Relevant and even prescient commentary on news, politics and the economy.

How Not to Build a Bailout Proposal

Let’s see. There are a bunch of people ready to riot on the streets—or at least do the White Person version of rioting and vote Republican, mainly because of the lies of several House Republicans.

And there are a precious few people who believe action needs to be taken and—while they might prefer, say, The Swedish Model as both more efficient and more likely to succeed—are willing to give Paulson/Bernanke a chance to be immortalized, even knowing that the odds are rather higher than Brad DeLong hopes that the immortality will be of the James Buchanan/Herbert Hoover variety more than General George Marshall. (Daniel Davies Three Laws have not been repealed, but the wolf really is at the door.)

So what do we see from the Democrats who, one way or the other, are going to be credited blamed with anything that passes? Besides arch-idiocy from the “progressives”, there was the rumor that they might actually produce a bill that Democrats can vote for?

You know how this story ends.

Kathryn notes that the Senate bill is even more of a giveaway than the House version was.

[N]ews reports suggest that the plan to be voted on by the Senate involves tax cuts. Tax cuts have no place in a bailout plan of this magnitude. Instead, the repealing of Bush’s tax breaks to the wealthy and large corporation should possibly be part of such a plan. Somehow this has to get paid for.

She means reports such as this one:

“I’m optimistic that we’re going to have a significant bipartisan victory on the rescue plan here in the Senate tonight,” said Senator Mitch McConnell of Kentucky, the Republican leader, who Tuesday reached an agreement with Senator Harry Reid of Nevada, the majority leader, to add $100 billion in tax breaks….

“This bill has been packaged with a lot of very popular things to give it even more momentum,” said Senator Jeff Sessions, Repubican of Alabama, an opponent of the measure that is expected to easily clear the 60-vote threshold in the Senate, providing some momentum for the House vote now set for Friday.

But the new items also increase the burden on future taxpayers. The $100 billion in tax breaks, which offer incentives for the use of renewable energy and relieve 24 million households from an estimated $65 billion alternative-minimum tax scheduled to take effect this year, will not be offset by spending cuts or tax increases elsewhere.

and while Kathryn was optimistic about one part of the bill:

I do support some of the smaller scale proposals, such as raising the FDIC insurance level to 250,000.

The Devil in the details makes even this a c.f. of major proportion:

Moreover, the increase in federal deposit insurance will not be financed, as the insurance program now is, by assessing a higher fee on the banks that benefit. Instead, banks will get an open-ended line of credit directly to the Treasury Department — meaning, taxpayers.

and when a chance of sanity appears, the power of the Republican Party is, as usual, never to be underestimated:

House officials spent much of Tuesday considering their own changes, including an extension of unemployment pay and a $1,000 tax credit for less affluent homeowners.

But those plans are not likely to advance, given the Senate decision. While the Senate left the door open slightly to other additions to the bill, such revisions would need the agreement of the full Senate, and the House proposals were likely to be blocked by Senate Republicans.

Right. Because the unemployed and “less affluent” homeowners would actually spend that money and stimulate the economy, and, in turn, the financial services industry.

As it currently stands, the “bailout” makes no sense, especially given the other actions that largely made it unnecessary. (The Financial Services industry will be running no better, but at least they get to gull some investors for a while longer. And those that fail in such an environment have enough cash flow problems that propping them up is a waste of resources.)

Call your Senators; tell them to vote “No.”

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Afghanistan and news


The top U.S. military commander in Afghanistan said Wednesday that he needs more troops and other aid “as quickly as possible” in a counterinsurgency battle that could get worse before it gets better.
Gen. David McKiernan said it will take more than adding troops to stabilize Afghanistan — including efforts to strengthen the Afghan government, improve the economy and build its military and police forces…

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Mark to Market Accounting

Robert Waldmann

is about to share his ignorance on banking, banking regulation, accounting, And accounting standards all in one post.

