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Social Security Reform: Three Frames and Three Ranges of Fixes

by Bruce Webb

This may be too wonkish for the Virtual Summit, so let me try it out here.

A lot of crosstalk on Social Security ‘crisis’ is a result of three different definitions of ‘crisis’ which I would sum up as follows:

Crisis one: Social Security promised benefits which may not be payable.
Crisis two: Social Security promised benefits which were not affordable.
Crisis three: Social Security promised benefits which should not have been promised.

Note the changes in tense and mood, changes which constrain the range of acceptable fix. Crisis one is probabalistic (‘may’), it doesn’t necessarily commit to the proposition that those benefits actually can’t be payable, and implicitly assumes that such payments are desireable. Crisis two however is deterministic, in this frame the damage has been done, and implicitly argues that the only question is what to do about it. Crisis three is moralistic, it claims that even the attempt to pay these benefits was a mistake, that the effort was flawed from the beginning.

Taking Crisis three first. From this standpoint, one associated with Rand, Friedman and the Austrians the only real question is how to transition away from Social Security as currently configured and the solutions proposed will tend to gravitate towards such things as private or personal accounts.

On the other hand Crisis two assumes that the damage has been done and its solutions will naturally tend to gravitate towards benefit cuts.

And finally Crisis one will see benefit cuts as the fallback position, given the probabilities maybe necessary but not something to be embraced, and is open to some sort of revenue enhancement.

As to ranges of fixes. A Crisis three person is not necessarily open to any kind of fix whether that fix is proposed on the cost or revenue side, that is just to perpetuate what with Friedman they believe to be an “immoral” system. On the other hand a Crisis two person will reflexively reject any tax based fix on the time honored principle of “Don’t throw good money after bad”. Only if you have a Crisis one mentality does, for example, the Northwest Plan even make sense, because Crisis three people refject the whole idea of a fix and Crisis two people regard the status quo as already broken.

Which is why supporters of traditional Social Security often just miss their marks entirely, they assume naively that their desired end of retirement security through social insurance at the promised level of benefits is simply accepted and that the only question is the method when neither half of that end is necessarily accepted by the opposition. So when people like my friend Dale make an argument in the form of “We have a moral responsibility to support the subsistence of the elderly and the cost of doing that in a way that delivers 100% of the scheduled benefit is cheap” it simply falls on deaf ears, with Crisis three people replying to the former assertion “The hell we do” and Crisis two people asserting that the current cost is already too high.

This is why I get impatient with progressives and to some extent with Dale (who doesn’t consider himself a progressive in that sense), they insensibly assume that their desired end is even shared. “Just lift the payroll tax cap and the problem is fixed!” is not compelling to people who don’t want to fix it that problem in that frame. Their frames will lead them to a totally different range of fixes. Hence the crosstalk.

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Please drop by the Virtual Summit on Social Security

by Bruce Webb

I mention from time to time that I talk with a number of D.C. policy types about Social Security, but mostly don’t use names because the conversations are officially off the record. Well a group of them, spearheaded by Roger Hickey’s folks at Campaign for America’s Future, have gone on the record in a big way and moreover want you to join in and comment on their new blog The Virtual Summit for Fiscal and Economic Responsibility

The blog launched yesterday with a piece by Dean Baker, who as those of you who follow this topic has been a key defender of Social Security for years, being notably ahead of the curve when he and colleague Mark Weisbrot published Social Security: the Phony Crisis in 1999, and another by Congressman John Conyers, plus contributions by Bill Scher and Dave Johnson of CAF (Dave also being a veteran of the ‘There is No Crisis’ movement of 2005) and Barbara Burt of the Frances Perkins Center (Perkins being FDR’s Labor Secretary and so the foster mother of Social Security).

I have been asked to contribute and will from time to time. So for those who have been asking when supporters of Social Security were going to get organized and push back on the Peter G Peterson contingent in a public way, well the answer was ‘yesterday April 20th, 2010’. Be there.

