovery of property values.
March 31, 2009 12:38 PM | Reply | Permalink
Good point. I am among the many who bought during the boom and am now upside down significantly. If no near term recovery is on the horizon and it remains in the best interest of people like me to walk away, why would we do differently?
How's that for exacerbating the problem.
March 31, 2009 1:37 PM | Reply | Permalink
1) I have to question your assumption that the velocity of capital and information may lead to a speedy recovery. Being "wired" isn't going to accelerate the repair of consumers' spreadsheets. (Ellen's right on the key nature of that problem.) There is if anything the danger of interconnectivity, faith-based optimism and group think feeding a new housing (or other) bubble. As argeec pointed out, housing prices can't realistically outpace income (or rentals), but a lot of people are anxious to get back to the days of easy commissions and hefty fees. That's why the whole idea that "things are different now" is incredibly dangerous - it short-circuits critical thinking and fundamental analysis, and can lead to chimerical "recoveries" that allow some to make short-term profits but decimate the rest of us.
Long-term sustainable growth may be "boring", but after spending the last few years riding on a rickety roller coaster without safety bars, we should realize it's the best we can realistically hope for.
2) I think you answered your own question: "just glorified salespeople with stunning commissions thanks to the sheer size of deals they have been rolling" is a fair assessment of the average financial CEO (they didn't originate complex derivatives, and in many cases simply allowed division managers to run wild with them). As Ptroub points out, there are plenty of financial professionals at all levels looking for work right now - a shortage of help shouldn't be a concern in any restructuring.
While it's obvious proprietary contracts need to be carefully unwound, it's unclear that financial institutions will need to continue producing opaque instruments with high profit margins or volume but with uncertain levels of risk. Banks should only sell products that risk managers and rating agencies can independently assess (unless they are partnerships where the partners take on the bulk of the risk).
Excessively complicated derivatives and insurance contracts aren't a requirement of our "wired" economy, any more than an insanely busy, unintuitive interface is necessary to a complex computer application. There are straightforward alternatives. They aren't as profitable, but that's something banks are going to have to live with for the sake of the rest of us.
Finally, I have to object to the constant use of the term "nationalization", as opposed to "restructuring" or "temporary oversight". As I understand it, the alternative to PPIP is to reduce those banks too large to fail to less dangerous size, clean house, and then set them free in the private sector, to go forth and sin no more. No one is talking about bureaucrats running things, or bank professionals being required to work for Uncle Sam forever.
"Nationalization" is a misleading frame opponents of restructuring are using to cloud the issue.
March 31, 2009 12:48 PM | Reply | Permalink
I agree, and just to reinforce the point: If the CEOs had the skill to even understand the complex financial instruments that their underlings were creating, they might not have let them run their companies into the ground with them.
March 31, 2009 1:09 PM | Reply | Permalink
The ultimate goal is the restoration of the sufficiency of reserves. Playing with the reserves, taking them out of acting as reserves to put them into play, caused the financial mess.
March 31, 2009 12:50 PM | Reply | Permalink
Bernard, I'm not sure your response to Hussman really addresses the problems with your position, which, to risk oversimplifying, seems to be "things might be terrible, but they also might not be so bad, so why not give the economy the benefit of a doubt?"
This assumption that home prices are so highly over-priced seems another way of saying we are stuck in the trough a long time. Perhaps. But I can make an argument that we are not. And what about the number people (including myself) meanwhile refinancing as a result of a drop in rates?
What exactly is the argument that we are not stuck in the trough - is this fact-based exuberance or wishful thinking? I'm refinancing, too, but like a lot of people I'm not going to be spending the resultant savings. And how long could a refinancing-spurred "recovery" last anyway? Are you seriously suggesting refinancing is going to jumpstart the economy?
The "innocent civilians" may be losing their pensions in this fairness. Why is this more tolerable than tax-payers temporarily leveraging the value of assets while the economy recovers (or at least that is the bet).
You're right that ordinary folk own bank shares and bonds through their retirement plans, and would suffer to some additional degree beyond the haircut they've already taken. But what I continue to wonder is: if betting on economic recovery isn't a fool's game, why can't private capital do the heavy lifting on its own? I sense a sales pitch here, not a credible economic forecast.