You know the end is near when ordinary people get interested in accounting standards.

A wide variety of politicians have decided that the problem with the US financial system is Mark to Market Accounting. It is tempting to argue that this is equivalent to arguing that closing our eyes will make the problem go away. However, there is one way in which accounting standards can create a crisis. It is through the interaction of accounting standards and capital requirements. Capital requirements are a way in which the numbers written on a balance sheet have real effects even if everyone knows they are made up.

So one could argue that the problem might be mark to market accounting if one were ready to argue that the problem is due to capital requirements. I’d say that is crazy. For one thing US investment banks didn’t long survive the relaxation of capital standards for US investment banks (held out about 4 years IIRC). For another its crazy.

However, there is a particular way in which mark to market times capital requirements can create a crisis. Paul Krugman called it a systemic margin call.
When the value of assets held by banks falls, the difference assets minus debt declines. Capital requirements imply that banks must reduce their total debt by selling assets and paying it off. Thus when the price of assets owned by banks declines banks sell those assets. This creates a downward sloping supply curve for the assets which can make multiple equilibria possible with one in which the capital controls are binding and prices are low and one in which they are not binding and the asset prices are high. The first equilibrium is Pareto inferior to the second and we seem to be in it.

So what is to be done ? I don’t think that eliminating capital controls or making them depend on made up prices is a solution. They were introduced because the same thing can happen at assets minus debt equals zero and then bankruptcy. A purpose of capital controls is to allow regulators to seize banks when the cost of liquidating them is still small. Notably investment banks have capital requirements on the REPO accounts of their clients (typically 2% I think but the investment bank knows what’s happening even before the client does). You’d have to be an idiot not to.

I think the problem is that banks decided to go close to the limit ignoring the risk in new instruments. Basically, I see a problem with allowing a bank to get as close to a line that it must not cross or it might be seized and liquidated while the CEO is in an airplane (al la WaMu even though that was triggered by liquidity requirements not capital requirements).

So I think there should be multiple levels of punishment for bad capital ratios. At a ratio of notionally 8% the bank can be seized. But if the ratio falls below 10% during a year no dividends or bonuses can be paid that year. This is painful enough that banks will try to stay well above 10% but they won’t go into a liquidation vicious cycle if they hit 10%.

The idea of no bonuses is that the dollar value of all payment for services under contingent contracts must be equal to the lowest possible value which means for example, if people are paid in shares or options they get $0 worth of shares or options.

The idea is a punishment so bad that bankers will act so as to make the subjective probability negligible (which we now know corresponds to an objective probability way higher than we should accept) but not so horrible that they will drive the bank bankrupt if they touch the line.

Maybe no bonuses is enough that the bankers will just blow up the bank in rage. If this is a concern a 70% tax on bonuses would probably work fine.

update: Hilzoy has an excellent discussion of the issues and (minds think a like) concludes that, if there is to be reform, there should be reform of capital requirements not accounting standards. She is a bit casual about relaxing capital requirements given what happened the last time that was done (2004 for institutions called “investment banks” which now don’t exist).

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Well Functioning Markets now, but not the last few years

by cactus

Well Functioning Markets

“My first instinct was to let the market work, until I realized … how significant this problem became.”
GW Bush

A year ago, many investment banks were having their most profitable year ever and the geniuses on Wall Street were making enormous bonuses. The profits were being generated by effectively buying, packaging, repackaging, and selling excrement. Now that just about everyone realizes the excrement is, in fact, what it looks and smells like despite the smooth talk from the geniuses on Wall Street, its value has dropped to zero.

Put another way – the market wasn’t working for the past few years when excrement was selling for a lot of money. It is working now that excrement is selling for a price commensurate with it being excrement. True to form, when the market was not working, GW looked the other way. Now that, at long last, we have well functioning markets, GW is demanding we act now! now! now! to kill it, and true to form, he’s managed to convince a bunch of crongresscritters to go along.