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Marshall Auerback: "Troubles in the EuroZone: Will the Contagion affect the U.S.?"

Roosevelt Institute Senior Fellow Marshall Auerback and Braintruster at the New Deal 2.0 explores the possibility, and what it means if deficit hysteria continues unchecked:

A recent poll by Douglas Schoen and Patrick Caddell suggests that swing voters in the US, who are key to the fate of the Democratic Party, care most about three things: reigniting the economy, reducing the deficit and creating jobs.

But the latter two goals are generally incompatible, especially during major recessions.

In times of high unemployment, government deficits are required to underwrite growth, given that the private sector shift to non-government surpluses has left a huge spending gap and firms responded to the failing sales by cutting back production. Employment falls and unemployment rises. Then investment growth declines because the pessimism spreads. Before too long you have a recession. Without any discretionary change in fiscal policy (now referred to in the public media as “stimulus packages”) the government balance will head towards and typically into deficit, unless the US miraculously becomes an export powerhouse along emerging Asia lines, and runs persistent current account surpluses, to a degree which allows the governments to run budget surpluses.

This is not going to happen, particularly when the largest current account surplus nations, notably Germany, cling to a mercantilist export led growth model, an inevitable consequence of that country’s aversion to increased government deficit spending. The German government’s reticence to counter any kind of shift in regard to its current account surplus is particularly significant in light of the ongoing and intensifying strains developing in the EMU nations (see here) . Last week’s Greek “rescue” is Europe’s “Bear Stearns event”. The Lehman moment has yet to come. One possible outcome of this could well be significantly larger budget deficits in the US and a substantial increase in America’s external deficit, given the unlikelihood of America becoming an export super power again. Let me elaborate below.

In the euro zone, I now see one of two possible outcomes. Scenario 1: the problem of Greece is not contained, and the contagion effect extends to the other “PIIGS” countries, leading to a cascade of defaults and corresponding devaluations as countries exit the EMU. Interestingly enough, the country which could well be affected most adversely in this situation is France, as the country’s industrial base competes largely against countries like Italy and the corresponding competitive devaluation of the Italian currency in the event of a euro zone break-up could well destroy the French economy (by contrast, as a capital goods exporter with few euro zone competitors, Germany’s industrial base will be less adversely affected in our view).

In Scenario 2 (more likely in my opinion) we get some greater fears about other PIIGS nations (discussion is now turning to Spain, Portugal and Ireland). The EMU might well hold together but the corresponding fear of contagion might well provoke capital flight and drive the euro down to parity (or lower) with the dollar. Of course, the euro’s weakness creates other problems: when the euro was strengthening last year due to portfolio shifts out of the dollar, many of those buyers of euro bought euro denominated national government paper (including Greece). The resultant portfolio shifts helped fund the national EMU governments at lower rates during that period. That portfolio shifting has largely come to an end, making national government funding within the euro zone more problematic, as the Greek situation now illustrates.

The weakening euro and rising oil prices raises the risk of ‘inflation’ flooding in through the import and export channels. With a weak economy and national government credit worthiness particularly sensitive to rising interest rates, the European Central Bank (ECB) may find itself in a bind, as it will tend to favor rate hikes as prices firm, yet recognize rate hikes could cause a financial collapse. And should a government like Greece be allowed to default, the next realization could be that Greek depositors will take losses, and, therefore, the entire euro deposit insurance lose credibility, causing depositors to take their funds elsewhere.

It all could get very ugly for the ECB. The only scenario that theoretically helps the value of the euro is a national government default, which does eliminate the euro denominated financial assets of that nation, but of course can trigger a euro wide deflationary debt collapse. The ’support’ scenarios all weaken the euro as they support the expansion of euro denominated financial assets, to the point of triggering the inflationary ‘race to the bottom’ of accelerating debt expansion.