Sounds so simple. But what happens to the management of these institutions while all this partitioning, cutting, liquidation, etc., is going on? Who is doing this once the whole institution fails and the owners completely wiped out? Washington Mutual was one bank, which was taken over by another. What bank will just take over Citi and Bank of America?
Joevan covered a lot of this already. Why is the idea of a receivership so terrifying here, when the financial community has calmly accepted an unprecedented rash of bankruptcies in other industries?
The fear really sounds more like a threat - "if the government takes these banks over, even temporarily, everybody who knows anything will walk out and never come back." Are you suggesting that capital will in effect go on strike if they don't get their way via PPIP?
March 31, 2009 1:15 PM | Reply | Permalink
Just to add to comments previously made (btw, I will claim priority over Krugman in having I told you so rights, having raised the issue first and more loudly), there is no reason to assume that house prices will rise even in the unlikely event that we restore growth reasonably soon.
If you look at the 100-year long trend in house prices, or price to rent ratios, the evidence is that house prices still have to fall about 20 percent just to return to trend levels. Given the enormous excess supply and the current rate of price decline (more than 20 percent at an annual rate), there is a serious danger that house prices will overshoot on the down side.
If Geithner and other Treasury people (all of whom somehow missed the housing bubble) are drawing up plans based on the expectation that house prices will rise from current levels, this is very scary.
March 31, 2009 1:16 PM | Reply | Permalink
While it is true that initially, rising house prices were factored into risk formulae used to grade MBSs and their associated derivatives, it is not true that rising house prices are necessary for either 1) the recovery or 2) an increase in the market value of those MBSs.*
MBSs are valued by the expected cash flows and those cash flows are dependent upon rates of unemployment. I can't put my hands on the study (Boston FRB?), but from analyzing the early 1990s New England real estate crash statistics, it appears that underwater mortgagors don't walk away; unemployed mortgagors do (because they have to).
In other words there's no reason to think that Geithner's counting on rising home prices to save "his" banks.
* MBSs supported by subprime and Alt-A mortgage cash flows may be a different kettle of fish.
March 31, 2009 3:49 PM | Reply | Permalink
Isn't there a lot of discussion of a more recent change in societal attitude towards walking away (cf. CalculatedRisk), and also the Bush era changes to bankruptcy law changed some incentives there, no?
March 31, 2009 4:37 PM | Reply | Permalink
I treat all witty memes ("jingle mail") with suspicion. In who's interest is it to inquire into their validity when they're so sexy?
It might be different this time, but I've yet to see statistics that say it is.
March 31, 2009 8:19 PM | Reply | Permalink
Dean, I just got this email from the manager of a real estate investment company in New Jersey:
"Krugman's assumption is that investors participating in the PPIP programs will be quick to default, leaving the government with losses on its loans to the buyers of legacy loans and securities. Because before the government loses anything, the co-investors will have to lose everything, right?
"Think about it for a minute. Vulture funds whose history is making outsized returns are not going to bid on these assets lightly. In fact, unless they have some idea they will make mid-teens returns, I doubt they will bid at all.
"I have been working in a field related to CMBS since the mid-1990s. Senior CMBS with 30% subordination is trading at an unleveraged yield of 12%.
"Loans in CMBS pools would have to default at more than 50% with 40% loss severity before those bonds would lose principal (current default rate is about 2%, albeit rising). So there are assets whose value is irrationally low based on liquidity issues, something Krugman doesn't acknowledge.
"Now I know CMBS is a smaller part of the problem, but still I think you are on the right track in questioning him.
"Another question is why nationalization will be less costly than PPIP. If the government nationalizes the banks, it immediately is on the hook for all the losses, right? It can sell assets, but the incentive for investors to pay up would be less than under the PPIP plan, in my opinion."
April 1, 2009 1:30 AM | Reply | Permalink
Not to barge in where lesser mortals fear to tread, but Dean's had 10+ hours to answer Bernard and . . . .
Bernard! You're email correspondent is a jerk!