I can’t stand it.
by cactus

(This is a great way to re-frame the notion of what markets were doing the last few years to the present…it is rather upside down from the advertised notions of markets…rdan)

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Who is buying/selling stocks?

by Noni Mausa

Each Seller has a Buyer — So Who Are The Sellers, Who the Buyers?

Stocks are changing hands like monopoly money, so far as I can see. The values may rise or fall, but the numbers of stocks stay the same more or less, right?

So, do we know who the sellers are, and who the buyers?

The cash may be viewed as a fluid, within which the stocks are moving like flakes in a snowstorm paperweight. So are the stocks redistributing randomly (sounds unlikely to me) or in some pattern?

Noni Mausa

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$630 billion pumped into economy before the $700 billion fail out

Sept. 29 (Bloomberg) — The Federal Reserve will pump an additional $630 billion into the global financial system, flooding banks with cash to alleviate the worst banking crisis since the Great Depression.

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed’s emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The Fed’s expansion of liquidity, the biggest since credit markets seized up last year, came hours before the U.S. House of Representatives rejected a $700 billion bailout for the financial industry. The crisis is reverberating through the global economy, causing stocks to plunge and forcing European governments to rescue four banks over the past two days alone.

“Today’s blast of term liquidity will settle the funding markets down, and allow trust to slowly be restored between borrowers and lenders,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. On the other hand, “the Fed’s balance sheet is about to explode.”

The MSCI World Index of stocks in 23 developed markets sank 6 percent, the most since its creation in 1970. Credit markets deteriorated further as authorities tried to save more financial institutions from collapse.

European Rescue

European governments have rescued four banks in two days and the Federal Deposit Insurance Corp. said today it helped Citigroup Inc. buy the banking operations of Wachovia Corp. after its shares collapsed. The Standard & Poor’s 500 Index fell 3.8 percent and the cost of borrowing dollars for three months rose to the highest since January. The rate for euros hit a record.

“If people think the authorities may give in to fears, they are wrong,” Financial Stability Forum Chairman Mario Draghi said today in Amsterdam, where the international group of regulators and finance officials is meeting. “There is willingness and determination on winning the battle to restore confidence and stability.”

Banks and brokers have slowed lending as they struggle to restore their capital after $586 billion in credit losses and writedowns since the mortgage crisis began a year ago. The bankruptcy of Lehman Brothers Holdings Inc. also sparked fears among banks they wouldn’t be repaid by counterparties, driving up the cost of short-term loans between banks.

Funding Risk

“By committing to provide a very large quantity of term funding, the Federal Reserve actions should reassure financial market participants that financing will be available against good collateral, lessening concerns about funding and rollover risk,” the central bank said.

The Bank of England and the ECB will each double the size of their dollar swap facilities with the Fed to as much as $80 billion and $240 billion, respectively. The Swiss National Bank and the Bank of Japan will also double their dollar swap lines, while the central banks in Australia, Norway, Sweden, Denmark and Canada tripled theirs.

All the banks extended their facilities until the end of April 2009.

The Fed is also increasing the size of its three 84-day TAF sales to $75 billion apiece, from $25 billion. That means the Fed will make a total of $225 billion available in 84-day loans. The central bank will keep the sales of 28-day credit at $75 billion.

Special Sales

In addition, the Fed will hold two special TAF sales in November totaling $150 billion so banks can have funding available for one or two weeks over year-end. The exact timing and terms will be determined later, the Fed said. The TAF program began in December, totaling $40 billion.

The bank-rescue plan being debated by Congress today would give the Fed more power over short-term interest rates by providing authority as of Oct. 1 to pay interest on reserves held at the central bank by financial institutions. That would make it easier for the Fed to pump funds into the banking system.

Paying interest on reserves puts a “floor” under the traded overnight rate, which would allow a central bank “to provide liquidity during times of stress” without affecting the rate, New York Fed economists said in a paper last month.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.netCraig Torres in Washington at

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