So timing is very problematic. A rapid decline of the euro would facilitate a competitive advantage in the euro zone’s external sector, but it could also set alarm bells off at the ECB if such a rapid devaluation creates perceived incipient inflationary strains within the euro zone.

What about the US? In the latter scenario, we can envisage a situation in which the combination of panic and corresponding flight to safety to the dollar and US Treasuries, concomitant with the increased accumulation of US financial assets (which arises as the inevitable accounting correlative of increased Euro zone exports) means that America’s external deficits inexorably increase. There will almost certainly be increased protectionist strains, a possible backlash against both Europe and Asia, especially if the deficit hawks begin sounding the alarm on the inexorable rise of the US government deficit (which will almost certainly rise in the scenario we have sketched out).

Assuming that the US does not wish to sustain further job losses, the budget deficit will inevitably deteriorate further, either “virtuously” (via proactive government spending which promotes a full employment policy), or in a bad way , whereby a contracting economy and rising unemployment, produce larger deficits via the automatic stabilisers moving to shore up demand as the economy falters.

How big can these deficits go? Easily to around 10-12% of GDP or higher (versus the current 8% of GDP) should a euro devaluation be of a sufficient magnitude to induce a sharp deterioration of America’s trade deficit. Possibly even higher.

What will be the response of the Obama Administration? America can sustain economic growth with a private domestic surplus and government surplus if the external surplus is large enough. So a growth strategy can still be consistent with a public surplus. But this becomes virtually impossible if the euro zone’s problems continue, as we suspect that they will.

President Obama, however, has long decried our “out of control” government spending. He clearly gets this nonsense from the manic deficit terrorists who do not understand these accounting relationships that we’ve sketched out. As a result he continues to advocate that the government leads the charge by introducing austerity packages – just when the state of private demand is still stagnant or fragile. By perpetuating these myths, then, the President himself becomes part of the problem. He should be using his position of influence, and his considerable powers of oratory, to change public perceptions and explain why these deficits are not only necessary, but highly desirable in terms of sustaining a full employment economy.

Governments that issue debt in their own currency and do not promise to convert their currency into anything else can always “afford” to run deficits. Indeed, in this context government spending financially helps the private sector by injecting cash flows, providing liquid assets and raising the net worth of some or all private economic agents. In contrast to today’s budget deficit “Chicken Littles”, we maintain that speaking of government budget deficits as far as the eye can see is ludicrous for the simple reason that as the economy recovers, tax revenue rises, the deficit automatically reduces. That’s the whole reason for engaging in deficit spending in the first place. Any projections that show the deficit continuing to climb without limit is misguided — the Pete Peterson projections, for example, will never come to pass. As we near and exceed full employment, inflation will pick-up, which reduces transfer payments and increases tax revenues, automatically pushing the budget toward surpluses.

In the 220 year experience of the United States there have only been a few years when we’ve not had deficits and each time the surpluses were immediately followed by a depression or a recession. History shows that we can run nearly permanent deficits and that when we do, it’s better for the economy. The challenge for our side of the debate is to expose these voluntary constraints for what they are and explain why the US is not a Weimar Germany waiting to happen.

This article was originally published at the New Deal 2.0 and reproduced with author’s permission.

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Current trends in paying for healthcare insurance

Crooks and Liars has us look at employers shifting the cost of health insurance to workers. In MA this shift will happen with public employees such as teachers probably soon as well.

Health care costs soar for insured workers presents another chart to gain a perspective when someone says health insurance premiums will rise with government intervention…ask more complex questions by remembering health care premiums are rising very rapidly anyway, and individuals will be bearing more of the costs of those premiums.

http://facts.kff.org/chart.aspx?ch=706

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What to do about CDO ratings?

One of the many causes of the financial crisis was excessive reliance on excessively generous ratings of novel financial instruments. There are proposals to change the incentives faced by the bond rating agencies to prevent them from being so lax. I don’t think that any such reform is likely to be successful. I think it would be better to rely on something other than the ratings. I explain my thoughts after the jump.