I doubt he owns a Bloomberg terminal, but did he it would make little difference. The vast majority of CMBSs which trade trade privately, their trade prices known only to the buyer and seller. Bloomberg's "market values" are suspect. There's no reason to think this guy knows what price any of these "legacy assets" are trading at.
He admits that CMBs are a "smaller part of the problem"; in fact, there's little evidence they're "part of the problem" at all or that the banks are going to offer them for sale.
He further admits that he doubts "[v]ulture funds . . . will bid at all." Of course they won't -- and that's the kernel of the controversy (which he neatly sidesteps).
The bidders will be SIVs the banks have set up, hedge funds who owe the banks favors, and big bond portfolio managers -- all of whom will grossly overpay for the "legacy assets" and none of whom expect to make a profit by participating in the PPIP itself.
Their profits will come in other forms -- bond value increases and increased bank capital, all paid for by the taxpayer.
April 1, 2009 12:18 PM | Reply | Permalink
If the government nationalizes the banks, it immediately is on the hook for all the losses, right? Bernard's emailer
Apparently, this guy's never read the FDIA -- or a balance sheet.
After the FDIC -- as "receiver" of Citibank, for example -- tosses the bank's derivative obligations and its unsecured bond obligations in the trash can where they belong, just how much in "losses" would the FDIC sustain?
Anywhere near the losses the taxpayers will sustain on this atrocity known as the PPIP?
April 1, 2009 12:42 PM | Reply | Permalink
If PPIP does allow gaming, what I believe you called "rent seeking", then it must never happen.
April 1, 2009 4:13 PM | Reply | Permalink
Uh, Bernard . . . .
What would your friend, Simplicimus New Jerseyensis, like to say about this purposeful undermining of the advertised intent of the PPIP?
. . . only firms that already have a minimum of $10 billion in toxic securities under management can apply. WSJ 4/1/2009
Well; let's see -- that means "Black Rock, Pimco, Goldman Sachs or Legg Mason, as well as a titan or two of the hedge fund industry, such as Bridgewater."
Obama's scam rolls on.
April 2, 2009 12:24 AM | Reply | Permalink
Jeez, you guys. Krugman posted specifically on the first question back in January.
http://krugman.blogs.nytimes.com/2009/02/17/slumps-and-spontaneous-remission-wonkish/
March 31, 2009 1:24 PM | Reply | Permalink
The answer to the first question is we don't know.
March 31, 2009 1:24 PM | Reply | Permalink
You really need to ask this question?
"Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery?"
I'm sure they all learned something about managing risk, assessing business plans, etc. either on the job or in their MBA programs. What good did it do them? Or anyone else?
The answer to your question is yes, they did in the most minimal sense know something but they chose not to use that knowledge.
So we lose nothing by ridding ourselves of them.
March 31, 2009 1:56 PM | Reply | Permalink
Question: So the second question is this: Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery?
Answer: No. There is no such thing as magic unless your last name is Madoff.
Question: Is there not real know-how here, not just know-about (that is, insider stuff, like ways of betting against "AIG's book")?
Answer: Yes, and there's lot's of people who know-how who are not in senior management.
Sir, with all due respect, I don't believe you have been following this all that closely, which admittedly requires a bit of time during the day.
Here is a short bookmark list for you to work with:
http://www.calculatedriskblog.com/
http://economistsview.typepad.com/economistsview/
http://delong.typepad.com/
http://blog.atimes.net/
http://www.marginalrevolution.com/marginalrevolution/
http://www.nakedcapitalism.com/
http://baselinescenario.com/
http://www.ritholtz.com/blog/
The Baseline Scenario, in particular, has an excellent primer.
There is also a wonder series by a producer on This American Life whose name and link I don't have handy, but I know you'll be able to spot it immediately.
I would also suggest you read the current Atlantic article by Simon Johnson as to the "wizardry" behind the curtain.
March 31, 2009 2:10 PM | Reply | Permalink
Here's the link to the Simon Johnson article you referred to. I would heartily recommend Bernard (and everyone else here) give it a read.
h/t saulgoodman, below, who links to the same article.
April 1, 2009 4:24 AM | Reply | Permalink
if betting on economic recovery isn't a fool's game, why can't private capital do the heavy lifting on its own?