There is no doubt that part of the reason for the unreliable over generous ratings was conflict of interests. The bond ratings agencies also consulted earning fees for helping to design the instruments they went on to rate. This is unacceptable and should be banned. Beyond that, many instruments were rated by only one of the big three – Moody’s , Fitch and S&P . This gave each an incentive to be generous in order to attract business. Maybe, it is possible to eliminate this incentive by requiring clients of any of the three to pay for ratings from all three. Since this is good for Moody’s, Fitch and S&P it wouldn’t be an unconstitutional bill of attainder (such a provision would be challenged and the Supreme Court would make the final decision).

As I argued here, the agencies’ incentives would still be unacceptably distorted. They have to power to decide if whole sectors of finance exist or not. If they had procedures such that no CDO tranche were ever rated AAA, then the volume of CDOs would have been a small fraction of what it was. Even without competing for business, the agencies have an incentive to help new types of structured finance grow, since more assets means more assets to rate and more income.

I think it is clear that procedures such that no tranche of any CDO got AAA were and are appropriate given the definition of AAA (almost certain full payment on time) and uncertainties concerning CDOs. Basically if an agency doesn’t fully understand the properties of a new instrument (which can only be determined with, you know, data on the instrument) and is 99% sure it should be rated AAA, then the agency shouldn’t rate it AAA. 99% is much too low a number to be associated in any way with AAA.

With my total lack of authority and expertise, I declare that no instrument should be rated AAA unless an instrument which was identical (except for maturity dates) paid in full and on time through the last two recessions. That means no AAA structured financial instruments. I think it is also clear that ratings agencies will never adopt the procedures which I think are reasonable, since that would kill the goose that gives them golden eggs.

The problem is simple. The ratings agencies were providing an immensely valuable service for very modest fees. When I first learned of their existence I was amazed that their power hadn’t corrupted them. We were very very lucky to have reliable rating’s agencies. In particular, when the ratings were explicitly given legal force by, among other things, Basel I, impossible strain was put on the rating agencies. Then the rating mattered even if sophisticated investors didn’t trust it, since it mattered because of a simple formula in a regulation.

Obviously you can’t expect a modestly paid institution with such power to resist temptation. The ratings agencies were like, say, bureaucrats in the Russian ministry of privatization. We should consider it normal that we don’t trust them and not hope to get reliable ratings for almost nothing. We were very lucky to have reliable ratings for decades, but our luck has run out.

So I think that we can’t rely on ratings. This means that capital adequacy standards and prudential regulations must be based on something else. I propose that we put our trust in the Vampire Squid et al – in the broker-dealers which did much more than any ratings agency to destroy the world economy. This is not a joke.
First assume that the CDS market is transparent with full disclosure and mandatory trading on exchanges. We learn a lot if an investment bank is willing to write CDS charging say 10 basis points per year vs the investment bank is only willing to write the CDS if it can get 100 basis points per year. The CDS writer has skin in the game. The price of a CDS will be wrong, markets aren’t efficient, but it won’t be as systematically biased in favor of new products as the ratings.
I think that the prices of CDSs are better indicators than ratings provided that counter party risk is modest. That is an investment grade asset must be an asset whose CDS written by a bank with adequate capital costs less than x basis points per year. Hmm I suppose that this creates interesting opportunities for market manipulation. Well something like that.

The point is that we can’t rely on the ratings agencies which have no skin in the game and which put only their reputations at risk. Their reputations are shot. They have nothing left to lose. They must be replaced by agents with skin in the game in prudential regulations.