What better way to make sure Big Government doesn't oppress us with comprehensive health care and other ambitious public policy reforms the liberals want to cram down out throats (at the expense of the fewer than 1% of us who account for most of the tax revenue) than to drain the public coffers?
Did you ever play Monopoly with that one kid on the block who had the really nice deluxe edition game board, only, whenever the game stopped going his way after a few turns, he would soon get belligerently angry, snatch up his game board, and storm off headed for home, accusing all the other players of cheating?
Well that's essentially what our modern-day American oligarchs are doing right now. They're taking their board and going home.
March 31, 2009 2:15 PM | Reply | Permalink
Question: So the first question is this: Given how much faster financial capital and entrepreneurial information move today than they did in the 1930s, or even in Japan in the 1990s, can we not assume that the pace, not only of decline, but recovery, too, will be much faster than any historical precedent? The president implied that he thought so in his "Sixty Minutes" interview last week, when he spoke of how "wired" the world has become.
Answer: What recovery? Based on demand (Use, delay, or obsolescence not withstanding) from who?
I believe the reason you are still somewhat confused is because you haven't determined for yourself from whence recovery comes.
I know this all sounds gruff, and I'm glad in a sense that I'm able to answer these questions, but I'm bitter about the whole thing and it shows in my tone. I'm sorry for that.
March 31, 2009 2:15 PM | Reply | Permalink
Let the banks go! Save the auto-makers and all the workers they employ!
Folks, we don't have a credit problem (banks won’t lend)--we have a people are too scared to buy and so they don't ask for credit from the banks problem. Reading the NYTimes last week, I learned that, despite Obama's ravings that payrolls will be missed unless the banks are whole, not one large company has missed a payroll, nor have the car rental companies (to take one example from a segment of the economy) suffered because they can't get loans to buy new cars--they are suffering because fewer people are renting. Besides, the banks don't really enjoy lending out money. There's not much money there. They enjoy taking in subprime junk mortgages and turning them into AAA rated securities--i.e. turning crap into gold. That sells (sold) like crazy. That's a much easier buck for them to make. It's also what led to the world-wide economic meltdown. In short, the banks, AIG, hedge funds, etc. are quick-buck fraudsters. Capitalism has finally developed its own economic weapons of mass destruction: cdo's, quants, credit default swaps, securitization, mega-million dollar salaries. Combine this with the usual greed, fraud and avarice and you have a killer system. Except it will kill itself.
March 31, 2009 2:31 PM | Reply | Permalink
[repost in correct thread order]
Recommended, not for the article's analysis but for the comments.
My pet peeve: The Geithner v. Krugman frame. While it does help, it also limits. There are more than two options available, and some of them are not merely a mix of the two too often presented as "either or".
Geithner rewards management and stock and bond holders, as others have noted. This is wrong. Haircuts please. Maybe G. should require banks to buy into their own rescues, if they are to be rescued.
Or maybe new banks should be funded from private cash (there are trillions out there) and people can just move their accounts to the new banks. Of course this might drive yields up on T-bills, thus costing the parasitic government more in debt service...
Maybe G. should be test-driven on assets from already failed banks, if it's to be tried at all. The FDIC lends people X% to pay itself X%, and allows people to buy the assets more or less like G. proposes, part loan part private equity. No bankers or stock or bond holders at the bank benefit from this, unless of course they bid on the assets for sale using private money.
The potential for gaming G. has been noted but not refuted. Rent-seeking must be prevented.
...
March 31, 2009 2:58 PM | Reply | Permalink
The first question, as framed, hinges on whether one is optimistic about a prompt recovery (like Geithner and Obama) or not (like Krugman).
I fear Krugman's concerns about an L-shaped Japanese Lost Decade or 1930s-style doldrums are, if anything, too optimistic.
The key difference between our current predicament and those of the past is not better communications, but depleting resources. Any sign of economic recovery will drive up oil demand and prices to where they were last summer, and beyond, which will in turn sink the nascent recovery.
Assumptions about "normal 2% growth" have flown out the window. We need to get realistic about planning for an economics of controlled descent, rather than growth.