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The 1920s Depression: Glenn Beck, Thomas Woods, and "Benefits" of Cutting Taxes to Combat a Recession, Part 2

by cactus

Last week I wrote a post about some nonsense Glen Beck was peddling, with said nonsense originating with Thomas Woods.  Woods claimed a smorgasbord of things, the dollar meal version being:

1.  lefties talk up how the New Deal (big gubmint, tax hikes) saved the economy from the Great Depression but it didn’t

2.  there is a conspiracy of silence about the recovery from the 1920s Depression because it shows that if the government does nothing (with the possible exception of cutting taxes), the economy will roar, as it did throughout the 1920s

Last week I put up a graph showing the marginal tax rates and the recessions from 1920 to 1940.  The graph of the data doesn’t quite mesh with the words that Woods chooses to use.  What we see is that while Republican administrations were happily cutting marginal tax rates in the 1920s, the economy kept going into recession after recession culminating with Great Depression.  In fact, between the end of the 1920s Depression and the start of the Great Depression (not including either one), the economy was in recession 30% of the time.  Conversely, once the New Deal started and the Big One ended in ’33, there was only a single recession before WW2 started.

Today we’re gonna do something different.  We’re going to look at economic growth and see how well that meshes with Woods’ storyline.  Now, the problem is… where do we find data?  After all, the Naitonal Income and Product Accounts tables were not being calculated back in the ’20s.  But…  Woods quotes a number or two on GNP, which he gets from Smiley on GNP.  Smiley, in turn, pulls his GNP data from the Historical Statistics of the United States.  I’m always leery of using pre-1929 national accounts data from the HSUS since its made up of interpolations, but I guess its as good a source for that data as one is likely to find.  Either way, they’re clearly good enough for Woods, so I cannot imagine he would object to us poking around.

Anyway, I had to enter the data by hand, and I’m using a mini-mini laptop right now, so hopefully I didn’t screw up anything, but here’s what real GNP per capita in 1958 dollars (I’m not changing the HSUS data at all…. I want to make sure Woods would approve) looks like:

Figure 1 - Woods & Beck Part 2

Sorry about the step figure look, but I wanted to get the recessions (the gray bars) as accurate as possible… and while that data is monthly, real GNP per capita from the HSUS is yearly.  Now, Woods’ focus is on the recoveries…  but the the graph doesn’t exactly scream at you that the Mucho Tax Cuts and Deregulation Roaring ’20s massacred the Drab Socialist New Deal period.  As a result, he adds a lot of verbage which I do encourage you to read.  I prefer to take a different approach, though.   I created the graph below, which I think is pretty self-explanatory.

Figure 2 - Woods & Beck Part 2

So there it is.  All of Woods’ verbiage boils down to this…  relative to the New Deal policy he excoriates, his example of success is a time of slower growth, more time spent in recession, and it all culminates in what may be the worst economic situation this country has ever faced. 

Now, you may be thinking…  Woods doesn’t realize that the policy he is promoting produced worse results than the one he is attacking.  But I disagree.  I believe he knows what the data shows.  I provided a few examples last week where Woods seemed to me, at least, to be very misleading.  One technique for doing that which I pointed out last week was to cite someone else when passing off incorrect data, but not to point out that the data was wrong.  That allows Woods not to outright lie, but it does lead readers to believe something which is not true.  Here’s another example…   Woods states:

Instead of “fiscal stimulus,” Harding cut the government’s budget nearly in half between 1920 and 1922. The rest of Harding’s approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third. The Federal Reserve’s activity, moreover, was hardly noticeable. As one economic historian puts it, “Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction.”

Now, Woods is very carefully not stating himself that the Fed did nothing. He himself states that the Fed’s actions were hardly noticeable.  That may be…  I have no way to measure that with the poor data that is available to us now.  But Woods goes farther.  He tells us that an economic historian has stated that “the Fed did not move to use its powers to turn the money supply around and fight the contraction.”  Which is stronger than hardly noticeable.  Does Woods agree with this statement?  Well, he doesn’t quite say so.  But what he never writes is this – “well, this dude says the Fed did nothing, but he is wrong.”  And by not doing that, by telling us what some historian said but not indicating we should not believe that historian, Woods is, in effect, endorsing that economic historian’s statement.  And by now, after two posts, you should realize that I’m only bringing this up because the Fed actually did something. 