See this recent post on The Oil Drum for a good discussion of the links between fossil fuel scarcity and the economy:
http://www.theoildrum.com/node/5230
March 31, 2009 3:18 PM | Reply | Permalink
I think Krugman has the better economic arguments but I think the problems associated with a disaster even given the right plan (Krugman type plans) were so high that the Obama administration decided to take a middle of the road course. Why was there a chance of disaster if Krugman's plan was adopted though the plan was on target. Noise in the system. Wall Street would have been sitting back and saying we have always gamed the system and and made billions we can game this latest plan and make billions too. There is some chance Wall Street could have undermined a Krugman type plan and sent the economy into a state where the Great Depression looks like a happy time. Secondly the neo-cons are anti any Obama plan and not just philosophically but are going to take steps to ruin the plan even if it makes obvious economic sense. In terms of economics Krugman wins I think but in gambling terms Obama may have still made the right decision. Being able to walk away from the table with the deed to the ranch in the pocket was I think held to be more important than winning the pot.
March 31, 2009 3:25 PM | Reply | Permalink
"Secondly the neo-cons are anti any Obama plan and not just philosophically but are going to take steps to ruin the plan even if it makes obvious economic sense."
Yeah, politically Republicans will squawk because that's all they can do, but I'm not so sure they're philosophically opposed. They just talk in terms of bankruptcy on their "protecting the taxpayer" track, whereas Krugman talks in terms of "nationalization," after the Swedish terminology.
The controlled, "pre-packaged" bankruptcy the Southern Dogpatch Congress-critters were pushing for GM, and that Obama is now apparently implementing, seems more or less what Krugman wants for insolvent banks.
At the end of the day, I just don't think it's the State of Alabamy that is the hold up, here.
March 31, 2009 3:42 PM | Reply | Permalink
Krugman's fast on his way to becoming a crushing irrlevancy
His anti-Obama hostility has been painfully obvious for two years now
[Politico] http://www.politico.com/news/stories/0309/20683.html
(Bloomberg)Financial Rescue Approaches GDP as U.S. Pledges $12.8 Trillion
And Krugman wants to nationalize the banks then will turn his whining 180 degrees and blast Obama for not getting health care reform passed or failing to stimulate him sufficiently
You don't have to waste your time reading his columns. Look at the title and you'll know all that you need to
The author of the Newsweek cover story subsequently reported that the Obama administration had decided to ignore Paul Krugman
Damn I wonder why?
March 31, 2009 3:40 PM | Reply | Permalink
Politico
http://www.politico.com/news/stories/0309/20683.html
March 31, 2009 3:42 PM | Reply | Permalink
Unbelievable.
Here in this thread we have a significant number of people who are actually able to discuss economics intelligently, and are doing so.
Then along comes a refugee from the TPMDC boards, complete with his Obama-logoed userpic, doing the typical witch-hunt for perceived anti-Obama heretics, in this case the standard whipping boy of that crowd, the "irrelevant whiner" Paul Krugman.
You have obviously neither read, nor cared to try to understand, the bulk of the comments in this thread. You do not discuss them, either to agree or to disagree, at any level of substance, but come here rather to mount ad hominem attacks against those you deem "irrelevant whiners."
Whatever.
April 1, 2009 4:28 AM | Reply | Permalink
I think it helpful to look at the first question from the opposite end, the housing market. In ordinary times, a house purchase is typically a luxury for a fair portion of the working and middle classes, and a bit of stretch (or risk) for another sizeable segment (speaking to income, not real need). By the early part of this decade, the new home market was saturated at normal, historical interest rates. By artificially lowering interest rates, the Fed, i.e., finance capital, brought a lot of people into the market who simply could not afford to be there for long. Some of them were, of course, induced by sub-prime mortgages, but that was a distorting overlay, not the fundamental problem. Someone at the Boston Fed did up some numbers on this last year, which showed that sub-prime (lower credit score) borrowers were already going under before the rate increases kicked in, and many better-credit non-subprime borrowers were only 6-12 months behind. That, in itself, would have been enough to bring about an eventual financial crisis, but then everything was exaggerated by superinflation in the housing market, as well as in the cost of some of life's essentials (e.g., food, oil), and major and minor financial institutions deciding to cash in by playing the lottery with mortgages.