As we can see on page 440 of this document from the FRASER collection at the Federal Reserve of St Louis, back in that era, there could be different rates at different Federal Reserve Banks.  And just about all the big ones had rate cuts in 1921 before the end of the recession.  Take the New York branch, the most important one.  The rate was 7% at the start of the year, was cut to 6.5% in May, cut again to 6% in June, and cut again to 5.5% in July, the month the recession ended.  One can argue that the Fed moved a little late – which would make “hardly noticeable” potentially true, but it certainly makes “the Fed did not move” BS.  This is just one of several examples where, in my opinion, Woods is careful not to lie by commission.  But readers will read it and conclude something that is untrue. 

So there it is.  After two posts, I conclude:

1,  the Roaring 20s prior to the start of the Great Depression were a period of deregulation, many tax cuts, and many recessions with very short lived recoveries.  The culmination of the Roaring 20s was a great economic disaster, perhaps the worst in American history.   None of this applies to the New Deal Era prior to the start of World War 2. 

2.  Over the length of the Roaring 20s “recovery” and the New Deal recovery, growth was quite a bit faster during the New Deal years. 

3.  Woods writes carefully and precisely enough that it is hard to conclude that he does not realize 1 and 2.

4.  Knowing what Woods appears to know, and knowing that economic policy has tremendous consequences on people’s lives, Woods is nevertheless willing to promote policies that did much more poorly than he implies and to attack policies that did much better than those he promotes

5.  Glen Beck is either in on the con or he’s being had.

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What went wrong ?

Robert Waldmann

Kevin Drum tries to list all proposed explanations for the financial crisis. I see if I can add others after the jump.

The Drum roll

1. Housing bubble (i.e., the pure mania aspect of the thing).
2. Massive increase in leverage throughout the financial system.
3. Global savings glut/persistent current account deficits.
4. Shadow banking system as main wholesale funder for banking system/Run on the repo market.
5. Fed kept interest rates low for too long.
6. De facto repeal of Glass-Steagall in 90s (and de jure repeal in 1999) allowed banks to get too big.
7. Commoditization of old-school banking drove increasing reliance on complex OTC securities as the only way to earn fat fees
8. Mortgage broker fraud.
9. Explosive growth of credit derivatives magnified and hid risk.
10. Overreliance on risk models (VaR, CAPM) that understate tail risk.
11. Wall Street compensation models that reward destructive short-term risk taking.
12. Originate and distribute model for mortgage loans.
13. Three decades of deregulation/political economy of lobbyists.
14. Endemic mispricing of risk throughout market.
15. Ratings agency conflict of interest.
16. Investment bank change from partnerships to public companies.
17. Government policies that recklessly encouraged homeownership.

That’s quite a list. Some of my proposed additions might be on the list. It is especially likely that they are the interaction of two terms on the list. My additions.

18. Banks that are too big to fail know that they are too big to fail and count expected bailout flows as part of their value. They chose to risk bankruptcy.

19. If all fail, no one suffers. Bankers know that we can’t do without all of them, so if they all make the same mistake few can be punished.

20. The Gaussian copula. This is under 10, but it includes two particular errors. First the Gaussian part – it was assumed that if small fluctuations in two random variables have low correlation then large fluctuations have low correlation. This follows from the assumption that all random variables are jointly normal which assumption doesn’t follow from anything. It also used the assumption that financial markets are perfectly efficient when looking for ways to make profits off of financial market inefficiency which brings us to

21. Schizzo-finance. Active traders must believe that markets aren’t efficient. However, they assumed market efficiency when measuring risk. Turning the efficient markets hypothesis on and off makes it possible to think that you can make excess returns without much risk.