From that perspective, Dean Baker probably understates the problem. Where are a large chunk of mortgage holders going to come up with Hussmann's 50%? What is the correct figure? And what kind of economy is going to be the foundation for them, when individual wages have been falling or stagnant in the U.S. since the early 1970s, except for a short blip in the late 1990s? Recall that the U.S. turned itself into a second-rate domestic industrial power from the late 1970s on, being propped up since then by foreign capital, industrial and financial.
The traditional role of banks and financial institutions is to facilitate the turnover of productive capital (directly and indirectly). From that perspective, I can see why many commentors would like to see these institutions become "boring" again. However, the question remains as to why they've grown to such a large proportion of the U.S. business profits in recent decades (25+%, up from about 7% in 1980). That's another discussion. What's not clear is how Obama's program to rebuild the country's infrastructure can reverse that trend over the long haul unless American capital changes its industrial tune. Anyone forsee that, in light of international competition?
So what policy(ies) to pursue? Does it matter? Krugman would like to think so, but even he's not so sure. After all, his fallback is the Great Depression, which he admits, "..ended by massive fiscal expansion, in the form of World War II. Maybe that will happen again; but so far policy seems inadequate to the task, and the political environment raises concerns about whether we’ll be able to do much more." Shades of Karl Marx, eh?
March 31, 2009 5:11 PM | Reply | Permalink
In the last part of 2008, mortgage default rates reached historical highs of around 12% in the sub-prime market, and something like 2.6% in the prime market.
What's wrong with our financial system that it can't handle these numbers? These are not giant numbers. They represent large increases in relative terms, but in absolute terms, it's not as though 90% of the value suddenly drained out of the housing market.
So why does it feel like 90% of the value drained out of the financial sector all of a sudden?
Unregulated derivatives markets that, contrary to their advertised purpose as mechanisms for hedging risk, actually increased the overall amount of risk exposure of the entire financial sector by multiplying those risks for speculative purposes (as in CDS purchased by speculators, synthetic CDOs derived from CDSs, etc). That's why the derivatives market grew to something like 5 trillion dollars--far in excess of the housing market itself.
The blame for this mess lies squarely with the financial institutions and the derivatives traders.
March 31, 2009 5:40 PM | Reply | Permalink
Well, duh, because both borrowers and lenders are leveraged out the wazoo. If you're leveraged 30:1, it only takes a 3.5% decline in the value of the underlying asset to wipe you out completely.
A ways up the thread there was the contention that things aren't so bad because lots of these securities are producing cash flow well in excess of what's needed to sustain their current effective yields. To which there are two answers. First, if so, why aren't smart people buying the heck out of them and bidding them up to sensible prices (and don't give me something about animal spirits)? Second, that scenario doesn't count the cost of the money required by the currently-not-well-capitalized to buy the securities, making the effective yield rather lower.
April 1, 2009 12:32 PM | Reply | Permalink
What's not clear is how Obama's program to rebuild the country's infrastructure can reverse that trend over the long haul unless American capital changes its industrial tune. Anyone forsee that, in light of international competition?
So what policy(ies) to pursue?
Answer: I think the opportunity may lie with the third world where there is a genuine need for a rise in the standard of living. How to get the money there without watching it leak out to Swiss bank accounts or disintegrate in an orgy of bakshi is something I don't know the answer to yet, but that's definitely where the opportunity lies.
March 31, 2009 6:00 PM | Reply | Permalink
micro banking has been doing this for awhile. Some guy won a Nobel prize for it...
Flooding "third world" with money is not a good idea, but helping them improve quality of life can be profitable without being the kind of burdens large scale capitalism ala Chicago Boys has ended up placing on developing countries.
March 31, 2009 7:55 PM | Reply | Permalink
Sorry, for the late reply eds - just got home. Well there is a massive amount of purchasing that needs to be replaced for jobs to recover and micro-lending to the third world doesn't seem like it would be able to match that need.
You use the perjorative term, "flooding", but I intentionally did not as I am well aware of the futility of an indescriminate injection of capital for capex to those "governments." I said as much and I'm not sure if you ignored that part of my post or if you were echoing my concern.