22. Regulatory arbitrage. Firms were willing to pay for high ratings even if they didn’t believe the ratings. Explicit references to ratings in prudential regulations and Basel I capital requirements make it possible for an entity which wants to evade those regulations to pay for ratings which it knows are invalid.

23. Firms which think they are profiting from regulatory arbitrage can believe in the efficient markets hypothesis except for those silly regulations and convince themselves that they are making huge returns with low risk. A story for how money can be made promotes recklessness and fraud.

24. Accountants effectively assume that financial corporations have risky assets and safe liabilities. Unusual liabilities like CDSs written appear on accounts at market value. Balance sheets look very different depending on whether firm A issues a bond and B writes a CDS on that bond or vice versa.

25. The financial system is Wobegone – that average participant thinks he’s above average. This means that people are eager to gamble against each other. Supply rises to meet demand and financial products which made it possible to gamble were invented. When people don’t know who won and who lost, people don’t know who is solvent.

26. Shopping for regulators. When Glass Steagal was repealed sectors were merged but the regulators weren’t merged. This means that firms could shop for the regulator they wanted. Regulatory agencies were financed with the fees of regulated firms. So they competed in laxness. The obscure office of thrift supervision sure isn’t obscure any more.

27. Most people had no clue what was happening. Top bosses are computer semi-literate and scared by computers and quants. The quants could trick them into allowing the quants to play heads I win tails I go back to being a physicist.

28. Some people understood what was happening. If an assumption is made, and is known to have been made, they can profit by making it invalid. So when ratings agencies decided to assume that the data on the mortgage tapes stayed about the same, mortgage initiators profited by making it get worse. When investors assume that ratings are a good indicator of risk, Paulson and Magnetar could make money by selecting the worst instruments with a given rating. Etc. If risk assessment isn’t rule based, it’s harder to trick the risk assessor.

29. Money market funds were like bank deposits except for the bit about the FDIC. There were old fashioned bank runs when it turned out that the FDIC exists for a reason. The bottom line was that the FDIC insured money market funds providing
insurance without having collected premiums.

30. 31 32 … in comments.

update 30. I understand that the same securities could be used as collateral for two different deals. I don’t see how this can be legal given the (not so) plain English meaning of “collateral.”

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CM + IT = Disaster

A note of comparison might come in handy when thinking in big numbers.

The top 25 hedge fund managers made a record $25.3 billion dollars in 2009. And despite all those dramatic congressional hearings, average compensation of Wall Street bankers rose by 27 percent in 2009. Meanwhile, banks are hiding their debt with the same old balance sheet magic they’ve been deploying for years and posting record new trading revenues—

On the other side of humanity, more sobering numbers include a record 2.8 million properties in foreclosure for 2009, a 21 percent increase over 2008’s astonishingly high figure, with another 4.5 million foreclosures projected for 2010.

Banks are incentivized not to lend. When the Emergency Economic Stabilization Act (which included TARP) was passed in October 2008, it included some fine print allowing the Fed to pay banks interest on reserves (money, or capital, banks are obligated to park with the Fed to back their businesses), and on extra reserves (money they aren’t obligated to park). In September 2008, the top banks were required to keep $43 billion dollars in reserve at the Fed, and placed $59 billion in extra reserves. Today, banks are required to keep $63 billion in reserves, but parked an extra $1.2 trillion at the Fed.
(bolding mine)

Lifted from an e-mail, our Ken Houghton opines:

What that $1.1T isn’t doing is being invested internally in new equipment or processes.

Take that pile of cash, and then look at the cash on hand (excess reserves) at the banks. Ignoring my natural tendency to rant about the idiocy of paying interest on reserves–LET ALONE EXCESS RESERVES–that’s breaking the accounting identity (S=I) and the money multiplier.

As a ballpark, you should see that in GDP trending annually about $200-300B below the previous trend. ($1T in reserves => ca. $5T in relatively safe lending; ballpark a 5% return = $250B.)

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