In any case, I am totally flumoxed as to how to move that kind of capex in an international context, but at the same time I don't think you can name any better alternative source of demand at this moment in time.
Perhaps an IMF program? Whatever, I think this is the solution with the most potential for restoring world growth and trade. I'd love to see your ideas of how to do this without losing control to petty dictators and local corruption, unless you have a different method altogether.
I suppose if the government were to fund the full need at home, as Krugman and others suggest.... which would be more politically viable? I just don't know anymore.
April 1, 2009 1:53 AM | Reply | Permalink
echoing, yes.
Third world economies also divide up into internal and export. Export to richer nations is easy as long as the richer nations are a lot richer. That's what outsourcing is about, taking wages out of the rich economy and paying them more effectively in the poor economy to create exports. So a gal in Bangladesh who uses a micro loan to buy a better loom can export more and better quality cloth products to the USA etc.
The internal part I don't understand. There seems to be a kind of bootstrapping which is necessary. Maybe that comes from acquisition of real resources on which further economic growth and so-called quality of life is leveraged. People mine, hunt, fish, and grow stuff, and the income from that kind of activity is the first ground of an economy. Then people make clothing and build shelters. Some do it better or faster than others and so you have competition with the better/faster manufacturing hogging the income in the sector, thus wealth disparity. Homesteading gives land for free, but eventually people start paying for land out of a combo of their saved income and IOUs. So you have a finance sector to service the allocation of scarce resources from the initial settlers (mega-wealth or not) to those who come later.
The gal with the loom can sell some stuff locally and thus compete with other sellers, but she can probably get a better price even allowing for export costs by selling to the USA. And if her investment in the loom costs too much her prices to even break even will keep internal purchases small. So investments should be targeted for local competitive advantage AND low capital/interest burden. But doing so builds local wealth disparity. Is that okay?
Does that simplistic picture offer any value here?
April 1, 2009 4:30 PM | Reply | Permalink
It depends on what you (we) want "banks" to be. Can we have banking-only banks and leave insurance, hedge fundery, and other forms of gambling to other institutions? I think I'd like that.
We used to have laws like Glass-Steagal that kept banks out of trouble. It recognized the importance of having reliable providers of loans to businesses and home and car buyers, and of a safe place to put money. Banks were a kind of utility and had serious regulation. Nothing more boring than a utility, right?
It seems that once the fences were torn down, banking banks had a hard time resisting the temptation to gamble in high-yield (read: junk) securities. Either that of succumb to being gobbled-up by Wall Street high-fliers that wanted the banks' money to play with.
Look, I've got nothing against gambling with derivatives or with making tons of money doing so. Just don't let it jeopardize the banking banks' ability to to serve the financial needs of business businesses and ordinary people.
Like disbanding the Baathist Army, you ask? Hey, even the Second Amendment recognizes the value of a well regulated militia.
March 31, 2009 8:32 PM | Reply | Permalink
Some have been re-regulated, but the system as a whole is still rather shaky right now.
April 1, 2009 5:38 AM | Reply | Permalink
No one seems to have addressed the point that a (the?) major reason for Japan's "lost decade" was its government's refusal to force the Japanses banks to accept realistic appraisals for the value of the real estate that served as collateral on loans made by those banks. We, by refusing to allow those US financial institutions that are holding "toxic assets" to sink/be re-structured/whatever, are simply setting ourselves up to repeat here what Japan suffered through during the 1990's.
March 31, 2009 8:41 PM | Reply | Permalink
But as of right now, the banks can say: "Gosh, we got a bunch of offers, but none of them were high enough. We'll continue to hold these assets instead, believing our internal estimates of value."
April 1, 2009 5:43 AM | Reply | Permalink
The current CEOs of Bank of America, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo were CEOs in 2007 and have led their companies effectively through the crises (well, maybe Lewis didn't do so well with the Merrill Lynch acquisition, but he was pressed to not back out by the Government).
The weak CEOs of Bear Stearns, Lehman, Wachovia, and the scoundrel CEOs of Countrywide, Golden West, IndyMac, Washington Mutual, etc have all sold out or been cashiered along with their teams as the residential mortgage backed security and wholesale mortgage business collapsed.
Liddy at AIG was installed by the government after AIG was taken over. Martin Sullivan was in the scoundrel class.
The current group of remaining CEOs are about as good as you will get and have been keeping/building their teams. Nothing would be served by changing them out at this point.
There might be some more management issues at banks below the top six, but the next 14 only average less than a tenth the size of the top 6. Most are in the $300 billion to $100 billion assets range.
March 31, 2009 11:08 PM | Reply | Permalink
No doubt remains that congress desperatly needs to get some new laws on the books that regulate the financial sector. Especially when it comes to isolating the kinds of things banks can do is necessary. We need bank banks and we need investment banks and they can't be the same company. Not even the same parent company actually.
I think also that banks should be restricted from issuing credit cards. The issuance of credit needs to be completely separate busineess apart from banks. The simple fact is banks use credit cards as a cash cow to feed their greed. Businesses focused on managing credit structured for that purpose need to be lean and well managed. There is no such thing right now.
It is all but impossible to have a regulatory scheme where traditional banks, investment banks and issuers of credit cards are under one roof. It probably can't be done effectively and invites too much potential for fraud and for activities that are flat harmful to people who need their services (everyone).
I know it'll be argued that the cost is too great. That is a lot of bull. The cost is too great only because the present structure makes it that way. Each of the sub units of the major banks have profit targets that are way out of line relative to other sectors of our economy. The only reason for that is to support a compensation structure and a level of perks and such that is not acceptable. That cost is absorbed by customers and is so far removed from any notion of competition that it is laughable.
The last and most difficult thing is the larger banks need to be broken up in order to achieve the above. With banks of the size we have they hold too great a possibility of doing great harm when they screw up. Citi and B of A are in this category and should never have been allowed to grow as large as they have in the first place. Their influence, both on the economic side and the political is an unhealthy condition that needs to be rectified.
April 1, 2009 1:25 AM | Reply | Permalink
I can't really make any comment about your first question. However, I'm always amazed when people make the suggestion, as you have, that "nationalisation" (which in this case is actually receivership) can't work because there aren't enough bureaucrats to run the banks.
People who make that sort of argument must not have had any first hand experience of a receivership. When a reciever is appointed, he and his firm are just about the only "bureaucrats" involved, and they replace the owner or CEO. Everyone else employed by the firm, no matter what they have done or not done to cause the company to go into default, usually keep their jobs.
Those that are on the "shop floor" keep doing the things they've always done to produce the cashflow, and almost always stay with the company when it is sold. Those higher up are instructed to do the things necessary to prepare the company for sale. When the sale takes place, a smart buyer will remove the top escelon with their own more trusted people, but won't do much with the income producers at the coal face.
In the case of American banks, I don't see any reason why the same companies that are already well-practiced at managing receiverships aren't appointed by government to carry out the task. Private enterprise is quite capable of carrying out the task, with oversight from the same government agencies that were involved in the saving and loan crisis.
I also can't understand why Americans keep using the term "nationalization" in relation to their banks. This is a terrribly value-loaded term, particularly with the wierd "reds under the beds" psychosis developed during the McCarthy era that continues to haunt your society.
Putting insolvent companies, including banks, into receivership, couldn't be more capitalistic. True "nationalisation", on the other hand, is when a government unilaterally appropriates assets without any recompense to shareholders. The two things couldn't be more different.
Americans have let ideology get in a way of a whole lot of things in recent years. The rest of the world (who didn't cause the meltdown, but are suffering its consequences) can only hope than on this occasion, at least, you will let rationality prevail.
April 1, 2009 4:33 AM | Reply | Permalink
The ideology of efficiency?
If you have 100 small banks, and compare that to having 1 bank covering the same territory with maybe 50-100 branches, the ideology of the efficiency of size says the 1 banks will be more efficient, generate more profit with fewer employees and outlets. But this ironically reduces GDP in addition to reducing local control, aka freedom in finance. It reduces competition and options for depositors and borrowers.
SIVs, CDOs, and even MBS were largely about efficiency in addition to generating commissions. You could tailor the risk and cash flow for the investor.
Is it time for inefficiency of a sort?
April 1, 2009 10:16 PM | Reply | Permalink